Turkey launched an exchange rate based stabilization program in late 1999 to help contain inflation and resolve its sovereign debt issues. While the International Monetary Fund (IMF) praised the program, financial markets quickly took advantage of the country's vulnerability and its economy collapsed into a steep recession just one year later.
The Turkish Economic Crisis is important for international investors, because it highlights some important lessons in how countries should manage their finances. Investors can take advantage of this information to identify potential opportunities in the equities, bonds or currencies of those countries undergoing similar programs.
What was the Turkish Economic Crisis?
The Turkish Economic Crisis of 2000 began in December of 1999 when the country pegged the value of the Turkish Lira to a dollar-euro basket. Unlike many earlier programs, the country pre-announced a timeline towards re-floating/unpegging the currency. The move was seen as a key strength of the program, but also represented a gamble on the pace of disinflation.
Despite some early success, problems began to surface during the fall of 2000, when the consumer price index (CPI) failed to fall as economists projected. The IMF provided a relatively large bailout to keep the program on course, but massive attacks on the lira and capital flight made it clear that the program was ultimately not viable.
As a result, Turkey abandoned its currency peg in February of 2001, plunging the Turkish economy into a deep recession. While another smaller bailout package from the IMF helped stabilize the economy towards the end of 2001, the economy remained depressed throughout much of 2002 before finally regaining investor confidence.
Lessons from the Turkish Economic Crisis
Many exchange rate based stabilization programs try to use currency exchange rates to set inflation expectations. Ideally, these expectations result in currency appreciation, which attracts capital inflows via arbitrage opportunities. The capital inflows are then used to finance growing external deficits and ultimately help the economy recover.
While these strategies seem straightforward, they failed miserably in Turkey's case and left the country in a deep economic recession. The country's banks failed to adapt to lower interest rates, public finances made capital inflows necessary, and the preannounced targets of the program provided bearish traders with the ammunition they needed early in the game.
These problems ultimately led to the country's deep recession:
- Watch the Banks - Turkey's banking sector was already in a weakened state when the exchange rate program was announced. As a result, they were ill equipped to weather the resulting currency and interest rate fluctuations and failed to stem the crisis.
- Public Finances First - Turkey's public finances were already in disarray when the exchange rate plan was announced, which meant that the program's success was more of a necessity than a luxury - a fact that currency markets exploited.
- Preannouncements Backfire - Preannouncing the programs goals was considered a major breakthrough in Turkey's exchange rate program, but failure to meet those public goals led to strong bearish sentiment in the financial markets.
Investing in Similar Situations
International investors face similar situations during any economic crisis. Many countries like Mexico, Brazil and Russia have relied on exchange rate mechanisms in the past and these trends are likely to continue given their success in many instances. As a result, investors should be able to read whether or not these programs are likely to be met with success or failure.
The Turkish Economic Crisis also brings to light some other key considerations for international investors. For instance, the increasing numbers of liquidity crises in emerging markets has led to reduced investor confidence in so-called "soft pegs", which has resulted in quick exits from these markets at the first sign of trouble in many cases.
Key Takeaway Points
- The Turkish Economic Crisis of 2000-2001 occurred as a result of an exchange rate based stabilization program that failed to inspire investor confidence.
- There are many lessons that can be applied from this crisis towards not only countries undergoing similar programs, but also investors with positions in those countries.