Durmuş Yılmaz: Current issues in economic governance
Opening remarks by Mr Durmuş Yılmaz, Governor of the Central Bank of the Republic of
Turkey, at the Conference on Current Issues in Economic Governance, organised by Bilkent
University, Ankara, 2 April 2008.
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Ministers, Academicians, Bureaucrats and Guests,
Thank you all for accepting the invitation. It is a great pleasure to address such a
distinguished audience. I would like to thank Bilkent University for organizing this conference
at this juncture. In fact, the timing could not be any better. The recent global financial
turbulence has put good governance principles at the center of public debate. I hope, the
conference will strengthen our understanding of the subject by building on the lessons
derived from the conference last year.
Let me start with reviewing the recent developments in financial markets.
You may have heard about a proverb attributed to the Chinese: "May you live in interesting
times!" Here, "interesting" means dangerous or turbulent; therefore, the whole phrase is
something of a curse. It turned out that the phrase was not of Chinese origin, but ascribed to
them to make it sound wiser. Whatever the origin, it is certain that we are experiencing such
a spell right now.
We have been witnessing a global financial turbulence since mid-2007. Its magnitude,
measured by the volatility index (VIX), is larger than that of the turbulence in 2006. It was
triggered by the falling house prices and subsequent problems in the sub-prime mortgage
market and mortgage based securities. Over time, investors have become nervous about the
valuations of financial instruments. Banks took large write-downs on mortgage-related assets
and other risky securities. Major financial institutions reported huge losses. Some of them
even came to on the brink of default and some of the hedge funds liquidated their positions in
order to match the increasing withdrawals of the investors. The sharp decline in risk appetite
and concerns about the counter-party credit risk has led to a significant deterioration in
shortterm credit and money markets leading to a major liquidity squeeze. Liquidity problems,
coupled with solvency crisis, have tested the resilience of global financial markets, and we
are still waiting for the light at the end of the tunnel.
The big losses of financial institutions and deep plunge in consumer confidence due to sharp
fall in house prices and declining personal income have increased the possibility of a
recession in the US economy, which may have already started as we speak. Deterioration in
risk perceptions has increased the risk premia of developing countries, including Turkey. So
far, the rise in Turkey's risk premium was in line with that of other developing countries,
although more recently the current political uncertainty has started to put Turkish financial
markets under considerable strain. I believe Turkey's risk premium would be even higher in
the absence of improvements in macroeconomic conditions and institutional reforms
implemented in recent years.
Dear Guests,
One can label the last two decades as the era of globalization, deregulation, and
privatization. It is not a coincidence that this period has overlapped with the rise of attention
paid to good governance. One may just look at the number of occurrences of the word
"governance" in academic search database (Econ-Lit) over time. It occurred just five times
from 1970 to 1979, 100 times in the 80s, 4000 times in 1990s, and more than 10000 times
since 2000.
Globalization of economic activity and greater reliance on private sector in economic
decisions has created an environment in which the pursuit of efficiency has acquired utmost
importance. Globalization has increased the likelihood of international financial crisis in
countries where the governments do not function properly. Economic crisis in South Eastern
Asia in late 1990s showed that even countries with considerable success in economic
development may easily collapse into turmoil if they do not follow good governance
practices. Quite paradoxically, as the control of governments over the economy decreases,
the quality of governance becomes more critical and decisive. With greater mobility of
capital, countries have become more vulnerable to negative assessment of investors.
Today, financial markets are facing the most acute crisis they have experienced since the
emergence of globalization. It is not surprising that good governance is once again at the
center of public debate at this juncture. The seeds of current problems may be traced to past
governance practices of governments, monetary authorities, financial institutions, and
corporate sector.
But before that, let me first introduce some conceptual issues. This may help us understand
how we ended up here.
It is not easy to give a short and comprehensive definition for economic governance. For the
sake of our discussions, let me define it simply as the nature and practice of economic
management, regulation and development. Economic governance is in fact part of a larger
picture that combines political governance, corporate governance and legal governance,
which continuously interact with each other.
The term "economic governance" is explained as "the study of arrangements, and
organizations that arise and evolve to govern economic activity." These institutions underpin
economic transactions by protecting property rights, enforcing contracts, and organizing the
physical and regulatory infrastructure to facilitate economic activity. Good governance
provides a very important set of pillars, which are critical in the design of an economy. The
most widely cited ones are transparency, accountability, rule of law and participation.
Let me go over these four principles rather quickly.
Transparency ensures that the necessary information is freely available and directly
accessible to those who will be affected by decisions and their enforcement.
Accountability is a mirror image of the authority. It is critical for decision makers to be
responsible for the consequences of their decisions and actions to those who will be
affected. In democracies, every independent institution or organization is accountable to the
public and to its institutional stakeholders.
Participation is the cornerstone of democracies, where every person in the system, in one
way or the other, has a voice in the decision-making process.
And last but not least, good governance requires a fair legal framework and impartial
enforcement of this legal system that protects property and individual rights and constitutes a
strong base for prudent policy-making. The rules need to be preset, predictable and applied
equally regardless of whether the parties in dispute are domestic or foreign, individuals or
state. Enforcement of rules in speedy and impartial manner would create a self-fulfilling
environment, where adhering to contracts voluntarily becomes the norm and there is little
need to formally recourse to the legal system.
How can we match governance practices with the current financial turbulence? It is too early
to make a judgment about the institutional failures that have led to current financial
turbulence, but we have a few clues on what went wrong. Lack of transparency and
accountability is at the top of the list. In retrospect there were some important gaps in the
U.S. regulatory structure that caused poor underwriting and some fraudulent practices in the
sub-prime mortgage sector. Parties in the originate to-distribute chain did not have incentives
to generate and provide information on the quality of assets. We can add poor investor
duediligence practices and poor performance of credit rating agencies to that list. Public
disclosures required of financial institutions were not enough to shed light to the risks
associated with their on- and off-balance sheet exposures. Public authorities were way
behind in assessing and regulating the complex financial instruments created by financial
engineers.
Of course, accommodating global monetary and financial conditions also contributed to
highrisk appetites, high leverage and search for high yields.
At this point we do not know the scale of economic fallout from the ongoing financial
turbulence, nor its duration. It is, however, conceivable to expect some regulatory backlash
by major industrialized countries. For example, just a few days ago the U.S. Treasury
Department announced a new plan to overhaul existing financial regulatory structure to make
it compatible with modern financial instruments. This is of course just a beginning and we
should not be surprised to witness similar steps by other countries.
Distinguished guests,
Let me turn to the Turkish case and discuss recent developments in Turkey.
As you may remember, throughout 1990s the Turkish economy was shaped by high and
chronic fiscal deficits, high inflation rates and a weak institutional environment. The economic
crisis in Turkey in 2001 was not only the lowest point of this period, but also a major turning
point for our economy. Since then we have witnessed a very ambitious reform agenda taken
towards reaching better economic governance. I classify these steps under four main
categories: (1) Monetary policy, (2) Fiscal policy, (3) Financial stability and (4) Structural
reforms.
Taking into consideration the fact that I am a central banker, I think it will not be surprising if I
start with the topic of monetary policy.
Central Bank independence that was granted by Law in 2001 was the key step on the
monetary policy side. In the absence of independence, the Central Bank of Turkey would not
be able to focus on its primary objective of price stability. Introduction of the free-floating
exchange rate regime in 2001 and formal inflation targeting regime in 2006 can be classified
as the other two key steps. The inflation targets became the new anchor instead of exchange
rates and the Central Bank has started using overnight interest rates as the main policy tool
to reach these targets.
Communication tools of the central bank have played a key role in explaining the price
developments and the monetary policy outlook to the public and also in managing
expectations. The Bank's communication policy has become more effective over time with
the introduction of new communication tools, such as the quarterly inflation reports since
2006, the bi-annual financial stability report since 2005 and the monthly price development
reports since July 2006. In addition, a summary of Monetary Policy Committee meetings are
published on our website within 8 business days following the Committee meeting,
simultaneously in English and Turkish. I believe all of these instruments have contributed to a
more transparent monetary policy.
After briefly touching upon the main features of the monetary policy in the context of good
economic governance, I will continue with the fiscal side.
The prudent fiscal policy that has been implemented since 2002 has made significant
contributions to the disinflation process and the economic growth. The ambitious primary
surplus targets are at the center of the improvement in fiscal policy. However, I should also
underline the progress in institutional and legal framework, such as the introduction of the
Public Fiscal Management and Control Law, the Public Procurement Law and the multi-year
budgeting framework. Three year inflation targets that are compatible with the three-year
budgeting practice are also one of the good examples of coordination between fiscal and
monetary policies.
Another pillar of better economic governance is financial stability. A stable and healthy
financial system is the key to sustainable growth through allocating savings to the real sector
in a country. Law defines financial stability as the auxiliary objective of the Central Bank of
Turkey.
Establishment of the Banking Regulation and Supervision Agency, successful
implementation of The Banking Sector Restructuring Program and the New Banking Law that
brought the legal framework with best international practices were the milestones of legal
and institutional reform in the financial sector. No need to say that the improved
macroeconomic framework through successful monetary and fiscal policy implementations
also contributed much to financial stability. Last but not least, I should say that there is also
an effective cooperation among the Central Bank of Turkey, the Banking Regulation and
Supervision Agency, the Undersecretariat of Treasury, the Capital Markets Board and other
public authorities and also with private sector representatives.
The fourth and the final set of actions that has been undertaken towards better economic
governance is structural reforms.
Turkey has achieved significant progress in this front, but today, I would like to put a special
emphasis on the role of regulatory and supervisory institutions without getting into details.
Establishment and effective implementations of institutions such as the Banking Regulation
and Supervision Agency, the Turkish Competition Authority, the Energy Market Regulatory
Authority, the Telecommunications Authority and many others have contributed to the
development of a competitive, resilient and efficient economy in Turkey. It is not surprising
that manufacturing, retail, energy and financial sectors have attracted the interest from
foreign investors in recent years, as witnessed by over 40 billion USD foreign direct
investment in the last two years. The good corporate governance practices have also
contributed to the overall economic governance in the country.
As a result of the steps taken in the four categories that I have just mentioned, Turkey has
shown an impressive economic performance after 2001. The consumer price inflation
declined to the single-digit territory. The GDP has continuously grown in the last 24 quarters.
This strong growth performance was private sector driven and supported by continuous
productivity gains. Along with the high economic growth, openness of the Turkish economy
has also increased substantially. Exports increased by more than two-folds since 2001 and
reached to USD 107 billion in 2007. The banking sector has strengthened significantly and
became resilient to internal and external shocks. Finally, budget deficit and debt stock of the
public are no longer sources of vulnerability. Even before recent upward revisions in GDP
figures, Turkey easily met the Maastricht criteria for the budget deficit and debt stock.
Turkey has demonstrated significant improvement in the World Bank's Governance Index
since 2000. Thanks to better governance practices, competitiveness of Turkish economy has
advanced drastically in recent years as well. In the last two years, Turkey moved up a total of
18 steps in the Global Competitiveness Index prepared by the World Economic Forum.
Turkey also moved up 34 steps compared to the previous year in the Ease of Doing
Business Index of the World Bank.
Distinguished guests,
I tried to highlight some of the important developments in Turkey regarding economic
governance in recent years and the resulting improvement in the economic structure. All
these led to improvement in the confidence, which was instrumental in further confidence
building and credibility for the economic management. These are all key ingredients of good
governance.
These achievements, however, are not enough. We still have much to do in terms of
reaching price stability and securing sustainable high growth rates. There is still much to be
done to improve economic governance and to reach a level compatible with the EU-15
average. As we are going through difficult times both internally and externally, we should not
lose the momentum gained in institutional capacity building. It is even more imperative at this
juncture to show and utilize the dexterity that we gained from our past experiences. We have
to list the things on the reform agenda and share it with the public at large and without
sacrificing the long-term benefits for short-term gains. To ensure that the reform agenda is
fulfilled in a timely manner, we need to prepare and announce a timetable, thus setting up
performance criteria and adhere strictly to its implementation. In case any delay occurs in the
execution of the pre-announced timetable, necessary mechanisms should be in place to
ensure that policy makers face the public and explain why it was not achieved. By doing so,
we will be able to preserve the gains we have brought about and maintain the medium and
long-term growth capacity of our economy.
The key word that I would like to underline here is sustainability. Better governance is of
great importance for making the gains of recent years permanent and reaching sustainable
high growth rates. There is a heavy reform agenda waiting for us. Macroeconomic stability,
structural reforms and adherence to good governance principles will unlock Turkey's
economic potential and achieve her convergence to European Union. Thank you.