Mr. Erçel speaks on lessons for Turkish policy-makers from the East Asian
Address by the Governor of the Central Bank of the Republic of Turkey, Mr. Gazi Erçel,
crisis
at the Euromoney Conference: Investing In The Future, in Istanbul, on 3/6/98.
It is a pleasure to address you at this new Euromoney Conference being held in
Turkey. I wish to thank Euromoney and its staff for arranging this conference, which has helped
us reach a better understanding of the Turkish economy and the macroeconomic policies pursued
by the authorities.
I would like to speak today about "Lessons from the East Asian crisis for Turkish
policy-makers". The financial crisis in the East Asian countries has had strong effects on the
economies of the world, on industrial and emerging market countries alike. Some of these effects
have made themselves felt very quickly, while others will not run their course for another two or
three years. I may say that these effects are strong but not dangerous. One area of particular
concern is capital flows to emerging market economies, which may increase spreads and bring
about a capital market retrenchment.
According to a study conducted by the Institute of International Finance, net
private capital flows to major emerging market economies have slowed only slightly below their
1997 level of $223 billion, but are well below their 1996 level of $304 billion. But the share
coming from commercial banks and direct equity investments from private creditors will
decrease more than was expected, which means that capital flows will be smaller.
I do not wish to review the origins of the East Asian crisis in detail, but it shows
us that it is the structural weakness of domestic financial systems and the growing foreign
perception of that weakness that triggers a crisis in an economy. Like the Mexican peso crisis, the
East Asian crisis was a classic "self-fulfilling prophecy" panic initiated by Jeffrey Sachs.
It is widely recognized that both the Mexican crisis and the crisis in the East Asian
countries stemmed from incorrect macroeconomic policies and structural imbalances. Exchange
rate policies in particular, combined with irresponsible fiscal policies, put enormous strain on the
balance of payments. Weak domestic financial systems and rapid expansion of domestic credit,
combined with pegged exchange rate regimes, deepen the economies' dependence on short-term
external borrowing.
But it is a distinctive feature of the East Asian crisis that it is based more on the
private sector than were the public sector crises seen during the 1970s and 1980s. The solutions
found for the public-sector-based crises of those years were simpler. Programs supported by the
IMF, and much less government borrowing from international institutions, were the main
elements in the solution of those crises. The private-sector-based crises of today are more
complicated and harder to understand.
Let me follow up this brief summary by focusing my remarks this morning on four
main areas where lessons from the recent East Asian crisis may be found.
First, it was the countries' ongoing exchange rate policies that contributed to the
build up of crisis conditions. The countries of the East Asian region chose to pursue a fixed
exchange rate policy, or one pegged to the US dollar, for about a decade after the Plaza Accord.
In the beginning these policies contributed to stronger growth and low inflation in these
countries. But starting in 1995, the appreciation of their currencies had begun to threaten their
balance-of-payments positions.
Second, to offset the weakness of their economies, the authorities relied heavily
on much short-term financing, which concealed the weaknesses of their macroeconomic policies.
The nature and direction of the flow of short-term international capital had not been properly
analyzed. The ratios of short-term debt to usable foreign exchange reserves were in the range of
170-200 percent for Indonesia, Korea and the Philippines, much higher than the average ratio of
70 percent for the other major emerging market economies.
Third, transparency of banking systems, including central banks, is essential for
analyzing ongoing developments in countries' financial sectors. In particular, trends in their
off-balance-sheet items, cross-border interbank funding and their transactions with offshore
centers should first of all be transparent and second should be available for making judgements
about the system. The absence of a sufficiently thorough system of banking supervision and the
lack of transparency not only became problematic before the crisis, but also caused confidence
problems later on.
Fourth, the quality of the assets of the banking system is vital for the soundness of
macroeconomic policy. In allocating savings to investment use, the banks should be extremely
careful about the risks that must be taken for a variety of reasons. There are five main types of
risk that the banking system and of course the appropriate authorities have to deal with: interest
risk; foreign exchange risk; maturity risk; loan risk; and market risk. A sound financial system is
the best assurance of efficient monetary and fiscal policies.
In my view, all four of these factors contributed to the change of foreign
perceptions and sentiment and produced a cutback in normal financing (in fact, 95 percent of
external flows to emerging market countries come from the private marketplace). This cutback,
in turn, weakened the external reserve positions of these countries. Then the combination of
weak reserves and a weak financial sector brought on a liquidity crisis.
We are now in a position to draw some lessons from the East Asian crisis. First,
policy implementation must pursue sound macroeconomic policies in order not to lose the
confidence of the markets. And second, four main principles must constantly be kept in mind:
• The currency should not be allowed to appreciate, except as part of a bold
anti-inflation program.
• Any short-term international capital flows that occur must be carefully
examined to determine their direction and nature. In addition, the ratio of
usable external reserves to short-term debt must be kept at reasonable and
internationally accepted levels.
• Weak banking systems have been the most important contributors to past
crises. A sound and transparent banking system is an absolute requirement for
avoiding future crises. Risk-taking strategies should be appropriate to a market
system. Off-balance-sheet items and cross-border lending should be under
tight discipline. An independent supervisory authority is the best guarantee of
efficient, sound, and effective banking supervision.
• Last but not least, the pursuit of sound macroeconomic policies in a
low-inflation environment is an essential precondition for building public and
market confidence. Confidence also requires that both public and private
sector institutions be guided by strong, high quality governance and accepted
ethical rules.
The last point that I want to make is that I disagree with those economists who
speak of the difficulty of anticipating the East Asian crisis, since these countries had assembled
all the ingredients of a perfect crisis recipe:
• An appreciated exchange rate;
• A high and worsening ratio of short-term debt to usable foreign reserves;
• Untransparent off-balance-sheet items in the banking sector;
• A widening current account deficit;
• Steep growth of domestic credits;
• And a continuous decline, during recent years, in emerging markets'
borrowing spreads without matching improvement in their economic
fundamentals.
If someone should combine all these elements, it is conceivable that they might
succeed in creating a crisis.
But the world's financial centers turned away from the existence of this perfect
crisis recipe and turned toward the Turkish economy, for which, ignoring the developments in
East Asia, they predicted a crisis during the last couple of years.
The Turkish economy does not satisfy the perfect crisis recipe described above. Of
course we have high inflation, a high nominal budget deficit, and high short-term domestic debt,
but on the other hand Turkey's exchange rate policy, current account situation, the nature of its
short-term external debt, and other fundamentals do not indicate an alarming situation.
The East Asian crisis should have greatly improved the ability of economists to
predict an episode. I would be glad to see some evidence of this improvement.