Durmuş Yılmaz: Global crises and economic governance
Speech by Mr Durmuş Yılmaz, Governor of the Central Bank of the Republic of Turkey, at
the conference on "Global crises and economic governance", İnönü University, Malatya,
15 April 2010.
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Distinguished Rector, Distinguished Academicians and Esteemed Guests,
First of all, I would like to thank everyone who has contributed to the organization of this
conference, primarily Prof. Cemil Çelik, the Rector of İnönü University and distinguished
faculty members of the university. I take great pleasure in participating in such an event with
you.
I would like to start my speech with a brief evaluation of the global financial crisis. Later on, I
will share with you my observations related to developments in the global economy and the
Turkish economy. After presenting a brief overview of the monetary policy implemented and
the measures taken by the Central Bank during the crisis, I would like to close my speech
with the monetary policy exit strategy, which we announced to the public yesterday.
As you know, problems that emerged in the US subprime mortgage market in the
second half of 2007 spread the whole world to reach threatening levels for both
financial and economic stability.
We can say that the reaction of market players and the public has gone through four
subsequent stages since the eruption of the crisis. These stages can be summarized as
those of Denial, Disappointment, Panic and Hope.
In the first stage, the markets had difficulty perceiving the dimension of the damage caused
by the crisis and considered that such an incident would be overcome shortly and/or would
not reach significant levels. As a matter of fact, especially in the first half of 2008, one of the
most discussed items on the agenda of international financial circles was whether there
would be a decoupling of economies or not. In that period, many economists and market
specialists supported the idea that the crisis that emerged in advanced economies would
have a limited impact on emerging economies and that emerging economies had the
capacity of compensating the global demand deficit, which was to be observed. In
conclusion, they claimed that there would be a distinct decoupling in the growth dynamics of
country groups.
It has been fortunate that the expected decoupling has not been as intense as estimated. It is
inevitable for both developed and emerging economies to be affected by global economic
turbulence in a period characterized by the progressively rising interdependent nature of
global economies. However, the scale of the impact has differed from one country to another.
When we look back, we see that the resilience of countries in the face of the crisis has been
determined mainly by four structural factors. It is possible to examine them under four
headings as (1) Floating exchange rate regime (2) Resilience of the banking system
(3) Countercyclical monetary policy and (4) Room for maneuver provided by the fiscal
discipline implemented in the pre-crisis period.
Countries implementing a fixed exchange rate regime have been hit more severely by the
crisis compared to those implementing a floating exchange rate regime. In countries with free
capital flows, a floating exchange rate regime, - by enabling monetary authorities to adopt a
flexible approach in the face of a liquidity crunch in markets - acts as a safety valve
preventing over-contraction of the economy, under rapidly deteriorating international liquidity
conditions. As a matter of fact, in countries implementing a floating exchange rate regime,
economic activity exhibited smaller fluctuations before and during the crisis. Moreover,
countries under a floating exchange rate regime experience a stronger economic recovery
compared to those under a fixed exchange rate regime.
The second structural factor that determines the resilience of countries against the crisis is
the structure of the banking system. In this period, factors such as asset quality of the
banking system, keeping leverage ratios at manageable levels, and proper implementation of
regulatory and supervisory activities played an important role in containing the damage and
credit crunch in financial markets.
The last two factors that determine the level of impact of the crisis on countries are monetary
and fiscal policy practices that are considered as cyclical movements in the economy. In
those countries, which observed fiscal discipline, implemented countercyclical monetary
policies, prevented excessive increases in private sector's indebtedness ratios in the
precrisis period, central banks and governments had the room for maneuver to implement
monetary and fiscal policies that could recoup demand shocks.
Owing to the aforementioned reasons, many countries, including Turkey, has been able to be
resilient beyond expectations, in the face of the crisis. However, it was undoubtedly
impossible to fully avoid the adverse effects of the crisis. In fact, an analysis of quarterly
growth rates of world economies suggests that almost half of the economies contracted in
the final quarter of 2008, and more than 90 percent in the first half of 2009.
The first half of 2008 became a period where problems driven by the crisis were ignored by
the markets. Nevertheless, despite certain monetary policy measures that were taken, the
global crisis entered the second stage, where the feeling of "denial and rejection" was
replaced by "disappointment" and "anger" due to the growing frequency of problems
emerging across financial markets. In this period, money markets were almost at a standstill
due to the deterioration of risk perceptions, banks were faced with liquidity problems, asset
prices experienced slumps, non-performing loans increased, balance sheets incurred losses
that led to serious damage to the health of banking system, numerous banks and investment
agencies came under strain and even went bankrupt - all of which describe the main
characteristics of the second stage.
Especially the rescue packages that were inevitably implemented by governments to prevent
the collapse of the financial system in developed countries gave way to serious public anger
directed towards banks and investment agencies. The USD 700 billion worth of stimulus
package, which was prepared in September 2008 to enable the government to assume bad
debts of US financial institutions and which was considered the biggest state intervention in
recent years, was pending at the US House of Representatives for a long time due to the
harsh reaction from the public. In the meantime, there was a negative reaction from the
public towards the excessively high salaries of banking sector managers, who frequently was
urged a readjustment to the remunerations of managerial staff. Furthermore, new
arrangements were brought onto the agenda for stricter supervision and to restrict the
activities of the financial sector. In addition to these developments, views related to inefficient
functioning of public institutions in charge of supervising the financial sector, primarily the
Federal Reserve, in the pre-crisis period, raised intense criticism on these institutions, too.
Meanwhile, under the name of financial protectionism there have been advocates of the
discourse that international banks should halt their functions abroad and instead lend to the
corporate sector experiencing difficulty in finding funds at home.
On the heels of "Denial" and "Anger", the global crisis entered the third and most disturbing
stage in the final quarter of 2008 and the first quarter of 2009. We can define the common
public feeling that prevailed in the whole world in this period as "panic" and "fear of collapse".
In early 2009, the effect of the global crisis on world economies deepened, world trade
volume fell to historic lows, almost all countries suffered economic contraction,
unemployment rates soared; in brief, the world had faced the possibility of an economic
depression of such dimensions for the first time since 1929 - as a result of which the fears of
a global and prolonged depression peaked.
In order to recoup the significant contraction in demand that emerged due to the decrease in
the private sector's total investment and consumption expenditures, governments and central
banks have prepared historically extensive and comprehensive stimulus packages. The
scope of the crisis and the economic contraction became worldwide in a short while, which
necessitated the timely implementation of measures in coordination with other countries.
Public resources that were allocated to the financial sector and the stimulus packages that
were put into effect during the crisis have brought significant burden on public budgets.
Research conducted by the International Monetary Fund indicates that the total amount of
capital transferred to the financial sector was USD 4 trillion; state purchases to prop up
securities markets amounted to USD 6 trillion; state guarantees to financial institutions and
the corporate sector became USD 14 trillion; and fiscal measures such as tax rebates and
new public spending reached USD 6 trillion.
As of the second half of 2009, we entered the fourth and last stage of the crisis. We can
simply describe this stage as the period of "hope" emerging in the world public opinion with
the support of the "green shoots" that appeared in economic activity.
Data, which have been released since April 2009, have confirmed that the worst of the crisis
has been left behind and has reinforced expectations that a recovery in the global economy
has started. The termination of monetary and fiscal stimulus programs and the inventory
de-stocking process - especially in developed countries - constitute the basis for recovery
signals in the global economy. The improvement in the Global Purchasing Managers' Index
of both developed economies and emerging markets in the first quarter of 2010 indicate that
the recovery in economic activity continues. An analysis of growth estimates of international
institutions reveals that in 2010, the United States is expected to display a growth rate close
to the long-term growth average and the recovery in Europe is expected to be slower than
that in the United States. Taking into account the fact that the European Union is our leading
export market, this constitutes an important risk factor for our economy.
Now, let us have a look at the risks with respect to the global economy in the upcoming
period. The distressed assets problem in the banking sectors of developed countries is yet to
be solved and vulnerabilities persist and they constitute the primary factors impeding
effective functioning of the credit mechanism. Meanwhile, the rapid rise or high levels of
unemployment rates in many countries affect the total demand adversely by reducing
household expenditures. The persisting uncertainties about exit strategies from the
extraordinary monetary and fiscal measures are another factor pose risk to the permanence
of recovery.
The ever-growing budget deficits and swelling public debt stocks driven by the expansionary
fiscal policies adopted especially in developed countries became an important risk factor as
they push long-term interest rates up and affect private demand adversely. Meanwhile, sharp
rises are observed recently in the risk premia of Greece, Spain, Portugal and Italy with high
debt stocks as concerns over the sustainability of their current budget deficit are elevated.
After summarizing the stages that the crisis has gone through since mid-2007, I would like to
talk about the reasons for the emergence of the crisis from the viewpoint of the main theme
of this conference; i.e. "the issue of governance".
There is a consensus over the fact that in the pre-crisis period, markets developed,
deepened and grew more complex at an astounding pace but the institutions responsible for
inspection and supervision failed to keep up with this change. Moreover, Basel II regulations
made credit rating institutions a part of the regulation process; and complex derivative
products and risk assessment methods spurred over-borrowing. In the pre-crisis period, the
accommodating monetary policies adopted by central banks of developed countries in the
form of the low interest rate-high liquidity led to moral hazards in financial markets.
Within this framework, assuming that financial markets always operate efficiently, we can list
the reasons for the crisis as deregulation, financial innovations, problematic accounting
standards and global instabilities. The liberty brought by deregulation led to shortsightedness
driven by over-confidence and short-term profits were preferred at the cost of risking the
financial system in the long run. Financial innovations generated complex derivative
products, where who owes how much to whom is not clear and, which actually lead to
multiplying of risk instead of distribution of it. Meanwhile, the accounting standards based on
"Fair Value" principle made cyclical effects and fuelled the destructive power of the crisis.
Having mentioned the stages and reasons for the crisis, now I would like to share with you
the monetary policy implemented by the Central Bank of Turkey during the crisis and my
evaluations on the recent developments in the Turkish economy.
Projecting that inflation would decrease sharply as of the last quarter of 2008, the Central
Bank of Turkey implemented a monetary policy focusing on restraining the potentially harsh
impact of the global financial crisis on financial activity without conflicting with the primary
objective of maintaining price stability. During this process, the CBT has delivered sizeable
cuts in policy rates and a counter-cyclical monetary policy has been implemented with the
aim of supporting the smooth operation of credit markets. Between November 2008 and
November 2009, the CBT cut policy rates by 1.025 basis points, playing a pioneer role
among central banks of developing countries.
As a result of the limited improvement in risk perceptions and the Central Bank's projections
supported by actual inflation data, market interest rates decreased significantly. In this period
marked by the crisis, policy rates continued to be one of the factors determining market
rates. In an era where ballooning government deficits are likely to put upward pressure on
medium to long-term interest rates across the globe and markets are still sensitive to risk
appetite, the fact that market rates continue to be primarily determined by the CBT's policy
rates is evidence of the increased effectiveness of monetary policy.
The course of real rates and financial tightening measures during the crisis are also
indicators of the improved effectiveness of monetary policy in Turkey. Real market rates
declined continuously amid CBT's policy rate cuts and reached historic lows. The tendency
of real rates to fall is quite common in well-functioning economies during times of recession;
yet, it is quite unprecedented for Turkey. In this regard, the current level of real rates is an
indicator of the improved effectiveness of monetary policy.
During the crisis, the monetary policy decisions of central banks in emerging economies had
very limited short-term effect on their currencies. The values of these currencies were mainly
determined by global risk perceptions. However, with the normalization in financial markets,
we foresee that the distinguishing characteristics of countries will come to the fore in the
upcoming period and currencies of those countries with lower risk, stronger economic and
financial fundamentals and high growth potential are expected to perform better. In this
regard, it would not be surprising if Turkey's credit rating is raised to reach the investment
grade implied by the actual CDS spread.
As for recent developments in the Turkish economy, the moderate recovery in economic
activity continues. Quarterly growth in GDP continued in the last quarter of 2009. As tax cuts
that were put into practice with the aim of spurring economic activity were phased out, private
consumption demand displayed a more moderate rise compared to the first half and the
gradual recovery in private consumption expenditures continued in the third quarter.
Meanwhile, private investment expenditures continued to pick up in the last quarter but
remained lower compared to strong growth periods. Taking into account the uncertainties
pertaining to domestic and foreign demand and the low capacity utilization rates, it is
estimated that it would take an extended period of time for investment expenditures to reach
their pre-crisis levels and no significant rise is expected in the short run. Recently, imports
have increased faster than exports and this indicates that the recovery in the economy is
mainly driven by domestic demand. The course of exports in the upcoming period will be
determined by the pace of global recovery. As I have mentioned earlier while talking about
global risks, forecasts for our largest trade partner, the European Union, suggest that it would
take a long time for foreign demand to return to pre-crisis levels.
Industrial production has been increasing moderately since March 2009. According to the
latest Business Tendency Survey conducted by the CBT, the moderate recovery in orders
both from domestic and foreign markets continues. On the expectations side, there is
improvement both in the real sector and consumer confidence indices. Nevertheless, the
stillweak foreign demand and the fact that Turkey's exports predominantly rely on products that
are susceptible to cyclical developments are retarding a rebound in industrial production.
Uncertainties regarding aggregate demand urge firms operating in the manufacturing
industry to take a cautious stance and to be more reluctant about inventory building
compared to the periods of strong growth.
The biggest headache for Turkey, unemployment, assumed a slight recovery trend in the
third quarter of 2009 as the economy started to generate employment opportunities again.
Industrial employment, which is the sector that is most severely affected by the crisis and
became the main driver of contraction in non-farm employment, started to recover at a
moderate pace. The services and construction sector supported non-farm employment as
well. Despite the recent partial recovery, the unemployment rate is still quite high compared
to the pre-crisis period. This high unemployment rate curbs the consumption demand as well.
Putting the structural reforms that would remedy chronic problems in the labor market into
practice immediately would prevent unemployment rates, which climbed during the crises,
from becoming permanent and support potential economic growth.
The lending appetite of banks significantly decreased due to the decline in risk appetite
accompanied by the erosion of confidence and elevated uncertainties during the crisis.
However, we can assert that there are favorable developments thanks to policy rate cuts
made since November 2008 and the improvement in global risk perceptions. Especially the
most recent developments suggest that there is an apparent improvement in Commercial
Loans. The rise in loans extended to SMEs, which have an important share in the labor
market, indicates that there is moderate recovery in economic activity. The NPL ratios, which
saw all time highs during the crisis, started to decrease, albeit slowly and gradually. To sum
up, the upward trend in bank loans, which started in the second quarter of 2009, continues
on a stable course.
As you all know, the impact of the global economic crisis on financial markets was terribly
severe in the last quarter of 2008: countries' risk premia saw record-high levels and
excessive volatilities occurred in the currencies of many developing countries. Despite
having been volatile at historically high levels and extremely sensitive to the global risk
appetite, the Turkish lira displayed a relatively stable course, which lasted through the first
quarter of 2010 following the peak of the crisis. Meanwhile, the improvement in global risk
perceptions in the fourth quarter led the currency of many developing countries to appreciate.
In terms of changes in currency values, the Turkish lira did not significantly differ from
currencies of other emerging markets in this period.
Public debts and budget deficits have increased on a worldwide scale due to fiscal stimulus
and decreasing tax incomes. In many countries, the ratio of public debt to national income
went beyond the sustainable level of 60 percent (Maastricht Criteria), which may ease
concerns about public finance and create upward pressures on market interest rates. I am of
the opinion that, should market interest rates increase; the severity and duration of the global
crisis will be adversely affected.
The discipline established by Turkey in public finance in the past has significantly increased
the resilience of the public against external shocks as well as confidence regarding the
sustainability of debts. These improvements in the structure of public finance and the
sustainability of debts allowed the implementation of expansionary fiscal measures, albeit
limited, in order to alleviate the impact of the global crisis. In this respect, SCT and VAT rates
on some products were temporarily reduced to allow de-stocking for firms and a new
investment incentive system was established to improve the investment atmosphere.
Additionally, tax cuts and fiscal incentives were introduced to increase employment, and
credit and guarantee supports were provided for SME's and exporting firms. It is thanks to
the fiscal discipline already established that countercyclical policy could be implemented in
this period.
Tax arrangements along with hikes in commodity prices that were put into effect at the
beginning of the year played a significant role in the increase of inflation in the recent period.
The hike in annual inflation mainly emanated from the co-emergence of many temporary
factors rather than general pricing behavior. Meanwhile, the main inflation indicators
remained consistent with medium-term targets. Moreover, the annual rate of increase in
services prices and the inflation diffusion index saw historically low levels. These
observations indicate that the increase in inflation in the last quarter of 2009 is mainly due to
temporary developments, and to factors beyond the immediate control of monetary policy,
rather than the main components of inflation.
We consider the possible effect of inflation hikes on expectations due to the base effect a
significant risk factor in forthcoming months. However, under the assumption that resource
utilization in the economy will remain at low levels for an extended period, employment and
credit conditions will not allow a strong expansion in consumption demand and fiscal policy
will gradually generate a contractionary effect, we believe that the effect of price increases
emanating from one-time shocks on general pricing behavior will be limited. It is important
that economic units accurately perceive the temporary quality of the said factors and that
medium and long term expectations do not deteriorate. The CBT are vigilant on pricing
behavior as inflation follows a high course, albeit temporary. The CBT foresees that inflation
will follow a fluctuating course significantly above the target and then reassume a decreasing
trend in the last quarter of the year once the temporary factors taper off and come back to
levels consistent with targets in the first months of 2011.
In the last part of my speech, I would like to mention about the general framework of the
monetary policy exit strategy that we shared with the public yesterday.
As you all know, recently, one of the most discussed issues in monetary policies has been
"exit strategies", which include the withdrawing measures taken during the global crisis and
normalization operations of monetary policies. We believe that the exit strategy of the CBT
will be simpler and easier as no need for radical measures arose and the balance sheet
structure was not damaged during the crisis period.
I would like to handle the exit strategy of the CBT in two groups as foreign exchange and
Turkish lira.
The basic principle of the CBT on foreign exchange liquidity is that the Central Bank, which is
the lender of last resort for Turkish lira and has broad flexibilities related to Turkish lira
liquidity management, is not be considered as the lender of last resort for other currencies.
For this reason, the banking system has to be much more discreet and prudent in its
management of foreign exchange liquidity. The facilities provided by the Central Bank during
the crisis should not result in complacency and the banking system should carry on with
effective foreign exchange liquidity management. Therefore, in the upcoming period, as
normalization in the global markets becomes significant, it is planned that measures related
to foreign exchange liquidity will gradually be taken to pre-crisis levels, in an orderly manner.
Even though the Central Bank's exit strategy related to foreign exchange liquidity may
change as needs arise, it is foreseen to be as follows:
1. The FX required reserves ratios may gradually be increased in a measured pace.
2. Considering developments in global interest rates, foreign exchange deposit lending
rates announced by the Central Bank may be increased.
3. Lastly, after the effects of developed countries' exit strategies are monitored, the
intermediary function of the Central Bank in the foreign exchange deposit market will
be abolished. However, banks will be able to borrow foreign exchange deposits from
the Central Bank within the predetermined borrowing limits. The maturity of foreign
exchange deposits borrowed within the predetermined borrowing limits by banks
from the Central Bank will be decreased from 3 months to 1 week.
Considering the allocation of liquidity within the system in order to prepare the banking sector
for technical rate adjustment, to reduce possible fluctuations in the money markets and to
maintain liquidity management flexibility against unforeseen liquidity developments, the
Central Bank decided to keep the integrity of both reducing overfunding in the context of the
exit strategy and technical interest rate adjustment operations and to adopt a gradual
strategy.
In the first stage, the amount of liquidity that has been provided as a part of the overfunding
policy will be reduced gradually. In this process, as currently is the case, due attention will be
paid to keep overnight interest rates close to the announced borrowing rate. The overnight
borrowing rate announced by the Central Bank will continue to be the reference rate of
monetary policy.
As for the second stage, the technical interest rate adjustment process will become
operative. In this respect, in order to maintain the flexibility of liquidity management against
unexpected liquidity developments and not to create volatility in money markets, it is planned
to be carried out in two steps.
In the first step, the Central Bank's borrowing and lending interest rates for overnight
transactions will not be changed. However, the one-week repo auction procedure will be
subject to change by implementing amount auction procedure via fixed interest rate instead
of the traditional auction procedure. In this step, the fixed interest rate for one-week repo
auctions will be determined by adding 50 basis points to the declared overnight borrowing
interest rate of the Central Bank. Therefore, the fixed interest rate for one-week repo
transactions will become the reference (policy) interest rate of monetary policy.
In the second step, the difference between the one-week repo auction interest rate and the
overnight borrowing interest rate may be increased. The CBT may aim to create the
secondary market average overnight interest rate around the one-week repo auction rate.
The difference between the one-week repo auction interest rate and the overnight borrowing
interest rate may be increased either by raising the one-week repo auction interest rate if the
Monetary Policy Committee (Committee) decides that monetary tightening is required, or by
lowering the overnight borrowing and lending interest rates if the Committee decides not to
make any change in the policy interest rate. In this period, the differences between the
oneweek repo auction interest rate and the overnight borrowing and lending interest rates may
not always be symmetrical and will be determined by the Committee as an element of the
operational framework of monetary policy.
As a result, some of the measures taken in the foreign exchange and Turkish lira markets
during the crisis are planned to be withdrawn gradually. In this context, primarily the
measures taken in direct crisis management will be withdrawn, and, as is the case in the rest
of the world, the exit strategy will be a cautious and gradual process that safeguards financial
stability in our country as well.
I would like to end my remarks by extending my regards to all the participating academicians
and policy-makers for their contributions to the "Global Crises and Economic Governance"
congress. Also, I would like to thank, once more, the staff of İnönü University and everybody
for their contributions to the conference.