[Does this argument hold water? The IMF crowd seemed surprised and sorry to see this guy go when he resigned, implying they had some respect for his acumen.]
COMMENT & ANALYSIS
The IMF's Blunder in Turkey
The Fund wrecked a comprehensive anti-inflation plan because it failed to understand market conditions, says Ercan Kumcu
Financial Times, Mar 13, 2001
By ERKAN KUMCU
At the end of 1999, the International Monetary Fund designed a comprehensive and popular anti-inflation programme for the Turkish economy. It now lies in ruins, thanks mainly to the Fund's panicky reactions to unusual market circumstances. The IMF essentially confused events in Turkey with those in south-east Asia or Latin America.
In November, the rise in interest rates caused by a seasonal demand for foreign exchange by Turkish banks was misconstrued as an attack on the Turkish lira, reminiscent of the outflow of short-term capital that caused Asia's financial crisis in 1997. In fact, Turkey's problem had a different root. Initially, the central bank did not react to the rising interest rates. Instead, it adhered to a strict monetary policy rule of keeping net domestic assets - money supply - within a narrow band. This was part of the IMF agreement.
Rising rates made some banks vulnerable. In addition, banks began to cut credit lines to each other, which further reduced liquidity. A temporary injection of liquidity by the central bank proved too little to save some local banks.
This liquidity injection returned to the central bank in the form of additional demand for foreign exchange, mostly owing to a reduction of short-term credit facilities by foreign banks to Turkish banks. But the IMF described the events as "a currency attack" and the central bank stopped injecting additional liquidity. Interest rates rose to more than 1,000 per cent, making the banking system even more vulnerable.
In fact, abandoning the monetary policy rule temporarily - albeit with some reduction in international reserves - to prevent interest rates from rising in the beginning would have sufficed to stop the process that led to the crisis last November. Indeed, given the adequate level of reserves, the supplemental reserve facility provided by the IMF at that point was unnecessary.
During January and the first half of February, financial markets were on the road to normalisation. Interest rates were coming down. Yet the IMF was pushing for tighter monetary policy, insisting that the level of net domestic assets should be brought to pre-crisis levels as soon as possible. This was interpreted by market participants as an obstacle to a further - and expected - reduction in interest rates, a vital sign of market normalisation right before a Treasury auction involving record domestic borrowing.
True, the crisis in February may well have been initiated by the now well publicised argument between Bulent Ecevit, the prime minister, and Ahmet Necdet Sezer, the president. But the IMF's reading of market conditions was again misguided. The day before the Treasury auction, the banking sector purchased more than Dollars 7bn from the central bank, to be settled the next day because of a holiday in the US. Such demand for foreign exchange was once more seen as "a currency attack".
Again, the central bank refused to provide sufficient liquidity. Dollars purchased the previous day were sold back to the central bank, including approximately Dollars 2.5bn to be paid to foreign banks. A loss in the central bank's international reserves was prevented but a crisis in the payment system was created. The Turkish authorities floated the lira, the currency depreciated by more than 30 per cent and the anti-inflation programme was officially abandoned.
The problem could have been avoided if a loss of international reserves in the range of Dollars 3bn-Dollars 5bn had been permitted. The fact that it was not means year-end inflation will now probably be more than 50 per cent, as opposed to the original target of 10 per cent in 2001.
Where did Turkey go wrong? The programme had received broad support from domestic and foreign investors. During 2000, interest rates declined sharply; inflation fell from more than 60 per cent to 33 per cent.
During the first six months of the programme, the government acted boldly. Later, "reform fatigue" set in. Delays in the privatisation programme raised concerns about the government's dedication to the IMF programme. Financial markets started questioning the sustainability of the exchange regime.
These were all factors behind the November and February crises. However, in both crises, the IMF panicked. Instead of finding a workable approach to smooth out sharp fluctuations in financial markets, it seemed more concerned with reducing Turkey's loss of international reserves. In doing so, the IMF tried to minimise its future cash support to Turkey in the event that the country lost substantial reserves.
Yet with international reserves during the crises at historic highs, one can hardly characterise either of the two events as "a foreign exchange crisis". The only possible conclusion is that the IMF has to be held accountable for its actions and their effects on the Turkish economy during the last three months.
The writer is former vice-governor of the Central Bank of Turkey
Copyright The Financial Times Limited 2000