Emerging Markets: Theory & Practice / Turkey’s Reforms Post 2001 Crisis

Duygu Uckun* and Mark Doerr**


The global financial downturn of 2001 affected broad swaths of the increasingly interconnected global economy.  The global effects of the economic downturn in the U.S. in 2008 showed that decoupling had not occurred to the extent many thought, and showed that indeed emerging market countries, including Turkey, were not immune from economic trouble in America. This paper addresses the question, whether the fiscal, financial, and regulatory reforms in Turkey after the 2001 economic crisis cushion the global financial crisis world is facing toward the end of the decade. In doing so we analyze the policies implemented by Turkey before and after the 2001 global economic crisis and identify the successes as well as failures of those reforms. The results of our research show that despite significant reforms in key economic and regulatory areas in the post-2001 crisis period, vulnerabilities remained; especially concerning the large current account deficit, volatility of exchange rates, increased private sector indebtedness, and persistent unemployment. These vulnerabilities will be visible in the deteriorating liquidity conditions in the global financial markets. We conclude by recommending infrastructure, education and health spending as well as restructuring of the economy to further attract FDI and avoid reliance on speculative foreign capital in order to achieve a more balanced and sustained growth in the long run.

Keywords: Emerging Market, Turkey, Post-2001, Economic Crisis, International Money Fund (IMF), Privatization, Double Mismatch, Liquidity Model, Investment Model

Journal of Global Analysis | Vol. 1 | No. 1 | 2010


This paper argues that Turkey’s experience with economic crisis in 2001 demonstrates the effects of the investment model of economic development interacting simultaneously with the liquidity model. Investment model focuses on pull factors. “Rich country investors continuously evaluate profit opportunities at home and abroad, and when growth prospects in less developed countries (LDCs) seem favorable, they make the decision to invest” says Michael Pettis, as he explains the cycles of hot money inflow to LDCs according to this model.[1] Liquidity model, however, puts emphasis on the changes in the liquidity of rich country markets as determining forces to invest abroad. Therefore, ‘capital investments precede and cause growth.’[2]

These two theories in concert help explain Turkey’s economic crisis in 2001, its resurgence following the crisis, and Turkey’s recent economic distress during the current global financial crisis.

This paper argues three main points.  First, capital flows in and out of Turkey can largely be explained by the liquidity model of development.  Secondly, Turkey’s reforms helped attract those capital flows and effectively “put Turkey on the map” in the eyes of global financial markets, thus rendering Turkey an attractive target for global liquidity. Finally, Turkey’s reforms, although helpful, did not promote long-term sustainability, thus leaving Turkey vulnerable to fluctuations in global liquidity.

Authors of this paper conclude by discussing the prognosis for Turkey’s economic future and providing several recommended policy reforms that may help Turkey establish itself as a more modern and sustainable destination for international investment.

In order to apply liquidity and investment economic models, that are mainly developed for emerging markets, to Turkey, it is essential to see emerging market characteristics of the country. Turkey has several commonalities it shares with other well-known emerging markets (EMs) and place it in this category. Turkey is a significant regional power with large population and a large market. It is the 17 largest economy with 794.2 billion USD GDP according to 2008 World Bank data. Another major characteristic of EMs is replacement of traditional economies with open door policies via economic and political reforms, which we will elaborate in coming sections. Turkey has similar per capita incomes as many other prominent, similarly situated emerging markets such as Mexico, Indonesia and Iran.[3] Its financial markets also bear several positive indicators of an emerging market: there is significant volatility in Turkey’s equity and credit markets and Turkey’s currency experiences significant and frequent fluctuations. Figure 1 below compares spreads in Turkey’s bond markets with the JP Morgan Emerging Market Bond Index (EMBI), which is a way to track total returns for traded external debt instruments in the emerging markets. The figure shows how Turkey is very much on the same track with the fluctuations in the index.

Political instability is another EM characteristic Turkey shares with countries such as Russia, Argentina, and India. The 2001 economic crisis was famously precipitated by an altercation between the Turkish President Ahmet Necdet Sezer and Prime Minister Bülent Ecevit during a meeting at which the President threw a physical copy of the Turkish Constitution in the face of the Prime Minister. Within hours, nearly USD 4 billion had left Turkish markets, and three days later the Turkish currency was devalued.

Finally, excitement over Turkey’s growth prospects have led Goldman Sachs to label Turkey one of the “Next Eleven” countries that are poised to experience dramatic growth.[4]  Some of Turkey’s proponents have gone so far to suggest that Turkey has such growth potential it should be considered amidst the “BRICs,” putting it on par with the well-known cases of Brazil, Russia, India, and China.

The well-known 2001 economic crisis has been selected as the mile stone for this paper because it was the impetus for the economic reforms that contributed to the mid-2000s resurgence in the Turkish economy and financial markets. Since the crisis was so far-reaching and foundational, we cover it here briefly with quick facts.  In 2001:

  • GDP growth fell to -5.7% (down from +3.8% in 2000);
  • the Consumer Price Index soared by 54.9% year-to-year;
  • the Turkish Lira depreciated 51%;
  • unemployment rose to 10%;
  • real wages were reduced by 20%.

An efficient cause of the Turkish financial crisis, as we have seen across the board in relevant case studies, was a large “double mismatch” in the banking sector.  Turkish banks had borrowed excessively in foreign-denominated debt in the short-term and had loaned out in domestic currency in the long-term. When the economy began experiencing crisis, stoked by significant political instability, the banks were caught in an untenable situation.

As a result of the 2001 economic crisis, Turkey enacted an expansive set of reforms to revitalize its economy and financial system. Turkey’s most important reforms were in (1) the regulatory system, (2) the privatization process, and (3) in its fiscal and monetary policy. During this post-2001 period, the global financial markets experienced a significant increase in liquidity, which helped set the stage for Turkey’s economic expansion, and indeed, was the main driver of that expansion.

Several important domestic factors contributed to Turkey’s ability to expand. First, a pro-European Union government was elected in 2002, which signaled to the global financial markets that Turkey was prepared to take the steps necessary to encourage further development. Further, the International Monetary Fund and World Bank announced the “Revised Strengthening of the Turkish Economy 2002-2004 Program” soon after the new government’s election, further stoking optimism in Turkey’s future. Clearly, following the 2001 economic crisis, the stage was set for Turkey to rise from the ashes.

Regulatory Reforms

The summer of 2003 marked a period of intense regulatory reform for Turkey. Indeed, the scope and variety of Turkey’s reforms in such a short period of time indicate the country’s willingness to respond rapidly to economic conditions and to take the drastic steps necessary to ensure future economic prosperity and stability. As we argue, those reforms aided in creating temporary economic development, but failed to create economic stability in the long-term.

In the short-term, however, Turkey’s regulatory reforms created an environment in which the increase in global liquidity was able to find its way into Turkey’s financial markets. The most significant reforms follow:[5]

Foreign Direct Investment Law No. 4875 (June 2003)

The new FDI provisions removed the requirement that a foreign company, in order to create a new company in Turkey with foreign capital, obtain a permit.[6] Formerly, an interested company would have to get approval from up to twenty government organizations to get such a permit. The bureaucracy that resulted was rampant, discouraged investment, and created the manifest potential for cronyism and corruption. Today, the International Finance Corporation claims that “company formation procedure in Turkey has become one of the easiest in the world.”[7]

Secondly, the FDI law created a new, comprehensive equality principle that created equal duties and privileges for foreign and domestic companies. This equal treatment permitted foreign companies to compete on equal grounds with domestic companies, thereby encouraging further investment.

Turkish Capital Markets Board Law (July 2003)

The Turkish Capital Markets Board (CMB) Law expanded the existing powers of the independent authority that oversees Turkey’s financial markets.[8] The CMB law also included a small-shareholder-friendly provision. This “mandatory offer” provision requires that, if an individual or group of individuals or firms working in concert were to acquire 25% of a company or take over management of a company, that individual or group of individuals must make a fair, good faith offer to purchase the entire company.[9] This law was enacted in response to situations in which a controlling shareholder acted in ways that would unfairly prejudice minority shareholders, especially retail investors, both foreign and domestic.  Reforms such as these made the Turkish financial markets much more attractive to investors from a variety of backgrounds, but especially small investors.

Enhanced Corporate Governance and Disclosure Laws (July 2003)

These laws require broad disclosure on the part of public companies. In the context of a public offering, for example, the Capital Markets Board itself reviews corporate documents of registered companies to determine whether “there are any share transfer restrictions affecting the liquidity of the shares to be offered or any provisions contrary to rights of minority shareholders.”[10] Extraordinary measures such as these, which directly benefit minority shareholders, have encouraged investment from parties with a broad array of investment expertise and resources.

Further, the CMB requires a company to disclose any material change in its policies, financial matters, or assets of the company that may affect an investor’s judgment of that company as an investment target.[11] These disclosure requirements are incredibly broad and, although somewhat onerous for the entities that must comply with them, appear to have encouraged investment in Turkish capital markets.

Expanded Privatization Laws (August 2003)

The main goal of Turkey’s new privatization laws is to accelerate the process of privatizing government assets. The Privatization Law No. 4046 was first enacted in 1994 and provided the general framework for privatization in Turkey.[12] Revisions to the privatization laws were put into effect via Law 4971.  The privatization laws are designed to:

  • expand the scope of assets to be privatized,
  • provide adequate framework, funds and mechanisms to speed up privatization,
  • establish a social safety net for workers who lose their jobs as a result of privatization, and
  • establish the Privatization High Council and the Privatization Administration to facilitate the decision-making process in the privatization endeavor.[13]

Banking Restructuring and Reform (January 2002)

Banking reforms during this period were modest but important. The main reform was an increase in capital requirements for banks.[14] Capital adequacy requirements were raised to a ratio of own funds to risk-weighted assets, non-cash loans, and obligations at a minimum of 8%.[15]

Also significant, yet not government implemented, the phenomenon of “creative destruction,” combined with M&A activity reduced the number of banks from 81 to 54 during the 1999 to 2002 period, thereby concentrating assets in fewer banks which increased banks’ ability to maintain adequate capital reserves.

Above mentioned regulatory reforms set the stage for broad economic expansion and drew more attention to Turkey from the global financial markets. This situation created a positive feedback loop that drew more investment to Turkish markets. As a result of these reforms and the increased global liquidity available at that time, Turkey witnessed a 500% increase in its ISE 100 stock market index from 2003 to 2007 and an 800% increase in foreign direct investment between 2002 and 2007. Turkey’s post-2001 reforms, in conjunction with the staggering availability of global liquidity during this period, led to unprecedented economic growth in the country. Year-to-year FDI went from a paltry $20 billion USD in 2002 to approximately $160 billion USD in 2007, an 800% increase.

Turkey’s equity markets, measured by the broad ISE 100, leapt 500% from 2003 to 2007. Again, we argue that this resurgence in Turkey’s markets would not have occurred in the absence of the global liquidity surge. As Pettis puts it, “when Chile for example, is benefiting from improvements in these underlying factors, there is no reason to assume that, coincidentally, Turkey, New Zealand, and Austria are also undergoing political and economic changes that suddenly make them better places in which to invest.” (pg. 53). Pointing out that despite this flow of funds to above mentioned emerging markets are highly correlated. This argument in support of the liquidity model is showing one of the reasons for expansion of FDI into Turkey but this flow would not have been effective or even possible if Turkey had not done the necessary changes in its law and regulatory system.

However, Turkey, as opposed to other emerging markets, would not have been a target for such liquidity had it not made the above-mentioned reforms.

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