Financial Liberalisation in Turkey
Background to the economy and reforms
From the 1960s until 1980 Turkey had an
uncompetitive financial market and an inefficient
banking system characterized by controlled
interest rates, directed credit, high reserve
requirements, restricted entry of new banks and
other restrictions on financial intermediation.
Many banks also exited Turkey during this period
therefore creating a concentrated market
dominated by banks owned by industrial groups
with oversized branch networks and high
overhead costs. The sector served was structured
to support state-oriented development and served
as an instrument of planned industrialisation
In the 1970s Turkey, as other developing
countries, experienced weaknesses in its import
substitution strategy and attempted to overcome
these by gearing towards a more outward
oriented economic development strategy.
Attempts at trade liberalisation were made in the
1970s but these were generally unsuccessful as
they were only short-term solutions to balance-of-
payments and foreign exchange problems.
During the 1980’s there was an accelerated
reform and adjustment process in almost all
sectors of the economy which started with
liberalisation of the foreign trade regime and the
financial sector, and culminated in the
liberalisation of capital accounts in late 1989. A
flexible exchange rate policy was also introduced
as were more effective measures to promote
export growth and gradually liberalise imports to
make Turkey more open to foreign trade. This
move towards greater freedom of trade created
the necessary external environment to enable
Turkey to benefit from trade gains.
Reforms also eliminated interest rate controls,
made it easier for new financial institutions to
enter the market, and introduced new types of
financial instruments. Regulatory barriers were
relaxed therefore attracting many banks, both
Turkish and foreign, into the system and
integrating it with world markets. The overall aim
of the reforms was to change the nature of the
economy from statism to a market structure with
the objective of achieving a more efficient
allocation of resources through the price
mechanism. Another aspect of Turkish financial
liberalisation was that it was undertaken with a
view to gaining eventual membership of the EU.
During the 1990s Turkey’s economy was
characterised by high inflation, high public
borrowing and high interest rates which crowded
out private sector direct investments. There was
also a lack of fiscal discipline, transparency and
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accountability in the public sector and major
structural problems in others sectors including
banking, energy, telecommunications and public
procurement. The country experienced severe
recessions in 1994 and 1999 after the
earthquake, and a serious banking crisis in 2001.
Government efforts at economic reform were half-
hearted with frequent reversals and hesitant
forward movements caused partly by political
uncertainty and partly by a reluctance to accept
the changing global economic realities. However,
after coming to power in June 1999, Ecevit's
coalition government accelerated the economic
reform process by passing a series of laws on
banking regulations, reform of the loss-making
pensions system, and international arbitration in
investment disputes. In August of that year
parliament also approved constitutional changes
clearing the way for private power projects and
privatisations of key energy companies including
Petrol Ofisi and Tupras which were privatised in
early in 2000.
In April 2000, a decree to break up the state
power company Teas into three companies for
generation, transmission and sales cleared the
way for the World Bank's $750m loan, and a
further decree subsidised farmers directly instead
of propping up agricultural prices. From the
beginning of 2000, the Central Bank pegged the
lira at a new exchange rate against both the US
dollar and the euro and in February 2001 moved
to a floating exchange rate. The Central Bank also
became independent in May that year. A further
spate of reforms was enacted between 2002 and
2007 around three key areas:
1. Structural reforms: speeding up of privatization
of the public sector, financial sector and
enhancement of the role of the private sector to
attract larger foreign direct investment (FDI)
inflows.
2. Fiscal policy: primary budget surplus, debt
management, social security and tax reforms.
3. Monetary policy: independence of Central
Bank, inflation targeting (January 2006), and
maintenance of the floating exchanger rate
regime.
Turkey’ s aim was to continue with a
comprehensive economic reform programme with
a view to avoiding falling back into the boom-bust
cycle of the past and overcoming the dualities
between the few highly productive enterprises and
the large number of low productivity companies
that hindered the country's long-term growth
performance. It is also took steps to move
towards a competitive market economy through a
continuation of structural reforms including
completion of the privatisation agenda and other
sectoral reforms including labour, education and
health.
Effects of the reforms
Turkey's reform programme has resulted in
impressive economic performance in the past few
years. GNP growth averaged 7.4% per year
during 2002 - 2006 compared with -1.6% between
1998 and 2001. GDP growth in 2007 was 4.5%
and cumulative growth between 2002 and 2007
was 40%. This was led largely by private
investment and consumption and also fuelled by
large capital inflows, declining interest rates and
credit expansion. Total factor productivity growth
also played an important role, having increased
from an annual average of 24.5% during 1996 -
2000 to 42% between 2001 and 2005. Due to the
robust economic growth, the unemployment rate
decreased from 10.3% in 2002 to 9.9% in 2006.
From a high of over 80% in the 1990s, inflation
has reduced to single digits since 2004. Public
sector debt decreased from 91% of GNP in 2001
to 29.2% in 2007. By the end of 2007 international
reserves exceeded US$ 76.4bn, more than 11.6%
of GDP. Privatisation revenue amounted to US$
8bn in 2006 and US$ 4bn in 2007. Financial
markets have performed well and banks have
improved both their capital adequacy, to over
30%, and also their profitability. The primary
general government budget operated an average
surplus of 5 percent of GDP from 2004 to 2008.
Turkey's merchandise exports have more than
doubled since 2002 and reached US$ 107bn in
2007. Manufactured goods contributed over 80%
of this followed by agriculture and mining
products. Machinery and transport equipment,
automotive products, textiles, food, iron and steel,
and chemicals are the main exports. In particular,
the share of automotive goods in total
merchandise exports has risen substantially over
the last few years, while that of textile and clothing
products has declined. More than half of Turkey's
exports still go to the EC and Germany remains
the single major export market followed by the
United Kingdom, France, Italy and the USA. The
reason for the change in the commodity
composition of Turkish exports was the new
development strategy which targeted
industrialisation through export growth and
resources were thus reallocated from the
agricultural sector to industry. Turkey was
exporting mainly resource-intensive agricultural
products in the 1970s, labour-intensive textiles,
together with leather and hide in the 1980s, while
rapidly growing capital-intensive export industries
emerged in the 1990s. Turkey continues to build
on an extensive network of preferential trade
agreements due to its customs union with the EC.
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Merchandise imports have also more than
doubled since 2002 and reached US$ 170bn in
2007. Manufactured goods represented about two
thirds of total merchandise imports followed by
mining and agriculture products. Machinery and
transport equipment, chemicals and automotive
products constitute the main imports. About half of
Turkey's goods imports originate in Europe,
mostly in the EU and Germany is still the leading
source of Turkey's imports, followed by the
Russian Federation, China, and the USA. Turkey
continues to be a net exporter of services and
generated a surplus of almost US$ 14bn in 2007.
The extent of openness of the Turkish economy
can be calculated by the ratio of exports and
imports to GDP and this was 17% in 1970, rising
to 20% in 1980 and to 34% in 1995. Reduction or
elimination of tariffs and quotas, and the
movement of resources from import-substituting
activity to the growth of export industries were the
main contributing factors in the liberalisation of
imports.
FDI inflows rose from an average of US$ 791
million during 1990 - 2000 to US$ 3,852 million
between 2002 and 2005. This rose further from
US$ 10bn in 2005 to US$ 22bn in 2007. The
services sector has attracted the large majority of
FDI inflows partly due to the privatisations of
several state-owned companies, followed by
manufacturing. However, FDI in agriculture and
mining has been very low. The EU is the largest
source of foreign direct investment in Turkey
providing almost 86% of its resources in 1996
and, although this has declined since, it still
provides more than half of FDI. Nevertheless, a
number of sectors are still subject to FDI
restrictions including broadcasting, fishing,
petroleum, mining and financial services.
Although reform has reduced concentration in the
banking sector, some problems remain. Leading
banks are still able to coordinate their pricing
decisions, therefore high profitability has resulted
from uncompetitive pricing rather than efficiency.
Deregulation and liberalisation need to be
continued and strengthened as market entry of
small-scale banks alone is not enough to increase
competition as these are incapable of altering
market structure. Further reform requires
addressing barriers to entry and reducing the
power of the large banks which exert a significant
negative effect on competition. Also, interbank
rivalry among the leading banks cannot be
facilitated without creating new banks of a certain
size with a reasonable number of branches.
Breaking up public banks, which hold 30 percent
of the sector’s assets, excluding the Agricultural
Bank and three development banks, could help
create 15 to 20 new banks with 40 to 50
branches. This would reduce concentration and
improve mobility in retail banking. Breaking up
public banks before privatisation may also
improve their governance structures and consensus and therefore are not likely to be
efficiency. Promoting the entry of non- banks and reversed.
local banks would also increase the number of
institutions competing for deposits. Turkey lacks a The moves towards liberalisation in the political
healthy variety of credit institutions and should and economic spheres are being undertaken by
consider developing a mortgage market and the secular Turkish leadership - both military and
institutions for housing finance. civilian - with a good understanding of the global
situation. They are well aware that the world is
Turkey’s economy has shown more resilience moving towards a multi-polar environment and the
than many in the recent financial crisis. objective is to make Turkey one of the important
International rating agencies have recently poles with links to Europe, the Middle East and
upgraded the country’s ratings to BB, the fourth Central Asia.
upgrading in three months, therefore recognising
the progress made in macroeconomic The energy sector is seen as a strategic catalyst
management of the economy. Inflation has which can help make this happen. Turkey
decreased and growth expectations for 2010 are continues to project itself as a corridor for energy
on the rise. However, unemployment at 13.1%, up supplies to Europe from Central Asia and the
from 11.0% a year earlier, is still a concern. Middle East, although none of the big pipeline
projects has materialised so far. Negotiations for
membership to the EU continue to be slow but if a
The Future deal can be reached over the dispute regarding
Cyprus, then things could move forward.
Under Turkey's ninth development plan, GDP is
expected to increase at an annual average rate of Finally, a debate exists as to the causes of
7% between 2007 and 2013, with a projected per financial liberalisation in Turkey i.e. are financial
capita income of US$10,100 by 2013. The share reforms the result of economic growth, or have
of agriculture to GDP is to decline to 7.8% by the reforms led that growth. There is probably an
2013, while the contributions of manufacturing element of both but, on balance, the reforms
and services are projected to increase to 27.2% would appear to have been driven more by
and 65% respectively. Exports of goods and Turkey’s economic growth and further reforms are
services, as a percentage of GDP are to rise from likely as the country becomes increasingly
28.2% in 2006 to 32.4% in 2013, while imports exposed to world markets and the effects of
are to fall from 35.9% to 35.8%. Turkey's long- globalization.
term strategy up to 2023 envisages promoting an
export-oriented, technology-intensive production
structure with emphasis on high-value-added
manufactured products and services. This is to be
achieved at the expense of agriculture, which is
projected to fall to 5% of GNP by 2023. In the long
term, the ratio of total investment expenditures to
GNP is expected to increase from c. 22% in 2000
to approximately 27% in 2023, and the share of
the public sector in total investments to decrease
from 30% to 10%.
February 2010
Unlike the other Muslim countries in the Middle
East, Turkey is the only one that is progressing
simultaneously on both the political and economic
fronts in terms of liberalisation. Democracy is
establishing itself, although Turkish liberalism is at
present limited mainly to secular lifestyles and still
has to make progress with regard to civil and legal
rights. In this respect, efforts are underway to alter
some structures to bring them more in line with
those of EU member states. Economic
liberalisation is a complex issue from the Turkish
perspective because, unlike most other Muslim
countries of the Middle East, leaders must take
decisions with one eye on what voters think. This
can have a slowing effect on the pace of reform in
the short-term but the changes that are being
implemented are being brought about by a broad