Turkey Shoot?

Turkey's renewed currency woes--which saw the lira's value drop by more than a third after it was allowed to float freely in February--once again highlight the financial vulnerability of emerging markets. That in itself is not new. It was just this past November that Turkey last stood at the brink of an acute liquidity crunch. At the time, the International Monetary Fund (IMF) and Western commercial banks rushed in to shore up investor confidence--apparently to little avail.

But beyond the gloomy headlines, it's useful to remember that the same week Turkey was sliding into that last crisis in late November, Vicente Fox was preparing to take office as President of Mexico. In the ultimate analysis, the connection of these two events--as obscure as it may first appear--actually offers Turkey reason for hope.

For starters, despite all the obvious differences, the present situation in Turkey is remarkably similar to the financial crisis that gripped Mexico in 1994 and 1995. Since then, however, Mexico achieved a remarkable turnaround in its economic and financial fortunes, which led to the peaceful and remarkably crisis-free transfer of power to President Fox. Mexico has thus impressively demonstrated what a country needs to stop the cycle of devaluation and financial crisis that is all too prevalent in the developing world: tough economic and political reforms, brought on by the catalyst of a severe financial crisis. Just as in Mexico, Turkey's old establishment may need to be swept aside before lasting financial stability is achieved.

Interestingly, the Turkish crisis was triggered by a dispute over corruption investigations. That illustrates the real cause of Turkey's foreign exchange problems. Banking reforms have moved too slowly because of government reluctance to touch politically influential bank owners. This exemplifies a crucial similarity between Mexico and Turkey. In both cases, the crisis was not triggered by foreigners, but by primarily domestic actors.

In Mexico, the first to get wind of trouble were the country's own political and business elites, who--acting on their own early warning systems--moved their funds from domestic banks to dollar-based bank accounts in Miami. That threw the undercapitalized domestic banks into a crisis from which they never emerged. As a result, much of Mexican banking is now in the hands of foreign institutions.

This is exactly what seems to be happening in Turkey right now. Financial markets are responding to concerns about the stability of the country's medium-size domestic banks, as richer Turks, who are best placed to know what's going on, vote against the government's policies by transferring their assets to offshore accounts. Economic disruptions then become a self-fulfilling prophecy as local depositors flee domestic banks and spur financial market turmoil.

But the Mexican example shows light at the end of the tunnel. There, the IMF bailout triggered a handsome payback in terms of more democracy, transparency, and accountability. The last PRI government in Mexico spent six years implementing and deepening economic reforms, bolstering the financial system, and improving the business climate. Putting the banking sector on a proper footing was a key part of those reforms. That, in turn, played a key role in weakening the power base of the old political establishment. As a direct result, for the first time in decades, power has been transferred peacefully to a different party--without triggering a devaluation or severe financial turmoil.

Just as in Mexico, the current political elites in Turkey will eventually give way. The government is unstable, and the three parties that make up the ruling coalition lack commitment to reform, unity of purpose, and stomach for decisive, concerted action. Although Prime Minister Ecevit and President Sezer may disagree on the pace of reform, in a few years the Turkish ruling class will no longer be able to prevent the emergence of a new, non-corrupt leadership. Financial markets today are giving a vote of non-confidence to Turkish political elites. They are calling for some new blood. So will the huge majority of the Turkish population suffering from rising inflation and eroding incomes.

The resulting urgent need for banking reform--and broader economic and political changes--will likely pull the rug out from under the old guard. And the country will need some Young Turks to take the country into the 21st century.

Stephan Richter ([e-mail]) is publisher of TheGlobalist.com