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Crisis Canice Liu Daniel Lim Eric Pradas Irmo Holslag Jordan Banov
Agenda • Exchange Rate Regime • Banking System • Foreign/Domestic Debt • Inflation • BOP • Summarize • Compare other crisis • Conclude
Exchange Rate Regime • Managed float up to 1999 • Pre-announced crawling peg starting 2000 • Stabilization program supported by IMF • Exit strategy after 18 months
The Banking System • Corruption • Banking licenses • Established and creditworthy borrowers • Uncovered Interest Arbitrage • Borrowed at cheaper foreign interest rates to invest in high yield domestic bonds
Total Domestic Debt (Treasury) • To finance budget deficit • Impact on inflation
Inflation & The Lira • High inflation vs. insufficient devaluation of the lira • Government spending (budget deficit) • Introduce crawling peg – inflation slow down
Balance of Payments • Imports > Exports because of overvalued lira • Negative trade balance – 22.4 billion • CA deficit: 1.3 billion (1999) to 9.8 billion (2000) • Financial account surplus • Seemed to indicate growing confidence • Warning sign – 7 billion increase in “net other investments”
Foreign exchange reserves of the Central Bank(Million dollars, Weekly Data, 1999.01-2001.12)
Adding it up • The banking system • High levels of debt • Exchange rate misalignment • Current account deficit • Insufficient actions on behalf of the government => Led to loss of investor confidence, speculation, massive capital flight, floating lira
Russian Crisis of 1998 • Comparison with Turkey’s crisis: • Corrupt practices and weak financial institutions • High levels of bad debt • External shocks • However in Russia, fundamental reason was not BOP deficit, but bad government.
Brazilian Crisis of 1999 Similarities: • Governments pursued a gradual but continual devaluation policy • High inflation rates (but lowered for Turkey in 2000) • Governments couldn’t keep the value of the currency after investors pulled their money out of the country • Both countries ended up with a floating exchange rate
Asian Crisis Similarities: • Corruption • Exchange rate misalignment • Persistent Current account deficit • Weak financial institutions • Uncovered Interest Arbitrage • High debt level • Speculative pressure • Crisis of confidence
Conclusion • Turkey’s Kriz reflected the underlying economic instability • Crises can be prevented by close monitoring of financial indicators • Recipe for crisis: • 2 cups inflation • Bowl of corruption • Sprinkle of economic boom • Exchange rate fluctuation mixed with lots of debt • Cook it on a “slow” government