Prepared By: Rosli Hasan, N0or Hidayu Rasman & Hanim Azira Mohd

Taib
Prepared For: Dr. Catherine Ho
Case Summary
 The case analyze the 3 sectors leading to
the Turkish Lira crash in 2001.
 First : Banking Sector
Licensing- not highly regularize
Upon approval, borrow heavily on USD
denomination loan in an international market
with low interest.
Reinvest in Government Bond on Lira
denomination with higher rate.
The Lira devalue, banks struggle to repay
their borrowings eventually will collapse.
Uncovered interest arbitrage (UIA) widely in
practice.
Case Summary

 UIA activities effect the Turkish financial

System
USD/Lira seems to be stable even Turkish
Inflation rate higher than US. The
devaluation of Lira was prevented due to
government intervention and conversion of
large quantities of dollar (loan) into Lira
Government deficit budget was finance via
selling of bond . Bought by their Bank,
prevent the market to warn the government
of the growing debt.
Devalue of Lira, leave the bank unable to
fulfill their loan commitment when it fall due.
Case Summary
 Second : Economic Death Spiral
 Upon Failure to repay the debt obligations, a
major Bank collapse. IMF was called for the
rescue.

 The economic reform was initiate as market

is open up, external debt to reduce,
government ownership in state enterprise
need to reduce, banking system need to clean
up.
 Case Summary
 Third : The Turkish Kriz
 Political instability created by open
confrontation between Turkish President
and his PM over corruption issue.
 This result in capital outflow of USD5
billion. Investor confidence was
shattered.
 Lira collapse ,together with the
economy.

Huge negative balance of payment in

2000.
Question 1: Was the Turkish lira’s
collapse the result of balance of payment
crisis, an inflation crisis, a political
crisis, or an economic crisis?

Answer
 In our opinion, the Turkish lira’s collapsed as a result of
balance of payment crisis, inflation crisis and political
crisis.
 Balance of Payment Crisis:
- the deficit on balance of payment grew dramatically in
2000, to over $9.8 billion, from a deficit in 1999 of only
$1.4 billion.
- capital account liberalization through a designed
stabilization program with IMF forced the government to
finance the deficit through government bonds
- Real interest rates on government bond soared; creating
arbitrage opportunities for private banks to exploit the
difference between the high rates on government
securities compared to foreign borrowing and domestic
deposits.
- In the end, the rising interest rates then forced the
Answer…
 Political Crisis
- On February 18, 2001, a
public argument erupted
between President Sezer
and Prime Minister Ecevit.
- The president had
accused the prime Prime Minister
minister of being "too Ecevit
passive" in the fight
against corruption, of
trying to prevent an
investigation of the
banking sector and of "not
respecting" laws. Mr
President Sezer
Ecevit said President Sezer
had "levelled grave
accusations against him,
using impolite language"
Answer…
- The prime minister and the cabinet are furious at
President Sezer, who has asserted his constitutional
right to call for investigations of his own by appointing
a board of directors to probe the transactions of state-
owned banks over the last 10 years.
The following day February 19,2001 international
investors pulled out over $5 billion of capital out of the
country.
- The Turkish central bank’s total foreign exchange
reserve, $20 billion, was unable to sustain a defense at
this rate of capital flight.
-Three days later, on February 22, 2001, the exchange
rate system collapsed and Turkey declared that it was
going to implement a floating exchange rate system.
The lira’s value immediately plummeted from
Answer…
Inflation Crisis
- Turkey has 50 years of history of high inflation and
unsuccessful disinflation programs.
- In cooperation with the IMF, Turkey designed in 1998
a stabilization program to reduce inflation. - The IMF
stabilization program included a crawling peg designed
to devalue the currency in line with targeted inflation.
However, virtually every other target was met, and
they were succeed in reducing the inflation rate from
64% to 39.03% .
- However, in February 2001 following the public war
between Turkey's Prime Minister Bulent Ecevit and
President Ahmet Necdet Sezer, a new wave of capital
outflows led to the collapse of the economic program.
Jittery investors pulled $5 billion out of Turkey on
February 19th alone.
- In the aftermath of the February crisis, the lira
collapse and inflation started increasing again to
Question 2: Describe precisely how the
Turkish banks were performing uncovered
interest arbitrage. Do you feel that this
was inappropriate investment policy?

Answer…
 Highly public sector borrowing to finance the balance of
payment deficit has created an uncovered interest
arbitrage opportunities for the Turkish private bank to
exploit the difference between the high rates on
government securities compared to foreign borrowing.
 The Turkish banking system was notoriously corrupt in
the latter part of the 1990s.
 Uncovered Interest Arbitrage by Turkish Banks:
(1) Throughout 1998, 1999 and the first half of 2000,
many Turkish banks borrowed large quantities of dollar
outside Turkey
(2)The banks then converted the dollar proceeds into
Turkish lira
(3) Then, purchased the government bonds as
investment.
The Uncovered Interest Arbitrage Diagram:
Value of Lira Maintain
The Uncovered Interest Arbitrage: Lira
lost its value
Answer…
 In our opinion, this was an inappropriate
investment policy.

 This is because the earnings of the banking sector

were highly dependence on the highly yielding
government bonds.

 For example, Demirbank was heavily concentrated

in government debt instruments business and
acting as a market maker to defend its position
and it was not active in traditional banking
business of collecting deposits and distributing
loans.

 This risky mode of investment can be found in the

QUESTION 3: How could the Turkish banks
be contributing to financial crisis if
they were purchasing Turkish government
bonds and helping finance and support
their own government?
 Borrowed money at low dollar rates and reinvesting in
much higher government bond rates in Turkish Lira.
 It helped finance and support their government to
finance their budget deficit and created significant
profit for the bank.
 When the Turkish bank invested their money to
government bond, indirectly it will help government to
generate economic activities from that money.
 The situation is temporary since the continuing demand
for Turkish government bonds increased the
government’s debt. It also allowed the government to
fund increasing budget deficits at manageable costs.
 It giving more badly since the growing external debt
obligation of Turkish banks was caused the instability of
the banking system.

 Once the obligations came due, and many of the bank

debts were callable in that the international banks could
demand repayment overnight, the rush to exchange lira for
dollars for debt service would drive the exchange rate
down dramatically.

 The lira’s was collapse since the balance of payment

current and financial accounts recorded major swings in
their relative values.

 According to that problem, international banks not

affordable to collect their debt from Turkish bank. It
caused international banks suffered from the Turkish
Bank’s high debt and also effected their financial.


QUESTION 4: Which do you think is more
critical to a country such as Turkey:
fighting inflation or fighting a large
trade and current account deficit?

 Fighting a large trade and current account deficit more

critical rather that fighting inflation.

 In February 2001, there was deteriorated of the Turkish

current account balance. Therefore, Turkish bank
borrowed money from international bank to stabilize
their current account. However Turkey government not
affordable to pay its international debt, it allowed the
government to fund increasing budget deficits at
manageable costs.

 It affected it’s current account deficit.

 Then, when international bank bring back their capital

to their country, it caused Turkey’s inflation increased
and exchange rate down dramatically.
 It can say that, because of current account deficit, Turkey
experienced high inflation rates.

 Turkish government turned to IMF for help. Unfortunately,

it was undertake a privatization program whereby it
reflected the political and trade relations.

 Turkish hard to fighting a large trade because European

Union was unfair and discriminatory barriers since they
were not in the spirit of membership.

 It caused Turkish experienced economic crisis and was only

attempting to slow the growing current account deficit.

 Turkey still can survive when fighting inflation if Turkish

banks not acquired the dollar-debt obligations from
international banks.
 Question 5: The quote from Corporate
Finance, although noting the outside
possibility of a devaluation, was largely
positive regarding Turkey’s future in
January 2001. What would you have
predicted
 The pendingat that time?
$7.5billion IMF support package and
standby arrangement are likely to ease market
concerns about the credibility of Turkey’s
stabilization program, particularly in view of the
revitalize privatisation agenda and strengthened
fiscal targets for 2001. The Turkish Lira has
strength on the back of IMF funding.
 On three-month view, however, expect the Lira to
return to track inflation performance suggesting a
level of below TL750, 000 by end of March. An
outside probability of full blown currency
devaluation- similar to that in 1993- cannot be
Answer
We would have predicted that same, given
the current situations, (January 2001). The IMF
bailout saves the banking sectors, bring the
stability and restore the investors sentiments.
However, the change of political situations
ruins everything. In February 01, the
investors pull out investment s worth USD5
billion, prompt the Turkish Central Bank to
defense the Lira value but its too big to
handle.
Last choice ,they float the currency in order
to restore the stability, leaving the market
force to determine the value of lira.
Answer….

 Immediate result, the Lira value plummeted

from TL685,000/USD to over
TL1,000,000/USD.
 The value continue to fall, bank collapsed,
economic activity halt and registered negative
growth.
 In long term, the floatation of currency will
bring the growth to the economy but in
practicality the government will intervene as
they will not allow the market forces to
determine the value of the currency if it will
bring harm to the economy
The government will not allow the Lira to
 Conclusion
 In conclusion there are many factors
that determine the value of currency.
 Dr David Aviel, Professor of
International business in his paper,
on foreign exchange markets,
currency devaluations and the
Malaysian strategy. List the
followings factors
 a) Inflation
 b) Balance of trade
 c) Government budget defisit
Conclusion….

d)Excessive money supply

e) External liquidity problems
f) Currency Black Market
g) Spot rate and forward rate
h) Fiscal and Monetary policy
i)Political situations
j) History of devaluation