Alexandra Zeitz (St Antony’s College, University of Oxford)
Speaker: Gazi Ercel, Former Governor of the Central Bank of Turkey
Chair: Nicholas Morris, St. Antony’s College, University of Oxford
How to prevent cycles of financial crises in emerging market economies? What interventions and reforms can stabilize and strengthen these economies in the aftermath of a financial crisis? Drawing on his extensive experience in Turkey, Gazi Ercel, former Governor of the Central Bank of Turkey, shared his insights on financial crises and reform in a PEFM seminar in late April, stressing the importance of reducing political uncertainties and ensuring post-crisis reforms are carried through once economic conditions improve.
Examining the record of financial crises in Turkey in the last four decades, Ercel identified common causes. In almost all crises the country has faced in recent history, public sector deficits had expanded, which provoked investors to withdraw short-term capital and in turn plunged the economy into crisis. For instance, Ercel attributed the inflows of large volumes of short-term capital in the lead up to the 1978-1979 crisis to a positive World Bank report. When these investors abruptly and rapidly withdrew in light of worsening public sector imbalances, the country experienced its worst foreign exchange crisis in three decades.
Domestic political economy, especially the pressure for a rising public sector wage bill, is at the root of the persistent public deficits that prompt financial crises, argued Ercel. The instability of Turkish politics exacerbates this problem, disincentivizing fiscal discipline as governments seek to maintain their hold on power.
In addition to identifying these Turkish political dynamics, Ercel argued that the particular causes of financial crises in emerging economies are distinct from those in developed economies. While industrialized economies are more likely to experience crises in their capital markets, emerging economies are frequently hit by debt crises. Emerging markets are likely to have weak and unsophisticated banking sectors, which may cause fragility, while instability in developed economies stems from the complexity and lack of transparency in banking sectors.
Post-crisis reforms in emerging markets should therefore target these areas of weakness, argued Ercel, prioritizing policies on debt management, public finance, inflation and structural reforms. Most importantly, both politicians and regulators should act as quickly as possible in the aftermath of crisis to restore credibility and reduce uncertainty.
However, reformers must remain vigilant as the crisis recedes into the distance. Using examples from Turkey’s recent past, Ercel highlighted how political commitment to post-crisis reforms dissipated in the years after the downturn, leaving structural flaws in place. For instance, in the aftermath of the 1994 crisis, new banking regulation was introduced through an executive decree. However, implementation of the law was delayed until a constitutional court decision five years later, leaving the banking sector effectively unregulated in the intervening years.
In the aftermath of the 2001 financial crisis, too, there was initial commitment to structural reforms aimed at ensuring fiscal discipline and strengthening central bank independence. However, Ercel argued that reforms to the central bank were insufficiently institutionalized, soon leaving it vulnerable to political pressure again. Other reforms, such as independence in the energy sector, were also gradually rolled back over the course of the decade.
Analyzing the cycle of crisis and reform in Turkey in recent decades, Ercel highlighted the obstacles to thoroughgoing reform. In an uncertain political environment, sustaining commitment to structural reform is challenging, especially when those reforms target politically sensitive areas such as civil service employment. As some in the audience pointed out, Turkey has also made itself particularly vulnerable to volatility and crisis through a liberal capital account policy. However, it seems clear that current trends towards greater centralization of political authority in Turkey may only exacerbate the cycle of public sector imbalance and crisis.