CAPITAL FLOWS TO EMERGING

MARKETS AND THE TURKISH CASE

 

 

            During the 1960s and 1970s, gradually growing number of countries liberalized the operations which were most closely related to real economic activities, and for this reason this period was relatively stable one. But later, starting from the middle of the 1980s, other financial operations with shorter maturities began to be liberalized. Capital inflows to developing countries surged in the 1990s, following the long break after the 1982 debt crisis. In the same period composition of capital flows to emerging countries had also changed dramatically, and become more and more private in origin. Increased access to global financial markets has brought some benefits to some countries but it has also made them more vulnerable to sudden shifts in investor sentiment and attacks on their currencies.

 

Capital flows to emerging markets: an overview

 

            The peak in capital flows in 1993 turned into a slowdown in early 1994 and the Mexican crisis of December 1994, the Asian crises of 1997, the crises in Russia and Brazil the following year and the crisis in Turkey in 2001 created a volatile era in which shocks transmitted from one country to other through real and financial sector linkages and channels of market perception.

 

            Although capital flows did contribute to the crises, they may be thought as a result of  underlying macroeconomic imbalances such as widening current account and public deficits, fixed or predictable exchange rate regimes and liquidity problems in a country, region or international scene. Recent volatility of capital flows made more clear that another important cause of the crises in emerging economies is the excessive credit and currency risk-taking by banks as much as moral hazard problems, failure of prudential regulations and bank supervision and weak effective standards of financial transparency. These problems in international financial system encouraged the discussions about the need for a lender of last resort which may be operated as a “banks fund” or an “international central bank” to strengthen financial system, and the new proposal of capital adequacy of Basel Committee may also help to this end.

 

            During the crises of the last decade which were started and exaggerated by the sudden reversals in capital flows some developing countries imposed capital controls, in different degrees, as an emergency measure. The recent experiences with capital flow volatility suggests that controls may yield some short-term benefits, but entail significant long-run costs, and are not likely to be useful strategy to avoid future crises.

 

            On the other hand, foreign direct investments (FDI) have been the least volatile type of international capital flows for many emerging countries. The world’s top 30 host countries account for 95% of total world FDI inflows, and 90% of stocks.

 

 

 

 

 

 

Emerging Market Economies’ External Financing (billions of dollars)

	1998	1999	2000	2001f	2002f
Current account balance	-8.2	23.5	47.8	19.2	-18.5
External financing, net	195.2	151.7	165.5	135.7	147.5
Private flows, net	143.3	141.2	166.7	106.1	127.3
Equity investment, net	134.3	163.1	146.4	128.2	117.0
Direct equity, net	120.7	147.6	130.2	124.4	108.0
Portfolio equity, net	13.6	15.5	16.3	3.8	9.0
Private creditors, net	8.9	-21.8	20.3	-22.1	10.3
Commercial banks, net	-54.7	-47.5	-5.8	-22.5	-2.3
Nonbanks, net	63.6	25.6	26.1	0.4	12.6
Official flows, net	52.0	10.5	-1.3	29.6	20.2
IFIs	38.3	1.5	2.7	30.5	22.0
Bilateral creditor	13.6	9.0	-3.9	-0.9	-1.8
Resident lending/other, net1	-146.1	-120.2	-142.6	-99.1	-95.8
Reserves (- = increase)	-40.9	-54.9	-70.6	-55.8	-33.1

f : forecast

¹ including net lending, monetary gold, and errors and omissions

Source: IIF

 

In 2000, private flows to emerging market economies increased by % 18 arising from the increase in private credits instead of equity investment. Net private capital flows are projected to fall sharply in 2001 to about $ 106 billion from $ 167 billion a year ago. Not only the heightened risk aversion following the terrorist attacks in the United States on September 11, but also the sharp slowdown in global activity and the impact of earlier crises points out such a decline. Emerging markets had already been struggling with an uncertain external environment before the attacks, which have affected investor and consumer confidence and increased volatility in financial markets. Although strength and duration of the effect is highly uncertain today, the attacks seem to have increased risk aversion and reduced investor appetite for emerging market assets. Further impact will be a result of any retaliatory action by the United States and others. Also, possible additional economic actions by G-7 authorities in order to prop up confidence and growth prospects should also be considered. A weak recovery in private flows resulting from an expected increase in portfolio equity is projected for 2002. Large net outflows in Argentina and Turkey in 2001 are anticipated to turn into modest net inflows next year.  

 

Turkey is paving the way for international integration 

 

Turkey abandoned its inward oriented policy stance and embarked on an export oriented growth strategy in the beginning of 1980s. The key elements of this change have been trade, capital account and financial sector liberalization. By the mid-1980s all quantitative restrictions on trade were lifted and only minimal controls on the current account remained. The drive to liberalize foreign trade culminated in a customs union with the European Union in early 1996. The move to fully liberalize the capital account started in 1989 and through a series of decrees Turkey accepted IMF’s Article VIII in 1990. This marked the completion of the external financial liberalization process, which was initiated in 1984 when Turkish residents were allowed to hold foreign exchange denominated deposit accounts. The goal of capital account liberalization was put forward as further integration with international capital markets, and in particular the European Union. During these years Turkey also liberalized its financial sector, new foreign and local banks entered into system, determination of interest rates by market forces was accepted, many new financial products and services began to be supplied, and Istanbul Stock Exchange Market grew rapidly. These developments have positively reflected on growth, external balance and financial system.

($ million)	1980	1990	2000
GNP	58.320	152.260	202.300
Exports Revenue	2.910	13.026	31.214
Total Assets of Banking Sector	18.631	57.229	155.237

 

One of the major policy decisions was the adoption of liberal and flexible foreign investment policies. The Foreign Investment Law which were last revised in 1995, guarantees free transfer of profits, fees and royalities and in case of liquidation the transfer of capital. Equal treatment is the basis for all investors; foreign investors have the same rights and responsibilities as local investors.

 

(million $)	1990	1991	1992	1993	1994	1995	1996	1997	1998	1999	2000	July 2001
Current Account	-2.625	250	-974	-6.433	2.631	-2.338	-2.437	-2.679	1.984	-1.360	-9.819	881
Capital Account	4.037	-2.397	3.648	8.963	-4.194	4.643	8.763	8.616	448	4.671	9.445	-10.391
Direct Investment	700	783	779	622	559	772	612	554	573	138	112	1.793
Portfolio Investment	547	623	2.411	3.917	1.158	237	570	1.634	-6.711	3.429	1.022	-4.055
Equity	-45	56	300	431	994	120	198	-42	-347	481	-593	-315
Debt	592	567	2.111	3.486	164	117	372	1.676	-6.310	2.948	1.615	-3.740
Other Investment	2.790	-3.803	458	4.424	-5.911	3.634	7.581	6.428	6.586	1.104	8.311	-8.129
Of Which: short - term	3.000	-3.020	1.396	3.054	-5.127	3.713	5.945	1.761	2.601	759	4.035	-7.134
Net Errors & Omissions	-469	948	-1.190	-2.222	1.766	2.355	-1.782	-2.594	-1.991	1.897	-2.623	-1.544

Source: CB of Turkey

 

            With a long term perspective from 1990 to onwards, Turkey can not be said a big net capital importer especially for current account financing. In the period of 1990-2000 Turkey’s current account deficit and net capital inflow totalled to $24 billion and $47 billion respectively. These amonts represents nearly 1% and 2% of GNP on a yearly average basis. And it should be noted that $16 billion of current deficit and $18 billion of the capital inflow occurred in two years namely in 1993 and in 2000. Turkey’s annual average GNP growth rate was above 3.5% during this period but with a volatile trend. Capital inflows contributed to the growth of aggregate demand in Turkey via private consumption and investment by increasing total loanable funds, and this made Turkey’s growth path sensitive to fluctuations in capital inflows. Throughout this period the most important pull factor for capital inflows to Turkey was short term interest rate differentials.

 

The Central Bank of Turkey (CBT), during the period of 1990-1999, preferred to follow a managed exchange rate regime and sterilized capital inflows partially. With this exchange rate regime the CBT tried to hold depreciation rate of TL closer to inflation.

 

            In late 1999, the Government launched an extensive economic program backed by IMF based on preannounced exchange rates and structural reforms. Initial reform results were encouraging, but Turkey was hit by financial sector turmoil in late 2000 and February 2001. In response, the government strengthened its program further including tighter macroeconomic policies for 2001 and renewed commitments to structural reforms. A large number of legislative measures has been passed in the recent years and this has greatly advanced structural reforms in several important areas. Structural reforms are being accelerated particularly in the areas of banking, energy and privatisations. The most recent legislative development can be summarized as fallow.  

 

-Law for International Arbitration

-Liberalization of electricity and gas sectors in harmonisation with the EU Electricity and Gas Directive and opening of these sectors for  competition.

-The amendment for facilitating the privatisation of Turk Telekom.

-Sugar Law

-The amendment in the Tobacco Law is underway

-Amendment in the Central Bank Law

-Law for tax allowance in the pension savings and investment system.

-Enabling tax advantage for the mergers of banks.

 

            Both programs represent a significant turning point in the policies on capital account. With both IMF backed  economic reform programs, Turkey has given up the last decade’s strategy based on interest rate differentials and replaces it with a market oriented policy which targets to attract FDI.

 

Market oriented privatisation and new legal framework to speed privatisation transaction with individual investors and purchasing groups is the vital part of the structural reform policies. The privatisation of THY(Turkish Airlines), TÜPRAŞ(Oil refinery), POAŞ(Petroleum distribution) and PETKİM(Chemical) are among the leading privatisation transactions of 2001. TEKEL (Tobacco and alcohol monopoly) has been included privatisation program and it will be privatised within 3 years.

 

            Successful implementation of the structural reforms will increase the economy’s efficiency, thus facilitating sustainable growth pattern and the most favourable climate for investments. Meanwhile The Turkish Foreign Investments Advisory Services (FIAS) a joint facility of the international Finance Corporation and the World Bank completed a study of the Administrative Barriers to Investment to enhance foreign direct investment environment in  Turkey and the necessary changes are underway.

 

            Turkey has a very dynamic private manufacturing sector and it is a major manufacturing base for a number of important multinational corporations. The experience of more than 5.500 foreign capital establishments, including 104 of the Fortune Top 5.000 companies, confirms Turkey as a predominant investment location. Unique geographical location, a fast developing economy, a huge domestic market, high-skilled labor, high quality standards, the gateway of energy resources, a state of art telecommunication network, strong ties with Caucasia and Central Asia are the salient assets of Turkey. Turkey is likely to use these assets so long as the structural reforms is to be effective in the near future. We believe that Turkey will attract more FDI in this decade.

 

Ayse Ozlem Cekim