A Hiccup in Turkey’s Prolonged Credit Fueled Economic Transition: A Comparative Analysis of Before and After the August Rout

Mustafa Kemal’s well-organized resistance army was victorious in the Turkish War of Independence, which expelled the occupying armies; subsequently, Mustafa Kemal abolished the Ottoman Empire in 1922 by overthrowing Sultan Mehmet VI Vahdettin and established the Turkish Republic in 1923. No doubt, there is absolutely no other event or development is more important than this in the young history of the Turkish Republic. Economically, the 2001 Turkish economic crisis was the greatest shock since 1923, which cost the government in excess of $50 billion and led to the signing of three standby agreements (over $ 40 billion) with the IMF. Turkey's near meltdown economy, a casualty of repeated speculative attacks on Turkish lira in August 2018 and the subsequent unfolding events, had contracted 5% or so in 2018 compared with that of 2017, and it is forecast to contract further in 2019 after a decade-long credit-fueled boom. It is feared that the farfetched implications of the August rout of 2018 could toss Turkey back in high inflationary mode; however, Turkish government authorities have dismissed the recent severe economic trouble and blamed the crisis on dysfunctional and hostile policies of non-economic basis. Regardless, in the immediate aftermath of the August shock, Turkish lira plummeted 42% of its value against dollar (i.e. from 5.09 on August 2 to 7.24 on August 13) and inflation (CPI) soared to 26% which prompted the Turkish central bank (TCMB) to hike the fund rate by 625 basis points to 24%. Although the Turkish lira has appreciated substantially against dollar since August 2018 (from 7.24 on August 13 to 5.61 on August 2, 2019), Turkey’s unemployment rate surged to 14.7 in February 2019, which is the highest level in a decade. Turkey’s depressed economic situation is in desperate need of foreign capital flows used by the financial authorities to service the debt obligations, but Turkey’s external barrowing have become substantially limited in recent years. With massive foreign debt stock (about $400 billion which is over 50% of its 2018 GDP), Turkey must find ways to attract capital inflows in the form of FDIs and FPIs.


Introduction
Turkey's near meltdown economy, a casualty of speculative attacks on Turkish lira in August 2018 and the subsequent unfolding events, is forecast to contract in 2019 after a decade-long credit-fueled boom. The Fed's historically low interest rates due to its expansive monetary policies in the aftermath of the 2008 global financial crisis (GFC) were a trap luring Turkish banks to borrow cheap greenbacks (i.e. dollar glut) which were lent back domestically to private businesses who now agonizingly face the amplified dollar dilemma because their substantially devalued cash flows are in lira while their foreign debt is mostly dollar (and euro) denominated (see Figure 1). According to the Turkish central bank (TCMB), Turkey's hemorrhaged gross external debt has alarmingly exceeded $400 billion at the end of 2017 and people fear that things may get a lot worse (double-dip recession) before recovery.
Many economists forecast further contraction in the broader economic activity in 2020; a wide ranging estimates show that Turkey's fragile economy may contract between 1% and 5% in 2020.
Source: TCMB -Turkish Republic Central Bank https://www.tcmb.gov.tr/wps/wcm/connect/EN/TCMB+EN/Main+Menu/Statistics/Chart+Gallery Although the August rout of 2018, the biggest currency shock since the 2001 Turkish economic crisis, could toss Turkey back in a high inflationary mode; Turkish government authorities have dismissed the recent severe economic trouble and blamed the crisis on dysfunctional and hostile policies of noneconomic basis. For the past four decades, Turkey's economy has been characterized as one with high inflation and persistent chronic of current account deficit (for a fuller discussion, see Altug et al., 2008;Aricanli & Rodrik, 1990;Eken & Schadler, 2012); nevertheless, Turkey's present gloomy economic situation is far more improved than that of the late 1960s during which the average exchange rate of USD/TRY was about nine lira per dollar (see Boratav, 2009;Boratav & Yeldan, 2001). 48 The new millennium has not only brought the biggest currency shock and the resultant economic collapse in Turkey's history, but also instigated a fresh start in Turkey's unstable political arena. The  (Önis & Aysan, 2000;Özatay & Sak, 2002;Yeldan, 2001). In the face of Turkey's huge progress of fiscal and structural reforms since 2002, its economic growth (stable exchange rates) has been costly and crisis-ridden. 3  (1950-1960), Justice Party (1965-1971), Motherland Party (1983-1991, Justice and Development Party (2002-present). There were coalition governments in-between; four governments (1973)(1974)(1975)(1976)(1977)(1978)(1979)(1980) and seven governments during 1991-2002. 3 Economic boom in the 1950s was interrupted by the 1960 military coup; the growth was reasonably moderate in the 1960s; export boom and resultant good growth in the 1980s; good growth and single digit inflation (2017) during AKP. 4 The US President Ronald Reagan and the UK's Prime Minister Margaret Thatcher made privatization become a household name; their eternal legacies and unique approaches have been referred to as "Reaganomics" and "Thatcherism". 49 rather bad for Turkey, therefore the 2001 economic crisis was inevitable. Furthermore, the seeds of Turkey's current economic problems had been planted by the last three bailout packages prior to and in the aftermath of the 2001 crisis (Önis, 2009;Raina & Bakker, 2003). After the AKP's win in the 2007 parliamentary elections (47% of seats), Prime Minister Erdoğan had said "No IMF in Turkey's future" 5 (Eken & Schadler, 2012); accordingly, Turkey made its last payment of the outstanding balance from the 19th standby agreement to the IMF in May 2008. Many contend that Turkey's divorce from the IMF can hardly qualify as a graduation since the country is on the brink of a financial collapse. Turkish lira barely lost value against the dollar (1.4050, a depreciation of circa 5%). In stark contrast to a mix of fear and speculation, Turkey managed to escape the adverse effects of the GFC with a minor dent in its economy. Regardless, Turkey is in constant need of capital inflows in order to service its foreign denominated debt obligations and finance government-supported infrastructure projects to leap into the next higher level of economic performance to catch up with the advanced nations.

Journal of Accounting, Finance and Auditing Studies 5/4 (2019): 46-66
Turkey had milestone achievements in the 1990s; as such, a customs union agreement 6 between the The economic crisis of 2001, inevitable contagion of contemporaneous crises throughout the 1990s (for Asian crisis' contagion, see Baig & Goldfajn, 1999), was a wake-up call for the Turkish government and its regulatory body of banking and supervision (abbreviated as BDDK in Turkish). Following the 2001 crisis, financial authorities finally understood the critical importance of painstaking fiscal and monetary policy decisions that manifestly contributed to stability; as a result, government debt ratios declined substantially and inflation was tamed during 2005-07 and 2012-17 (average CPI of 5-6%).
A stable macroeconomic environment resulting from higher growth, profitable banks, and improved FSIs alleviated risks and this resulted in positive country ratings. These factors and more have made Turkey's image shine at home and abroad, triggering a surge in FDIs and FPIs 9 (IMF, 2007). 6 Although the Customs Union Agreement between Turkey and the EU was signed in December 1995, the process actually began more than half a century ago with signing of the Ankara Agreement in 1963 to abolish tariffs and quotas.. 7 In 1963, Turkey signed the Ankara Agreement (EEC-Turkey Association Agreement) and became an associate member of the EU in the following year (1964), More than two decades later, Turkey applied for full membership on 14 April 1987. 8 1999 was the darkest year, earthquakes in August and November at the magnitude of at least 7.2 claimed more than twenty thousand lives and cost billions of dollars. Just as Turkish people were trying to deal with tremendous pain and suffering, they were hit by an economic crisis which was the biggest financial shock in Turkey's history. The farfetched implications of two crises, natural and financial, took an unbearable toll on the citizens of Turkey. Directly related or not, 9 FSI: Financial soundness indicators; FDI: Foreign direct investment; FPI: Foreign portfolio investment (stocks and bonds).

Literature Review
Turkish economy has encountered numerous economic and financial shocks 10 , three of which turned into high-magnitude crises and the fourth potential economic crisis is in the works since the August rout of 2018, but virtually all of them were somewhat related to the first external borrowing took place by the Ottoman Empire 11 in the mid-19th century before it was succeeded by the new Republic of Turkey 12 (Akyüz & Boratav, 2003;Celasun, 1998;Ertuğrul & Selçuk, 2001;Kibritçioğlu, 2001). Once militarily superb and financially resilient Ottoman Empire -for the first time since its establishment in 1299 -was forced to borrow consequent of its fatal decision to participate in the costly Crimean War (1853-56), this also marked the beginning of the ailing Empire's everlasting addiction to foreign barrowing (Inalcik & Quataert, 1995;Caillard, 1894). Over a century later, Turkey's gloomy economic situation 13 attests that not a thing has changed; then, the Ottoman Empire was besieged by loans from Britain and France that put a leash on its economy forcing Sultan Abdülhamid II to create the Ottoman Public Debt Administration (OPDA) in 1881 in order to administer war reparations and the Empire's debt (Blaisdell, 1929; also see Birdal, 2010 for striking similarities between OPDA and the IMF).
As Keynes (1919;1936) advocated the necessity of government intervention during a depression like crisis; in the early days of the war-devastated Turkish Republic (1923-38), Atatürk realized that any type of a factory to produce goods had to be built by the government due to a lack of skilled labor, raw materials, private capital, and potential investors. Therefore, this was the start of an era in which any sort of production in Turkey was done by the state-owned enterprises (see Boratav, 2009;Nas, 2008). Bredenkamp et al. (2009) argue that the Turkish economy ensuing severe financial or economic crises tends to follow an inward-looking growth strategy characterized by rigorous regulation, protection from foreign rivalry, and increasing state ownership in commercial activity. Without an exception, a crisis in Turkey is fostered by a credit-fueled boom that turns ordinary folks into avid buyers; this in turn creates large deficits and substantially increases debt levels of households and private firms. 10 For further readings, see Taskinsoy (2008;2012a, b, c;2013a, b;2019 a, b, c, d). 11 For longer discussion and historical perspective on the Ottoman Empire's public debt, see Caillard (1894), Eldem (2005), Owen (1987), Urquhart (1833), Fişek (1968), Genç (1987), Issawi (1966), and Goodhart (1972). 12 Mustafa Kemal's well-organized resistance army was victorious in the Turkish War of Independence, which expelled the occupying armies; subsequently, Mustafa Kemal abolished the Ottoman Empire in 1922 by overthrowing Sultan Mehmet VI Vahdettin and established the Turkish Republic in 1923. Ataturk was elected as the President in 1923 and the Grand National Assembly of Turkey (TBMM) honored him with the title Atatürk in 1934 which means "Father of the Turks". 13 Although at times the Turkish economy has enjoyed low inflation and a more manageable deficits of current account and government budget, it is still highly vulnerable to endogenous and exogenous shocks due to its extremely high reliance on external borrowing to service its debt obligations that come due in the short-term and in the long-run. Another big reason why Turkey's economy is susceptible to shocks is the fact that the country has always lagged behind compared to peers in terms of adopting and implementing international banking standards (see Taskinsoy, 2013a, b;2018 a, b, c;2019 e, f, g, h). Due to the United States' repeated abuse of sanction power and its use of dollar as a weapon of economic destruction, Turkey (also China and Russia) has been trying to accumulate gold to reduce its elongated addiction on the U.S. dollar (for a fuller discussion on alternatives to dollar, see Taskinsoy 2018d; 2019i, j, k). Turkey's inevitable balance of payments and debt crisis in 1977-79, which was also contributed by macro events that triggered the oil crisis in the same decade (for a perspective on Adnan Menderes and his Democratic Party, see Akın, 2002;Albayrak, 2004;Armaoğlu, 1994;Aydemir, 2013). The decade of the 1960s in many aspects was challenging, increasing instability was apparent in every facet of life; consequently, GDP growth was low attributable to high inflation (circa 16% in 1959-60) and large current account deficit (Dibooğlu & Kibritçioğlu, 2001;Domaç, 2003). In 1960, the GDP of $14 billion is only 1.6% of the 2017 GDP of $851 billion and the GDP per capita of $509 is less than 5% of $10,541 in 2017. In addition to augmented political turmoil and social unrest, the devaluation

of lira in August 1958 caused a spike on inflation and a surge in dollarization that in turn resulted in
a contraction in the broader economy. While Turkey was muddling with extreme problems at home, the IMF was waiting anxiously on the sideline to put a leash on the Turkish economy via its stringsattached bailout loans; due to the mounting political and financial pressure, Turkey gave in and signed its first standby agreement with the IMF in January 1961. Turkey expanded its GDP in the 1970s compared with the previous decade, the GDP per capita fell by about 4%, from $509 in 1960 to $490 in 1970 (see Dibooğlu and Kibritçioğlu, 2004;Karacal & Bahmani-Oskooee, 2008;Pongsaparn, 2002).
The decade of the 1980s -coined as a "lost decade" 14 -began in Turkey with the inheritance of great had produced more instability than stability in Turkey in the long-run (see Furman & Stiglitz, 1998;Stiglitz, 2004;Rodrik, 2001 Stiglitz, 2004). 16

Increased capital inflows in the form of FDIs and
FPIs is a common feature of capital-market liberalization, but the downside is that financial integration may make some developing and emerging market economies more prone to crises.
As the 1980s was a "lost decade" for many countries in Latin America (i.e. unable to service foreign debt, suspend payments or unilaterally declare a debt moratorium), the 1990s had qualified as a lost decade for Turkey as its economy was in deep recession by the mid-1990s ensuing the 1994 economic crisis (Aricanli & Rodrik, 1990;Boratav & Yeldan, 2001;Celasun, 1989;Ekinci, 1990). Mody and Schindler (2005) argue that the growth during Özal administration responded strongly to the capital 14 In the 1960s and 1970s, some countries in Latin America, namely Brazil, Argentina and Mexico incurred far more foreign debt than their ability to repay them back (principle plus interest). In just several years, the debt stock of Latin America exceeded from $75 billion in 1975 to over $300 billion in 1983. 15 The Organization of the Petroleum Exporting Countries (OPEC) sharply raised the oil prices as a retaliation to the U.S. for its aid to Israel during the Arab-Israeli conflict and the subsequent Yom Kippur War in 1973. The price of oil skyrocketed from circa $3/barrel in 1969 to $12/barrel in early 1974. For economic effects of the 1973-79 oil crisis, see Burbidge and Harrison (1984);Finn (2000); Blanchard & Gali (2010); Skeet (1988); Leduc & Sill (2004). 16 Under neoclassical economics, assuming perfect information, perfect capital markets, and perfect competition exist, capital market liberalization should lead to growth and reduced volatility; however, it should also be noted that there is asymmetry of information, imperfect capital markets with frictions, and competition is far from perfect (Obstfeld & Rogoff, 2000). Procyclicality, arbitrage, high volatility in exchange rates, and beggar-thy-neighbor policies are other issues (Lewis, 1995). The biggest negative effect of capital market liberalization is that it reduces the government's ability and capacity to adequately respond to macroeconomic shocks. The IMF's capital market liberalization has made Turkey more prone to economic and financial crises because Turkey greatly lacks of transparency (i.e. imperfect information). market and trade liberalization, however the anticipated positive impact of the fiscal and structural reforms 17 was undermined by a poor financial discipline by the government. The perceived success of Özal's economic programs were overshadowed by the growing current account deficit bubble and staggering foreign debt. Additionally, Rijckeghem and Üçer (2005) argue that rising political turmoil, growing concerns about bank soundness, and worsening economic indicators created a perfect storm that subverted market confidence. Rawdanowicz (2010) points out that financial or economic crises in Turkey are usually the end result of Turkey's chronic current account and budget deficits. Capital-market liberalization as the IMF policy required for bailout loans combined with large deficits of current account and government budget as well as lira's devaluation led to the 1994 economic crisis (Bruno and Easterly, 1998;Feldstein, 1998;Rodrik, 1997;Stiglitz, 1997). In each of Turkey's three high-magnitude crises, the GDP declined 5% or more (see Table 3) and lira plummeted in excess of 50% against the dollar; circa 60% in 1994, 70% in 2001, and 50% in 2009. At the backdrop of deteriorated economic indicators (a recipe for currency crises, i.e. Kaminsky et al., 1998), inflation "a monetary phenomenon" (Friedman, 1970) skyrocketed in 1994 (125%) and 2001 (70%), but tamed during 2008-09 (circa 10%). Egeli (1999) argues that crisis-inflicting aspect of budget deficit is more apparent in developing and emerging market economies than advanced nations (Peker & Acar, 2010), Şen et al (2007) believe that geopolitical alignments and military risks could tick inflation upward.
Under the helm of the IMF, macroeconomic policy adjustments were main concern of tackle in Turkey during and after the 2001 crisis; enormously challenging task was to prevent falling asset prices and try to keep inflation tamed; moreover, fiscal policy (Friedman, 1948) was reserved to provide limited support for capital outflows and to finance, if needed, any bank re-structuring or assuming private debt of ailing insolvent banks (Gros & Selçuki, 2013). These essential reforms could be seen as the first phase in the long recovery process (Quinn, 2003), nevertheless they need be taken immediately to restore the investor confidence and at the same time allow a sustainable growth to resume without any speculation or doubt of its resilience (Bredenkamp et al., 2009). Risks were still tilted to the downside as Turkey's protracted bid for its accession to the EU was blocked by Cyprus in December 2009 plus then the Prime Minister Erdoğan had blamed the IMF and its policies for Turkey's economic problems and said "No IMF in Turkey's future" 18 and "the IMF chapter will not be reopened" 19 .
The repeated speculative attacks on lira in August 2018 were unprecedented and the ensuing massive damage on the Turkish economy has been far greater than that of Turkey's antecedent crises (1994, 2001, and 2009 , 8.4% in September 2011, 8.4% in September 2012, 9.3% in September 2013, 10.5 in September 2014, 10.3 in September 2015, 11.4 in Sep 2016, 10.7 in Sep 2017, 11.5 in Sep 2018 in January-February period in 2019. Owing to the political stability since 2002 helped by a ruling party without a coalition 21 , Turkish lira has experienced rare stability. Between July 23, 2009 and August 1, 2018; lira's low volatility during this period was positively correlated with major currency pairs (see Table 4 Table 5 illustrates the correlation between lira and other major currencies following the August rout; unfortunately, Turkish lira's plummet against dollar tops the list when it is compared with the same currency pairs in Table 4, no statistically meaningful correlation; USD/ZAR (0.5745), USD/BRL (0.5553), USD/CNY (0.3941) had faced some volatility against dollar.

Concluding Remarks
Before the recent August rout, for analysis purpose, the Turkish economy is usually divided into two distinct periods; before and after the 2001 economic crisis. Except a brief period of stability ( Due to the lack of financial, fiscal, and monetary discipline, privatization of the state-owned entities since the 1980s and capital market and trade liberalization in the 1990s have produced instability rather than stability, therefore the 2001, 2009 economic and currency crises and the August rout of 2018 were inevitable; in fact, any potential crisis in the near future will also be triggered by the same factors that are never resolved. The biggest negative effect of capital market liberalization is that it has reduced the government's ability and capacity to adequately respond to macroeconomic shocks. The IMF's capital market liberalization has made Turkey more prone to economic and financial crises because Turkey continues to lack transparency (i.e. imperfect information) and governance.
Turkey's gloomy economic situation is in desperate need of foreign capital flows as Turkey's options to service its debt obligations through external barrowing have become substantially limited in recent years. With massive foreign debt stock (about $400 billion which is over 50% of its 2018 GDP), Turkey must find ways to attract capital inflows in the form of FDIs and FPIs.