Financial Crisis in Turkey and Argentina

Abstract

The study aims to develop a more profound understanding of the financial crisis in the emerging economies during the period of 1999 to 2001. The two emerging economies further selected for a comparison are Argentina and Turkey. Both the countries have exhibited similarities in economic and political background hence the underlying causes for the crisis have also found some similar ground. The few common fallacies include baking sector failures, failure of a market economic structure and labour market imperfections. Both the economies attracted foreign investments prior to the years of crisis, resulting in one of the highest-ranking stock markets however, resulting in an economic bubble that burst in the midst of shortfalls in the financial markets in terms of lack of fiscal stimulus, monetary policy and a mitigating role of the central bank. The crisis management has also been incorporated in the analysis whereby identifying the flaws and strengths of each economy as a social and political milieu. Sufficient secondary research has been carried out using the inductive approach to study, shedding light on the important aspects of various theories, books, and journal articles. The study also provides some valuable recommendations based on the empirical research in the studies.

Introduction

Background

A financial crisis is a situation where the value of assets and financial institutions falls rapidly and is exacerbated by the investor behaviour. This string of sell offs initiated by the investors can result in a serious economic recession if left unchecked. Whereas Hermann’s model focused on three variables that defined crisis including surprise, short decision time and threat to valued goals, the new models focus on perception as an integral prerequisite to establish a theoretical meaning of crisis (Billlings, Milburn and Schaalman 1980). According to Weiner and Kahn, financial crisis has no defined meaning but is influenced by different political orientations and perceptions. Hence a crisis is defined by the decision maker’s approach and perception towards understanding the magnitude and nature of the situation (James 1978).

The research thus focuses on the financial crisis inflicting Argentina and Turkey in the years 1999-2001. Both the economies were hit by a financial crisis and faced worst economic conditions and stock market collapse (TotirFelix 2011). Thus the significance of the study lies in its implication to serve as a remedy to manage the economic crisis and the most practical policies to peruse.

The success of Argentinean economy before the crisis surprised many as prior to 1999 Argentina experienced economic growth and precisely outplayed the other economies in the region with favourable external economic indicators. However, the Russian crisis in 1999 reversed the economic conditions for the country and the economic position took a down turn. The retrenchment in capital flow not only resulted in a deeper recession but also Argentina to be hit with a severe external shock than other countries owing to weak financial policies and the corrupt regime of De la Rua government. The paper aims to examine this very question as to why the Argentine economy was more vulnerable to external economic shocks than rest of the Latin American economies and the underlying reasons of a multiple nature (Perry and Serven 2002).

On the other hand, the Turkey has been experiencing economic deficits since the 1980’s and the crisis which had its roots in the failure of an exchange rate stabilization pregame that hit the country in the financial year 2000, worsened the economic conditions. The major cause of this crisis was the political instability in proposing a corrective exchange rate system; whereby in 1999 the managed floating exchange rate system was proposed, the year 2000 saw an implementation of the crawling pegged system. The interest rate increased four times whereas the bond market rates also proliferated five times more than the lira. A collapse of the proposed exchange rate system resulted in Turkey to implement the floating exchange rate system. What makes this topic interesting is that the crisis hit Turkey in the midst of a stabilization programme already under implementation by IMF (Guven and Ozatay 2002).

Hence the research project will help present a comparative analysis of these two economies over the given years, and will enable a meaningful comparison to be drawn on the basis of qualitative research to enable conclude the various studies that have already been carried out on the respective topic.

The paper is organized as follows: The next section provides a detailed background to set the stage for an analysis. The two countries and their markets are compared based on the literature that is already available; the research that has already been conducted is consulted to draw a conceptual framework. The research findings are discussed in the third chapter, answers to research questions have been drawn and comparisons have been made with empirical study. The fourth chapter concludes the paper, suggesting some recommendations

Project Objective

The objective of the research project is to develop an understanding of financial crisis in the Argentina and Turkish economies and identify the similarities and differences in the contexts of implementation of corrective policies.

Project Aim

The aim of the research is to examine and analyse the financial crisis in both these economies and identify the underlying factors responsible for the up surge of crisis. The scope of the study is the economic conditions in the financial years 1999-2001 and these years will be looked into with more detail and focus. The policies that the respective governments perused after that in attempt to take corrective measures are also analysed. The research is further going to present a comparative analysis, highlighting the similarities and differences in the nature and magnitude of both these economic crisis in the given financial years.

Research Questions

What are the similarities and differences in the causes, impacts and implications of financial crisis in Turkey and Argentina?

Subsidiary Questions

• What were the economic conditions in Argentina and Turkey before the crisis?
• What were the underlying causes of the crisis?
• Was the Argentine economy vulnerable to external shocks?
• What was the magnitude of crisis?
• Did the Turkish financial crisis of 1980 have fuelled the economic downturn in 2000?
• Was the Turkish crisis of 2000 an aftermath of political instability or a failure of the economic indicators?
• What were the policies adopted by respective governments to fix the crisis?
• What were the implications of these strategic decisions after the crisis years?

Methodology

For the present qualitative research approach has been chosen and implemented. The reason for this is that the present study could be considered as an extension of the existing literature. Qualitative research pertains to gathering a profound understanding of the reasons and underlying causes for a certain subject under consideration. On the other hand, quantitative research examines only the statistical information, qualitative research goes a step ahead in monitoring the reasons and implications and qualitative analysis explains why and which variables affect the most (Robert and Frank 1987). Thus, on the basis of these the present study has drawn clear and definite results drawing the relationships between the variables being attested.

Amongst the many tools of qualitative approach, the present study uses inductive approach. This means specific observations will be used to draw generalizations and to draw a tentative hypothesis based on the understanding of general patterns. Thus, the study is inclusive of a degree of uncertainty (Burney 2008). Arguments, theories and experiments already available are used to draw the conclusions and therefore secondary, as opposed to primary research is used. There is a lot of secondary data available on this topic, and many studies have been carried out in the form of experiments, or longitudinal studies where the changes and their root causes have been observed overtime. Thus, the secondary data plays importance as a means of comparison, because the financial crisis occurred due to different root causes and had different implications in varied circumstances. Hence, the study incorporates a lot of journal reviews, reports and statistical secondary data to support the hypothesis and also to analyze the data (Robert and Frank 1987). Further, stock market indicators have also been used to examine the volatility and trading volume in the Istanbul Stock Exchange (ISE) and The Buenos Aires Stock Exchange (BASE). These include Merval Index for the BASE and ISE-100 Index for the ISE (Padma 2003).

Summary

The introduction and background presented in this chapter set the stage for further analysis in the following chapters. Sufficient evidence will be collected from the secondary research tools in the next chapter to facilitate the comparative analysis.

Literature Review

Introduction

This chapter focuses on the evaluation and analysis of secondary research conducted pertaining to the topic under consideration in the form of journal articles, reports, statistical reports, and websites. The chapter aims to develop an in depth understanding of the research that has already been conducted and drive conclusive results. It thus states different theories and ideas that relate to the financial crisis in Turkey and Argentina. The literature review further explains the causes and circumstances in which the crisis hit both the countries. Argentina faced an overvaluation of currency at 55% in 2001 because of the hard pegged currency against depreciating Euro and trade shocks. Along with this were the problems of fiscal deficits, a large debt, and low economic growth (Padma 2003). Whereas Turkish economy, already hit by the worst financial crisis of 1980’s was subject to a political instability and its detrimental impact (Macovei 2009). The following chapter thus discusses theories and studies to support the above mentioned facts.

Theoretical Framework

In order to develop a better understanding of economic conditions in Argentina and Turkey, various theories have been suggested. These theories of financial and economical growth belong to different areas of thoughts and provide a deeper knowledge of the trends and relations of monetary and economical crisis. Some of the theories applicable to the subject at hand are the following:

Karl Marx’s Theory

Based on Karl Marx’s theory of Capitalism, it can be stated that the financial crisis in both the countries is a direct result of capitalism. Whereby, capitalism is an economic system in which can be represented by a private ownership resources and thus the allocation of productive resources is done majorly by the private sector. Self interest is the main driving force and thus profit maximization is the main objective of private producers. Such an economic system is plagued with market imperfections and failures that often result in an economic crisis. These externalities include the third party effects and the social costs to the society and nation on the contrary. The Karl Marx’s theory highlights the advent of a crisis as an unavoidable phenomenon that is bound to result because of a lasses-faire system of corporate governance and also a lack of regulatory authorities. “Fictitious capital” referred to as securities, is a source of income for the owner and hence is viewed as capital because its value can fluctuate; it multiplies the real capital as shares of stock and the ability to not represent capital at all. This makes the stock markets more volatile leading to shorter economic cycles (Jerzy 1990).

Nikolai’s Super-Cycles Theory

The Super-Cycles theory of Nikolai Kondratiev in 1925 defines cycles as normal and subdivided into three phases; growth, stagnation and decline. These cycles vary between 40-60 years and often have an “inflection point” in between the first two phases. The Juglar conjecture cycle, which was incorporated in the Kondratiev waves, consisted of four phases; expansion, crisis, recession and resume. This term cycle has an average duration of 8-9 years. If the expansion phase is represented by low income and production, it will give rise to the development of credit market, the resultant crisis will have stagnation in the production sphere and a change in economic climate.

On the other hand, recession will be characterised by declining production and income thus resulting in unemployment, inflation, rising interest rates and an outflow of capital. Therefore, the economic behaviour is the factor that fuels financial crisis. This behaviour could be collective or individual within an economy. If in the initial phase of crisis, economic mechanisms and tools are used, the impact will be mitigated thus the fiscal policy plays a dominant role in shaping the economic crisis and also in its prevention and management and this should be the main focus of governments in crisis management, however, at the same time ignoring the monetary stimulus could result in an unsatisfactory result of management tools (Principle 2005).

Hyman’s Theory

Hyman Minsky, in 1974, proposed the theory that financial crisis has its origin in the inherent system of capitalism and its characterised feature of profit maximization. As the economic players come out of recession, they move towards opting for safest investments and eventually to speculative investments yielding high interests and thus low costs. Investor confidence escalates and so does the market conditions characterised by an increase in loans to even those investors who are unable to pay referring to “Ponzi financing schemes”. This leads to shrinkage in loans whereby investors are not paid the high returns they had expected. This eventually transforms a financial crisis into an economic crisis and thus the economy enters into a new cycle (Papadimitriou and Wray 2010).

Theory of Coordination Games

The theory of coordination games by John Nash manifested the use of similar strategies by economic players based on positive feedback. Because of small changes on economic environment, the prices of assets change considerably. Hence depositors withdraw the money from their banks because they expect others to withdraw money as well. This phenomenon can also be observed in the stock valuation. The value of a stock can be maintained at a constant rate over a long period of time until the sales experience a multiplication and thus the price falls considerably. The expectations theory is also applicable here and explains the behaviour of speculative investors and economic cycles. Bubbles occur because of investor expectations of growth in the economy and crashes occur because economic players expect a fall in the economic market (TotirFelix 2011).

The Grouping Model

The Groupings Model, developed by Kehoe and Chari in 2004, explains the economic behaviour, which causes fluctuations in the financial and economic markets as information rather than expectations. This flow and transfer of information determines the inflationary and deflationary cycles. Hence purchase of one asset will be interpreted as positive information regarding that asset, facilitating further purchases. This may lead to over or underestimation of financial asset valuations representing a high degree of uncertainty as the initial decision may have been wrong. This phenomenon has been termed as “bounded rationality” whereby investors exhibit irrational decision making skills (TotirFelix 2011).

Reflexivity Theory

Lastly, the theory of reflexivity developed by George Soros in 2008 examines the future oriented nature of financial markets and its implications and takes a sociological perspective in interpretation of the theory. It stipulates that the financial markets cannot estimate their trends because the trend it aims to adopt is influenced by the action it takes to estimate the trends. Hence financial markets are plagued with a lag in informational efficiency. Thus financial, economic and social events are featured by instability. Confidence of some economic players triggers them to create derivatives while such tools further result in rising interest rates which further creating a bubble. And thus the financial product directs the crisis (Soros 1994).

Previous Studies

Government Fallacies in Crisis Management

The article by Seraina N. Gruenewald represents the common fallacies of governments in crisis containment. The financial crisis which initiated in the United States in the year 2007 was a mere result of mismanagement and a lack of tools to remedy the initial situation. Hence financial crisis is similar to a very technical decision making process which requires utmost financial acumen and allocation of responsibility and accountability of each member involved in the process. In order for members, which would be authorities in this case, to deliver the allocated responsibility, objectives must be matched to the power that each member can exercise to ensure financial stability is restored and social welfare is promoted.

Hence, allocation of public resources in attempt for efficient crisis containment endures significant accountability and shall not be left to the irresponsible agents. It is the duty of the government to ensure that the authorities in responsibility should be legitimate. This, however, does not mean that the responsibility should be held by the central bank alone as was the case in US financial crisis due to inadequate funding. The decision making process, further, should be independent of any political influence in order to maintain credibility. Disagreement between authorities or political parties may develop further panic which would be detrimental to investor confidence and an already volatile market and institutional checks in the form of checks and balances shall be established by a separate crisis containment council (Seraina 2010).

Role of Central Bank in mitigating the crisis

The role of banks in mitigating the financial crisis has been explained by Nada Mora in her quarterly economic review report whereby the author explains, with reference to the recent financial crisis in the US, the role of central bank as a source of liquidity. A comparison has been made of the recent crisis of 2007-2009 to the entire past crisis in terms of sources of funding. A failure of funding by market based securities has been observed in both the periods of financial crisis which led the US investors to invest in “flight for safety” approach by shifting funds to low risk assets such as treasury bonds and T-bills. The bankruptcy of a rail road company, Penn Central in 1970’s is an evident example of firms’ need for liquidation unmet by their commercial papers. Likewise the Russian debt default also resulted in a liquidity shrinkage which led USA to fail in terms of hedged securities. In such cases banks act as a guaranteed source of funding as their financing is done by the government. This is done through holding a buffer for diversification, having deposit inflows during a financial crisis as banks are considered a “safe haven”. However, this is not true when the crisis is bank-centered (Nada 2010).

Post Crisis Financial Management Approach

The article by Ziya Onis focuses on the post-crisis financial management approaches and political strategies that Turkey undertook in order to effectively manage the financial crisis of 2000-2001. Turkey has been plagues with a history of frequent financial crisis in less than a decade, which marks its similarity with Latin American countries like Argentina. However, the crisis of 2000-2001 proved to be the most severe as unemployment increased by one million and many bankruptcies were registered. The magnitude of impact was large as all segments of the society were adversely influenced. On one hand these crisis have repeatedly put Turkey under debilitating economic situations and financial markets in the form of declining output, employment, real wages and a collapse of the democratic regimes like in 1980’s. However, they have also created an “opportunity space” for the country whereby the country has moved towards export oriented production in the previous crisis and in the most severe recent crisis, it has experienced political transformations (Ziya 2009).

Firstly, it has enabled Turkey to develop as a “competition state” which requires it to have a much more liberal financial environment, something previously lacking in Turkey. Opting for the Washington Consensus resulted in the country being more sensitive to international institutions like IMF and hence a greater importance to be given to institutional reforms. Secondly, in order to rebuild the state capacity which previously lacked in the country, it was essential to identify its geo strategic structural environment it operated in. Thus the identification of close ties with USA and EU helped it establish the post crisis adjustment strategy (Ziya 2009).

Conceptual Framework

The above mentioned studies show relevance to the financial crisis in respective countries. The study by Ziya Onis shows how the financial crisis in Turkey is similar to Argentina in terms of frequency of occurrences and magnitude of impact. It further stipulates how both the economies have improved and how the crisis has resulted in positive opportunities for structural reforms (Guven and Ozatay 2002).

Further, the studies have highlighted the importance of banks to act as a source of liquidation, same was the case at Turkey and Argentina, the responsibility with central bank resulted in a lag of structural capacity to fund the prevention of crisis (Ziya 2009). The Turkish and Argentina crisis were fuelled by political instability and politically wrong decision making that mounted to financial crisis (Padma 2003).

Summary

The chapter highlights important aspects of various theories and previous studies to develop an analytical framework to examine the topic under discussion in much more profound detail and presents a framework to apply to the financial crisis in Turkey and Argentina. The implications have been discussed in the next chapter.

Research Findings and Analysis

Introduction

This chapter critically examines and evaluates the data gathered through qualitative secondary research. The data has been interpreted in the inductive approach whereby generalizations have been made of specific events occurred in both countries which eventually led to eruption of a financial crisis (Burney 2008). The chapter further lays down a basis for the research questions in light of the studies carried out on the related topic and builds a strong foundation for research findings.

Stock market has been volatile globally in the last decade while at the same time developments in banking sectors and IT facilities has changed the world’s focus on emerging economies. According to the Emerging Market Equity Funds USA statistics, in 1996, the US held only 1.2% of equity finds belonging to emerging economies whereas now the foreign bonds and stocks transaction by USA alone is worth $545 billion as measured in 2002. The total activity of stocks of emerging economies amounts to $1.2 trillion. This basically shows the increased globalization in stock markets and an augmented significance of these emerging economies over the past decade which has lead to increasing volatility in these stock markets, resulting in a financial crisis (Zeynep 2002).

Furthermore, long term capital inflows in the emerging economies grew at an average rate of 15% over the decade because of higher yields that these markets were offering. This return was 50% higher than that offered by developed economies and the developed economies were rather facing a downturn in their stock markets. The US stock market incurred a loss of 13.4% compared to a decrease if only 8.4% in the emerging economies. The following section of the paper, aims at exploring the impact and consequences of these market conditions (Zeynep 2002).

Secondary Research Findings

Background of Financial Crisis in Turkey and Argentina

The Argentine economy has been under constant economic pressures since a decade prior to the crisis. The Tequila Crisis of 1994, however, strengthened the role of central bank as a mitigated in reducing the impacts of the crisis and the economy regained in 1996. However, this was followed by another crisis in 1998 and then finally in 1999 fuelled by the Brazilian Crisis. The Asian and Russian crisis had weakened the currency already and the crisis in 1999 thus was the most hard- hit. The assurance to the investors by CBA proved futile as the liquidity was not addressed to maintain the currency peg and the country was unable to finance huge debts of $142billion. This eventually resulted in the climax of crisis in 2001 whereby apart from the inability to pay external debts, Argentina was in a deep recession, massive unemployment, and loss of economic growth in the 1990’s. However, what is interesting in Argentina crisis was the robustness of its banking sector. Argentina’s banking sector had been very strong in terms of enduring the impact of financial crisis and was actually able to bring about an economic recovery in 1996 (Michael 2003). Hence the inefficiency of the banking sector along with other underlying causes responsible for the crisis aggravation are discussed in this chapter in much more detail.

Turkish crisis also took plunge during the same time period when the Turkish government introduced an exchange rate stabilization program in accordance with the Bretton Woods Institution. However, this resulted in escalating exchange rates, high rates of inflation, currency fluctuations because of which economists proposed a free floating exchange rate system to take over the existing one. Similarity with Argentine crisis lies in the very nature of ignition which proved to be the convertibility of lira in case of Turkey. In 1999, Turkish government resorted to IMF for a standby agreement to stabilize the currency rates and a massive decline in the foreign exchange reserves as in the case of Argentina. The central bank lost 20% of its foreign exchange reserves. The crisis was strengthened due to a PSBR deficit arising from financing external debts from domestic investments rather than taxes and the fiscal policy was not expansionary. At the same time, the antagonism between the Abakan’s regime and military caused inconsistency in policy formulation and implementation leading to a lack of domestic faith as well as investor confidence (Macovei 2009).

Further, the research stipulates that both the countries were experiencing political instability in the midst of an economic and financial downturn. There was an absence of strong fundamental institutions and political acumen to counter the rising turmoil which eventually led to a row of social and political protests and unrest across the countries (Guven and Ozatay 2002).

Hence the reason for this comparative study proves significant as the flowing lays down the basis for a comparison between the two countries;

• Both the countries have faced economic and monetary turbulence. They tried to bring down inflation using the tool of exchange rate systems through their stabilization programs and experienced a resultant robust growth. This shows that both the countries have experienced periods of hyperinflation in attempt to stabilize the exchange rate.
• Both restored to IMF standby arrangements to overcome the crisis and finance their PSBR (Public Sector Borrowing Requirement) and domestic debts from external investments and IMF.
• Both the countries have remained politically unstable and their stock markets have been volatile prior to the period of financial crisis.
• Both the countries have depended on international finances and remained vulnerable to external shocks.
• The financial liberalization and the banking sector reforms took place during the same year; Turkey’s official financial sector liberalization took place in August 1989 whereas Argentina’s date is November 1989.
• The stock market for both the countries, Istanbul stock exchange and Buenos Aires, is highly volatile.
• Despite these volatile markets and fixed pegged currencies, they still were able to attract foreign investments. Turkey and Argentina were ranked as the sixth and seventh highest market amongst emerging economies which attracted US investments. The stock market for Argentina accounted for 6.38% of total investments and Turkey’s stock market accounted for 5.38% of investments in 2000.

The similarity in economic and political environments of these two countries will be discussed in the following chapters along with the corrective measures and their response to socio-economic and political risks has been gauged. These countries have been selected in order to further explore the impact of this political and economic vulnerability on the stock exchange volatility and resultant crisis that emerged (Zeynep 2002).

The Common Underlying Causes of Financial Crisis in Turkey and Argentina

Based on the qualitative research, and consulting various journal articles, statistical reviews and news headlines, the following causes have been identified, which are common to both the countries. Since the financial crisis occurred in almost the same time period and both the countries have shared some inherent economic and financial history, the underlying causes were based on these similarities.

Poor Economic conditions

The Argentine crisis began as a result of convertibility law which allowed the central bank to equalize its foreign exchange reserves with the cash in circulation enabling anyone to convert their domestic currency to dollars; at the same time causing appreciating the dollar in terms of peso which lead to and appreciation in real and a loss of competitiveness of Argentinean exports in Brazil as peso became cheaper, and so did the Argentine exports in foreign markets. This precisely also meant that Argentina had to rely more on external finances to finance its domestic savings. In case of Turkey, the political turmoil led to a shattered investor confidence. Many foreign investors moved away from the country and Turkey faced a massive capital outflow of $70 billion in just a few months. Government defaulted and could not pay its bond payments due to a huge PSBR deficit (Guven and Ozatay 2002). Due to prior inflation and high consumption patterns, people had drawn more money out of the banks leading to very few savings. According to Keynesian theory, this situation is referred to Paradox of Thrift. A mild and stable inflation can be beneficial for the long term performance. An increase in interest rates reduced the discretionary incomes in real terms (Billlings, Milburn and Schaalman 1980).

The following table demonstrates a comparison of the economic conditions in both the countries pertaining to export deficits in years before the crisis and in years after the crisis had occurred;

Table 1: Export Deficits in Turkey and Argentina.

Resultantly both the countries have experienced budget deficits but Argentina has been able to maintain its budget deficit at around $2 billion but Turkey’s budget deficit has increased from $8.4 billion in 1996 to $1.4 billion in 2000. This is represented in the table below;

Table 2: Budget Deficit in Turkey and Argentina.

The external financing in Argentina increased from 0.9% in 1999 to 4.1% in 2000. Reasons behind this trend were the positive expectations of households for future economic growth for which they increased borrowing and this consumption. This reliance on external finances also resulted in higher debt and lower investor confidence. The CBA was unable to respond because of its rigid policies pertaining to fixed exchange rate system and an inability of the closed economy to correct the shortfall through changes in export and import quantities (Padma 2003). Hence whereas capital inflows became common, trade flows were restricted. This is explained by the following table indicating FDI in Argentina.

Table 3: Foreign Direct Investment in Turkey and Argentina.

The table shows how Argentina experienced an increased inflow of capital prior to the year of crisis 1999 whereby it increased from $6.9 billion (1996) to $24 billion (1999) and faced a massive decline in foreign investments in just one year due to extremely unfavorable political and financial conditions of the market. On the other hand, Turkey’s FDI has remained consistently lower than that of Argentina because of the severe debt crisis of 1980’s but it did improve in 2000 as well (Zeynep 2002).

Table 4: Present Value of Debt and Ratio of short term debt to long term debt.

Debt in Argentina was higher in real terms but it was able to keep the ratio of short term debt lower than Turkey, indicating a comparatively positive economic condition as Turkey was entrapped in the long term debts by IMF which meant increasing interest payments to service the debt and an increasing budget deficit (Perry and Serven 2002).

Banking Sector Imperfections and Weakening Fiscal Policy

There were several reasons for not having an effective fiscal policy in place which could prevent the crisis in times of high inflation and consumption rates based on positive future expectations. Firstly, the pension reform resulted in pensioners switching to private systems in attempt for tax evasion thus disturbing the fiscal balance to a further 1% of GDP annually. The interest rate service charges increased as lower interests were being paid on the external debt, resulting in a negative structural impact on fiscal deficits. Exchange rate fluctuations proved to be detrimental due to the fixed exchange rate system and the domestic borrowers became more vulnerable to currency risks. PSBR (Public Sector Borrowing Requirement) increased dramatically, with CBA having minimum mitigating role (Perry and Serven 2002). Following is the table representing a comparison for of both the countries impact on PSBR and the resultant interest rate payments during the crisis.

Table 5: PSBR as a percentage of GDP and Interest Payments on Debt.

The diagram shows that the impact of banking sector inefficiency was much more profound in Turkey as compared to Argentina. In turkey, the inability of the banking sector to finance the government and domestic debt proved detrimental to the country. The government debt, as shown above, stood at 60% of the GDP by the end of 1999 two thirds of which was domestic debt. Interest payments on debt reached to 22% of the GDP. Interest rates thus surpassed the inflation rate by 30% (Macovei 2009)

Demirbank, for example, signifies the weak business position banks faced at the cost of government non repayment of securities. The central bank could not lend to Demirbank which forced it to adopted retrenchment policies and sell of its assets. Government debt was used to support foreign exchange borrowing as lira became weaker in the international markets and lost its value considerably, causing an even more increase in the exchange rate. The Treasury could not borrow below 57% in compounded interest rate terms whereas it should have reduced to be compatible with the fall in depreciation (Zeynep 2002).

The Fixed Exchange Rate Regime

One of the most prominent causes of the financial crisis in Argentina has been the policies of CBA which strictly follow a pegged peso. This policy helped in bringing down inflation from and increased the increased the per capita GDP from -2.9% in 1980’2 to +3.2% in 1990’s. However, the policy backfired and an ever appreciating peso, losing its competitiveness in international markets. There was a lack of monetary control in terms of its ability to respond to external shock and exchange rate fluctuations. The CBA created a very limited cushion to finance the liquidity of banking sector which limited the role of central bank to mitigate the crisis (Perry and Serven 2002). Similarly, the hard peg of Turkish lira against an appreciating dollar resulted in CPI (Consumer Price Index) increase. The exchange rate system was vulnerable to external price shocks due to energy prices increases, also domestic imbalances caused due to wage increases in the public sector and reducing the losses of public sector organizations. All of these issues caused the domestic costs to increase much faster than inflation while at the same time interest rates followed an opposite trend. T-bills resultantly increased from 35% to 50% and investor confidence shattered (Guven and Ozatay 2002).

Stock Markets in Turkey and Argentina

Historically, the Istanbul Stock Exchange (ISE) and the Buenos Aires Stock Exchange (BASE) of Argentina are similar in many aspects. The market capitalization in both the markets increased hugely as observed below;

Table 6: Market Capitalization in Turkey and Argentina.

After liberalization in Argentina and Turkey, the stock markets have become hubs for international investments. The number of stocks traded has increased from 200 in 1990 to 316 in 2000; despite the crisis the ISE has shown positive performance. Turkey does not exhibit a weak form of efficiency whereas Argentina does. Prior to the financial crisis both ISE and BASE had a long term relationship with the international markets but after the crisis, it considerably reduced. Thus even a diversified portfolio does not provide the same level of risk aversion as does a US portfolio (TotirFelix 2011).

The failure of Free Market System

Both the countries had adopted a free economic structure but after the Tequila crisis and the Russian crisis, they resorted to a customs union membership and launched major privatization of public industry. Argentina, along with Brazil, Uruguay and Paraguay formed the Mercosur in 1995. This customs union also served as a political and military partnership and an integrated economic bloc. Because of Mercosur, Argentina was able to attract major investments by USA, Canada, and Spain etc for its manufacturing as well as telecommunication industry. Turkey also joined the customs union with the European Union in 1995 but full membership is still pending (Ziya 2009).

However, most of these privatization proceeds were coming from international investors. The free market economic structure proved to be unbeneficial for an emerging economy that required free trade, liberalization and privatization. Although the Argentine economy did experience economic progress in the first half of 1990’s but as the crisis began to develop, the economy needed to be more flexible and required structural reforms. The labor market imperfections included high labor costs including the dismissal costs and taxes. The pay roll taxes accounted for 60% of the wages thus the economy faced a downward rigidity in wages (Padma 2003).

Likewise, the political instability of Turkey, the deep economic impact of the earthquake in 1999 and the incompatibility of the President and Prime Minister lead to many other market failures. Turkey passed several reforms for banking sector and for the industry in general but received major setbacks in implementation due to conflict of interests at the political stage. For example, the privatization of Turk Telecom was delayed due to the proposition by IMF for establishment of a regulatory body. The country also, at the same time, lacked the leadership and administration to implement these structural reforms with credibility and accountability (Macovei 2009).

Therefore, it experienced high unemployment even in times of rapid economic growth. Further, a collapse of the private institutions in terms of delivering the performance and goals required of them also constituted to another market failure (Jerzy 1990). Under the piecemeal program, initially six banks were taken over by the SDIF (Saving Deposit Insurance Fund) in 1999 in proposition to criminal investigations for corruption and intransperency. In total, eight banks became insolvent and had to be taken over by the Saving Deposit Insurance Fund, adding to the PSBR and public sector deficits (Guven and Ozatay 2002).

Corrective Measures and the Impact of financial Crisis in both the countries

As the peso was pegged against an appreciating dollar, the peso also experienced an appreciation and a 20% decrease in the investment activity.

Table 7: Percentage decline in GDP in Argentina.

The real GDP fell by 3.5% in 1999 and a further 0.5% in 2000 in Argentina. Recession along with appreciating peso required a structural change in the policy of CBA through nominal devaluation, which however was denied. Peso was appreciating by 12% on 2000 and the real prices were falling causing the real value of debt to increase. The interest payments from public dent also increased to 15% of total public sector spending (Zeynep 2002).

Although the De La Rua cabinet proposed a contractionary fiscal policy and in attempt to reduce the PSBR from 3.8% and a standby arrangement by IMF amounting to $7billion, both the propositions failed. An inability to resume to a floating or managed exchange rate system left Argentina with no other option to improve economic conditions than to attract foreign investment or resume to IMF which it did. Despite the aid from IMF, it was unable to resume economic recovery and the spreads on bonds increased by 1000 points (Padma 2003).

The IMF has played a contradictory role in mitigating the financial crisis in Asia. The promotion of a neoliberal economic model in Argentina by the IMF posed many questions for its effectiveness and its increasing financial support which led Argentina to be entrapped into more and more debt. One questions the validity of IMF standby agreement which extended beyond its date and ripped no results and stipulated a continued support for the pegged peso and convertibility law (Perry and Serven 2002).

The research has shown that the underlying cause for this crisis was not after all economic or financial. The domestic vulnerability of institutions and politics within the country made it more prone to a heightened impact and climax of the crisis (Padma 2003).

Since the provisions held by IMF standby arrangement did not materialize, Argentina faced massive setback in inflows of capital due to a failure to use expansionary fiscal monetary policy or fiscal policy to attract foreign direct investments. The zero deficit law came into effect in 2001 indicating massive cuts in government spending in order to balance out the public sector deficits. Therefore pensions and benefits were cut by 13% which not only adversely affected the pensioners but all household and individuals on fixed incomes. The banks were forced accept lower yields and deposits were frozen. The chaotic conditions resulted in a political and social unrest. Public protests and riots took over the country with banks and businesses closing down. The debt instruments were replaced with longer maturity dates of 2006 which meant much greater debt payments would have to be made after the maturity date, further deepening the long term impacts of the crisis by US$ 66 billion (Padma 2003).

Turkey experienced a relatively more severe crisis than its counterparts in the emerging economies, its economic indicators declined more rapidly with a greater magnitude. This is also because of the historic crisis of 1980’s which made the Turkish economy more vulnerable and this explains why Turkey still faces certain impediments. However, it has learnt from its mistakes and the recent election campaign of 2009 was more focused towards a crisis prevention approach. There have been improvements in the education levels, privatization and labor market which highlight the progressive growth and recovery from the crisis. It has experienced many financial sector reforms but the state run social security system has incurred losses which indicate the need for further reforms (TotirFelix 2011).

Basis for Research Questions

Hence the study paper represents an analysis which is based on the theories predominant in the financial market. The failure of a market economic system, as stipulated by the Karl Mark’s Theory, suggests that a free economic system is inherently unequal and thus will result in a failure if not monitored and regulated. Both Argentina and Turkey opted for massive privatizations without regulatory authorities; banking sector remained a dominant institution of the political as well as economic and financial fabric of the countries. The failure of banking sector resulted in an economic bubble which was bound to bust (Ziya 2009).

The study by Seraina N. Gruenewald which represented the government mismanagement in crisis mitigation, stipulated that the financial crisis of USA was an evident example. Hence financial crisis is similar to a very technical decision making process which requires utmost financial acumen and allocation of responsibility and accountability of each member involved in the process. In order for authorities in this case, to deliver the allocated responsibility, objectives must be matched to the power that each member can exercise to ensure financial stability is restored and social welfare is promoted.

Hence allocation of public resources in attempt for efficient crisis containment endures significant accountability and shall not be left to the irresponsible agents. It is the duty of the government to ensure that the authorities in responsibility should be legitimate. This, however, does not mean that the responsibility should be held by the central bank alone as was the case in US financial crisis due to inadequate funding. The decision making process, further, should be independent of any political influence in order to maintain credibility. Disagreement between authorities or political parties may develop further panic which would be detrimental to investor confidence and an already volatile market and institutional checks in the form of checks and balances shall be established by a separate crisis containment council (Seraina 2010). This happened in case of Turkey where the conflict between President and Prime Minister resulted in a stock market volatility and massive outflow of capital form the country (Guven and Ozatay 2002).

The study by Nada Mora explained the role of banks in mitigating the financial crisis has with reference to the recent financial crisis in the US, the role of central bank as a source of liquidity. A failure of the central bank in both the countries increased the concerns for funding the liquidity and public deficits. The same pattern was repeated in USA in the recent crisis of 2007-2009 to the entire past crisis in terms of sources of funding. A failure of funding by market based securities has been observed in both the periods of financial crisis which led the US investors to invest in “flight for safety” approach by shifting funds to low risk assets as happened in the case of Turkey (Macovei 2009).

Evidence can also be found of the Groupings Model proposed by Kehoe and Chari in 2004, which represented the significance of economic behaviour, causing fluctuations in the financial and economic markets as information rather than expectations. The inflationary and deflationary cycles are determined by this flow of information, as was the case in Turkey and Argentina. The Wall street Journal and the New York Times (NYT) are common sources of political and economic and financial news which investors can access internationally. Speculations are based on these sources of information which cover the paradigms of world and domestic economic and political news (Zeynep 2002). Any events like G20 or G-8 summits or any domestic event that may directly impact Turkey or Argentina have the potential to cause volatility in the stock markets. This flow and transfer of information determines the inflationary and deflationary cycles. This may lead to over or underestimation of financial asset valuations representing a high degree of uncertainty as the initial decision may have been wrong (TotirFelix 2011).

Summary

The findings presented in this chapter present a comparative analysis that supports the very objective of the study. Evidence has been collected from secondary research and the basis for research questions has been laid. The implications of these results are discussed in the next chapter to conclude the study.

Conclusion and Recommendations

Conclusion

The study examines and critically analysed the financial crisis in two emerging economies; Turkey and Argentina. The main aim is to stipulate a comprehensive comparison between the two economies which faced a crisis at the same time, shared similar history and background and thus had some common factors that led to a crisis. The poor economic indicators in terms of high inflation rates, public deficits, export debts, and the resultant interest payments fuelled the crisis in both emerging economies. Further, stock market volatility, weakening financial institutions and most importantly, the fixed exchange rate system which made the currency more vulnerable to external shocks, are amongst many reasons for the ignition of a crisis in respective countries. These factors can also be termed as market failures of capitalism, liberalization and privatization in these countries.

Both the countries exhibited periods of hyperinflation, currency risks, unemployment and increasing PSBR (Public Sector Borrowing Requirement). The International Monetary Fund (IMF) standby arrangements, the goals of which failed to materialize, further aggravated the market conditions. The role of central bank in mitigating the crisis was limited because of an absence of an expansionary fiscal policy in place. Apart from economic and financial setbacks, both the countries had political instability and lack of social and administrative leadership which ultimately lead to a socio-political turmoil and unrest in the country. However, the crises have major global implications for future financial years and serve as a general guideline for crisis management in terms of policy decisions and corrective measures to be taken. The corrective measures taken by these countries have lead Turkey to become the 17^th largest economy in the world in 2008.

Recommendations

In light of the above research, I would like to propose the following recommendations;

• The entire financial system, not just the currency, should be stabilized thus incorporating all financial corporations from banks to leasing companies.
• The Federal Government should lend loans directly to the corporations in order to avoid banking sector failure in solvency and debt deficits.
• The government needs to play a vital role in moderating and preventing the crisis in the first place. Public sector spending should be focused on projects that reap long term economic benefits like education, health and housing etc. however, this spending should be limited and made transparent through independent regulatory authorities and watchdogs.
• A floating exchange rate system with managed pegged should be used in economies open to liberalization and privatization. The study has shown how a fixed peg causes great volatility in the stock market and fluctuations in the currency, leading to an outflow of capital by foreign investors.
• Turkey must try harder for its EU accession to benefit from the great potential it has for economic growth and to become one of the largest economies in the European region.

Summary

The chapter concludes the study with some important implications, based on inductive secondary research. Important aspects of the Crisis have been identified and valuable recommendations have been suggested for future prevention and control of crisis management.

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