The Turkey-Mexico Parallel

Turkey is not enjoying the attention it is getting from international financial markets right now. Fears of a banking crisis and a liquidity crunch triggered a flight from government debt and an interest rate spike. Luckily, there’s a good precedent on how to deal with this crisis. All you need to do is go back six years to when Mexico nearly went bust. As in Mexico, Turkey’s political establishment may need to be swept aside before lasting financial stability is achieved.

For all their obvious differences, the situation in Turkey now is similar to Mexico circa 1994. Inflation was high, the current account deficit kept widening, government spending was profligate — and the peso came under pressure.

By early 1995, Mexico was a ward of the IMF and in the throes of a nasty recession. With a budget deficit at 12% of GDP and high inflation, Turkey is not doing much better. Perhaps most significant, banking reforms have moved slowly because of the government’s reluctance to touch influential bank owners.

And unlike the epidemic of the “Asian flu,” which damaged the tigers’ financial markets in 1997, it was not the foreigners who caused the Mexican debacle. The first to get a whiff of trouble were Mexico’s political and business elite, who withdrew money from domestic banks and abandoned the peso for Miami bank accounts. This is what seems to be happening in Turkey right now.

As domestic depositors desert local banks, they can spark a general rush for the exits — making severe economic disruptions in Turkey a self-fulfilling prophecy. But just as Mexico in 1994, the IMF won’t allow Turkey to go down the drain. Economic reforms have been underpinned by an $8 billion stabilization package, and the IMF is likely to make additional funds available.

Once again, just remember Mexico. There is simply too much at stake. Mexico’s luck was its border with the United States. Besides, Latin American markets were highly sensitive to any adverse impact from in Mexico. Turkey’s luck is its location on the Southeast border of the EU, and the importance of its role as a stable force in an area which is currently being buffeted by rising oil prices, violence in the Middle East and guerilla war in Chechnya.

The Mexican example shows there is light at the end of the tunnel: an IMF bailout can trigger a handsome payback in terms of more democracy, transparency, and accountability.

The last PRI government in Mexico spent six years implementing and deepening economic reforms, bolstering the financial system and improving the business climate. Ultimately, however, the impact of market forces weakened the power base of the old political establishment.

As a direct result, for the first time in decades, power has been transferred peacefully to a different party — without triggering a devaluation of the Mexican peso or severe financial turmoil. Markets are looking at President Vicente Fox, who was inaugurated on December 1, to extend and deepen the reform process.

Just as was the case in Mexico, the current political elite probably won’t last in Turkey. The government is unstable, and the three parties that make up the ruling coalition lack commitment to reform, unity of purpose and the stomach for decisive, concerted action. Prime Minister Ecevit, while enjoying a reputation for integrity, has been around too long and is too much a part of the establishment to be a credible reformer. Financial markets are giving a vote of non-confidence to Turkish political elite. They are calling for some new blood — for some Young Turks to take the country into the 21st century.