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MEHMET YÖRÜKOĞLU CENTRAL BANK OF TURKEY DEPUTY GOVERNOR

GLOBAL FINANCIAL TURBULENCE AND ITS IMPACTS. MEHMET YÖRÜKOĞLU CENTRAL BANK OF TURKEY DEPUTY GOVERNOR. October 2008. Contents. Reasons behind the turbulence , Measures taken so far … Impacts of the turmoil on; III.1. Emerging markets , III.2. Turkey ;

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MEHMET YÖRÜKOĞLU CENTRAL BANK OF TURKEY DEPUTY GOVERNOR

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  1. GLOBAL FINANCIAL TURBULENCE AND ITS IMPACTS MEHMET YÖRÜKOĞLU CENTRAL BANK OF TURKEY DEPUTY GOVERNOR October 2008

  2. Contents • Reasons behind the turbulence, • Measures taken so far … • Impacts of the turmoil on; III.1. Emerging markets, III.2. Turkey; IV. Prospects.

  3. Reasons Behind the Turmoil Real Policy Rate in USA (January 1981 – September 2008, percentage) • Loose Monetary Policies: As a result of low real interest rates in the developed economies, especially in USA, during the period 2001 – 2005, investors initiated leveraged transactions and used risky instruments in order to gain high yields. • Lack of Transparency and Supervision : Parallel to the widespread use of originate-to-distribute business models, financial innovation and technolobical advancements, complex instruments were used widely, which in turn complicated tracing of the investments and risk analysis of these investments. • Problems in the Housing Sector : Decline in house prices in USA that began in the first quarter of 2006 adversely affected household consumption demand and brought about increase in the mortgage foreclosure rate. Soruce: FED, Bureau of Labor Statistics Housing Price Index (January 2001 – July 2008, annual percentage change) OFHEO Case&Shiller Source: OFHEO, Standard&Poors

  4. Reasons behind the Turbulence What triggered the crisis? Increased delinquency rate in sub-prime mortgages and therefore decline in mortgage-backed securities (MBS). • Big exposures of financial institutions which also have high leverages to these MBS. • Increased risk appetite in the face of low real interest rates • Creation of complex financial instruments in search of higher profitability • “Originate to distribute” model and extensive use of off-balance sheet instruments • Imprudent credit decisions • Erosions of capital due to financial losses • Cut back in loan supply

  5. Reasons behind the Turbulence Uncertainty in financial markets transformed into atrust problembetween financial institutions In spite of correcting actions of regulatory bodies, arising financial weaknesses of large financial institutions such as Lehman Brothers, Bear Stearns, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual Fund and AIG.

  6. Global Losses • As of October total losses that the international financial system has suffered reached 659 billion US Dollars. • IMF revised its global loss forecast from 945 billion US Dollars to 1.4 trillion US Dollars. • During the same period banks were able to raise up equity by 638 billion US Dollars. • Due to the financial turmoil banks faced significant losses and hence they tightened the credit standards significantly. Losses in the Banking and Financial Sector (billion US dollars) Ratio of Banks Reporting Tightening Credit Standards to the Total Banks (2006 Q1 – 2008 Q3, quarterly, percentage) World USA Europe Europe USA Asia Source: Bloomberg Source: FED, ECB

  7. Measures taken so far … • Coordinated response of Central Banks by providing liquidity support • Bail outs from U.S. and European governments • Intervention of US government by its fiscal policy • Capital injection and assets expansion by accepting as collateral, • Encouraging some banks to fund the troubled banks by secured funding, • Paying interest on depository institutions required and excess reserve balances (by Fed), • Guarantee on bank deposits and/or other liabilities in USA and Europe

  8. Impacts of the Turmoil • Volatility index (VIX) has reached its highest level of the last 19 years, surpassing previous highs seen during the Asian crisis, dot-com bust and after the 11 September attacks. • TED spread, an indicator of credit risk in the economy, used to range around 50 basis points prior to the start of the turmoil but lately the spread has widened to around 460 basis points. Difference Between LIBOR and US Treasury Bill (3 month) (1 January 2007 – 6 October 2008, basis points) Volatility Index (2January1990 – 20October 2008) Long-term average Source: Bloomberg Source : Bloomberg

  9. Foreign Exchange Rates and Risk Indicators • Since the beginning of August fall in the value of Turkish Lira against US Dollars is close to the average depreciation rate of emerging economies’ currencies. • In the second quarter of 2008 Turkey’s risk premium increased more than that of other developing countries. Yet, a marked correction has been observed since July 2008. Change in the Spot Foreign Exchange Rate vs USD (between 1 August 2008 and 16 October 2008, percent) Risk Indicators (2 January 2008 – 20 October 2008, basis points) EMBI + EMBI + Turkey (Turkey) – (EMBI+) Source: OANDA Source: JP Morgan

  10. Potential Impacts on Turkish Economy • Banking and Financial Sector • Capital Inflows and Current Account Deficit • Economic Activity • Exchange Rate and Inflation

  11. Impacts on Turkish Banking and Financial Sector • Until now, limited effects on banking and financial sector due to, • Considerable improvement in macroeconomic stability, • Prudent macroeconomic policies, • Conservative Regulation and Supervision, • Tools used by Central Bank of Turkey to calm the markets, such as reintroduction of FX deposit market, • Tight fiscal policy and monetary policies.

  12. Banking Sector Net FX Position of the Banking Sector (2000 Q1 – 2008 Q3*, billion USD) • Compared to earlier periods Turkish banking sector’s resilience has improved remarkably. • The sector does not hold a noteworthy FX short position. • Net FX positions of the banks are at a low level compared to their equity capital. • The capital adequacy ratio is well above the legal limit and the EU average of 12.1%. • Banks’ short-term FX liquidity and total short-term liquidity adequacy ratios remain above the legal limits of 80% and 100%, respectively. • Strong capital structure and high profit to equity ratios curtail banking sector’s vulnerability to the financial turmoil. * As of 19 September 2008 Source: BRSA, CBT Capital Adequacy Ratio (December 2005 – July 2008, percent) Operational risk included Target rate is 12% Legal limit is 8% Source: BRSA, CBT

  13. Banking Sector Total Short-Term Liquidity Ratio (6 July 2007 – 12 September 2008, percent) Short-Term FX Liquidity Ratio (6 July 2007 – 12 September 2008, percent) 0-7 days 0-7 days Up to 1 month Up to 1 month Legal limit is 100% Legal limit is 80% Source: BRSA, CBT Source: BRSA, CBT

  14. Banking Sector Ratio of Non-Performing Loans to Total Loans(2003 vs. 2007, percent) Developing Countries* Turkey Developed Countries** * Developing countries: Argentina, Brazil, Bulgaria, Czech Republic, Croatia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovakia, Ukraine ** Developed countries: France, Germany, Italy, United Kingdom, USA Source: IMF, CBT

  15. Bank Credits Business Loans and Retail Loans(1 January 2006 – 5 September 2008, year-on-year percentage change) Retail Loans Business Loans Source: CBT

  16. Households FX Debt of Households ((2003 – September 2008, percent of total consumer loans) Total Household Liabilities (2004 – 2006, percent of GDP) European Union Eastern Europe Turkey Source: CBT Source: ECB, CBT

  17. Impacts on Turkish Banking and Financial Sector Banking sector is still quite small with a strong potential to grow. • Turkey (A) shows the data of 2007 including participation banks; Turkey (B) shows the data of June 2008 including participation banks. For EU members, the data of 2007 is used. • Source: Turkstat, BRSA-CBRT, ECB.

  18. Impacts on Turkish Banking and Financial Sector Source: BRSA,CBRT, Association of Capital Market Intermediary Institutions, CMB (1) Figures are as of June 2008. • Financial system in Turkey is bank dominated; • No toxic financial instruments in banks’ portfolio; • Shallow markets for complex financial derivatives.

  19. Impacts on Turkish Banking and Financial Sector Financial Stability Index Source: CBRT • FSI is a composite index that is used as a measure of the financial soundness. • It indicates a sound Turkish banking sector.

  20. Inflation Developments in Turkey • Thanks to achievements in price stability, Turkey’s ranking in terms of inflation has improved. • While in the 1997-2003 period, Turkey was among the 10 countries with highest inflation in the world, as of September she declined to the 62th position. Turkey in the Global Inflation Ranking(1997 –2008) Inflation in Turkey (1980 – 2008*) Inflation Targeting Regime * Most recent data as of September 2008 The total number of countries is 155. The ranking is in descending order. Source: IMF, TURKSTAT, CBT * 2008 forecast of the Central Bank of Turkey Source: IMF, TURKSTAT, CBT

  21. Effects on the Turkish Economy; Inflation • As a result of global crisis commodity prices, especially food and energy prices, declined drastically. • Falling commodity prices, moderating domestic demand and depreciation of Turkish Lira will have favorable effects on the current account deficit and an improvement in the current account deficit is expected in the months to come. Current Account Balance and The Effect ofEnergyPrices on the Current AccountDeficit* (2002 – 2007, percent of GDP) Wheat Price (1 January 2007 – 9 October 2008, US Dollars/Bushel) Source: Chicago Board of Trade Oil Prices (NYMEX WTI, 1 January 2007 – 9 OCtober 2008, US Dollars) Current Account Deficit * Keeping energy prices constant at 2002 levels. Source: TURKSTAT, CBT Source: Bloomberg

  22. Effects on the Turkish Economy; Inflation • Favorable developments in commodity prices and deterioration in the domestic demand suggest that inflation will improve in the following months. • However, recent depreciation of Turkish Lira may create upward pressure on the inflation rate in the short-run. • The items outside the domain of monetary policy such as food prices, food and energy prices prices contributed to annual inflation by 41% in 2004-2006 period, whereas their contribution rose to 63% in September 2008. Components of Annual Inflation (percentage share) September 2008 2004 – 2006 Average Food and Energy Food and Energy Other Goods and Services Other Goods and Services * Food: Food and Non-Alcoholic Beverages ** Tobacco: Tobacco Products and Alcoholic Beverages Source: TURKSTAT, CBT

  23. Balance of Payments – Current Account Domestic Savings and Investments (2001 – 2007, percent of GNP) Investments Domestic Savings *1987 based series Source: SPO Program for 2008, CBT

  24. Balance of Payments – Current Account Current Account Balance and The Effect of Energy Prices on the Current Account Deficit* (2002 – 2007, percent of GDP) Current Account Deficit Excluding the Effect of Energy Prices Current Account Deficit * Keeping energy prices constant at 2002 levels. Source: TURKSTAT, CBT

  25. Capital Flows Financing of the Current Account (2000 – 2008*, percent of current account deficit) Financing of the Current Account (2000 –2008*, percent of current account deficit) Long Term Credits2 Non-Bank Private Sector Credits 2 Portfolio Investments 4 Foreign Direct Investment 3 Foreign Direct Investment 3 Bank Credits 1 Equities5 Short Term Credits1 Public Sector Borrowing4 * Last 12 months as of 2008 May 1Short Term Credits: Net short term loans of the banking sector, non-bank private sector and the public sector, plus trade credits 2Long Term Credits: Net long term loans of the banking sector, non-bank private sector and the public sector 3ForeignDirect Investment: Foreign direct investment inflows 4Portfolio Investment: Purchases of equitiesand securities by nonresidents and deposits of nonresidents * Last 12 months as of 2008 May 1Bank Credits: Short and long-term borrowing of the banking sector 2Non-Bank Private Sector Credits : Short and long term borrowing of the non-bank private sector, plus trade credits 3ForeignDirect Investment: Foreign direct investment inflows 4Public Sector Borrowing: Purchases of government securities (including Eurobonds) by nonresidents, credits to central government and to the Central Bank (including IMF credits) 5Equaities: Purchases of equities by nonresidents Source: CBT Source: CBT

  26. Foreign Direct Investment Foreign Direct Investment(Annual, billion US dollars) Foreign Direct Investment Inflows(2006, billion US dollars) Source: UNCTAD Source: CBT

  27. Economic Growth Cumulative GDP Growth(Percentage change, 2001-2007) Source: TURKSTAT, IMF World Economic Outlook

  28. Productivity and Wages Productivity, Real Wages and Real Unit Wages in the Manufacturing Industry(1998 Q4 – 2008 Q1, per hour worked, 4-quarter moving average, logarithmic scale) Productivity Index (lhs) Real Wages Index(rhs) Real Unit Wages Index(rhs) Source: TURKSTAT, CBT

  29. Export Performance Turkey’s Share in World Exports (1950 – 2007, percent) Source: WTO, CBT

  30. Foreign Trade Real Imports and Real Exports Indices (1982 – 2007, 2003 = 100) Imports and ExportsGrowth (January 2006 – August 2008, 12-month rolling year-on-year change, in USD, percent) Exports Imports Imports Exports Exports Imports (ex-oil) Source:TURKSTAT, CBT Source:TURKSTAT, CBT

  31. Export Performance Composition of Turkey’s Exports (top 8 export sectors, billion USD) Apparel and clothing Textile yarn, fabrics Food and live animals Industrial Machinery Chemicals and petroleum products Iron and steel Electrical machinery and appliances Motor vehicles * 12-month rolling as of May 2008 Source: TURKSTAT, CBT

  32. Public Sector • Public sector has become more resilient to external shocks due to tight fiscal policy that has been implemented since 2001. • The Treasury maintains a high level of FX reserves with the aim of minimizing any liquidity risk that might arise in cash and debt management. Public Sector Net Debt Stock / GDP (2000 – 2008 Q2, percent of GDP) EU Defined General Government Budget Deficit (2001 – 2007, percent of GDP) Total Net Debt Stock Net Domestic Debt Net Foreign Debt Maastricht Criteria: 3.0% Source: Treasury Source: Treasury

  33. Central Bank Foreign Exchange Reserves Ratio of Short Term Debt to Central Bank FX Reserves(1996 – 2008 Q1, percent) Central Bank FX Reserves(2002- September 2008, billion USD) Source: CBT Source: CBT

  34. Prospects for World Economy • Challenges for the world economic outlook • Coupling, • Further squeeze in liquidity and increase in funding cost, • Further deterioration of expectations and confidence in • international markets, • Slowdown in world economic growth, • Unemployment, • New architecture of financial markets • Consolidation • Reshaping of financial institutions • Need for effective regulation and supervision, • Coordination and cooperation among both • local and cross border authorities.

  35. Thank you. MEHMET YÖRÜKOĞLU CENTRAL BANK OF TURKEY DEPUTY GOVERNOR October 2008

  36. Public Sector General Budget Primary Expenditures and TaxRevenues (March 2007 – August 2008, year-on-year change, 3-month moving average, percent) Central Government Primary Balance(Program defined, 3-month total, 2006 Q1- 2008 Q3*, TRY billion) 2008 2007 Tax Revenues Primary Expenditures *July-August average Source: Undersecretariat of Treasury Source: Ministry of Finance

  37. Corporate Sector • The FX position of the non-banking sector was USD 73.8 billion as of the first quarter of 2008. • Short term net FX position of the real sector is about 2 billion USD. • Maturity composition of the real sector debt has extended considerably. Maturity Composition* of the Long-term External Debt of the Corporate Sector (as of July 2008, billion USD) FX Position of the Corporate Sector (2005 – 2008 Q1, billion USD) FX Liabilities FX Assets Net FX Position * Days to maturity Source: CBT Source: CBT

  38. Households • In Turkey, the practice of variable interest rate for consumer loans is limited.FX denominated loans are not extended to consumers and companies with no FX income.FX-indexed consumer loans make up only 4.1 % of total amount of consumer loans. • Household indebtedness is at a low level compared to European Union and Eastern Europe countries.. Ratio of FX-indexed Consumer Loans to Total Consumer Loans (2003 – September 2008, percent) Ratio of Household Liabilities to GDP (2004-2006, percent) European Union Eastern Europe Turkey Source: CBT Source: ECB, CBT

  39. Commercial Activities • Parallel to the economic activities that gained pace between 2002 and 2007, the number of bad checks increased in line with the number of bank checks used.The ratio of the amount of bad checks to the total checks submitted to the clearing house, which was 6.8% in 2003, declined to 5.5% in 2007. This ratio stood at 5.1% as of July 2008. • Likewise, the ratio of protested bills to commercial loans (an indicator of commercial activities) declined to 2.9% in Augustos 2008 after reaching 11% in 2002. Ratio of the amount of Protested Bills to (12 months, cumulative, real) Total Commercial Loans (January 1999 – August 2008, real, percent) Ratio of Bad Checks to the Total Amount of Checks Submitted to the Clearing House (2003-2008*, percent) * January-July average Source:CBT, ICHC Source:CBT

  40. Inflation and Policy Rates • Developing countries that followed a tight monetary policy in 2007 were in better position to resist inflationary pressures in 2008 as compared to countries that followed accomodative monetary policies. Change In Inflation Rate and Real Policy Rates In Developing Countries Source: Central Banks

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