U.S. Watches Warily as Turkey's Economy Teeters By Paul Blustein Washington Post Staff Writer Wednesday, March 26, 2003; Page A30
A severe financial crisis is engulfing Turkey as a result of its diplomatic rift with the United States, raising the prospect of a debt default that could wreak economic havoc in a country long viewed in Washington as a linchpin of stability in the Muslim world. The Turkish lira hit a new low against the U.S. dollar Monday, and the yield demanded by investors for holding Turkish government domestic bonds shot well above 70 percent, amid mounting fears that policymakers in Washington would balk at funneling aid to Ankara's heavily indebted regime. Turkey's refusal to cooperate fully with the U.S.-led attack on Iraq has angered administration officials and many members of Congress. Although Turkish markets rallied yesterday on news of a White House proposal to Congress for $1 billion in aid to Ankara, the gains erased only a modest portion of the sell-off that has battered Turkish currency, bonds and stocks over the past couple of weeks. At 60 to 70 percent interest rates, the government stands little chance of being able to carry its debt burden for very long, analysts agree. Moreover, administration officials suggested that the new aid offer -- much less than the $6 billion Washington once envisioned as compensation for Turkey's cooperation in the war -- may not pan out. Deepening the gloom surrounding Turkey's economic prospects, the country's debt was downgraded yesterday by Fitch Ratings Ltd., the credit-rating agency. Turkey's foreign debt rating is now the same as that of Moldova, an impoverished nation that was recently forced to restructure its obligations. "Fitch is concerned over how the authorities will manage to fill a growing public sector funding gap in 2003," the agency said, using polite terminology for a possible default. The crisis is a potentially enormous headache for the Bush administration because Turkey's geopolitical importance far exceeds that of some other "emerging markets" that have been stricken by financial panics -- Argentina, for example. Not only is the country strategically located, but it also is a NATO ally and its moderate Muslim society is viewed by Washington as a model for its neighbors. Until recently, that was enough to convince investors that Washington would move heaven and earth to keep Turkey's economy afloat, including using its dominance at the International Monetary Fund, which committed last year to lend Ankara $17 billion. But now irritated U.S. officials are sending quite different signals, and in conveying their displeasure to Ankara they risk worsening the Turkish crisis by confirming the market perception that the country can no longer count on easy IMF support. Some experts believe that the administration will ultimately resolve the dilemma in Turkey's favor, perhaps by prodding the IMF to increase its loan program. "The last thing they need is a major financial crisis in Turkey on top of everything else that's going on in the region," said Steven Radelet, a fellow at the Center for Global Development, who previously oversaw relations with Ankara at the Treasury Department. But administration officials have shown little enthusiasm for increasing the IMF loan and have confined themselves mainly to admonishing Ankara to stick to the fund's requirements for fiscal discipline. The amount Turkey owes the IMF is already more than five times what it would ordinarily be permitted to borrow under fund rules. So in the markets, many are betting that Turkey will eventually decide to default because of a vicious circle that has taken hold. Worries about U.S.-Turkey relations have prompted investors to insist on higher bond yields, which drives up government borrowing costs, which worsens the budgetary problem, which arouses even further market anxiety. "They've got to get on a virtuous path of some sort, and it's hard to see how they can do that even if they implement the IMF program," said Daniel Hewitt, a senior international economist at Alliance Capital Management. The overarching problem is that the government is staggering under a debt of about $160 billion, close to the nation's annual national output. So when interest rates shoot up a few percentage points, as they have recently, the impact is huge. The same goes for declines in the lira, because a substantial chunk of the government's debt is denominated in dollars or linked to the U.S. currency. The recently elected government has taken many of the budgetary steps required by the IMF, which praised Ankara's latest moves yesterday. But those measures are often "swamped by changes in financial market sentiment" such as higher interest rates and a lower lira, said Dani Rodrik, a Turkish-born economist at Harvard University who is advising the nation's central bank. If the government finally gives up and suspends payment on the debt, the most likely effect would be a major contraction in credit that would add to the problems of an economy already threatened by a war-related drop-off in tourism. "One could argue that in the medium to longer term, [default] might be a better thing than just stumbling along with this albatross around your neck," Rodrik said. "But in the short term, it's very damaging. We're not talking just about foreign debt; this is debt held by domestic residents and the banking sector."
