Turkey is rewarded for failure

On May 15th, the International Monetary Fund (IMF) decided to reward failure. With the agreement of its shareholders, it added $8 billion (€9.2 billion) to the amount it was prepared to lend Turkey. This brought IMF credit available to the country to $19 billion. If Turkey were to draw this, it would become the IMF's largest debtor.

At first glance, this is a clear case of throwing good money after bad in a country with a long history of failed attempts at stabilisation. It is the second rescue of a programme initiated in December 1999, with a stand-by of $3.7 billion. The first rescue followed a currency crisis in November 2000. An additional credit of $7.3 billion was advanced in December.

The IMF is no longer supposed to save lenders from the costs of taking amply rewarded risks or to rescue countries from the consequences of their governments' folly. How then can this possibly be justified?

One justification - that Turkey is vital to the stability of a critical region of the world - should be put to one side. It is true, but provides a weak argument for IMF involvement. Fund programmes should be grounded in economics, not just in politics.

Fortunately, it is possible to make an economic case. The negative point is that Turkey will almost certainly default on its foreign and domestic public debt or experience something close to hyperinflation, in the absence of a rescue. The positive one is that judicious assistance may bring stability at last.

While Turkey retains the same coalition government as before, its Minister for the Economy, Mr Kemal Dervis, is a former vice-president of the World Bank - someone who understands what needs to be done and why.

Structural reform includes the elimination of the huge overnight exposures of the state banks, their recapitalisation and an overhaul of their corrupted governance. It also includes closure or resale of insolvent private banks and strengthening of those still solvent. In addition, the government has agreed to privatise many state companies and reform the markets in which they operate.

Fiscal targets include a primary budget surplus (balance before interest payments) for the public sector of 5.5 per cent this year and 6.5 per cent in 2002 - a big improvement on the primary deficit of 2 per cent in 1999 and surplus of 2.8 per cent in 2000.

However, the most obvious risk lies in the dynamics of debt, and Turkey has reached the limits of debt manageability. The overall public sector borrowing requirement is forecast at 17 per cent of GNP this year and 10 per cent in 2002. Financing this is bound to impose heavy demands on the fragile domestic financial system.

Confidence will also depend on political developments. A big risk is that the combination of real cuts in spending with structural reforms and a deeper-than-forecast recession will generate job losses and fierce political resistance. Another risk is that Turkey's politicians will destroy monetary and fiscal credibility again.

Whether the IMF was right to take these risks is a matter of judgment. If the IMF was to involve itself in only safe operations, it would have no reason for existence. Yet the Turkish people could end up not just with a collapsed economy and a discredited political regime but with a heavier foreign currency debt burden than the one they bear today.

Many informed official observers do think the programme is indefensible. I am prepared to give the IMF the benefit of the doubt, even though an argument can be advanced for having made debt restructuring a condition for further official assistance on this scale.

However, from now on, the Turkish authorities need to be told, forcefully, that this is their last chance, however strategically important their country remains. Rescuing Turkey from one failure after another is bad for the country, bad for the financial markets and bad for the IMF. This programme must be the end of it.