The financial markets in Turkey

THE WORLD BANK 1b 0)0 2. Internal Discussion Paper EUROPE, MIDDLE EAST AND NORTH AFRICA REGION Report No. IDP-0062 The Financial Markets in Turkey By Sven B. Kjellstr0m April 1990 Office of the Vice President Europe, Middle East and North Africa Region Discussion Papers are not formal publications of the World Bank. They present preliminary and unpolished results of country analysis or research that is circulated to encourage discussion and comment; citation and the use of such a paper should take account of its provisional character. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. TFE FINANCIAL MARKETS IN TURKEY BY Sven B. Kjellstrom April 1990 The Author is a Principle Economist at the World Bank Resident Mission in Turkey. ABSTRACT The purpose of this paper is to present the development since 1980 of the financial markets in Turkey, especially the stock exchange, in a broader economic context. After a review of the macroeconomic setting, the financial system is presented, highlighting the dominant role of banks. The origins and operations of the still embryonic stock exchange are analyzed, and its future assessed against a background of favorable policies, an expanding more competitive economy, but continuing structural obstacles. Various prerequisites (economic, financial and political) for the development of financial markets in general, and the stock exchange in particular, are identified. These might prove applicable to other middle-income developing countries intent on promoting a liberalization of their economies through greater reliance on market forces and the private sector in an international framework. i Table of Contents Paragraphs I. Introduction 1 -2 II. Overall Framework A. Macroeconomic Developments Since 1980 3 - 15 B. Financial System 16 - 22 C. Banking System 23 - 42 D. Private Sector Indebtedness 43 - 44 E. Public Sector Indebtedness 45 - 51 III. Current State of the Stock Exchange A. Historical Survey 52 - 57 B. Organization and Operations of the Stock Exchange 58 - 66 C. Relative Importance of the Stock Exchange 67 - 68 D. Stock Market Developments, 1986-88 69 - 78 E. Secondary Market 79 - 81 F. Private Demand and Supply on the Stock Exchange 82 - 92 IV. Development and Dynamics of Financial Markets A. Potential and Constraints of the Present Situation 93 - 95 B. Incentive Schemes 96 - 106 C. General and Economic Aspects 107 - 118 V. Conclusion 119 - 126 Statistical Annex List of Tables and Graphs i i List of Tables and Graphs in the Text Tables Pages 1. Domestic Financial Assets, 1980-87 9 2. Indicators of Financial Depth, as percent of GNP, 11 1980-87 3. Total Bank Credits, 1980-87 15 4. Distribution of Value Added for the Largest Private Industrial Firms, 1982-87 23 5. Public Sector Borrowing Requirements, 1980-88 24 6. Comparison Between Stock Markets in Turkey and Other Middle-Income Developing Countries, 1985-87 33 7. Daily Average Trading Volume on the Istanbul Stock Exchange, 1986-88 35 8. Distribution of Transactions bf Member Groups on the Istanbul Stock Exchange, 1987 43 9. Comparison Between the Insurance Industry in Turkey and the OECD, 1986 44 Graphs 1. Indicators of Financial Debt, 1980-88 11a 2. Monthly Closing Values of the Istanbul Stock Exchange Index, 1986-88 37a Acknowledgements This paper has benefitted greatly from the information and analyses that the representatives of banks and brokerage - s, active on the Istanbul Stock Exchange, were kind enough to share with t author. The Executive Director of the St9ck Exchange, Mr. Muharrem Karsli, generously provided information about its current and prospective operations. The staff of the Capital Markets Board were most cooperative in furnishing data and clarifications about the regulatory framework. Among the staff, Mr. Abdullah Akyuz, provided incisive and valuable comments on an earlier draft of the paper. My colleagues, Mr. Tevfik Yaprak and Ms. Sebnem Akkaya, of the World Bank Resident Mission in Ankara, made an inestimable contribution to the collection and editing of statistical data. Pointed and useful comments were received from Ms. Patricia Annez of World Bank Headquarters in Washington. Mesdames Rabia Akay and Ipek Kutay made a series of corrections and revisions with dillgence, and patience. Ms. Kutay prepared the final version of the report with her usual oxriciency and verve. Finally my wife, Brigitte Kjellstrom, first helped me with polishing the French version of the paper, and subsequently with translating it into English. To her I am doubly indebted. The author remains indebted to all of these persons for their assistance in the preparation and writing of this paper. Nonetheless, he alone is responsible for the opinions expressed, as well as any errors of fact and judgement that might subsist. THE FINANCIAL MARKETS IN TURREY I. Introduction 1. Turkey is an illustrative case of the development of financial markets in a middle-income developing country. Since 1980 Turkey has experienced its share of both turbulence and economic progress. The country was forced to overcome a debt service crisis, while trying to restore growth. This was achieved in a rapidly evolving economic framework, where important elements of the previous economic policy were abandoned in favor of sometimes radically different policies. The Turkish Government has ever since tried to promote the development of financial markets through numerous supportive measures. Progress have been achieved, but structural changes have been limited, and many bottlenecks remain. The financial markets are consequently far from having reached their full potential. For all these reasons, the Turkish experience in the development of its financial markets could serve as an example for other countries attempting to develop their own financial markets under more or less similar circumstances. 2. The purpose of this paper is to present the development since 1980 of the financial markets in Turkey, in particular the stock exchange, in a broader economic context. First the general framework is presented. This includes an overview at the macro-economic situation, followed by a presentation of the financial system, and in particular of the banking zystem, due to its leading role. This is, in turn, followed by a summary of the financial situation of the private and public sectors, emphasizing the critical role of the latter. 2 Secondly, the major aspects of the stock exchange will be presented: institutional setup, operations and its recent expansion. The role of the stock exchange and of its participants are examined as is its emerging role. Thirdly, the conditions necessary for the expansion of the stock exchange as well as means to promote its further development are reviewed. The prerequisites are to be found both in the economic and political domain. The means conducive to a flourishment of the stock exchange comprise a vast range of incentives, such as fiscal, institutional, legal etc. Furthermore, miscellaneous economic and general conditions are to be met in order for the stock exchange to develop. The paper ends with a conclusion providing a synthesis between the present situation and perspectives for the future, as well as lessons that other middle-income developing countries can draw from the Turkish experience. II. Overall Framework A. Macroeconomic Developnents Since 1980 3. Since 1980, the Turkish macroeconomic situation has greatly improved. A serious debt-service crisis, reflected partly in a shrinking economy and a 100 percent inflation, was overcome and a viable balance of payments restored. Many factors contributed to this recovery. Turkey benefitted from a vast rescheduling of its external public debt between 1978-80, i.e. before the onset of the South American debt crises. An OECD consortium orchestrated a major financial aid package to Turkey, including substantial bilateral aid, and not least IMF stand- bys amounting to $1.2 billion and five IBRD structural adjustment loans for a total of $1.6 billion. Buoyant export demand, in particular from the OPEC 3 countries of the Middle East, also contributed greatly to the improvement in the balance of payments. 4. The fact remains that most of the merit for the improvement of the economic performance since 1980 belongs to the Turkish Government, for having undertaken vast policy reforms and for having persisted with the reforms long enough to obtain positive results. In many ways Turkey illustrates a successful case of growth with adjustment. 5. The year of 1980 constitutes a critical transition period in Turkey's long- standing economic policies. In that year, the Government undertook a radical change in economic policies. It should be emphasized that the Govern=-nt itself pushed through the radical change, hence its lasting commitment toward the new policies. The new policy course consisted of giving priority to exports, instead of import substitution, emphasizing private sector expansion, in lieu of promoting state enterprises, while displaying greater confidence in market forces, with less recourse to direct interventions, price controls, and subsidies. The radical and durable change in policy course was accompanied by multiple measures in the areas of fiscal and monetary policy, foreign trade, interest and exchange rates, prices, subsidies and so forth. 6. The performance of the Turkish economy in the period 1980-85 has few equals in a global setting, where an increasing number of developing countries started to run into debt-servicing difficulties. Growth was soon reestablished in Turkey, and its credibility on international capital markets was gradually restored (see Annex Tables I and 2 for domestic and external economic indicators of macro- ~' ~ R -, 4 economic performance). It is noteworthy that, contrary to many other countries faced with a debt-service crisis during the 1980's, Turkey succeeded in overcoming its crisis by increasing exports, which allowed domestic demand to expand, instead of reducing imports by means of compresaing domestic demand, in order to generate the necessary resources for external debt service payments. For this reason, structural adjustment and economic stabilization have since 1980 been less difficult in Turkey than in many other countries. 7. On the domestic front, growth soon resumed after 1980. A large devaluation in 1980, positive real interest rates, a more moderate fiscal policy and a monetary policy aiming at a more efficient credit allocation all contributed to a substantial increase in exports; meanwhile domestic demand (chiefly private) could resume although slowly, partly thanks to the elimination of severe shortages of imported products. Between 1981 and 1985, real GDP growth was steadily in the order of 5 percent per year. Inflation, at the consumer price level, decreased from 101 percent in 1980 to 31 percent in 1982-83, but then rose to 45 percent in 1985. The public sector borrowing requirement (PSBR) declined from 10.0 percent of GDP in 1980 to 4.8 percent in 1985. The expansion in broad money supply (142) fell from 67 percent in 1980 to 57 percent in 1985. 8. On the external front, the swift and continued increase in exports constituted a remarkable feat. Exports grew from 5.1 percent of GDP in 1980 to 15.6 percent in 1985. Simultaneously their composition underwent a major change: the share of industrial products (including processed agricultural products) rose from 36 to 75 percent of the total. The major reasons for the remarkable growth in exports were: strong external demand, real exchange rate depreciations, major 5 export incentives, reinforced by an excess production capacity, due to the 1979- 80 recession, and weak domestic demand. Imports also increased, but not as fast. As a result, the current account deficit in the balance of payments fell from 5.8 percent of GDP in 1980 to 1.9 percent in 1985. The improvement was gradual, and it was only from 1984 on that Turkey generated a non-interest current acccunt surplus. Nonetheless, voluntary lending by commercial banks did not resume until 1983 for trade purposes and until 1984 for general balance of payments support. 9. Starting in 1986, the impressive economic performance began to be undermined. Large increases in public expenditures could not but weaken domestic financial balances. Granted, GDP grew by 8.0 percent in 1986 and 7.3 percent in 1987, but growth slowed down to only 3.4 percent in 1988. The fact remains that following a steep increase in public investment beginning at the end of 1985, the PSBR rose to 8.2 percent in 1987. A large portion of the growing deficit was financed by domestic borrowing, often at high interest rates, even in real terms. Thus, despite a decrease of 8 percent in public investments (in real terms) in 1988, the PSBR was only brought down to 6.8 percent, due in great part to better financial performance of state enterprises, more through price increases than higher productivity. This did not fail to contribute to higher inflation in 1988. The main reason for failing to bring down the PSBR was the steep increase in interest payments on the domestic public debt. Following the real devaluations of the exchange rate in order to make Turkish exports more competitive, the payments on the external public debt also increased. The Turkish Government found itself caught in a vicious circle where deficits, debts, and interest payments fed on each other. 6 10. For the Central Goverroent alone, interest payments absorbed 31 percent of revenue in 1988. For this reason it was obliged to generate a primary surplus in the budget (i.e. before interest payments) in excess of 1.3 percent of GDP in 1988, in order to limit its overall deficit to 4.0 percent (with interest payments amounting to 5.3 percent). The deterioration in public finances contributed to the recrudescence of inflation, which climbed to 75 percent in 1988, while money supply increased by 65 percent. 11. Contrary to developments on the domestic front, the balance of payments continued to improve after 1985. With exports growing faster than imports, and thanks to rapid growth in tourist receipts, the current account deficit shrunk further. In 1988, Turkey registered for the first time since 1973 a current account surplus, a rare event indeed in its history. This achievement resulted mainly from a rapid increase in tourist receipts and from a decrease in the trade deficit: a decrease due mostly to the fact that imports grew more slowly with the diminishing growth rate. In large part, thanks to its current account surplus, which pari passu reduced its external borrowing requirements, Tukey had no difficulty in refinancing maturing old loans in 1988. In 1988, external debt service reached $7.3 billion ($4.3 billion in principal and $3.0 billion in interest). The ratio between debt service and export earnings, including remittances from Turkish workers abroad, reached 39 percent. 12. At the beginning of 1989, the Turkish economy was confronted by the challenge of reducing both the public sector deficit and the inflation rate without triggering a recession, following the sharp decrease in the growth rate during the second half of 1988. To sustain the growth rate was of primary 7 importance in order to avoid an increase in unemployment and a worsening of social conditions. Escaping the vicious circle of escalating deficits and the burden of ever-increasing interest charges would not be an easy task, for the margin of maneuver was narrow. Increased revenue, more selective and productive public investments, would be indispensable to attain this goal. Early in the year, the Turkish Government has approved a program toward such ends for 1989. 13. The distribution of the fruits of the growth that resumed after 1980 has not been equal, rather the opposite. The income distribution has become more unequal during these last few years. Some categories of wage-earners and retired workers, in particular in the public sector, have seen their real income fall. The acceleration of inflation in 1988 has only made the problem worse. If this trend continues, it will inevitably lead to a deteriorating social climate. R.-toring health to public finances in such a context will not be easy. 14. On the external front, the improvement observed during 1988 could be reversed if inflation and the public sector deficit are not brought under control in a near future. The dichotomy between internal and external performance may be eliminated at the cost of the balance of payments. It could become difficult to maintain the confidence of international capital markets, if the Government were to prove unable to redress the domestic situation. Without the confidence of international capital markets, Turkey could experience serious difficulties in obtaining the new loans she needs to replace maturing old debts. In 1989 debt service will be approximately $7.3 billion: $4.2 billion in principal and $3.2 billion in interest. Turkey needs to mobilize substantial new loans to face these 8 payments. Turkey has not had any difficulty in obtaining project credits, but credits for general balance of payments support have been less easy to mobilize. But this is nevertheless the type of loans which is necessary to refinance maturing old debts. The Government is aware of the stakes and has elaborated a program, mentioned in paragraph 12 above, aiming at redressing macroeconomic balances. 15. Lastly, concerning the evolution of savings and investments, it is to be noted that there has been a sharp increase in savings since 1980, while the increase has been less for investments. The savings rate rose from 14.1 percent of GDP in 1980 to 25.7 percent in 1988, thanks in part to positive real interest rates. The mobilization of savings is thus not a priori a problem. For investments, the increase was from 21.9 percent to 23.6 percent of GDP. In the past years, the private sector has generated a savings/investment surplus, which has been appropriated by the public sector. For the latter, savings has not increased much, while recourse to external borrowing has been restricted in net terms, because of the already heavy external indebtedness. The external public debt was still equivalent to 58 percent of GDP and 210 percent of exports in 1988. Although the Government's policy is aimed at promoting the private sector, in 1988 public investment was still almost equal to private investment, which has not responded very vigorously to the past-1980 economic policies; for instance growth in private sector manufacturing (and exports) was more due to higher capacity utilization ratios than to rising investment. 9 B. Financial System 16. Despite major changes in the Turkish economy since 1980, the financial system has changed relatively little. It remains dominated by the banking system, for the capital market is still very limited. In 1980, the banking system held 90 percent or all domestic financial assets (see Table 1 for details). Currency in circulation and sight deposits alone absorbed more than 62 percent of the total. Public financial instruments made up only 7 percent and private instruments 4 percent. But it should be underlined that in 1980, Turkey was in the midst of an economic crisis with a galloping inflation. It consequently suffered from a financial disintermediation, especially for longer term instruments. Table 1. Turkey : Domestic Financial Assets, 1980-88 1980 1983 1986 1988 1/ Percent Percent Percent Percent Percent Percent Percent Percent of total of GNP of total of GNP of total of GNP of total of GNP Currency in Circulation 19.3 4.9 12.9 4.7 7.6 3.6 9.3 3.8 Sight Deposits 43.1 10.8 32.9 11.8 19.4 9.1 13.3 5.5 Time Deposits 10.5 4.0 31.8 11.7 35.7 16.9 30.1 14.6 Official Deposits 16.8 4.3 16.3 6.0 7.9 3.7 6.3 2.6 Foreign Exchange Deposits by 0.0 0.0 0.0 0.0 10.3 4.9 16.7 6.9 Residents Subtotal: Banking Sector 89.7 24.0 93.9 34.2 80.9 39.9 75.6 33.4 Government Securities 2/ 6.6 1.7 4.7 1.7 17.5 8.3 21.6 8.9 Private debt instruments 1.9 0.5 0.4 0.2 0.9 0.4 1.9 0.8 Private equity issues 3/ 1.6 0.4 0.8 0.3 0.5 0.3 0.9 0.4 Total 100.0 26.6 100.0 36.4 100.0 48.9 100.0 43.4 1. January-October, 1988 2. Bonds, Treasury bills, and revenue sharing certificates 3. Stocks quoted at the Stock Exchange Source : Central Bank of Turkey, Annual Reports, and data provided by the Turkish Authorities 17. Between 1980 and 1988, the structure of the financial system has nevertheless somewhat changed. The share of the banking system decreased to 76 10 percent by 1988. The share of time deposits has tripled, while the share of currency in circulation and sight deposits has fallen to 23 percent. This is a sign of expanding financial intermediation, following the restoration of positive real interest rates. The decrease in the share of the banking system, although still preponderant, was due to the rapid increase in the share of public debt instruments. Their share reached 22 percent in 1988, while the share of private sector debt instruments was less than 3 percent. 18. The conclusion is unavoidable that in Turkey the private capital market remains embryonic, in spite of the improved economic situation since 1980. The lethargic state of the capital market is all the more surprising in light of the Government's emphasis on the role of the expansion of the private sector in its development strategy. The strategy has been more successful regarding exports, mostly by private enterprises; it was less successful in promoting a flourishment of private capital markets. The fall in the share of the banking system was compensated by a sharp increase of public debt instruments. Compared to the latter, the volume of private debt instruments is still marginal. 19. Globally financial intermediation has nonetheless progressed substantially between 1980 and 1988; the ratio between domestic financial assets and GDP jumped from 25 to 39 percent during this period, after having reached 47 percent in 1986. The decrease since then was due to the resurgence of inflation in 1988. However, the progress in financial intermediation has benefited mostly the public sector, which has financed sizeable deficits by growing domestic borrowings. 11 20. As to indicators of financial depth, Turkey has also progressed considerably after 1980. It remains nevertheless that, compared to other countries with similar per capita income, the indicators of Turkey are still rather low. In 1980, the ratio between money supply (narrow money, or Ml) and GDP was of only 16 psircent (see Table 2 for details). Furthermore, since time deposits were equivalent to only 4 percent of GDP, the same ratio for money supply in the broad sense (M2) did not quite reach 20 percent. The diminutive weight of time deposits stemmed obviously from the sharply negative real interest rates at that time. Table 2. Turkey : Indicators of Financial Depth, 1980-88 (as percent of GNP) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1. Currency in Circulation 4.9 4.3 4.7 4.7 4.0 3.6 3.6 4.4 3.8 2. Demand Deposits 10.8 10.4 10.5 11.8 8.1 7.8 9.1 6.6 5.5 3. Ml 15.9 14.8 15.4 16.8 12.3 11.5 12.8 10.8 9.3 4. Time Deposits 4.0 10.1 13.9 11.7 15.7 17.8 16.9 14.1 14.6 5. M2 19.9 25.0 29.2 28.5 28.2 29.3 29.6 24.9 23.9 6. FX Deposits .. .. .. 0.0 1.1 2.8 4.9 6.6 6.9 7. M2X 19.9 25.0 29.2 28.5 29.3 32.1 34.5 31.5 30.8 Source : Central Bank, and State Institute of Statistics 21. The far-reaching economic reforms introduced since 1980 have led to a deepening of the financial system (see Graph 1). Once conditions more favorable for financial intermediation had been restored, the importance of M2 compared to Ml increased greatly. In 1988, the ratio between Ml and GDP had decreased to 9 percent, whereas the same ratio for M2 had climbed to 24 percent. This latter development was due to the growing importance of time deposits mentioned above. It has to be underlined that the increase 12 in the ratio for M2 has mostly taken place between 1980 and 1982: thereafter the ratio has tended to plateau. A major cause for the relative stagnation in M2 has been the introduction of foreign exchange deposits for Turkish residents starting in 1984. If account is taken of these deposits, by adding them to M2 to get M2X, then the financial deepening has continued after 1983. In 1984, M2X amounted to 29 percent of GDP, while the ratio reached 31 percent in 1988. 22. The introduction of foreign exchange deposit has thus contributed to the progress realized in expanding the financial system. The other side of the coin is that a substitution of currency in favor of foreign exchange could render the system less stable, and furthermore make the conduct of monetary and exchange rate policies more difficult. C. Banking System 23. Since the banking system forms the keystone of the Turkish financial system, an analysis of its structure and modus operandi is called for. The banking system has progressed much since 1980, although its structure has not changed fundamentally. The mobilization of resources and the distribution of credits have become more influenced by efficiency criteria and less by public intervention. It is nevertheless obvious that the banking system is a component of the economy where competition, i.e. market forces, only prevails to a limited extent. The resurgence of inflation and, with it, of uncertainty these last years, has weighed heavily on the banking system. The same effects have been felt from the growing public deficits, mainly financed by heavier domestic borrowings. By the same token, the access of the private sector to credit at affordable costs has been hindered. 13 24. The liberalization of the Turkish economy since 1980, in particular its opening to the outside world has led to an increase in the number of banks, from 43 to 57 between 1980 and 1987 (see Annex Table 3 for more data). It is however peculiar that this increase should exclusively touch private foreign banks, for which the number has passed from 4 to 18. Yet this has had little effect on the intensification of competition, because foreign banks represented not even 3 percent of total assets of the banking system in 1988. 25. The distribution, in terms of bank assets, between public and private banks has remained remarkably unchanged since 1980. The share of public banks is still around 50 percent. On the private side, commercial banks are prevalent; investment and development banks are only playing a marginal role, partly because they are not allowed to raise resource through deposits. 26. Another aspect of the relatively immutable structure of the banking system is its high degree of concentration, which has contributed significantly to limit competition. Only three banks represent approximately half of total assets. The largest, the Agricultural Development Bank (TCZB), a public one, owns 25 percent of the entire banking system assets, followed by two private banks, Isbank and Akbank, which between themselves own another 25 percent of total assets. Such a structure lends a conservative bias to the banking system, where the defense of positions gained hinder innovations. Instead of an invigorating competition, gentlemen's agreements have had a tendency to preserve acquired rents for the main and well established participants. 14 27. The distribution of bank credit has evolved since 1980 and shows that the policy of promoting market forces has made some progress. The granting of credits is henceforth made less on the basis of preferential credits, or ceilings to be respected in favor of so-called priority sectors. The banks have nowadays greater scope to grant credits according to profitability criteria. However, since the largest banks are either public, or controlled by large private industrial holdings, they have so far only partly used this greater potential to apply profitability criteria. 28. The distribution of bank credits by origin: central bank, commercial banks and investment and development banks, has changed much since 1980 (see Table 3 for details). The share of the Central Bank has fallen from 28 percent of the total credits allocated in 1980 to 11 percent in 1988. It was mainly central bank credits to state enterprises that fell: from 13 to 3 percent of the total. This decrease reflects the Government's policy to diminish cheap credit to state enterprises and to force them to rely more on their own means, or credits at market rates. In fact, the performance of state enterprises has improved, but more because of price increases for their output, than as a result of better productivity, by exploiting monopolistic or oligopolistic market positions. Some state enterprises continue to benefit from preferential credits granted by public banks; these banks can grant such credits since they receive compulsory and cheap deposits from other public entities, or benefit from discount facilities at preferential rates with the Central Bank. Some progress has nonetheless been recorded in decreasing preferential credits in favor of productive sectors. Preferential credits are a source of multiple distortions and privileges, but their share in global credits granted has gone down from 23 percent in 1983 to 18 percent in 1988. 15 Table 3. Turkey : Total Bank Credits, 1980-88, (in percent of total, end of period) 1980 1984 1985 1988 1987 1988 1/ Central Bank (direct) 27.7 13.4 12.9 10.2 11.0 10.7 Public administrations 14.3 12.5 11.2 8.5 7.2 7.2 Public enterprises 13.4 0.9 1.7 1.7 3.8 3.4 Deposit money banks 59.5 74.0 78.0 81.3 81.5 79.1 Public administrations 0.8 1.3 3.9 2.0 3.5 4.4 Public enterprises 10.4 3.5 5.8 10.7 11.3 7.8 Private enterprises & households 48.3 69.2 68.3 68.6 66.7 66.9 Investment and development banks 12.8 12.6 9.1 8.5 7.5 10.2 Public enterprises 9.2 7.1 4.6 4.2 3.1 4.1 Private enterprises & households 3.6 5.5 4.5 4.3 4.4 6.1 Total 100.0 100.0 100.0 100.0 100.0 100.0 Total (TL billion) Current prices 1,326 4,232 7,115 12,355 19,660 24,298 1982 prices 2,398 2,202 2,573 3,412 3,928 2,928 Percentage change 2/ .. -8.2 16.9 32.6 15.1 -25.5 Total credits as percent of GNP 29.9 23.0 25.6 31.4 33.7 24.3 Memorandum Items (percent of total) Credit to: Public admin4strations 15.1 13.8 15.1 10.5 10.7 11.6 Public enterprises 33.0 11.5 12.1 16.6 18.2 15.4 Subtotal public sector 48.1 25.3 27.2 27.1 28.9 27.0 Private enterprises & households 51.9 74.7 72.8 72.9 71.1 73.0 Total 100.0 100.0 100.0 100.0 100.0 100.0 1/ As of November 2/ Central Bank short-term credits to the Treasury and the public enterprises were consolidated in 1982 (TL 80.7 billion) and 1984 (TL 423.8 billion). In Central Bank accounts these amounts are recorded not under "credits" but under "accounts to be redeemed." Here percentage changes are adjusted for the consolidation, other figures do not include the consolidated credits. Source : Central Bank of Turkey, Annual Reports 29. Contriry to the Central Bank, the share of commercial banks in total credits granted has grown from 60 percent in 1980 to 79 percent in 1988. The retreat of the Central Bank has thus been compensated by the advance of commercial banks. The share of investment and development banks has decreased from 13 percent in 1980 to 10 percent in 1988, because these have suffered from their inability to mobilize resources through deposits. Their resort to external financing has been hampered by exchange rate risks, aggravated by the devaluation of the Turkish Lira in real terms, and by the difficulty to lend medium- and 16 long-term at fixed interest rates in an inflationary and uncertain environment. The introduction of variable interest rate loans has been opposed by the monetary authorities, who feared the detrimental effects of a growing indexation of the economy. This also explains the scarcity of medium- and long-term credits. Between 80 and 90 percent of total credits are short-term. In fact, these credits have no fixed maturity, because they are systematically rolled over, sometimes even with capitalization of interests due at the current prevailing rate. 30. As to the destination of credits, the Government's policy of granting priority to the private sector since 1980 is evident. The share of private enterprises and households in total credits has climbed from 52 percent in 1980 to 73 percent in 1988, while the share of state enterprises has fallen from 33 to 15 percent. For public administrations, the reduction in credits has only been from 15 to 12 percent. It should however be noted that the share of private sector share has somewhat shrunk since 1984, whereas the share of state enterprise has increased anew. 31. The sectoral distribution of credits reveals also some important changes since 1980 (see Annex Table 4 for details). The share of industry has fallen from 45 percent of the total in 1980 to 30 percent in 1987. This reflects mostly the relative diminution of credits granted to industrial state enterprises, for which investments have been cut. The share of services, mostly private, increased from 12 percent in 1980 to 26 percent in 1987, partly reflecting the dynamism of the tourism sector. The share of real estate rose from 2 to 15 percent during the same period. This was due to private investment, which benefitted from a vast public program of subsidized mortgage credits, starting in 1984. 17 32. Interest rates have naturally been utilized as a primary instrument in the mobilization and allocation of resources. In conformity with the Government's policy of giving a freer play to market forces, interest rates have begun to be determined more according to supply and demand, taking inflation into account. Some restrictions nevertheless remain; deposit rates are still subjected to ceilings, while lending rates are free. 33. The evolution of credit rates is shown in Annex Table 5. For sight deposits, the rate has remained negative in real terms. For time deposits, particularly one-year, the rates have often been positive in real terms, except during high inflation periods. For instance, in 1988 the rate for one-year deposits increased from 54 to 85 percent, which was more than sufficient to outpace inflation. The discount rates imposed by the Central Bank have often remained below the inflation rate. During 1988, they changed little. With higher inflation, they consequently constituted more important subsidies. 34. Non-preferential lending rates have remained very high, in real terms, since their liberalization at the outset of the 1980s. At the beginning of 1989, they varied between 110 and 125 percent, compared with an inflation rate of approximately 70 percent. This has discouraged the resumption of private investment. Yet the real burden of high lending rates is less heavy than what it appears. First, interest payments (in nominal terms) are deductible from a company's taxable income. With an effective corporate income tax rate of 49.2 percent, this lightens the burden of interest cost considerably. Secondly, many enterprises, or holdings, own their own bank, which facilitates their access to 18 preferential credits. It remains nevertheless that for small Drivate enterprises, or for those being established, the high lending rates present a genuine obstacle. The renewal and flourishment of Turkish economy have suffered correspondingly. 35. The high lending rates result naturally from relatively high deposit rates, but also from the substantial discrepancy between lending and deposit rates. At the beginning of 1988, approximately 58 percent of this difference was caused by the compulsory reserve and liquidity ratios (totaling about 50 percent). Taxes on financial intermediation and levies for Extra-Budgetary Funds contributed to around 21 percent of the difference. Finally, bank operating costs accounted for the remaining 21 percent. Bank margins between the average cost of deposits and non-preferential lending rates fluctuated between 30 and 40 percent at the end of 1988. The margin is limited to 1.5 percent on rediscounted preferential credits at the Central Bank. The margin of intermediation on foreign currency loans barely exceeds 3 percent. The weighted average margin of bank intermediation is probably over 10 percent. In Western Europe, the same margin is around 3 or 4 percent (and even around 1 percent for the biggest and most solvent customers). 36. Turkish banks have generally numerous branches and thus considerable fixed capital and a large number of employees. Compared with OECD countries, they have high operating costs, nevertheless remain profitable. In the period 1981-85, the operating cost of Turkish banks was 4.7 percent of intermediated assets, whereas the OECD average was 2.7 percent (see Annex Table 6 for more details). This has not prevented the net revenue of Turkish banks from reaching 2.2 percent of 19 intermediated assets, compared with 1.1 percent for all of the OECD. This is another illustration of the oligopolistic nature of the Turkish banking system. On the other hand, the relatively high profitability of Turkish banks is somewhat misleading in the sense that it compensates partly for the substantial erosion of capital caused by high inflation. For this reason, the minimum level of subscribed capital for banks has had to be .aised several times. 37. The instruments of monetary policy have gone through major changes following the reorientation of economic policy after 1980. Interventionist instruments have been partly replaced by other instruments relying more on market forces. Preferential credits have diminished and compulsory minimum ratios in credit allocation have been abandoned. The Central Bank relies more on interest rates, that despite inflation are positive in real terms most of the time, as the key instrument in the conduct of monetary policy. Yet deposit rates remain subject to ceilings. Preferential credits subsist, but in a lesser way. The central bank discount rates have remained below inflation. 38. The Central Bank still uses reserve requirements and liquidity ratios in monetary policy, but has added a few other instruments lately. The reserve requirement was 14 percent for time deposits and 25 percent for sight deposits at the end of 1988. The liquidity ratio was 30 percent. The latter is in part satisfied by Treasury bills and bonds, which guarantees the Treasury a captive market. An interbank market was introduced in April 1986 under the auspices of the Central Bank. This market has been quite successful in improving bank liquidity management and almost all the Turkish banks have joined it since 1987. Open market operations by the Central Bank commenced in February 1987. Since 20 then, the Central Bank has accumulated Treasury bonds in order to be able to use more this instrument of monetary policy. 39. From August 1988, the Central Bank has opened foreign exchange markets under its direction. Commercial banks and other authorized financial institutions are participating in these markets. The opening of these markets has bridged the gap between the official exchange rate and the parallel rate (the parallel market is tolerated, except in periods of turbulence on the foreign exchange markets). Although the bulk of foreign currency transactions is dealt with in an informal interbank market, the new markets under the direction of the Central Bank allow it to influence the evolution of the exchange rate. The Central Bank has accumulated important foreign exchange reserves to this end. 40. These last few years, the Central Bank has elaborated annual monetary programs containing targets for key monetary aggregates. These programs have not been published. Assuming a stable relation between M2 and GDP in nominal terms, the Central Bank has aimed to control M2. This was to be achieved through reserve money, assuming a stable relation between reserve money and M2. These assumptions of stability between various monetary aggregates have not always revealed themselves correct and have hampered the implementation of the monetary programs. What has made the monetary programs inoperative is the fact the Central Bank has had to satisfy the Treasury's liquidity needs. As long as the Central Bank is sutject to this obligation, an autonomous monetary policy will not be feasible, even if the Central Bank acquires increasingly more instruments for the elaboration and implementation of a genuine monetary policy. 21 41. Since a few years, the World Bank collaborates closely with the Turkish authorities in the elaboration of a reform program for the financial system. To this end, a first financial sector adjustment loan of $300 million was approved in 1986. A second financial sector adjustment loan of $400 million followed in 1988. Beginning in 1986 a standardized accounting system was introduced for all banks. From 1987 onward the financial statements of banks have had to be verified by external auditors. In March 1988, the minimum capital of banks was doubled, from Turkish Lira 2.5 billion to 5.0 billion, to start to remedy one of the shortcomings of the banking system, namely its relative under-capitalization. In order to limit preferential interest rates, and the ensuing distortions in the allocation of credit, a gradual restoration of positive real interest rates is forecast in the context of the reform program for the financial system. Access to preferential credits is not always easy to ensure according to established criteria. Excessive use of preferential credit could degenerate into the accumulation of arrears. 42. The banks have also accumulated non-performing loans; in a rapidly evolving economy accompanied by a high and variable inflation rate, a certain number of enterprises have lost their profitability. With the indirect help of rolled-over bank loans and capitalized interest payments, these enterprises have avoided bankruptcy. Meanwhile such practices have worsened the problem caused by non- performing bank loans. To remedy the problem, a decree was promulgated in May 1988, requiring banks to proceed with a standardized classification of their assets and, specifically to identify non-performing loans according to objective and clear criteria. The decree also foresaw the need for appropriate provisioning after a transition period. The build-up of more substantial provisions would be 22 deducted from bank profits. The implementation of the new regulation will lead to important changes in the banking system, while strengthening it. Procedures are provided for banks having difficulties with solvency following the enactment of the decree. Finally, the introduction of minimum weighted risk asset/capital ratios is foreseen. This measure, together with loan exposure regulations, should diminish the concentration of the banking system and its close relations with large holdings. All these reforms aim at modernizing the banking system to make it more sound and competitive. D. Private Sector Indebtedness 43. The indebtedness of the private sector is difficult to get a handle on for lack of data. However that may be, according to indirect evidence, its indebtedness must have increased on the basis of the high cost of non- preferential bank credits. The distribution of value added of enterprises has for example turned in favor of financial charges (interest payments) at the expense of salary payments. According to a sample of about 400 large private enterprises in the Istanbul area, the share of financial charges in total value added increased from 31 percent in 1982 to 45 percent in 1986 (see Table 4). Since 1987 was a particularly profitable year for the private sector (rapid growth and postponed price increases for state enterprises), the share of financial charges fell to 35 percent in that year. 23 Table 4. Turkey : Distribution of value added for the largest private industrial firms, 1983-88 1/ (in per 1982 1983 1984 1985 1988 1987 1988 Interest payments 31.0 29.9 33.1 36.2 45.1 35.1 38.4 Wages ano Salaries 42.5 42.7 38.2 39.4 32.6 29.4 31.8 Rents 0.6 0.5 0.7 0.7 0.7 0.5 0.5 Profits 2/ 26.1 26.9 28,0 23.7 21.6 34.9 29.3 Net value added 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1/ On the basis of factor incomes, around 400 firmas 2/ National income definition Source : E. Ozotun, "Contribution of 500 large firms to value added and its distribution", Journal of the Istanbul Chamber of Industry, September 1986, pp.154-163, and subsequent data conmunicated by the Istanbul Chamber of Industry. 44. Other indicators also bear witness to a heavier financial burden on private enterprises. For the same sample of about 400 enterprises in the Istanbul region, financial costs compared to sale receipts increased from 6 to 10 percent between 1983 and 1986, but fell to 7 percent in 1987 (see Annex Table 7). The debt/equity ratio increased from 146 percent in 1984 to 194 percent in 1986, before descending to 166 percent in 1987. High interest rates have contributed to heavier financial costs of private enterprises, which, in turn, has increased non-performing loans of banks. E. Public Sector Indebtedness 45. The widening of the Public Sector Borrowing Requirement (PSBR) starting in 1984 has obviously led to an increase in public sector debt. The PSBR/GNP ratio had crept back up to 6.5 percent in 1984. Following improvements in 1985- 86, the ratio climbed to 7.9 percent in 1987 (see Table 5 for details). For 1988 the Government hoped to bring the ratio back to 6 percent. The financing of the PSBR has changed much since 1963. The share of the Central Bank decreased from 24 62 percent in 1980 to 18 percent in 1988. This reflects the intention of avoiding a monetization of public deficits in order to reduce inflationary pressures. Internal borrowing should in great part replace the monetization of public deficits. Thus the share of internal borrowing in the financing of the PSBR financing rose from 27 percent in 1980 to 78 percent in 1988. Table 5. Turkey : Public Sector Borrowing Requirements, 1980-88 1980 1981 1982 1983 1984 1985 1986 1987 1988 Public Sector Balance/GNP (percent) Genoral Government -3.3 -0.8 -0.9 -Z.5 -4.2 -1.7 -1.2 -3.7 -3.6 Central Government -3.7 -1.8 -1.7 -2.6 -5.3 -2.8 -3.6 -4.5 -4.0 Municipalities 0.2 0.2 0.1 0.0 0 2 0.2 -0.1 -0.6 -0.4 Revolving Funds 0.2 0.8 0.7 0.1 0.4 0.4 0.4 0.7 0.1 Extra-budgetary Funds .. .. .. .. 0.5 0.5 2.1 0.7 0.7 State Economic Enterprises (SEEs) -6.7 -4.6 -4.7 -2.3 -2.3 -3.1 -3.4 -4.2 -2.5 Total Public Sector -10.0 -5.4 -5.6 -4.8 -6.5 -4.8 -4.6 -7.9 -6.4 Central Government primary -3.0 -0.7 -0.8 -0.9 -2.9 -0.4 -0.2 -0.6 1.1 (or non-interest) balance Sources of financing (% of total) Central Bank 62.1 31.2 20.6 23.2 19.4 33.8 18.3 13.7 17.5 Foreign Borrowing, net 10.6 20.3 -7.5 -28.6 34.1 -28.8 -0.4 -10.2 4.6 Domestic borrowing, not 2/ 27.3 48.4 86.9 105.5 46.5 95.0 82.2 96.6 78.0 Memorandum Items Public debt/GNP General Government .. .. 33.5 47.0 47.7 48.7 52.4 55.8 43.4 Domestic .. .. 15.4 27.5 25.2 25.1 26.8 29.5 18.0 Foreign .. .. 18.1 19.5 22.4 23.6 25.6 26.3 25.4 1/ Provisional 2/ Including short-term borrowing and the arrears Source : State Planning Organization 46. The deterioration of public finances is equally reflected in the increase of public debt in relation to GDP. For the public sector, except for the state enterprises for which no reliable data is available, the debt/GDP ratio increased from 34 percent in 1982 to 56 percent in 1987; the decline in 1988 was due to accelerating inflation. Internal and external debt have contributed almost equally to the increase. As for external debt, the depreciation of the Turkish Lira has generated most of the increase. 25 47. The increased recourse to internal borrowing to finance growing public deficits has compelled the Treasury to sell larger amounts of Treasury bills and bonds. Treasury auctions began in May 1985. Since end-1986, these auctions take place weekly according to a pre-announced schedule. Until mid-1988, it was mostly short-term bills that were sold (three, six and nine months maturity). Subsequently, the Treasury attempted to sell longer term bonds. Since it introduced simultaneously two- and three-year bonds, at variable rates, it has been rather successful in this attempt. 48. Only a certain number of large banks participate in Treasury auctions, and keep most of the bills and bonds sold. Consequently, there is little intermediation between Government securities and bank deposits. The intermediation is rather operated by the banks between placements in Government securities and loans granted, which explains the high yield of the securities. Nonetheless, from mid-1988, the Treasury has attempted to diminish its borrowing cost by selling variable rate bonds and by convincing banks, through different means, to accept lower rates. 49. The secondary Treasury bond market remains modest, because the banks are not very active in this market. It has nevertheless to be noted that Treasury bonds remain the prevailing instrument on the secondary market (see Annex Table 8). Besides, they show a turnover rate that is particularly high and that reached 320 percent compared with 113 percent for private bonds in 1988. In that year, the secondary market has nevertheless gone through a certain expansion, because the banks began to sell and repurchase a growing amount of bonds to their largest 26 clients. The purchase/repurchase agreements are strictly speaking not permitted, but are de facto tolerated. Through this means and through mutual funds (which keep a great share of their assets in government paper), some enterprises utilize these bonds as a tax-free means to manage their liquidity. 50. In the context of the financial sector reforms, supported by the World Bank financial sector adjustment loans, several measures have been taken to make the Treasury auctions more competitive and thereby less costly to the Treasury. Allowing openly purchase/repurchase agreements should facilitate an expansion of the secondary market. Widening the number of participants in the auctions should lower the return, or cost, of the securities sold. This could be brought about by accepting a version of non-competitive bids from mid-size investors, be they intermediaries or individual investors. Non-competitive bidding means that the bidders would get government paper in the desired quantity, but at the average price realized at the auction. 51. With limited recourse to external borrowing in net terms, due to a still heavy external debt, and with the monetization option not very attractive due to its inflationary effects, the Treasury is forced to find means to reduce the cost of its internal borrowing. However, without a decrease in the PSBR, this task will remain difficult. 27 III. Current State of the Stock Exchange A. Historical Survey 52. The first stock exchange established in Turkey goes back to the Ottoman period, but it is only in the 1980's that a genuine stock exchange emerged. After the Crimean war 1853-56, the Ottoman Empire began to contract external borrowing and to establish a domestic financial market. Thus the first stock exchange was opened in Istanbul in 1866 under the name of "The Royal Stock Market". This stock market was primarily used to exchange external debt instruments. In 1906 the stock market was renamed "Equity and Bonds Stock Market", implying a larger range of transactions. 53. The first World War, and the independence war that followed, interrupted stock market operations. The new Turkish Republic proclaimed a law in 1929 on the trading of securities and foreign exchange. This new law led to the creation of the Securities Stock Market in Istanbul the same year. The 1930's were however not propitious to an expansion of the stock market, which was transferred in 1938 to Ankara, the political but not financial capital of Turkey. Since this change turned out to be less than felicitous, the stock market was moved back to Istanbul in 1941. 54. Despite the economic rise of Turkey after the second World War, the stock market remained inactive. Although a legal framework favoring its expansion existed, it did not benefit the market at a time when economic and institutional prerequisites were not yet met to permit it to move toward its potential. The stock market remained marginal in the financial system dominated by commercial 7172-7-7777 28 banks. Some of the development and investment banks mobilized funds by issuing bonds, most of which were bought by a few institutional investors, such as private retirement funds and insurance companies. A very limited number of private enterprises issued bonds on the stock market. 55. At the outset of the 1980's, unregulated brokers attracted deposits from private individuals by offering higher interest rates than banks. The brokers invested the deposits in company bonds etc. Since they had no recourse to the Central Bank in case of difficulties, and having become seized by a wave of speculation on short-term benefits, one of the biggest brokers went bankrupt in 1982. This triggered an urge to modify the regulatory framework for the stock exchange. 56. Following the reorientation of economic policy in 1980, the Government had proceeded to enunciate a new capital markets law. But without a complementary legislation, this law remained initially without real impact. The complementary legislation was however adopted step-wise during the following years. In 1982, the Capital Markets Board was created. The Board controls the operations of the capital markets and its participants. It must approve all private sector issues. The regulation adopted by the Board was at the outset rather rigid, following the bankruptcy of the big broker in 1982, but it has grown a bit more flexible with the years. 57. In October 1984 a stock market decree was promulgated that specified the modalities according to which the new stock exchange was to operate. In March 29 1985, the Government appointed the Executive President of the Stock Market. At the end of 1985, the new Stock Market opened in Istanbul. Operations began in January 1986. B. Organization and Operations of the Stock Exchange 58. The Istanbul Stock Market is an autonomous public organization. It operates under the supervision and control of the Capital Markets Board. The Executive Board is elected by the General Assembly of the members of the Stock Market, presided by the Executive President. The latter, initially appointed by the Government, will henceforth be appointed by the General Assembly, which also elects the Council of Internal Auditors. The Stock Market comprises the following departments: one listing department, one floor operations department, one department of financial and administrative affairs and one of evaluations and statistics. 59. There are three markets at the stock exchange and a smaller over-the- counter market outside. Two of the markets are listed: the senior market, or regular market, handles the shares of the 50 largest companies (blue chip companies). The junior market deals with about 20 companies, the shares of which are traded less regularly. The third market is non-listed and deals in particular in public instruments that have been traded in the stock market since 1986. 60. Different instruments are traded on the stock market. On the private sector side, there are shares and bonds. On the public sector side, there are Treasury bills (with a maturity of less than a year), government bonds (with a maturity -~--#~--~-NIXF.? 30 of a year or more) and revenue shariag certificates. As indicated above, the Capital Markets Board must approve all private sector issues. In order for private instruments to be listed on the stock market, a company must satisfy several requirements. It must have a minimum capital (including reserves) of Turkish Lira 200 million and must not have incurred any loss in the preceding two years. Furthermore, at least 15 percent of its shares must be sold publicly. The share holders must total at least one hundred. The financial soundness of the company is to be thoroughly reviewed before any issue is approved. 61. There are four categories of members operating on the stock exchange: commercial banks, development banks, brokerage firms and private brokers. No particular restrictions apply to foreign investors, but these have so far been reluctant to participate. Only the banks are exempted from obtaining beforehand a trading certificate at the stock market. The banks play a privileged role in the stock market, where they can pursue all their banking activities on top of their share trading activities. Conversely, intermediary institutions, such as brokerage firms and private brokers are limited to their trading activities (and over-the-counter activities outside the stock market), as specified in their trading certificate. Furthermore, only banks are entitled to establish mutual funds. These have gone through a rapid expansion since they were first introduced in July 1987. The stock exchange participants are subject to ceilings on the commissions they can charge for their services. For public sector instruments the ceilings are reduced by 50 percent. The stock exchange deducts 10 percent from the commissions in the form of membership fees. it= - 31 62. The terms and conditions of trading on the stock market floor have been amended since the beginning of transactions in January 1986. Until November 1987, the system was based on the single price method to establish the starting price level for the next day. Later, the multiple price method was applied. In order to establish a single starting price at the beginning of each day, the staff of the stock market had to compare received buying and selling bids, before they could find a hypothetical equilibrium price that could be use as the opening price. 63. With an expanded volume of transactions, the shortcomings of the single price/multiple price system became more of a drawback. Consequently, in November 1987, the Anglo-Saxon system of continual trading was introduced, simultaneously with the move of the stock exchange to a more modern and spacious building. The buyers and sellers indicate their buying and selling bids in a continuous fashion on posting boards. A transaction takes place when a participant indicates, with a sign on the board, that he accepts the proposed transaction. Oral agreements are also allowed. 64. A few minutes after the transaction has taken place, it is recorded in a computer and posted on a lighted display tape that everyone on the floor can see. A tele-bulletin service works 24 hours a day to assist participants outside Istanbul. A daily bulletin recapitulates transactions from the previous day. Weekly, monthly and annual publications, in Turkish and English, complete the list of publications of the stock exchange. 32 65. All transactions are spot transactions. Payment must be completed in cash within three days (this deadline was reduced to one day in November 1988). The creation of a Settlements Center is planned for 1989. Term transactions or future options do not yet exist. The stock exchange does not handle take-overs and mergers. Insider operations are not yet regulated in order to prevent insider trading. This lack of regulation could lead to ambiguous situations, and conflicts of interest, damaging the reputation of the stock market for impartiality and transparency. Furthermore its attraction for new investors might be diminished. 66. The dividends paid on shares are tax exempt, on the grounds that the company earning these profits has already been subject to a 49 percent profits tax. Interest earned on private bonds are subject to a 10 percent withholding tax, while public bonds are tax-free. C. Relative Importance of the Stock Exchange 67. Although the stock exchange has grown significantly since its inception in 1986, and seems to be heading towards a promising future, it remains nevertheless a small component on the Turkish financial system. As indicated in paragraph 17 above, private shares and bonds made up barely 2 percent of all assets of the financial system in 1988. This share is insignificant compared to the 71 percent constituted by bank deposits, 10 percent by currency issued and 17 percent by public securities. 33 68. The lack of depth of the Turkish stock market is also striking in an international context. When compared to other middle-income developing countries, which have pursued liberal economic policies, Turkey is endowed with an under- developed stock market. In 1987 the capitalization of the stock exchange in relation to GDP was only 4.6 percent in Turkey, while it was 5.2 percent in Brazil and 8.8 percent in Korea in 1985 (see Table 6). The number of companies listed on the main stock market was only 50 in Turkey, compared to 650 in Brazil and 342 in Korea. In addition to its small size, the Turkish stock market is not very active. Its turnover rate was only 3.2 percent, compared with 94 percent in Brazil and 41 percent in Korea. All these figures indicate that the Turkish stock market has still a long way to go before reaching its full potential. Table 6. Turkey : Comparison Between Stock Markets in Turkey and Other Middle-Income Developing Countries, 1985-87 Turkey Brazil Korea Thailand 1987 1987 1985 1985 Market capitalization, 3.1 16.9 7.4 1.85 billions of dollars Market capitalization, 4.6 5.2 8.8 4.9 percent of GNP Trading volume, millions 123 10,000 3,500 574 of dollars Number of listed companies 50 650 342 96 Dividend yield, percent 6.3 .. 6.0 8.2 Price/Earnings ratio 10.0 .. 5.2 9.6 Turnover ratio, percent 3.2 94 41 26 Source : Finanabank, Istanbul 34 D. Stock Varket Developments 1986-88 69. The opening of the new stock market in Istanbul in early 1986 generated a large increase in the issuing of private bonds and shares. Whereas in 1985 only TL 33 billion in bonds and 98 billion in shares were issued, in 1988 TL 182 billion in bonds and 331 billion in shares were issued (see Annex Table 9 for details). Even accounting for inflation, cumulatively about 190 percent in those three years, this nevertheless constitutes an increase in real terms. In parallel, the volume of public securities issued also greatly increased from TL 2.0 trillion in 1985 to TL 8.7 trillion in 1988. It should be emphasized that most issued bonds have a relatively short maturity, be they public or private. 70. The increase in public and private issues is reflected in the volume of daily trading at the stock exchange. Daily trading went from an average of TL 6.6 billion in 1986 to TL 43.9 billion on average for the first nine months of 1988 (see Table 7). The share of trading in public bills and bonds remains predominant; it vent from 94 percent in 1986 to 90 percent in the first nine months of 1988. The share of private bonds increased from 5 to 9 percent, while the share of private stocks rose from 1 to 2 percent. Although the share of private instruments increased in overall trading at the stock market, public instruments still dominate by far. The share of the senior market in trading at the stock exchange is, not surprisingly, preponderant; it increased from 82 percent in 1986 to 94 percent in 1987. The junior market has thus become more marginal. This evolution underscores the narrow foundation of the stock exchange, in which a restricted number of companies account for the quasi-totality of trade in shares. 35 Table 7. Turkey : Daily Average Trading Volume on the Istanbul Stock Exchange, 1986-88 (in millions of Turkish Lira) 1986 1987 1988 1/ Treasury bills and government bonds 5,998 15,304 38,572 Revenue sharing certificates 242 1,618 1,701 Private sector bonds 340 2,256 4,849 Stocks 35 425 589 Total 6,615 19,603 45,711 Memorandum items (Z of total) Treasury bills & government bonds 90.7 78.1 84.4 Revenue sharing certificates 3.7 8.3 3.7 Private Sector bonds 5.1 11.5 10.6 Stocks 0.5 2.2 1.3 Total 100.0 100.0 100.0 Turnover ratio 2/ for senior 1.2 3.2 7.1 market companies (percent) Equity trading (percent of total) Senior market 82.4 94.3 97.0 Junior market 17.0 3.8 2.4 Unlisted market 0.6 1.9 0.6 Total 100.0 100.0 100.0 1/ January - September 2/ Trading volume/market capitalization Source : Istanbul Stock Exchange 71. Public bills and bonds remain very attractive, notably to investors and banks. The bonds are generally offered at competitive rates. They are considered involving few risks and their return is tax-free. The bonds furthermore allow the banks to satisfy part of the liquidity ratio required by the Central Bank. In the past, the Treasury indicated ahead of time how many bonds were intended for sale during its weekly auctions. If the Treasury found that the returns demanded by the buying banks were too high, all the bonds offered were not sold. For a couple of months, starting in late summer 1988, the Treasury fixed the volume of bonds for sale, as well as the maximum return. The banks of course did not appreciate this new approach but since they were, at that time, confronted L!; 77 36 by higher liquidity ratios and not too much solvable demand for bank loans, because of high lending rates, they had little choice but to comply. 72. The revenue sharing certificates issued by the public sector have proven very attractive to private investors. It was first and foremost for the construction of the Bosphorus bridge that these certificates were used. Since the Government had underestimated the traffic growth on the bridge, private investors gained annual returns sometimes beyond 100 percent, in nominal terms, on these certificates. 73. Private bonds must by law have a maturity of two to seven years. In fact almost all private bonds have a two-year maturity. Starting in 1987, private financial bonds were introduced; these have a maturity ranging from 3 to 12 months. Their return is subject to a ceiling by the Central Bank. The issuing criteria established by the Capital Markets Board for financial bonds are stricter than for the longer-term private bonds, which has inhibited the diffusion of this new instrument. 74. Another new instrument are the bonds indexed on foreign exchange. Their issuing is subject to Treasury approval. Until now, only public institutions have bad recourse to these instruments, such as the Central Bank, public development and investment banks (outside of Turkey) and some Extra-Budgetary Funds and state enterprises (on the domestic market). The borrower assumes a foreign exchange risk if he is not going to have corresponding receipts in foreign currency. To make the transaction more interesting to the borrower, this risk has to be compensated by a more attractive interest rate. 37 75. The stock market index of the price of shares traded climbed steeply between January 1986 and August 1987. Starting with a base of 100 in January 1986, the index reached 171 at the end of the same year (see Graph 2 and Annex Table 10 for details). At the end of June 1987, the index had climbed to 446 and then took off to reach an all-time high of 1,332 in August before crashing. At the end of 1987 it was back to 673 and the lackluster performance continued through 1988. Throughout the second half of 1988 the index fluctuated between 370 and 490. 76. The market instability stems from its small size. The volume of trading is modest, which leads to price instability. Furthermore there are no market makers of any significant weight, such as institutional investors, to stabilize the market and protect smaller investors. The absence of trading mechanisms, such as options and term contracts, makes the market susceptible to short-term speculation. Many a participant at the stock market is young and little experienced; this feature tends to reinforce speculative trends. 77. The drop in interest rates during the second half of 1986 caused in part the sharp increase in the stock market index. Also the substitution between different assets in investor portfolios played in favor of the stock market. Furthermore the establishment of the first mutual funds in July 1987 strengthened demand. The return of migrant Turkish workers during the summer months also boosted demand to such a point that stock exchange prices no longer had any common measure with reality. 38 78. The factor which shattered the sharply ascending trend of the stock market was the announcement in August 1987 that the Government was about to accelerate its privatization program of state enterprises, initially by selling its minority shares in companies managed by private partners. The predictable increase in shares offered, in a shallow market, broke the speculative trend on the stock exchange. The announcement of the accelerated privatization was, in fact, rather a catalyst of an event that was bound to occur any time, so seized by frantic speculation had the stock market become by then. Interest rates had also begun to increase in the second half of 1987, making shares less attractive. Higher inflation, followed by an increase in interest rates during 1988, has impeded the recovery of the stock market. It needs moderate and stable inflation and interest rates to prosper. E. Secondary Market 79. The secondary market, being neither formal non transparent, is difficult to analyze. It is also a fragmented market, in which intermediation costs are high, reaching 10 to 20 percent of the value of traded shares. The imperfections of the secondary market limit its capacity to reflect the accumulation of withheld profits of companies in the value of their shares, thus making the market less attractive. Concerning public securities, the fact that purchase/repurchase agreements are not allowed, although de facto tolerated, has impeded the growth of secondary markets. The absence of a secondary market has made longer maturity instruments less liquid than what they would otherwise have been. By the same token, the growth of finance bills with longer maturities has been slowed. 39 80. Despite the various obstacles to the expansion of the secondary market, it has nevertheless made some progress these past years. According to data collected by the Capital Markets Board (which records both the secondary market transactions registered by the Istanbul Stock Market, and those outside the stock market, i.e. the over-the-counter trausactions), the total of transactions on the secondary market has gone up from TL 2.4 trillion in 1986 to TL 5.8 trillion in 1987 (see Annex Table 8 for details). In 1987 trading in the secondary market made up 60 percent of the total value of transactions on the Istanbul stock exchange. Despite its lack of structure, efficiency and transparency, this market is to be reckoned with. Its expansion continued in 1988, during which total transactions on the secondary market reached TL 10.1 trillion during the first ten months. Public securities are mostly responsible for this expansion. The banks holding these securities began to sell more and more of them to their main customers with repurchase agreement. The transactions are not, strictly speaking, legal and there have been a few cases of abuse, where the same security was sold to more than one client (a phenomenon made easier by the fact that the security sold often remains deposited at the bank). Public securities have become much sought after by big clients of banks because they are tax-free and pay competitive interest rates. 81. The distribution of securities traded on the secondary market reveals a marked preference for public securities. The share of public bonds and bills and income sharing certificates accounted for 92 percent of the market in 1988. 40 Private bonds constituted only 5 percent, and all other instruments taken together less than 3 percent. Once again, here is a financial market dominated by public sector instruments. F. Private Demand and Supply in the Stock Market 82. The structure of the Turkish economy, as it has evolved since the second World War until now, has provided little incentive to private companies to satisfy their financing needs by issuing equity on the stock market. Other financing alternatives, more interesting from a financial and managerial point of view, were available. Consequently, the stock exchange has not been able to play its full role, because of a shortage of equity issues. 83. In the Turkish private sector, large companies, often with their own bank, have maintained a key role. These companies have remained under the control of the founding families (sometimes the patriarch who founded the company is still around). They are little disposed to "dilute" family control by issuing equity on the stock market. This can be explained by the primary role of the family in Turkish society. Furthermore, before being able to issue shares, they would have to open their company to outside inspection, private or public, which is not always appreciated. By having direct access to its own bank, the company benefits from an attractive source of financing, with even the possibility of preferential crelits and often automatic refinancing when needed. Indeed, interest rates charged on non-preferential credits are high, even in real terms, but the effective cost is far lower, because interest costs are deductible in deriving the taxable profits of a company. With a tax rate of 49 percent, the 41 incentive is greatly in favor of debt over equity issues. Finally, the embryonic state of the stock market, and the easy resort to bank financing, often intramural, favor large and well-established companies over small and new companies. 84. The opening of the new Istanbul Stock Exchange, early 1986, has however given a new impulsion to stock market transactions. The number of companies with quoted shares has increased from 368 in late 1986, to 506 in late 1988. In a similar fashion, the number of companies with only listed bonds has grown from 101 to 135. The market capitalization in relation to GDP has risen from 1.8 percent in 1986 to 5.6 percent in 1987. Nevertheless, following the fall of share values since August 1987, the same ratio fell to 2.3 percent in 1988. The sectorial distribution of companies with quoted shares shows again the preponderant role of banks; these make up 53 percent of the total. The textile and mining sectors follow next. As to the sectorial distribution of companies with listed bonds, the banking sector represents only 7 percent. The pharmaceutical sector is at the top with 16 percent, followed by glass, china, plastic and leather. 85. Regarding the demand for instruments on the stock exchange, there are also some constraining factors. Historically, the stock market has never been considered a safe and major option for investments; its small size, and the scarcity of variety in equities, have contributed to a vicious circle. Other placements of savings have been seen as more attractive: gold still holds a considerable attraction for Turkish investors, as well as real estate. Foreign currency is also an important means of investment, particularly since foreign 42 currency bank accounts were allowed in 1984, with the right to withdraw deposits in foreign currency. High inflation, combined with credit rates that have often been positive in real terms and modest dividends in real terms, have not contributed to make investments in shares competitive. 86. The confidence factor has also played against the expansion of the stock market. Until recently, external audits according to international standards, were the exception (see paragraph 101 below for progress realized in the last few years in this area). Moreover, the necessity of disclosing the financial situation of a company before it could issue shares, was not firmly established. In these circumstances, to invest in the shares of an unknown company, with an undisclosed financial situation, was rather hazardous. 87. The performance of the stock market since its reopening in 1986, does not inspire much confidence either. The wave of speculation, which had seized the stock market in the summer of 1987, broke rapidly and was followed by an abrupt fall of share values. The decline in the share index has practically stopped since the summer of 1988. The fact remains that, late November 1988, the index was only 30 percent of its peak in August 1987. Many investors had by then incurred substantial losses, which served as warnings to others. 88. The lack of stability on the stock market results essentially from the absence of institutional investors who could reduce the fluctuations in share values and promote the safety of investments. Insurance companies make very little investment on the stock exchange, as is the case for the Social Security 43 Fund and private pension funds. The mutual funds have been introduced only recently, and thus do not yet play an important role. 89. Despite a restrained demand for securities traded on the stock market, the number of stock market members increased from 47 in 1986 to 78 in 1988. Half of these are commercial banks. Brokerage firms and individual brokers make up about a fourth each. Mutual funds were introduced in July 1987, but only banks are entitled to establish such funds. At the end of 1988, there were 18 mutual funds with total assets of TL 147 billion. Mutual funds play potentially an important role by offering investors liquid placements that are often tax-free. Until recently, their investments have been made in fixed return securities rather than in shares. Lately some mutual funds have invested in foreign currency. 90. Table 8 provides a matrix showing the importance of participants on the stock exchange according to securities traded. In 1987, commercial banks handled 88 percent of the transactions. Brokerage firms handled 11 percent. Development and investment banks, as well as private brokers handled only 1 percent together. The fact remains that, considering only trading in equities, the share of commercial banks is more modest, being only 43 percent. Brokerage firms and individual brokers are more active, with shares of respectively 32 'and 23 percent. 44 Table 8. Turkey : Distribution of Transactions by Member Groups on the Istanbul Stock Exchange, 1987 (in billions of Turkish Lira) Private Sectox Conercial Public Sector Percent of Member Groups Equities Bonds Paper Securities Total Total Investment and Development Banks 4.5 .. 0.2 43.5 48.2 0.5 Canmercial Banks 90.2 830.4 44.1 7599.4 8564.1 88.1 Intermediary Institutions 67.8 216.6 27.1 750.3 1061.8 10.9 Exchange Brokers 48.3 .. .. .. 48.3 0.5 Total 210.8 1047.0 71.4 8393.2 9722.4 100.0 Memorandum Item (share of equity trading, percent) Investment and Development Banks 2.1 Comaercial Banks 42.8 Intermediary Institutions 32.2 Exchange Brokers 22.9 Total 100.0 Source : Istanbul Stock Exchange 91. One of the reasons why insurance companies are not very active on the stock exchange is that the insurance industry is not much developed in Turkey. Insurance premia per capita amounted to only $5 in 1989, compared to $46 in Greece and $77 in Portugal, not to mention the United States with $1,536 and Switzerland with $1,747 (see Table 9). Such an under-developed insurance industry does not have the means to play a major role on the stock exchange. It is not clear whether they would have liked to play such a role in any case, since they are often subsidiaries of large industrial holdings. They prefer investing their resources in the securities of the parent company (about 60 percent of their resources), or in Treasury bonds with short maturity (30 to 40 percent). 45 Table 9. Turkey Comparison Between the Insurance Industry in Turkey and the OECD, 1986 Insurance premia ----------------- Premia per Premia/GNP (millions (millions capita (percent) Country national US Dollars) (US Dollars) currency) Turkey 191,510 253 5 0.5 USA 371,072 371,072 1,535.9 8.8 Germany 115,789 59,685 977.6 6.0 France 235,400 36,440 657.9 4.7 UK 31,470 45,804 807 8.2 Switzerland 18,390 13,352 1,746.5 7.2 Sweden 45,500 6,672 797.1 4.9 Portugal 114.417 783 76.7 2.7 Greece 63,989 461 46.2 1.2 Source : Turkish Daily News. Nov. 21, 1988, p.12 92. Foreign investment cannot be a subttitute to increase demand and supply on the stock market. Despite the Government's intention to promote private investment since 1980, and to eliminate discrimination in favor of investment by nationals, foreign investors have proven fairly reticent toward Turkey. The inflow of foreign investment has remained modest in the balance of payments. Nevertheless, Turkey is becoming gradually more attractive for private investors. Receipts under foreign investment have increased from $364 million in 1986 to $536 million in 1987. IV. Development and Dynamics of Financial Narkets A. Potential and Constraints of the Present Situation 93. Financial markets in Turkey offer a considerable potential. Since 1980, the Turkish economy has grown at a rate far superior to the international 46 average, or the OECD average. The population has already reached 55 million, which ensures a large domestic market. Income per capita is around $1,200 per year. The economy has become much more open. In parallel, international competitiveness has become reinforced. The Government proclaims openly its intention to promote the private sector and to diminish state intervention. The private sector has known rapid growth since 1980. 94. Despite these major assets, the expansion of financial markets in Turkey has been impeded by other, no less important, factors, at least in the short- term. A high and variable inflation has spread uncertainty in financial markets. Large deficits in public finances have entailed internal borrowings on such a scale that funds available for private sector investment have greatly diminished, the crowding out effect. 95. The financial and industrial structures of Turkey remain in some ways archaic, despite the undeniable progress made since 1980. The symbiosis of holdings and banks has led to high concentration ratios, which have diminished competition and erected entry barriers. A corollary of this has been the reluctance to let market forces, such as the issuing of equities, play their part in the financing of enterprises. The predilection has instead been toward institutional and privileged sources of financing. All those factors, taken together, have created obstacle difficult to surmount in the path of developing financial markets in Turkey. Most of these factors are of a structural or psychological nature and are thus difficult to remedy rapidly. 47 B. Incentive Schemes 96. At the fiscal level, much progress has been made these past years to harmonize the treatment of different securities and avoid barriers to the expansion of financial markets. Despite progress achieved, there remains much to do in this area. 97. In 1985, double taxation of dividends (tax on company profits and tax on shareholders, income) was abolished. Henceforth dividends are tax exempt. Moreover, capital gains on shares is also tax exempt. In 1986 the withholding tax on dividends paid was abolished. After these tax exemptions, shares benefit from a rather privileged fiscal status, but this has not proven sufficient to generate more share issues. Tax relief was also introduced for companies offering their shares to the public, but this incentive had little effect. At the end of 1988, only private bills were subject to a 10 percent tax withholding tax. All public securities were exempted from tax. Interests earned on bank deposits were subject to a 10 percent withholding tax for deposits in Turkish Lira and 5 percent for foreign exchange deposits. 98. Effective January 1 1989, the taxation of financial instruments was standardized in order to reduce the difference in treatment of various securities. Income from public securities (bills, bonds and income sharing certificates) became subject to a 10 percent tax (retroactively 5 percent for income earned during 1988 and declared in the Spring of 1989). The tax is not withheld at source, but declared separately from other sources of income. Companies alone are taxable, not individuals. This change has nevertheless made 48 the treatment of private and public debt instruments more similar. The tax withheld on interest earned on foreign exchange deposits was raised to 10 percent, thus eliminating the discrimination toward Turkish Lira deposits. 99. Mutual funds are still enjoying a privileged fiscal status by being exempted from withholding tax on the securities they own. Their profits are exempted from income tax. The return on their shares, issued to participants, is also tax-free. Given the fact that banks alone are entitled to establish and manage mutual funds, incentives exist for them to use these funds as a means of minimizing their tax liabilities. 100. The standardization of the fiscal treatment of financial intermediation is one thing; examining its raison d'etre is another. Taxing financial intermediation, directly and visibly, impedes its progress without producing substantial public revenue. To alleviate these taxes, by finding compensatory means through general taxes, or by the gradual elimination of the deductibility of the nominal portion of interest payments from the taxable income of corporations, should promote financial intermediation. The aversion of individuals towards such obvious taxes must also be considered, all the more so, because there exist untaxed alternatives, perhaps even untaxable ones. 101. On the legal side, much progress has been achieved these past years. In 1985, a new banking law granted more authority to the Central Bank in the supervision of commercial banks. In 1986, a standardized accounting system was introduced for the banks. Starting in 1987 all banks, and all companies issuing shares or bonds, have had to have their accounts audited by independent external 49 auditors according to international standards. The Capital Markets Board is planning to publish supplementary standards for external audits in the course of 1989. These reforms have been conceived and implemented in the context of the two financial sector adjustment loans granted by the World Bank. A desirable complementary reform would be to establish a professional organization of auditors. The creation of a Council of Registered Financial Advisers is scheduled for end-1989. 102. The improvement in accounting, the introduction of independent audits, better supervision by the Central Bank, and a greater disclosure of data thus collected, will undoubtedly bring more information and a heightened sense of security to potential investors. This cannot but help develop the financial markets. It remains nonetheless that the lack of counselling agencies, well established and with a good reputation in the area of security investments, and the lack of stock rating agencies, constitute deficiencies to be remedied soonest in order to accelerate the development of financial markets. 103. It would also be timely to reexamine the role of banks on the stock exchange. These are presently combining the functions of banks and brokerage firms, which can lead to conflicts of interest, and at any rate puts the brokerage firms proper at a disadvantage. The potential for conflicts of interest should one day be taken into consideration in the banking regulation in a country like Turkey that wants to develop its capital markets against a background of a financial system dominated by banks. The fact of allowing only banks to create and manage mutual funds is an unnecessary restriction, which inevitably hinders the expansion of mutual funds. 50 104. On the institutional side, the stock exchange foresees the creation of a Settlements Center in 1989 with the objective of accelerating payments. It also seeks a larger and more functional building. Diversification of its transactions, for instance through options or term contracts, is not being considered for the near future, but could be considered in due course. A second stock exchange, independent from the one in Istanbul, could possibly open in Izmir during 1989. 105. Regarding the diversification of instruments, some measures have already been taken towards an indexation of bonds on foreign exchange. Another proposition is to index government bonds on the European Ecu and to pay only real interest before maturity, in three or four years. Such a measure would spread inderation in the economy, and currency substitution in favor of foreign exchange. The Central Bank is resisting this kind of proposition, because it sees its role as that of defending the national currency (and the confidence it inspires, plus its use throughout the country). The concept of income sharing certificates has already been introduced by the public sector. However, in an uncertain environment of high and variable inflation, it is not always easy to find a formula for the distribution of profits that would satisfy all parties. 106. A new dimension could arise from build-operate-transfer (BOT) projects, for which an investor, often foreign, initiates a project, such as for instance a dam or bridge, then operates the project during 15 years, upon which the structure is transferred to the state. The investor finds his profit in the sales agreements (quantity and price) negotiated up front with the state. To complete his financing program, and reduce his debt/capital ratio, the investor could sell 51 shares on the stock exchange. If he has a good reputation, and if the delivery agreement with the state seems profitable, local investors might show interest in participating. C. General and Economic Aspects 107. The context of overall economic policies is crucial to the development of financial markets. That is, the Government's announced policy stance and even more so its actual policies, in conformity or contradiction to the proclaimed policy, are a key-factor. Financial markets cannot develop in an uncertain climate; they need stable governments and policies. The mistrust of private investors towards the state is probably the most paralyzing factor in the development of financial markets. It is furthermore crucial that the Government grant, by its actions, priority to the private sector, complemented by economic policy instruments operating through market forces. The opening of the economy to the outside world will increase its international competitiveness and will by the same token offer more profitable investment possibilities to the private sector. A convertible currency, or one in the process of becoming convertible, is a positive factor, because convertibility would inspire confidence among foreign investors by guaranteeing the transferability of their funds, yield and capital. 108. According to all the factors listed in the preceding paragraph, Turkey benefits from a relatively favorable framework for the development of financial markets. It has to be acknowledged however that the historical mistrust between individuals and the state is still lingering on. Besides, the Government tends 52 sometimes to be atavistic by reverting back to old interventionist policies, particularly when facing with sudden difficulties. Old habits die hard, on both sides. 109. Another positive factor for Turkey is its application for membership in the European Community (filed on April 14, 1987). Even if the attainment of this goal will necessitate more years than the Government wishes, it seems probable that Turkey will pursue its gradual integration with the EC. This initiative should normally bring a new impulse to the Turkish financial markets. It is also clear that Turkey expects to attract a great deal of investment funds from the EC. 110. The macro-economic situation and perspectives also play an important role in the development of financial markets. High and steady economic growth, generating confidence in the future, is indispensable, as is the absence of crises or macro-economic dislocations. Long-term investment perspectives are very important; otherwise speculative frenzies could invade the markets. Once the frenzies have collapsed, often sooner rather than later, a climate of distrust remains. Financial stability is a sine qua non; this presupposes a moderate rate of inflation as well as moderate public deficits and borrowing. The same applies to monetary policy, which must be credible and lead to reasonable interest rates. Besides, the limitation of real estate speculation (plus gold and foreign currency speculation) would promote the development of financial markets. Since nothing equals a proven success, a stock exchange on the rise (but not excessively so) with small fluctuations, conducive to a better and more stable 53 profitability of traded securities, is another important factor for the continued development of financial markets. 111. With respect to a sizable number of the economic criteria mentioned in the preceding paragraph, Turkey is not in a very good position. In the absence an improvement in the macroeconomic situation, notably in the areas of inflation, public finances and interest rates, it is difficult to conceive a fast and sustained growth in the financial markets. An economic crisis is not likely in the foreseeable future; the balance of payments has, for instance, strengthened in 1988, but financial markets have nevertheless a need for more stability and certainty than what has been provided by economic performance in recent years. 112. The supply of securities on the stock exchange could be raised by different means. The size, diversity and structure of the Turkish economy are, a priori, sufficient to support the expansion of the stock market, a keystone of financial markets. The privatization of state companies should increase supply, but it should be made certain that the shares of these companies are saleable, which is not necessarily the case without preceding rehabilitation measures. Consequently, it is not probable that the stock exchange could be suddenly flooded by shares of state enterprises for sale; this is moreover not in the interest of the stock market if it is to avoid e:Lcessive fluctuations in share values. 113. The first attempt at privatization (in this case rather a divestiture) was the sale of parts of the public shares in a mixed telecommunications company in February 1988. The operation was hardly a success and did not set a precedent 54 because, despite the great number of buyers, the shares sold were to lose half of their value over the next six months, in the general fall of share values. Subsequently, the Government changed its strategy, bypassing the stock exchange. Rather than selling shares in limited quantity on the stock exchange separately to individuals, it opted for block sales, primarily to foreign companies, which in addition offered the transfer of advanced technology. It was in this manner that five state cement plants were sold to the French Company Societe des Ciments Francais. 114. The Government has begun, these past few years, to encourage banks and holdings to get rid of part of their asset portfolio not related to their main activities (for instance real estate). Little has resulted from such measures. It is to fear that exhortations and punctual incentive measures will by themselves prove insufficient, in the absence of an overall economic improvement and a recovery of the financial markets in particular. Besides, this structural phenomenon is deeply entrenched in the Turkish economy, which precludes any immediate changes. 115. The supply of equities could furthermore be increased if the distinction between company owners and managers could be clearly established. This would amount to making family companies public with a broader distribution of share holders. Such an evolution has taken place in other countries. There is a priori no reason why Turkey should not follow this pattern. The ascendancy of holdings and banks, often linked, is bound to decrease in the modernization and opening up of the Turkish economy. Entry barriers will thereby decrease. A new class of 55 entrepreneurs could then emerge. In the establishment or expansion of their enterprise, the issuing of shares on the stock market would become common. 116. The demand for equities could increase by enlarging the number and kinds of participants, as long as economic and political prerequisites are met. At present the absence of institutional investors is conspicuous. This shortage could be filled by changing the manner in which they make their investments. Furthermore, the expansion of the Turkish economy should lead to the emergence of more important institutional investors, such as insurance companies. The emergence of a middle class, with resources available for savings, should proceed in parallel with the increase in per capita income. Thus a new group of small individual investors would appear on the stock exchange. But in light of their small size, they will probably rely on intermediaries, which will give a new impulse to brokerage houses and to individual brokers. 117. Turkey is presently striving to apply an open door policy toward foreign investors. But in spite of this stance, there has not been any rush by foreigners to invest in Turkey; the stability of the country and the region have not been deemed sufficiently reassuring. Until now, direct investments have been larger than portfolio investments. Yet, as the stock exchange expands, and Turkey moves closer to the EC, the possibilities of attracting foreign portfolio investments should increase. 118. In order to attract foreign portfolio investments, the International Financial Corporation is currently setting up a fund for Turkey in cooperation with the Government and international banks. The fund will initially invest $60 56 million in various Turkish securities. Given the presently small size of the stock exchange, part of the fund's investments will bypass it. The intention is to re-sell securities purchased in Turkey to long-term institutional investors in the U.S., Japan and Europe. Through this fund, Turkish securities will be introduced to foreign investors, which is likely to generate a growing demand in years to come. V. Conclusion 119. The present situation contains many favorable aspects for the development of financial markets. The Government is in a strong position for the next four years with a solid majority in Parliament. In the past, its policies have proven relatively stable and coherent. Although intermittent improvisations have multiplied through 1988, nothing portends government instability or a very destabilizing economic policy in the next few years. 120. The economy continues to grow at a relatively rapid pace. The balance of payments is improving, and the exchange rate is regularly devalued to maintain export competitiveness. The external debt is serviced on schedule and, apparently, without difficulty. Foreign investment is being promoted and is beginning to respond, after initial reticence. The opening up of the economy, its growing competitiveness and rapid growth, particularly in industry and services, offer many investment opportunities. The increase in incomes and the emergence of a middle class will expand investment resources. All these are factors favorable for the expansion of financial markets. 57 121. Nevertheless, in spite of many favorable conditions, the development of financial markets, and of the stock exchange specifically, remains impeded by deeply rooted obstacles. As a result, the stock exchange remains embryonic in the Turkish financial system. The historical and lingering distrust between individuals and the state has still not been overcome. Government policies can differ, sometimes visibly, between public claims (priority to market forces) and implementation (intervention due to atavistic reactions). The domestic macro- economic situation is not very favorable for the private sector: high and variable inflation, considerable deficits in public finances, covered by large internal borrowing, which in turn pushes up interest rates and renders private investment more expensive. 122. The structure of the banking and industrial system presents another impediment. The close links betwe3n banks and industrial holdings lead to high degrees of concentration and to entry barriers. Companies avoid the stock exchange for fear of diluting the founding families' control. Access to their own banks, and the fiscal advantages of debt financing, are such that companies have recourse to other sources of financing than issuing shares. Financial intermediation, outside bank credits, takes place mainly through bank placements in public securities. Private securities remain marginal. In the domestic financial system, in 1988 10 percent of total assets were constituted by currency issued. Reflecting the preponderant role of banks, 71 percent came from bank credits. Public securities accounted for 17 percent, thus highlighting the extent of public domestic debt, especially when compared to private securities, still marginal with private bonds and shares each contributing to only 1 percent of the total. To summarize: in spite of the presence of considerable economic and 58 political advantages, the development of financial markets in general, and of the stock exchange in particular, continue to be hindered by structural factors special to the Turkish economy. 123. The perspectives for the future of the financial markets, and of the stock exchange more specifically, are nonetheless relatively promising. An economic or political dislocation is improbable. Economic and political stability, with the restoration of a democratic parliamentary system, is nowadays rooted in Turkish society. However, the Government remains confronted with the challenge of redressing the domestic macroeconomic situation. Without a reduction in inflation and in interest rates, following a lowering of the public sector deficit, the expansion of financial markets will be undermined. The state currently appropriates too large a share of domestic private savings. It will have to leave more room for private investors in order for financial markets to prosper. 124. Sustained growth in an open, competitive and dynamic economy, gradually moving toward closer integration with the EC, will create growing investment opportunities and by the same token the resources needed to exploit them. Despite promising perspectives, and an economic and political situation globally favorable, the development of financial markets could be comparatively slow due to structural obstacles. The slow but sustained progress could accelerate, provided the expansion and modernization of the Turkish economy prompt impersonal market forces to replace privileged institutional and personal relationships, thereby inter alia reducing entry and exit barriers. Once all these conditions 59 have been met, Turkey will be in good position to equip itself with an internationally first rate financial system and stock exchange. 125. Even though the Turkish economy presents many specific characteristics, and the policies pursued by the Government have been both radical and original, other middle-income developing countries can nevertheless draw some lessons from the Turkish experience. This experience reveals the opportunities and constraints relevant to the development of financial markets. Despite the application in Turkey of a large range of incentives and economic policies globally favorable for the development of financial markets, the results achieved so far have been rather mixed, against which has, however, to be set relatively promising perspectives. 126. The main lessons of a broader applicability that can be drawn from the Turkish experience in the development of financial markets, and the stock exchange in particular, are the following: 1) A favorable government policy, in actions and not only in words, a sizeable and relatively competitive economy, with a per capita income allowing non- negligible savings, are necessary but not sufficient prerequisites. 2) The macro-economic situation and perspectives are of utmost importance: a) A stable evolution without dislocations is indispensable in order to generate a climate of confidence and long-term perspectives, rather than 60 short-term perspectives conducive to speculative frenzies that often end with a crash and confidence shattering consequences. b) Macro-economic developments must also promote a mutual confidence between the private and public sectors; c) A steadily growing economy generates optimism and confidence in the future, key factors in the flourishing of financial markets; d) A high and variable inflation constitutes a major obstacle; thus a moderate monetary policy is imperative; e) High interest rates in nominal terms, and even more so in real terms, constitute a major impediment; f) Substantial public sector deficits, financed either by inflation or by the appropriation of a sizeable part of domestic private savings, inevitably chokes the development of financial markets trading in private securities; g) A currency that is convertible, or on the way to become convertible, will facilitate the expansion of financial markets; h) A wide field of action for the private sector with recourse to market forces (where the prerequisites for their proper functioning are met, which is not always the case) is another important positive factor; financial 61 markets work and flourish better in an environment of free competition than in oligopolistic or similar conditions; i) Finally, outside the realm of macroeconomics proper, structural and psychological factors play an important role, notably the ownership structure in industry and in the financial system, as well as their modus operandi. 3) The key factors pertaining to financial markets have proven to be the following in Turkey: a) On the supply side: i) A varied and growing supply, with remunerative returns, is indispensable; ii) The availability of other instruments, with lower cost for the borrower or higher return for the investor, can only impede the flourishing of financial markets; iii) The tax regime can discriminate against financial markets: in Turkey, borrowing has been favored in this manner compared to bonds and share issues; 62 iv) The perceived threat of a dilution of the tight control of companies (often under family control) through the issuing of shares can render this financing mode less attractive. b) On the demand side: i) An emerging middle class, which often entails a less unequal distribution of income, greatly widens the number of potential investors in the financial markets; ii) A performance of the financial markets which inspires confidence is crucial; falling markets, or markets seized regularly by speculative bouts, do not attract many investors, particularly serious investors; in Turkey, the stock exchange has gone through an abrupt decline since August 1987, and some investors have lost large sums of money; it is therefore only natural that in such circumstances many investors might be inclined to shun the stock market. iii) A stock exchange considered as an important and credible investment alternative, offering a wide range of securities, is necessary; iv) Competitive dividends compared to other investment outlets are indispensable; in Turkey, bank time deposits, often with positive 63 real interest rates, have been more attractive than more or less risky placements on the stock exchange. c) The importance of legal aspects is not to be underestimated: i) The transparency and objectivity of the financial results of companies issuing shares or bonds are crucial to inspire investors' confidence; ii) A standardized and analytical accounting system is a must; iii) External audits following international or equivalent norms are also indispensable; iv) Regarding banks, a more thorough supervision by the Central Bank might prove necessary, among other things to ensure an objective classification of loan portfolios and sufficient funds to make provisions for non-performing loans; v) Conflicts of interest, caused by allowing banks to play multiple roles on the financial markets, are to be avoided; insider trading can seriously damage the reputation of a stock exchange. d) Regarding the operations proper of financial markets, it should be stressed that: I V_ 77. 477U -5 64 i) The scarcity of counselling agents in security evaluations and investment has to be remedied; ii) The shortage of institutional investors, who can stabilize the market should the need arise, needs to be overcome; e) Foreign investors can contribute to the expansion of financial markets, but one should not expect too much from these in the beginning: i) In spite of a non-discriminatory legislation, at least on paper, foreign investors often seem rather reticent, being cautious towards an unknown market, which has not yet proven itself; ii) Direct investment appears more easy to attract than portfolio investment; iii) Trying to promote capital inflows, while limiting their outflows, even for quite comprehensible reasons, might well turn out to be counter-productive. 4) Privatization, on which much hope has been pinned in the development of financial markets, is not a panacea. It is rather a slow and difficult process, because: i) If the financial markets are narrow and shallow, the announcement of a large privatization program could trigger their 65 downturn, such was the case of the Istanbul Stock Market in 1987, after the launching of an expanded privatization program; ii) Even if the privatizations unfold gradually, the absorptive capacity of the market must be rigorously monitored; a undeniable success in the first operations is necessary; thus it is crucial to sell in a market on the rise (in Turkey, the contrary happened), but this makes the operation even more critical, if the market is narrow and the company for sale sizeable; iii) Many state enterprises are not sellable without preceding rehabilitation measures, which can only delay the privatization program and perhaps even make the initial cash-flow negative; iv) The evaluation of assets to be sold is a difficult and often controversial task; allegations of sellouts of the national patrimony to foreigners are sometimes made. Privatization can therefore generate resistance from opposition parties, the media, academia, local industrialists and the unions; these might resort to legal rear-guard actions to slow or even revert privatization agreements. Such actions, or threats thereof, weaken the bargaining position of the state and make potential investors, especially foreign, suspicious; v) The future of the sometimes plethoric labor force under new private sector ownership and management is a sensitive issue that 66 can provoke a hostile attitude toward privatization among labor unions. State attempts to assure that the labor force is not adversely effected by privatization can make the process itself that much harder by reducing the expected profits of potential buyers. Difficult trade-offs will therefore be required; vi) The sales strategy to be adopted is not obvious: is it better to sell, piece by piece, to domestic investors, including perhaps the employees of the company, or is it better to use block sales to foreign investors? The second option is more rapid, but leads to the transfer into foreign hands of companies with until then might have been considered strategic in the domestic economy. 67 References Central Bank of Turkey; 1987 Annual Report Istanbul Stock Exchange (ISE); Establishment, Organization, Functioning, Activities, 1986 ISE; Annual Report for the Year 1987, May 1988 ISE; Information File, Semi-Annual, 1988 ISE; Market Watch, Quartely Report, 1988/3 Kopits, George; Structural Reform, Stabilization, and Growth in Turkey, Internatioanal Monetary Fund, Occasional Paper 52, May 1987 The Middle East Business and Banking Magazine Publications; The Turkish Banking Sector in the Light of E.C. Integration, 1988 Organization for Economic Cooperation and Development; Turkey Economic Survey, 1987/88 Soydemir, Selim and Akyuz Abdullah; Issues Related to the Performance of Mutual Funds in Turkey, Nov. 1988 (paper initially submitted at the Annual Conference on the Role, Regulation and Operation of Investment Companies organized in 68 Ankara June 20-24, 1988 by the Capital Markets Board of Turkey and the Technical Cooperation Service of OECD). Turkish Industrialists' and Businesmen's Association (TUSIAD); The Turkish Economy, 1988 International Bank for Reconstruction and Development (IBRD); Turkey Special Economic Report, Policies for the Financial Sector, No.4459-TU, Sep.21, 1983 IBRD; President's Report, Financial Sector Adjustment Loan, No. 4258-TU, May 15, 1986 IBRD; President's Report, Second Financial Sector Adjustment Loan, No.4784-TU, May 25, 1988 International Finance Corporation; Emerging Stockmarkets Factbook, 1988 69 Statistical Annex January, 1990 70 Statistical Annen List of Tables 1. Key Domestic Economic Indicators, 1980-89 2. Key External Economic Indicators, 1980-89 3. Composition of the Banking System, 1980-87 4. Sectoral Distribution of Real Stocks of Credit, 1980-87 5. Selected Interest Rates, 1980-88 6. Cost and Margins in the Banking Sector, 1981-85 7. Debt Service Indicators for the Largest Private Industrial Firms, 1983-87 8. Secondary Markets, 1986-87 9. Private and Public Sector Issuing of Financial Instruments, 1983-88 10. Monthly Closing Values of the Istanbul Stock Exchange Index, 1986-88 Table 1. Turkey : Kel mestic Economic Indicators. 1980-89 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1/ National Accounts GDP growth rate (percent) -0.9 4.4 5.0 3.7 5.7 5.1 8.0 7.3 7.2 5.0 In percent of GDP: Comsumption 85.9 83.3 82.7 84.7 84.3 82.1 78.2 76.0 75.1 73.9 Savings (domestic) 14.1 16.7 17.3 15.3 15.7 17.9 21.8 24.0 24.9 26.1 Investment 21.9 22.0 20.6 19.6 19.9 21.1 24.8 25.4 25.6 26.5 Resource gap 7.8 5.3 3.3 4.3 4.2 3.2 3.0 1.4 0.8 0.3 Prices (% change from previous year) Wholesale price index (annual average) 90.3 34.1 27.0 30.5 50.3 43.2 29.6 32.0 65.0 45.0 Consumer price index (annual average) 101.4 36.6 30.8 31.3 48.4 45.0 34.6 38.9 70.0 50.0 Public Sector Finances Central Government (% of GNP) Revenue 20.6 21.3 16.6 20.0 15.3 16.1 18.3 18.2 17.1 17.6 Expenditure 24.3 23.1 18.3 22.6 20.6 18.9 21.8 22.5 21.1 20.4 of which: interest payments (0.6) (1.0) (1.1) (1.6) (2.4) (2.4) (3.4) (3.9) (5.3) (5.8) Deficit 3.7 1.8 1.7 2.6 5.3 2.8 3.6 4.3 4.0 2.8 Primary deficit(i.e. excl. interest) (3.1) (0.8) (0.6) (1.0) (2.9) (0.4) (0.2) (0.4) (+1.3) (+3.0) -a Public Sector Borrowing Requirement (percent of GNP) Central Government 3.7 1.8 1.7 2.6 5.3 2.8 3.6 4.4 4.0 2.8 State Economic Enterprises 6.7 4.6 4.7 2.3 2.3 3.1 3.4 4.2 2.5 1.8 Municipalities -0.2 -0.2 -0.1 -- -0.2 -0.2 0.1 0.5 0.4 0.4 Revolving Funds -0.2 -0.8 -0.7 -0.1 -0.4 -0.4 -0.4 -0.7 -- 0.1 Extra-Budgetary Funds -- -- -- -- -0.5 -0.5 -2.1 -0.3 -0.1 -- Total 10.0 5.4 5.6 4.8 6.6 4.8 4.5 8.2 6.8 5.0 Public Fixed Investment (percent -3.7 10.2 2.2 -4.9 -5.3 23.1 9.9 -3.0 -8.0 3.6 change in real terms) Money supply (percent change from previous year) Ml 58.4 37.0 30.9 41.4 17.3 37.1 58.7 51.1 M2 67.1 72.5 69.7 37.7 58.2 56.9 42.0 36.1 40.0 Foreign exchange deposits -- -- -- -- -- 114.; 114.4 118.1 M2X 67.1 72.5 69.7 37.7 58.2 62.6 51.3 51.6 1/ Government Targets Source : State Planning Organization, Central Bank, Treasury and World Bank estimates Table 2. Turkey : Key External Economic Indicators, 1980-89 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1/ Balance of Payments Export volume (percent change) 8.8 82.4 33.9 13.5 23.1 10.1 -4.2 29.3 8.8 6.2 Import volume (percent change) 1.9 17.7 1.4 16.2 28.1 8.4 11.0 13.0 6.7 6.5 As a percent of GDP: Merchandise exports 5.1 8.2 11.1 11.6 14.9 15.6 13.1 15.4 16.3 17.0 Merchandise imports 13.2 14.9 16.1 17.4 20.8 21.3 18.4 20.2 20.3 20.8 Current account deficit 5.8 3.3 1.7 3.7 2.8 1.9 2.6 1.5 0.8 0.3 Interest payments 2.0 2.5 3.0 3.0 3.2 3.3 3.7 3.5 4.1 4.2 Non-interest current account -3.8 -0.8 1.3 -0.7 0.4 1.4 1.1 2.0 3.3 3.9 External Debt Debt outstanding and disbursed, 19.5 19.7 20.2 20.7 22.5 26.1 32.7 40.4 41.7 43.1 -j DOD ($ billion) Debt service ($ billion) Total 1.4 1.9 2.5 2.7 2.9 3.9 4.7 5.6 7.3 7.4 Principal 0.7 0.7 1.1 1.3 1.3 2.1 2.5 3.2 4.3 4.2 Interest 0.7 1.2 1.5 1.4 1.6 1.8 2.1 2.4 3.0 3.2 DOD/GDP, percent 34.3 34.1 38.1 40.5 45.3 49.4 56.3 60.0 61.5 58.7 DOD/Exports of goods and services 339.9 231.2 200.6 218.8 194.6 199.0 262.3 248.5 222.2 210.0 percent 2/ Debt Service/Exports of goods and 30.6 27.3 28.5 30.3 26.1 33.4 35.7 34.4 39.0 35.9 services, percent 2/ Interest payments/exports of goods 19.8 17.0 15.5 16.0 13.7 13.4 17.1 14.5 16.0 15.6 and services, percent 2/ Exchange rates TL/US dollar (annual average) 76 111 163 225 367 522 675 857 1450 2170 1/ Government Targets 2/ Including workers' remittances Source : Central Bank of Turkey and World Bank Estimates Table 3. Turkey : Composition of the Banking System. 1980-87 1980 1986 1987 Number of Number of Share in Number of Number of Share in Number of Number of Share in Institut. Branches Total Institut. Branches Total Institut. Branches Total Assets (in%) Assets (Lz) Assets (in%) 1. Public Banks 13 2,469 51.5 12 2,732 50.1 13 2,903 51.3 2. Private domestic banks 26 3.380 45.7 26 3,499 46.2 26 3,410 45.7 of which: 2.1 Development Banks 2 6 3.1 2 6 2.1 2 6 1.9 2.2 Commercial Banks 24 3,374 42.8 24 3,493 44.1 24 3,404 43.8 3. Private foreign banks 4 105 2.8 18 117 3.7 18 104 2.9 4. Total 43 5,954 100.0 56 6,348 100.0 57 6,417 100.0 Source : Banks' Association of Turkey Table 4. Turkey : Sectoral Distribution of Real Stocks of Credit (Excluding Central Bank direct credits) (percent share) Foreign Year Agriculture Industry Trade Services Housing Other TOTAL 1980 15.1 44.9 6.2 11.8 1.9 20.1 100.0 1981 17.0 43.3 7.9 13.8 2.7 15.2 100.0 1982 15.6 40.6 20.3 17.8 3.3 2.4 100.0 1983 18.0 32.3 20.8 21.8 4.6 2.5 100.0 1984 14.4 36.7 18.9 20.3 6.8 2.9 100.0 1985 15.4 37.3 15.7 19.3 9.6 2.7 100.0 1986 15.1 31.4 16.1 22.9 12.0 1.5 100.0 1987 14.9 29.5 13.3 26.2 14.5 1.6 100.0 Source : Central Bank of Turkey Table 5. Turkey : Selected Interest Rates, 1980-88, (in percent per annum) Dec. Dec. Dec. Dec. Dec. Dec. Dec. Dec. Feb. Apr. June Aug. Sep. Oct. 1980 1981 1982 1983 1984 1985 1986 1987 1986 1988 1988 1988 1988 1988 Commercial Banks Deposit rates Sight 1/ 5.0 5.0 5.0 5.0 5.0 5.0 10.0 -- 36.0 36.0 30.0 25.0 10.0 35.0 Time 1 month -- -- 25.0 -- 35.0 35.0 29.0 28.0 40.0 40.0 40.0 35.0 35.0 62.0 3 Months -- 45.0 45.0 49.0 53.0 45.0 36.0 35.0 45.0 45.0 45.0 42.0 42.0 67.0 6 Months 35.0 50.0 50.0 47.0 52.0 50.0 41.0 38.0 52.0 52.0 52.0 51.0 51.0 72.0 1 year 2/ 40.0 50.0 50.0 45.0 45.0 55.0 48.0 53.6 65.0 65.0 65.0 64.0 64.0 85.0 L Effective yield on 1-year time deposits 3/ 30.0 37.5 40.0 36.0 40.5 49.3 43.1 48.1 58.2 58.2 58.2 57.3 57.3 76.2 Central Bank Discounts and Advances Short-Term Rates General 26.0 31.5 31.5 48.5 52.0 52.0 48.0 45.0 54.0 54.0 54.0 54.0 54.0 54.0 Agriculture 19.5 20.0 18.0 25.0 25.0 28.0 28.0 28.0 40.0 40.0 40.0 40.0 40.0 10.0 Exports -- 15.0 23.8 35.0 45.0 52.0 38.0 35.0 40.0 40.0 35.0 35.0 35.0 35.0 Long-Term Rate General 26.0 31.5 33.0 50.5 50.5 50.5 50.5 48.5 60.0 60.0 60.0 60.0 60.0 60.0 1/ Freely determined within a limit of 90% of interest rate on 1 and 3 month time deposits after 1986 and until February 1988 2/ For December 1987, average of interest rate paid by banks; rates were free between July 1987 and February 1988. 3/ After reduction of witholding tax: 25 percent before January 1, 1982; 20 percent between Jan.1, 1982-Jan.1, 1984 thereafter 10 percent plus 3 percent of the witholding tax for Defense Industry Support Fund between November 13, 1985-January 1, 1988 and 4 percent thereafter. Source : Central Bank of Turkey Table 6. Turkey : Costs and margins in the banking sector, 1981-85 average (percent of intermediated assets) Operating Interest Gross Net Capital Country Costs Margin Earnings Earnings Ratio Turkey 1/ 1981-85 4.7 2.1 6.4 2.2 6.5 1986 4.1 2.1 6.0 1.9 4.0 Public banks 3.6 2.1 5.3 1.7 4.5 Private banks 4.6 2.0 6.8 2.1 3.5 Austria 1.1 1.2 1.5 0.4 2.3 Belgium 1.8 1.7 2.2 0.4 2.5 Canada 2.0 2.5 3.3 1.2 4.2 Denmark 3.0 3.3 6.3 3.4 9.1 France 2.2 2.7 3.2 1.0 2.5 Germany 2.1 2.4 3.3 1.1 4.0 Greece 2.5 1.9 3.5 0.9 3.5 Italy 2.9 3.2 4.4 1.5 3.8 Japan 1.2 1.5 1.7 0.5 2.4 Norway 3.3 2.6 3.8 0.4 4.6 Portugal 2.1 2.3 3.4 1.3 5.9 Spain 3.6 4.7 5.7 2.2 Sweden 1.9 2.1 3.1 1.2 1.2 Switzerland 1.4 1.3 2.5 1.1 6.0 United Kingdom 3.5 3.4 5.0 1.5 4.5 United States 2.9 3.2 4.3 1.4 6.0 Area average 2/ 2.4 2.3 3.3 1.1 4.4 1/ Including development and investment banks, excluding foreign banks 2/ Excluding Turkey Source : OECD, Bank Profitability, 1987; Turkish Bankers' Association, Annual Reports, OECD Secretariat calculations Table 7. Turkey : Debt service indicators for the largest private industrial firms, 1983-87 1/ (in percent) 1983 1984 1985 1986 1987 Interest expense/sales revenue 6.1 6.5 6.7 9.5 7.3 Interest coverage ratio 2/ 2.1 2.1 2.0 .. .. -4 Debt/total assets 68.1 63.6 67.5 67.0 62.4 Debt/equity 3/ .. 146.1 177.0 194.0 165.7 Average cost of debt 4/ 13.7 14.6 14.4 19.2 16.9 1/ 406 firms in the 1985 survey 2/ Operating income/interest expense 3/ Equity includes operating profits 4/ Interest expense/debt Source : 0. Ertuna, "500 Large Industrial Establishment in 1986". Journal of the Istanbul Chamber of Industry, October 1987, pp.34-71 Table 8. Turkey : Secondary Markets, 1986-87 (in billions of Turkish Lira) End of Oct. 1986 1987 1988 Shares 5.3 60.1 60.4 Banks 3.5 33.2 30.3 Financial Intermediaries 1.8 26.9 30.1 Corporate bonds 104.5 394.9 513.6 Banks 64.4 300.6 437.5 Financial Intermediaries 40.1 94.3 76.1 Government bonds 546.3 1520.1 2481.0 Banks 540.1 1513.6 2469.0 Financial Intermediaries 6.2 6.5 12.0 Treasury bills 1411.9 3219.8 6431.1 Banks 1180.8 2864.1 5965.6 Financial Intermediaries 231.1 355.7 485.5 Bank bills 36.4 95.6 139.5 Banks 27.8 51.5 99.8 Financial Intermediaries 8.6 44.1 39.7 Income sharing certificates 289.6 445.9 387.8 -4 Banks 289.2 443.2 387.0 OC Financial Intermediaries -- 2.7 0.8 Finance bills -- 51.7 95.6 Banks -- 34.6 60.2 Financial Intermediaries -- 17.1 35.4 Total 2393.6 5788.1 1/ 10109.0 Banks 2105.8 5240.8 9449.4 Financial Intermediaries 287.8 547.3 659.4 Memorandum Items (percent of total) By institution Banks s8.0 90.5 93.5 Financial Intermediaries 12.0 9.5 6.5 Total 100.0 100.0 100.0 By Instument Treasury bills and government bonds 81.8 81.9 88.2 Income sharing certificates 12.1 7.7 3.8 Corporate bonds 4.4 6.8 5.1 Other 1.7 3.6 2.9 Total 100.0 100.0 100.0 1/ Compared to total transactions on the Istanbul Stock Exchange of TL 9,722 billion, or 60 percent thereof. Source : Capital Market Board Table 9. Turkey : Private and Public Sector Issuing of Financial Instruments, 1983-88 (in billions of Turkish Lira, stocks at end of period) 1983 1984 1985 1986 1987 1988 Private Sector 45.6 42.5 132.2 221.5 689.7 857.3 ----------e---------------- Bonds 14.1 12.1 33.3 77.0 338.0 181.9 Equities 31.5 30.4 98.4 94.7 187.5 330.7 Certificate of Revenue 0.5 0.9 0.8 0.0 Partnership 48.9 66.1 164.4 Bank Bills 52.3 127.3 Finance Bills 45.0 53.0 Mutual Fund Participation Certif. Public Sector 284.0 733.0 2030.6 3277.3 6659.3 8718.5 Government Bonds 206.8 228.0 673.0 1269.4 2045.2 3436.6 Treasury bills 78.0 495.0 1217.6 1787.9 3954.5 4621.9 Revenue Sharing Certificates 10.0 140.0 220.0 660.0 660.0 TOTAL 329.6 775.5 2162.8 3498.8 7349.4 9575.8 Memorandum Items Share of private sector (2) 13.8 5.5 6.1 6.3 9.4 9.0 Share of public sector (1) 86.2 94.5 93.9 93.7 80.6 91.0 Source : Capital Markets Board (Sermaye Piyassai Xurulu) Table 10. Turkey Monthly Closing Values of the Istanbul Stock Exchange Index, 1986-88 1986 1987 1988 January 100.0 216.9 857.7 February 119.9 260.8 721.0 March 115.8 245.8 635.3 April 112.3 269.4 554.0 O May 115.1 394.8 553.1 June 115.4 446.3 468.9 July 121.5 1021.1 492.9 August 138.6 1149.0 1/ 428.1 September 146.7 1029.3 455.2 October 150.2 786.4 396.8 November 160.3 890.6 396.3 December 170.9 673.0 373.9 1/ Peaking at 1,332 Source : Istanbul Stock Exchange