Statement by Franco Passacantando at the meeting of December 21, 2000

87170 CO~lAL, lEI2s2oooW500 December 20, 2000 04:00:10PM Statement by Franco Passacantando Date of Meeting: December 21, 2000 Turkey: Country Assistance Strategy, Financial Sector Adjustment Loan, and Privatization Social Support Project 1. We broadly share the Bank's view on Turkey's progress and on the reasons for the recent banking crisis. Turkey represents an important emerging market in the global economy; and deserves the appropriate support and attention. However, the recent financial crisis clearly highlighted the weaknesses of the Turkish economy and its vulnerability to shocks. It is commendable that the Bank had clearly perceived these weaknesses before the onset of the crisis and had prepared a strategy with a very comprehensive set of structural reforms to deal with them. We wonder however whether the changes made lately in the projections of the main macroeconomic indicators should have been accompanied with changes in the features of that strategy, particularly after the crisis has erupted. In addition, we wonder whether to restore confidence in the financial markets the reform program that was envisaged before the crisis should be accelerated and deepened. This issue can be looked at by considering separately the following three aspects. Mitigating the real impact of the macroeconomic adjustment program 2. Recent data show that inflation is expected to be above the target and the current account deficit has deteriorated further. Furthermore, the uncertainties generated by the crisis may result in an economic slowdown due to fall in demand, higher financing costs and deterioration of consumer and investor confidence. In this context, it is important that the Government of Turkey strengthens the commitment to fiscal consolidation and monetary stability. Since the crisis will inevitably have a negative impact on unemployment and on social conditions in the poorest areas, we wonder whether the Bank should have further strengthened the component of the strategy directed at alleviating poverty, particularly by scaling up the programs in health, education, and gender issues. Strengthening the reforms in the Turkish banking system 3. The latest developments in Turkey show that the momentum in the banking system reform has not been maintained, and weaknesses have not been addressed properly, thereby This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without the consent of the Executive Director concerned.  2 exposing banks to increased vulnerability. It is now crucial that the program of restructuring and privatization of the banking sector be accelerated and strictly followed, in order to reassure confidence in the financial markets. We broadly concur with the Bank's program and consider imperative the need for a substantial improvement of surveillance and control, ranging from bank examination procedures, mandatory asset ratios, disclosure provisions, securities laws, and moral suasion. Given the weaknesses that exist in the supervisory regulatory framework and the enforcement capacities, we are concerned regarding the timely implementation of the privatization and resolution plan, the involvement of strategic investors, and the sustainability of the banking system network. As we already stated in the past, we feel uncomfortable with the explosively increasing volume of derivatives, including repos and swaps in the banks' balance sheets, and the risks associated with them and related products. We think the World Bank should actively support banks' programs to adequately measure their exposures and value-at-risk under different scenarios, including ones that would imply substantial deterioration of market conditions. We also believe that the IFC's technical expertise in support of the resolution, commercialization and privatization process is necessary. Another crucial aspect is that of the cross-shareholding between the financial sector and large industrial groups, which, as it now clearly appears, has generated a number of severe distortions. 4. A broader question that we have is the extent of the support that the Banking system needs. Unfortunately the experience of most countries that have suffered from crises in the financial sector shows that early estimates of their costs proved insufficient It is therefore important that an assessment of the gravity of the problems that the banking system faces be soon undertaken. In addition, it will be important to have a full picture of the overall fiscal implications and budgetary costs of the bank restructuring and privatization well in advance of the "Bank Restructuring and Privatization Project". 5. Given the structure of the financial markets in Turkey, we are also concerned about the extent of contagion effects to healthy banks and other financial institutions. We also wonder whether enough information is available to assess the quality of their balance sheet and the level of risk exposures, particularly with the introduction of the new standard rules on foreign exchange and lending exposure limits, capital adequacy and the evaluation of risks and performance on consolidated basis. This becomes even more critical in a situation of excessive lending under which banks may have overstreched themselves to certain sectors. 6. Integrity and transparency. We strongly appreciate the emphasis given to this issue. In banking, trust and confidence are ethical standards that cannot be compromised. It seems that many of the failed banks are involved in corruption allegations and certainly in mismanagement practices. We want to make very clear that sincerity, cooperation, transparency, and disclosure of information play key roles in resolving the problems we are facing. Financial institutions cannot maximize the long-run values if they don't promote greater transparency of market risks and ethical behavior. Therefore, we urge the authorities that the illegal practices on financial and banking activity should be addressed immediately. Failure to deal with this issue in a transparent way would be a serious setback to the program and a blow to Turkey's efforts to attract foreign capital. Implementation, monitoring, and enforcement This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without the consent of the Executive Director concerned.  3 7. We share the Management's concern regarding the implementation capacities and most importantly the timely enforcement of the new rules. Inadequate implementation of the program's actions could result in costly failures, further bureaucratic inefficiency and political influence, and strong market pressures. We also understand that additional efforts, including technical assistance are needed for the implementation, monitoring and enforcing of the regulatory system, and would strongly encourage the Bank Group's involvement in this area. 8. The need to accelerate the privatization process is clearly stated in the documents and incorporated into the triggers. This task becomes even more important after the crisis. The Authorities seem to have agreed for more substantial efforts towards liberalization on the telecommunication and power sector, a process that will strengthen foreign involvement into the privatization. Given the agriculture share of GNP and the low productivity in this sector, we welcome the strong CAS focus on rural and agriculture development. However, close monitoring and technical expertise in this process is necessary. In addition, fighting corruption and illegal business practices is a critical element for enhancing economic reforms and strengthening credibility. 9. Reducing poverty and inequality remains a great challenge for Turkey. We endorse the CAS proposal to focus the Bank's program on restoring higher growth, reduce unemployment, and improve health and education. We also encourage the Bank Group to continue its efforts to support Turkey's disaster prevention and environmental agenda. In addition, we believe that a stronger harmonization between Bank Group's lending and non-lending activities is needed. 10. Finally, while expressing our support for the program we would like to emphasize that even though Turkey is a large borrower for the Bank, the size of the package is substantial and quite ambitious. We strongly believe that the World Bank Group can greatly contribute to the reform process in Turkey, particularly in the difficult structural reforms and in the financial sector development, which should have a high priority within the agenda of the region and the Financial Sector Department. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without the consent of the Executive Director concerned.