Towards a sustainable debt burden: challenges facing Turkey at the turn of the new millennium

Abstract

Following the failure of the disinflation program initiated in December 1999, Turkey embarked on yet another disinflation program in May 2001, albeit in a radically different environment. In May, the fragility of the financial sector was drastically higher following two interest rate shocks and the consequent devaluation of February 2001.1 The market participants were also sensitive about the exchange rate regime switch to a free float with virtually no anchor.2 Besides the fragility of the financial sector and the uncertainty concerning the exchange rates, another issue of concern was Turkey’s short-to medium-term debt financing position. In the post-crisis environment, which is characterized by political uncertainty and risks, researchers have been paying particular attention to this issue. Indeed, it is an ongoing consensus that the long-term debt sustainability issue in a low inflation program depends crucially on three factors, which are not necessarily mutually exclusive: 1) consecutive governments that are committed to fiscal discipline; 2) strong real economic growth; 3) lower real interest rates on government securities and lower depreciation rate of the Turkish lira (TL).