The events leading to the Turkish crisis of 2001 include a similar story of “surge and drought.” At the beginning of 2000, Turkey embarked on a new IMF-supported program featuring a preannounced crawling peg exchange rate regime that would give way to a more flexible “widening band” regime after 18 months. The objective was to defeat chronically high inflation, which had averaged close to 70 percent in the 1990s, and to regain debt sustainability that was threatened by the very high real interest rates that had prevailed for years. The program got off to a good start, as markets “believed” the preannounced path of the nominal exchange rate would be followed, at least for a while. With risk premia declining, short-term capital flowed into Turkey, taking advantage of th large exchange rate depreciation-adjusted interest rate differentials. The current account deficit widened dramatically by the summer of 2000 without much worry in the financial markets, for inflation was indeed declining rapidly, although not rapidly enough to avoid a significant appreciation of the real exchange rate. The Turkish economy could possibly have digested the real appreciation, at least during the 18-month period for which the exchange rate path was to remain rigid and preannounced, had it not been for serious weaknesses in the banking system translating into large contingent liabilities for the government. The combination of the large current account deficit and the underlying fiscal weakness led to attacks on the Turkish lira first in November 2000 and then again in February 2001. Just as some Asian countries had to give in to overwhelming market pressure, Turkey too had to abandon the exchange rate regime and let the lira float, leading to a massive devaluation in the early spring of 2001. Private short-term capital that had provided an inflow of about 5 percent of GDP in 2000 changed direction, with outflows totaling about 7 percent of GDP in 2001!...
Many policymakers have contemplated imposing higher taxes on wealth or high incomes when confronted with the need to “find” another 1 or 2 percent of GDP to meet a “strengthened” primary surplus target at the onset of a macroeconomic crisis triggered by debt event fears. I lived through a typical example of this in Turkey at the peak of the 2001 crisis. We had agreed with the IMF in March 2001 on a new and more ambitious primary surplus target of 5.5 percent of GDP and were trying to put together a revised budget that would meet this target. The distribution of income in Turkey is highly unequal, and the pending decline in GDP and employment due to the crisis was going to hurt the poor and threaten many jobs. It would have been very desirable, for equity and social cohesion, to derive greater tax revenue from the rich. The problem is that, in a crisis situation, one needs revenue quickly and cannot wait for the results of a comprehensive tax reform. We considered an income tax surcharge, a tax on liquid wealth, and a windfall gains tax, because many investors that had held foreign exchange before the onset of the crisis had made spectacular gains due to the collapse of the Turkish currency. In the end, we decided reluctantly, however, that any significant measure of that type would accelerate capital flight and increase the degree of panic that was already our biggest problem. We did try, using an amendment added to a bill in Parliament around midnight, to increase the deposit insurance “tax” received on deposits in the banking system, but we failed even at that because of the defection of a group of government deputies during the midnight vote. In the end, there was an increase in the value added tax, increases in taxes on tobacco, alcohol and fuel, and many increases in administered prices. The budget targets had to be met, as usual, by increasing the effective tax burden on the middle- and lower income groups. We tried to compensate this by direct income support programs to the poorest sections of the population. The 2002 data published by the State Institute of Statistics suggest that we had some success. But we could not impose new taxes on the rich at the height of the crisis. It would have led to a further acceleration of capital flight and would have ended up hurting the country and the poor through a deepening of the crisis.
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