The operation economist have for long been asking from the ECB resembles that the CBT had launched in 2001.

One of the main pillars of the economic program initiated after the 2001 crisis was the operation to rescue and strengthen the banking sector. A significant part of the operation was targeted at public banks. During the 1990s, public banks extended loans to farmers or artisans, depending on the preference of the government, at rates significantly below the cost. Such support mechanisms following from natural political preferences should have been involved in the public budget. However, the loans were delivered via public banks, which therefore recorded high amounts of losses. In exchange for the loss, the Treasury did not transfer any funds to public banks. Therefore, public budget balances looked as if they were not disturbed while the balance sheets of public banks deteriorated constantly.

At the end of this process, public banks moved to the edge of the cliff. In the context of the stability program initiated a couple of months after the 2001 crisis, the Treasury paid the accrued debt to public banks with government bonds. Public debt stock to GDP ratio increased from 38.2 percent in 2000 (49.8 percent as a ratio to the GDP in 2000) to 74.1 percent by the end of 2001 (94.6 percent as a ratio to the GDP in 2001). The above-mentioned operation was the chief reason for the doubling of the debt ratio. The reason for the escalation in Turkey’s debt stock in 2001 is similar to the reason for Spain’s current problem with hiking public debt stock.

Such indispensible operations to rescue banks (as the entire economy will “sink” alongside the banking sector otherwise) might affect the perception about the solidness of the economy adversely. Market actors think that the Treasury might fail to fulfill the financial liabilities on the hiking public debt. Countries faced with such liabilities cut down certain budget expenditures, but funds generated this way failed short of liabilities, where additional borrowing was required to close the gap. As expectations about the economic performance worsened, however, investors either refrained from purchasing bonds or asked for higher interests. And high interest lowered the price of new bonds as well as those traded in the secondary market.

Now, let’s recall some basic facts: Why did Turkey’s public debt stock hike after the 2001 crisis? One chief reason was the government bonds transferred to public banks in order to offset the melt-down of their capitals. The bonds, however, are useless if they are just kept in the vault: as banks were in severe need of liquidity, they had to sell the bonds to fulfill the cash requirement. On the other hand, the demand for government bonds was low and the few who were willing to buy offered low prices (asked for high interest). Therefore, giving bonds to banks in trouble is necessary, but not enough to solve the problem. Banks have to find customers willing to purchase bonds.

The only institution that can purchase bonds at large amounts and at an interest rate above the “waif” rate is the central bank of the country. Indeed, after the 2001 crisis, the Central Bank of Turkey (CBT) immediately purchased the bonds transferred to public banks by the Treasury. As a result of the operation, the value of government bonds in the CBT balances increased from 1.5 billion liras by the end of 2000 to 34.3 billion liras by the end of 2001, a 13.7 percent increase as a ratio to the GDP in 2001.

This operation was one of the keys to the success of the stability program and it resembles the operation economist have for long been asking from the European Center Bank. I will continue.

This commentary was published in Radikal daily on 25.08.2012