Financial systems and development

a brief period firms faced rapid changes in relative radically reorganized. Between 1980 and 1986 the
prices, a fall in domestic sales, sharp increases in banking system's assets shrank 44 percent in real
interest rates, a major devaluation of the currency, terms.
and a sudden termination of external credit. The Until 1980 the Turkish government maintained
biggest problems began in the real sectors of the strict control of nominal interest rates. Inflation
economy, but efforts to liberalize the financial sec- was high, and real interest rates were negative. In
tor undoubtedly contributed to the resulting insta- 1980 the government removed the controls and albility.
lowed banks to issue negotiable certificates of deposit
(CDs). At the same time it embarked upon a
The Philippines and Turkey stabilization and structural adjustment program.
The financial reforms were short-lived, however.
The Philippines and Turkey have also reformed Two years later, after financial difficulties, the centheir
financial systems, which were once heavily tral bank reimposed ceilings on deposit interest
repressed. Their reforms, however, centered on rates.
freeing interest rates. In the early 1980s the Philip- Turkey's liberalization program differs from the
pines liberalized interest rates and allowed com- others in several respects. The government's budmercial
banks to provide a much broader range of get deficit declined between 1980 and 1982, which
financial services. In the first years after the re- took some pressure off the financial markets. The
forms, interest rates rose to about 10 percent in real government did not liberalize capital flows beterms,
and the financial sector grew rapidly. But tween 1980 and 1982 and thus avoided some of the
when the country suffered serious macroeconomic complications that plagued the Southern Cone
instability during 1983-85, a widespread financial countries. The annual inflation rate, as measured
crisis developed.
by changes in the wholesale price index, declined
Beginning in the late 1970s the Philippines pur- from more than 100 percent in 1980 to 25 percent in
sued expansionary policies to sustain high eco- 1982. Real interest rates increased sharply during
nomic growth despite a world recession. The fiscal the stabilization period. The domestic currency dedeficit
increased from 0.2 percent of GNP in 1978 preciated in real terms, GNP growth became posito
4 percent in 1982, and the current account deficit tive after two years of contraction, and the comporose
from 5 percent of GNP to 8 percent over the sition of demand shifted from domestic absorption
same period. Political uncertainty reinforced a toward exports. Turkey appeared to be on the right
gradual loss of confidence in the domestic econ- path.
omy; capital began to flow abroad just as the sup- These macroeconomic changes, however, hit
ply of foreign finance began to dry up. A smaller corporate profits and left businesses struggling to
external deficit in later years was made possible adjust. Financial problems in the corporate sector
only by sharp cuts in imports and domestic ab- then caused distress in the banking system. Nonsorption.
The peso devaluation of 1983-84 and the performing loans, especially among smaller banks,
large fiscal deficit caused inflation to rise to 50 per- prompted intense competition for financial recent
in 1984. In that year the government imple- sources. Banks that needed liquidity increased
mented a stringent stabilization program that in- their deposit rates. Bigger banks tried to limit this
cluded the sale of new high-yield instruments by competition with a gentlemen's agreement on inthe
central bank, with the aim of slowing monetary terest rates, but they failed and the competition
growth. To keep their deposit base in the face of continued. Banks also issued large volumes of CDs
this new competition, banks and financial compa- through brokerage houses (which offered higher
nies also increased their interest rates, which at interest rates), even though this practice was protimes
rose to more than 20 percent in real terms. hibited after 1981. Additional financial resources
The highly leveraged corporate sector thus faced were used to meet immediate obligations and to
mounting financial strain.
refinance nonperforming loans: in other words,
Financial distress in the corporate sector, bad many insolvent borrowers continued to borrow.
management in the banks, political corruption, Indicators of financial depth improved during this
and inadequate regulation and supervision all led period, but a large part of the additional intermedito
a rapid deterioration in the balance sheets of ation went to finance interest payments on nonfinancial
institutions. Eventually the crisis forced performing loans.
the government to intervene. A number of smaller The government finally intervened in mid-1982.
banks were taken into the public sector, and the It found that some banks had failed to meet their
two largest banks, both government-owned, were reserve requirements because of liquidity prob-
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