Financial liberalization and currency crises: the case of Turkey

Abstract

This article aims at identifying the determinants of currency crises in Turkey in the period of 1980:01-2006:06. A broad set of explanatory variables was tested through the signals approach and bivariate and multivariate logit regressions. The same procedure is then repeated for the postcapital account liberalization period (1989.09-2006:06). The results obtained are novel and deviate widely from the existing literature. The findings suggest that conventional crisis indicators fail to provide a satisfactory explanation for the crises experienced in Turkey. For the period spanning 1980:01-2006:06, banking sector fragility index, short-term debt/international reserves, bank reserves/ bank assets, US GDP, M1, and US 3-month T-Bill rate have been identified as significant leading indicators by both the signals approach and logit regressions. Analyzing the post-capital account liberalization period spanning 1989:09-2006:06 in isolation, strong evidence is obtained confirming the importance of US federal funds rate, banking sector fragility index, US GDP, and US 3-month T-Bill rate by both approaches. Overall, the results confirm the significance of global economic conditions, and suggest that financial liberalization has rendered the Turkish economy vulnerable to currency crises.