Financial Liberalization Under External Debt Constraints

Abstract

Development planning constituted the main focus of economic policy making in Turkey from the 1960s until the mid-1970s. The external resource requirements of the plans were financed essentially through state-to-state loans or project credits from other governments or supranational institutions. Domestically, the financial structure involved the allocation of credit and foreign exchange according to the priorities of the plans. In this setting, finance is repressed in the sense of Shaw-McKinnon—that is, the allocation of financial resources is based on nonprice criteria, so that the prices, usually implying negative or insignificant yields for financial assets, are not indicative of the true scarcity of financial resources. Moreover, the financial-repression hypothesis implied that because finance was repressed, financial resources would be scarce. The idea of financial repression rested on the belief that repressed finance and planning, on the one hand, and liberal finance and allocation of resources through the market, on the other, form two mutually exclusive resource allocation mechanisms. Thus, financial reform has almost invariably been implemented as part of a wider project involving a market-oriented structural adjustment program. In the market-oriented scheme, the economy is to borrow from international financial markets through the mediation of domestic financial institutions, and domestic credit allocation is to be based on price criteria. The expectation (and this was the aspect most emphasized by the early literature) was that as a result of market-determined prices that fully reflect the scarcity of resources, savings and investment would increase both in quality and quantity, thereby enhancing the sustainable-growth prospects of the reforming economies.