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Is it contagious?
We first became the expert of the US economy, and now Greek economy. We cannot stop writing a commentary on the state of affairs in Greece occasionally. The last commentary was also on Greece, but I am willing to add another one to the list. This time I want to focus on the dimensions of the Greece case that frightens Turkey as well. The question is; will the crisis in Greece transmit to EU member countries and Turkey?
We can address this issue at two levels. First is the contagiousness within a country, and second is the transmission of a crisis in one country to other countries. It is this second level we are interested in.
1997-1998 Asian and 1998 Russian crisis triggered the research on contagious effect. Thailand forced to float its currency baht on 2 July 1997, following which a crisis erupted in Korea, Philippines, Indonesia, and Malaysia. On 18 August 1998, Russia declared that it cannot fulfill the obligations born from state bills, putting into trouble a number of countries which seem to have no connection with Russia at the first instance. This was not the expected declaration. In fact, only two months before this declaration Russia's credit rating was expected to be increased. However things did not evolve that way and the rating was eventually cut two times: first five days before and the second one day before the eruption of the crisis. Moreover, right before the crisis, famous speculator Soros made a statement that Russia should introduce devaluation. It is evident that these developments had a triggering role in the eruption of the crisis. From July 1998 to January 1999 ruble devaluated by 262 percent.
Long Term Capital Management (LTCM), US hedge fund which held at substantial amounts the financial assets of countries with high credit risk such as Russia folded on 2 September 1998. As a result of this emerging market economies were also affected by the crisis even if they did not have much commercial relations with Russia.
This is an important observation; because it implies that the main reason behind the contagious effect is not necessarily intense commercial relations between the country where the crisis emerged and the country where the crisis was transmitted to. Of course there are some examples where this is the case. For instance one reason why Turkey was affected negatively by the crisis was the major drop in exports which took place as a result of the reductions in the purchasing power of trade partners of Turkey.
One of the main reasons for the contagiousness of the crises is the presence of common international investors (creditors). For instance one bank might have extended substantial amount of credits to several economies with fragilities. In fact this is the reason why EU's avoiding and delaying to find a solution for Greece's problems frightens several economists.
Majority of the banks holding substantial amounts of Greek bills are in the EU region. These banks which did not yet completely overcome the damages caused by the global crisis might encounter another shock. We know relying on our experiences from the global crisis what comes next if this happens. Turkey will not be immune from the intensification of the crisis in Greece, solely because the two does not have much commercial relations. Let us hope that the IMF, which is not much liked in Turkey, steps in as soon as possible blossoming hopes that Greece can overcome the current problems.
Note: For more information on contagion you can refer to the following studies:
G. L. Kaminsky, C. M. Reinhart, and C. A. VÈgh, 2003. The Unholy Trinity of Financial Contagion, Journal of Economic Perspectives, 17(4), 51-74.
F. Özatay, 2010. Financial Crisis and Turkey.
This commentary was published in Radikal daily on 02.05.2010