The Gordian Knot of Turkey's Economy - Reformers Hope to Tame A Reckless Tradition Of Politicized Lending

ANKARA, Turkey -- As a state bank inspector, Hamit Ucer thinks he knows exactly why his country keeps limping from one financial crisis to the next.

From an office above a furrier's shop, he and other members of the Association of State Inspectors -- watchdogs over Turkey's sprawling bureaucracy -- are fighting alleged corruption and political abuse at state banks such as T.C. Ziraat Bankasi, where Mr. Ucer works.

Last week, the U.S. government backed a $10 billion international rescue package for Turkey, replacing a previous financial support program that imploded in February with the country's financial markets. The money will come from the International Monetary Fund and the World Bank, where the U.S. is a dominant force.

It is the first test of how to balance misgivings about such bailouts with the need to keep financial crises in check. Bush administration officials demanded the money be disbursed only after Turkey implements economic reforms. It also vowed this would be the last time Turkey will receive aid with U.S. backing.

Turkey's government has lurched in the direction of reform, appointing a World Bank veteran, Kemal Dervis, economic minister. He is trying to execute a plan to straighten out the country's finances -- and the state banks that control 40% of the banking system by assets.

But a look at the sprawling state banks shows why the problem will be difficult to turn around quickly.

It was a spat between the country's president and prime minister on Feb. 20 over alleged corruption at the banks that spooked markets already concerned that political wrangling was blocking reforms required under the last IMF plan.

The key to success will be whether Turkey is ready to break the economic tyranny of political special interests. Mr. Dervis's openness has laid bare what many Turks had long suspected: Politicians have forced Ziraat, along with state-owned T. Halk Bankasi and T. Emlak Bankasi, to hide bad debts of about $20 billion, or nearly 20% of Turkey's entire annual economic output.

It wasn't supposed to be like this. Ziraat Bank, whose name means Agriculture Bank, was founded in 1888 to help farmers oppressed by a tax system that left produce to rot and denied them access to capital. Thick brass light fittings still hang over the original banking hall, now a museum with paintings of bazaar moneylenders depicted as snakes and murals of upright Turkish peasants with wooden carts and pitchforks.

Upstairs, the state-appointed general manager works from a wood-paneled office worthy of a 1920s New York magnate. For two years until this month, the job was held by Osman Tunaboylu, an ample, balding former officer of Turkey's central bank. He brooked no doubts about how Ziraat became the center of Turkey's woes.

"Ziraat has just one problem," he says. "Duty losses."

Since 1992, successive governments have ordered state banks to provide cut-rate loans to politically powerful interest groups, and then failed to pay the state banks back for the "duty losses" these loans create. High interest rates since the last major financial crisis in 1994 sent the debt soaring exponentially. And that was only part of the budgetary never-never land of 1990s Turkey.

A war against ethnic Kurdish guerrillas in southeastern Turkey allowed the army to grab an estimated one-fifth of state outlays. A 21-dam project in southern Turkey swallowed up billions of precious dollars. U.N. sanctions against neighboring Iraq, the Asian financial crisis and the economic meltdown in Russia took their toll. So did a massive earthquake that killed 20,000 people in Turkey's industrial heartland in 1999.

Crisis bred a parade of unstable governments between 1993 and 1999. Each hurried to distribute benefits to supporters. All put off paying the Treasury's debts to the banks for the next administration. "First came subsidized loans for cotton producers," says Mr. Tunaboylu. "Then tea planters. Then cheap agricultural credits, and on top of that, of course, emergency aid for natural disasters."

State banks provided below-market rates to farmers, small businesses and other interest groups engaged in about 40 types of professions and activities. Even now, Mr. Dervis has only managed to put a $320 million annual cap on the habit, and to promise that the Treasury will pay the banks back quickly.

Ziraat's critics say the bank's problems go well beyond loan losses. All state banks are managed by bureaucrats, but overseen by a politician who can hire and demote executives, as well as block corruption investigations.

As a result, Ziraat has had 33 general managers in the past 77 years, with two years in which the top job changed hands four times. Politicians would get people hired, but laws said nobody could be fired. Bank insiders say its 38,000-strong work force is far more than is really needed.

State bank practices remain an uncharted black hole. Ziraat bank sued a Turkish bank expert, Selcuk Abac, when he asked for details back in 1993 after its published domestic accounts showed it top in the world in profitability. Ziraat is about to publish its first-ever audit under international accounting standards, in its annual report for 2000.

"When I was in charge, there were whole areas of the accounts where nobody dared to go," says one former head of Ziraat. He asked not to be identified because he could be prosecuted under harsh secrecy laws that have until now shrouded the operations of the state banks.

Persistent allegations of outright corruption dog all the state banks, and they have sapped the patience of many Turks, including Mr. Ucer, the Ziraat Bank inspector.

Mr. Ucer refused to countersign a contract that would have paid 750,000 German marks ($410,000) in 1996 to an advertising agency in Europe. A pro-Islamic government was in power, and he thought the recipient was a front for an exiled Turkish Islamist group. In what he says was a punishment, Mr. Ucer was transferred to another department. When he continued to protest, his managers transferred him to a small branch in a slum area 15 miles outside Ankara.

A court heard his case -- a sign in itself that the backlash against corruption is gaining traction -- and Mr. Ucer was reinstated a few months ago in his old job. A suit against his managers is in the appeal court, and Mr. Ucer remains nervous.

"The honest people are not organized in Turkey. The dishonest people are. That's what we're trying to change," says Atilay Erguven, head of the State Association of Inspectors, which is supporting Mr. Ucer's case.

Mr. Dervis has made bank reform his first task. Last week, the Treasury issued bills to cover about $10 billion of the debt. The cleanup operation will be overseen by Vural Akisik, once Turkey representative of the former Bankers Trust Corp. He is now chairman of the board at Ziraat, under which the three main state banks are to be united.

But turning them around will not be easy. Mr. Dervis says Mr. Akisik needs $3 billion to recapitalize them and $13 billion just to sort out their short-term obligations. That's not counting the estimated $10 billion in losses of another 13 private banks taken over by the state after failing in the past three years.