2. THE CREATION OF THE STOCK EXCHANGE

Abstract

The origins of the country’s stock exchanges extend to the time of the Ottoman Empire. Following the conquest of ‹stanbul in 1453, and with the aim of strengthening economic and political ties, a number of banks installed in the Galata district were permitted to carry on with their business and went unhindered provided they paid taxes and accorded with legal requirements. During the Ottoman period, these banks gained greater power and acquired an important role in the wider diffusion of financial activities and in taking on the state’s foreign debt.

Following the proclamation of the Republic of Turkey in 1923, the effects of the First World War rendered it difficult for Turkey’s capital market to re- capture the dynamism it had exhibited in the Ottoman period. The capital market began to pick up speed in the 1960s when the stock exchange’s aggregate capital reached a significant level, the issuance of corporate shares and government stocks increased. However, as a result of both an inadequate legal and regulatory order and the inability of the capital market to meet the needs placed upon it, no significant development was to be achieved.

It wasn’t until the 1980s and the 24th January decisions’ implemenation of a liberal, free market economy that the development and access to foreign investors of Turkey’s capital market displayed considerable progress. During this period, the framing and enactment of an adequate regulatory and legal framework accelerated the process of the capital market’s development. The establishment of the Istanbul Stock Exchange in 1985 was to prove an important turning point in the development of Turkey’s capital market. This organisation has moved in a positive direction

THE CREATION, DEVELOPMENT AND

OPERATION OF THE ISTANBUL STOCK EXCHANGE

Prof. Dr. Nurgül R. CHAMBERS Marmara University Faculty of Economics and Administrative Sciences

due to its first rate infrastructure and its use of high tech capabilities.

It has developed into a focal point of interest for foreign capital markets and has allowed the the Istanbul Stock Exchange (ISE) to assume the profile of a stock exchange which is a powerful player in global competition.

Key words: The Stock Exchange in Turkey, Development of the Istanbul Stock Exchange, Creation of the Istanbul Stock

Exchange, Operation of the Istanbul Stock Exchange.

1. INTRODUCTION

Risk and non-proximity to uncertainty are indispensable elements in the development of a capital market. In addition, the existence of strong, stable, and sustainable economic growth ‹s of great importance to capital markets.

It is the capital market which largely determines how existing resources are brought together, where new resources are located and in which areas these resources are to be used most productively.

In today’s Turkey, the contribution of the capital market in the development of the private sector has reached the highest, positive level. However, the existence of economic and political instability over many years, rather high inflation rates, and the periodic eruption of financial crises have, to an important extent, slowed down the development of the country’s

capital markets. Notwithstanding these problems, the position reached by the the Istanbul Stock Exchange (ISE) through its proven technological strengths, is one of an Exchange open to global competition. One of the important advantages possesed by the ISE is that Turkey has a dynamic economic structure. One further advantage is that the country’s capital market is open to development and innovation.

When examined from a historical perspective, it is possible to observe that the formation of exchanges extended to the early years of the Ottoman Empire and continued through the 19th century. The issuing of government bonds in reponse to factors such as Ottoman attempts at opening to the West, the existence of economic problems, and the financing of military conficts and so on, all made the formation of a capital market necessary.

Furthermore, the idea of instituting similar financial institutions to those existing in European countries was also an important factor at play in Ottoman considerations.

The purpose of this paper is to examine how the ISE has reached its current stage of development, the problems it has encountered and the difficulties through which it has passed. To accomplish this aim, it is necessary to examine the period encompassing the exchange’s birth, development and practices beginning as long ago as the Ottoman period.

2. THE CREATION OF THE STOCK EXCHANGE

When exemined from the historical perspective two factors led to the emergence of the first stock exchanges in the world. The first was the radical innovations introduced by Venetian bankers who played a major role in the development of Mediterranean trade. The second was the expenses incurred by the centralised states which arose on the ashes of the fedual system in Europe as they endeavoured to enhance their economic, political and military power. After the Crusades, Europe’s trade with the Levant via Venice gathered momentum. So that the city soon had a monopolistic hold over European trade and led to the new developments about finance of trade Venetian banks began to issue notes which were convertible into either gold and silver or goods at every Mediterranean port, and these became the new currency of trade.

The most significant advantage of the notes issued by Venetian banks and bankers was the monetary gain to the issuer. In time, the papers themselves took on a value in their own right and became commodities to be bought and sold. These papers were demanded in the trading of goods at all major ports. The transition to organised exchanges

for the notes alone gained momentum with the establishment of central governments in place of the fedual city states of Europe ¹.

It is known that the first registered issue of stocks in the modern sense was undertaken in the Netherlands in 1602. These stocks for the first time offered dividend yields to investors who until than had been accustomed to interest payments. Leaving aside the trading of these stocks, the first stock exchange in Europe was founded in London. It was followed by organisations formed in Berlin, Frankfurt and Paris, where the issue of debit notes and stocks became widespread. First over the counter market has occurred in Paris².

The stock exchanges developed at the beginning of the 17th century in Europe. Mechanisms were established in order to trade securities according to certain rules in these stock exchanges. The first stock exchanges operated under the auspices of corporations of merchants, but later came under the control of central governments. The industrial revolution resulted in not only commercial papers but shares and debentures issued by industrial companies, and securities representing their entire assets being traded on the stock exchange.

1 Kazgan, Haydar, The Istanbul Stock Exchange in a Historical Perspective, ISE Publications,

‹stanbul, 1995, p.10,14,15.

2 Tanör, Reha, The Turkish Capital Market, Volume 2, Public Offering, Garanti Investment, Publications, Special Edition, Beta, Publishers, Istanbul, 2000, p.5,6,7.

In America, the first stock exchange dealings started initially in Philadelphia and one year later in New York in 1817. The USA bonds were traded as financial instruments in these stock exchanges. The first stock traded on Wall Street was issued by the Bank of New York.

Upon the start of big infrastructure investments, the issue of stocks started to increase too and in parallel capital markets entered into a rapid period of development. This process was operated by the establishment of new stock exchanges in several places, the development of auditing mechanisms, the enactment of the necessary laws and the setting in place of the necessary organizational structure. Thus, the most developed capital market of the present started to established ³.

3. THE OTTOMAN EMPIRE AND THE GALATA STOCK EXCHANCE

The past of the country’s capital market lies in the Ottoman Empire.

After Ottoman Sultan Mehmet II completed the conquest, he believed that it was important to maintain economic and political relations with Europe. Therefore the Sultan pursued a policy of agreement and compromise with the Italian colony in Galata, negotiating with their representatives so as to enlist their

loyalty to Ottoman state. The result was a firman, or imperial decree, declaring that they could continue to pursue their affairs as they before on the condition that they complied with Ottoman commands and laws, and paid their taxes and dues. The bankers and merchants of Galata had not only loaned money to the Byzantines, but acted as tax farmers for various different taxes. This system continued under Ottomans, and the Galata tax farmers wielded considerable influence as a result. In time Ottoman state granted them the right to mint gold and silver coins. This created an exchange in coinage of diverse values, carat and weight as opposed to the exchanges based on negotiable instruments in Europe ⁴.

In the Ottoman Empire, one important economic development, which was late in coming when compared to Western countries, was the issue of bank notes. As the Ottomans did not issue any bank notes in return for gold and silver until the 1840s, they could not benefit either from domestic or foreign borrowing. Tax increases were the first policy choice when the Treasury was in difficulties.

Whereas, at the beginning of the 18th Century, England issued bank notes, which could be converted anytime to gold and the use thereof became widespread in Europe within

3 Tanör, Reha, ibid, p.7.

4 Kazgan, Haydar, ibid, p.28, 34.

a very short period. These notes were used in Ottoman foreign trade and they further became valid for use in this country. In the 1840s, special paper was imported from abroad to be used for the first issue of hand-written bank notes. These interest earning instruments would both function as money and, as bonds since they earned interest.

Serving as money on the domestic market, these bills would also find a market abroad among investors, and so assist in clearing the bottleneck in foreign trade. In reality, bank notes started to be accepted domestically and abroad. However, this situation affected trade levels at the Galata market negatively and bankers were far from satisfied as a result ⁵.

The trading of bank notes outside the stock exchange was carried out by bankers. However, from many points of view, trade with bank notes caught the interest of and impacted the stock exchange.

The first factor was that the bank notes were traded like a bond with interest payment due and as these transactions were carried out at locations outside of the stock exchange, the reliability and respect accorded to the stock exchange was reduced. Another point was that due to the fact that the bank notes

were an alternative financial instrument of the securities, it affected negatively stock exchange transactions and prices. Another factor was, that a part of the debts were used to eliminate the bank notes, which reduced the effectiveness of borrowing and influenced the economic environment negatively ⁶. It was decided to remove bank notes from circulation, which had become a growing problem for the Ottoman Treasury and had started to affect the stock exchange negatively.

Instead it was decided to mint the

‘Mecidiye’ coin, in accordance with the standards of European coins.

Circulation of foreign money was prohibited.

The Galata bankers benefited from a respectable profile in the financial world of Europe and took care to ensure that the Ottomans foreign trade with direct or indirect bill of debts was continued.

Additionally, when trade agreements, concluded with England and France (1838-1841) were expanded to other countries, the reduction of customs clearance taxes and the removal of any importation bans caused an increase in the important deficit in foreign trade⁷ . The Ottoman

5 Kazgan, Haydar, Europe Finance Capital during the Ottomans, Yap› Kredi Publications, Istanbul, 1995, p.18,72,75.

6 Fertekligil, Azmi, The History of the Stock Exchange in Turkey, Research on Stock Exchange History, ISE Publications, April 2000, Istanbul, p.93,94

7 Kazgan, Haydar, Europe Finance Capital during the Ottomans, ibid, p.121.

government was no longer able to determine a foreign trade policy by itself. In the period following the development of an open market economy, industrial products from Europe could easily enter the Ottoman countries. The process, which influenced domestic industry negatively and along with the effect of the deteriorating trade balance, foreign trade subsequently displayed continuously deficits. In addition to, difficulties with the collection of taxes were seen, so that the financial situation became steadily worse. As a natural result of the policy of opening to the West, it was decided to opt for foreign borrowing ⁸.

Innovations in the field of finance ended during the Crimean War, which lasted from 1853 to 1856.

During this period, the attention of the government was fully concentrated on the Crimean War.

During this war, for the first time the Ottoman government concluded debt agreements with foreigners.

After the Crimean War, the government intended to continue with improvement in finance policy and the Treasury announced important reductions in state expenditure. However, the money borrowed in 1854 was not enough for war-related expenditures the government became re-indebted

after this debt was structured.

Among these debts, the most concern was about the debts to the Galata Bankers ⁹.

For purposes of clarification, the Ottoman government had to borrow money from European countries, which started with domestic debt.

In order to solve the income- expenditure balance arising at tax collection and given that there were as yet no financial institution such as banks, the government entered into dialogue with the Galata bankers and began receiving short-term debts from them. These bankers were supplying the debts to the government at higher interest rates, which they had obtained from bankers or banks in Europe at low interest rates, so that important gains on interest were achieved. The budget deficit caused by expenditures on the war and an increase in luxury consumption were increasing steadily at the same time.

Many difficulties were experienced in covering the advance payments obtained form the Galata Bankers¹⁰. Delay of the payments was complicating the situation of the bankers and it was of causing a financial crisis.

In order to borrowed money in 1854, the Ottomans issued bonds.

These bonds were on sale on the

8 Fertekligil, Azmi, ibid, p.11.

9 Stock Exchange and Financial System in the Ottoman Period, Stock Exchange Guide - 1928; (2), Research on the History of the Stock Exchange (2) ISE Publications, Istanbul, 1990, p. 6,7,76.

10 Fertekligil, Azmi, ibid, p.11,12.

Paris, London, Frankfurt and Vienna stock exchanges and represented a major opportunity in opening up to foreign markets. The Galata Stock exchange experienced unexpected vigour when many English and French officers and diplomats relocated to Istanbul because of the Crimean War. Moreover, commodity prices increased and because of this the merchants’s profit became higher.

Thus the debt which was taken on in 1854 influenced Istanbul's social and commercial life and the stock exchange positively. In other words, the Ottomans venture into indebtedness played an important role in the diversification of financial instruments in terms of financial markets and the activities of the stock exchange and the development of the stock exchange ¹¹.

The Ottoman Bank, founded in 1863, was the most important institution for the Ottoman government. It was in charge of acquiring debts from Western countries and in providing necessary services for the payment of capital and interest on principal, arranging foreign payments and exchange businesses, and preventing speculation on foreign currency rates. Further, the bank was authorized to issue paper money.

Since its foundation, the Ottoman

Bank was an indispensable source of strength for the Ottoman Treasury.

While progress was experienced in banking, the first steps were taken for the establishment of a stock exchange and a stock exchange was founded. The exact date of the foundation of this stock exchange can not easily be determined. According to diverse opinions, the stock exchange may have been established in either 1864, 1866 or 1873. The increasing exceptional behaviour demonstrated before and right after the establishment of the stock exchange caused discomfort to grow and restricted the market. The code of rules of the stock exchange matters greatly given that it is the first text enshrining the necessary legal regulations to set up an honest and secure environment, which in itself constituted the weakest point of the Ottoman stock exchange ¹². With this regulation, the Government aimed to control the Galata stock exchange and its employees. Some structural changes were instituted at the stock exchange upon changes to the act realized in 1906. With the new act (The Securities and Currency Exchanges Act), the name of the stock exchange changed to stock exchange of stocks and bonds.

The Ottoman Government's entre to World War I created

11 Fertekligil, Azmi,ibid, p.11,15.

12 Tanör, Reha, The Turkish Capital Market, Volume 1, Parties, Garanti Investment Publications, Special Edition, Beta Publishers, Istanbul, 1999, p.20,24.

deadlock in the country's financial order. The country, which at the best of times could not put its economy and financial situation on a firm footing, was then forced to carry the burden of wartime expenditure. At the beginning, gold was borrowed from Germany in return for meeting war expenses, later the extension of the war hindered the borrowing of gold from Germany. When the Ottoman Empire joined the First World War, the stock exchange directors asked the government to close the exchange down. Far from putting a stop to stock market activity, however, this move merely caused unofficial trading to spiral, spreading out of stock exchange.

4. THE CREATION OF THE REPUBLIC OF TURKEY AND THE STOCK EXCHANGE

During 1908 - 1922, the social and economic chaos caused by the war influenced the stock exchange severely and hampered its operation and development. The Securities and Foreign Exchange Act 1447 which came into force in 1929, provided the possibility for the transition from one stock exchange to many stock exchanges and one of the first signs of a new system was the restrictions in foreign exchange that represented an important level of progress.

The period from the collapse of the Ottoman Empire up to 1929 was a transition period for both The Istanbul Stock Exchange and economic policies. It was a time when foreign companies were nationalised, but otherwise only short term measures were taken in the economic field while the government focused on restructuring the country. The restructuring of the exchange as a currency exchange in 1929, the introduction of exchange controls, the worldwide economic crisis, and etatist policies all combined to exert negative effects on the stock exchange, bringing securities trading to a virtual halt.The stock exchange was insufficiently effective in the area of trading securities ¹³. However, it should also be noted that in those years, as there was no accumulation of capital which would create a stock exchange market in Turkey, there was also no decline, no fall as seen in stock exchange in other countries and companies terms. Nevertheless, the world economic crisis, which coincided with the restructuring effort of the Istanbul Stock Exchange and which lasted for many years, created an environment, which was to impact negatively on the progress of the stock exchange in the near future ¹⁴.

Concern by over the volatility and a rise in exchange rates in 1938, the government decided to close

13 Kazgan, Haydar, The Istanbul Stock Exchange in a Historical Perspective, ibid, p.112,115.

14 Fertekligil, Azmi, ibid, p.154.

down the Istanbul Stock Exchange.

Then it was reopened in Ankara under a new name; the Currency, Stocks and Bonds Exchange. In this way the government viewed the exchange merely as a currency market, attaching no importance to its securities trading function. The exchange was relocated to ‹stanbul, after being closed down in Ankara in 1941. Although Turkey had not entered into World War II, Turkey was influenced negatively by the war from the outset and soon shifted to a war economy footing. The Istanbul Stock Exchange experienced and initiated no important activities in the war years.

The 1950s brought a crucial change for the stock exchange. In 1958 the foreign exchange bottleneck prompted a decision to give the Central Bank responsibilty for exchange transactions, which for years had been the principal function of the stock exchange. As a result of this stock exchange attained its proper function as an institution devoted to trading securities ¹⁵.

The rebirth of the stock exchange started with the Hurriyet bonds and saving bonds in the 1960s. As the saving bonds had full compulsory saving nature and the Hurriyet bonds partial compulsory saving nature, buyers tried to find a way of

converting these into money after a short time. Some people on the market bought them thus reducing the interest rates and due dates.

Later by calculating a certain profit on the same, they sold them to people who wanted to add value to their money. Thus, the resale stock exchange market was created ¹⁶.

5. THE CREATION OF THE ISTANBUL STOCK EXCHANGE (ISE)

With the devaluation experienced in 1970, new balances appeared in the economy. However, as structural economical measures were not taken and due to difficulties in the implementation, the years following 1975, were characterised by a rapidly worsening economic outlook and inflation in particular, increased enormously during the years 1977- 1979. As a result of these difficulties, in 1980 the necessity of implementing new economic measures grew strongly.

24 January 1980 was a milestone for Turkey's economy, for the capital market and the stock exchange.

With the Economical Stability Decisions of January 24 followed by other decisions, important steps had been taken in the transition period from a mixed economy to a liberal economy and the economy became more outward-looking. In this

15 Kazgan, Haydar, The Istanbul Stock Exchange in a Historical Perspective, ibid, p.120.

16 Karsl›, Muharrem, Capital Market Stock Exchange, Securities, Alfa Publishers, Istanbul, 2003, p.37.

context, the following objectives were considered to be of critical importance; a decrease in inflation, reduction of foreign trade deficit by increasing exports, limitation of public spending, reduction of budgetary deficit, transition to implementation of free interest rate, and transition to flexible currency and daily currency rate.

As a part of these policies capital market and stock exchange were reconstructed. These decisions run parallel to the liberal policies emphasising the leading role of private enterprise and integration with international markets prior to 1980. The most notable of the decisions taken by the government were those concerning exchange rates and currency regulations. The legislation relating to the Protection of the Value of Turkish Currency which had imposed severe restrictions on the handling of foreign currency was amended in accordance with the principle that the exchange value of Tukish currency should be protected not by force of law but by economic forces.

The worldwide oil crisis of 1973- 1974, followed by the second oil crisis of 1977-1978 put in motion inflationary pressures. Companies began to have difficulty raising the funds they required from the banking sector. There was no capital market able to meet the long term funding needs of business and

industry, and the stock exchange was unoperational. At this point bankers appeared. These were the stock exchange members defined as

‘banker’ according to the low but whose activities were conducted entirely outside the stock exchange.

The large finance houses began to sell deposit certificates issued by banks as well as corporate bonds.

The main cause of the banker's problem was the high level of inflation seen during that period.

High inflation caused the interest rates on deposits and bonds to decline in value and the sales of the bond and saving notes to the secondary market, which resulted in new bankers appearing in the secondary market ¹⁷.

The first bankers scandal appeared in August 1981. After public confidence had collapsed entirely, the bankers which had secured their borrowing with bonds and deposit certificates found themselves deactivated. Although the bankers scandal was largely a money market affair, investors destroyed confidence in all brokers and their activities on the financial markets. The worst result of this stuation was that it delayed the establishment of the capital market and damaged trust in the government. Meanwhile efforts to revive and restructure the inert stock exchange never got off the ground.

The bankers scandal had

17 Karsl›, Muharrem, ibid, p. 38.

demonsrated the urgency of new capital market legislation to protect small investors. Due to this factor the Capital Market Act 2499 was passed on 30 July 1981. Its primary aim was to ensure the reliable operation of the capital market, and protect the rights and interest of investors. The drafting of the law created the legal framework to overcome this important deficiency.

The aforementioned act was designed to encourage the public to invest their deposits into stocks and securities which would result in an effective and extensive contribution to the progress of the national economy. Accordingly, new resources were to be provided which would benefit development and to which investments could be channelled. Progress was to be realized by promoting investments and the ensuing prosperity extended to the whole of society.

Thus, a financing policy for progress based on stability was to be part and parcel of the general economic policy ¹⁸.

The Capital Market Board established in 1982 is responsible for organising, regulating and supervising the Turkish capital market. The purposes underlying the foundation of the Capital Market Board were to provide for the operation of the market in a reliable, clear and stable way and supply

information to the public, to prepare the appropriate environment for the operation and expansion of the stock exchange, to initiate necessary arrangements, audits and investigations.

The Capital Market Board began preparations for the legal and institutional infrastructure of Turkey’s capital market, and drew up new stock exchange legislation.

On 19 October 1984 the Ministry of State passed a resolution for the establishment of Istanbul Stock Exchange. Istanbul Stock Exchange Regulations which went into force on 18 December 1985 encompass the rules and principles of its operation. The new exchange opened with an official ceremony on the 26 December 1985 in the Ca¤alo¤lu district of Istanbul.

The year 1987 was one in which a budget deficit and higher inflation, savings and activities in other fields of investments declined and the first important speculative movements started on the stock exchange.

While the index increased to 1.330 in August, investors were uncertain and afraid of the privatisations which were about to be implemented and the expansion of supply in the market, and thus started to sell their stocks. This resulted in a fast decrease of prices, which caused the index to decline to 786 in October and 673 in December. This was recognised as the first big crisis

18 Tuncer, Selahattin, The Capital Market in Turkey (Theory and Practice) Okan Publishers,

‹stanbul, 1985, p.20.

experienced at the Istanbul Stock Exchange. In 1988, public deficits and public borrowings increased, inflation continued to grow and the interest rates of the bank deposits entered into a trend of rapid increase. All these negative developments caused the fall of stock prices. Negative effects experienced in the economy continued in to 1989 as well ¹⁹. However, in the second half of the year, in August 1989, the No 32 Law on the Preservation of the Value of Turkish Money, was issued and important measures were taken to open up the capital market and the stock exchange to other markets.

The increasing demand of foreign investors together with other effects also caused the ISE to gain dynamism. In the second half of the year, the index recorded an important increase in the volume and number of transactions.

6. THE DEVELOPMENT OF THE ISTANBUL STOCK EXCHANGE

6.1. The 1990 – 1999 Period and the Development of the ISE

The year 1990 was marked by a number of significant features. A high rate of development occurred despite the growth of inflation within the year. In the middle of the year the Gulf Crisis erupted, which impacted the economy and the stock

market negatively. Privatization and the idea of ‘going public’ gained speed and many companies entered into the stock market. In addition, the purchasing of stocks in the stock market by foreigners also continued in the year 1990. Consequently, the share index exceeded the 5.000 level by demonstrating increases with fast fluctuations despite the Gulf War.

For the economy and the stock market, the year 1991 passed under the influence of the Gulf Crisis and the uncertainties before general elections. The index could not maintain its high level of the first months of the year , thereby declining to the 2.746 level within the course of the year. Under the influence created by the new government after the election, the index exceeded the 4.000 level in the last months of the year. The uncertainty and the fluctuation in the prices of the shares continued in the year 1992 and the index followed a zigzag course below and over 4.000 ²⁰.

On 31 July 1990 the regulation for ‘ISE Exchange and Storing Centers’ was issued. The aim of the regulation was to make the buying and selling transactions by means of the exchange center, to eliminate the difficulties and delays that could take place while the parties were fulfilling the liabilities bearing from their operations, to provide the

19 Fertekligil, Azmi, ibid, p.380.

20 Fertekligil, Azmi, ibid, p.380, 381

confidence to the stock market and fluency in operations. In our country, the publication of the official index for the stock market commenced firstly with the ISE. The basis value of the index used in ISE was determined at 100 as of January, 1986. The levels of the prices which formed over time was calculated and declared according to this measure.

At the very time, when the new legal regulations were being established and implemented, the 1994 crisis arose as a grave misfortune for the stock market at this particular stage in its development. The crisis began together with problems centred on foreign debts and difficulties that had occurred in Turkey’s foreign borrowing. Moreover, the fact that there was insufficient demand for tenders opened for domestic borrowing at the end of 1993 and the fact that rating institutions decreased their credit notes had triggered this crisis. In early 1994 TL devalued by a 50% rate as the US$

and the Central Bank of Turkey lost approximately half of its currency reserves. A significant amount of currency was released from the country. In this period the over night interest rates increased to a level of 1000% the Gross National Product

(GNP) decreased by 6%. The 1994 crisis when inflation rates reached over 100% was eliminated via an agreement with the IMF and the 5 April decisions taken thereafter. In this context the 3 months treasury bills having 400% combined interest annually were issued. All these developments led to rather negative developments on the capital market.

The bond and treasury bill market due dates were shortened, the interest rates increased, and the first serious convulsion was experienced in the stock share market. The market index devalued by nearly 68% and operation volumes decreased by 73% on the basis of dollars ²¹.

In general, 1998 passed under the effects of the financial crisis which had begun in South East Asia in the middle of 1997 and then spread further afield. The influences of the crisis were intense in the Southeast Asia region and in some developing countries such as Russia and Brazil. The fact that Russia, which could not perform the requisite reforms in its transition to the market economy, devalued the Rouble by 33% against the dollar and declared a moratorium, accelerated the tendency of the investors to exit from risky developing markets ²².

21 Karan, Mehmet Baha/Karacabey, Ali Argun, The Place of the Capital Market in the Financial System in Turkey, its Problems and Future, Capital Market Board Publications, Publication No:140, Ankara, 2003, p.109,110,111.

22 Global Capital Markets, ISE Journal Year: 3, No: 9, January, February, March 1999, p.73.

In 1997 the financial crisis spread to Turkey as a result of the devaluation of the Rouble in August, 1998 and the demand related to a restructuring of borrowings. Therefore the increase which was experienced by the ISE in 1997 and continued until the summer months of 1998 gave way to a rapid decline. In fact the stock market was successful in maintaining the index level over the level of 1.5 Dollars despite the fact that foreigner investors had departed the market in May 1998 after providing the adequate yield.

However in August 1998, together with the Russian crisis the index fell from 1.597 to 0.767 in Dollar terms.

Thus, the stock market lost 50% of its value and operation volume fell to 48%. During this crisis foreign capital totaling more than 4.5 billion Dollars which was invested in the domestic borrowing bonds and stock shares left the country. A serious decline occurred in the currency reserves. The foreigner investor came back to the stock market in February 1999 ²³. 6.2. The Financial Crises in 2000 and 2001 and Their Effects

As is known there is a close relationship between the economic structure and the stock market of a country. The more risk and uncertainty declines in the economy,

the more the country’s stock market develops. Our country entered the 21st century with a financial crisis.

The ISE also received its share from this crisis and was affected rather negatively. For this reason while the development of the ISE is being examined in the 2000s, it has been considered necessary to point out the broader economic situation and the monetary policy practiced in the country.

Economic crisis may be defined as strong fluctuations which occur beneath the limitation of a certain change in the prices and amounts which happen in the production and service sector or in the currency market. The economic crisis can be divided into two groups as the real sector crisis and the financial crisis.

The real sector crisis results from declines experienced in the production amount of goods and services markets because of inflation and stagnation or from the increase of unemployment in the labor force market. Financial crisis is defined as the serious economic problems flowing from extreme price fluctuations in the stock and currency markets or as a result of the increase of structural and operational problems in the banking sector ²⁴.

The two crises experienced in Turkey first came into being as a

23 Karan, Mehmet Baha/Karacabey, Ali Argun, ibid, p.112,113,114.

24 Kibritçio¤lu Aykut, Economic Crisis and Governments in Turkey, 1969-2001, New Turkey Journal, Economic Crisis Special Bulletin, 2001, p.1,2.

financial crisis and in a short conflated into an industrial crisis. In 1997, with the effect of the crisis in the Asian countries, an increase in the rate of inflation accelerated in Turkey and parallel to this development, interest rates increased. The effect of the crisis was more intense than in 1998 and the growth rate regressed to 3.8%.

In order to be able to eliminate negative factors in the economy, the “Program related to Inflation Prevention and the Restructuring of the Economy” supported by the IMF came into force as of the beginning of 2000. The program aimed at sustainable development by taking the currency rate and inflation rates under control. The first 6 months of the program’s implementation gave positive results. The annual inflation rate decreased from 70% to 50%, annual interests on state bonds decreased from 120% to 40% and the increase of foreign exchange decreased to the 25% level. In such an environment where the production and investments accelerated, the financial depression which arose in November turned all expectations upside down ²⁵. An impression developed that the decrease in inflation, interest rates and currency rates was artificial and thus the reliability of the economic policies being followed was damaged.

The fact that both public banks and some private banks demanded large amounts of foreign exchange from the market in order to close positions through the end of the year is accepted as the beginning of the financial crisis. One of the most important reasons that the banks demanded foreign exchange was that by taking debts from abroad in foreign currency, they were then able to convert that foreign currency into TL which was subsequently used to buy high yielding, risk-free state bonds and treasury bills. The banks increased their demands for foreign exchange in order to pay their foreign exchange debt with due dates and because of increasing discredit in the market.

In the meantime some banks made efforts to receive short term loans in the domestic market and that the Central Bank sold foreign exchange by intervening with increasing currency rates led to a decrease of the TL amounts present in the market. The decreasing amount of TL gave rise to an increase in interest and to the fact that the market became short termed again. Simultaionusly foreign investors emptied their portfolios, a release of 7 billion Dollars took place from the Central Bank and the usable reserves of the Bank decreased by a significant level.

This development threatened the

25 Aysan Mustafa, The Year 2001Expectations with the Basic Indicators of Economy, Accounting and Finance Journal, No :10, April 2001, p. 6.

sustainability of the economic program supported by the IMF. All these factors decreased the reliance of the Turkish economy in the international market.

Another significant point is that the banking system can be exposed to important changes in a very short time frame. This situation may be observed more easily in periods when loans were intensive and the borrowing portfolio worsened because of the high interest rates.

The fact that the banking systems funds itself on a short term bases resulted in the crisis arising in a shorter time frame. This situation is one of the most important characteristics of the crisis experienced in November 2000 in Turkey ²⁶.

In the crisis period, the simple interest rate of inter-bank, over- night loans in the markets increased three fold and reached 110.8% and 210% on average. The fluctuation in interest and the fast erosion of foreign exchange reserves reflected the degree of pressure and tension in the markets. In order to measure the degree of pressure in the financial markets, a financial pressure index (FBE) was formed from the average of macro economic variants such as interest rate, foreign exchange and official

foreign exchange reserve. The fact that the index exceeds a certain level is acknowledged as crisis. For example, if the value of the index exceeds its average for the standard deviation of 1 or 1.5, it is regarded as the critical level is exceeded. This index may be shown as below ²⁷.

FBE = Change of the Interest in Percentage + Change of the Foreign Currency in Percentage – Change in the Foreign Exchange Reserve in Percentage

The sudden arrival and exit of foreign investors into the markets caused sudden fluctuations in capital movements and played an important role in the formation and development of the crisis. The first negative signals of capital movements were first observed in September 2000 together with the net capital account turning negative.

After the temporary amelioration in October, the first shock was experienced with foreign investors selling financial assets to the value of 5.2 billion Dollars and this yield was transferred abroad. This shock caused the reserves of the Central Bank to erode. Temporary stability was provided in capital movements with the contribution of 2.9 billion Dollars coming from the IMF in December 2000 and January 2001.

In February 2001, due to the sale of

26 Dornbusch Rudiger, A Primer on Emerging Market Prices, NBER Conference on Preventing Currency Crises in Emerging Markets, Paper Submitted to the Conference, January 2001, p.5.

27 Uygur Ercan, Turkey From Crisis to Crisis: November 2000 and February 2001 Crisis, ODTÜ Paper Submitted to the International Economy Congress, September 2001, p.5-6.

financial assets by foreigners and the non renewal of short term credits by foreign banks, significant capital releases were observed. While the foreign based net capital currents were +15.2 billion Dollars in the January-October 2000 period before the crisis, it was – 10.4 billion Dollars in the November 2000-June 2001 period of the crisis. This comparison reveals the size of the shock encountered by the Turkish economy because of net capital releases ²⁸. The flow of the capital outside the country, exerted pressure on both foreign exchange demand and foreign exchange prices and caused interest rates to increase by raising the liquidity requirement to high levels. As of the second half of the year 2000 the uncertainties related to the program increased especially because of the fast growth in the current account deficits.

All of these negative events also impacted on the results obtained from one year operation of the related program. Despite the decrease in the inflation the targeted rates could not be reached, imports increased against exports and record deficits in trade and payments balances were observed. The important increase in the external loans also increased the burden of

paying interest. Although the policy related to the substitution of domestic loans to external loans partially decreased the interests within the country, because of the fact that the inflation did not decrease at the targeted rate, the real interests turned into negative.

And this situation also prepared a basis for the crisis to be experienced in the future ²⁹.

Under the effect of the shocks experienced in the year 2000, the year 2001 started with a new crisis triggered by negative political events on 19 February. The overnight interest rate increased to 6200%, which had never been seen until this period, in the monetary market between the banks on February 21st. In the meantime as a result of the pressure of demand for foreign exchange the currency rates exhibited great fluctuation. The crisis became more intense together with the effect of the major decrease in the stock market level. In the first three months of the year a decrease of 4.5% in the national income, increased three times to 11.8% in the second three months and the highest decrease in national income came into being.

In the year 2002, the severity of the crisis began to marginally decrease and a hope for recovery

28 Boratav Korkut, Capital Movements in the 2000/2001 Crisis, Economy, Business and Finance Journal, Year :16, September 2001, p.7-17.

29 Ertuna Özer, Economic Stability Program and Debt Strategy, Accounting and Finance Journal, No:10, April 2001, p.21.

began to appear. Within the year interest and exchange prices displayed a declining tendency and the index of the stock market showed an increase. Positive signals were observed in the capacity usage rates of manufacturing industry and in growth. Growth in the economy exceeded all estimations and increased 7.8% in the third quarter of the year and reached 6.2% in the first nine months. In the industrial sector the capacity usage rates reached 6.3% in the public sector, 14.2% in the private sector and 11.8% in total in the third quarter of the year. The annual inflation rate decreased to 31.8% at the end of the November. The improvements in economic indicators began to be felt more strongly together with the positive environment created by a new government which came to power in November, 2002 without needing coalition partners. However this situation lasted only for around two months, because of an expectation of a second Iraq war towards the end of December, together with an increase in interest and currency rates and a decrease in the stock market, the situation in the stock market became uncertain again. However it is important to mention that the inflation rate decreased below the level which was targeted and was 29.7% at the end of the year 2002.

One of the most important

reasons for economic uncertainties is when domestic loans reached an extraordinary size within the public expenditures. This situation restricts the transformation of domestic savings into fixed capital investments and decreases the growth potential of the national economy. Further, the high real interest paid on domestic loan instruments contributes to the capital group obtaining income, thus disturbing national income distribution. The fast increase in the amounts of interest paid to domestic loans began to be felt after the year 1993.

While the ratio of the payments of the domestic loan interests to gross national product (GNP) was 2% in the early 1990s, parallel to the increasing borrowing this ratio increased to 22% in 2001. The ratio of the domestic borrowing stock to the GNP increased to 68% at the end of the year 2001 and as of June 2002 domestic loan interest payments reached to 120% of the tax incomes ³⁰.

As of the end of November 2002 the total borrowing of Turkey reached 150.1 billion Dollars: 94.6 billion Dollar of which was domestic and 55.5 billion Dollar of which was external. The fact that budgetary deficits were financed mainly by means of domestic borrowing led to such high increases in the loans. The high domestic loan problem can be solved in two ways. Firstly, by

30 Voyvoda Ebru , Yeldan Erinç, Alternative Harmonization Strategies for the Turkish Economy post Crisis, Economy, Business and Finance Journal, Year : 17, November 2002, p.18-28.

increasing the income of the public, limiting their expenditures and decreasing the loan stock. Secondly, by decreasing the cost of the real loaning and preventing the growth of the domestic loans parallel to interest.

As is widely known, the general evaluation of an economic crisis is connected to the existence of specific indicators. However, the issue of

‘when’ and ‘how’ the crisis will occur can not be known with any certainty.

According to this opinion, ‘the crisis can only be observed when it bursts out. These crisis indicators can be listed as follows ³¹.

1- Short Term Foreign Loan / Foreign Exchange Reserve

2- Current Account Deficit / Foreign Exchange Reserve

3- Current Account Deficit / Gross Domestic Product

4- Total or Short Term Foreign Debt / Exportation

5- Open Position for The Banking Sector / Foreign Exchange Reserve 6- Bank Credit / Foreign Exchange Reserve

7- M2 / Foreign Exchange Reserve 8- Valuation of the Local Currency Unit

9- Fluctuation in the Capital Movement

10-Fluctuation in the Short Term Foreign Exchange

The balance between the inflation, interests, foreign exchanges and wages are of great importance in market economies. A disturbance in the balance leads to economic and social crisis and the risks arising during counter-inflation struggles are reflected in interest rates and the establishment of the balances become more difficult. The view that targeting can be performed on the basis of only one of two related indicators such as the inflation rate and currency peg can be regarded as inadequate.

Programs predicated on the basis of such indicators, for example, concerning the fight with inflation, result in failure and crisis as is the case in Turkey. The reorganization of the programs to include balance targeting or the application of the programs which take balance targeting into consideration will be able to secure more positive results. Balance targeting is the establishment of the balance between inflation, interests, currencies and wages and its stabilization. The achievement of this target is mainly dependent on the provision of sufficient confidence in the economy and national conciliation

32.

If a crisis is handled in view of the developmental rates of the countries, it can be seen that the reasons and effects for crisis in the industrialized countries and in the

31 Uygur Ercan, ibid, p.12-13.

32 Ertuna Özer, Balance, Trust and Zero Inflation Target, Accounting and Finance Journal, No:12, October 2001, p.22.

developing countries are significantly different. Since financial markets in developing countries are small scale, even medium scale investors from developed countries may create great price fluctuations when they enter and exit from these developing markets. The characteristic common to developing countries is the fact that financial crises result from the panic that has arisen from the desire of investors and creditors to depart the market at the same time. Macro economic policies, (especially monetary and interest rate policies), by providing cause for confidence in the market and stopping the flow of money outside the country can be viewed as preventative measures to be taken at the national level against any crisis in general terms ³³ . Solutions should be sought in the increase of the production, employment, rate of capacity usage, exportation and national income.

6.3. The Monetary Policy Applied Between the Years 2001 – 2003

Within the framework of banking sector restructuring that occurred in 2001, together with the provision of resources to the banks under the control of the Savings Deposit Insurance Fund (SDIF) these banks

stopped overnight loans. Therefore, the Central Bank withdrew the extra liquidity of banks with reverse repo operations as a guarantee for this liquidity not to be translated into inflation and became the unique determiner of the overnight interest rate. In 2002, open market operations net reverse repo balance for the Central Bank continued to increase and reached an important level compared to the monetary base which is the indicator of liquidity. The volume of repo which began the year at 1 quadrillion TL increased to 9,6 quadrillion TL by the end of the year.

For its part, the Central Bank, determined short term interest rates by taking inflation expectations into consideration. Generally, in periods when regression was recorded in inflation expectations, the Bank decreased interest rates in cases when it did not observe other risk factors. It did not change interest levels in periods when uncertainty increased because of domestic and international political developments ³⁴.

The monetary policy of the Central Bank focused on the objective of price stability in 2003 as in 2002 and declared that the determination of short term interest rates would be performed only for reaching the

33 Akyüz Y›lmaz, Cornford Andrew, Capital Flows to Developing Countries and the Reform of the International Financial System,United Nations Conference on Trade and Development, No:

143, Geneva, November 1999, p.15-17.

34 Turkish Economy, Turkish Capital Market 2002, Developments in the Capital Market - Investor Analysis – Institutional and Financial Data of the Intermediary Institutions, Publications of the Association of Capital Market Intermediary Institutions of Turkey, Publication No: 11, ‹stanbul, 2002, p.12.

targeted inflation rate. For this reason the Central Bank followed a careful interest policy in order to reach to the inflation target of 2003 considering both international and national developments. By responding to the liquidity demand arising in cases when uncertainty increased, the Central Bank demonstrated a trust-worthy approach related to the protection of sustainability in the monetary markets.

Within the year 2003, the Central Bank decreased short term interest rates six times depending on the positive developments displayed in the macroeconomic indicators.

While the Bank decreased the overnight and weekly borrowing interest rates from 29% to 26% with the quoted discount it performed on

15th October lastly within the year, decreased the overnight interest rates for giving loans from 35% to 31%. As a result of these developments the Central Bank decreased short term interest rates to 26% at the end of the year 2003 which had been 44% at the end of the year 2002 ³⁵.

In terms of the currency policy, a further continuation of the fluctuating currency regime which had started in February 2001 was forecast also for 2003. In line with this concept, the Central Bank announced that it would conduct transparent currency purchase tenders to counter extreme fluctuations in currency rates in such a way as to lead to an increase in currency reserves ³⁶.

35 Banking Sector Evaluation Report, Banking Regulation and Supervision Agency, February 2004, p.28.

36 Banking Sector Evaluation Report, ibid, p.28.

Table 1 : Interest Rates, Currency and Inflation 2002 2003

December March June September December Interest rate

(annual compound)*

O/n 55 55 46 38 26

Public sheets 50 58 47 36 28

Currency

TL/(dollar) 13 27 -10 -16 -15

TL/(euro) 34 59 3 -1 2

Inflation (Whole

sale price index) 31 35 30 19 14

Source : BRSA.(Banking Regulation and Supervision Agency

While the December 2002 overnight interest rates of 55%

remained at the same level in March 2003, it started to decline in June 2003 to 46%, to 38% in September and to 26% in December. A similar situation was experienced in the interest rates of the state domestic borrowing bonds. Interest rates which were 50% in December 2002, increased to 58% in March 2003 and began to decline as of June and decreased to 47%, 36% and 28%

respectively. The fact that interest rates remained unchanged or increased during March is closely related to the fact that the inflation rate increased to 35% in March while it was 31% in December. As of June parallel to the decrease of the inflation rate to 30%, 19% and 14%

respectively, decreases were also observed in interest rates. Besides inflation, financial discipline, portfo- lio preferences, capital movements and high foreign currency supply are other factors effective in the deter- mination of interest rates. Despite not being reflected in the table, aver- age deposit rates which were 45- 50% at the end of 2002, regressed to levels of 25-30% by decreasing 15-20 points by the end of December.

While in December 2002 TL was devalued 13% against the Dollar, this devaluation increased to 27% in March 2003. In the same period, devaluation against the Euro increased from 34% to 59%. This sit- uation changed as of April and TL started to gain value against both foreign exchanges. At the end of

June, while TL gained 10% value against the Dollar, its loss in value against the Euro decreased to only 3%. In September the gain value of TL against Dollar was 16%, against Euro was 1%. At the end of 2003 TL had gained 15% in value against the Dollar and lost 2% in value against the Euro.

Due to the strong foreign exchange supply, the Central Bank created additional demand for for- eign exchange by means of foreign exchange purchasing tenders and direct interventions. The TL liquidity created via the purchasing of foreign exchange was realized by means of the open market operations or repo purchasing tenders. Therefore no fluctuation were allowed in the short term interest rates which were deter- mined in compliance with price sta- bility. The Central Bank stated that the aim of the intervention in foreign exchange was not in determining the level of currencies but was con- cerned with the prevention of excess fluctuation in the currencies and increasing the reserves without gen- erating conflict with the fluctuating currency policy. The Central Bank declared that the fluctuating curren- cy policy was to be continued and that care was given to the fact the currencies were formed under mar- ket conditions with the minimum level of intervention. The Central Bank purchased foreign exchange at the record level of 9.9 billion Dollars in 2003 and its foreign exchange reserves increased to 7 billion Dollars. Almost all of this increase

occurred as a result of foreign exchange purchasing tenders in the second half of the year. The foreign exchange reserve which was 26,7 billion Dollars in 2002 reached 33,6 billion Dollars in the end of the year.

The net foreign exchange position improved with an increase from – 2.2 billion Dollars to 0,4 billion Dollars. Therefore the improvement in the net foreign exchange position of the Central Bank exceeded 10 bil- lion Dollars in the 2002-2003 period ³⁷. 6.4 Developments in the ISE between 2001 – 2003

Stock markets have two main functions. One of these involves accelerating economic development by providing long term and low cost funds for entrepreneurs and the other is to help the distribution of national income to the public in a more just way. The prerequisite for the stock markets to perform these functions in the best possible way is the establishment and operation of the free market order with all its institutions and mechanisms. The stage which comes next is setting in place the process for providing the stock markets with a healthy and fruitful structure ³⁸.

The tendency towards a decrease in the stock share of ISE, which

started with the Iraq war continued during the first half of the year 2003.

Both prices and operation volume increased in the stock share market due to positive developments in the economy and the regression in inter- est rates in the second half of the year. While the average of the index in December which increased fast was at the level of 15.045 points, the average of operation volume increased to the level of 1.138 tril- lion TL ³⁹. At the ISE, two primary public offerings and 4 secondary public offerings were executed in the year 2003.

Due to the influence of negative events the financial markets were reduced in size in 2001 and foreign investors abstained from making investments. Under this abstention the operation volume of the foreign investors increased only to a level of 6% in ISE during 2002. This ratio increased to the 34,6% level under the influence of positive develop- ments in 2003 as for the previous year. While purchasing operations of 6,3 billion $ by foreign banks and intermediaries or individual investors in 2001, this number reached 6,4 billion $ and 9,2 billion $ respective- ly in 2002 and 2003. In the same way, purchasing operations which totaled 5,8 billion Dollars in 2001,

37 Turkey’s Economy and Turkish Banking System in the year 2003, Our Banks 2003, Publications of the Banks Association of Turkey, February 2004, p.16.

38 The Place of the Stock Market in the Economy and their Reconfigurations in Globalization, the search for a Turkish model, Publications of the Association of Capital Market Intermediary Institutions of Turkey, Publication No: 12, ‹stanbul, April 2003, p.5.

39 Turkey’s Economy and Turkish Banking System in the year 2003, ibid, p.29.

In 2000, with the effect of the trust to the economic program sup- ported by IMF, the transaction vol- ume at the ISE Stock Market dou- bled its ascension and reached to 181 billion $ in respect to 1999. But, because of the unexpected negative effects of the November 2001 and February 2001 crisis, the transaction volume decreased by %56 to 79 bil- lion $ in 2001. This recession contin- ued in 2002 and the transaction vol- ume decreased to 70 billion $. The year 2003 began with tension over the Iraq war and saw a tendency towards a fall in the stock exchange

that continued until the second half of the year.The transaction volume increased by %42 and reached to 99,4 billion $ due to the ending of the war at the second half of the year in March, the positive improve- ments in the economy and the recede on the interest rates. ISE index increased to %111 in Dollar basis at the end of the year 2003.

b) Market Value of Publicly Traded Companies

One of the basic economic indi- cators is the ratio of the market value of traded companies /GDP.

reached 6,4 billion $ in 2002 and 8,2 billion $ in 2003. The foreign investors which were in the position of net purchaser in 2001 and net supplier in 2002 became net pur- chaser in 2003 again. As per the clo- sure prices of the end of the year, the industrial index increased at a level of 47,9% and the financial

index increased to the level of 15,5%

when compared to the closure prices of the previous year ⁴⁰.

a) Index of Stocks and Transaction Volume

The chart below contains data in US Dollars as of 1999 related to the Istanbul Stock Exchange (ISE) index and transaction volume.

40 2003 Annual Report, Central Bank of the Turkish Republic, Ankara, 2003, p.130.

Graphic 1 : ISE Index (as of $) and Transaction Volume (Million $).

Source : ISE (Istanbul Stock Exchange).

The total market value of compa- nies being traded on the ISE increased under the influence of the public and rises in value. However, the total market value has displayed a decrease, due to the financial crisis in 2000 and 2001, the decrease in the indices of ISE as a result of the crisis, a limited number of public offerings and due to the stocks,

taken out from the ISE market. On the other hand, in 2003 the propor- tion of the market value compared to the Gross Domestic Product again entered an upward trend.

c) Number of Companies Traded on The Stock Exchange

The chart below shows compa- nies traded on the stock exchange, segmented according to years.

The number of companies quot- ed on the stock exchange displayed a rapid increase until 2000.

However, after multiple public offer- ings in 2000, it started to regress.

Among 35 public offerings in 2000, 1 company has been started to be quoted, while 6 companies have been taken out of the stock exchange, so that the number of companies traded on the stock exchange increased by 30 to be summed up to 315 companies. In 2001, however 1 company was pub- licly offered and another 6 compa- nies have been taken out of quoted on, so that the total number of com-

panies traded on the stock exchange decreased to 310. In 2002, the num- ber of companies decreased to 288.

In 2002, 4 companies were publicly offered. On the other hand, due to the fact that 13 companies started to be traded on regional markets and 14 companies were taken out of quoted on, the total number of pub- licly traded companies decreased by 22. In 2003 however, 2 public offer- ings were realized, the stocks of another 2 companies started to be quoted again. However, as 7 compa- nies have been removed from quota- tion, the total number of companies traded has decreased to 285 ⁴¹.

41 Turkish Capital Market Development, Strategy, Targets, Publications of the Association of Capital Market Intermediary Institutions of Turkey, Publication No: 16, Istanbul, May 2004, p.4,5.

Table 2 : Market Value of Publicly Traded Companies

1990 1995 2000 2001 2002 2003 Trillion TL 55 1.265 46.692 68.63 56.370 96.72 Market / Value/GDP 14.1% 16.3% 37.5% 38.5% 20.4% 26.7%

Source : ISE (Istanbul Stock Exchange).

1990 1995 2000 2001 2002 2003

Number of firms 110 205 315 310 288 285

Source : ISE (Istanbul Stock Exchange).

7. OPERATION OF THE ISTANBUL STOCK EXCHANGE AND EVALUATIONS

7.1. ISE Practices in 2004 and 2005 One of the important develop- ment is that a derivatives market was established in 2005. This is the market for derivative securities, including futures contracts, forward contracts, options and swaps.

Derivatives are securities whose val- ues of other more basic variables.

These include the value of linked assets, for example ordinary shares, bonds, currencies, and commodities.

Derivative securities are being used in order to avert or reduce financial risk ⁴².

In general, 2005 was a year of stable macro economical balances.

The inflation rate decreased to the lowest level of recent years, foreign exchange rates moved horizontally, important progress was achieved in

privatisation and the Gross National Product continued the consistent increase of the last few years. By contrast, the foreign trade deficit and the current account deficit have increased. Positive developments in macro economic indicators have also affected the stock exchange.

Turkey's ability to benefit from the global liquidity addressing emerging countries has also contributed to the 2005 performance of the stock exchange.

a) The ISE National - 100 Index and Transaction Volume

The positive atmosphere, which started in the markets in 2003 increasingly continued in 2004 and 2005. The trend of decrease in the inflation and interest rate has affect- ed positively the stock exchange so that the ISE-National 100 index and transactions volume increased rapid- ly within the year. This situation can also be seen in the graph below.

42 Chambers, Nurgül, Derivatives Markets, Avc›ol Publishers, ‹stanbul, 1998, p.1.

As shown in the graph, the index entered 2005 on an upward trend.

This trend which lasted for the first few months, began to display a horizontal movement in April and May. From June onwards, it is possible to see that the index had increased again. The speed of this increase continued to grow in the following months and 2005 closed with a high index reaching the 39.778 level. Positive expectations surrounding accession negotiations

between Turkey and the European Community accelerated the upward trend of the index in September.

When it became apparent that full accession negotiations were to start in October, increases climbed to record levels. The ISE-National 100 index has shown increases of 59% in YTL terms and 61% in USD terms in 2005 ⁴³.

b) Market Value

The graph below shows the market values per years as of 1986.

43 Turkish Capital Market 2005, Publications of the Association of Capital Market Intermediary Institutions of Turkey, 2005, p.46.

Graphic 2 : ISO-100 Index and transaction volume.

Source : Turkish Capital Market 2005, Publication of the Association of Capital Market Intermediary Institutions of Turkey, p.45.

When analysing the graph, it is possible to see that the market value reached the highest level in the history of the stock exchange in 2005. While the total market value was 98 billion Dollars in 2004, it increased by 65% in 2005 amounting to 163 billion Dollars.

This increase is also due to the contribution of 11 public offerings realized in 2005.

c) Transaction Volume

The graph below shows average daily stock transaction volume as of years, 1986-2005.

Graphic 3: Market Value.

Source : Turkish Capital Market 2005, Publication of the Association of Capital Market Intermediary Institutions of Turkey, p.47.

Graphic 4: Dayl Stock Transaction Volume..

Source : Turkish Capital Market 2005, Publication of the Association of Capital Market Intermediary Institutions of Turkey, p.47.

It is possible to discern that stock transaction volume exhibited a trend of slow but stable increase during the years 1990-1999. In 2002 however, the transaction volume doubled with a sudden increase in comparison to the previous year and later declined with a sharp decrease again to the levels of 1990. This decrease was, to a major extent, caused by the financial crisis experienced in November 2000.

In 2000, the daily average transaction volume of 740 million Dollars decreased to levels of 250 - 300 million Dollars in 2001 and 2002. However, in 2003, the daily average transaction volume started to increase due to positive developments in the markets. In 2004, it reached 600 million Dollars.

The increase continued in 2005 and in comparison to year 2004, the daily average transaction volume increased by 34% in Dollars terms and reached 794 million Dollars.

Thus, the level of 740 million Dollars achieved was exceeded in 2000 ⁴⁴.

d) Number of Companies Traded and Public Offerings

12 New public offerings were made at the ISE in 2004 so that the total number of companies quoted has increased to 297. In 2005, 11 public offerings were undertaken, 3 companies were taken out of quotation and 1 company has started to be quoted again. Thus, the total number of quoted companies has increased to 297.

7.2. Comparison of the ISE with the Stock Exchanges of Other Countries

In order to better present the situation and progress of the ISE, it has been considered useful to compare the stock exchanges of some EU member states with the stock exchanges of emerging countries.

a) Comparison of Index Yields with Other Countries' Stock Exchanges The graph below shows stock index yields in US $ segmented according to some member countries of the EU and developing

44 Turkish Capital Market 2005, ibid, p.48.