Monday, October 5, 2009

Daily Hurriyet Column: Financial Center dreaming

The unedited version of my third column covering The Meetings is below; you can read the final version at the Daily News web site.

And some confessions: While writing the column, I called up my friend Kaan Sariaydin to get his opinions on the issue as a market participant. It turns out that he has spent a lot of time thinking about it, and over the course of the next hour, he shared such valuable input with me that I offered to have a joint article. All the technical details in the second part of the article are from Kaan, and due to space constraints, I could use only a small portion of what he gave me. I also have to thank the editor-in-chief of Hurriyet Daily News, David Judson, for suggesting I write on this. My journalistic instincts are nowhere near as developed as his, as I had no idea I would get so many congratulatory remarks for the article.

BTW, the news items in the Turkish papers that appeared on Monday and Tuesday confirmed my gut feeling that the valiant efforts of the Turkish authorities would not be taken seriously by the attendees. Istanbul traffic was humorously cited as the biggest obstacle to Istanbul's, or rather the Turkish government's, aspirations; a joke that came up during my interview with Martin Wolf as well.

Economics tsar Babacan disclosed the strategy and action plan (SAP) to make a financial center out of Istanbul to great fanfare on Friday. We would like to dissect the plan on its preparation and content.

It is obvious that a lot of work has gone into the plan, for which the State Planning Organization (SPO) deserves praise. Seven broad areas have been determined: Enhancing legal infrastructure, increasing financial products and services, developing a simple and effective tax system, improving the regulatory and supervisory framework, augmenting infrastructure and boosting human capital. An organizational structure to monitor this workplan as well as to promote the city has been added in as well. All in all, 23 priorities have been revealed, along with 71 action plans to carry out these priorities.

We have yet to figure out how the seven main areas were determined. While they all make sense, it seems too much like a laundry list to us. In essence, the SAP has fallen into the Washington consensus trap: The World Bank and IMF had long been advocating a long list of reforms without identifying the binding constraints. Realization of this mistake has led to the Investment Climate Assessment framework in the Bank and focused conditionality in the Fund.

As for the actual determination of the priorities and actions, as one of us has been involved in a couple of such exercises with SPO, we are not that sure that, despite the best of intentions, they reflect responses to binding constraints. In such work groups, it is usually the loudest, not the wisest, who gets her ideas in. Another issue is benchmarking: Unless you are planning to tap into Martian or lunar colony funds, you’ll be competing with other centers, so you need to know how you compare to the competition. We believe this to be one of the fundamental deficiencies of the report. Without knowing binding constraints and relative performance, you wouldn’t know what you are getting for your buck.

But it is really the content that worries us. For one thing, to have a finance center, you need, well, financing. To start, the institutional investor base and institutional funds are still marginal in Turkey. With public placement low and most of what is out there grabbed by foreigners, there is not much of a domestic participation in the game. This leaves domestic financial institutions with very low placing power. The low free floating rate and corporate governance problems limit M&A activity, one of the symptoms of a well-functioning capitalist market. Despite great efforts from the ISE, there is no small or mid-cap market. Without much of project financing and venture capital companies, there is no real venture capital.

When you get into the nitty gritty stuff, it gets uglier. Just to give a few examples, it is impossible to hedge your delta by short-selling in the current set-up. Collateral usage of third parties is prohibited. The market maker is banned from offering a lower price to a big customer, and as a result, all the big deals go through New York or London. We could go on and on…

Does the SAP address these issues? Yes and no. The government could argue that one or more of the 23 priorities or the 71 action plans touch on these issues. For example, when you get the bottom of it, the binding constraints in the selective examples we have given seem to be concentrated in the institutional, legal and regulatory frameworks. So the government could point to the relevant sections of the report, some of which could get part of the job done, at least in theory, while others are just too vague to mean anything.

Of course, we could be wrong, but all this reeks of another case of opium to the masses.

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