Obstacles may worsen for Russian and Turkish financial reformers, Italian paper says

Financial reformers in Turkey and Russia have been unable to address some key problems and may face greater difficulties in the future, a working paper from the Bank of Italy argues.

In The financial systems in Russia and Turkey: recent developments and challenges, Simone Auer, Emidio Cocozza and Andrea Colabella say reform efforts in both countries led to "unquestionable improvements" in their financial systems. But while reformers did score some major successes, they say, financial markets in Turkey and Russia deepened and diversified far more slowly than those in other emerging markets.

Failures in both countries were partly due to "a highly volatile economic environment and deep-seated institutional and structural weaknesses". But the weaknesses were different in the two countries, the paper says.

Russia suffered from a "high degree of dependence on commodities and low economic diversification", with the economy's volatility stemming largely from changes in world hydrocarbon prices.

Turkey suffered from a low and declining saving rate. This is "one of the key factors underlying macroeconomic volatility", the paper says, as the Turkish economy is "largely dependent on capital inflows and the evolution of external financing conditions". In both countries, the volatility makes it hard for potential international investors to gauge risks and returns and to "provide long-term financing at a reasonable premium".

The paper notes that politics was also a factor. The aftermath of the financial crises in the late 1990s and early 2000s led to "more disciplined economic policies" and structural reforms. But there has been "a slide in policy discipline, particularly in the aftermath of the last global financial crisis, and reform fatigue has gradually taken hold".

Turkey and Russia still have inadequate enforcement of property rights and contracts, which hinders firms' access to external finance. "A lack of trust in the financial system" means there is a high preference for dollar-denominated assets and short-term instruments, "especially during turbulent periods". Neither country has a "broad and diversified domestic investor base", says the paper.

Failure to undertake deeper reforms has led to the "build-up of key vulnerabilities" in both countries, the authors say. These vulnerabilities "have come to the fore more recently in the context of a less supportive external environment". Carrying on with financial reforms could become "even more difficult" in the current "less supportive, if not adverse, conditions", they argue.

The paper also includes two detailed appendices on the Russian and Turkish financial systems.