Disputes between Prime Minister Tansu ?iller (1993- ) and the Central Bank governor undermined confidence in the government. The prime minister insisted on monetizing the fiscal deficit (selling government debt instruments to the Central Bank) rather than acceding to the Central Bank's proposal to issue more public debt in the form of government securities. The Central Bank governor resigned in August 1993 over this issue. In January 1994, international credit agencies downgraded Turkey's debt to below investment grade. At that time, a second Central Bank governor resigned.

Mounting concern over the disarray in economic policy was reflected in an accelerated "dollarization" of the economy as residents switched domestic assets into foreign-currency deposits to protect their investments. By the end of 1994, about 50 percent of the total deposit base was held in the form of foreign-currency deposits, up from 1 percent in 1993. The downgrading by credit-rating agencies and a lack of confidence in the government's budget deficit target of 14 percent of GDP for 1994 triggered large-scale capital flight and the collapse of the exchange rate. The government had to intervene by selling its foreign-currency reserves to staunch the decline of the Turkish lira. As a result, reserves fell from US$6.3 billion at the end of 1993 to US$3 billion by the end of March 1994. Before the end of April, when the government was forced to announce a long-overdue austerity program following the March 1994 local elections, the lira had plummeted by 76 percent from the end of 1993 to TL41,000 against the United States dollar.

The package of measures announced by the government on April 5, 1994, was also submitted to the IMF as part of its request for a US$740 million standby facility beginning in July 1994. Measures included a sharp increase in prices the public-sector enterprises would charge the public, decreases in budgetary expenditures, a commitment to raise taxes, and a pledge to accelerate privatization of state economic enterprises (SEEs). Some observers questioned the credibility of these measures, given that the tax measures translated into a revenue increase equivalent to 4 percent of GDP and the expenditure cuts were equivalent to 6 percent of GDP.

The government actually succeeded in generating a small surplus in the budget during the second quarter of 1994, mainly as a result of higher taxes, after running a deficit of 17 percent of GDP in the first quarter. The slowdown in government spending, a sharp loss in business confidence, and the resulting decline in economic activity reduced tax revenues, however. The fiscal crisis resulted in a decline in real GDP of 5 percent in 1994 after the economy had grown briskly in 1992 and 1993. Real wages also fell in 1994: average nominal wage increases of 65 percent were about 20 percent below the rate of consumer price inflation.

Analysts pointed out that despite the fragility of the macroeconomic adjustment process and the susceptibility of fiscal policy to political pressures, the government continued to be subject to market checks and balances. Combined with a stronger private sector, particularly on the export front, the economy was expected to bounce back to a pattern of faster growth.