We are not accustomed to recessionary periods. No one has yet completely acknowledged that nothing will be the same. Everyone is waiting with hope to say "it was a storm and it ended. We are just soaked a little bit". But, they fail to notice the changes happening in the meanwhile. See, for instance, Turkish lira is appreciating nowadays. Turkish lira used to appreciate as a result of the confidence in Turkey's economy. As the credibility of government policies increased, Turkish lira appreciated against foreign currencies. Nowadays, Turkish lira is also appreciating. So, what happens now? Is the confidence in the policies implemented by the government rises? No, from where did you get that impression? This would only be an oxymoron. Can we talk about the credibility of a policy that is not existent? Cause of the recent appreciation of the Turkish lira is the rise in unemployment. Let us see how.

We are still at the same point we referred to in the commentaries you read at this column in 2008 reading "we had better not expect large movements in exchange rate". Back then, we were entering a period where the increasing demand for foreign exchange exaggerated the existing supply of foreign exchange. As you see, the impacts are more prominent now. We are going through a period of economic decline and recession that we are not accustomed to. Let us stop calling this period a crisis. We are in no way in a condition that will be over and done with overnight. We are in a period we will live in for a certain period along with the fall in production volume and rise in unemployment. This is the foreseeable future for now. Then, it is wise to revise the framework of our conception. So, under the current conditions, what happens to the exchange rates? Let us begin with this.

What determines exchange rates is the foreign currency supply and demand. In the past, increase in foreign exchange supply was the main determinant of the appreciation. Now, the main determinant is the demand for foreign exchange. If we cannot acknowledge the difference, we cannot give sense of the process we are in. We can make wrong diagnosis. Wrong diagnosis leads to wrong treatment. Wrong treatment results in losing the patient. Let us explain ourselves with such emotions and thoughts.

What happened when following the 2001 crisis, a solid program framework and the political determination to vitalize that framework was put forth? First, residents that desperately switched to foreign exchange led to a rise in foreign exchange supply. Then, foreign investors that had confidence in the program stepped in. Foreigners proceeded on the path opened by resident people.  Turkish lira immediately became a desired currency. Turkish lira began to appreciate along with the rise in foreign exchange supply in line with the rise in confidence. To put it differently, foreign currencies started to depreciate in Turkey. Currently, the determinant factor is the rise in the demand for foreign exchange. Turkey's exports deteriorate more month by month. That domestic demand tightens throughout the world also affects Turkey. It is not possible not to get affected by the developments in the world we are an integrated part of. Therefore, production level deteriorates. The deterioration in production level also leads to a tightening in foreign exchange demand. Moreover, as domestic consumption falls down, demand for imported consumer goods also decrease. Along with this, foreign exchange demand directed to consumer goods imports decrease. As the number of the people willing to spend their holiday in Turkey diminishes, demand for foreign exchange decreases further. And it goes on like this.

What are the outcomes of the fall in foreign exchange demand considering the exchange rates? First, existing stock of foreign exchange within the country starts to be more than necessary. In the face of the fall in foreign exchange demand, existing foreign exchange stock starts to give a surplus. Second, in countries like Turkey, as long as foreign exchange flows in even at significantly low amounts, the fall in foreign exchange demand leads to rapid appreciation of domestic currency. Let us see this in this sense: If in the past, 500 units of rise in foreign exchange supply was necessary for 1% appreciation, today 5 units of rise is sufficient. Of course, this is just an example.

So, what does the appreciation of Turkish lira cause? In the past, appreciated Turkish lira coupled with the contribution of the fund abundance, led to a competition within the Turkish industry for improving productivity. Back then, there existed a set of facilities to realize the competition for improving productivity. "Creative destruction" process could work thanks to those facilities. There was destruction; but those who cannot keep up with the time was replaced with those who can. Now, the set of opportunities has been narrowing rapidly. Capital is not as abundant as before. World markets are not dynamic anymore. Domestic market operates only if there is doping. In this new world, appreciation of Turkish lira can only cause an "uncreative destruction". And this is exactly what is to happen nowadays. In such an environment, production capacity is faced with the risk of collapsing.

What must be done to protect the production capacity? Turkey has to return to the 1980s where incentives for exports and foreign exchange generating transactions were provided. This is the first thing to do. Second, in the current milieu, either foreign exchange liberalization or fund flow liberalization must be discussed again. Appreciation of the Turkish lira is not an exit sign. And this is the third point.

It is a virtue to acknowledge the change.

What should we do to wake up the administrators from woolgathering? Shall we ring bells?

This commentary was published in Referans daily on 28.07.2009