We started the week saying "Cause of valuable Turkish Lira is the rise in unemployment". Today, let us proceed saying "Valuable Turkish lira pushes up unemployment further". Let us try to understand the dynamics of the economic recession period we are faced with considering Turkey and similar countries so that we can implement measures.
Such is life. It makes the most senseless argument of yesterday might root in your mouth. Time changes, concepts change meaning. You remember those proudly repeating the empty "high interest, low exchange rate policy" talks just yesterday. Then, they started the empty talks reading "valuable Turkish lira damages the industrial sector". In the meanwhile, Turkey has become automotive exporter. What do you say? Now, the same talks are presented in this column. Time has changed. What was wrong yesterday is not so anymore. Then, we must say what has to be said: Valuable Turkish lira pushes up unemployment further. It is time to seek precautionary measures.
Let us summarize what we said do far: The current economic recession period did not at all look like old crisis periods. Back then, exchange rate went up like a lamb, interest rates boomed up and inflation rate rose steeply. However, this is not the case today. Interest rate goes down; exchange rates decreases and inflation hits the bottom. What is going on? Will not the crisis progress as we are used to see? No, it will not. This is a recessionary period. It does not resemble the previous crisis. Here adjustment is not ensured through prices but through quantities. Therefore, production levels go down and unemployment rate reaches unprecedented levels.
TEPAV report published at the beginning of the year said "the crisis will affect Turkey through four channels". Good news is; there is a fifth channel. First was the tightening of foreign demand. Second was inability of foreign credit channel to fulfill its function. Third was that domestic credit channel did not operate for the corporate sector. Fourth, domestic confidence decreased and domestic demand evaporated. All has happened. And yet there is no sustainable recovery in any of the channels. Under these circumstances, a fifth channel became evident. Due to the fall in demand for foreign exchange, Turkish lira began to appreciate. In the past, Turkish lira appreciated due to the increase in foreign exchange supply. Currently, there is no strong capital inflow. Despite, figures as of May 2009 indicate that there exists a capital outflow. Inflow in net errors and omissions does not compensate for the outflow. (Let us sometime take a look at this net errors and omissions issue with the lens of decreasing foreign exchange demand.) But in spite of this, Turkish lira appreciates. A short quantity of temporary capital inflow leads to appreciation of Turkish lira (Figure 1).
In the past, foreign investors waited for residents to switch to Turkish lira to enter the market and take a position. It appears that we will see foreign capital inflows that feed themselves. The investor will come and convert a small amount of foreign exchange into Turkish lira. As there is no significant demand for foreign exchange, he will receive gradually lower amounts of Turkish lira. He will invest in TL denominated instruments. When the investment is due, he will get the TL denominated interest plus the gains from exchange rate appreciation and leave the market. In the meanwhile, Turkish lira will appreciate.
Figure 1. Net capital inflows and exchange rate movements
What will happen in the meanwhile? In the meanwhile, Turkish firms will have difficulties in competition over price in the export markets. There already exists a foreign demand problem. Now, it will be intensified. Why is this so? Because, the FED cut down interest rates to zero level. Countries like Turkey will be affected more by the weakening fund flows. In the past, firms could compete through increases in productivity. Let us list the missing items today. Today, capital is not as abundant as before. It is now harder to access capital for new investments. Is not that weird? Interest rate is zero; but there exists no capital to invest. This is the impact of the fall in risk appetite. Second, there is no strong foreign demand creating incentive to increase productivity and rapidly change position. In the ongoing climate of weak demand, corporate sector cannot run from one investment to another. Let us quickly state the third point: In the past, the appreciation of Turkish lira made it possible for firms to switch from textile exports to automotive exports. There existed a process of creative destruction. Now, we are to enter a period where the only thing to be expected is destruction. Valuable Turkish lira translates into higher production and employment losses. This time, the process will go on like this.
What must be done? The first thing to do is to revise the central bank policies. It is necessary not to amplify what is already abundant due to demand shortage. Then, it is necessary to negotiate with trade partners. We are in a period where the policies of foreign central banks will closely affect our lives and future. This fifth channel is a though one. We just need a bit of courage!
This commentary was published in Referans daily on 30.07.2009
