Macroeconomic stability is not the only factor that attracts foreign funds. The risk appetite also must be strong.

It is possible to draw two contrasting pictures. On the bright side, the economy has grown during a period when the largest export market Europe suffered from economic contraction. Unemployment rate that was rigid at around 10 percent before the crisis diminished to 9.3 percent in 2012. The two key vulnerabilities of the economy were tackled successfully: first, current account deficit was lowered remarkably. Second, credit growth rate that reached levels that could threaten financial stability was reduced.

We can assess the year from a pessimistic perspective, too: growth rate will be around 2.6 percent which is quite low compared to the average growth rate since 1960 at 4.6 percent. Turkey’s growth in 2012 was substantially below the potential, in other words. Furthermore, the rate is lower than the expected global growth rate at 3.2 percent. On the other hand, current account deficit in proportion to the GDP is it still high. Therefore, we now have a different structural problem: slow growth-high current account deficit-high external borrowing requirement. Besides, Turkey’s inflation rate is higher compared to rival exporters.

Both of the assessments are correct. And we will be making contrasting assessments as such also in the future unless a critical problem is not remedied: Turkey’s growth performance is highly dependent on the capacity to access foreign funds. When foreign fund inflow increases, growth increases, ceteris paribus. On the contrary, in the case of foreign fund outflow, Turkey’s growth performance weakens, turning negative if outflow strengthens. The figure below shows seasonally adjusted GDP series and net foreign fund (capital) inflow to Turkey. The close correlation between the two is evident.

The prerequisite for uninterrupted foreign fund inflow is macroeconomic stability. Turkey has made significant process on this account since the 2001 crisis. Yet, macroeconomic stability is not the only factor that attracts foreign funds. The risk appetite also must be strong. If the global risk appetite weakens due to exogenous conditions as was the case in the late 2008 and throughout 2009, Turkey’s economy shrinks. On the contrary, when global risk appetite strengthens, current account deficit and domestic credit supply escalates, threatening financial stability.

Best wishes for the new year.

Figure 1. Real gross domestic products (GDP) and net capital inflows (right axis, billion $): 2000 Q1–2012 Q3. Source: Central Bank of Turkey and TURSTAT

This commentary was published in Radikal daily on 29.12.2012