You cannot understand what you read if you are thinking something else. At least this is the case for me. As I nowadays have a busy life, I thought that I misunderstood what I read. However, I checked the newspapers on Friday and saw that this is not the case this time. 1st page caption of the Dünya daily reads: "if the IMF will be in the picture, the Treasury should borrow in foreign exchange." The story is given in page two; the heading there says "borrow in foreign exchange, avoid liquidity." The suggestion given in the story is made by President of Turkish Exporters' Union (TİM). However, our concern is not the source of this suggestion but the essence of it. But, the 'essence' here is quite dangerous; this is why I want to assess it today.
Adam and Eve's eating the forbidden fruit in heaven is known to be the 'first sin'. This phrase was first used in the literature of economics in a study in 1999. It refers to the case where a country with a 'bad reputation' cannot borrow in domestic currency terms. The concept is familiar for us as well as Latin American countries. In countries which lived with high inflation rate for long years, foreign currency is preferred to domestic currency even by its citizens. Therefore, the Treasuries of these countries are forced to borrow in foreign exchange.
Please pay attention to the 'forced to' part: it represents the bitter side of the story. And it remains as a bitter story until the 'sinner' swears off. Once the exchange rate jumps for some reason, treasuries come to the edge of bankruptcy. The value of their debt in domestic currency terms increases significantly. As the revenue they collect is domestic currency denominated, the difference between the revenues and the debts widen. The economy comes to the edge of sinking. The interesting part is, the bitter situation does not disappear even the countries 'swear off'. Foreign currencies continue to be used in the country for a long time.
Therefore, economists specialized on instabilities, financial crises, and inflation are highly scared of the situation where the treasuries are 'forced to' borrow in foreign currency terms. Please recall that in the way to the emergence of 2001 crisis, weaknesses of the banking sector played the key role. Fundamental weakness of the banking sector was that the value of foreign exchange denominated debts was high above that of foreign exchange denominated receivables.
By the end of 2002, 58 percent of the net public sector debt was in foreign exchange. This ratio fell down to 10.2 percent by the end of 2008, which is a highly favorable development. The global financial crisis showed us once more that market economies are constantly prone to trouble. We should always keep this in mind. We should recall that the risks in the global financial system are not completely eliminated as well as keeping in mind the 2001 crisis.
Thus the questions we have to ask are as follows: Why would the Treasury, which is about to overcome a 'trouble' get into another 'trouble?' Is it for sure that exchange rate will not jump in the future?
This commentary was published in Radikal daily on 25.01.2010
