Fatih Özatay, PhD - [Archive]

Going off halfcocked? 24/05/2011 - Viewed 1229 times

Measures to limit short term capital inflows can work; but the administration categorically rejects that sort of measures.

As of March 2011, current account deficit over the last twelve months have reached a record-high US$ 60.5 billion. It is commonly known that Turkey's current account deficit reaches high levels in periods of rapid growth. We can put this as follows: if you try to ride a car that ideally goes at 120 km/hour at max at 200 km/hour, some components of the engine (the component of current account deficit) start to go bad. The question that really matters here is whether this disturbs and breaks down the entire engine.

We commonly hear arguments that when the payments for energy expenditures are excluded, current account deficit does not sound that terrifying. This is correct. The current account deficit excluding the energy expenditures is around US$ 23.5 over the last twelve months. Nevertheless, this must not relieve us. After all, we have to import energy; this elevates the current account deficit and thus we have to finance that deficit. Disregarding the energy expenditures is not suitable for our analysis as this does not remedy the problems with the engine. 

Domestic savings problem

The close relationship between the growth rate and current account deficit proves that Turkey has a domestic savings problem. We need to improve investments to ensure rapid growth. However, we need funds to increase the investments at the desired pace. Domestic savings are insufficient; so we have to access to foreign savings (borrow). This is a significant structural challenge for Turkey that cannot be solved overnight. On the other hand, it is apparent that this challenge must be overcome somehow.

Here is the main question: How can we improve the domestic savings are? Academic studies indicate that it is not simple to increase the private savings rate. On the other hand, the savings of the public sector can be improved; we have the room to maneuver. The ratio of the tax revenues to GDP, which is substantially low in Turkey compared to the OECD average, can be improved by three to four points as a first step, for instance. This will definitely prove successful and ease the current account deficit problem to a certain extent. Nonetheless, accomplishing this "first step" alone cannot be ensured overnight; even the political will to do this exists.

Deficit financed via short term borrowings
Turkey has a more urgent problem to solve: from the aftermaths of the 2001 crisis to 2008, Turkey financed the current account deficit increasingly via long term foreign borrowing. And the share of foreign direct investments in foreign borrowing used to increase gradually. But the year 2010 witnessed a severe deterioration with this respect. Turkey started to finance the record-high current account deficit increasingly with short term foreign borrowing. This adverse outlook remains intact in 2011, too, which implies a significant risk given the current global economic circumstances.

This risky method of finance Turkey uses is closely associated with the actions of developed countries' central banks which injected high amounts of liquidity to the market and reduced interest rates to extremely low levels after the global crisis. And with this parallel, these policies will be reversed eventually. If this reversal will be sooner and more aggressive than anticipated, counties like Turkey might face huge problems. What is more, a country which finances the current account deficits with short term borrowing is to face problems even if the reversal process takes place as anticipated.

Unfortunately, Turkey has not introduced significant measures to counteract potential problems. We have to reduce the current account deficit by "cooling" the economy, on the one hand and minimize the weight of short term borrowing in the financing scheme, on the other. The Central Bank of Turkey is trying to take steps. However the attempts so far failed. To be successful in these attempts, fiscal policy has to be tightened. In addition, the Banking Regulation and Supervision Agency also has to take action against the rapid credit expansion. Measures to limit short term capital inflows can work; but the administration categorically rejects that sort of measures. This outlook might not be attracting sufficient attention as we are on the eve of the general elections. But this course of events is by no means favorable.

This commentary was published in Radikal daily on 24.05.2011