It is likely that with a short-term drop in foreign finance opportunities, Turkey’s current account deficit might not fall in the short-term and rise back to its normal level.

Yesterday industrial output figures for July were released and today will come the GDP figure for the second quarter. Given the current climate marked by financial tensions, we may conclude that these figures will not bring light on Turkey’s economic performance in the period ahead. This is mainly because the impact of exchange and interest rate movements and changes in foreign finance opportunities on GDP will be lagged.

Leaving the GDP dynamics aside, I would like to recall a potential development which I have in mind for some time now, as stated at the title. I have written this issue before, but after a new study released in July I wanted to address that again. The research note by Central Bank (CB) researchers Hakan Kara and Çağrı Sarıkaya is titled “Cyclically adjusted current account balance.” The note is accessible on the CB’s webpage.

The study decomposes current account deficit under two categories: structural and cyclical. The former refers to the current account deficit Turkey would have if domestic demand, foreign demand and foreign trade prices would have been at their long-term trends (the potential levels). They define the difference between the actual and structural current account deficit in a given period as the cyclical current account deficit. For instance, if the actual level of domestic demand is significantly above its potential level, current account deficit stands significantly above the structural level. In the context of the study, the authors separately calculate the potential levels. They suggest, if the potential level for domestic demand is high (basically if Turkey’s potential growth rate is overstated), current account deficit also becomes high.

The authors hence calculate the two components of current account deficit for the 2003-2012 period. This calculation is of vital importance for economic policymakers since it is possible to influence the cyclical current account deficit with short-term economic policy measures such as interest rate policy, policies to restrict credit supply or fiscal policy. The study gives an idea about the magnitude of Turkey’s cyclical current account deficit as well as the levels of three sub-components of cyclical current account deficit: the levels stemming from the volatility in domestic demand, foreign demand, and foreign trade prices. This sheds light on the appropriate policy measures.

The authors calculate that Turkey’s structural current account deficit that cannot be changed by short-term policy measures is quite high and increasing. As a ratio to GDP, structural current account deficit floated between 3.4 and 3.8 percent in the 2003-05 period, 4.5 and 4.6 percent in the 2006-09 period, and between 4.5 and 5.1 percent in the 2010-12 period. In 2012 alone, the rate is as high as 5 percent.

What has been disturbing me more is that foreign finance opportunities have lately been shrinking and it is likely that they will decrease further in the coming two to three years. This does not match with Turkey’s high current account deficit. In other words, it is likely that with a short-term drop in foreign finance opportunities, Turkey’s current account deficit might not fall in the short-term and rise back to its normal, that is, structural level. Turkey’s structural current account deficit, in other words, its potential growth rate will probably be lower now. Indeed, it might already have slowed down lately (if so, the structural current account deficit level as calculated in the study would be lower).

This clearly is not a pleasant possibility.

This commentary was published in Radikal daily on 10.09.2013