EMRE DELİVELİ >Child’s play in Turkish monetary policy

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WhenI saw Central Bank of Turkey Governor Erdem Başçı confidently assert on Fridaythat the “lira will beat the dollar” this year, I remembered the movie that putMarion Cotillard on the mapfor me, long before her Oscar-winning performance in the Édith Piaf biography La vie en rose. 

In“Jeux d’enfants”, which canbe translated as “Child’s Play”, the two protagonists undertake a lifelongcompetition to outdo one another with one daring stunt after another. So if Iwanted to carry on with the game, I could equally boldly claim that the euro-dollarbasket will hit 2.3 sometime during the year, contrary to Başçı's assertions.


 Thereis a good chance that both of us will be proven right. After all, the lira isnot as overvalued as a year ago, even when you look at real exchange rates,which take into account inflation differentials across countries. On the otherhand, fundamentalequilibrium exchange rates calculated by Peterson Institute’s Bill Cline& John Williamson at the endof October show the lira 13 percent overvalued against the dollar.


Theirmethodology is based on current account sustainability, and their “benchmark of+/- 3 percent of GDP as the limits on current account imbalances consistentwith sustainability” is very conservative for Turkey. And, while the lira haslost 6.7 percent against the dollar since then, the real exchange rate hasdepreciated only slightly because of the rise in inflation. So we could seefurther lira weakness should the external financing environment deteriorate. 

Iagree with Başçı that the current account deficit has stemmed from ample andcheap financing in the last few years. However, that financing has dried up oflate. The capital account has been consistently lower than the current accountsince July. There was actually an outflow of $ 481 million in October, anddespite the nearly $1 billion of “unidentified financing objects” (net errors& omissions), reserve assets decreased by $3.7 billion.



Başçıis assuming that trend will not continue. On the contrary, he is confident thatsome of the extra liquidity pumped by the European Central Bank will find itsway to emerging markets and especially Turkey, thereby strengthening the lira.For that scenario to materialize, we need no major periods of global riskaversion. 

Andif investors do test the lira, Başçı contends the Centra Bank has sufficientreserves, but traditional measures of reserve strength do not support thisclaim. In fact, Turkey’s reserves look less than adequate once you takeexternal vulnerability into account, as arecent IMF paper has done.



Ata more fundamental level, I don’t think it is appropriate for a central bank tobehave like a hedge fund, with its Governor talking so much about the country’scurrency and giving investment advice. If nothing else, markets may decide totreat you as one and test you, and as Europe found out the hard way back in 1992, noreserves will then be enough. 

Consistentlyraising the stakes, the protagonists of Jeux d’enfants bury themselves inconcrete at the end of the movie. I hope that’s not where we find ourselves atthe end of the Central Bank’s dangerous currency game.


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