When
I saw Central Bank of Turkey Governor Erdem Başçı confidently assert on Friday
that the “lira will beat the dollar” this year, I remembered the movie that put
Marion Cotillard on the map
for me, long before her Oscar-winning performance in the Édith Piaf biography La vie en rose.
In
“Jeux d’enfants”, which can
be translated as “Child’s Play”, the two protagonists undertake a lifelong
competition to outdo one another with one daring stunt after another. So if I
wanted to carry on with the game, I could equally boldly claim that the euro-dollar
basket will hit 2.3 sometime during the year, contrary to Başçı's assertions.
There
is a good chance that both of us will be proven right. After all, the lira is
not as overvalued as a year ago, even when you look at real exchange rates,
which take into account inflation differentials across countries. On the other
hand, fundamental
equilibrium exchange rates calculated by Peterson Institute’s Bill Cline
& John Williamson at the end
of October show the lira 13 percent overvalued against the dollar.
Their
methodology is based on current account sustainability, and their “benchmark of
+/- 3 percent of GDP as the limits on current account imbalances consistent
with sustainability” is very conservative for Turkey. And, while the lira has
lost 6.7 percent against the dollar since then, the real exchange rate has
depreciated only slightly because of the rise in inflation. So we could see
further lira weakness should the external financing environment deteriorate.
I
agree with Başçı that the current account deficit has stemmed from ample and
cheap financing in the last few years. However, that financing has dried up of
late. The capital account has been consistently lower than the current account
since July. There was actually an outflow of $ 481 million in October, and
despite the nearly $1 billion of “unidentified financing objects” (net errors
& omissions), reserve assets decreased by $3.7 billion.
Başçı
is assuming that trend will not continue. On the contrary, he is confident that
some of the extra liquidity pumped by the European Central Bank will find its
way to emerging markets and especially Turkey, thereby strengthening the lira.
For that scenario to materialize, we need no major periods of global risk
aversion.
And
if investors do test the lira, Başçı contends the Centra Bank has sufficient
reserves, but traditional measures of reserve strength do not support this
claim. In fact, Turkey’s reserves look less than adequate once you take
external vulnerability into account, as a
recent IMF paper has done.
At
a more fundamental level, I don’t think it is appropriate for a central bank to
behave like a hedge fund, with its Governor talking so much about the country’s
currency and giving investment advice. If nothing else, markets may decide to
treat you as one and test you, and as Europe found out the hard way back in 1992, no
reserves will then be enough.
Consistently
raising the stakes, the protagonists of Jeux d’enfants bury themselves in
concrete at the end of the movie. I hope that’s not where we find ourselves at
the end of the Central Bank’s dangerous currency game.
January/09/2012