Turkey’s chronic headache: Forex
Everybody accepts that the current account deficit is one of the serious problems of the Turkish economy. Like some other countries an important part of the deficit is financed by short-term foreign investment. It is not difficult to understand why authorities, business circles, some economists and even some foreigners are uneasy now. First of all a recent surge in foreign exchange rates creates and will also continue to create serious difficulties for some private businesses and public authorities that use FX credit. In addition they know well from their past experiences when some signs of an economic or political turmoil appear in Turkey or abroad, as happened several times before, the owners of the short-term foreign investment want their money back at once.
This creates bigger problems in foreign exchange and financial markets. Exchange rates suddenly jump to unbelievable levels; so it becomes necessary to increase interest rates over those levels in order to make the domestic currency attractive again for stopping the rush to the foreign exchange market. This turmoil spreads to other sectors of the economy and creates a widespread crisis in a short time. This happened last time in Turkey during the 2001 crises. People my age remember easily how many times foreign exchange problems created very serious economic crises during the last 60 years in Turkey. To fight against such crises by using FX reserves has always been partly successful and mostly unsuccessful.
The main reason that makes FX a chronic headache for the Turkish economy is obvious: Exports never reach the level of imports. It might be defended that even in some rich countries such as the U.S. the situation is similar. However, as their national currencies are also international media of exchange (so simply they can finance deficits by their national currencies), countries like Turkey need hard currency to finance foreign trade and as a result accumulate current account deficits.
During recent years additional problems appeared that increased imports over normal levels. Until recently hot-money inflows created a vicious cycle such as the overvaluation of the Turkish Lira, which limited exports and encouraged imports. The result has been ever-enlarging foreign trade and current account deficits. The new surge in FX rates will not change this in a short period of time. It means that foreign exchange needs for importing goods, energy and services cannot be met still for a long time by exporting domestically produced goods and services. It becomes necessary to fill the gap by mainly short-term foreign investment. This makes the FX position of the country critical.
An additional problem that limits exports and encourages imports is the unjust competition in international markets. Cheap labor, unrealistic input (including capital) prices and some other extra advantages in some emerging economies give them an advantage to compete in international markets under normal prices. This increases the attraction of imports from those countries. That is one of the main reasons for the rapid increase in Turkey’s imports. However it must be accepted that the core problem is the insufficiency of exports. And it is almost impossible to change this situation by intervening in FX markets. Efficiency, productivity, innovation and technology are more important than FX rates.
In short, almost everybody becomes unhappy regardless of whether the FX rates increase or decrease. The reason is obvious. Both cases create different but serious problems as mentioned above, but the real problem is not the level of FX rates. And in addition using FX reserves to fix rates can only provide temporary relief for the volume of the reserves are limited not only as quantity but also as some important ratios