Swimming as usual when the tide goes out
Those behind the rise in the exchange rates, which has been experienced not only over the past couple of months but in the past five years, are “foreign powers.” Who are those foreign powers? They are the “foreign powers” that believed in our story in the first place and “bought this story,” bringing in a huge amount of capital. Savers, international investors of other countries and the central banks that had pumped cheap and a lot of money into the system are now withdrawing money. We had the “rosy picture” when the capital kept coming in and the “gray shades” when money exited.
This quote from 2002 by Warren Buffet has been circulating around recently: “Only when the tide goes out do you discover who’s been swimming naked.”
In order to understand what is going on today we need to look at the past 20 years.
In 2001, in the wake of an economic crisis, Turkey adopted the floating exchange rate regime. The Central Bank would not have to struggle to keep the exchange rates at a certain level. Capital inflows began after reforms and financial aid following a deal with the International Monetary Fund (IMF) signed after the economic crisis, the single party government of a new political party, and a date for the launch of membership talks with the EU were set. All these triggered capital inflows into Turkey. The volume of capital inflows well surpassed the current account deficit but at the same time the inflows increased the country’s deficit up until 2008. The period between 2002 and 2008 was the period when the exchange rates remained almost flat, fluctuating within a narrow band. Even in the wake of the 2008-2009 global crisis the currency rates followed a similar path with small fluctuations between April 2009 and May 2013. Turkey also received huge foreign capital during this period.
The cheap and abundant money created in developed nations to pull those economies out of recession flowed into emerging markets and created “false havens” that borrowed heavily only to pay back those debts in the future. Politicians have won consecutive elections. The inflow of cheap and abundant capital helped Turkey produce a current account deficit beyond its means and at the same time created an illusion that the exchange rate would “stay where it was” despite the current account imbalance.
Because of those huge capital inflows, local politicians became complacent, thinking that “our political mistakes did not hurt the economy nor had a limited impact.” But at a time when the tide goes out and capital inflows slow down, repeating the same political rhetoric does not help. The markets give a different and strong reaction.
The only reason behind the decline in Turkey’s interest rates to 4.64 percent in May 2013 was the capital inflows to the tune of a record $96 billion versus the current account deficit of $52 billion. And the interest rates rose afterwards because we did not act accordingly when the capital inflows declined.
Between 2002 and 2013, households, producers, importers and industrialists had learnt that “if the exchange rates go up, they will eventually come down.” However, there were tons of data and writings on the wall suggesting that this has changed in the post-2013 period. Nobody wanted to wake up to this reality. People might have seen all this but probably thought “we can handle it.”
Different this time
When capital inflows declined compared to five years ago and when the interest rates are kept at a low level, it is just an illusion to think that “the exchange rates will come down.” Turkey’s current account balance tells us that the story has changed after 2013 but the authorities implement the economic policies as if we still live in the “abundant money” period.
In the past it was possible to manage the economy with “moderate single-digit inflation” at a low policy rate at a time when large amounts of money kept coming in. But this is not possible now.
It is known that the politicians are preventing the Central Bank from raising rates ahead of the elections. The mood in Ankara is that “the exchange rates will eventually calm down even if they remain at elevated levels.”
It is obvious that the current volatility in the exchange rates is different than what happened in the past. Over the past 15 years households and companies with debts had held the view that “the exchange rates would eventually come down” but these views have transformed into “the rates would go up if they fall.” And the attitudes of the authorities who just sit and watch the rising rates just added to this mood.
We are reaching a critical point where the troubles of the financial markets will only grow. It is a point where “a rate hike will not resolve the problems.” Economy policymakers who set an inflation target and try to convince economic units that this target is achievable just watch the rising exchange rates and this attitude only adds to the already existing uncertainties. This will inevitably create uncertainties over “credit risks” among local and foreign economic units. On the other side of the coin is the risk of “sudden stop” triggered by the interruption of capital inflows.