Fatih Özatay, PhD - [Archive]

Limited things can be done in the short term 03/09/2009 - Viewed 1399 times

The time and the pace of the recovery from recession are now out of our control even partially. If we could have taken the control and make some decisions at the end of 2008 where the crisis intensified and potential effects became apparent, we would now have the control. Now, this is not a possibility. The main reason is the current level of the budget deficit and the risk of further increase in the deficit if no measures are introduced. The most concrete evidence for this are the latest raise in the electricity price and the discussions focused on health expenditures. It seems that the financial structure of the public enterprises operating in electricity market is so corrupt that such a huge raise in electricity price was introduced.

Despite the series of reforms made in the social security system, level of funds transferred to the system from the budget increases gradually.  It is stated that health system in particular must be examined into. Recently, quality of the health services is improved significantly. To reduce the burden of the sector on the public budget without reducing the quality of the service is a quite complex.

Add the huge spending some municipalities make as if there is no budgetary constraint. As a result, budget deficit grows day by day. In this crisis period where the economy contracts by record high levels, the deficit obscures the most common economic policy response: decisions to boost domestic consumption and investment cannot be made or decisions in this direction prove insufficient.

As the budget does not allow the introduction of domestic demand boosting measures, only the monetary policy is left. But in the crisis periods reducing interest rates or injecting liquidity to the banking sector are not sufficient at all though are necessary to ensure the functioning of credit market. For these measures to have a meaning for the real sector, consumers and firms must demand credits feeling secure about the 'future'. Second, their demand must be responded. In other words, banks must not stop extending credits. However, the uncertainties and risks created in the crisis climate forces bank to be cautious. When no one takes the lead and control, the uncertainties remain present and banks tend to limit credits.

Under these circumstances, the growth rate will be shaped by the developments in the rest of the world. If developed countries, in particular the EU countries who receive 50 percent of our exports recover and if people living there start making consumption, we will export to them. Second, if the foreign credit channels woks, the problem will ease as much and firms and banks will reach funds more easily.

This is the picture that appears as of October. Yes, recently, credit interest rates have been decreasing and there are statements that there is resurgence particularly in the consumer loan market; but... This 'but' is an important 'but': Deteriorated budget balance forces the Treasury to borrow more than the level of due debt paid. However, before 2008, public debt stock was reduced significantly as the exact opposite was accomplished. So, now debt stock will go to rise again.

I believe the significance of this for real sector is obvious: With the funds they have collected banks will purchase more and more Treasury bonds because the Treasury has to borrow more and thus issue more bonds. This is the least risky option for banks as the pace of the recovery from the crisis is still indefinite. This, however, limits the credit extended to the real sector. Recently, I used a graph that indicates that this phenomenon started to apply.

In short, a couple of years ahead will possible be hard for the real sector. So, if these theories are to prove correct, what can be cone to reduce this risk? I will address this issue tomorrow.

This commentary was published in Radikal daily on 06.09.2009