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How does risk appetite rise in the world we know?
If Adam Smith made a short visit to the world; wouldn't he think that the prophecy the stated around two hundred years ago was coming true? Yes, he would. What was that he said? He has foreseen that West's advance through the East which seems to be the misfortune of the east will result in the East's strengthening. The outcome would be the equalization of powers. Is this exactly what has been happening nowadays? Is it a head becomes foot, foot becomes head situation? Oh my God, or is the world we know coming to an end? Maybe this must be the question of the day: How does risk appetite rise in the world we know?
What is the problem of the world? Things are not bad at all in China and India. In particular studies and news on China indicate that China, who is currently the second biggest lender country following Japan, will continue increasingly to be a lender country over the next two decades. This is what a recent study published in the website of Bank for International Settlements in July 2009. What does this mean? It means that considering the medium term, China will be sitting in a wide savings pool over the next two decades; i.e. will achieve an income more than what will be spend. As you might remember, savings rate have increased from 38 percent in 2000 to 50 percent in 2007. (Remember the "bride shortage".) It means that this situation will remain valid. Nearly half of the savings of China is composed of private sector savings. Under these circumstances, let us state another point for the short term. In the short term, Chinese firms will have at hand resources that can be used for recovery. What does this mean? Let us present the third point: It means that the East of the world seems to have a bigger chance than the West to experience rapid recovery. This is the case for now. However the story does not end here. Holding resources is not enough. It seems that it is not only resources but also risk appetite that the East of the world maintains. Otherwise, why would Chinese firms wonder around in various countries all over the world to purchase other firms and land? This is where I believe the main difference between the East and the West shapes around nowadays: Risk appetite is quite high in the East and the West seems to present loss of appetite. And this is where the problem arises.
So, what happens in the known part of the world? When talking about world we know we know Europe is the first place that should come to our minds. This week almost everyone in Germany from Bundesbank governor to European Central Bank, from German ministers to Russian prime minister was blaming banks. Banks held resources. Central banks have transferred cheep resources to banks and they transferred those resources to relatively safer investment tools like treasury bills or foreign currency. That is, they preferred to sit on the resources. But why did that do that? Probably as they believed that in the face of the global crisis conditions, growing portfolios would only refer to growing non-performing loan rate. Banks were acting more cautiously to protect their balance sheets which seem to be solid for now. Preserving the current solidity was what banks cared about.
So, it is necessary to add another factor to the analysis: Why does banks' risk appetite do down? First, banks might have reduced the pace they extend credits to the corporate sector upon the belief that performance of the banking sector in the period ahead will affect negatively corporate sector's ability to pay. So what? Banks might be of opinion that they are approaching a period where profitability of the corporate sector will drop further. This might be the first reason. Second, banks, whose balance sheets are already damaged seriously, might possibly start to have a more cautious stance about the period ahead. Among the abovementioned reasons, former is based on a serious exogenous and gradually growing danger while in the latter; an already existing danger which does not grow further might be seen at the magnifying mirror. Or, there might be a third option: Both can be valid. This is the million-dollar expert question of the current period. For the answer, balance sheets of the corporate sector must be waited with growing passion.
Where does the reality lie? Reality will most probably be somewhere in between. However, this does not eliminate another reality. Let us underline three points about Turkey: According to friends from the "I am currently feeling what the figures will tell you two months from now" school; the economic dynamism observed in the economy over the last period stems from sales at loss or sales at par. This is the first point. Second, each firm that goes on operating in this climate day by day reduced the operating capital. And the third and the final point: Turkey should focus on the vitality of the corporate sector with updated production incentives rather than wasting time with aforethought investment incentives. What happens otherwise? When the exit day comes, there might be no firms to start the race. Let us add another thing: At least, halting risk appetite of banks in the western part of the world shall be evaluated with this lens.
Now is the time to set aside the dream that the market mechanism will easily set out everything. The problem we are faced with is too serious to be remedied automatically.
It is time for policy activism if Turkey does not want to lag behind in the race.
This commentary was published in Referans daily on 09.07.2009