Things were not like this before. When domestic tension on political issues increased, exchange rate used to go out of control. It is different not. While the negotiations in the context of the Supreme Military Council continue, Turkish lira tends to appreciate quietly. As the Turkish lira appreciates, or remains constant in nominal terms, exports get disturbed. As exporters get disturbed, the responsible Minister now and then loses consciousness. Then things turn entertaining. So, how shat we assess this situation? Why does not Turkish lira depreciate despite intense negotiations taking place in the country? Why are exporters so upset about the irresponsiveness of the exchange rate to these 'political developments'? Why does everyone tend to get angry at the Central Bank nowadays? If you wonder why, please join me down.

Let us start with the last question: Why does everyone tend to get angry at the Central Bank nowadays? The reason is quite simple: they are angry to the Bank for not keeping the value of the lira against foreign currencies at a certain nominal level. But the Bank does not have such a goal or commitment. Exchange rate policy of Turkey is not based on fixing the value of lira against foreign currencies at a certain nominal level. What is more, the Bank is not entitled to decide a fixed exchange rate regime. This authority is held by the government. So, this is sort of a 'spare the rod and spoil the child' situation. We first have to underline this.

OK, now, why does the exporters lobby believe that it would be better if the nominal value of lira against foreign currencies dropped slightly? Clearly because they will get more liras for each dollars earned from exports. As the recent TEPAV policy note "Export Losses in EU Market" revealed, competition in the export market has gone wild. I would like to repeat for those who did not understand yet: The report mainly said that the share of imports of the EU out of the Union increased while the share of Turkey decreased. Therefore, the profit margins of the exporter firms dropped down. Moreover, according to the calculations made by TEPAV's economists, competition in export markets intensified not only in the EU market. The most serious competition goes on for the Middle East market. In brief, the essence of the "there is no shift of axis here" issue applies also for the EU countries. They are interested more in the Middle East market, too. The reason is quite simple: What happens if a market has potential to grow while the rest of the world suffers from the crisis?  Everyone heads there to make exports. I remember underlining this exact issue last year. I talked about the growth projections for Qatar in 2009, highlighted the opportunities and then said 'please note that everyone around the world is currently checking these figures.' Back then the issue read as follows: Given the intensified competition in export markets, it was necessary to invent smart support mechanisms for exporters. But we could not achieve this. Anyway, let us get back to the issue. The main challenge for exporters is the intensified competition, not the exchange rate. Elevation of competition pushes exporters out of the market and evaporates the profit margins. It is crucial to identify correctly the source of the problem.

Then, what does the depreciation of lira serve for? Since the exporter receives more liras for each dollars earned from exports, income flow in lira terms increases. This way, expenses in lira terms, labor costs to begin with, can be met more easily. However, if expenses are in foreign exchange terms, things get harder for the exporter. So, we can talk about two types of exporters depending on the production structure: those using lira denominated inputs and those using FX denominated inputs. Then, the first group wins and the second group loses. The reality lies in between. But, assumptions make it easier to think. Thus; depreciation of lira can temporarily ease the loss encountered due to rising competition in the export market for the exporters using lira denominated inputs. In this respect, exchange rate plays a role. Then, those arguing that the Central Bank must intervene to depreciate the lira actually imply that exports must be supported. And they are correct.

But, why does the lira keep appreciating despite this grassroots debate? The prolonged crisis in the EU countries affects Turkey's exports negatively slowing down the economic recovery of the country. We will feel this more clearly in the second half of the year. So, this is the negative impact. But at the same time, during the crisis period EU countries increased the flow of funds toward developing countries. Turkey is exposed to foreign fund inflows over the last period, though with a relatively shorter maturity. When investors come to Turkey, they receive lira in exchange for foreign currency. So, demand for lira increases. If exchange rate is set freely in the market, if fund inflows are allowed, and if foreigners can invest in domestic financial instruments, what can the Central Bank do? This is how the system works.

On the other hand, this is not a sufficient answer to the question above. Foreigners come to Turkey in the scope of a certain risk perception particularly for portfolio investments enjoying a sound ability to maneuver. This reveals the confidence in the sustainability of the decision of Turkey for free market made three decades ago. The efforts are paying. Özal's reforms have passed the irreversibility threshold long ago.

We had better keep this in mind.

This commmentary was published in Referans daily on 05.08.2010