The excess liquidity and low interest rates in developing countries is a source of trouble for developing countries including Turkey. And it appears that we will discuss more often the trouble developed countries brought on us. This phenomenon gives way to a rise in short term fund inflows to developing countries.

Countries with savings gap have to find new areas of savings that will close the saving gap in order to maintain investments at a level that will not decelerate the growth rate. In the short term one way to do this is attracting foreign savings. Therefore, it is maintained that countries with savings gap should not introduce aggressive capital controls which would limit such fund inflows. But the current FX inflows do not qualify as growth-friendly fund inflows for two reasons. First, they are low quality; there is a shift towards short term. Second, they are temporary. Developed countries will eventually withdraw the liquidity and raise interest rates.

What can Turkey do against such funds which are and seem to remain as a source of trouble? When you take a look at the recent literature on capital controls, the steps recommended to be taken before implementing capital controls go as follows:
At the macro level, if you have a low-value currency, let is appreciate to a certain extent. Additionally, if the Central Bank has insufficient FX reserves, it is advised to accumulate FX. On the other hand, if inflation is not a concern, the Bank is advised to reduce interest rates. In the meanwhile, if loose, the fiscal policy is recommended to be tightened.

In the financial sector: Regulations and supervision should be intensified.  If fund inflows accelerate domestic credit expansion, this should be prevented. Similarly, regulation and supervision methods that will prevent the widening of the gap between FX denominated debts and FX denominated receivables of the financial sector or the corporate sector are recommended.

In short, recent literature on this issue completely matches with the recent debates on how to tackle short term fund inflows. As you might note, some of the steps summarized above coincide with the monetary policy realm. And the Central Bank of the Republic of Turkey (CBRT) has already initiated almost all of those steps.

Some of the items in the list correspond to the fiscal policy realm. Medium Term Fiscal Plan for 2011-2013 was published in the Official Gazette on Sunday. The target for the ratio of central government budget deficit to GDP in 2011 is 2.8%. The figure will be limited at 1.6% as of 2013. And the ratio of primary surplus to GDP as foreseen is 1.2% and 1.7%, respectively. Over the same period, a fall in the ratio of public debt to GDP is also targeted.

Given that the period covered will be the election period, such figures for budget deficit must be considered reasonable. If we are not happy with the rise in fund inflows and if we believe that the temporary and short-term inflows give way to problems, the solution for the short term lies at direct capital controls and at regulation and supervision. Of course we can still discuss monetary policy, but these are the elements we must concentrate on.

This commentary was published in Radikal daily on 11.10.2010