Erdem Başçı talks about the comprehensive change in the monetary policy in line with the new normal.

Recently I chatted with a Venezuelan friend who is a resident in the USA. At one point the conversation came to the appreciation of the Turkish lira. My friend told me, "Before I came here my broker called. He said that I should allocate some part of my portfolio to TL and Singapore dollar denominated investments. He said the TL offers great returns. And if the appetite for TL investments has spread to affect even small investors like me, you are done." I noted down his comments with keen interest. I had these comments in mind when I read the speech of Erdem Başçı, Vice Governor of the Central Bank of Turkey. So today let me underline some important points for those who are yet not aware that we are in a new period with respect to monetary policy.

In the past, we observed fund flows from developed to developing countries. However, the never-ending economic crises in developed countries would further the significance of fund flows towards developing countries, including Turkey. The reason was quite simple: not because such countries had qualifications that attracted capital, but because there was something that detracted capital from developed countries. They prefer to invest in developing countries not because they offer high returns, but because developed countries offer almost no returns due to measures introduced to tackle the crisis. There interest rates get close to zero whereas here they remain at a moderate level, say at 8 percent. If you add up the appreciation of domestic currency due to fund inflows to the picture, returns achieved in countries like Turkey have started to go significantly beyond 10 percent. What happens if you compare zero percent returns with more than ten percent returns? What happens is what happened to my friend. Your broker calls you and advises you to invest in TL to make some profit. And if all small investors receive such calls from their brokers, fund inflows towards Turkey increase. The TL appreciates further. It is for a reason that Goldman Sachs seeks to get authorization from the Capital Market Board to issue TL denominated bonds. The reason was stated above.

This was not a threat in the past

You might state rightfully that this was the case also in the past. But then this was not as big of a threat as it is today. There are three reasons for this. First, then developed countries were not in crisis, meaning that the amount of the funds to be transferred to developing countries was limited. However, now the fire has surrounded all developed countries. The crisis in Europe is not dissolving no matter what. So, the proportion of international fund flows directed to developing countries has increased; funds now target a restricted region. The set of "attractive" countries such as Turkey has shrunk. Second, the current account deficit of Turkey has been rising, as is the case in all growth periods. Nevertheless, this time the deficit, different from in the 2001-2002 period, does not stem from a recovery in exports or the elevation of investments. It stems solely from the rapid recovery in domestic consumption. Third, the quality of finance of the current account deficit worsens day by day. What this implies is that today an ever-increasing proportion of international fund flows is short-term flows. The hike in the riskiness of Turkey can be traced also in the quality of fund flows.

I personally think that the first point stressed above is evidence of the "new normal." And the third one results from Turkey's failure to implement the necessary policies. Therefore, under these circumstances we should expect the central banks to go beyond the standard inflation-targeting framework and be more sensitive to current account deficits, deficit finance and exchange rates. In such a milieu, central banks have to expand their set of tools and use constructive uncertainty as an effective policy tool. And Mr. Başçı talks about comprehensive change in the monetary policy in line with the new normal.

This commentary was published in Radikal daily on 14.12.2010