Measures aimed at reducing short term capital inflows must not be categorically objected.

The negative impact of the global crisis on our national income was eliminated as of the third quarter of 2010. On the other hand, the impact on the export performance and unemployment prevails. We are talking about a crisis the effects of which became visible as of the end of 2008. In other words, although two and a half years passed since the eruption of the crisis, the employment market could not recover and the demand for Turkey's exports did not achieve the pre-crisis levels.

We are consoling ourselves with the fact that both of the said indicators move in the "right" direction: unemployment rate is decreasing and exports are recovering for some time now. On the other hand, one development still concerns us - in fact, this development is a source of concern for other developing countries as well. 

Huge amount of liquidity injected
The mentioned development was triggered by the global crisis in itself and the efforts to overcome the crisis. The latter caused a huge amount of money to be generously injected into the system. In developed countries, interest rates became extremely low. The crisis messed up the real estate markets in many developed countries. Later, the ongoing financial crisis that erupted in some European Union countries made us question the soundness of the financial institutions of the European Union.

Last Thursday, I addressed a development that attracts more people every day: The media features nothing but commercials about plazas, residences, houses; whatever you call them. Around us have mushroomed construction sites of skyscrapers and large housing estates. The credit expansion does not slow down despite all the measures.

There exists a close connection between this and the mentioned development. As the rest of the world is in crisis, funds flow in streams towards countries like Turkey. You might think, "whatever! Fund is fund, anyway." But this situation is actually quite dangerous for two interconnected reasons: first, the circumstances facing developed countries and triggering the fund inflows to developing countries will ultimately disappear. After some time, interest rates in developed countries will tend up and certain measures causing monetary expansion will be annulled. In short, we are faced with a temporary phase. Second, though we also witnessed similar periods of strong fund inflows, this time the movement is different in that the funds are predominantly short term this time. 

Current account deficit financed with short term FX
In 2010, a great proportion of the current account deficit in Turkey was financed with short term foreign exchange (FX). For instance, in 2006 and 2007, during another phase of strong FX inflows to developing countries like Turkey, Turkish banking sector had repaid more than the amount of short term debt received and thus reduced the short term debt stock. But in 2010, the short term debt of the banking sector increased by US$ 12 billion. Similarly, the deposits of the foreign investors in Turkish banks, that is, the liability of the banking sector in FX deposits, increased substantially. This phenomenon is encountered also in other developing countries. For instance, in the seven largest Latin American economies, the share of short term FX in total inflows increased from 50 percent in 2006 to 70 percent in 2010.

Measures aimed at reducing short term capital inflows must not be categorically objected. Some of the studies on this subject argue that such measures do not always work. But there also is a literature that criticizes such studies and reports that measures to reduce short term capital inflows bring great benefits. I will continue with this subject.

This commentary was published in Radikal daily on 05.05.2011