FED's policy saves Turkey time to solve the accumulated problems.

I was assigned the task of seeking an answer to the question "how the monetary policy will be shaped in the context of the outlook the election results created?" The analysis must be conducted on two scales: short term and long term. Let me start with the short term.

The weakest link of Turkey's economy is that the record-high current account deficit is financed via short term capital inflows. This makes the economy vulnerable to developments in three fields: the Middle East, the monetary policy of developed countries and the unsolved problems of the European Union (EU).

The uncertainty about how the Middle East will be shaped raises the possibility of changing the risk perception about Turkey without affecting the global risk appetite. In terms of monetary policy, it is of significance when and in what pace the Federal Reserve (FED) will withdraw the generously injected liquidity, when it will raise the interest rates, for how long this process will last and in what magnitude the initial increases in the interest rates will be. The statements of the FED signal that the process will not start in 2011. The US economy recovers more slowly than expected. Some even denounce that the US might be dragged into a new crisis. When we let these prophecies aside, since a tighter monetary policy is not anticipated by the FED; economic policy designers and executors in Turkey can take a deep breath. This implies that they will have enough time to attempt the policies that will solve the accumulated problems.

The biggest risk in the short term is the possibility that the problems of the peripheral EU countries are transmitted to the core and shake the entire financial system of the Union. Compared to the uncertainty about FED's possible policy, the uncertainty across the EU is much more significant.

As you might have noted, the risks about the Middle East will affect the risk perception about Turkey before it affects the global risk appetite. The other two might affect Turkey indirectly via influencing the global risk appetite. If the latter to occurs, the first thing we observe will be foreign exchange (FX) outflows from the weakest links of the emerging market economies. I have already explained why Turkey is among the weakest links. So, possible developments in the Middle East might be the last straw.

Then, what economic and monetary policy must be implemented in the short term? If the elections had brought a strong AKP (the Justice and Development Party) majority sufficient for a constitutional amendment, a structure in which the constitutional amendment requires a consensus, or a coalition government, the following measures would have been introduced to counteract the above risks: Fiscal policy would have been tightened. Measures to slowdown the credit expansion would have been implemented in collaboration with the Bank Regulation and Supervision Agency (BRSA). With these two critical steps, the monetary policy that has been implemented since the second half of 2010 would have been replaced with a more usual one. Great minds think alike; I believe that these steps will be taken. There is one other measure to prevent short term capital inflows: taxes discouraging fund inflows. The ruling AKP has rejected this option categorically until now. The election results therefore suggest that such a measure is quite unlikely to be mobilized.

And the structural problems of Turkey for the long term: sustainable growth rate is low. Whenever the growth rate reaches above this rate, problems arise one after another. High current account phenomenon in particular follows right after. The economy fails to generate the resources to finance rapid growth and benefits from the savings of other countries (foreign borrowing). It is difficult to say that the AKP has taken any step to solve these critical problems so far. If the performance in the past implies the performance in the future - I hope not - we should not be expecting any significant step for the solution of structural problems. What is more, the AKP's election campaign pledges focused more on infrastructure project which require new funds. Turkey can generate a substantial proportion of the funds by its own means. It is difficult, but not impossible. Nevertheless, given the performance before the elections and the direction of election pledges, such reforms are unlikely to come on the agenda.

Conclusion: average 4.5-5 percent growth rate highly vulnerable to external loan outlook. A monetary policy relatively tightened following the elections and loosened on the eve of the elections. Monetary policy framework that struggles in all battles. Meanwhile, the status quo is maintained; that is, the income gap between developed countries and Turkey will remain intact: the same old story.

This commentary was published in Radikal daily on 13.06.2011