It became apparent that Turkey has vulnerabilities that might lead to sharp market movements in the case that sudden changes in perceptions are somehow created or caused by external developments.

The way the economy will move towards in the short term is closely related with external factors. External factors refer to the developments in the European Union (EU) and the US. I will make two assumptions which are more likely to prove right: the decisions the EU took late last week implies that will to solution is gaining ground even though doubts started to be raised right after the relief of the markets with the announcement of the decision. So, my first assumption is that steps to this end will continue coming. Of course this assumption might prove wrong, but I will stick to it anyway. Second, I assume that the conflict in the US will smooth over.

Rapid chance of perceptions

Let us define the crisis as "existing vulnerabilities' causing a considerable increase in unemployment and significant economic contraction due to some triggering shocks." In this context and under the above assumptions, we cannot expect that a crisis erupts in Turkey despite the fact that vulnerabilities grew compared to the pre-crisis period. Because there will be no triggering external shock. And the existing vulnerabilities are not as strong to trigger a domestic crisis unless unusual steps are taken in the field of economic policy. Evidently, arguing that no crisis will erupt in Turkey does not imply that economy will be just as it was in 2010. The most evident indicator to this is the rapid depreciation of Lira and the drops in the stock market and the fact that neither of these is observed in other emerging market economies. Then, there exists an increase in the risk perception against Turkey which pushes the demand for foreign exchange (FX) upwards.

We have to focus on why the recent sharp exchange rate movements did occur now but not a month ago, let's say. If the economy suffers from certain vulnerabilities, triggering factors can suddenly alter expectations. While the perception that "everything will be the same" remains despite the vulnerabilities and say that credit supply and demand functions without any change, a triggering factor might emerge and change the perceptions entirely. Then, vulnerabilities start to come to attention and the perception that "things might change" becomes prevalent. Despite the fact that the economic fundamentals did not change, this sudden change of perceptions might lead to sharp movements in the market.

Vulnerabilities have emerged

This is an important point that might give hints about the developments ahead: It became apparent that Turkey has vulnerabilities that might lead to sharp market movements in the case that sudden changes in perceptions are somehow created or caused by external developments. You do not have much chance to make experiments in the science of economics. But this way we sort of made an experiment which revealed that the existing vulnerabilities might give way to sharp movements in the exchange rate and the stocks market. This point must be emphasized. This might work in Turkey's benefit under the assumptions that new triggering shocks will not emerge and that the economic policy will become active in the fields beyond the scopes of the monetary policy. With "benefit" I refer to the normalization of the economy. In this milieu, the corporate and the banking sectors are normally expected to step on the break a little. So, investment expenditures and consumption on durable goods will most likely be affected negatively. Under normal circumstances, at the end of this process we will witness higher exchange rate, lower growth rate and smaller current account deficit. Economic contraction is normally not among the possibilities. And the risk that circumstances change beyond the normal is quite low unless the global conditions turn unfavorable and domestic triggering factors step in.

This commentary was published in Radikal daily on 28.07.2011