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    Commenting on the exchange rate

    Fatih Özatay, PhD18 August 2011 - Okunma Sayısı: 857


    In countries like Turkey, the officials of central banks had better not comment on exchange rate or imply a certain level.

    In countries like Turkey, the officials of central banks had better not comment on exchange rate since such remarks, especially when frequent, might drag them into difficulty. This time, "countries like Turkey" do not represent emerging market economies. This time, I am referring to a sub-unit of emerging market economies: those which lack sufficient domestic savings and rely on foreign savings even for achieving potential growth rates; in other words, those which generally have a current account deficit.

    Economic theory fails to explain

    There is a common reason and a reason specific to countries like Turkey why central banks had better not comment on exchange rate. The common reason is that, economic theory fails to explain exchange rate movements. At the outset of this failure lies the fact that expectations about the future level of exchange rate determine the current exchange rate. The expectations are affected easily by even the slightest movement. For instance, an unanticipated military operation initiated against a neighboring country affects the rate significantly. Or, someone important makes a statement reading "Foreign exchange is risky". Or the central bank of a developed country, FED to begin with, increases interest rates earlier and harsher than anticipated. Or, sudden shocks emerge in the financial system of the developed world. There are a number of reasons that might affect the exchange rate expectations and thus the exchange rate.

    Need for savings

    The reason specific to countries like Turkey is evident from the introduction above: these countries are significantly in need of foreign savings. In other words, they have to borrow substantially from foreign financial investors. This makes them vulnerable against the changes in the risk appetite of foreign investors, which unfortunately is sensitive to any development in the globe. In the past, any development in Argentine affected Brazil, Turkey and South Africa. These countries have recovered remarkably in economic terms over the last decades. Therefore, it is now less likely that the risk of bankruptcy in one emerging market economy affects other "innocent" counterparts. However, the developments in developed economies as well affect the risk appetite severely. Hence, exchange rate movements which are difficult to foresee due to the common reason above show even steeper movements in countries like US and severely affect the consumption and investment decisions.

    It is not right to speculate

    So, the morale of the story is this: Central banks of countries like Turkey had better not speculate and comment on a variable, the movements of which cannot be well-estimated by economic theory and which can steeply change its direction due to a number of reasons you cannot control. Implying a value for the rate is even worse. The officials of the Central Bank of Turkey (CBT) used to avoid such speculations due to the above reasons. Since the second half of 2010, however, both the remarks by the CBT officials and inflation reports have been comparing the average value of the currencies of other emerging market economies and that of lira against foreign currencies. They first implied, "The currencies of other emerging market economies have been appreciating. Lira, however, has been depreciating thanks to the measures we have implemented." After some point, they stated it explicitly. In the current milieu of global uncertainties, such assessments might corner the CBT officials. I will give a couple of examples in the following days.


    This commentary was published in Radikal daily on 18.08.2011