The recapitalization of banks in Europe will sharpen the competition over the temporary savings surplus and increase the cost of these resources for Turkey.

Europe needs to introduce serious measures, one way or another. Either the European Union will lead the process directly and resolve the problem or a resolution will emerge automatically through banks, the credit ratings of which are being lowered one after another. In any case, renowned European banks will have to obtain capital support from some channel. The way things have been evolving is apparent. By European banks I do not refer solely to the banks of the Union member states. It appears that Sweden and others also are involved. So, what will happen to Turkey if European banks start strengthening their capital structure? Let’s see.

The economy is not normal

World economies have not been normal for the last three years. For three years, economies, including the Turkish economy, have been supported in different forms by the public sector. Every country has been taking steps to maintain economic dynamism. The difference is that some measures have proved fruitful while others have not. Why is that so? This is so because some economies suffer from structural problems that have prevented the productiveness of the measures. The measures have worked if the questioned economy was not suffering from any structural damage, which was the case in Turkey. For some others, however, the structural damage might have affected all countries negatively. The structural problems of Europe, for instance, have had adverse effects on the recovery process of the modern world, including the US. The risks involved in the balance sheets of European banks are hindering their ability to support the economic recovery process. How? Banks that hold larger risks in proportion to their capital are refraining from taking new risks, harming the life-line of the economy. As a result, a savings surplus has emerged. This is the first point.

And the second one. At this stage, let’s avoid the theoretical questionof How those risks accumulated in the first place. This is a subject for later. At this point, let’s concentrate on what to do to prevent the paralysis of a bank which holds large risks in proportion to its capital. Capital is the oldest known tool for controlling risks. If the level of risks on the balance sheet is high in proportion to the bank’s capital, the capital base needs to be strengthened. The bank has to be provided with additional capital so that the risk melts away and the damage caused is limited. This is the second point.

Then, how will the recapitalization of banks affect Turkey? The relative and temporary savings surplus of Europe made it possible for Turkey to finance the historically high current account deficits . The low risk appetite of banks in Europe channeled some resources to Turkey on a short-term basis. However, Europe will need these resources during and after the recapitalization process. This is the third point.

What is the difference?

Let’s talk about Turkey now. At the outset of the 2008 crisis, Turkey’s current account deficit was not low at all. The current account deficit was slightly lower than it is today, 4.3 billion USD in March 2008 versus 5.3 billion USD in July 2011. This isn’t a significant difference in absolute terms. However, in March, 10 percent of the deficit was financed via short-term funds compared to 90 percent today. What is this? This is Turkey’s vulnerability. Turkey is more vulnerable today compared to 2008. Let this be the fourth point.

The recapitalization of banks in Europe will sharpen the competition over the temporary savings surplus and increase the cost of these resources for Turkey. If so, Turkey will not be able to sustain such high current account deficits and rapid economic growth and will bear higher recourse costs. This is the fifth point.

Europe’s solution might be Turkey’s problem. Is this what the ongoing exchange rate adjustment signals?

This commentary was published in Radikal daily on 27.09.2011