How should Turkey respond if the risks the IMF highlighted become reality?

First it is necessary to stress one point: The Turkish economy will be sound and safe if the crisis in the European Union does not spread further but go back to the “abeyance” phase witnessed before August and no more bad news are heard from the US.

The reason is obvious: The ratio of public debt to national income is low. Budget performance is fine though fiscal policy was loosened slightly compared to the previous year – if transient revenues are not taken into account. The banking sector is sound with the assumption that the rapid credit expansion will eventually be controlled. And as a repercussion of these, the risk premium of Turkey is quite low. The only factor that blurs the picture is that the current account deficit varies at historic levels and is increasingly financed via short term capital inflows.

Two significant risk factors

The way Turkey has to respond to this problem is evident, again assuming that the global circumstances which prevailed before August will be reestablished: trying to limit rapid credit expansion, taking decisions that will discourage short term capital inflows and tighten the fiscal policy compared to the previous year, ignoring the transient revenues. You might say, “In August, we naturally lived in the pre-August circumstances and all we saw was decisions about the first and partially the third item on the list.” However, this policy mixture can easily carry the Turkish economy to 2012 and on if the mentioned circumstances are met. Meanwhile, we can go back to discuss the steps needed to improve the potential growth rate.

I hope we can skip the “we could have gone back to discuss” part this time. Because, there are two major risk factors and if these occur, it will be too naïve to think that Turkey will not be affected negatively, the unemployment rate will not increase and the economy will not contract. It is evident! While the conditions were similar in 2008, the economy contracted by 4.8 percent and unemployment reached from 10 to 14.9 percent in 2009 following the emergence of the global crisis. Different than the circumstances back then, this time Turkey has been attracting high levels of short term capital. That is, these funds can flow out as quickly as they had flown in and cause the balance sheets of banks to shrink.

Two risk factors as highlighted in the IMF's “World Economic Outlook” are as follows: First is on Europe. The report stresses that the crisis in Europe runs beyond the control of European policymakers. It implies that politicians fail to take decisions in time and argues that necessary steps to ratify the decisions have not been taken. As you might remember, the European Union has announced a number of decisions on July 21, 2011, which relieved the markets to a large degree upon the belief that European leaders were finally taking steps in the right direction. But those decisions are yet to be put into effect since they are not ratified in the parliaments of some member states. The second risk has to do with the US. The economic activity in the country which is already slowing down might weaken further. One reason of this is political polarization which hinders the implementation of fiscal policy measures. Moreover, the report stresses that the housing market is still weak and the US citizens who do not have confidence in the economy and thus are afraid of losing their jobs due to uncertainties might prefer to consume less and save more. It emphasizes that these developments has the potential to weaken financial institutions.

Then, which policies in particular can prevent these risks turning into reality? How should Turkey respond? These are important questions we need to dig in.

This commentary was published in Radikal daily on 29.09.2011