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    Exchange rate movements: why different now?

    Fatih Özatay, PhD06 October 2011 - Okunma Sayısı: 1238

    Global risk perception is high and capital is heading towards safe havens.

    Exchange rate has been moving up for some time now. On Tuesday, the value of the Dollar-Euro foreign exchange (FX) basket reached 2.21 Liras. The value of the basket a year ago was 1.70 Liras. Therefore, exchange rate increased year-on- year by 30 percent. The increase before the end of July when the world economy was dragged into a chaos stemmed from intended policy attempts of the Central Bank of Turkey (CBT) as had formerly been announced to public. The increase as of the end of July, corresponding to 11%, was out of the will of the CBT as had also been announced to public.

    High risk perception

    I want to address the developments witnessed since the end of July. To begin with, it is necessary to state that there is nothing odd here. After all, the world is faced with large uncertainties. Europe continues skidding, which complicates their problems further. The polarized political outlook in the US does not allow economic policies that will rebalance the re-shaken economy. As a result, global risk perception is high and capital is heading towards safe havens. This increases the demand for FX and thus the exchange rates in Turkey. There is nothing odd here. There is nothing new, either. Such hikes in exchange rate were witnessed several times in Turkey. You can just recall the developments we witnessed after the 2001 crisis in 2002, 2004, 2006, the late 2008 and the early 2009. The reason for the hike in the exchange rate was the same (excluding 2002, when the hike resulted from the chaos in domestic politics): the increase in global risk perception and the escape of capital to safe havens. Then, if the domestic economy is sound, that is, if the economic fundamentals are solid, exchange rate will start decreasing as soon as the global circumstances that caused the hike disappear. This way, the exchange rate bubble caused by an external shock will burst and the main exchange rate dynamics will again be determined by the strong economic fundamentals. Then, the number of people complaining about high valued Lira will increase and wrong beliefs that the CBT implements a “high interest rate-low exchange rate” policy will spread all around and so on.

    When things will rebalance is uncertain

    However, the exchange rate dynamics since July 2011 have a distinguishing feature. We do not know when the global circumstances causing the exchange rate hike will ameliorate. You may ask, “We did not know when the circumstances in the fall of 2008 after the bankruptcy of Lehman will ameliorate, either. Why would it be different this time?” But please note that back then a number of developed countries generously transferred resources to their financial systems and loosened their fiscal policies to boost the economy. This blossomed hopes for recovery. But now, it is not likely to see a fiscal policy loosening in the US until the presidential elections at the end of 2012. Republicans seem to be determined not to follow that option at the risk of sacrificing the economy. Moreover, it is known that some large European banks are on the edge of the cliff, and it is not certain whether the recapitalization of these banks will be facilitated. Under these circumstances, we cannot estimate when the exchange rate fluctuating with an upwards trend will rebalance. This will eventually happen and after that point the Lira will increase in value again (unless we take weird actions and the US and Europe makes another surprise). But when that time will come is uncertain.


    This commentary was published in Radikal daily on 06.10.2011