I hope that the CBT stops playing in the sand and eliminates the second source of uncertainty today.

Our opinion about the situation in Turkey has been changing. Lately I have been hearing the same question everywhere. People approach to me shyly and ask, “Excuse me. Are things as well as we are being told they are?” It is like they want to believe that things are all right. It seems like they will be very upset if they hear that things might go badly. But one way or another, they want to hear the truth only halfheartedly. I am sensing a growing trend of pessimism. Such are transition periods. The shift from optimism to pessimism, or vice versa, is not an overnight process. I believe that the rising pessimism is related closely to the exchange rate movements. Today I want to put in a framework what I heard about Poland during a conference carried out last week jointly mby the World Bank and TEPAV.

When things were rebalancing after the 2001 crisis, we as a nation were quite determined that we would not forget what we had gone through. The government did not abide by its promise to keep the exchange rate constant until a certain date. The exchange rate was allowed to float. We were pessimistic. The credibility of the Central Bank of Turkey (CBT) had reached its lowest level. The economy delivered positive signals thanks to the reforms initiated by Kemal Derviş, but everyone discounted the positive signals. Expectations evolved to positive slowly over a couple of years.

Today, the government has made no commitment about the exchange rate. We are pursuing a free exchange rate regime. We are aware when borrowing in foreign exchange (FX) terms that the exchange rate might change. We were aware of the risks. The CBT started the game with great credibility, but lately I have been having difficulty understanding what the CBT is trying to do. It seems to me that they are wasting FX reserves. We will wait and see. Now let’s look at the picture: Since the end of 2010, the value of the Turkish Lira against the dollar has dropped more than 30%. At the beginning of Ramadan, the ratio was around 25%. In such a period, the wave of optimism has started to be questioned increasingly. In the beginning, everyone tended to discount the bad news. Nowadays, it seems to be that we rapidly are becoming pessimistic. This is what I meant with “sticky expectations.” Currently we are at the breaking point. And I believe that the depreciation of the Lira is triggering the break of expectations.

What is the problem, then? The problem is that it is uncertain when the ongoing exchange rate adjustment process will end. Here, internal dynamics are as important as external dynamics concerning the magnitude of the exchange rate movements. Internal dynamics concerning the termination of exchange rate movements  refer to the lack of confidence in administrators’ ability to manage the process. External dynamics refer to the possible effects of the lowering of the credit ratings of European banks.

The Global Financial Restructuring conference in Istanbul, organized jointly by the World Bank and TEPAV, was illuminating. The presentation on Poland was especially of interest to me. In Poland, foreign banks have a considerable weight in the financial system. The system is dominated by Spanish, Portuguese and Belgian banks. Therefore, around 80% of the banks in Poland are European banks in crisis. These banks are facing difficulties in their home countries; they have to improve their capital outlook. What can be expected for Poland, in this context? It is expected that foreign investors will sell the Polish assets they hold. What will happen then? The recapitalization of a European bank does not necessitate the recapitalization of the banks in the countries at the core. The search for capital also begins in the periphery, in countries like Poland, which is out of the Eurozone. Banks in those countries also need new sources of capital.

Then, here is the issue at hand: Fund requirement will increase not only for the core, but also for the periphery, regardless of whether European leaders step in to mobilize public funds. The resource costs in Europe increase as credit ratings decrease. This is how we should address this new process. External dynamics are driven by Europe’s quest for a solution whereas internal dynamics are driven by the uncertainty about the CBT’s actions. I hope that the CBT stops playing on the sand and eliminates the second source of uncertainty today.

This commentary was published in Radikal daily on 25.10.2011