Latest data confirmed that unlike the expectations things did not get back on track in the second quarter. In June exports have decreased by 32.8 percent as compared to June 2008. In May industrial production have fallen 17.4 percent than the same month last year. Figures for the second quarter imply a relative recovery compared to the first quarter; but after all we are talking about large rates of downward movement. It is not a joke! 17 and 33 percent falls are quite serious. Turkey's economy was among those that contracted most rapidly over the first quarter. A number of comparative tables took place in the media.  The reasons why Turkey is rising to the peak in the league of economic contraction started to be questioned more frequently. The starting point of the questioning is: It is said "Our financial sector did not have any problems. There were no toxic assets. Banks had strong capital. Rate of non-performing loans was quite low. Despite the soundness Turkey's economy contracted at a much higher rate than the countries whose financial sectors were ruined. How does this happen?" It is an interesting question we need to think and discuss.

I would like to remind you one point to facilitate this discussion. Even before the emergence of the financial crisis, some economists pointed out an important volatility in Turkey. You have read about it several times at this column. That volatility is: Corporate sector had a serious balance sheet weakness. This problem became more evident in 2006. In the said sector sum of foreign exchange (FX) denominated payables were highly above the sum of FX receivables.  In other words, corporate sector had net FX open position. This phenomenon posed four potential threats all of which were related to the evaporation of foreign resources directed to the corporate sector.

First, such evaporation was expected to scale up the FX demand of the corporate sector which will has trouble in paying foreign debt.  This implied an upward pressure on exchange rates. The intensity of this pressure would depend on the magnitude of the fall in foreign resources and on the time interval it will spread over. Second, companies that have problems in paying foreign debt were expected to prefer downsizing to limit the cash flow shock. It was possible that they cut down production and lay-off employers. This, given the same climate, created an additional adverse effect on the production decreasing effect stemming from the fall in domestic demand.

Third, it could be concluded that this problem would also affect the capacity of the companies to pay debt to the domestic market. In that case, the commercial credits one company extends to another company and banks extend to companies were also expected to be tightened by the borrower as risk perception toward such troubled companies would rise. On the other hand, companies that had to pursue downsizing also had to decrease credit demand. In short, a credit tightening would take place.

Fourth, soundness of banks was a dynamic concept. Soundness of companies a bank engages in heavy work relationships was of great importance for the sustainability of the soundness of that bank. If foreign resource problem was to affect a certain part of corporate sector negatively, banks would also be expected to be affected negatively.

There is no doubt that these four risks were interrelated to a certain extent. For instance, an upward pressure on exchange rate would disturb balance sheets of companies at open position and push up the need for operating capital. But this would also imply that risk perception toward such companies would go up further making it harder for them to access credit. Consequently, this would mean much lower production. It is wise to assess the reasons for such high rate of contraction as well from this angle. Soundness of corporate sector's balance sheet structure is as important as that of banks.

This commentary was published in Radikal daily on 09.07.2009