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    FED: Then and now (3)

    Fatih Özatay, PhD22 June 2013 - Okunma Sayısı: 1212

    Turkey has to make sure that this movement will not push unemployment up or GDP down. The way to do this is to prevent any loss of confidence in the economy.

    On June 1st, I started a series about the impact of the possible changes in the FED’s policy. After two pieces, the Gezi Park incident intervened. Today I want to continue from where I stopped.

    The first question I asked was if Turkey should be scared of the possible interest rate raise and liquidity withdrawal by FED in the near future. I said this would obviously affect Turkey adversely but we had to take a look at the past experiences to decide the magnitude of the damage. Here the past refers to the spring of 2004: the expectation that the FED will aggressively increase interest rates before the anticipated timeframe became widespread, which dampened the risk appetite towards Turkey and countries alike and led to capital outflows. Although the Central Bank of Turkey kept interest rates constant, the market rate, due to the expected reversal of the FED policy, increased from 24 percent in mid-March to 33 percent in 11 May 2004. Then the rate started to decrease and by the end of the year fell three percentage points below the level in mid-March. Alike, exchange rate hiked considerably by 16 percent between March and the mid-May. It later eased a little bit while by the end of the year it was 7.5 percent higher compared to March. This indeed was normal given that average inflation in the last nine months of 2004 was 7 percent.

    Now let’s compare yesterday with today. In the case for Turkey, the hikes in interest rate and exchange rate stopped after two months while the tension decreased later on and things went back to “normal” in a total timeframe of six months. There were two reasons underlying the movement: first, the fiscal policy was disciplined and the banking sector was solid. Current account deficit to GDP ratio was not ominous, it was 3.6 percent. Second, the European Union (EU) accession process that was closely watched by the public opinion and financial markets was moving in the positive direction.

    Turkey enjoys disciplined fiscal policy and solid banking sector also today. However the current account deficit to GDP ratio is 6.1 percent, way above the level in 2004. Besides, in 2004 the GDP growth rate was 9.4 percent while today current account deficit is high despite the weak growth performance and short-term financing opportunities. Concerning economic fundamentals, the only positive factor for today is that Turkey’s credit rating is stronger. But it is worth noting that the EU process that contributed to the positive mood back in 2004 is absent today and there is no development that would substitute it in developing a positive mood. On the contrary, polarization has been growing within the society. On top of it is the Syrian issue. Hence, Turkey is more fragile today when it comes to domestic issues.

    Comparing the FED’s monetary policy now and then: the FED’s policy rate was 1 percent then. Now it is lower, varying between 0 and 0.25 percent. Therefore, the FED has to raise the rate at a higher degree this time in order to attain the same interest rate at the end of the intervention. But what really makes the difference is that the monetary base in the US today is 4.3 times higher than it was in March 2004 and 3.8 times larger than it was in December 2007. This refers to the excess liquidity to be withdrawn. Evidently the withdrawal will be gradual, but the overall magnitude to be withdrawn is astonishing. This is true even if we assume that the excess liquidity will not be withdrawn entirely, since this is the main source of the short-term capital inflows to Turkey and similar countries. In the end this implies a substantial outflow from Turkey.

    In conclusion, Turkey has to make sure that this movement will not push unemployment up or GDP down. The way to do this is to prevent any loss of confidence in the economy, mainly by minimizing social polarization, guaranteeing civil liberties and revising the Syria policy.

    This commentary was published in Radikal daily on 22.06.2013