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We should be aware of economic vulnerabilities
Tough days are to come. We should be aware of our vulnerabilities when taking our steps.
The possible policy reversal by the Federal Reserve (FED) affected emerging market economies adversely due to the rise in risk perception in the international markets. Reports by the international financial markets suggest that if this trend continues, Turkey will be among the countries that will be affected at the highest degree.
There are two interrelated reasons for this. First is that, Turkey’s FX liabilities are considerably higher than its FX assets. The Central Bank releases figures in its international investment position reports. At the end of 2002, liabilities were $8.5 billion higher than assets. By the end of 2012, this figure reached $418 billion, corresponding to 53 percent of the GDP. The difference between FX liabilities and assets increased further and reached $451 billion by the end of April 2013. The corporate sector in particular has a large open FX position.
The second reason is the low savings rate. In order to achieve satisfactory growth rates, the share of investments in GDP shall not decrease. In the 2010-12 period, investment to GDP ratio was 21.7 percent. This is not a high level, actually. Yet, savings fall short of financing this level. Savings to GDP ratio in the same period stood at 13.5 percent. The difference is met via foreign borrowing. Hence, if foreign funding options deteriorate, Turkey cannot sustain the current level of investments. This inevitably means that growth rate will decrease.
With the rise in risk perception in international financial markets, FX outflows are seen in emerging market economies like Turkey. Foreign investors sell bonds and securities of emerging market economies and invest the FX in the financial assets of less risky countries such as the U.S. As a result of this movement a series of movements take place spontaneously: due to the increase in FX demand in emerging market economies, exchange rates go up; the prices of financial assets decrease (stock markets go down and interest on bonds increase); loans from abroad cannot be renewed, putting emerging market economies into net borrower position.
The first vulnerability is the high level of FX liabilities against FX assets. That’s why Turkey is affected negatively by extreme increases in exchange rate. The second is the dependency on external borrowing even for meeting unsatisfactory levels of investment. Being a net foreign borrower affects investments and growth negatively. This is why Turkey is highly sensitive to developments in international financial markets and the rise in risk perception over a long time frame scares us. It’s not only about interest rate and exchange rate movements alone. These turning into a trend means higher risk of slower growth and higher unemployment rate.
So, will international risk perception keep on increasing? The main reason behind this movement lately was the announcement by FED that it will gradually end the third quantitative easing scheme introduced in September 2012. The quantitative easing was largely carried out with the first and the second schemes, and these will be reversed later in the next year or two. In a nutshell, tough days are to come. We should be aware of our vulnerabilities when taking our steps.
This commentary was published in Radikal daily on 27.06.2013