A significant decline in net capital inflow implies hikes in exchange and interest rates and drops in domestic credit growth rate.

Turkey spends a large proportion of its national income. With the low domestic savings rate, Turkey has to borrow from abroad at large amounts even to sustain a moderate level of investment at global scale. Here lies the source of vulnerability against net capital movements. This is also the very reason why we talk extensively about the potential decisions the Federal Reserve is to take: those will (and already started to) determine the level of net capital inflow to Turkey.

Yesterday, balance of payments figures for September were released. Let me neglect monthly fluctuations and focus on the overall outlook as I usually do. On the basis of three-month figures net capital inflow diminished considerably in the third quarter, as was expected. Capital inflow was recorded at $5.2 billion, compared to the previous two quarters when net capital inflow was above $20 billion each.

From a different perspective, net capital inflow to GDP ratio might be guiding. Although the GDP of third quarter is not released yet, we can assume 4 percent real GDP growth and 8 percent inflation to calculate the GDP for the third quarter and convert it to dollars using the average exchange rate over the period. When we do that, we see the lowest level of capital inflow since the third quarter of 2009. Net capital inflow to GDP ratio in Q3 2013 is 2.2 percent compared to the second lowest since Q3 2009 at 4.1 percent. There is a drastic difference. This holds not only compared to the 2009-2013 period. It is the lower than the rates recorded between Q1 2005 and Q3 2008 as well.

Each and every report of the Central Bank since the late 2010 draws attention to the correlation between net capital movements, and exchange rate and credit growth rate. I want to remind you of this correlation on the basis of the current agenda, that is, the drop in net capital inflow. A significant decline in net capital inflow implies hikes in exchange and interest rates and drops in domestic credit growth rate.

This correlation peaks when net capital movement turns from inflow to outflow as was witnessed in the last quarter of 2008 and the first quarter of 2009. This movement evidently puts a downwards pressure on GDP growth and an upwards pressure on inflation.

I guess the picture is all clear. The tension in financial markets that started in May, cooled down in mid-September and October, and flamed back lately has a strong potential to affect the Turkish economy adversely.

This commentary was published in Radikal daily on 14.11.2013