Global Liquidity, Current Account Deficit, and Exchange Rate Balance Sheet Effects in Turkey

ABSTRACT

This study investigates the current account deficit (CAD) of Turkey from the perspective of its capital account. We discuss how global liquidity conditions and monetary policies in Turkey have contributed to higher deficits through real exchange rate appreciations. We analyze the impact and consequences of exchange rate (ER) changes on the investments of non-financial firms. In the case of real ER depreciations, we find that the magnitude of the contractionary effect through balance sheets of firms with dollarized liabilities is significantly higher than the expansionary effect through trade competitiveness. We also analyze the “soft-landing” policies aimed at reducing the CAD in Turkey and estimate the rate of economic growth that must be foregone for a percentage reduction in CAD.

KEY WORDS:

• Balance sheet effect
• capital flows
• currency depreciation
• current account deficit
• global liquidity
• liability dollarization

Notes

1. For simplicity, both capital account and financial account are considered to be under capital account in this research.

2. All cases of domestic currency “appreciation” or “depreciation” are considered to be in real terms in this work.

3. Capital account surplus at the same time equals current account deficit. The capital account and the current account together should sum up to zero, or lead to the balance of payments.

4. Escalation of political unrest was associated with the news of a graft investigation linked to high-level government officials on 17 December, 2013.

5. FED Press Release from December 18, 2013. http://www.federalreserve.gov/newsevents/press/monetary/20131218a.htm The FED had given signals to gradually stop quantitative easing earlier in June 2013, though.

6. In June 2006 only, CBRT raised overnight interest rates three times, to 18%, 20.25% and 22.25%.

7. According to the competitiveness effect, domestic currency depreciation makes domestic goods become cheaper relative to the rest of the world and it stimulates exports and hence, improves current account. Alternatively, lower interest rates contribute to higher investments and production of both tradable and non-tradable goods.

8. However, the control variables in our model differ to some extent from the model in Bleakley and Cowan (2008). We included real exchange rate changes as a control variable, because it is part of an interaction term, and we intended to see its pure effect on the firms with different levels of dollarized debt. Other macroeconomic control variables also differ negligibly, with the GDP and money supply variables included in our model.

9. CEPALSTAT provides statistical information for Latin America and the Caribbean countries which is collected, systematized, and published by ECLAC (Economic Commission for Latin America and the Caribbean under the United Nations Organization).

10. For detailed information see ECB, Euro area 17 (fixed composition)—Industrial Production Index.

11. Shares of construction and real estate in the total GDP in 2013 constituted 6% and 8.4%, respectively (Turkstat GDP statistics).