The exchange rate issue for Turkey
The times when politics becomes intensified and nearly turns into a conflict are also the times when economic sharing comes to a climax. We can see this bare fact blatantly when we look at the region where we live. Today, Eastern Europe, Turkey, the Middle East and the Caucasus are the most important centers of a war on sharing new resources and markets. This sharing is taking place through the instruments of the "contemporary" economic narrative as well as weapons. The economic terms that we currently use and repeat are also the means of a political showdown.
Exchange rates, for instance, are a direct means of market sharing and a major political instrument. The People's Bank of China's (PBOC) devaluation of the yuan last week indicates that it prepares its monetary unit as a reserve currency and that China aims for a new exchange rate mechanism by doing this. Today, all developing countries, including China, care about determining their currencies within the scope of a market-oriented exchange rate regime, as expressed by the PBOC that is now being monitored closely by the whole world.
The motive behind this requirement goes back to the past. In independent studies carried out by Robert Mundell and Marcus Fleming in the early 1960s, they pondered on how John Maynard Keynes's theory would work in countries that were fully open to capital movements. The key concept in their study was "balance of payment" and the model that they put forth, and which is known as the Mundell-Fleming model, can be practiced in open economies today. The model suggests an impossible trinity consisting of the alternatives of a stable foreign exchange rate, a free capital movement (absence of capital controls) and an independent monetary policy. Governments can implement just two out of these three options simultaneously. The essence of this trinity suggests that a country can achieve only two out of the following three objectives: a stable exchange rate, an independent monetary policy and free capital movements. The basic consequences of the trinity can be explained as follows:
In an economy where capital movements are free, a stable exchange rate can be ensured when a fixed exchange rate system is adopted. In this case, however, a country's central bank cannot change interest rates independently from interest rates in the world, which means that it is impossible for that country to pursue an independent monetary policy.
If the central bank of a country wants to maintain its power to determine interest rates in an economy where capital movements are free, it is not possible to control exchange rate movements. This is because exchange rate is determined by the market.
If a country wants its central bank to set interest rates and exchange rate to remain stable at the same time, capital movements must be controlled.
Turkey and other developing countries did not act in accordance with this theory. Unfortunately, many analysts and rating agencies that argue for an open market mechanism for developing countries propose non-market applications for these countries. Let us take a look at what Turkey has done in this regard.
Turkey has been implementing a floating exchange rate regime for a long time. Unlike before the 2001 crisis, the Central Bank of the Republic of Turkey (CRBT) does not target exchange rate and leaves it to the market. In this case, Turkey does not need to launch a huge devaluation to overcome major balance of payments problems since the market brings balance over the course of time. Although this is a major gain for Turkey, it should be applied properly. While the CRBT conducts inflation targeting, it also targets the exchange rate - which makes high interest rates and valued Turkish lira become basic requirements for low inflation and financial stability. The CRBT achieved its inflation target for three years in a period of nearly 10 years. However, we saw that the Turkish lira became overvalued in those years and, parallel to this, the debt-import economy surged. Indeed, this was a trap that forced Turkey to borrow and import more and rendered Turkey's politics open to outside ratifications. That is why the CRBT should not make an implicit exchange rate targeting through interest rates. In other words, when the market brings exchange rates to a certain level, some should not consider this to be a crisis and press the CRBT to bring down interest rates, or the CRBT should not resort to its interest rate weapon to regulate the exchange rates.
Turkey broke its relation with the International Monetary Fund (IMF) in 2008 with a strategic decision by President Recep Tayyip Erdoğan who was prime minister at the time. Turkey did not sign the 20th stand-by agreement with the IMF and came to a very strategic crossroads: It would decide its economic policies in line with its own realities and interests. There are two important points here: First, economy-related institutions would escape the cliches of the past and would not accept past impositions as absolute truths. Second, people would not be misled. For instance, it would be wrong to suggest that a crisis will come about if the dollar reaches a high level. This is because there will be no crisis in Turkey no matter how high a level the dollar reaches. I would argue that there would not be a difference in the degree of the harm that the dollar will bring to Turkey whether it is TL 2 or TL 3 or TL 2.5 after China's devaluation of the yuan.
These "low" and "high" levels can be defined as strong, stable and competitive. However, these are not the levels that should exist. Well, how do we understand the levels that should exist? The CRBT describes it with Real Effective Exchange Rate (REER), which is determined by calculating the weighted average of price levels of 36 countries where Turkey carries out the greatest number of exports.
The basic element that determines REER is where domestic price movements, i.e. Consumer Price Index (CPI) figures, that determine the depreciation or appreciation of the Turkish lira stand in the face of the weighted price average of 36 countries, rather than the U.S. Federal Reserve's expectation manipulation in markets regarding interest rate hikes and political decisions. It should be noted that the rise of REER indicates the appreciation of the Turkish lira and rise of the price of Turkish-origin goods in the face of the price of foreign goods.
The CRBT announced that it would interfere with all kinds of instruments if REER ranged between 120 and 125 or exceeded 130. The Turkish lira real exchange rate index (CPI-based 2003=100 REER index) rose from 98.29 points to 99.55 points with a 1.3 percent increase on a monthly basis in July. The developing countries-based REER index increased from 66.82 points to 67.36 points and the developed countries-based REER index rose from 116.03 points to 118.10 points. So, the Turkish lira has undeniably gained value.
According to the base year of 2003 and the developed countries-based index, the CPI-based REER index increased to 118.10 points in July 2015 - which means that the Turkish lira was 18.10 percent more valuable on average in July. Now, there are those who write articles suggesting that there is a crisis in Turkey because of the rise of the dollar and argue that if the dollar rises, national income will drop on a dollar basis and dollar-based indebtedness, production costs and inflation will surge. They cannot write about the export loss in a period where the dollar-euro parity is heading toward one and about what kind of a crisis Turkey will face if Turkey continues with an overvalued Turkish lira and high interest rates after devaluations were launched in China and Asia. They cannot do this because they are proceeding on their ways as the media outlets of monopolies that create Turkey's current account deficit and prefer debt and import economy to production. As required by the dynamics of the Turkish economy, the market mechanism determines exchange rates in Turkey. It is no more than disinformation to describe the rise of exchange rates as a crisis.
Exchange rates, for instance, are a direct means of market sharing and a major political instrument. The People's Bank of China's (PBOC) devaluation of the yuan last week indicates that it prepares its monetary unit as a reserve currency and that China aims for a new exchange rate mechanism by doing this. Today, all developing countries, including China, care about determining their currencies within the scope of a market-oriented exchange rate regime, as expressed by the PBOC that is now being monitored closely by the whole world.
The motive behind this requirement goes back to the past. In independent studies carried out by Robert Mundell and Marcus Fleming in the early 1960s, they pondered on how John Maynard Keynes's theory would work in countries that were fully open to capital movements. The key concept in their study was "balance of payment" and the model that they put forth, and which is known as the Mundell-Fleming model, can be practiced in open economies today. The model suggests an impossible trinity consisting of the alternatives of a stable foreign exchange rate, a free capital movement (absence of capital controls) and an independent monetary policy. Governments can implement just two out of these three options simultaneously. The essence of this trinity suggests that a country can achieve only two out of the following three objectives: a stable exchange rate, an independent monetary policy and free capital movements. The basic consequences of the trinity can be explained as follows:
In an economy where capital movements are free, a stable exchange rate can be ensured when a fixed exchange rate system is adopted. In this case, however, a country's central bank cannot change interest rates independently from interest rates in the world, which means that it is impossible for that country to pursue an independent monetary policy.
If the central bank of a country wants to maintain its power to determine interest rates in an economy where capital movements are free, it is not possible to control exchange rate movements. This is because exchange rate is determined by the market.
If a country wants its central bank to set interest rates and exchange rate to remain stable at the same time, capital movements must be controlled.
Turkey and other developing countries did not act in accordance with this theory. Unfortunately, many analysts and rating agencies that argue for an open market mechanism for developing countries propose non-market applications for these countries. Let us take a look at what Turkey has done in this regard.
Turkey has been implementing a floating exchange rate regime for a long time. Unlike before the 2001 crisis, the Central Bank of the Republic of Turkey (CRBT) does not target exchange rate and leaves it to the market. In this case, Turkey does not need to launch a huge devaluation to overcome major balance of payments problems since the market brings balance over the course of time. Although this is a major gain for Turkey, it should be applied properly. While the CRBT conducts inflation targeting, it also targets the exchange rate - which makes high interest rates and valued Turkish lira become basic requirements for low inflation and financial stability. The CRBT achieved its inflation target for three years in a period of nearly 10 years. However, we saw that the Turkish lira became overvalued in those years and, parallel to this, the debt-import economy surged. Indeed, this was a trap that forced Turkey to borrow and import more and rendered Turkey's politics open to outside ratifications. That is why the CRBT should not make an implicit exchange rate targeting through interest rates. In other words, when the market brings exchange rates to a certain level, some should not consider this to be a crisis and press the CRBT to bring down interest rates, or the CRBT should not resort to its interest rate weapon to regulate the exchange rates.
Turkey broke its relation with the International Monetary Fund (IMF) in 2008 with a strategic decision by President Recep Tayyip Erdoğan who was prime minister at the time. Turkey did not sign the 20th stand-by agreement with the IMF and came to a very strategic crossroads: It would decide its economic policies in line with its own realities and interests. There are two important points here: First, economy-related institutions would escape the cliches of the past and would not accept past impositions as absolute truths. Second, people would not be misled. For instance, it would be wrong to suggest that a crisis will come about if the dollar reaches a high level. This is because there will be no crisis in Turkey no matter how high a level the dollar reaches. I would argue that there would not be a difference in the degree of the harm that the dollar will bring to Turkey whether it is TL 2 or TL 3 or TL 2.5 after China's devaluation of the yuan.
These "low" and "high" levels can be defined as strong, stable and competitive. However, these are not the levels that should exist. Well, how do we understand the levels that should exist? The CRBT describes it with Real Effective Exchange Rate (REER), which is determined by calculating the weighted average of price levels of 36 countries where Turkey carries out the greatest number of exports.
The basic element that determines REER is where domestic price movements, i.e. Consumer Price Index (CPI) figures, that determine the depreciation or appreciation of the Turkish lira stand in the face of the weighted price average of 36 countries, rather than the U.S. Federal Reserve's expectation manipulation in markets regarding interest rate hikes and political decisions. It should be noted that the rise of REER indicates the appreciation of the Turkish lira and rise of the price of Turkish-origin goods in the face of the price of foreign goods.
The CRBT announced that it would interfere with all kinds of instruments if REER ranged between 120 and 125 or exceeded 130. The Turkish lira real exchange rate index (CPI-based 2003=100 REER index) rose from 98.29 points to 99.55 points with a 1.3 percent increase on a monthly basis in July. The developing countries-based REER index increased from 66.82 points to 67.36 points and the developed countries-based REER index rose from 116.03 points to 118.10 points. So, the Turkish lira has undeniably gained value.
According to the base year of 2003 and the developed countries-based index, the CPI-based REER index increased to 118.10 points in July 2015 - which means that the Turkish lira was 18.10 percent more valuable on average in July. Now, there are those who write articles suggesting that there is a crisis in Turkey because of the rise of the dollar and argue that if the dollar rises, national income will drop on a dollar basis and dollar-based indebtedness, production costs and inflation will surge. They cannot write about the export loss in a period where the dollar-euro parity is heading toward one and about what kind of a crisis Turkey will face if Turkey continues with an overvalued Turkish lira and high interest rates after devaluations were launched in China and Asia. They cannot do this because they are proceeding on their ways as the media outlets of monopolies that create Turkey's current account deficit and prefer debt and import economy to production. As required by the dynamics of the Turkish economy, the market mechanism determines exchange rates in Turkey. It is no more than disinformation to describe the rise of exchange rates as a crisis.
Last Update: August 19, 2015 02:19