For obvious reasons, all eyes in Turkey have been focused in recent days on the outcome of Saturday’s parliamentary elections. But the release on Monday of April’s balance of payments data by the central bank shouldn’t be overlooked. Turkey’s widening current account deficit is shaping up to be one of the country’s potential achilles heels. It has political as well as purely economic implications, opening the country to the risk of economic disruption of a sort that the AKP has not yet had to grapple with.
Before looking at developments on Turkey’s balance of payments, let’s remind ourselves of what it measures. In essence, the balance of payments is a record of a country’s transactions with the rest of the world. It comprises two main components. The current account covers trade in goods and services, flows of investment income, and a number of smaller financial transfers including workers’ remittances and international aid payments. The second component, the capital account, measures capital flows including foreign direct investment (FDI), bank loans and deposits, and purchases of government and corporate debt.
As a matter of accounting necessity, the current and capital accounts sum to zero. This means that any deficit recorded on the current account is matched by a surplus on the capital account. Another way of putting this is to say that if a country runs up a current account deficit, it must finance it with increased inflows of capital. Such a country is basically spending beyond its means on imported goods and services, thus becoming reliant on overseas capital to sustain itself. This is the position in which Turkey now finds itself.
The chart below plots the development of Turkey’s current account deficit since the mid-1990s. The clearest trend is obviously the rapid widening of the deficit in the early-to-mid 2000s. This was when the economy began to grow rapidly following the deep crisis of 2001. The deficit plateaued at around 6 per cent of GDP from 2006 to 2008. There was then an anomalous year in 2009, reflecting the impact of the global financial crisis on Turkey’s economy—the deficit narrowed sharply in line with a slowdown in economic activity.
In 2010, however, the economy returned to rapid growth and the current account deficit widened again relative to its pre-crisis levels, reaching 6.4 per cent. Nor have things stopped there. Indeed, the deterioration of the current account has worsened worryingly in the early months of 2011. According to the data released on Monday, a rolling 12-month measure of the current account deficit stood at around 8 per cent in April. That is not sustainable.
The most significant contributor to the recent widening of the current account deficit has been an explosion of credit in the economy. In response to the global financial crisis, a wave of liquidity was unleashed by the advanced economies’ central banks to keep the system afloat. Much of this money has found its way into emerging economies such as Turkey’s, in search of higher returns than are on offer elsewhere. These inflows have sustained a credit boom in Turkey, which in turn has financed a binge on imports. And this surge in imports has pushed the current account ever further into the red, to the point that it now represents a real threat to the stability of the economy.
The easiest way to understand this threat is to think of the economy as having become unhealthily dependent on the inflows of capital it has enjoyed in recent years. Ideally this dependence would be unwound gradually, with the Turkish authorities engineering a rebalancing of the economy away from its current import-intensity. This is what the central bank has been aiming at with its unorthodox twin-pillar monetary policy, which is designed both to slow capital inflows and to limit Turkish banks’ lending. (The central bank has reduced its key interest rate to deter inflows, while increasing the capital reserves that banks must hold for their short-term liabilities.)
But there is no guarantee that Turkey will have unlimited time in which to effect this rebalancing in a gradual manner. If global liquidity (and thus inflows of capital to Turkey) were to dry up rapidly, the impact here could be swift and could lead to significant volatility.
If the tap providing overseas capital were turned off, a chain reaction would be set in motion. The value of Turkey’s currency would fall, reflecting the fact that a reduced level of global capital would now be chasing Turkey’s lira-denominated assets. This would prompt a return to accelerating inflation, because imports would now cost more to buy with a depreciating lira. This in turn would prompt a round of interest-rate increases by the authorities in an effort to bring prices back under control. And these higher interest rates would lead to a sharp slowdown in economic activity.
This process would move the current account swiftly back towards balance. But the price paid would be economic instability of a sort that hasn’t been seen here in a decade. That would be bad news for the AKP, which has benefited greatly from the fact that its time in power has thus far been one of almost uninterrupted economic stability.