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Hot, hot… cold

24 October 2011 By Ian Campbell

The human cost of the Ercis disaster comes as Turkey fights to keep it once-booming economy on track. Ankara is playing a high-risk game by intervening in markets to shore up its currency and lacks the reserves to do so. Turkey needs to adopt higher interest rates to shore up the lira – even though that may push a previously overheating economy towards recession.

Until recently Turkey sought to restrict hot money inflows by keeping interest rates down. But that allowed growth to roar and the trade deficit to soar. Now, its huge external deficit – together with rising inflation and a lira that has lost a quarter of its value this year – is making Turkey’s unorthodox response to hot money glut look a mistake.

According to the central bank, short-term external debt with a maturity of less than one year amounted to $135.5 billion in August. In addition, Turkey has to finance a deficit on the current account, the broadest measure of trade, that may approach $75 billion, or about 10 percent of GDP, this year. The central bank’s foreign exchange reserves stand at $85 billion – enough to cover about five months of imports – which is unusually low. It can ill afford to intervene in the currency market.

There are some signs it may adopt a more realistic stance. The central bank warned last week that inflation would rise significantly due to the “recent excessive depreciation” of the lira. Yet its only interest rate move was to raise the overnight lending rate, from 9 percent to 12.5 percent. That makes it more expensive to speculate against the lira. The key policy interest rate was held at 5.75 percent – below inflation of 6.2 percent.

The central bank hopes for a soft landing as a weak euro zone weighs on exports and growth. And the economy has strengths: undoubted dynamism, low public debt of 40 percent of GDP and a modest fiscal deficit close to 2 percent of GDP. But Turkey has let hot money knock its economy off balance. Higher interest rates seem certain to be needed to shore up the lira and control inflation. That means Turkey’s landing could be painfully hard.


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