Global Trade Imbalances and Turkey’s Trade Deficit

The International Monetary Fund’s [IMF] upcoming World Economic Outlook Report asserts that a further depreciation of the U.S. dollar would reduce the trade deficit experienced by the U.S. in the medium term, the German daily Süddeutsche Zeitung reports. Along the same lines, the IMF contends that currencies of main exporters should strengthen for global trade imbalances to subside in the longer term, the Chinese yuan among them noted in the WEO draft.

China receives most of the blame for global trade imbalances, but other exporters have also attracted global attention in this matter. However, the yuan is especially undervalued, and revaluing the currency could seriously undermine China’s competitive edge in the global markets. That’s why China does not do it, and trying to convince them to revalue has so far been a futile exercise in lobbying.

Citing the “mercantilist urge to manipulate their currencies”, the Financial Times has undertaken an impressive argument on why it is in the self-interest of Asian countries to consider currency revaluations. They could encourage more domestic consumption by making imports more attractive, and thus they could pass on their immense foreign exchange reserves to their citizens. (“Central Piggy Banks”, February 14, 2007.)

I don’t mean to deflate the spirit, but to a skeptic it sounds like an effort to convince Asian economies to make themselves less competitive in the global market place, disguised in a sophisticated “revalue the currencies, free the Asian consumer” rhetoric.

It is curious how Turkish trade deficit and its currently overvalued currency get little, if any attention, despite all the talk that goes on regarding global trade imbalances. That makes me wonder if Turkey would receive more (negative) attention if it had an undervalued currency, since that would obviously render the country more competitive in the global market place.

I don’t believe that international powers collude to make Turkish economy less competitive, yet I’m confident that’s what Chinese officials must be thinking every time they hear the revalue-the-yuan-and-free-the-Asian-consumer chorus. Yet the same chorus along with the IMF is suddenly silent when it comes to the unsustainable trade deficits experienced by Turkey.

In fact, the IMF has prescribed an economic regime of fiscal austerity along with an inflation-targeting scheme that very much resembles the failed stabilization programs they advocated in the 1990s throughout much of the emerging world.

The so-called “twin-targeting” program, which includes fiscal as well as monetary tightening, is supposed to enhance the “credibility” of the government, but it may end up doing the opposite. Firstly, the “monetary tightening” pillar of the program has resulted in very high real interest rates that ended up attracting exorbitant amounts of “hot money” into the Turkish capital markets, which has ironically resulted in “monetary expansion” rather than a tightening. Secondly, the fiscal austerity policy has ended up cutting expenditures in the areas of education, healthcare, and infrastructure, thus making it impossible for the government to invest in the future of its people. Along with high interest rates, the current fiscal austerity regime has retarded both public and private investments, thus making it all the more difficult for the country to pave the way to long-term sustained growth.

By offering the highest interest rates in the world in real terms, the authorities in Turkey have caused an appreciation of the currency, and hence exacerbated the current trade deficit via suppressing exports and boosting imports.

The twin-targeting program of fiscal austerity and monetary tightening have thus resulted in a severe reduction in the competitive status of the country’s export and manufacturing industries, while driving away the country’s manufacturing businesses to overseas havens where they have much lower production costs as a result of cheaper foreign currencies, as well as destroying the country’s potential to create new jobs.

The IMF seems to have noticed that this is a risky and unsustainable situation. It has recently come up with a “soft-landing” scenario where Turkey should “continue its tight monetary stance”. It has also suggested further increases in fiscal tightening, which has already channeled taxpayer’s money to servicing debt at the expense of their healthcare and social security programs. They predict that if Turkey maintains the program of austerity long enough, the debt levels will come down. (They claim that it has already come down, but currently it is the same as the pre-crisis levels.)

Of course given the enormous dependencies on foreign capital flows to finance the current economic instability (of which trade deficit is a symptom), a crisis could possibly rock the boat by pressuring the overvalued exchange rate to devalue. Such devaluation is not necessarily a bad thing, but it is made worse by the authorities’ need to intervene in the markets by raising the (already very high) interest rates in defense, as the Turkish Central Bank did during the global selling pressure of May and June 2006.

Such rate hikes perpetuate expensive borrowing to meet future debt, thus making it impossible to conceive a decrease in the future debt levels as the IMF predicts. The mathematical formula of fiscal austerity regime along with exchange-rate based inflation-targeting policy cannot attain the desired effects because it can’t stand the forces dictated by the free flowing capital markets.

It is false to claim that Turkey has a free-floating exchange rate when in reality it does not. In fact, many major emerging market-related crises stories of the 1990s include monetary policies that aimed for currency stabilization via a fixed or pegged exchange rate, among them Mexico, Korea, Thailand, Russia and Brazil.

Turkish monetary authorities are willing to engage in more rate hikes if global selling waves start pressuring the overvalued currency. Recent CPI and PPI figures have shown that doing so does not succeed in reducing inflation. At whose expense and for how long they can sustain such disequilibria are questions that beg to be answered.

Comments

[EP]

Great article. Do you think that given that current state of affairs that they might choose to lower rates? If so, would a trade consisting of being short the lira be valid? What about longer term bonds, does the selling pressure on the lira negate the benefit of holding bonds?

Thanks