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Understanding Turkey's Current Account Deficit

For want of better returns, investors are looking to invest in emerging economies such as Turkey, Brazil and Russia. While is it important to diversifying one's portfolio by investing in such economies, it is also important to understand the underlying risks. Post global crisis in 2008, high inflation and current account deficit have become common features of emerging economies,. Turkey is no different from its other emerging market counterparts, however it might take a long time and lot of efforts before it can emerge as net current account surplus economy again.

Having being hit by the global crisis in 2008-09, the country (NYSEMKT:GDP) swiftly grew by 9% average in 2010-11. The growth was driven by the 2009-10 credit-boom in the banking sector which was caused by change in policies and reforms during the period. However, the rapid growth in economy also led to high inflation and widening of the current account deficit prompting the Central Bank to take strong monetary and fiscal stance in October 2011. Following deliberate efforts by the Central Bank, the country was able to curtail both inflation and deficit drastically by year end in 2012. However, the January 2013 numbers released recently showed inflation rising by 1.15% and Moody's decision to keep the ratings unchanged citing wide deficit, has increased scepticism among investors in Turkey. Central bank has been using unorthodox methods with a mix of various monetary and exchange rate tools and policies to ensure financial stability in the country. It has been doing a balancing act of dealing with inflation and deficit on one hand, and currency appreciation and economic growth on the other.

In order to better understand the deficit one must understand the reasons behind the deficit and solutions available with the Central bank to tackle this problem. A closer look at the balance of payments of the country indicates certain structural deficiencies which will take time to get corrected. Firstly, Turkey is highly dependent on the energy imports due to lack of sufficient energy resources domestically. Central Bank of Turkey estimated that every $10 increase in the oil prices would widen the current account deficit by 0.5% of GDP. During 2011, Turkey's trade deficit and current account deficit widened due to increase in domestic demand for imported goods (mainly energy) and sluggish demand for its exports from Europe. Another structural deficiency can be seen in the composition of the current account financing of the country. Apart from the size of the deficit, post 2008 crisis there has been a visible change in the composition of the financing. Short term financing has replaced a portion of foreign direct funding and long term capital inflows. This shift has made the country vulnerable to external shocks. Thirdly, the domestic savings and investment remains very low compared to other emerging markets due to disparity in the income groups and low household disposable income and high inflation. This has led to increased dependency on the foreign funds and further deepened the deficit.

The Turkish Government along with its Central Bank has already taken up several measures in the past to tackle deficit, most important being encouraging exports. During 2012, due to high exports and deliberate curtailing of imports, the country achieved 37% decline in the deficit. However, in order to keep the deficit at a sustainable level it should invest in alternative energy resources and reduce its dependency on the energy imports. Savings must be encouraged among work force by improving financial literacy in the country. Most of the labour being unskilled or semi skilled, the country should invest in improving the skill sets by investing in training and development activities. Exports of high technology products and services which will increase their competitiveness must be encouraged. It should also provide incentives to encourage foreign direct investment which would reduce the dependency on short term capital inflows.

Due to the small size of the bond market in Turkey, investors might have to invest in Sovereign bonds in order gain exposure to the country. However, it is really important to understand the macroeconomic factors associated with the country. It is highly advisable to approach a financial advisorwho can help the investors in gaining better understanding of the systemic risk and default risk involved while investing in such sovereign bonds.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.