Is Turkey bracing for a crisis?

Turkey has an emerging market, but it also has a history of financial crises and turbulence.

While the US, Japan and Europe slashed interest rates to unprecedented low levels, growth remains sluggish. Dealing with debt problems and supporting the recovery, the ECB provided money to quasi-finance the euro area problem children. Similarly the Federal Reserve is trying to jump start the economy and has been flooding markets with money so that they have no idea about what to do with all the liquidity.

But – wait – there are emerging markets. They are booming from Brazil to Turkey. Hence, investors target emerging market asset markets until there is something to gain at home. As a consequence Poland and Brazil just raised interest rates to fight inflationary pressure in goods and asset markets. On the contrary, while inflation picks up (expected rate for 2011 is 5.9 percent), Turkey LOWERED interest rates and raised reserve requirements.

This might seem odd?

But it makes sense: Turkey has a history of severe crises (1994, 2001) and turbulence (1999, 2006) over the last two decades caused by sudden capital flight and depreciation. And again, an economy that is growing at rates of eight percent, faster than any European economy, is the natural target for speculative investment. “Can it happen again?”, asked the Turkish Prof. Onaran in 2006. The Turkish authorities seem to think so:

In my opinion, this unorthodox measure shows not only that Turkey’s primary fears stem from hot money inflows, but also that the country is already preparing for a possible crisis. As higher interest rates might attract more speculative capital inflows due to appreciation of the lira, this is not seen as a wise option to fight inflation. The policy answer of the Turkish central bank makes a lot of sense: First, lower interest rates. In a second step, raise reserve requirements. Raising reserve requirements increases interest rates back to where they were or even more. But then banks are better prepared to deal with possible capital flight.

Unfortunately this unorthodox policy has shown that it might already be too late. Easy money investment is already very sensitive to devaluation. After the Turkish central bank lowered rates (19.Jan. 2011), financial stocks lost about 20 percent as the depreciation of the currency led foreign investors to sell out their portfolio. Therefore it seems that Turkish authorities have nothing to stop easy money inflows without risking severe disinvestment. They are trapped.

But what is worse: this immediate market turbulence signals that the risks taken by investors in emerging markets around the world might be very high and trouble may be ahead. Once the major economies return to a more moderate monetary policy stance, it is likely that emerging market asset market booms go bust. The longer they wait, the worse it will be. Let us hope the Turkish turbulence is just a small cloud on a clear sunny sky!

Add/view comments on this post.

------------------------------

The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.