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Tevfik Güngör, writing in his column in the serious business daily Dünya, examines some of the causes behind recent volatility in the stock exchange and currency markets in Turkey. The first article was dated 15 June 2006; the second 16 June 2006. Translated from Turkish by Tim Drayton.

External markets are adjusting to revised interest rates.

There is a danger that higher interest rates in response to worries about inflation will cause economies to slow down and that the profits of publicly-quoted companies will decrease and thus that share prices will fall.

Players are taking positions based on just such a danger. They are abandoning shares that they perceive to be risky or are leaving the stock market.

For this reason stock exchanges are falling in a number of countries. This is the problem for external markets.

Panic is causing stock exchanges to fall in various countries; some investors or funds are leaving the stock market; but money is not crossing the borders of those countries. Even if it is, this is not destabilising the monetary system.

Here the situation is different. Of course, in the face of a global trend, we also see foreign investors here adjusting their stock exchange risk, but here the main problem is that foreign investors are abandoning the stock exchange due to the country and exchange rate risk and that those who abandon the stock exchange are changing YTL (New Turkish lira) into foreign currency and removing the foreign currency from the country.

The move from YTL to foreign currency increases the demand for foreign currency. Foreign currency leaving the country increases the foreign currency deficit.

According to figures at the beginning of the year, 63% of shares traded on the Istanbul Stock Exchange are in foreign portfolios. The corresponding figure before the crisis was reported to be in the region of 70%.

Clearly if foreign investors who own 70% of the shares traded on the stock exchange, for one reason or another, sell a certain portion of their shares, this will cause a collapse on our stock exchange just as on external markets.

However, one point needs to be stressed: the main problem on external markets is stock exchanges; our main problem is foreign currency.

Foreigners are not only selling shares on the stock exchange; they are also selling treasury bills and bonds.

It is worth repeating. External global developments are influencing these sales; the main reason is the increased country risk.

What is the country risk? (1) The current account deficit (external deficit) has grown. Turkey has reached the point at which it can no longer support this deficit. This means there is a reduced inflow of foreign currency. (2) If the inflow of foreign currency decreases, the exchange rate of foreign currency increases. Foreigners can no longer buy foreign currency at the rate at which they sold it and thus make a loss.

Against just this backdrop, foreigners are saying that’s enough profit for now and are selling their bonds and shares, even at a loss, to buy foreign currency.

The Central Bank, by raising interest rates and intervening with sales of foreign currency, is trying to control the rise in foreign currency exchange rates. But we are forgetting the fundamental problem. The fundamental problem is the current account deficit.

As foreign currency that previously entered Turkey begins to leave, this destabilises the exchange rate. When the exchange rate is destabilised, the exchange rate must find an equilibrium at a new level.

What I am now looking for is for the correction to halt somewhere and stabilise.

A fresh daily dose of adventure and disquiet threatens the future of the economy. We have to recover from this shock in a short space of time.

If foreign exchange rates had risen painlessly over the past three years and reached their current level, there would have been no problem. They could even have risen above today’s level.

Then the current account problem may also not have assumed such proportions. Because the floating exchange rate system has failed to function, three years later the need for an “accumulated correction” has appeared.

The culprit for the problems currently being encountered is not the “floating exchange rate system” but the “Central Bank’s high interest rate and low exchange rate” policy.

It is wrong to look at the current problems and condemn the “floating exchange rate system” or change the system.

The thing that currently needs changing is people’s heads.

What do we want? “Even if only temporarily”, do we think we can sustain a low foreign currency exchange rate?

The important thing is for the “correction” to pause for “breath”, for the exchange rate to stabilise at least temporarily at some point, and then for the “floating exchange rate” system to function unhindered.

This economy can cope with soft corrections in the exchange rate in response to supply and demand. But coping with accumulated corrections is tough and painful.

If the floating exchange rate system had been left to do its job, many things in Turkey would be very different today. (1) The current account deficit would not have grown so much. (2) Imports would not have increased so much; exports would have grown faster. (3) Turkish agriculture and production would not have suffered structural distortion; productive power would not have been weakened. (4) Employment would have grown.

Most importantly, the Turkish economy would not have run headlong into a wall.

The shock effect of the delayed correction has until now been responsible for many mistakes. Many people and companies took incorrect decisions. Risks were taken. Many companies and undertakings altered calculations and expectations with reference to the future.

Most important of all, the state’s calculations were turned inside out. The state’s calculations were based on 5% inflation, 10% interest and YTL 1.2 to the dollar. Now the government is forced to redo its sums on tax collection, expenditure and balancing the budget.

Let’s come to the most important point. What will happen now? Will the Central Bank continue its high interest, cheap foreign currency policy? More to the point, will it be able to? Or will amendments be made to the IMF-supported programme without abandoning the “floating exchange rate” system? Will import-driven growth be abandoned in favour of export-driven growth?

These are matters that currently require debate and clarification.