Does improving the trade balance matter?
The inter-temporal YES, BUT NOT ALWAYS MUCH. approach goes beyond the Mundell-Fleming model, and as Maurice •bstfeld has put it, it gives us a tool for thinking about the interplay of external balance, external sustainability, and the equilibrium real exchange rate. Any approach that fails to take into account capital gains and losses on the net foreign asset position, i.e. valuation effects, would necessarily be misleading in a world of instantaneous financial capital flows.
WHY NOT?
The currently huge gross cross-holdings of foreign assets and liabilities make sure that asset price movements largely affect highly leveraged country portfolios.
Balance of payments reports the current account at historical cost, and the same consideration applies to the national income accounts. Nevertheless, for countries that either issue huge chunks of debt in foreign currencies, or for countries that hold large amounts of assets in foreign currencies –China and Japan are now good cases in point, it is imperative to take into account valuation effects.
TURKEY
Turkey more or less falls in this category. This is not because of its large foreign asset holdings, but because of its large F►-denominated debt. Furthermore, the standard inter-temporal approach not only overlooks the financial adjustment channel and focuses solely on the traditional trade adjustment channel it also by the same token downplays the role of risky investments and that of adjustment costs.
Therefore, the terms of trade only show that net exports may or may not contribute to growth in the long-run. The balance of payments per se only provides an account of how the international competitiveness unfolds. The current account only showcases the amount of F►-needs on a monthly basis. The financial account, including valuation effects, determines the final verdict.
WHY IS GROWTH NOT SUSTAINABLE?
It isn’t sustainable and it is also low quality for a number of reasons, first because earnings are low. Earnings are low because productivity is low. Net profits are also low because firms are heavily indebted, in both F► and TL terms, and EBITDAs don’t translate into the bottom line to shore up equity capital. Add to these the impact of the outbreak. Many sectors are practically closed. Growth isn’t sustainable, second, because equity capital is weak, F► and TRY debt is taking its toll, and the vicious cycle continues. The other side of the coin is that because capital is scarce given high growth and prosperity ambitions – with a retrograde and deteriorating education and university system, things get worse day by day - it all depends on foreign capital inflows, mostly portfolio inflows. If the financial account deteriorates, growth falls. They go hand in hand. Adding insult to injury, if the policy mix is wrong and if the financial account is going sideways, reserves are depleted, except of course episodes of somehow booming net errors & omissions. There is also concern about the rule of law and doing business. Hence, FDI is nothing compared to the financial account.
A TYPICAL MIDDLE INCOME TRAP, BUT EVEN WORSE
This is a typical middle-income trap. Unless Prometheus is unbound by chance, it warrants a conscious government-driven all-encompassing initiative. The private sector alone can’t do it; it has proven this incapacity many times. The private sector is not only myopic, but it is dependent on subsidies, tax amnesties, credit guarantee funds, selected incentives – mostly conditional upon political affiliations - and suchlike. Even worse, the private sector itself struggles to survive these days, and can’t orchestrate a technologically-driven investment wave well-ordered within a comprehensive macro framework. Portfolio inflows don’t help much either. The trend
wise decoupling from EMs over the last 8 years is now clearly visible. There is never a sudden stop, reminiscent of the 1990s, but the ‘slow death’ endures. Because old generation EM crises are now out of joint with financial realities, the new trend is a slow decay. Everything takes time now. There may be a reversal in 2021, because the CBRT is on track, but to what extent can a partial comeback of portfolio investments remedy all these vulnerabilities? Could exchange rate stability alone do the trick? No, and not even this question poses itself because it can’t be rendered sustainable as we have witnessed over the last couple of months.
FX DEBT, LOST RESERVES, AND THE SMALL CONSOLATION OF TOURISM
The first policy problem concerns developed economies and some developing economies that do have low levels of F► debt or that don’t depend on commodity exports or tourism. This is a monetary policy issue. Just how long and how deep should easing be and should nominal interest rates turn to negative? The U.S. won’t resort to negative nominal rates so easily although even that is on the table. The second problem is a balance of payments issue. Countries where capital flights abound and reserves are low or exports leave a lot to be desired or tourism falters face that problem.
In such economies the real rate of interest is of prime importance. Monetization wouldn’t necessarily trigger demand but it would help. There may be an inflationary aftermath if sterilization leaves a lot to be desired, but this is conditional upon a truly recovering demand. Nonetheless, negative real interest rates can distort equilibrium. •verseas investors are continuing to sell – USD 670 million in the week of June 5-12. Non-residents now hold 52% of equities and 5% of bonds, the lowest over the last decade. Also, the ex post real rate has ordinarily been below the ex ante rate. This means inflation has consistently been above expectations. The 12-month real rate is deep in negative territory.
Faced with the second type of (currency) problem, there is no way negative ex post real interest rates can do the trick. Even ex ante they are negative. Negative real rates aren’t suitable if one is in dire need of foreign currency. The exchange rate can only temporarily stabilize given the loose policy stance. Capitalizing public banks is good, but is it wise to continue selling precious reserves? •ne thing is certain though: tourism revenues will be low again but net exports will increase relative to 2020. Suppose these two items amount to a USD 20 billion loss relative to 2019. Add to this the reserves sold, and you come up with a sum total of at least USD 70-80 billion. Well what next? Could swaps cover that loss? Can anyone tell the upper limit in the USD/ TRY rate?
WHAT DOES IT MEAN?
•ver the last 8 years everything has changed. An over-appreciated exchange rate turned back to normal after 2008, and then the real effective rate depreciated as a trend. When the TRY appreciated, and the exchange rate pass-through fell, that is between 2003 and 2008, we could not lower inflation. We missed the chance of below 5% CPI in 2009 also. After 2013, the lira depreciated visibly among its peers. The pass-through stayed between 12-15%, and it is even higher today probably. What was gained is lost big time. The current surge in inflation is also due to that, due, but not entirely due. It is also because credit card and consumer loan growth went up very fast. The recovery of Q3 2020 was predicated on spending, not exports and not investments. And now it will be payback time. As such dollarization can never end. It looks tame from time to time only because risk appetite is high or the expected real rate of interest is sufficiently high or other investment venues become popular. The “six million dollar question” of the 2021-22 will again be the answer to the exchange rate conundrum. It raises inflation, and it adds insult to injury in terms of firm balance sheets. Now they will export, and try to keep afloat through sheer turnover.
FINALE
Asset dollarization coupled with debt dollarization-cum-F► denominated public and private debt, and a complete lack of usable net reserves for at least 4-5 years to come has totally endogenized the rate of interest. It isn’t a policy variable any more. Hence, there is no way to cut it. Such an option doesn’t exist, and ought not to be voiced for at least a year. And the Fed cavalry is on horseback, too.