Slides from 2016 PK Conference

1. TRADITIONAL AND NEW FORMS OF
EXTERNAL VULNERABILITY:
Capital flows, credit expansion and economic
growth in Turkey
Özgür Orhangazi Gökçer Özgür
Kadir Has University, Istanbul
ozgur.orhangazi@khas.edu.tr
Hacettepe University
gozgur@hacettepe.edu.tr

2. Main argument:
Despite the post-2001-crisis structural reforms based on orthodox
policy suggestions, the external vulnerabilities of the economy did
not disappear.
1.The major risk is still a capital flow reversal.
2.Furthermore, new forms of external vulnerability also emerged in
this period
3.More importantly, vulnerabilities in the economy are not limited
to the external balances.

3. Main conclusion:
Sources of vulnerabilities have increased, making it fundamentally
more difficult, if not impossible, to foresee all the effects of a
potential negative shock

4. Capital flows and crises literature
Three generations of crisis theories
 First-generation models were based on the idea that the origin of the
vulnerabilities lied in the weak domestic economic fundamentals of the DEEs
(Krugman 1979).
 Second-generation theories focused on the trade-off between economic
fundamentals and the maintenance of fixed exchange rate regimes in these
countries (Obstfeld 1996).
 Third-generation models developed after the 1997 Asian financial crisis
argued that external debt accumulation, liability dollarization and insufficient
foreign exchange reserves were the main reasons behind financial crises in
DEEs (Radelet et al. 1998, Rodrik and Velasco 1999, Calvo et al. 2004, Bordo
2006).
 Also, mistaken economic policies led to information asymmetries and moral
hazard (Krugman 1998, MacKinnon and Pill 1998).

5. Capital flows and crises literature
Policy conclusions:
 maintaining strong domestic economic fundamentals
 decreasing government borrowing requirements
 strengthening the financial sector, particularly the banking sector
 switching to flexible exchange rate regimes
 increasing the level of foreign exchange reserves.

6. Turkey in 2000s
A series of structural reforms were introduced after the 2001 crisis,
following mostly the policy suggestions of the orthodox economics
literature.
 The government budget deficits were brought under control through
primary budget surpluses and extensive privatizations
 banking system was reformed in an effort to increase its resilience
 attempts to fix the exchange rate were abandoned and the Central
Bank began increasing its foreign exchange reserves
 Introduction of central bank independence was followed by the
adoption of tight monetary policy and inflation targeting.

7. External vulnerabilities
-80000
-60000
-40000
-20000
0
20000
40000
60000
80000
-10%
-08%
-06%
-04%
-02%
00%
02%
04%
06%
08%
10%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Real GDP growth
Current account
balance as a
percentage of
GDP
Net private capital
inflows (million $)

8. External debt
19%
24%
28%
23%
19%
15% 14%
11% 11%
14% 12% 12% 13% 14% 15% 16%
9%
6%
5%
5%
6%
8% 11%
11%
10%
11% 12% 12%
15%
18%
20%
22%
12%
15%
13%
11%
10%
9%
12%
14% 15%
17%
14% 14%
14%
14%
15%
18%
0%
10%
20%
30%
40%
50%
60%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Government external debt stock/GDP
Banks external debt stock/GDP
NFC external debt stock/GDP

9. Foreign exchange position of NFCs
-30%
-20%
-10%
0%
10%
20%
30%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Net foreign exchange position of NFCs/GDP Domestic borrowing in foreign exchange/GDP

10. International investment position
-60%
-55%
-50%
-45%
-40%
-35%
-30%
-25%
-20%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

11. Central Bank reserves
Gross reserves/Short-term external
debt
Net reserves/Short-term external
debt
2000 69.4% -10.6%
2001 114.3% -91.7%
2002 162.7% -29.9%
2003 146.2% -10.8%
2004 111.8% 1.7%
2005 129.8% 36.4%
2006 142.0% 44.7%
2007 165.2% 68.7%
2008 133.4% 65.9%
2009 142.1% 69.6%
2010 104.5% 63.0%
2011 96.0% 48.5%
2012 100.1% 43.2%
2013 85.9% 30.2%
2014 80.7% 28.1%
2015 93.1% 28.6%

12. Bank credit to private sector
-25%
-15%
-5%
5%
15%
25%
35%
45%
55%
65%
75%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

13. Borrowing by sector
0
10
20
30
40
50
60
70
80
90
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Government debt/GDP Household debt/GDP NFC debt/GDP

14. 0
2
4
6
8
10
12
14
16
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Private nonfinancial sector debt service ratio
Private nonfinancial sector debt service ratio

15. Banks
0%
20%
40%
60%
80%
100%
120%
140%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
BCPS/Deposits

16. Conclusion(s)
 Containment of a negative shock is more difficult as the fragilities
do not lie only in the government budget or the banking sector
but are more dispersed in the economy.
 Given the finance-led nature of economic growth, even in the
absence of a shock, a slowdown in credit growth is likely to
generate problems for the economy.
 The combination of traditional and new forms of external
vulnerabilities with domestic ones makes it more difficult to
foresee the chain reactions.