Friday, November 7, 2008

Anchoring to the IMF

Suna Reyent has a well-written article at Seeking Alpha. While the article's main point of interest, as its title suggests, is whether or not Turkey needs an IMF anchor, Suna goes on to discuss other issues of relevance as well. Here are my random ramblings on some of the interesting arguments from her article:

I would have agreed with Suna that Turkey would not have needed an IMF program, if in fact other market-soothing/signaling mechanisms were in place or if I could have been sure that capital flows would not dry up and foreigners would not have to flee Turkey after a country-specific shock or, more likely, another bout of global risk aversion. Simply put, other mechanisms aren't in place, and the PM's populist remarks on the IMF are not helping either. Note that with Dr. Doom still predicting that the worst is to come and the father of currency crises reporting a likely hard landing in EM in the coming months, I can not say with confidence that the worst is behind us. Moreover, add the weakening demand and tigthtening credit and exporters faced with a global slowdown to Turkey's well-known vulnerabilities. I am convinced that the latest Fed and IMF initiatives made an IMF program a necessary condition to sail the crisis with minimum damage, but the long list of vulnerabilities means that it may not be a sufficient condition either...

One argument Suna makes against the IMF anchor is that Turkey doesn't need the money because high interest rates will keep the money flowing in. Leaving aside the signaling effect of an IMF program, I beg to disagree because i. nominal interest rates are high, real rates are not that high. ii. When there is a sudden stop and capital flight, all EM will be likely affected regardless of the interest rates. Speaking of interest rates, my main disagreement is with her high interest-overvalued currency argument. Specifically, she notes:
My pet theme has been about bashing the Central Bank of Turkey regarding their decision to keep a high level of interest rates. I have been writing about the “hot money” that has been pouring into the Turkish markets, and specifically about the fact that Turkish authorities have knowingly and consciously advocated the inflow of such money in order to sustain a growth rate that depended upon cheap financing of imports via an overvalued currency.
I know I am damaging my credibility by referring to someone who was in the control room for most of the so-called high interest-overvalued currency era, but his arguments are very similar to mine- for a more rigorous treatment, see here.

Being involved in risk management, Suna also makes a very interesting point:
Such capital flights and the ensuing devaluation of the currency need NOT cause severe damages within an economy as long as preventive risk management techniques and necessary liquidity valves (for emergencies) have been instituted throughout the economy.
Unfortunately, such measures are almost non-existent in Turkey. At my stint as a bank economist, I was shocked by the small volume of currency derivatives in Turkey [footnote: For Suna or anyone else interested, looking at the determinants of FX derivatives market development a la this paper would really be a very interesting exercise]. In fact, Suna concurs that firms outside of the financial sector have not instituted the kinds of risk management procedures that banks have. And it is the absence of liquidity valves that has prompted some of the more thoughtful Turkish economists on suggesting mechanisms aimed at providing a lifeline to consumer and business credit such as bank guarantees and incentives for making loans.

No comments: