Monday, October 12, 2009

Weekly Hurriyet Column: A hitchhiker’s guide to the IMF-Turkey saga

Below is the unedited version of my column for this week. You can read the final version at the Daily News website. As usual, there is the cheesy movie reference, although I did not think much of this one.

With the IMF-Turkey saga looking more like a Brazilian soap opera everyday and market expectations changing by the hour, I will not like speculate on the deal, opting for a rough guide instead.

I should state my position upfront: I favor an IMF deal. But I do not think Turkey will sink without one; it certainly will not. It is just that a sans-program scenario will surely be more costly than one with program. This is a point Economics tsar Babacan has emphasized quite a few times as well. But when I say more costly, I am not only thinking about interest rates, which will definitely be lower than what Turkey could borrow from markets, but also about financing and credibility.

The recent normalization in Turkey’s Balance of Payments has led to a wide misconception that external financing is no longer an issue. It has been forgotten that the current and capital accounts summed up to a deficit of nearly 20 billion dollars from the Lehman collapse to the markets’ trough in March, which was mainly financed by the Central Bank, or CBT, running down reserves and UFOs, or unidentified financing objects. With an external financing requirement expected to approach 100 billion dollars next year, continuing with the same set-up is simply asking for trouble.

Even if all goes well on the external financing front, there is the risk that the banking system will not be able to accommodate the private sector’s needs. For one thing, with the high redemptions schedule, especially in the early months of 2010, Treasury borrowing could start to bite on lending. Moreover, the Central Bank’s liquidity injection into the system through open market operations has been running very high recently, ringing alarm bells that the liquidity shortage could be permanent this time around.

Rough banking sector balance sheet calculations and statistical analysis suggest that the annual nominal loan growth consistent with a 3.5-4 percent recovery next year would be 10-15 percent. If lack of liquidity in the system and allocation what is available into bonds clog the lending pipes, the CBT could have to resort to the dangerous road of buying bonds on the secondary market.

As for credibility, maybe it’s just me, but I just do not understand the argument that Turkey could do without an IMF program if fiscal discipline were sustained. Sure, it can if the markets buy it from a government who has a really bad recent fiscal track record, is facing elections in a year or two and therefore is completely time inconsistent in terms of fiscal policy. In fact, I doubt whether the markets would even buy a constitutional fiscal rule after the PM's candid remarks on his appetite for Central Bank independency. Anyway, the fiscal side of the Medium-Term Economic Program, or MTEP, has gone tangent to sustaining fiscal discipline, to use the PM's own Economics phrasebook, so this discussion is solely theoretical.

But things are not as bleak as they look. It is likely that the Fund is ready to accommodate Turkey more than ever. Evidence to this bold statement comes from the Fund’s aptly-named paper, Review of Recent Crisis Programs, which was presented at the IMF-WB Annual Meetings. While I summarized the presentation in my October 3 column, the key result regarding Turkey is that the fiscal easing allowed in the most recent 15 Stand-By Arrangements is only slightly tighter than that envisaged in the MTEP. Skipping such a good deal looks like a missed opportunity.

In the meantime, I am becoming extremely paranoiac when rumors of large IMF deals emerge just before large Treasury auctions. Maybe, I should reread the famous Lucas paper showing that governments cannot fool people as a tranquilizer.

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