Thursday, December 2, 2010

Reader Comment/Question on capital flows

Blog follower David Rogovic asks a very valid question on the effect of tight fiscal policy, as a response to a recent post on the subject:
Do you think that tightening fiscal policy could actually attract more capital flows into Turkey? For example, if Turkey tightens fiscal policy next year (or maintains decent fiscal balances) that could prompt a ratings upgrade which would make Turkey even more attractive in the eyes of investors. In this scenario, tighter fiscal policy could actually spur even more 'hot money' inflows.
Definitely, but at the end of the day, investors care about the return they are getting. So I see two opposing effects playing out and the lower nominal interest rate winning out.

The game changer here would be investment grade, which is not out of the question if the markets' darling AKP wins another term, there is no major political/geopolitical crisis and the government does not make a fiscal mess in the run-up to the elections. But that would open up Turkey to a whole new breed of investors, more longer-term guys like pensions that are not in for the short haul. So these new guys would not exactly be hot money, although they would not be as safe and sound as FDI, either- sort of "warm money":) In fact, I see a great research note on how Turkey's composition of portfolio (not capital!!!) flows would change under investment grade using EPFR data!!!

Another big game changer would of course be global capital flows. On that we don't know anything!!! But there is also the question of Turkey's growing CA deficit, the other side of the capital flows coin, which has started to emerge on investors' and Turkey economists radars. The more the CA deficit and associated capital flows, the more likely you'll end up with a major destabilizing sudden stop/reversal at some point, right?

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