Journal Issue

Turkey: Selected Issues and Statistical Appendix

International Monetary Fund
Published Date:
February 2000
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IV. Turkey’s External Currentaccount42

A. Introduction

88. Over the past 15 years, Turkey’s external current account has undergone a remarkable transformation, with both current receipts and current expenditures increasing in dollar terms almost fivefold, against a threefold increase in U.S. dollar GNP during the same period. By 1998, current receipts had reached US$63 billion and current expenditures US$61 billion—together amounting to some 60 percent of GNP (Table 1). This process of trade deepening, spurred by the opening of the economy in the mid-1980s and the customs union agreement with the European Union (EU), has not always been even, however. At times, imports have increased by more than 50 percent (following a decline of 24 percent), while export growth rates have occasionally reached 20–30 per year. The largest current account deficit recorded during the 1990s was in 1993, on the eve of the balance of payments crisis, when the deficit reached US$6.4 billion (3.5 percent of GNP),43 caused primarily by a 30 percent surge in imports, associated, in part, with an appreciation of the real exchange rate.

Table 1.Key Items of the Current Account, 1985–98(in billions of U.S. dollars)
Total Receipts13.4026.4528.0729.3731.1733.1742.5751.5258.7762.75
Total recipts excluding shuttle trade13.4026.4528.0729.3731.1733.1742.5742.6852.9259.06
Exports f.o.b. in trade returns8.2613.0313.6714.8915.6118.3921.9823.6026.7827.53
Shuttle trade0.
Travel (Credit)
Interest (Credit)0.300.920.941.011.140.891.491.581.902.48
Other (Credit)1.774.795.725.776.696.489.657.4012.3716.14
Workers’ remittances1.713.252.823.012.922.633.333.544.205.36
Other transfers0.
Total Expenditures14.4129.0827.8230.3437.6030.5444.9053.9661.4560.88
Merchandise Imports f.o.b.11.2322.5821.0123.0829.7722.6135.1943.0348.0345.55
Interest (Debit)1.753.263.443.443.573.924.304.204.594.82
Other (Debit)1.433.233.383.824.264.015.416.738.8310.50
Current Account-1.01-2.630.25-0.97-6.432.63-2.34-2.44-2.681.87
(Growth rates; in percent per year)
Total Receipts15.920.
Total recipts excluding shuttle trade15.917.
Exports f.o.b. in trade returns11.710.
Shuttle trade-33.8-36.9
Travel (Credit)99.626.1-17.737.
Interest (Credit)
Other (Credit)5.924.219.30.916.1-3.248.9-23.367.230.5
Workers’ remittances-5.16.8-13.26.7-3.0-
Other transfers-1.8140.782.8-53.9-19.2-45.2151.4-22.6-26.1-44.5
Total Expenditures8.635.4-
Merchandise Imports f.o.b.8.741.1-7.09.929.0-24.155.722.311.6-5.2
Interest (Debit)10.512.
Other (Debit)5.325.84.513.211.3-5.734.924.331.218.9

89. This chapter examines the sources of volatility of Turkey’s external balance, with a view to assessing the “sustainable” current account deficit and, relatedly, the level of the real exchange rate. The chapter is organized as follows. Section B looks at the main sources of volatility of the current account. Section C presents some empirical estimates of the key elasticities governing the behavior of exports and imports. Section D turns toward a calculation of the sustainable current account and trade deficit, based on the criterion of stabilizing the ratio of net debt-to-GDP. Section E uses the estimated elasticities of Section C to calculate the maximum real exchange rate appreciation consistent with achieving a sustainable current account deficit. Section F concludes.

B. Structure of the Current Account

90. Turkey’s external current account transactions now amount to about US$125 billion per year, on a dollar GDP of about US$200 billion. In 1998, current receipts were US$63 billion, and current expenditures about US$61 billion, yielding a current account surplus of US$1.8 billion (or about 1 percent of GNP); Table 1.

91. Key exports include textiles, apparel, and leather products; iron, steel and associated products; and tools and machinery (Table 2). The main destination markets are the EU and the United States. The Russian market, which gained importance in the 1990s (becoming the fourth most important market for Turkish recorded exports), has since collapsed in the aftermath of the Russia crisis in August 1998. Imports, consisting mainly of industrial inputs, are also mostly from the EU and the United States (Table 3).

Table 2.Destination and Composition of Exports(In thousands of U.S. dollars)
West Germany1,390,989West Germany3,063,574Germany5,460,333
Iran1,079,882Italy1,106,319United States2,233,347
Iraq961,374United Slates967,622England1,739,619
United States505,992France736,799Russia1,348,002
Saudi Arabia430,123Iran495,482Holland888,601
Holland213,317Saudi Arabia338,427Spain513,231
Switzerland128,374Libya220,541Saudi Arabia473,868
Articles of iron or steel968,773Articles of apparel and clothing accessories knitted1,443,591Articles off apparel and clothing accessories knitted4,233,920
Cotton556,295Iron and steel1,328,953Articles of apparel and clothing accessories, not knitted2,476,314
Edible fruit527,552Articles of apparel and clothing accessories, not knitted1,187,069Electrical machinery and equipment1,847,475
Articles of apparel and clothing488,147Edible fruit995,414Iron and steel1,589,502
Articles of leather, saddlery and harness, travel goods469,930Articles of leather, saddlery and harness, travel goods676,082Edible fruit1,294,275
Reactors, boilers, machinery377,653Cotton, cotton yarn and cotton fabrics587,778Reactors, boilers, machinery1,163,948
Mineral fuels and mineral oils376,788Electrical machinery and equipment475,775Other made-up textile articles, sets, worn clothing933,738
Tobacco and manufactured tobacco substitutes330,454Tobacco and manufactured tobacco substitutes442,359Vehicles other than railway or tramway797,369
Articles of apparel and clothing accessories knitted312,157Vegetables394,823Cotton, cotton yam and coton fabrics783,846
Vegetables267,449Salt, sulphur, earthst, stone, lime, cement318,776Man-made staple fibres671,006
Man-made filaments243,970Preparations of vegetables, fruits, nuts304,113Articles of iron or steel662,102
Salt, sulphur, earthst, stone, lime, cement233,211Mineral fuels and mineral oils296,347Preparations of vegetables, fruits, nuts621,134
Live animals175,940Articles of iron or steel280,277Tobacco and manufactured tobacco substitutes589,861
Man-made staple fibres166,109Man-made staple fibres274,704Plastics and articles there of437,869
Vehicles other than railway or tramway138,340Other ready-made textile articles, sets, worn clothing267,689Salt, sulphur, earthst, stone, lime, cement413,754
Source: Data provided by the Turkish authorities.
Source: Data provided by the Turkish authorities.
Table 3:Origin and Composition of Imports(In thousands of U.S. dollars)
West Germany1,368,789West Germany3,496,831Germany7,316,337
Iran1,264,655United Stales2,281,647Italy4,221,740
United States1,150,064Italy1,727,064United States4,053,750
England468,431Saudi Arabia723,628Spain1,276,378
Belgium-Luxembourg235,029Switzerland536,647South Korea1,124,195
Saudi Arabia226,231Belgium-Luxembourg522,732Switzerland1,017,738
Mineral fuels and mineral oils3,779,837Mineral fuels and mineral oils4,622,407Reactors boilers, machinery8,927,832
Reactors boilers, machinery1,550,501Reactors, boilers, machinery3,778,476Mineral fuels and mineral oils4,509,461
Articles of iron or steel1,059,754Electrical machinery and equipment1,663,894Electrical machinery and equipment4,401,424
Electrical machinery and equipment663,472Iron and steel1,613,339Vehicles other than railway or tramway3,727,576
Vehicles other than railway or tramway489,877Vehicles other than railway or tramway1,117,970Iron and steel2,769,416
Organic chemicals483,945Organic chemicals868,996Plastics and articles there of1,943,004
Inorganic chemicals312,173Plastics and articles there of562,986Organic chemicals1,626,640
Plastics and articles there of246,406Cereals560,584Optical, photographic, cinematographic1,144,685
Animal or vegetable fats and oils215,623Optical, photographic, cinematographic304,465Cotton, cotton yam and cotton fabrics994,752
Aircraft, spacecraft and parts196,319Inorganic chemicals376,113Aircraft, spacecraft and parts797,532
Fertilizers183,156Tanning, or dyeing extracts and their derivatives344,748Man-made filaments781,818
Cereals182,538Tobacco and manufactured tobacco substitutes337,195Pharmaceutical products720,403
Optical, photographic, cinematographic149,947Articles of iron or steel307,471Paper and paperboard, articles of paper pulp719,259
Miscellaneous chemical products134,117Cotton, cotton yarn and cotton fabrics303,801Tanning, or dyeing extracts and their derivatives669,482
Wool, fine or coarse animal hair, horsehairAnimal or vegetable fats and oils303,138Articles of iron or steel649,006
yam and woven fabris98,131
Source: Data provided by the Turkish authorities.
Source: Data provided by the Turkish authorities.

92. Both current receipts and expenditures tend to show a high degree of volatility. On occasion, imports have risen by as much as 55 percent in a given year (admittedly, following the recovery from the 1994 crisis), and merchandise exports have risen by 20 percent (even excluding shuttle trade).44

93. In terms of assessing vulnerability of the current account, therefore, it is useful to begin by identifying which components of the current account are subject to the greatest volatility, Table 4 decomposes the volatility of current receipts and expenditures into sub-components, weighted by their shares in receipts and expenditures, respectively. Thus, even though unrequited transfers, workers’ remittances, and interest credits individually show a high degree of volatility, their low weights make them relatively unimportant as sources of volatility of the current account itself.

Table 4.Sources of Volatility of the Current Account
Growth rates (in percent per year)Avg.Std.Var.SharesWeighted

Variance 1/
Volatility 2/
Total receipts
Total recipts excluding shuttle trade12.810.5111100740.40
Exports f.o.b. in trade returns10.310.511153310.51
Shuttle trade
Travel (Credit)23.531.196912130.64
Interest (Credit)26.535.11,232310.64
Other (Credit)19.622.751420210.57
Workers’ remittances10.022.65121050.84
Other transfers16.865.74,322330.94
Total expenditures12.717.02891002890.64
Merchandise Imports f.o.b.13.021.1443772620.72
Interest (Debit)8.46.4421000.37
Other (Debit)16.311.61351320.34
Sources: Turkish authorities; and Fund staff estimates.

Variance multiplied by shares in total receipts and total expenditures, respectively. Does not sum to variance of total receipts and expenditures due to covariation of components.

Volatility: 1-(μ222))

Sources: Turkish authorities; and Fund staff estimates.

Variance multiplied by shares in total receipts and total expenditures, respectively. Does not sum to variance of total receipts and expenditures due to covariation of components.

Volatility: 1-(μ222))

94. Indeed, on current receipts, the key components of current account volatility are (i) merchandise exports; (ii) other service credits; and (iii), much less important, tourism receipts. On the expenditures side, merchandise imports account for virtually all of the volatility. In what follows, we focus on the behavior of merchandise exports and imports, both because they are the most important in terms of volatility of the current account and, it turns out, the most sensitive to real exchange rate movements.

C. Modeling Exports and Imports

95. The structural changes in the economy, the relatively short data series available, and the massive swings in both exports and imports present particular challenges for econometric estimation. The modeling strategy, therefore, is to estimate key elasticities using standard times series methods, rather than developing a full structural model, which would require estimating a large number of parameters and impose greater demands upon the data.

Import function

96. Real import demand (dollar value of imports deflated by the dollar price index) is assumed to depend upon economic activity and the real exchange rate. Economic activity is proxied by real GDP, while three different measures of the real exchange rate are used: a CPI-based measure (the INS index); a private manufacturing price-based measure (PMP); and relative unit labor costs (RULC). The data are quarterly, covering the period 1988:1–1998:4. Estimation of the long-run relationship is undertaken by the Johansen procedure, while the short-run dynamics are modeled using an autoregressive distributed lag (ARDL) representation.

97. Table 5 (left-hand panel) presents the estimated elasticities and the eigenvalue statistics of cointegration. The null of no cointegration is rejected strongly both the maximum and trace statistics (Reimers small sample statistics are reported). Consistent with the trade deepening which has occurred over the past decade, the point estimates of the activity variable are extremely high, at around 2.5 to 2.8. The estimated real exchange rate elasticities, on the other hand, are quite low and vary widely from 0.05 to 0.5, according to the index used.

Table 5.Long-run Relationships, Johansen Estimates
Import FunctionsExport Functions
1. CPI-based REER1. CPI-based REER
Real GDP2.560Foreign Real GDP1,870
2. PMP-based REER2. PMP-based REER
Real GDP2,760Foreign Real GDP1,300
3. Relative Unit Labor Costs3. Relative Unit Labor Costs
Real GDP2,550Foreign Real GDP1,580

98. Table 6 turns to the short-run dynamics. Again, the activity elasticity is high, ranging from 0.6 to 1.7 depending upon the specification, while the short-run real exchange rate elasticity is significantly higher than the corresponding long-run elasticity, at about 0.7. Both the activity and real exchange rate coefficients are significant at the 5 or 1 levels.

Table 6.Short-Run Dynamics
Import Functions 1/Export Functions 1/
1. CPI-based RBER0.4041. CPI-based REER
Δ Real GDP1.5303.79**Δ Foreign Real GDP0.7600.800
Δ CPI-Reer0.7003.62**Δ CPI-Reer-0.3701.96*
2. PMP-based REER2. PMP-based REER
Δ Real GDP1.6923.96**Δ Foreign Real GDP0.9180.998
Δ PMP-Reer0.8402.74**Δ PMP-Reer-0.3801.280
3. Real Unit Labor Costs3. Real Unit Labor Costs
Δ Real GDP0.6001.74*Δ Foreign Real GDP1.6001.650
Δ RULC0.5413.91*Δ RULC-0.4153.12**

Seasonal dummies, time trend, and lagged level variables included but not reported.

Seasonal dummies, time trend, and lagged level variables included but not reported.

99. Despite the model’s simplicity, its overall fit model is satisfactory, with the R2 around 0.87, and a correlation between actual and fitted values of +0.92. That said, the time series plot (Figure 1) shows that the model can account only partially for the surge of imports in 1993 (on the eve of the balance of payments crisis) when imports rose by almost 30 percent in the space of one quarter whereas the model predicts “only” a 14 percent increase (the model also underpredicts the degree of forced adjustment in 1994).

Figure 1.Turkey: Imports and Exports, 1990–98

Source: Fund staff calculations.

Export function

100. Analogous to the import function, real exports are assumed to depend upon foreign economic activity and the real exchange rate. Foreign activity is proxied by real GDP in the United States and Germany45; for the real exchange rate, the same three series as above are used.

101. Again, the null of no cointegration is strongly rejected. Long-run activity elasticities are perhaps surprisingly high, at around 1.3 to 1.8, while the real exchange elasticity ranges between –0.5 and –1.3.

102. Turning to the short-run dynamics, the activity elasticity ranges from 0.7 to 1.6 (but is only marginally significant statistically), while the real exchange rate elasticity ranges from –0.37 to –0.42 (and is statistically significant). The fit of the export function is also satisfactory, with the R2 around 0.82, and a correlation between actual and fitted values of +0.91. A comparison of the time series of actual and fitted values (Figure 1) does not suggest particular anomalies.

103. Finally, for the analysis below, the impact of a real exchange rate appreciation on dollar export prices, which depends upon the pricing behavior of exports, is required. This elasticity is estimated, again using the ARDL representation, to be 0.35 (t-statistic: 2.93**).

104. In summary, the simple time series models perform relatively well in accounting for movements of both exports and imports, yielding short-run elasticities broadly in line with those of other countries.46 The long-run activity elasticities, however, are implausibly high—interpreted literally, they would imply that eventually imports (exports) would exceed domestic (foreign) GDP. Clearly, the estimation sample covers a period of tremendous trade deepening in Turkey and the elasticities will eventually decline.

D. Sustainability of the Current Account

105. As is well known, the standard intertemporal solvency criterion—that the present value of absorption be less than the present discounted value of production, net of initial debt—implies implausibly sustainable debt-GDP ratios.47 An alternative approach to calculating the maximum sustainable current account deficit is to use some sort of rule-of-thumb, based either on time series for the country, or on cross-country evidence.48 Thus the current account deficit of 3.5 percent of GDP in 1993 proved unsustainable (a deficit close to the rule-of-thumb proposed by Milesi-Ferretti and Razin as the trigger level that eventually necessitates and abrupt reversal). Yet a third approach, adopted here, is to define a sustainable current account deficit as one which stabilizes the net external debt-to-GDP ratio. While this is a rather conservative criterion, it seems appropriate given the relatively high debt-to-GDP ratio of Turkey already.49

106. The starting point is the end-1997 level of debt, about US$92 billion, against central bank reserves of about US$20 billion, and commercial banks’ foreign assets of US$10 billion, yielding net debt of US$62 billion and a net debt-to-GDP ratio of about 32 percent.50

107. Calculating the “sustainable” current account deficit, as defined above, requires only assumptions about the real growth rate of the economy and the real exchange rate (or, equivalently, the growth rate of dollar GDP).51 Real GDP growth is assumed to average 5 percent per year (slightly below the average for 1990–98), while the equilibrium real exchange rate appreciation arising from productivity increases are assumed to average 2 percent per year.

108. Since the real exchange rate determines the trade balance, the next step requires linking the current account deficit to the trade balance via assumptions about net interest payments and transfer receipts (mainly workers’ remittances).52 Net interest payments are driven by the endogenous stock of net debt and the net interest rate. The latter is calculated by the historical ratio of net interest payments to net debt, which in 1997 was 4.3 percent. As this seems low, for the purposes of the projections the effective real interest rate is taken to be 6 percent.53 Finally, the dollar growth rate of transfers is assumed to be 5 percent per year (slightly below the average for the period 1990–98).

109. Table 7 delineates the baseline projection as well as a number of sensitivity scenarios (higher interest rates or lower GDP and transfers growth). The projections suggest that the balance on goods and nonfactor services could range between 2.0 percent and 3.0 percent of GDP while keeping the net debt-to-GDP ratio constant. The corresponding current account deficit ranges between 1.6 percent and 2.6 percent of GDP—a full percentage point of GDP below the current account deficit witnessed in 1993. As noted above, to the extent that there are FDI flows, the equilibrium current account deficit can be correspondingly larger, while maintaining the same net external debt to GDP ratio (though not the net external liabilities to GDP ratio).

Table 7.Trade Balance Required to Stabilize Net Debt/GDP
Scenario 1: Baseline
Interest rate (percent per year)
Transfers (percent growth per year)
Real GDP (percent growth per year)
Real exchange rate (percent growth, per year)
Current account (percent of GDP)-2.14-2.14-2.14-2.14-2.14-2.14-2.14-2.14
Balance good and nonfactor services (percent of GDP)-2.99-2.94-2.89-2.84-2.79-2.75-2.70-2.66
Net external debt (percent of GDP)31.6731.7131.7531.7831.8231.8531.8731.90
Scenario 2 (higher effective interest rate)
Interest rate (percent per year)
Transfers (percent growth per year)
Real GDP (percent growth per year)
Real exchange rate (percent growth per year)
Current account (percent of GDP)-2.10-2.10-2.10-2.10-2.10-2.10-2.10-2.10
Balance good and nonfactor services (percent of GDP)-2.00-1.95-1.90-1.86-1.81-1.77-1.73-1.68
Net external debt (percent of GDP)31.6331.6331.6331.6431.6431.6431.6431.65
Scenario 3 (low GDP growth and transfers growth)
Interest rate (percent per year)
Transfers (percent growth per year)
Real GDP (percent growth per year)
Real exchange rate (percent growth per year)
Current account (percent of GDP)-1.60-1.60-1.60-1.60-1.60-1.60-1.60-1.60
Balance good and nonfactor services (percent of GDP)-2.47-2.42-2.37-2.32-2.27-2.22-2.17-2.13
Net external debt (percent of GDP)31.7031.7731.8431.9131.9732.0332.0932.15
Scenario 4 (high GDP growth)
Interest rate (percent per year)
Transfers (percent growth per year)
Real GDP (percent growth per year)
Real exchange rate (percent growth per year)
Current account (percent of GDP)-2.63-2.63-2.63-2.63-2.63-2.63-2.63-2.63
Balance good and nonfactor services (percent of GDP)-3.16-3.12-3.07-3.03-2.98-2.94-2.90-2.85
Net external debt (percent of GDP)31.6131.5931.5731.5631.5531.5331.5231.51
Sources: Turkish authorities; and Fund staff estimates.
Sources: Turkish authorities; and Fund staff estimates.

E. Toward an Equilibrium Real Exchange Rate

110. In 1998, Turkey’s current account was in surplus to the tune of 1 percent of GDP (corresponding to a deficit of 0.75 percent of GDP on the balance of goods and nonfactor services).54 In part, this presumably reflects an “undervaluation” of the real exchange rate. But it also reflects the slowdown in economic activity which served to lower the level of imports. Assessing the current level of the real exchange rate in relation to its “equilibrium” value, therefore, requires cyclically adjusting the trade balance.

111. Totally differentiating the trade balance (measured in U.S. dollars) yields:

where asterisks denote values measured in U.S. dollars, x and m are the volumes of exports and imports respectively and where use of the assumption that the country is small in its import market has been made. A real exchange rate appreciation on export volumes should be negative but the effect on export prices, if any, should be positive.55 Higher foreign output raises exports. A real appreciation increases the volume of imports, as does higher domestic demand.

112. Estimates of potential output suggest that the output gap in 1998 was in the order of 2.5 percent, while the output gap in Turkey’s trading partners was perhaps 2 percent. Applying the elasticities in Table 6, therefore, suggests that the deficit on the goods and nonfactor services balance of 0.75 percent of GDP would, in fact, be close to a deficit of 1.0 percent of GDP (Table 8). Assuming a larger output gap—4 percent—raises the estimate of the underlying deficit to 1.5 percent of GDP.

Table 8.Underlying Dollar Trade Balance and Impact of Real Appreciation
10 pet.10 pet10 pet10 pd10 pet
BaseBase10 pet.20 pet.real appr.real appr.real appr.real appr.real appr.
largereal appr.real appr.largehighhighlowhigh
GDP (in millions of US$)203,833203,833229,822250,715233,185229,822229,822229,822229,822
Real exch. (proj. - r(t))
(ηpq+ηxq) x real exch. rate0.000.000.00-0.010.00-
ηxy* ygap*
9. Real exch. (proj. - r(t))
ηmq x real exch. rate0.
ηmyx ygap0.
Trade balance-1,502-1,502-1,502-1,502-1,502-1,502-1,502-1,502-1,502
(in percent of GDP)-0.74-0.74-0.65-0.60-0.64-0.65-0.65-0.65-0.65
Trade balance + d(trade balance)-1,983-2,992-6,070-10,157-7,079-7,270-7,751-6,724-7,891
(in percent of GDP)-0.97-1.47-2.64-4.05-3.04-3.16-3.37-2.93-3.43

113. The projections in Table 8 show that a 10 percent average real appreciation (together with closing of the output gaps) would deteriorate the trade deficit to 2.6 percent of GDP, while a 20 percent real appreciation would bring the trade deficit to 4.1 percent of GDP—rather larger than the sustainable trade deficit estimated above; a 15 percent real appreciation would result in a trade deficit of 3.4 percent of GDP, or just over the maximum sustainable deficit in the “high growth” projection (Table 7, scenario 4).

114. How sensitive are these results? The right-hand panels consider a 10 percent real appreciation under alternative assumptions about the key parameters. Increasing the output gap to 4.0 percent, for instance, suggests that a 10 percent real appreciation would be associated with a trade deficit of 3.0 percent. Sensitivity analysis on the estimated elasticities (varying them by about 1 standard error around the central estimate) yields trade deficits of about 2.9 percent to 3.4 percent of GDP (right hand panel of Table 8), or around the maximum sustainable in the “high growth” scenario if the real exchange rate appreciates by 10 percent from its 1998 average value. If FDI flows are 0.5 percent of GDP, this lowers the “debt-creating” deficit to 2.5 to 2.9 percent of GDP, sufficient to stabilize the net external debt to GDP ratio even in the baseline scenario (Table 7, scenario 1).

115. Taken as a whole, the results suggest that the lira could appreciate by about 10 percent from it’s 1998 average while remaining consistent with a sustainable current account deficit. Of course, this is only the initial “undervaluation:” beyond the 10 percent real appreciation, higher productivity growth in the tradeables sector (relative to nontradeables) should allow for a couple of percentage points of real appreciation per year on account of Balassa-Samuelson effects.

F. Summary

116. The economic liberalization and the customs union agreement with the EU has resulted in substantial trade deepening in Turkey. Nonetheless, as the 1994 balance of payments crisis underscored, the external accounts remain vulnerable, particularly when confidence is weakened by a sizable monetary expansion and the resulting overheating of the economy.

117. Rather simple econometric trade models perform reasonably well, accounting for much of the observed movements of imports and exports, and even for part of the import surge in 1993 which was later associated with the balance of payments crisis.

118. Based on these econometric estimates, and using the criterion of stabilizing the net debt-to-GDP ratio, the analysis in this chapter suggests that Turkey’s real exchange rate was “undervalued” by about 10 percent in 1998.

Prepared by Atish R. Ghosh (PDR).

The dollar value of GNP in 1993 is overstated by overvaluation of the exchange rate. In terms of 1994 (post-devaluation) dollar GNP, the current account deficit in 1993 was over 5 percent.

Growth rates are for U.S. dollar values. Since price and quantities tend to be negatively correlated, the corresponding growth rates generally show a higher degree of volatility. Shuttle or “suitcase” trade with countries of the Baltics, Russia, and other former Soviet Union countries (BRO) mushroomed in the early 1990s, reaching almost US$9 billion in 1996, before declining dramatically in the wake of the Russia crisis; see SM/98/196 (7/23/98) Annex II for a description of shuttle trade.

Using the G7 real GDP with Turkey’s export weights, or the first principal component of the G7 real GDP growth rates does not perform as well.

On export elasticities, see Abdelhak Senhadji and Claudio Montenegro, “Time Series Analysis of Export Demand Equations—A Cross-Country Analysis, IMF Working Paper 98/149

For instance, if the minimum “subsistence” level of absorption is 75 percent of GDP, and the real interest rate exceeds the real growth rate by 2 percent per year, the maximum debt-GDP ratio consistent with intertemporal solvency would be 12.5.

See Gian Maria Milesi-Ferretti and Assaf Razin, “Current Account Reversals and Currency Crisis-Empirical Regularities,” IMF Working Paper 98/89.

Turkey’s external debt-GDP ratio would be classified as moderately indebted according to the World Bank classification, and at the very upper-end of medium indebted countries according to the EBRD classification for the net external debt-GDP ratio.

Other foreign assets of the private sector are difficult to track and are ignored here.

If the objective is to stabilize the net debt to GDP ratio, then an assumption about the behavior of nondebt creating flows is also required. Thus foreign direct investment can finances a current account deficit without increasing the country’s net external debt. However, if the objective is to stabilize the ratio of net external liabilities (debt or nondebt), then only the current account deficit is relevant. In Turkey, FDI flows have been very small, typically less than 0.5 percent of GNP, and are ignored in the analysis below (to the extent that the objective is taken to be stabilization of net debt to GNP, and FDI flows increase, the equilibrium current account deficit can be correspondingly larger.

Implicitly, the real exchange rate elasticities for services are assumed to be the same as for merchandise goods. In fact, the estimated elasticities are much lower for services, so the calculation of the equilibrium real exchange rate below is a conservative estimate.

One reason for the estimated net interest rate being low is that the country’s net debt is overestimated inasmuch as there are private sector foreign assets that are not being captured.

Exports of goods and nonfactor services are defined as current receipts minus interest payment minus transfers; imports of goods and nonfactor services are defined as current expenditures minus interest payments. Since components of current receipts and expenditures other than merchandise trade tend to be less sensitive to real exchange rate movements (in Turkey), the deterioration of the trade balance arising from a real appreciation, calculated below, is probably overstated.

Consider a firm that has a markup μ, then ep* = μc(e), where c(.) is the cost function (which may depend upon imported inputs) and e is the nominal exchange rate (increase: depreciation). Totally differentiating: dp*/p* = [ηcμ – 1]de/e where ηc and ημ are the exchange rate elasticities of the cost function and the firm’s markup, respectively. If there are no imported inputs and no mark-up ημ = 0, then the export price measured in U.S. dollars falls one-for-one with the exchange rate depreciation (dp*/p = –de/e). More generally, if a share (l-β) of costs reflect imported inputs, then dp*/p* = –βde/e.

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