Is Turkey going to be the next sudden stop– A case of Financial and Political bubble..

Prof. Sebnem Kalemli-Ozcan of University of Maryland has this nice piece in voxeu.

She has this interesting thing on political bubbles which rhymes with India story:

Political bubbles are likely to form during periods of political stability and strong government support. Research has shown that, in the past, emerging-economy crises are preceded by a strong increase in government support (Herrera et al. 2013). On average, in emerging markets, government stability increases by more than 50% in the five years prior to major crisis events. The AK Party’s support over the last five years was around 50%.

One explanation for such a pattern is that in emerging economies, people assign a larger importance to the government in driving economic performance. This increases the incentives of governments to delay reforms, since reforms will reduce popularity, and with less popularity the chances of being re-elected are lower. Hence political bubbles and financial bubbles can go together during periods of stability and growth. Domestic credit growth helps to stimulate the economy in the short run, but can also lead to a bubble in asset prices, mostly likely in the real estate sector – especially in the absence of any domestic structural reform.

Well, it is a pity that econs have marginalised the role of politics in economics. Politics is supreme. Most financial bubbles have a political backing (or based on political bubble as the author says)…

So Turkey also has this political party called AK Party (ironically means clean and pure in Turkish) has been running into scams which keep growing bigger:

A case in point is Turkey, which might very well be the next ‘sudden stop’. During the last decade, under the AK Party government, Turkey enjoyed political stability and resilient growth that averaged 5% annually. Turkey earned praise from financial markets and economists alike until recently, when it was put on Morgan Stanley’s so-called ‘fragile five’ list together with Brazil, India, Indonesia, and South Africa. All of these countries have experienced a slowdown in growth and other vulnerabilities. Turkey seems to be the most fragile with the biggest current account deficit – this stood at 7.5% of GDP as of November 2013, and is mostly financed by short-term volatile capital flows.

The situation became more alarming with the major corruption scandal that is currently unfolding. Allegedly, several high-level officials, sons of ministers, top businessman, and mayors were involved in extensive graft, in which development projects which acted as a catalyst to Istanbul’s and other urban centres’ growth were shadowed by large bribes. The AK Party (AK means clean and pure in Turkish) has made transparent governance and the fight against corruption their key motto. According to the prime minister, this is the key reason for the political stability and growth that they have provided to the country during the last decade.

The last decade was a political bubble in the sense that no major structural, institutional, or legal reform had occurred (Kalemli-Ozcan 2013). It would not be surprising if there has also been a financial bubble. The prime minister’s initial reaction to the corruption charges did not suggest that there had been any institutional reform in the past decade, especially in judicial and legal institutions. The government sacked 70 top police chiefs and passed a law that restricts prosecutors from conducting probes without approval. Journalists are blocked from accessing the police, and are being asked not to report anything that would compromise the investigation in any way.

So this political and financial bubble in Turkey created chaos as the taper word echoed in May 2013 leading to large scale depreciation much like other EMEs..

Financial crises are generally preceded by credit booms and a build-up of external debts. Although it is unclear whether Turkey is experiencing a financial bubble, as of 2013, 58% of the corporate sector’s debt was denominated in foreign currencies. This column argues that this explains the Central Bank of Turkey’s interventions to prop up the value of the Turkish lira. Given the relatively low level of reserves and the unfolding corruption scandal, it is a critical question how long the Bank can continue to do so.

Not much different from India..though our figures of corporate sector debt in foreign currencies should be lower.

How quickly Turkey lost flavor with macro guys is also amazing. Not too long ago we were lectured by former CEA Kaushik Basu that we should try and look at Turkey’s monetary policy etc..

Nice bit..

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