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November 05, 2012, Monday

Depreciation is hardly a tool for competitiveness

Since Turkey adopted a flexible or floating exchange rate regime in the aftermath of the 2001 crisis, one observes quite frequent ups and downs in the value of the Turkish lira.

We can count in both directions at least eight separate episodes of dramatic changes exceeding 10 percent, some of them being close to 30 percent, between 2003 and today. The two main factors behind this instability does not constitute the subject of this article; nevertheless, I can just note them for your information: The first one is the high volatility of speculative capital flows, the famous "hot money" that depends on investor mood and expectations about the economic conjuncture and economic policies that are, in turn, also highly volatile. The second factor is the inflation difference existing between Turkey and its trade partners. Albeit Turkish inflation has run under 10 percent since 2005, there still exists an inflation gap of five-six percentage points per year. This requires a correction in the nominal exchange rate (the value of the Turkish lira against the US dollar/euro), but this correction is not smoothly done but by fits and starts.

When the lira starts appreciating, exporters also start complaining about the “overvalued lira," arguing that they cannot compete with prices in international markets. However, when silence prevails in the exporters' camp, you can conclude, without checking the statistics, that the lira depreciates. So, we should expect at least that during depreciation periods, Turkish export prices decrease in terms of the dollar or euro in order to give a push to the competitiveness of exports. However, it does not seem to be the case. Recent research published by the Bahçeşehir University Center for Economic and Social Research (BETAM) [“Exchange rate changes are not reflected in export prices” by Zümrüt İmamoğlu, in Turkish but very soon in English also] points out that export prices are “quite rigid,” or if you like, quite insensitive to real exchange rate changes.

Taking into consideration the last episode of exchange rates moving down and up, BETAM's research shows that from October 2010 to August 2011, driven by the new monetary mix of the central bank, the lira depreciated by 18.5 percent at a time when the real appreciation had reached 37 percent compared to its 2003 level. But in the same time period, the ratio of producer prices to export prices decreased almost by the same magnitude (19.1 percent), indicating that exporters did not decrease their prices in terms of the dollar and the euro. To put it simply, this means that our exporters -- instead of using the opportunity of depreciation for gaining competitive strength -- preferred increasing their profits as export prices in the lira rose much more than the costs. From August of last year to July of this year the lira appreciated by 12.4 percent in real terms, mainly because of inflation differences, but again export prices did not move that much, meaning that this time exporters accepted giving up some of their extra profits.

Should we blame Turkish exporters for this “insincere” behavior? I do not think so. The case of appreciation episodes is quite understandable. Exporters cannot increase their prices in terms of the dollar or the euro since they face, indeed, severe price competition in world markets, particularly regarding the export of consumer goods based on medium-level technologies, which is the case for the majority of Turkish exports; during periods of appreciation their profit margin evaporates slowly but decisively. So, the rising complaints of the exporters cannot be considered crocodile tears during these times. That said, in the opposite case, when the lira depreciates, exporters are able to decrease their prices in terms of the dollar or the euro according to the difference existing between import price-cost increases and export price rises in terms of the lira. But it seems that they don't.

How to explain this attitude? I believe that the critical point is to know whether the value of the depreciated lira will be long lasting or not. In other words, it is important to know if the real exchange rate will be stable at its depreciated level. If exporters perceive that this is a transitory phenomenon, it is rational to not touch the quite rigid export prices, as they are not set in daily markets. Indeed, it would very difficult to increase them when the lira starts appreciating again. But if exporters consider that the depreciated lira will last for years, then they can seize this opportunity in order to gain market share.

Maintaining a depreciated lira, in other words a stable real exchange rate at a competitive level, is not, unfortunately, an easy task since it necessitates narrowing the inflation gap to 1-2 percentage points, at least. We are not there yet. But also it necessitates neutralizing the adverse effects of excess capital flows on the nominal exchange rate; we do not know exactly how to do it at the moment.

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