Vulnerable growth and to-do list for post-election period

Turkey's March deficit was $9.8 billion, up from $5.5 billion a year earlier. The annual CAD, on the other hand, reached $60.5 billion in March of this year, compared to the $48.6 billion observed in 2010. The bad part of the story is that only $9.2 billion was financed by FDI. The April figures will not be any better than that. That's why $9.6 billion fled the İstanbul Stock Exchange (İMKB) during the second and third weeks of May alone.

Now, the question is how we reached this point. After the global financial crisis, the Turkish government and the Central Bank of Turkey implemented successful policies to control the budget deficit and inflation. Such monetary and fiscal policies resulted in a very successful recovery period. The share of foreign debt in the government's debt decreased to 1 percent and the overall debt to gross domestic product (GDP) ratio is around 40 percent, which means the government does not have any problems financing the debt.

Loan availability and strong consumer confidence led consumers to spend and the private sector to invest. The main source of growth in Turkey in 2010 was domestic consumption. Loan expansion was heavily financed by international funds which were made available via expansionary policies implemented in the developed world to get out of the crisis. So the liquidity in the international system found a place in the developing world, including Turkey, for a profit.

As long as those funds are available to emerging markets, the Turkish CAD will be easily financed as well. However, a maturity mismatch and short-term funds has made the central bank enact policies to limit loan expansion and control the CAD indirectly while keeping interest rates low so as not to attract more international funds.

Starting last November, a policy mix of low interest rates and higher reserve requirements has been implemented. Initial reactions were seen; however, it's still too early to say whether this policy mix will limit loan expansion. As a second step, the bank has already announced in the stability report published on Monday that they will decrease the amount of US dollars purchased daily from $50 million to $40 million. This is another step forward to help decrease liquidity. More steps can be taken on this front and they expect to see a response in the third and fourth quarter of this year.

The Turkish banking system and private sector at this point do not have any problems finding international funds. So a CAD at this level with strong fiscal performance and low government debt will not cause a short-term problem for the Turkish economy. But confidence is deteriorating and the post-election period is a good time to start with constructive structural reforms.

Fiscal discipline needs to be part of this reform. Exchange rate policies may be reconsidered thoroughly before facing a loss of the competitive edge in different sectors. However, the exchange rate itself cannot be considered the source of instability. That will not solve the problems of the economy.

Turkey has wasted too much time on developing a coherent energy policy. About 70 percent of the deficit is due to energy imports. Nuclear energy, renewable energy, hydropower and all sorts of energy sources should be used without wasting any more time on developing a strategy.

An export-led growth model is good, but a coherent strategy for decreasing the share of imported products in the manufacture of final goods should also rapidly be put in place. Turkey is lacking a competitive edge in several sectors without making it up for it with high-value-added products. Daily policies will not solve long-term problems. Market diversification is important. Outreach to new markets like Africa and East Asia should be a critical part of any strategy. But a more critical approach would be to develop an industrial strategy and to use the country's strongholds to increase welfare.