Global Credit Supply and External Exposure in Turkey

Abstract

Present study investigates the link between net capital inflows and the current account balance in Turkey. Using monthly data for the period of 2002-2014, we provide evidence that higher capital inflows are associated with larger deficits in the current account. We include two alternative measures of the net inflows – the financial account and foreign liabilities of the banks in Turkey. The paper analyzes this relationship under the different model specifications with a number of control variables that capture both domestic and external factors. We also show that imbalances in the current account are highly responsive to the fluctuations in the real exchange rates, mostly triggered by the changes in capital flows. The Granger causality test reveals one-directional causal link from the financial account to the external balance but not the reverse. Given exogenous character of the global capital and random nature of the developments in the financial account, high inflows to Turkey have been creating high exposure and fragility of its external balance. Our findings highlight on the importance of the macro-prudential policies to monitor short-term inflows and on minimization of destabilizing effects of the real exchange rate fluctuations on the external account in Turkey.