Denial is not just a river in Egypt. The Turkish government is displaying a worrying lack of concern about the turmoil in its markets.

It may be right. As Credit Suisse points out, the time to buy Turkish assets has traditionally been after periods of currency weakness and interest rate volatility. There are good reasons for believing that the Turkish economy is more resilient than at other crucial turning points in the past. Two home-grown factors have compounded the impact of the global sell-off in emerging markets. Political risk has increased following controversy over the appointment of a central bank governor and the murder of a prominent judge. The main trigger, though, was last month’s unexpectedly sharp rise in inflation, to nearly double its 5 per cent IMF-backed target. Although worrying, this should be put in the context of the dramatic improvement in Turkey’s economy over recent years. Economic growth was over 7 per cent in 2005. This year’s foreign direct investment receipts, encouraged by structural reform, privatisations and Turkey’s potential membership of the EU, may be double last year’s $8.6bn. This could finance two-thirds of the large current account deficit.

Therein lies the rub. Turkey, as a small open economy, is still highly vulnerable to changes in external sentiment. Although debt ratios have improved, the public sector remains very susceptible to exchange rate and interest rate volatility, in part because of the short maturity structure of much of its borrowing. Inflation, in turn, responds quickly and sharply to currency weakness.


Whether the current uncertainty turns into a crisis will depend on policy makers’ response. The central bank on Wednesday raised interest rates by a credibility-sustaining 175 basis points. With Turkey on a knife-edge, denial is definitely not an option.

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