The impossible Trinity test

If a curious person looks at the foreign exchange regime that was liberalized in 1989, which in turn paved the way for the free movement of capital, he or she can observe the following: 

It is free to bring in forex and transfer foreign currencies abroad. Such transactions do not require any permission from the authorities. This is not an issue subject to arbitrary decisions by the executive power. This is also true for the Turkish lira. The bank must report transactions exceeding $50,000 to the Treasury and that is all. This is not about imposing limitations but a method.

You do not need to seek any permission if you transfer money abroad through banks. Such transactions are, however, are registered for statistical purposes and determining the nature of the transaction. You can do anything with the foreign currencies you transfer abroad; you can make investments or deposit the money with a bank. You can buy stocks or bonds in any country or invest in any instrument. You can “park” your money in any country. There are no constraints.

According to decree no. 32, “residents in Turkey may freely keep foreign exchange; purchase foreign exchange from and sell foreign exchange to banks, authorized exchange offices, PTT, precious metal brokerage institutions and establishments abroad that are authorized to sell and buy foreign exchange; hold foreign exchange in their foreign exchange accounts with banks; use foreign currency banknotes and make deposits in banks in Turkey and abroad.” It further states “residents in Turkey and non-residents may freely transfer foreign exchange abroad through banks.”

Moreover, if you are an exporter or active in the tourism industry and your revenues are in foreign currency, you can keep your foreign exchange in a foreign bank. You do not have to convert your forex into the Turkish lira as had been the case before the decree was issued.

The amendments made in the law regarding the protection of the value of Turkish currency and decree no. 32 issued in 1989 were truly a revolution in the realm of economy: The Turkish economy was opening up.

When then Prime Minister Turgut Özal made those decisions, bureaucrats had some doubts, asking “if Turkey was ready for this.” Over the past 29 years, the capital liberalization system has taken such deep root in Turkey that it cannot be reversed now. It is not possible to impose bans.

Following the liberalization of capital movements, Turkey adopted the floating exchange regime in 2001.

What do we see if we look at the data regarding the international investment position, which is a stock indicator for capital movements in the period from 2002-2009 and 2009-2017?

The data shows the amount of foreign direct investments in Turkey declined after 2009.

While the pace of change in investments by locals in foreign countries has accelerated, their portfolio investments abroad have not been changed. The value of other investments (bank deposits and loans) declined by $5 billion in 2017 compared to 2009. Thus, we cannot answer “yes” to the question of whether “capital is leaving Turkey.” However, outgoing direct investments in Turkey are continuing.

The main problem here is the fact that foreign direct investment (FDI) inflows have been declining. In the first seven years, FDIs increased by $127 billion whereas they rose only $36 billion in the following eight years. The rise in the value of the current stock is related to the exchange rate effect that occurs when certain assets and liabilities denominated in lira are converted to foreign currencies.

A country that fails to increase its FX assets but its FX liabilities rise rapidly feels the pressure from the exchange rates, whichever you chose—the U.S. dollar, gold or the Polish zloty. The exchange rates inevitably rise if you keep interest rates low when capital movement is free and exchange rates float freely. There are times we are testing all of these.