Sustainability of current account deficit with high oil prices: Evidence from Turkey 1

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1 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 Susainabiliy of curren accoun defici wih high oil prices: Evidence from Turkey 1 Erkan Özaa ABSTRACT Curren accoun defici as a raio of GDP is a commonly used measure ha deermines he susainabiliy of curren accoun deficis. Bu oher facors such as he composiion of he curren accoun defici, he mehods which are used o finance i, exchange rae policy, macroeconomic condiion and global economic oulook may also have imporan implicaions abou he fuure of curren accoun deficis. The curren accoun defici in Turkey is regarded as srucural because of he dependence of Turkish producion and expors on impored inermediae goods. Anoher facor affecing he curren accoun defici is he changing oil prices which is a cyclical componen. Turkey s reliance on energy impors is a major facor behind is bloaed curren accoun defici. The radiional approach o invesigae he improvemen of he exernal imbalance is based on he impor and expor funcions. Differen from his approach in his sudy a Srucural Vecor- Auoregression (SVAR) model will be applied o invesigae he effecs of fuel impors and foreign exchange policy on Turkey s curren accoun defici and economic growh. This model will allow us for simulaneous examinaion of he link beween real oil impors, real effecive exchange rae, domesic income and he curren accoun. Key words: Curren Accoun defici, Susainabiliy, oil price, exchange rae, SVAR JEL Classificaion: C32, E10, F21, F41 Auhor Erkan Özaa : Anadolu Universiy Yunusemre Kampusü, 26470, Eskişehir, Turkey. Ciaion Erkan Özaa (2014). Susainabiliy of curren accoun defici wih high oil prices: Evidence from Turkey. Inernaional Journal of Economic Sciences, Vol. III, No. 2/2014, pp This paper is a revised version of he one presened during he 8h Inernaional Academic Conference, which was held in Sepember , in Naples Ialy organized by IISES. I am graeful o he paricipans of he conference for heir valuable suggesions and commens. 71

2 Inernaional Journal of Economic Sciences Vol. III / No. 2 / Inroducion Susainabiliy of curren accoun deficis always drew aenion of he economiss. Curren accoun defici as a raio of GDP is a commonly used measure ha deermines he susainabiliy of curren accoun deficis. A widely used rule of humb is ha curren accoun deficis above 5% of GDP begin o raise doubs abou longerm susainabiliy. Bu oher facors such as he composiion of he curren accoun defici, he mehods which are used o finance i, exchange rae policy, macroeconomic condiion and global economic oulook may also have imporan implicaions abou he fuure of curren accoun deficis. Turkey is an oil imporing developing counry and here is a close relaionship beween oil impors and curren accoun defici. As a growing economy ha needs a lo of energy, niney percen of he oil ha Turkey uses has o be impored. Turkey s dependence on impored oil is hampering is growh and is likely o coninue doing so as he counry s prosperiy increases. In his sudy a Srucural Vecor-Auoregression (SVAR) model will be applied o invesigae he effecs of fuel impors and foreign exchange policy on Turkey s curren accoun defici and economic growh. This model will allow us for simulaneous examinaion of he link beween real oil impors, real effecive exchange rae, domesic income and he curren accoun. The balance of paymens of a counry is a sysemaic record of all economic ransacions beween he residens of he reporing counry and he residens of he res of he world over a specified period of ime. The balance of paymens allows us o invesigae he accouning relaionships beween inernaional flows of goods, services and financial asses. The BOP consiss of hree pars: Curren accoun (CA), Capial Accoun (KA) and Cenral Bank Reserves. When all componens of he BOP accouns are included hey mus sum o zero wih no overall surplus or defici. Curren accoun also shows he foreign currency balance of a counry. If here is a defici in a counry, his means ha i is consuming more foreign currency han i is earning. This gap in he foreign currency can be closed eiher by receiving loans from oher counries or by running down cenral bank reserves. The quesion if he curren accoun defici is harmful or no can be answered from differen perspecives. Curren accoun deficis may be beneficial because hey may enable more invesmens han previously observed. The invesmens flowing in from abroad leads o higher produciviy and higher living sandards. Also invesmen inflows from abroad are an implici voe of confidence by foreigners and can be regarded as a signal ha invesmen is safe. On he oher hand curren accoun defici may be harmful if increased sock of foreign owned asses in he counry leads o capial fligh during an economic downurn. In counries having curren accoun deficis policy makers and many economiss worry ha he deficis are oo large. There are roughly wo views concerning his idea: The firs is known as he Lawson docrine. According o his docrine o he exen ha curren accoun deficis reflec privae saving and invesmen decisions, ha here are no disorions, and ha expecaions are raional, hen here are no reasons for he 72

3 1998Q1 1999Q1 2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 governmen o inervene The second view could be called he prudenial" or he IMF" view. I is ha, even if deficis refleced privae saving and invesmen decisions, disorions are presen and lead o deficis ha are oo large. Governmen inervenion o reduce hese deficis is desirable (Blanchard, 2006). So he answer o inervene or no can change according o he specific form of disorions in he economy. The remaining par of he paper has been organized as follows. The curren accoun defici problem of Turkey will be summarized in he nex par. Then he lieraure review abou he susainabiliy of curren accoun deficis will be given. In he nex pars he economeric mehod, he daa and he model will be explained. Afer he esimaion resuls and heir inerpreaions he las secion concludes Curren Accoun Defici Problem of Turkey Turkey has experienced impressive economic growh following subsanial reforms afer he 2001 economic crisis. One remaining concern is he very large curren accoun defici, which hreaens he susainabiliy of his growh. Looking a he curren accoun over , Turkey experienced relaively small curren accoun deficis and even occasional surpluses during 1990s; on average he curren accoun balance was a lile smaller han -1% GDP, falling o -3.2% and -3.7% in he years before he 1994 and 2001 crises respecively. A differen rend emerged afer 2002, wih large persisen curren accoun deficis, which peaked in 2011 near -10% a level never before seen by he counry (Zaidi, 2012). Curren accoun balance had surpluses only in crises years of 1994, 1998 and 2001 where he lessening in he GDP decreases he impors for considerable amouns and narrows he rade defici (İnsel and Kayıkçı, 2012). The curren accoun defici is he economy s bigges vulnerabiliy even as i reduced he shorfall o abou 6 percen of gross domesic produc in 2012 from 10 percen in The cumulaive defici has widened in 2013 as growh gained momenum and is forecas o reach 6.9 percen of GDP in Figure 1: Curren Accoun Balance (% of GDP) CAD/GDP GDP Source: Cenral Bank of he Republic of Turkey 73

4 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 As much as he raio of curren accoun defici o GDP, financing mehods of he defici is also imporan. The curren accoun defici can be financed by capial flows. These capial flows can be in he form of foreign direc invesmens which can be regarded as permanen, he currencies coming o buy socks and bonds, foreign loans or unidenified money which can be colleced in he ne errors and omissions. If he amoun of foreign currency exceeds he demand for foreign exchange, he naional currency will appreciae, impors will increase and he curren accoun defici problem will coninue o grow even more in he following period. Also he danger of he fligh of shor erm speculaive capial ou of he counry in case of some emergency is always expeced. Foreign capial inflows ha are shor erm and speculaive in naure, however, may leave Turkey especially vulnerable o economic shocks if hey resul in sudden sops in capial inflows (Zaidi, 2012). In Turkey here were negaive developmens abou he way of financing of he curren accoun defici in he las years. The share of deb insrumens in financing has increased agains Foreign Direc Invesmen. FDI inflows, which are long-erm and relaively sable, comprised a significan porion of capial inflows earlier in he decade bu have since declined o only 50% of heir 2006 peak. According o he savings invesmen ideniy, invesmen mus be financed by some combinaion of privae domesic savings, governmen savings (surplus), and foreign savings (foreign capial inflows). Bu if he privae domesic savings are no enough he invesmen heavily relies on foreign capial inflows which resuls in curren accoun defici. For he las hiry years Turkey s naional savings rae has been lower han ha for counries wih similar levels of income. Since 1998 his rend has led o a widening savingsinvesmen gap. While invesmen has hovered around 20% of GDP on average, savings as a per cen of GDP declined from 24% in 1998 o 12% in Improved access o consumer credi reduces privae savings and negaively affec he curren accoun. Turkey s growing curren accoun defici depends on he impor of cheap consumpion and inermediae goods. The susained appreciaion of he lira during he pas decade which made impors cheaper coupled wih he shif of he economy owards a more capial-inensive producion increased he demand for inermediae inpus and worsen he rade imbalance (Zaidi, 2012). When he increase in impors is more han he increase in expors, he resul is a huge curren accoun defici. To overcome his problem, measures can be aken o cu he domesic demand growh of he economy can be slowed by sacrificing from high growh raes. As a resul when impors of consumpion and inermediae goods decrease, a emporary soluion o he curren accoun defici problem can be found. However o solve he curren accoun problem permanenly, some srucural changes in he producion ha ends he dependency of he economy o cheap impored inpus has o be realized. The main reason for he growh of he curren accoun defici is he use of more impored goods by consumers and producers as a resul of cheap foreign exchange. Also he fall in ineres raes and expansion of credi faciliies are he oher facors ha increase he demand for impored goods. To solve his problem, some srucural changes in boh producion and consumpion have o be made. Firs of all in he agriculural 74

5 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 and indusrial producion use of domesic inpus raher han impored inpus should be encouraged. Also consumpion of domesic goods insead of impored goods mus be simulaed. However, as long as he foreign exchange is pleniful and cheap self-realizaion of his ransformaion is no possible. For a susainable producion srucure, he creaion of a realisic exchange rae policy is necessary. If he producers and consumers believe ha his policy will be permanen, hey can change heir choices from impored goods o domesic producion. In Turkey he proponens of non-inervenion hinks ha he curren accoun defici has resuled from high growh raes of he economy. Kasman e.al. (2005) provide empirical evidence abou he ongoing discussion on he possible causes of curren accoun defici and show ha overvalued TL and economic growh are he main causes. Bu as long as he foreign asses would like o finance his growh here will no be any problem. Anoher hesis of hem is abou he sources of curren accoun defici. They hink ha he curren accoun defici is no semming from he public secor bu from he privae secor and he dynamic srucure of he privae secor can solve he problem by aking he necessary measures if required. Oher han hese ideas he nex imporan defense is abou he exchange rae sysem. In he floaing exchange rae sysem if he curren accoun deficis increase o he dangerous levels, exchange rae will auomaically make he necessary correcion wih an increase. Turkey s heavy reliance on impored energy and inermediae goods is a key challenge for reducing he curren accoun defici. According o he Cenral Bank of he Republic of Turkey every 10 dollar increase in oil prices increases curren accoun defici by $ 5.6 billion and pull down he growh rae by 0.5 percen. Depending on developmens in he Middle Eas, Syria and Iran, oil prices in 2013 are expeced o be high. For his reason i is no possible for Turkey o decrease he curren accoun defici wihou reducing he nonenergy curren accoun defici. To his end, he economy has o be slowed down and growh has o be sacrificed. In he curren siuaion, i does no seem very possible o decrease curren accoun defici wih high growh raes and high oil prices. A curren accoun defici of abou %10 of he naional income always creaes a quesion mark on he inernaional invesors. This high rae may resul in he escape of ho money which is used o finance he curren accoun defici. 2. Lieraure Review The curren accoun deficis of Turkey are mainly he resul of foreign rade deficis raher han anyhing else. As menioned by İnsel and Kayıkçı (2012) hese kinds of deficis are more dangerous in erms of susainabiliy and more open o debae abou balance of paymen crises since hey indicae srucural weaknesses in inernaional rade and compeiiveness. Dalgin (2012) finds ha long erm susainabiliy of he Turkey s curren accoun is very quesionable bu concludes here is no immediae risk assuming Turkey can mainain is curren growh. Özlale and Pekkurnaz (2010) analyzes he impac of oil prices on he curren accoun balances for he Turkish economy using a srucural vecor auoregressive model. The resuls 75

6 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 show ha he response of curren accoun raio o oil price shock increases gradually up o he firs hree monhs and hen sars o decrease, which indicaes a significan effec of oil price shocks in he shor run. During he las decade sudies abou he susainabiliy of curren accoun defici have focused mainly on coinegraion relaionship beween impors and expors. (Narayan and Narayan 2005; Arize, 2002; Irandous and Ericsson, 2004). If here is a coinegraion relaion beween expors and impors hen foreign rade defici is emporary and he curren accoun defici is susainable in he long run. Also differen empirical approaches have been used o measure he seriousness of he curren accoun defici problem. Glick and Rogoff (1995) rely on srucural esimaion of he model and focus on he esimaed responses o various ypes of shocks. Ghosh and Osry (1995) use vecor auoregression analysis o esimae he consumpion smoohing curren accoun. Edwards (2005) assigns paricular imporance o he deb o GNP raio and nominal GNP growh rae. He noes ha very few counries have had persisenly high curren accoun deficis for more han five years and ha hisorically imbalances end o be shor lived and followed by curren accoun adjusmen. Narayan (2013) uses a four dimensional SVAR model o invesigae he implicaions of fuel impors and devaluaion policy on Fiji s curren accoun deficis and economic growh. The paper finds ha shor erm deerioraion of he curren accoun is parly due o higher fuel impors. Zaouali (2007) invesigaed he chinese economy and find ha increasing oil prices have modes effecs on he curren accoun since he economy could arac foreign capial and invesmen. Baharumshah, lau and Founas (2003) examines he susainabiliy of he curren accoun imbalances for four ASEAN counries (Indonesia, Malaysia, he Phillippines and Thailand) over he period. They found ha he curren accouns of hese counries were unsusainable and did no move owards exernal accoun equilibrium. Moreover, he persisen curren accoun deficis migh serve as a leading indicaor of financial crises. The evidence also sugges ha acion o preven large appreciaions should have aken prior o he 1997 crises. Milesi-Ferrei and Razin (1996) found ha a specific hreshold on persisen curren-accoun deficis (such as 5 percen of GDP for hree o four years) is no in iself a sufficienly informaive indicaor of susainabiliy. The size of curren-accoun imbalances should insead be considered in conjuncion wih exchange-rae policy and srucural facors such as he degree of openness, he levels of saving and invesmen, and he healh of he financial sysem. Mussa (2005) has emphasized ha large persisen US exernal paymens deficis on he order of 5 percen or more of US GDP are no susainable in he longer erm and ha imporan macroeconomic adjusmens will be needed, in he Unied Saes and in he res of he world, in order o bring hese exernal imbalances down o susainable levels. 3. The SVAR Mehod In his par firsly he empirical model will be inroduced. Then he concepual framework of he relaionships beween curren accoun defici, oil impors, real income and real exchange rae will be drawn. 76

7 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 The effec of oil prices on he curren accoun defici and naional income will be invesigaed by using Srucural Vecor Auoregression (SVAR) mehod. SVAR models are used o examine he relaionship beween he macroeconomic variables and dynamic effecs of sochasic shocks on he sysems of equaions. In he SVAR mehod o idenify he sysem, no ordinary consrains bu, consrains from macroeconomic models ha are consisen wih he heory are used. Thus o overcome he problem of idenificaion, insead of illogical consrains, consrains wih heoreical background are used and more meaningful resuls are obained. The SVAR mehod uilized here will provide us o invesigae he relaionship beween oil impors (OIM), real effecive exchange rae (REER), Gross Domesic Produc (GDP) and Curren accoun (CA). SVAR model requires o apply enough number of consrains o obain he srucural componens of he error erm. If we sar wih he reduced form VAR model Y AY ApY p u (1) Here Y is he variables vecor of 4x1. The variables used in he model are impors o oal impors, domesic produc, REER which is he real effecive Exchange rae, OIM which is he raio of oil RGDP which is he real gross CA which is he raio of Curren accoun defici o naional income. All he variables used in he analysis are saionary. (RGDP becomes saionary afer we ake he firs difference. So i is used in he firs difference form) A i s are coefficien marixes of ( K K ) and p represens he lag lengh of he VAR model. u is a 4x1 vecor and represens he residuals derived from he model. The error erm of he reduced form VAR model u, can be wrien as a linear combinaion of srucural shocks 1 u A B, (2) Here B represens he srucural form parameer marix. Afer puing equaion (2) in equaion (1) and making some arrangemens, we can ge he srucural form of he reduced form equaion (1) : Here * * AY A1Y 1... ApY p B (3) * A j is 4 4 coefficien marix and defined as A A A j p 1 * j j ( 1,2,... ). is a 4x1 vecor which represens srucural shocks and have he propery of (0, I ). Therefore srucural covariance marix E( ) is an ideniy marix. This model is known as AB model and wrien as: Au B, (0, I ) (4) K Wih four endogenous variables OIM, REER, RGDP and CA; he srucural shocks can be defined as oil price shocks, exchange rae shocks, naional income shocks and curren accoun shocks. In A and B marices K 77

8 Inernaional Journal of Economic Sciences Vol. III / No. 2 / which are symmerical of order 4x4 here are 32 ( 2K ) unknowns. Therefore in order o deermine unknowns in he A and B marices 2 K K( K 1) addiional consrains are necessary In he model wih 32 unknowns maximum 10 parameers can be deermined by he sysem. Therefore we need 22 addiional consrains o jus idenify he sysem. These consrains are provided by zeros and ones in he marices. In order o esimae he model zero exclusion consrains are used and he elemens of he marix esimaed by he sysem are represened by s. The oher values in A and B marices are consan. Sims (1980) makes he marix A lower riangular by ordering he elemens of i. The elemens in he main diagonal of marix A are 1 and all he enries above he main diagonal are 0. Economiss have adoped wo approaches as a basis in deermining he addiional consrains. These are he use of shor erm and long erm consrains. Sims (1980) preferred he shor erm consrains and deermines he elemens of marix A above he main diagonal as zero. Because he hough ha he effecs of economic shocks have a naural iming. For example afer a shock in price level he lack of insan response from he moneary policy can be represened by puing zeros o he appropriae places in marix A. Similarly he iming of ax collecion can be used as a corporae consrain for idenificaion (Blanchard & Peroi, 2002). The populariy of long erm consrains is provided by Blanchard and Quah (1989). They have invesigaed he effec of demand and supply shocks on unemploymen and oupu. They have idenified he models by using he long erm consrains such as demand shock do no have any long erm effec on unemploymen and oupu bu alhough supply shock do no have an effec on unemploymen in he long run, i may have an effec on he level of oupu. 3.1 Variable Definiions and Daa Sources Quarerly daa beween he firs quarer of 1998 and he fourh quarer of 2012 is used in he analysis. The variable called OIM is he raio of crude oil impors o oal impors of Turkey. The value of crude oil impors unil he year 2002 is obained from Turkish Saisical Insiue (TUIK). Bu value of crude peroleum has no been shared because of he confidenialiy since he beginning of So he daa afer 2002 is calculaed manually by using he quaniy of crude oil impors in barrels and he price of crude oil per barrel in he world marke. Toal impors of Turkey are obained from he cenral Bank of he Republic of Turkey and are used for calculaing he raio. REER is he real effecive exchange rae index ha measures he movemens in Turkish Lira wih respec o he counries which are in a commercial relaionship wih Turkey. The daa for REER is obained from he Cenral Bank of he Republic of Turkey. RGDP is he real Gross Domesic Produc of Turkey calculaed wih 1998 prices. The daa which is obained for his series from he Cenral Bank is in Turkish Liras. The daa is hen convered o US Dollars by using he average exchange rae of US Dollar/TL. As seasonaliy is observed in he naional income series, i is seasonally adjused wih Tramo Seas before using in he analysis. CA is he raio of Curren accoun defici o GDP and i is calculaed wih he daa obained from he Cenral Bank of he Republic of Turkey. All he variables excep he CA is used in he naural logarihm form. 78

9 Inernaional Journal of Economic Sciences Vol. III / No. 2 / Descripive Saisics The descripive saisics of he variables used in he model are repored in able 1. As can be seen from he able during period he raio of curren accoun o GDP is -3,6 % on average. There was an ongoing defici in he curren accoun afer he year In he same period he raio crude oil impors o oal impors of Turkey was 7,07 % on average. According o he resuls of Jarque Bera Tes all he series are normally disribued. Table 1: Descripive Saisics OIM CA REER RGDP Mean Median Maximum Minimum Sd. Dev Skewness Kurosis Jarque-Bera Probabiliy Observaions In order o have some prior informaion abou he relaionship among he variables he correlaion marix in able 2 is calculaed. According o his marix, a posiive correlaion beween oil impors and curren accoun, a sronger negaive correlaion beween naional income, real effecive exchange rae and curren accoun is deermined. Table 2 : The Correlaion Marix CA OIM RGDP_SA REER CA OIM RGDP_SA REER Uni Roo Tes The assumpions of he classical regression model necessiae ha he ime series ha are used in he model mus be saionary and he errors have a zero mean and a finie variance. In he presence of nonsaionary variables, here migh be wha Granger and Newbold (1974) call a spurious regression. To es for uni roo 79

10 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 we apply Augmened Dickey Fuller (ADF) es on each variable. The ADF es consiss of esimaing he following regression: i i i1 m Y Y Y (1) Where is a pure whie noise error erm. The null hypohesis of he ADF es is 0 which means ha he series has a uni roo and is non-saionary. The alernaive hypohesis is 0 which means ha he series is saionary. As SVAR mehod requires ha all he variables used in he analysis o be saionary, sandard Augmened Dickey Fuller es is applied o learn he uni roo properies of he series. The former leer L represens he naural logarihm of he series and D represen he firs difference of he series which is considered. The able summarizes he resuls of he ADF ess for he 4 variables used in he analysis. Table 3: ADF Uni Roo Tes Variable ADF Tes Saisic [lag lengh] LOIM ** [0] (Consan) LREER ** [0] (Consan linear rend) LRGDP [1] (Consan linear rend) D(LRGDP) * [0] (Consan linear rend) CA ** [4] (Consan) Noes: For he es he lag lengh is chosen using Schwarz Informaion Crierion (SIC) wih a maximum of 10 lags. The ADF es for LOIM and CA were run wih jus a consan, and he ADF es for LREER and LRGDP were run wih consan and linear rend as boh of hese series seems o have posiive rends. The criical values ha apply for LOIM and CA series a he 1 percen, 5 percen and 10 percen levels are -3,54, -2,91 and -2,59. The criical values ha apply for LREER and LRGDP series a he 1 percen, 5 percen and 10 percen levels are -4,12, -3,48 and -3,17. * denoes he significance of he es saisics a %1 level ** denoes he significance of he es saisics a %5 level According o he es resuls LOIM, LREER and CA series are saionary a heir levels. In oher words hese series are I(0). LRGDP series becomes saionary when we ake he firs difference of he series. So LRGDP is inegraed of order one or shorly I(1). Hence only his series will appear in he SVAR model in he firs difference form and he oher 3 series will appear in heir levels. 3.4 VAR Lag Order Selecion The choice of he lag lengh of he VAR model is based on he five principal crieria which are Likelihood Raio Saisic (LR), final predicion error (FPE), Akaike informaion crierion (AIC), Schwarz informaion crierion (SC) and Hannan-Quinn informaion crierion (HQ). As shown on he able 3 crieria indicaes ha he lag lengh should be 5. Bu according o Schwarz and Hannan Quinn crieria 1 lag is beer. So we relied on he majoriy and used 5 lags in he esimaion of he SVAR model. 80

11 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 Table 4: VAR Lag order selecion crieria Lag LogL LR FPE AIC SC HQ NA 4.11e e * * e e e * 4.40e-07* * e * indicaes lag order seleced by he crierion 4. Empirical Resuls In he Srucural Vecor Auoregression Models i is necessary o impose some resricions on he sysems of equaions o idenify he effecs of srucural shocks. In order o esimae he parameers of he srucural model and o invesigae he effecs of shocks we have o uilize economic heory. The resricions imposed on he model o esimae he parameers can be summarized as follows: 1) Oil prices are assumed o be given. Under he assumpion of Turkey being a small and oil imporing counry which is an open economy, none of he shocks in he Turkish economy can affec he oil prices in he world. Oil prices are deermined wih is own sochasic process and domesic condiions and variables do no have any effec on his. Under hese assumpions we are ready o impose one of he resricions which we can use in our srucural model. Oil prices have a sochasic process in which oil prices are affeced from jus oil price shocks. OIM c * OIM 1 2) Real effecive exchange rae can be defined as he nominal exchange rae ha akes he inflaion differenials among he counries ino accoun. I is he weighed average of a counry's currency relaive o an index or baske of oher major currencies adjused for he effecs of inflaion. The weighs are deermined by comparing he relaive rade balances, in erms of one counry's currency, wih each oher counry wihin he index. The real exchange rae can be defined in he long run as he nominal exchange rae (e) ha is adjused by he raio of he foreign price level (Pf) o he domesic price level (P) (Kıpıcı and Kesriyeli, 1997). Mahemaically, i can be shown as P f r e P In erms of his definiion, he decline in he r can be inerpreed as he real appreciaion of he Turkish Lira and an increase in r can be inerpreed as he real depreciaion of Turkish Lira. As he oil prices affec producion coss, real effecive exchange rae is also affeced from oil price shocks. Naional income and curren accoun defici do no have any effec on he real effecive exchange raes. Wih hese heoreical explanaions our second consrain for he srucural model will be as follows: REER c * c * OIM 2 3 REER 81

12 Inernaional Journal of Economic Sciences Vol. III / No. 2 / ) According o he hird line in he sysems of equaions he naional income is affeced from oil price shocks and exchange rae shocks. When here is a change in oil prices boh supply and demand sides of he economy are influenced from his change. Therefore our hird consrain is RGDP c * c * c * OIM REER RGDP ) The fourh line in he sysems of equaions shows he facors and shocks ha are effecive on he curren accoun defici. In he heoreical models he mos imporan deerminans of he curren accoun defici are erms of rade, oupu and exchange raes. In Turkey, as a resul of he dependency of he producion o impored raw maerials and oil, oil prices has also imporan influence on he curren accoun defici. In his sudy, he effecs of oil impors, real effecive exchange raes and oupu on he curren accoun defici will be analyzed. Therefore, according o he fourh line of he sysems of equaions, he shocks ha affec he curren accoun defici are oil price shocks, exchange rae shocks and producion shocks coming from naional income. Curren accoun is he mos endogenous variable in he sysem which is effeced from all he shocks. The ordering is made from exogenous o endogenous according o he responses of he variables o he emporary shocks. So our fourh consrain will be CA c * c * c * c * OIM REER RGDP CA ) By using he 4 resricions he heoreical model and is esimaion resuls are as follows OIM OIM u b REER REER u 0 b RGDP RGDP u 0 0 b33 0 CA CA u b Shows he effec of oil impors on real effecive exchange rae, 31 Shows he effec of oil impors on he naional income 32 Shows he effec of real effecive Exchange rae on he naional income 41 Shows he effec of oil impors on he curren accoun defici 42 Shows he effec of real effecive exchange rae on he curren accoun defici 43 Shows he effec of naional income on he curren accoun defici OIM OIM u 0, , REER REER u 0 0, RGDP RGDP 0,032 0, u 0 0 0,022 0 CA CA 2,068 4,370 18,16 1 u ,089 82

13 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 Table 5: Esimaes of he Srucural VAR Model Coefficien Sd. Error p-value 0,057 0,072 0, ,032** 0,0185 0, ,045 0,034 0, ,068* 0,939 0, ,370* 1,738 0, ,163* 6,705 0, b 0,163* 0,015 0, b 0,865* 0,0083 0, b 0,022* 0,0021 0, b 1,089* 0,1047 0, *: Significan a %5 **: Significan a %10 Alhough he coefficien esimaes from he srucural model are no very imporan, he invesigaion of he signs of he parameers may provide us some heoreical implicaions. As he subjec of he analysis focus on he curren accoun, primarily he effec of he oher variables on he curren accoun will be analyzed. Consisen wih his purpose, we realize ha oil impors have significan posiive effec on he curren accoun defici. This is an expeced resul for a developing counry ha is dependen on foreign energy and using impored oil in he producion process, public and privae consumpion. Anoher variable ha effecs he curren accoun defici is he real effecive exchange rae. In he analysis a negaive significan effec of REER on he curren accoun defici is deermined. Afer a decrease in he real exchange rae he naional currency Turkish Lira appreciaes, impored goods will become relaively cheaper when compared o he domesic goods, and impors will increase. During his process curren accoun defici will coninue o increase. Bu an increase in he real exchange rae will resul in a depreciaion of he Turkish Lira, decrease in impors and decrease in he curren accoun defici. Real income has a significan posiive effec on he curren accoun defici. This is an indicaor ha shows us Turkish economy can grow by increasing he curren accoun defici. In order o decrease he curren accoun defici, high growh raes should be sacrificed o slow down he economy. In he curren siuaion i is no possible o decrease he curren accoun defici wih high oil prices and high growh raes. 4.1 Srucural Impulse Response Analysis One of he imporan ools which have made VAR models so aracive is he impulse response funcions (IRF). IRF summarizes he dynamic reacion of a variable o a specific shock. The figures below shows he dynamics of he effecs of hree ypes of shocks on he curren accoun defici. 83

14 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 Figure 2: Response of Curren Accoun o Srucural 1 Sandard Deviaion Oil Price Shock As can be seen from figure 2, a one sandard deviaion shock on oil prices effecs he curren accoun negaively and his effec coninues unil he fourh quarer. There is a small recovery lasing for one quarer bu he deerioraion in he curren accoun posiion coninues afer ha. Alhough i is geing smaller he effec of he shock do no fade away. This is an imporan finding abou he susainabiliy of he curren accoun defici. As a developing economy which demands a lo of energy and oil for he producive aciviies, i is no possible o susain curren accoun defici wih increasing oil prices. Figure 3: Response of Curren Accoun o Srucural 1 Sandard Deviaion Real Exchange Rae Shock Figure 3 shows he impulse response of he curren accoun o a one sandard deviaion shock in he Real Effecive Exchange Rae. A depreciaion of he Turkish Lira leads o a deerioraion of he curren accoun 84

15 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 immediaely in he firs wo quarers afer he shock. Bu a recovery comes afer ha which is consisen wih he J-curve phenomenon. According o he heory following depreciaion of a counry s currency (e.g., due o devaluaion), iniially he rade balance deerioraes bu evenually i improves, assuming oher hings are he same (Krugman & Obsfeld, 1994). This recovery coninues unil he enh quarer and he overall effec of he devaluaion of he Turkish Lira on he curren accoun posiion is an improvemen. Figure 4: Response of Curren Accoun o Srucural 1 Sandard Deviaion Real GDP Shock Figure 4 shows he impulse response of he curren accoun o a one sandard deviaion shock in he Real GDP. We can see from he figure ha he cumulaive effec of an income shock on he curren accoun is negaive. An increase in real income will resul in an increase of he curren accoun defici. This is no a surprise for a counry whose producion is bound o he impors of inermediae goods. As he growh raes increase, he demand for impored raw maerials will increase and he curren accoun balance deerioraes more. Besides, wih he increase in real income, he demand for impored consumer goods will also increase when saving raes are decreasing. If we add up hese wo forces, he resul is an increasing curren accoun defici. 4.2 Variance Decomposiion The variance decomposiion of he effecs of he four ypes of shocks on he Curren Accoun is presened in able 6. Shock 1, shock 2, shock 3 and shock 4 are oil price shock represened by increases in oil prices, real exchange rae shock which is an appreciaion of he exchange rae and depreciaion of he Turkish Lira, Real GDP shock which is represened by an increase in real income and he curren accoun shock iself. The facors effecing he forecas error variance is differen in he shor and long run. In he firs quarer abou 70 percen of he curren accoun forecas variance is explained by he shock o he curren accoun iself. Bu in he long run, a he end of 10 quarers, he disribuion has compleely changed and he share of curren 85

16 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 accoun shock has decreased o 18 percen. The oher shocks gained power in explaining he forecas error variance. In he long run 17 percen of he variance is explained by oil price shock, 34 percen of he variance is explained by real exchange rae shock and 30 percen of he variance is explained by real gdp shock. So in he long run he mos imporan facors effecing he curren accoun posiion are he real exchange rae and real gdp. Oil price shock is coming afer hem. Table 6: Variance Decomposiion Resuls Period Sandard Error Shock 1 Shock 2 Shock 3 Shock Conclusion Susainabiliy of curren accoun defici is always an imporan subjec for economiss. Curren accoun defici as a raio of GDP is a commonly used measure ha deermines he susainabiliy of curren accoun deficis and deficis above %5 of GDP are considered as dangerous. Bu oher facors such as he composiion of he curren accoun defici, he mehods which are used o finance i, exchange rae policy, macroeconomic condiion and global economic oulook may also have imporan implicaions abou he susainabiliy of curren accoun deficis. Turkey has experienced impressive economic growh following he subsanial reforms afer 2001 bu he curren accoun defici is he economy s bigges vulnerabiliy. Turkey is an oil imporing developing counry and here is a close relaionship beween oil impors and curren accoun defici. In his sudy, a srucural Vecor Auoregression (SVAR) model is used o invesigae he effecs of fuel impors and foreign exchange policy on Turkey s curren accoun defici and economic growh. We found ha overvalued TL and economic growh are he main causes of curren accoun defici. This is resuling from he dependency of he producion on he impored inermediae goods and increase in he privae consumpion of impored goods. From he coefficien esimaes of he srucural model, we found ha oil impors have significan posiive effec on he curren accoun defici. This is an expeced resul for a developing counry ha is dependen on foreign energy and using impored oil in he producion process. Anoher variable ha affecs he curren accoun defici is he real effecive exchange rae. In he analysis a negaive significan effec of REER on he 86

17 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 curren accoun defici is deermined. Wih he appreciaion of he TL (a decrease in he real exchange rae) curren accoun defici will coninue o increase. Finally real income has a significan posiive effec on he curren accoun defici. This is an indicaor ha shows us Turkish economy can grow by only increasing he curren accoun defici. In order o decrease he curren accoun defici, high growh raes should be sacrificed o slow down he economy. The impulse response analysis also reinforces hese findings. A shock on oil prices affecs he curren accoun defici negaively and he effec of he shock does no fade away. This is an imporan finding abou he susainabiliy of he curren accoun defici. As a developing economy which demands a lo of energy and oil for he producive aciviies, i is no possible o susain curren accoun defici wih increasing oil prices. References Arize, A. (2002), Impors and expors in 50 counries: ess for coinegraion and srucural breaks, Inernaional Review of Economics and Finance, 11, Baharumshah, A.Z., Lau, E. and Founas, S. (2003), On he susainabiliy of curren accoun deficis: evidence from four ASEAN counries, Journal of Asian Economics, 14, pp Blanchard, O. & Peroi, R. (2002), An Empirical Characerizaion Of The Dynamic Effecs Of Changes In Governmen Spending And Taxes On Oupu, The Quarerly Journal of Economics, MIT Press, vol. 117(4), pp , November. Blanchard, O.J. and D. Quah (1989), The Dynamic Effecs of Aggregae Demand and Supply Disurbances, American Economic Review 79, pp Blanchard, O. (2006), Curren Accoun Deficis in Rich Counries Polak Annual Research Conference. Dalgin, M.H. & Gupa, K. (2012), How Relevan is Turkey s Curren Accoun Defici?, Inernaional Research Journal of Finance and Economics, 97, Edwards, S. (2005), The End of Large Curren Accoun Deficis, : Are here Lessons for he Unied Saes?, NBER Working Paper No Ghosh A. R. and Osry J. D., (1995), The Curren Accoun in Developing Counries: A Perspecive from he Consumpion-Smoohing Approach, World Bank Economic Re-view, Vol. 9, No. 4, pp Glick, R. and Rogoff, K. (1995), Global versus Counry-Spe- cific Produciviy Shocks and he Curren Accoun, Journal of Moneary Economics, Vol. 35, No. 1, pp Irandous, M. and Ericsson, J. (2004), Are impors and expors coinegraed? An inernaional comparison, Meroeconomica, 55, İnsel, A.& Kayıkçı, F. (2012), Evaluaion of Susainabiliy of Curren Accoun Deficis in Turkey, Modern Economy, 3, pp Kasman, A. Turgulu, E. and Konyalı, G. (2005), Cari açık büyümenin mi aşırı değerli TL nin mi sonucudur?, İkisa İşleme ve Finans, Ağusos, pp Kıpıcı, A.N., & Kesriyeli, M., (1997), The Real Exchange Rae Definiions and Calculaions, Cenral Bank of he Republic of Turkey, Research Deparmen Publicaion No: 97/1. 87

18 Inernaional Journal of Economic Sciences Vol. III / No. 2 / 2014 Krugman, P.R. & Obsfeld M., (1994), Inernaional Economics: Theory and Pracice 3d ed. Harper Collins, New York, p.465. Milesi-Ferrei, G.M. & Razin, A. (1996), Curren Accoun Susainabiliy, Princeon Sudies in Inernaional Finance No 81. Mussa, M. (2005), Susaining global growh while reducing exernal imbalances, The Unied Saes and he World Economy: Foreign Economic Policy for he Nex Decade, p Narayan, P. K. and Narayan, S. (2005), Are expors and impors coinegraed? Evidence from 22 leas developed counries, Applied Economics Leers, 12, Narayan, S. (2013), A Srucural VAR model of he Fiji Islands, Economic Modelling, 31, pp Özlale, Ü. and Pekkurnaz, D. (2010), Oil Prices and Curren Accoun: A Srucural anaysis for he Turkish Economy, Energy Policy, 38, pp Sims, Chrisopher A, (1980), Macroeconomics and Realiy, Economerica, Economeric Sociey, vol. 48(1), pages 1-48, January. Zaidi, I. (2012), The Exernal Curren Accoun in he Macroeconomic Adjusmen Process in Turkey, The Woodrow Wilson School s Graduae Policy Workshop Zaouali, S. (2007), Impac of higher oil prices on he Chinese economy, OPEC Review, 31 (3), pp

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