Turkey’s Current Account Deficit Puts Pressure on the Lira

November current account deficit widens

Turkey’s current account balance data for November 2016 was released on January 11. It showed the current account deficit had widened to $2.27 billion compared to $2.24 billion in November 2015. In October 2016, the deficit had stood at $1.7 billion.

Meanwhile, the annualized current account deficit rose to $33.65 billion in November from $33.62 billion in October.

This widening of the current account deficit, though lower than expected, put downward pressure on the Turkish lira and caused it to weaken further against major units like the dollar (UUP) and the euro.

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Why did a bigger deficit hurt the Lira?

Simply put, the current account balance is the difference between exports and imports. If exports are greater than imports, then the balance is reported as a surplus. On the other hand, if imports outpace exports, then the balance is reported as a deficit.

When the current account is in surplus, it signals lesser demand for the dollar (assuming to be the standard unit for trade) as value of imports is lesser than value of exports, leading to decreased demand for the dollar and increased demand for the local currency. This increased demand makes the local unit stronger.

The converse is true when the current account is in deficit, signifying more imports than exports, leading the country to borrow foreign currency to make up the deficit.

Theoretically, the currency exchange rate impacts the current account balance. If a currency is devaluing, or weakening, then it leads to a contraction in the current account deficit or an increase in the current account surplus as a weak currency supports exports. The opposite is true when a strengthening unit increases the current account deficit or reduces the current account surplus.

With the Turkish lira weakening, it should have a contractionary impact on the country’s current account deficit. However, even after this, the deficit has widened further vis-à-vis the previous month and year, thus leading to additional downward pressure on the currency.

In the next article, let’s look at measures taken by the Central Bank of Turkey to arrest the slide of the lira.

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