I.
Introduction
Although Turkey has suffered from current account deficits earlier, the last two years have
seen ever increasing current account deficits. These large deficits have caused a great level of
discussion of the current account which has mainly focused on the real exchange rate and short-
term international competitiveness. However, changes in the fundamentals of the Turkish
economy warrant a longer term approach in the analysis. This paper addresses this issue by
computing Turkey’s optimal consumption smoothing current account for the sample period using
an intertemporal benchmark model (IBM) and tests for solvency of the current account.
High levels of current account deficits which become unsustainable could precipitate a
sudden reversal in capital flows or might necessitate adjustments in interest rates or exchange
rates. This was seen in Mexico prior to the 1994 peso crisis and occurred in countries in East
Asia prior to the East Asian financial crisis. In previous periods when the current account deficit
increased significantly, Turkey suffered a crisis as was seen in 1994 and 2001. The deficits today
are higher than those experienced prior to the crises. Since Turkey has not witnessed a crisis this
might indicate that even though the deficit is very high, it may still be sustainable. We examine
this issue of sustainability in the paper.
Our analysis of current account sustainability in Turkey is based on the intertemporal
benchmark (IBM) model used by Ghosh and Ostry (1995).1 This model which builds on the work
done by Sachs (1982), Campbell and Shiller (1987) determines current account sustainability
based on intertemporal solvency. The intertemporal approach to assessing current account
sustainability allows us to compute the optimal or benchmark current account and compare the
actual with the optimal current account. If the actual current account deficit is significantly
higher than the optimal it sheds light on the unsustainability of the current account deficit.
1 There have been other models to determine current account deficit sustainability. Hudson and Stennett
(2003) highlight that the GS-SCAD model and Deutsche Bank model also shed light on current account
deficit sustainability. We focus on the intertemporal approach only.