# **I. Introduction**

**The current account balance (CAB) can be seen in two different ways.** First, the current account balance can be expressed as the difference between the value of imports and exports of goods and services plus net factor payments and net transfers. As the trade balance tends to be the largest component of the current account, a current account deficit often, although not always, implies a trade deficit, although this need not be the case as countries also earn and pay income and send and receive transfers, most commonly in the form of interest and dividends and remittances. Second, the current account balance also represents the difference between national saving and investment, both public and private. As such, the current account balance indicates a country’s position as international net debtor or creditor (for further detail see Annex 1).

**While there is no preferable current account position, certain positions are more consistent with a country’s stage of development, and the appropriate policy stance depends on the structure of the economy and the underlying drivers.** Understanding the drivers of the current account in conjunction with the external developments is crucial for a policy stance even when the current account is not necessarily the target of policy actions. Countries at early stages of their development tend to be net borrowers because, with less abundant capital, their economies offer higher returns to investment relative to developed economies. Countries which aim to diversify their export structure can finance the part of the transformation via lower current account balances. Yet, when a country runs a current account deficit, it is accumulating liabilities to the rest of the world that are financed by flows in the financial account that have to be paid back eventually.  Solvency requires that the country can eventually generate sufficient current account surpluses to repay what it borrowed to finance the current account deficits. Therefore, whether a country should run a current account deficit or borrow more depends on the extent of its foreign liabilities and on whether the borrowing will finance investment with a higher marginal product than the interest the country must pay on its foreign liabilities. Even if the country is intertemporally solvent, its current account deficit may become unsustainable if it is unable to secure the necessary financing. While some countries, such as Australia and New Zealand, have been able to maintain current account deficits averaging about 4 to 5 percent of GDP for several decades, others, such as Mexico in 1995, Thailand in 1997, and others during the recent global crisis (IMF 2018) experienced sharp reversals of their current account deficits after private financing withdrew during the financial crisis. These reversals can be highly disruptive because private consumption, investment, and government expenditure must be cut abruptly when foreign financing is no longer available.  Thus, large and continuous current account deficits have the potential to make the economy more vulnerable to shocks, with an associated negative effect on the growth prospects (Calvo et al, 2006).

**The issue of current account sustainability and its determinants has risen to the fore in recent months as interest rates in developed countries have begun to rise and external financing has become costlier.** Nowhere has this been more evident than in Turkey, which suffered a sharp depreciation of its currency in 2018 as investors pulled money out, in turn leading to significant financial sector instability and domestic economic pressure, particularly given existing high levels of exposure to foreign exchange-denominated debt. From the beginning of 2018 to end-September, Turkey’s nominal effective exchange rate depreciated by 37 percent. The causes of this sharp adjustment have been variously cited as concerns over political developments, particularly as disagreements between the leaders became apparent in August, the relatively high current account deficit and external financing requirement and growing domestic economic imbalances.

**This paper sets out to build a more in-depth understanding of the drivers of current account imbalances in Turkey, and in doing so, to highlight policies that may help avoid CA imbalances becoming unsustainable.** Emerging economies, including Turkey, witnessed a marked reduction in their current account balances in the aftermath of the 2008-09 global financial crises. A combination of stronger domestic demand relative to developed countries and international interest rates at historically low levels allowed emerging countries to finance growing investment and consumption by borrowing from abroad relatively cheaply.  Worsening of current account balances caused financing concerns in several countries, especially given the perspective of rising global interest rates following normalization of monetary policy in advanced economies. This paper sets out to apply statistical and econometric analysis to the question of what has driven changes to the current account in Turkey over time. In doing so, questions of the sustainability of the current account deficit are discussed in the context of its drivers, and projections are presented for future scenarios.

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