253-66. BIS Review 17/2005  5  Consequently, derivatives markets contribute to the predictability cash flows of economic agents and their profits or losses arising from risk or volatility by reducing excessive volatility in spot markets, on one hand, and by offering an opportunity to economic agents for risk management, on the other hand. In this way, fragilities in the firms sector arising from deteriorations in balance sheets are restored and the economy as a whole strengthens itself against shocks. At this stage, I would like to highlight one more point about the floating exchange rate regime. In Turkey, firms have to be cautious about imbalances in foreign exchange denominated assets and liabilities on their balance sheets. Under the floating exchange rate regime, firms with foreign currency-denominated income and domestic currency-denominated expenditure, or vice versa, should restore the imbalances on their balance sheets, in other words, eliminate the exchange rate risk they are faced with. In order to achieve this, firms should observe risk management principles and employ derivatives market instruments. Firms, especially production firms, can allocate more resources for production by reducing the financial risks on their balance sheets. This also makes an important contribution to enhancing the competitiveness of firms. As of 2003, 92 percent of world’s largest 500 non-financial firms are protected against risk through derivatives instruments and this further reinforces the importance of such instruments6. Moreover, I would like to point out that the benefits of derivatives instruments do not depend on the size of the firms they are used by.
This is one of the underlying reasons for the poor risk management in our country. The fact that future uncertainty was high until recently due to macroeconomic instability had kept the general level of interest rates in an upward trend. As a result, these factors have prevented the smooth operation of derivatives markets. The second factor that has led to the poor development of risk management and of derivatives markets in Turkey is high public deficits, which caused the fragility of the public finance. As we are all aware, in the past, capital accumulation was based on public resources in Turkey. However, as a result of increasing public deficits, the capital provided by the public sector to the private sector was then extended by the private sector to the public sector. In this context, the market developed by “government securities” that are issued against public debt have become the most important and only market, which uses almost all the resources of the economy due to increasing public debt as well as high real interests payable. Such a framework, in other words, an environment where fiscal dominance is rather high did not allow neither the emergence of new financial instruments to finance the private sector, nor the deepening of financial markets. Moreover, portfolio diversification, the simplest element of risk management; could not be achieved.