Keeping in mind that the risks for both financial and real sectors are interrelated, the banks that lend in foreign currency to firms, which earn revenues in domestic currency, are also indirectly affected. In such cases, the whole economy becomes more vulnerable to shocks due to amplified risks resulting from dollarization. A recent strand of literature and country cases such as the Asian meltdown of 1997 and the 2000-2001 banking crisis in Turkey, have all emphasized the importance of such vulnerabilities brought about by dollarization. Moreover, firms adjust their prices more frequently in a dollarized economic environment where depreciation of national currency is perceived as permanent. Thus, dollarization leads to higher pass through effect from exchange rates to prices via deteriorating pricing behaviour of firms. Ultimately, from the public sector’s point of view, the issue of debt sustainability is highly influenced by dollarization. In fact, public sector is exposed to problems similar to that of non-trading firms indebted in foreign currency 4 . There is no doubt that dollarized debt adversely affects government’s solvency as its assets are in domestic currency. In this sense, given the high level of dollarization, the fluctuations in real exchange rate might turn an apparently sustainable fiscal situation into an unsustainable one. Furthermore, public sector insolvency can immediately lead to banking sector insolvency if domestic banking system holds large claims against government. Dear Guests, Before continuing with the Turkish experience, I have to add that dollarization deserves a special attention from a central banker’s perspective.
The amendments made in the Law of the Central Bank of Turkey in 2001 have been a turning point and instrumental for the efforts to maintain macroeconomic stability. With these amendments, achieving and maintaining price stability is stated as the primary objective of the Central Bank and the Bank acquired its instrumental independence. In fact, the independency has given the Bank the opportunity to set its policies for longer terms, free of political cycles and pressures. As an assurance given to the public to ensure the long term price stability objective, the independence of the Central Bank of Turkey together with its transparent and effective communication policy have increased the credibility of the monetary policy. Besides, the new monetary policy framework implemented first as implicit and then as full-fledged inflation targeting regime together with the floating exchange rate regime have contributed a lot to the decline in dollarization since 2002, as the literature 10 suggests. In this respect, we can observe the findings of the portfolio approach in Turkey very clearly. To be more specific, the volatility of exchange rates has increased due to floating exchange rate regime on the one hand and inflation and its volatility have declined significantly on the other.