Exchange Rate Misalignment in Turkey: Overvalution of the Turkish Lira

In 2001, Modern Turkey experienced the most severe financial collapse in its history during the implementation of an anti-inflationary, fixed-exchange-rate-based stabilisation program. An important part of critisms following this collapse focused on the exchange rates. The main argument was that the program overlooked the fact that Turkish Lira was highly overvalued during the implementation of the stabilisation program. The currency of a country would be overvalued if its realized values against other currencies persistently stayed over the long-term equilibrium trend. Overvalution of a currency is an important matter for any country because the exchange rates are decisive on the external balance of a country, the stability of financial system, and the internal prices and hence on the allocation of resources. Plus, the two recent financial crises in Turkey, in 1994 and 2001, broke out after significant overvaluations in the Turkish Lira. This study found significant overvaluations in cumulative terms in the Turkish Lira for the period after 2001. Although, Turkey might have gained some resilience to exchange rate misalignments after 2001 due to political and economic changes in the country, the high level of overvaluation in the Turkish Lira should nevertheless be seen as a risk factor.