Real Exchange Rate, Inflation and Tourism

We have been experiencing one of the densest price increases in our national history. This (un)expected inflation has hit the domestic consumers as we have observed the decreasing purchasing power of Turkish Lira. Other than disrupting the economic system by making creditors vulnerable as the value of their loans have been melting, inflation is also argued as a harmful factor for the tourism sector, which made commodities and services more expensive even for foreigners. However, we will emphasize rather a distinct observation. A simple examination will be helpful to indicate the decreasing real exchange rate with the existence of rising inflation, does not lead to increase in expenditures of tourists in Turkey, as it was referred as a possible outcome if real cost of commodities and services in Turkey were to decline.

\begin{equation} e = \frac{E\times P}{P^*}\end{equation}

\begin{equation}e=\textrm{Real Exchange Rate} \;\;\; E= \textrm{Nominal Exchange Rate}\end{equation}

\begin{equation}P=\textrm{Price Level in Domestic Sphere}\end{equation}

\begin{equation}P^*=\textrm{Price Level in Foreign Sphere}\end{equation}

          First, we should understand that the nominal exchange rate does not affect the decisions of individuals solely. Yes, it is one of the important determinators of domestic prices for foreign-product dependent countries such as us. But the important factor we should look at is the real exchange rate. It simply compares the domestic price levels based on foreign currency (CPI Turkey times tl-usd nominal exchange rate) and the price levels in foreign country (CPI in other countries based on their national currency). The dataset for real exchange rate in TCMB (years 2020:2023 are excluded due to pandemic) shows us that the prices in Turkey have been decreasing in real terms. This means that the things foreigners want to buy are obtainable in Turkey with much cheaper cost based on foreign currency. An important assumption is that if the real cost of commodities and services are lower then tourist will spend more money than otherwise. This assumption simply not true.  As we observe from graph, between 2012 and 2020, the average tourist expenditure by person in dollar terms has been decreasing (it can be seen by the peak points of each year). Though there is another effort to validate the depreciation of Turkish Lira is trade balance. From macro classes we have seen according to Marshall-Lerner condition, if domestic prices decrease in real terms, the export of country will increase and import of country will decrease, thus improving the trade balance condition by making commodities that are produced in Türkiye more competitive. The spillover effect would be expected to be higher in developing economies, in which competitive real exchange rate will expand and improve the development of industrial sector through sharing the necessary information for manufacturing (Guzman, Stiglitz, & Antonio, 2017). Though, the further depreciation just disrupted the stability of internal economy. Thus, the implications of beneficial feedbacks of competitive real exchange rates are valid for countries that are affected by the existence of Dutch disease, such as countries that are dependent on exportation of natural resource. At final, though, a cost-benefit analysis should be carried out, because the tourism sector lies at the heart of the Turkish economy. 

            Second point that I want to emphasize is the detrimental impact of this depreciation policy on the general price levels and huge gap between our inflation numbers and other countries’. As we are able to observe, the incredible rise in price levels in our country did not necessarily compensate the effects of depreciation of our currency. We may attribute this phenomenon to the semi-dependency of domestic price levels to the exchange rate deviations. In order to infer such a conclusion, we may have to pursue a more statistically and scientifically hard process. Thus, the question of relationship between exchange rate and domestic price level is a debated subject, which has to be carried in a more profound way. While our people have been carrying the harmful consequences of inflation, tourists are able to buy most of the goods in a much cheaper way compared to their country and this cheapness does not lead to increase in real expenditure level of foreigners. Also, the decreasing real expenditures of tourists leads to diminishing power to purchase foreign commodities (It is also valid for ML condition in which real exchange rate decreases the imports will decrease). Therefore, we lose for three times as the depreciation of our currency was carried out.  

            Another thing to consider is the different increases in price levels for different commodities. As you may expect, the commodities that are mostly imported or built with imported components or commodities that have internationally determined price levels increased more than garment or transportation. Assume that a domestic tailor making clothes, which consist of mostly domestic components. Due to prices are mostly determined and affected by cost levels, even though depreciation affected the prices, the price increase of this tailor’s prouducts will not be as high as the commodities that are mainly consist of foreign components, such as cars (domestic cars as well). So, a foreigner will be able to buy this product in a more easier way after depreciation compared to prior to depreciation. Thus, the gap between nominal exchange rate and real exchange rate, can be interpreted as the result of gap between inflation rates of different commodities and it also depends on the disparity between the countries’ cpi levels. Thus, if we calculate real exchange rate with only prices of cars or music instruments, the gap between the values of real exchange rate and nominal exchange rate will be lower compared to the case where we calculate real exchange rate with prices of commodities that mostly has domestic features.

            Even though the expenditures of tourists are mainly consist of things that have highest cpi levels (such as food, beverages and accomodation), because their expenditures also include products that have lower cpi levels which makes real exchange rate below the level of nominale exchange rate, as we have indicated, the real expenditures of tourists have been declining. So, the potential benefits of depreciation of our currency for tourism sector, did not respond as parallel to the expectations of policymakers.

            The currency of a country is located at the top of the importance hierarchy. Even though the depreciation of our currency has been declined not by discretionary policies, the results that we are experiencing can be interpreted only by the policies that we implemented. To be able to be competitive in international area price competitiveness is important for attracting investments and tourists. However, we also have to be prudent about the real revenues that we are about to receive from these activities, which has the utter importance for the internal stability of our economy in international sphere.