What drives dollarization in Turkey?
This paper provides an analysis on the source of dollarization in Turkey by constructing measures for asset, liability and offshore dollarization. In doing so, the study seeks a co-integration relationship among these variables. Results suggest that rising asset dollarization was mainly demand-driven originating from increasing demand for foreign assets before the 2001 financial crisis. The increasing demand for foreign assets in turn resulted in an increase in foreign currency-denominated debt thus causing an increase in liability dollarization. However, this story changed radically after the crisis. The post-crisis period witnessed externally driven dollarization albeit at a decreasing rate. Increasing external funding opportunities for the banking system produced an increase in offshore dollarization, which eventually fed into higher asset dollarization than otherwise would have occurred. Thus, the empirical evidence suggests that if it were not for the increasing rate of offshore dollarization, asset dollarization would have been lower. The evidence also suggests that the strong fight against inflation under the Inflation Targeting framework led to lower asset dollarization through lower inflation and a more stable exchange rate; however the resulting interest rate differentials and decreased currency risk also motivated more external funding thus leading to higher offshore dollarization.