Journal of International Trade, Logistics and Law, Vol. 8, Num. 1, 2022, 198-203 198 THE RELATIONSHIP BETWEEN THE REAL EFFECTIVE EXCHANGE RATE AND INDUSTRIAL PRODUCTION IN THE TURKISH ECONOMY Okşan KİBRİTCİ ARTAR Istanbul Commerce University, Turkey Received: March 25, 2022 Accepted: May 18, 2022 Published: June 01, 2022 Abstract: The industrial sector is one of the key sectors for the Turkish economy in terms of production, employment and exports. The volatility in the exchange rate in the Turkish economy has important effects on industrial production, as well as many economic variables. The main purpose of this study is to empirically analyse the effects of real effective exchange rate on industrial production for the Turkish economy in the 2009M08-2022M01 period. According to the results of the study, the real effective exchange rate adversely affects the industrial production in the Turkish economy. Other things being equal, the depreciation of the domestic currency increases the foreign demand for industrial products, in line with the economic theory. Considering these relations between real effective exchange rate and industrial production while designing economic policies is important for sustainable economic growth. Keywords: Industrial Production, Real Effective Exchange Rate, Economic Policies 1. Introduction Total industrial production and manufacturing industry production play a critical role in the Turkish economy in terms of production, employment and exports at the national level. Total industrial production is affected by changes in domestic and international demand. In particular, one of the important factors affecting export demand is the real effective exchange rate. The current account deficit, which arises due to the chronic savings deficit in the Turkish economy, has significant effects on exchange rates. The sustainability of the external financing deficit for the Turkish economy also significantly affects the exchange rate stability. The economic and financial stability of the Turkish economy may be adversely affected due to the internal and external economic and non-economic shocks it faces. In this study, it is aimed to analyse the relationship between the real effective exchange rate and total industrial production in the Turkish economy with econometric techniques. The original contribution of the study to the literature is to contribute to the effective design of industry and exchange rate policies by reanalyzing the relationship between the current data and the real effective exchange rate and total industrial production within the framework of the Covid-19 Epidemic. 2. Literature on Real Effective Rate of Exchange and Industrial Production in The Turkish Economy Industrial production has a critical role for the Turkish economy. The sustainability of industrial supply depends on the sustainability of domestic and foreign demand on the one hand and on the input supply conditions and costs on the other. The real effective exchange rate is an important factor in the export of industrial goods. Table.1. gives the share of total industry and manufacturing industry GDP in the Turkish economy. Accordingly, for 2021, the share of Industrial Production in GDP is around 25% and the share of manufacturing industry in GDP is around 22%. The Relationship Between The Real Effective Exchange Rate and Industrial Production in The Turkish Economy 199 Table.1. GDP Share of Total Industry and Manufacturing Industry in Turkish Economy Table.1. GDP Share of Total Industry and Manufacturing Industry in Turkish Economy Share of Industrial Production in GDP (%) Share of Manufacturing Industry Production in GDP (%) Year/Quarter I II III IV I II III IV 1998 28.82 26.31 22.22 24.28 25.78 23.66 19.70 21.49 1999 24.80 24.12 20.29 22.79 21.92 21.44 17.77 19.83 2000 23.18 22.68 19.57 21.35 20.08 20.03 17.03 18.33 2001 22.91 20.53 19.02 21.73 19.67 17.56 16.09 18.20 2002 22.08 20.98 18.28 19.81 18.28 17.85 15.50 16.70 2003 21.59 21.02 18.20 20.42 18.26 18.03 15.38 17.21 2004 21.61 20.54 18.06 19.52 18.49 17.76 15.45 16.62 2005 21.28 20.23 17.65 20.10 18.28 17.56 15.13 17.05 2006 20.59 20.26 18.35 20.14 17.64 17.67 15.84 17.29 2007 21.31 20.04 17.96 19.61 18.30 17.32 15.27 16.68 2008 20.89 19.91 17.89 19.09 17.87 17.07 14.96 15.50 2009 19.15 18.83 17.19 18.75 15.62 15.68 14.22 15.27 2010 19.40 19.14 16.80 18.75 15.69 15.82 13.58 15.37 2011 20.70 20.10 18.33 20.01 17.24 17.01 15.32 16.48 2012 21.02 20.12 17.52 18.73 17.17 16.75 14.47 15.33 2013 20.33 19.80 18.52 20.16 16.72 16.51 15.35 16.66 2014 21.48 20.84 18.60 19.67 17.76 17.57 15.54 16.48 2015 20.36 20.43 18.17 20.16 17.10 17.31 15.30 17.22 2016 21.02 20.19 17.61 19.82 17.67 17.27 14.72 16.88 2017 21.78 20.79 19.17 21.07 18.39 17.87 16.30 17.99 2018 22.25 21.92 21.45 23.47 19.02 18.85 18.37 19.91 2019 23.10 22.72 20.43 21.44 19.38 19.15 17.07 17.86 2020 23.43 21.48 21.51 24.36 19.66 17.78 18.13 20.60 2021 25.51 26.37 23.96 27.68 21.68 22.35 20.06 23.51 Source: TUIK In Figure 1, The production level in the total industry and sub-sectors in the Turkish economy is given annually. Accordingly, in the second quarter of 2020, when the Covid-19 epidemic was dominant, the contraction in industrial production was observed around 30%, especially in April and May 2020. Okşan KİBRİTCİ ARTAR 200 Figure 1. Turkish Economy Total Industry and Sub-Sector Production (Annual%) Source: TCMB, TUIK In Figure 2, graphs of industrial production and real effective exchange rate variables (log) are given. Accordingly, the real effective exchange rate and total industrial production exhibit a volatile trend in the opposite direction to each other. 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2 09 10 11 12 13 14 15 16 17 18 19 20 21 LSANAYI_URETIMI LREEL_EFEKTIF_DOVIZ_KURU Figure 2. Industrial Production and Real Effective Exchange Rate Variables Graphs (Log) The Relationship Between The Real Effective Exchange Rate and Industrial Production in The Turkish Economy 201 Within the framework of the literature review, the findings of the related studies examining the relationship between industrial production and exchange rate in the Turkish economy are summarized as follows. Balaylar (2011) stated in his study that the rise in real exchange rates in the Turkish economy weakens the relations between industrial production and employment. In the study of Barışık and Yayar (2012), it was determined that the exchange rate for the Turkish economy adversely affected industrial production in accordance with the theory. Aytekin and Doyar (2019) study found that there is a long-term relationship between industrial production and exchange rate, while there is a mutual causality relationship in the short-term. Şanlı and Petek (2019) study examined that the exchange rate increases the capacity utilization rate in the manufacturing industry. In the study of Aytekin (2020), it was stated that there is a long-term relationship between industrial production and exchange rate, and there is a causality relationship from exchange rate to industrial production in the short run. Petek et al. (2020) found a strong and inverse relationship between the Real Effective Exchange Rate and the number of manufacturing for the Turkish economy. Çalışci and Gögül (2021) study found an inverse relationship between the Turkish economy's exchange rate and industrial production in the long run. In international studies, the effects of exchange rates on industrial production or GDP may differ from country to country (see Akinlo and Lawal, 2015; Tang, 2015) 3. Econometric Analysis 3.1. Data and Methodology The variables used in the analysis were obtained from the Central Bank of the Republic of Turkey. Variables are, • Total Industrial Production Index (2015=100) • CPI Based Real Effective Exchange Rate (2003=100) The data period is the period 2009M08-2022M01 and is monthly data. The variables are logarithmic. The method used in the analysis is time series econometric techniques. 3.2.Econometric Analysis Results Descriptive statistics for the logarithmic values of the variables used in the study are given in Table.1. Accordingly, while the industrial production average was 4.581, the average real effective exchange rate was 4.519. Table 1. Descriptive Statistics (Log) Industrial Production Real Effective Exchange Rate Mean 4.581 4.519 Median 4.597 4.605 Maximum 5.109 4.840 Minimum 4.040 3.868 Std.Dev. 0.216 0.222 Skewness - 0.220 - 0.770 Kurtosis 2.569 2.574 Jarque-Bera 2.378 15.945 Probability 0.305 0.000 Total 687.1 677.8 Observation 150 150 Okşan KİBRİTCİ ARTAR 202 According to the ADF unit root test results in Table 2, it has been determined that the variables are stationary at the first difference according to the most appropriate model result. Table 2: ADF Unit Root Test Results for Variables Data/Model Industrial Production Real Effective Exchange Rate Level/Trends t-stat -2.5155 -2.4051 Prob. 0.3203 0.3754 First Difference/Constant t-stat -5.0516 -9.9642 Prob. 0.0000 0.0000 Since the variables were not stationary at the level, the Johansen cointegration test was performed in Table 3 and it was determined that the variables were cointegrated in the long run. Table 3: Johansen Cointegration Test Results Trace Test Results Trace 0.05 Rank Eigenvalue Stats Critical Value Prob.** r = 0, r ≥ 1 0.155807 32.34675 25.87211 0.0068 r = 1, r ≥ 2 0.049409 7.448754 12.51798 0.3000 Maximum Eigenvalue Results Eigenvalue 0.05 Rank Eigenvalue Stats Critical Value Prob.** r = 0, r ≥ 1 0.155807 24.89800 19.38704 0.0071 r = 1, r ≥ 2 0.049409 7.448754 12.51798 0.3000 Since the long-term relationship between the variables was determined by cointegration analysis, the long-term equation between the variables was estimated with the Dynamic OLS estimator. The results in Table 4 show that the real effective exchange rate adversely affects industrial production. As the value of the Turkish lira decreases, industrial production increases depending on foreign demand. This is an economically expected result. The depreciation of the domestic currency leads to an increase in foreign demand, an increase in exports and an increase in industrial production. Table 4: Dynamic OLS Regression Results for Industrial Production Dependent Variable Variable Coefficient Std. Error t-Statistic Prob. Real Effective Exchange Rate -0.820572 0.062885 -13.04879 0.0000 C 8.300751 0.275533 30.12618 0.0000 D_2020M04 -0.411128 0.024588 -16.72068 0.0000 R-squared 0.716966 Mean dependent var 4.587075 Adjusted R-squared 0.709049 S.D. dependent var 0.210560 S.E. of regression 0.113576 Sum squared resid 1.844614 The Relationship Between The Real Effective Exchange Rate and Industrial Production in The Turkish Economy 203 HAC standard errors & covariance (Prewhitening with lags = 1 from SIC maxlags = 5, Bartlett kernel, Newey-West fixed bandwidth = 5.0000), Cointegrating equation deterministics: C D_2020M04, Automatic leads and lags specification (lead=0 and lag=1 based on SIC criterion, max=13), Jarque-Bera (Prob) = 0.192 4. 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