Dubai: Over the past week global financial markets have been roiled by the steep decline in the Turkish lira and the knock-on consequences that this will have not only for Turkey but for emerging markets (EM) overall.
In my view the Turkish issue needs to be split into two, a fundamental economic issue, which has been exacerbated by the ongoing political drama between Turkey and the US.
To be sure, the economic consequences for Turkey are significant and it will require all of Erdogan’s acumen to try to navigate out of an increasingly dire situation for Turkey. The signs so far are not encouraging. However, in my opinion, Turkey is unlikely to be the Thailand of 1997, when a de-pegging of the Thai currency led to an Asian financial crises that swept up Korea, Malaysia, Indonesia and others in its wake.
There are several reasons I believe that the Turkish issue will not lead to a wider EM crises in the near future. Firstly, I believe the recent turmoil is primarily political. In my view, Erdogan took a difficult economic situation and threw gasoline on the fire by starting a political spat with the US at precisely the wrong time.
The economic headwinds for Turkey have been blowing for a while, a stubborn current account deficit, an overheating, highly leveraged economy with a large amount of foreign currency borrowings were all factors that have been apparent for many years. Turkey is the only major EM economy that has not made significant headway in improving its current account deficit since the “taper” tantrum of 2013. Normal economic policy would have called for a slowing down of the economy through both monetary and fiscal tightening, but Erdogan has openly tried to influence the central bank not to raise interest and has resisted the adoption of any measures aimed at slowing the economy and controlling the current account.
The decision earlier this month by the central bank to hold interest rates at current levels, when most of the market was expecting a rate hike had already unsettled markets. The last thing Turkey needed at that point was to get into a political spat with the US on the status of the US pastor who has been detained in Turkey.
But that is exactly what markets got, with Trump tweeting about stiff tariffs on Turkish steel which caused the bottom to fall out of the lira and market volatility to spike.
Once we get a political resolution to the current spat, I think we will be left with the more manageable problem of stabilising the Turkish currency and trying to engineer a soft landing for the Turkish Economy. To be sure, Turkey has the ability and the tools to do this, in addition to the traditional measures of raising rates and cutting fiscal stimuli, Turkey could look for some help from its international partners.
While the US and the International Monetary Fund (which is heavily US influenced) may not be the first stop, its European trading partners, China and Russia are all likely sources for help, if required. I seriously doubt any more serious measures, like imposing capital controls would be contemplated by the Turks at this time, but that is only if the more traditional measures are implemented as soon as possible.
While Turkey has many difficult economic and political decisions to make in the near term, I don’t believe we are at the start of a wider EM meltdown just yet. Unlike the 1997 crises, most of the larger EM economies are must better positioned to handle the current turmoil. Floating currencies, deep local currency debt markets and generally less leveraged economies mean that countries like Brazil, Mexico, Indonesia, India etc, have the tools at hand to guide themselves out of difficult situations, if and when they need to.
None of this is to say that we will not enter a period of slower growth and weaker EM currencies overall, but in my view it is unlikely that we will have a full blown EM crises like we did in 1997-98.
Abdul Kadir Hussain is the managing director of Fixed Income Asset Management at Arqaam Capital.