Dubai: The sharp devaluation of Turkish lira following a series of unconventional macroeconomic policies and monetary policy decisions has seen the currency plunging more than 40 per cent year to date and sending the shock waves through global financial makers spreading a spectre of a contagion across emerging markets.
Economists and market analysts fear that the reverberations of the Turkish crisis felt across many emerging markets will have longer than expected consequences on their currencies, asset classes and investment flows.
“This turbulence, amid heightened tensions between the US and Turkey has clearly weighed on investor appetitive for emerging market assets, putting further pressure on a broad range of EM assets and currencies. Contagion and spillovers have also been evident in cross-border portfolio flows,” said Emre Tiftik, Deputy Director, Global Capital Markets at the Institute of International Finance (IIF).
According to IIF statistics, after a modest recovery in July, emerging markets portfolio flows have slumped in recent days. Countries that they track daily have registered portfolio outflows of some $1.4 billion (Dh5.14 billion) since August 9. Most of that has been out of emerging market stocks ($1.3 billion). Outflows from EM bonds were much smaller, at just $100 million.
By country, outflows were largely concentrated in South Africa and China, amounting to $0.6 billion and $0.5 billion, respectively. Flows to India also turned negative early this week amid a reversal in debt flows.
“While the downturn in sentiment has prompted outflows from Malaysia, Indonesia, Korea, Philippines, Korea and Vietnam, the pace of retrenchment has been moderate to date. Thailand, Qatar and Brazil have been the only countries in our sample recording portfolio inflows,” said Fiona Nguyen, Senior Research Analyst, Global Capital Markets, IIF.
Although causes may differ Turkey’s currency crisis has all the characteristics of a typical emerging market currency turbulence caused by large external deficits and a failure to recognise it on time and work on viable remedial measures. Analysts say the fear of contagion comes largely from Turkey’s unwillingness to recognise the serious nature of the current account deficits, the unconventional policy response and the underlying political crisis.
“Turkey’s currency crisis will continue to weigh on global markets as it is largely the result of unorthodox economic policies and a deterioration in political relations with the US, which are unlikely to improve in the very near-term. The fact that Turkey’s central bank has opted for unconventional intervention methods, rather than raise its key policy rate, suggests that the country may not return to more orthodox policies anytime soon,” Fitch Solutions said in a recent note.
Analysts say, if Turkey is not returning to tried and tested policy solutions it could drag itself into a deeper economic crisis with some global level consequences.
An IMF-led bailout may require US/Turkey diplomatic conciliation and would typically involve conditionality of orthodox policy tightening that may be difficult for Turkey to agree to at this juncture.”
- Sim Moh Siong | Currency Strategist at Bank of Singapore
“A more concrete policy tightening, that signals acceptance of the need for economic slowdown to narrow Turkey’s large external deficit, is still lacking. The alternative policy choices, which carry high domestic political costs, would be to resort to either an International Monetary Fund (IMF) bailout or some form of capital controls. An IMF-led bailout may require US/Turkey diplomatic conciliation and would typically involve conditionality of orthodox policy tightening that may be difficult for Turkey to agree to at this juncture,” said Sim Moh Siong, Currency Strategist at Bank of Singapore.
While developed economies do not have much to fear from the troubles facing Turkey, as economic and financial linkages are relatively weak some emerging markets are sure to get caught up in the contagion. The basic way to avoid the risk of contagion is to run the economy well.
“Large current account deficits, high inflation, excessive external borrowing or over-valued exchange rates create a vulnerability that can be exposed when rising US interest rates create uncertainties over access to funding. This has been the story for many emerging markets crises in the past, where financial markets differentiated relatively efficiently. Most recently, stress was seen with the Taper Tantrum of 2013, when a small group of countries with wide external deficits came under pressure as markets worried about premature Fed tightening,” Bank of Singapore said in a note.
Analysts say among the Asian countries, India, Indonesia and Philippines to a lesser extent run current account deficits. However, the external funding needs, at less than 3 per cent of GDP, seem manageable relative to the size of these countries’ foreign reserves and capacity for policy response. “Given Asia’s limited financial and trade linkages with Turkey, Turkey should not pose systemic risks for Asia’s growth. We expect the spillover from Turkey’s turmoil on Asian currencies to diminish over time. China/US trade war risk matters more than Turkey to the outlook for Asian currencies,” said Siong.