Turkey’s woes won’t trigger a full-blown crisis across emerging markets, economist says

Turkey’s currency crisis is sending ripples through global financial markets, but analysts say it isn’t necessarily a death sentence for all emerging-market currencies.

Indeed, “the factors that are driving the lira down appear mostly country-specific and so the slump in the lira should not trigger a full-blown currency crisis in most other emerging markets,” wrote Agathe Demarais, principal economist at the Economist Intelligence Unit. “Very few — if any — of them share similar characteristics.”

“The Turkey crisis is largely idiosyncratic, although its triggers are often external factors,” said TD Securities strategists led by Christian Maggio, head of EM strategy.

But even idiosyncratic problems can lead to a chain of dominoes to fall, warned Scott Minerd, global chief investment officer at Guggenheim Partners, calling on investors not to be complacent.

The selloff in the lira USDTRY, -3.1285%  has weighed on sentiment and caused drops in other emerging currencies, even those that don’t face issues similar to Turkey, which is struggling with high inflation, a big foreign currency-denominated debt burden, and — perhaps most important — a president at odds with the country’s central bank.

The timing couldn’t be worse for emerging markets, which already are struggling with the prospect of trade wars, as well as a strengthening U.S. dollar DXY, -0.17%  and rising American interest rates.

The Federal Reserve’s monetary policy agenda, moving steadily along to normalization since late 2015, doesn’t help matters. The central bank began shrinking its balance sheet in October 2017 and is expected to raise interest rates for an eighth time in September, which is draining liquidity available for emerging markets.

“Our concern remains on the liquidity side, and the EM selloff is a manifestation of this tight liquidity,” wrote Morgan Stanley strategists Hans Redeker and Gek Teng Khoo, in a note. “Credits have withdrawn from risky investments since February.”

“Within a world of ample liquidity, recent EM developments would have a far smaller impact on price fluctuations and local liquidity,” said the Morgan Stanley strategists.

While so far the contagion risk seems limited, “economies with large current account deficits such as India, Argentina and South Africa will come under increased economic pressure as the Fed continues to tighten monetary policy,” said Hussein Sayed, chief market strategist at FXTM.

The rupee USDINR, +0.5360% peso USDARS, +0.0084%  and rand USDZAR, -0.1071%  sold off heavily on Monday. Argentina went through multiple interest rate increases earlier in the year and struck a deal with the International Monetary Fund in June to stave off an economic and currency crisis.

The currency turmoil has weighed on global equities, even as the lira has rebounded somewhat. The S&P 500 SPX, -0.76%  and Dow DJIA, -0.54%  came off intraday lows but still closed down Wednesday as worries surrounding Turkey and trade tensions weighed.

Ahead of the lira’s selloff, Oxford Economics “identified the currencies of Turkey, Argentina and South Africa as most vulnerable” to a crisis. “Despite a major depreciation since April, Argentina’s deep imbalances left the peso with more room to fall; and similarly, the rand is vulnerable owning to South Africa’s twin deficits as well as an overstretched banking system,” wrote economists Evghenia Sleptsova and Daghan Ozbilenler.

But not all emerging markets have these issues.

The currencies of Central and Eastern Europe, for example, such as the Polish zloty USDPLN, -0.4910% , Czech koruna USDCZK, -0.3676%  and Hungarian forint USDHUF, -0.55% , “despite their proximity and trade exposure to Turkey, have done relatively well, due to their strong external balances, low inflation and rebalanced banking sectors,” the Oxford Economics economists said.

Besides poisoning emerging-market and risk sentiment, the Turkish crisis could also impact other economies, if it hampered trade. European Union countries account for more than half of Turkey’s trade, most notably Germany. China and Russia follow suit on rank two and three, nevertheless accounting for less than a quarter of Turkish trade together, according to research by TD Securities.

Concerns about the exposure of some European banks to Turkey has also weighed on the region’s financial sector.

Overall, analysts aren’t sweating the contagion risk, however, because the crisis Turkey is facing is unique to its circumstances, although they will keep watching for signs of deterioration in other currencies that are driven by similar but idiosyncratic factors.

“In general, Asian FX is more insulated — not immune — from the Turkey shock and will recover less in a rally scenario, but also exhibit more resilience to a global turmoil if the Turkey crisis deepens,” TD Securities strategists said.

Similarly, Latin American currencies — excluding Argentina's and Mexico’s peso — are further removed as well. Mexico is one of the most popular EM plays and tends to be a bellwether, making it more sensitive to sentiment, even though it is in a uniquely different economic situation.

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