The Turkish lira was 2.1% weaker against the dollar on Monday after President Tayyip Erdogan dismissed the central bank governor, laying bare differences between them over the timing of interest rate cuts to revive the recession-hit economy.
SHARP declines in the Turkish lira, Indian rupee and other currencies have raised the prospect of a self-reinforcing flight from riskier emerging markets.
While the lira recovered slightly on Tuesday, and so did many peers, India’s currency tumbled past 70 per dollar, a historic low. Across the world, the Argentine peso fell another 2.1%, even after an emergency increase in interest rates to 45% from 40%.
The unexpected price action has sparked questions over how contagious the selloff might be, even for far-flung markets. That has driven a widespread selloff as portfolio managers rush for safety, or are forced into selling less risky assets to offset losses. In recent days, world equity markets have traded down, and currencies from Mexico, South Africa and Indonesia sold off, despite minimal economic links to Ankara.
On Tuesday, though, developed-world markets largely shrugged off such concerns. U.S. stocks rose, with markets poised to post gains for the first time in five days. In Europe, stocks were mostly flat.
Several factors will likely determine how far the distress spreads. In the past, markets have panicked if other countries share the same economic weaknesses, or if foreign lenders are badly exposed, or if the same external shock hits several nations at once.
On one end of the crisis scale are episodes such as South Africa’s troubles in August 1985. The apartheid government of President P.W. Botha defied international financiers, extending a collapse in the rand, and spooking foreign banks. But that self-inflicted crisis stayed at home.
On the other is the Asian financial crisis of 1997-1998, which began with Thailand burning through its meager foreign currency reserves to defend the baht. Other markets seen by speculators to have similar problems were quickly overwhelmed, including Malaysia, the Philippines, South Korea and Indonesia. A repeat is something many emerging-markets investors fear.
Today’s situation may be somewhere between the two, according to investors, as the Federal Reserve raises U.S. interest rates and reverses its massive bond-buying program, known as quantitative easing. That is feeding into borrowing costs thousands of miles away, and boosting the dollar, with often painful consequences in many other countries.
Edward Park, investment director at asset management firm Brooks Macdonald, said many nations had made up for budgetary holes by borrowing cheaply in dollars.
“When you look around and say, how many countries have large deficits and large external funding needs, the answer is a lot. I don’t think people know at the moment how far this goes,” he said.
Lending in dollars to developing economies has boomed since the financial crisis—as of the first quarter, some $2.489 trillion was outstanding, according for the Bank for International Settlements. The amount has more than quadrupled in 15 years. However, India and China, the two largest emerging economies, are notably less reliant on dollar debt than others.
Still, Asia’s difficulties with capital outflows in the 1990s taught a harsh lesson. Today, currency reserves in developing countries are typically far larger.
Rob Drijkoningen, co-head of emerging-market debt at Neuberger Berman, said most developing countries had bigger foreign-exchange reserves, and had improved their balance-of-payments positions. Among investors, “the sense of a general vulnerability is just not there” he said.
And some investors say Turkey’s problems are unusual. “Turkey isn’t an average emerging market,” said Colin Croft, emerging-market fund manager at Jupiter Asset Management. In President Recep Tayyip Erdogan, the country has “concentrated power in one person who has economic views which are extremely unorthodox," he said.
Banking systems have been another conduit for previous trouble. Many U.S. banks had lent extensively in Latin America before its 1980s debt crisis, which peaked in 1987 when Brazil suspended interest payments on foreign debt. Eight major banks, including a predecessor of Citigroup Inc., lost a combined $5.5 billion that year.
A handful of European banks with largest exposure to Turkey have sold off in recent days, while the Stoxx Europe 600 Banks Index has fallen modestly, dropping about 3% since Thursday. Most analysts expect the impact on those institutions to fall well short of a systemic threat to the European banking system.
“On the other hand, and what is not being focused on, is the impact for trade finance banks,” said Olly Burrows, an analyst at Nomura. Their exposures, he says “could be larger, and certainly more widespread.” - WSJ
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