A very Turkish mess
Get into a taxi in Rio de Janeiro, Jakarta or Cape Town, and ask for that day’s US dollar exchange rate, and the chances are that the driver will know the answer to within a decimal point. Try the same thing in Tokyo, London or Berlin and you will likely receive a blank stare. My anecdote reflects a simple reality: most people in emerging markets think in two currencies: their own and the US dollar. This highlights most emerging market consumers’ limited trust in their own currency and is why international investors fret about EM risk assets when the US dollar rises. The worry is always that as the dollar appreciates, local savers will abandon local assets and seek refuge in US currency and bonds. And yet while the US dollar’s post-November 8 breakout did cause a knee jerk sell-off in global emerging markets, recent weeks have seen a retracement and the MSCI EM benchmark is now making new post-election highs (in local currency terms). By and large, this bout of dollar strength has not sparked capital outflows from EMs.
By and large, except for one country: Turkey, which now seems to be spinning toward a full-blown, fairly typical, emerging market funding crisis. And the reality is that it is hard to see who, or what, will come to Turkey’s aid in the near to medium term. This is because Turkey’s problems go far beyond its ability to finance a current account deficit of about 4.5% of GDP, and a budget deficit running at about 2.5% of GDP.
The first and possibly biggest problem for Turkey is that its own bourgeoisie (the lawyers, journalists, financiers...) was shocked by the brutality that followed last summer’s “coup”. And that’s if people believe it was a coup at all! After all, who organises a coup and doesn’t take control of the TV and radio stations, along with aviation control centres? As such, Turkey’s “moneyed class” is likely busy getting assets out of the country.
The second problem for Turkey is that it is fast running out of friends internationally. Having blackmailed Europe (especially Germany) over its willingness to release hundreds of thousands of refugees onto European shores, Recep Tayyip Erdogan can hardly now turn to Angela Merkel, or other European leaders, for help. The Gulf nations, which for years funneled capital into Turkey to fund the construction of malls, apartment towers and other infrastructure investments, thereby providing the capital account surpluses to offset Turkey’s big current account deficits, are nowhere near as cash-rich as they once were.
In fact, the likes of Saudi Arabia must finance its own enormous social spending, bankroll wars in Syria, Iraq and Yemen and still have money left over to send to the army in Egypt to ensure that that country does not fall (back) into the hands of the Muslim Brotherhood. This does not leave much money for Turkey. Especially now that Turkey has decided to make friends with Russia, Saudi Arabia’s indirect enemy/rival.
This brings us to the third, and perhaps most important problem facing Turkey. After all, why did President Erdogan reach out to Vladimir Putin last summer? One explanation is that in the past year, Russia has evolved from being a bit player in the Syrian conflict, to the major actor that was able to disrupt the status quo on the ground. And recent developments in Syria pose a grave threat to Turkey; in particular the increasing strength of the Syrian Kurds who now control most of the Northern third of Syria.
It is not a stretch to think that the Syrian Kurds will try to attach themselves to the Iraqi Kurds to try and forge the Kurdistan state that Turkish leaders have always fought to prevent. This “Kurdistan” threat likely explains why Erdogan sent Turkish troops into Syria in August. His problem is that with little air support and stretched logistics lines, the Turkish Army has struggled to put away the Syrian Kurdish Peshmergas.
And so it seems that this potential threat on its border explains why Turkey sought Russia’s help. Of course, in making this entreaty, Ankara would obviously have annoyed Saudi Arabia — also known as the marginal buyer of Turkish assets in recent years.
All this is a long way of saying that Turkey’s struggles have a whole lot more to do with problems inherent to Turkey, and to some extent, to the broader Middle East, than to emerging markets in general. Yes, Turkey is going through a typical EM crisis, with capital outflows, rising bond yields and a collapsing currency. But Turkey is not the first domino of a broader emerging market upheaval. It is an isolated case of a country in deep trouble following years of poor, increasingly authoritarian, and rapidly deteriorating decision making.