Turkey’s troubles may come home to roost
The 1998 financial crisis was sparked by the sharp depreciation of a series of emerging market currencies. The rout of the Thai baht, then the Russian rouble, meant both countries were unable to service their debts. That raised fears of “financial contagion”, which led to a sweeping and extremely damaging worldwide market sell-off.
Ahead of this “Asia crisis”, there was a sustained period of strong growth across the emerging market economies. That pumped up asset bubbles largely financed by foreign direct investment and heavy debt, much of it raised overseas and denominated in overseas currencies.
It was the bursting of such foreignfunded investment strategies, as Western money fled the emerging markets, that caused the 1998 collapse. Could history be about to repeat itself?
This summer, the Turkish lira has plummeted – which, by making imports more expensive, has driven up domestic inflation. After expanding 7pc in 2017, GDP growth in Turkey looks set to dip below 4pc this year. Meanwhile, as the Federal Reserve has repeatedly raised rates over recent months, the dollar has strengthened.
As such, Turkey’s numerous large companies and even the Ankara government are struggling to service their overseas debts. While corporate and government revenues are denominated in fast-depreciating lira, a high share of debt interest payments must be made in rapidly rising dollars – the currency movements sending the real cost of such payments spiralling upward. This combination of dollar appreciation, relative domestic currency weakness and rising inflation has seen similar concerns about debt servicing lately being raised in other emerging economies too – including Argentina and South Africa.
This, in turn, is fuelling comparisons between 1998 and today – with some arguing the next financial crisis could soon, as in 1998, be sparked by a bond market collapse in a sizeable emerging market. I agree that’s possible, but would also argue that the biggest danger in terms of systemic instability, and the most likely cause of the next meltdown, lies somewhat closer to home.
Sitting at the crossroads of Europe and Asia, Turkey could hardly be more strategically located. With its blend of cultures and fast-growing 80m-strong population, many of them young and well educated, this largely secular country should be among the world’s most attractive emerging markets.
And so it has seemed. The Turkish economy has tripled in size since the early 2000s, riding an almighty wave of consumption and construction. Foreign investment has poured in. Mega-projects include the $11bn (£8.6bn) Istanbul-izmir motorway, a high-speed Ankara-istanbul rail link and a plausible bid to build the world’s largest airport.
Yet economic storm clouds have gathered. Turkey’s audacity has begun to look like hubris. Debt levels have soared. Trade remains heavily dependent on a sluggish eurozone and unrest in Syria and Iraq, just across the southern border, hasn’t helped.
Neither has Turkey’s increasingly authoritarian president Recep Tayyip Erdogan, who has made some major
economic mistakes – not least his clumsy attempts repeatedly to undercut the independence of the country’s central bank, nominally independent since 2001. His tirades against higher rates have alarmed domestic and foreign investors, while stoking inflation – now at a crippling annual rate of 16pc. As foreign investors have fled, they’ve sold Turkish lira and bought dollars.
And now, of course, Donald Trump is turning the screw. This Us-turkish row is ostensibly about an American pastor previously jailed for two years and now under house arrest in Turkey, pending trial on espionage charges.
But the US president is more fundamentally angry at how Turkey has played the West off against Russia as regional powers have tried to contain Syria’s civil war.
Trump has now announced sanctions on Turkish goods. Erdogan has returned the favour, unveiling a massive hike in tariffs against the US, sending the lira haywire. The Turkish currency has lost 35pc of its value against the dollar this year – prompting concerns that the Fed’s rate rises and Trump’s determination to rein in Ankara could threaten a repeat of 1998. While this story is set to run for months, for now I’d make three observations. Firstly, even if Turkey stabilises in the short term, its recent switch from potential EU member to radical dictatorship is a major concern.
The EU has been near silent about Turkey’s transgression – not least as Ankara has massive leverage. One peep out of Brussels and Erdogan could renege on his deal to use Turkish border forces to stop an influx of Syrian refugees into Europe, fuelling the flames of the EU’S populist fire. This lack of EU action against Turkey has riled Trump.
Secondly, emerging markets are now vulnerable. The MSCI Emerging Market Index, which tracks major EM stocks, last week fell into “bear market” territory – having lost a fifth of its value since its recent peak. After years of Western quantitative easing, “hot money” has flowed to highyielding emerging markets. Now, currency turmoil, US sanctions on Turkey and others and disappointing results from China’s tech giants are causing such money to “return home” – so the MSCI EM could well have further to fall.
Having said that, emerging market assets are fundamentally far more attractive than 20 years ago. If they look cheap, they’ll be snapped up once more. The biggest threat to global markets doesn’t come from the East. It lurks within the eurozone’s own fragile bond markets – as the European Central Bank, at German behest, terminates its QE programme this autumn.
‘One peep out of Brussels and Erdogan could renege on his deal to use Turkish border forces to stop an influx of Syrian refugees’