Turkey’s troubles may come home to roost

The Sunday Telegraph - Money & Business - - Business - LIAM HALLIGAN Fol­low Liam on Twit­ter @liamhal­li­gan

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’

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