currencies such as Argentine peso, Indonesia’s rupiah, Indian rupee, Mexico’s peso and South Africa’s rand. Are other EM economies vulnerable to the crisis à la Turkey? Some individual economies other than Turkey could potentially face financing challenges. Vulnerable counties could experience their own external debt crises if their currencies continue to come under downward pressure and/or if the Fed hikes rates further. But we believe that the concerns that problems in Turkey will spread to other EMs are overblown.Can the Turkish problem spread to other emerging markets?
We do not think that the financial issues that Turkey is now facing are similar to the entire developing world
Monaem Sarker
Turkish assets have been hammered over the past few days and fear of contagion has led to selling pressure on other emerging market (EM) assets more broadly. The Turkish liras plunge has also hit other emerging-market currencies such as Argentine peso, Indonesias rupiah, Indian rupee, Mexicos peso and South Africas rand. Are other EM economies vulnerable to the crisis la Turkey? Some individual economies other than Turkey could potentially face financing challenges. Vulnerable counties could experience their own external debt crises if their currencies continue to come under downward pressure and/or if the Fed hikes rates further. But we believe that the concerns that problems in Turkey will spread to other EMs are overblown.
Few other countries are troubled by as broad a constellation of economic problems as Turkey. Its economic woes include one of the largest trade deficits of any emerging-market country, unmatched external debts, a currency vulnerable to decline, exceptionally high inflation and unorthodox monetary policy. Turkey runs an unusually large current account deficit (approx. $49 billion in 2018), making the economy dependent upon capital flowing into the country and prone to reversals in investor sentiment.
Turkey has financed this deficit by borrowing extensively in foreign currencies. It is largely corporate borrowing, in euros and dollars. Turkeys government also has issued debt in foreign currency amounting to 11% of GDP. Turkeys central bank has kept interest rates low. Then inflation built as the economy heated up. Turkeys inflation rate will top 11% this year, about double the rate of any other major emerging market except Argentina. Turkeys currency has been another financial red flag as it is exceptionally overvalued.
We do not think that the financial issues that Turkey is now facing are systemic to the entire developing world. Individual economies could indeed face financial difficulties in coming weeks and months. But we do not think that a wave of financial crises will engulf the developing world la 1997-1998. Few markets share Turkeys vulnerabilities, and global banks are relatively insulated from foreign defaults. There are a couple of reasons for our optimism. First, many developing economies are better equipped to deal with their external debt problem than they were two decades ago. Most developing economies allow their currencies to float at present. Consequently, central banks can allow the exchange rate to adjust gradually downward, and they do not need to raise interest rates to defend their currencies to the same extent as they would under fixed exchange rate regimes. Less monetary tightening means that their economies are more resilient than they would be under fixed exchange rates.
Furthermore, the ability of many EM economies to service their external debt is better today than it was two decades ago. The debt service-to-export ratio of the developing economies is about 20% today compared to 30% in 1997. In addition, EM economies have larger foreign exchange reserves, which they can use to counter some of the downward pressure on their currencies.
The writer is a political analyst
