Are Turkey’s woes contagious?
Author: Regina Chi
August 14, 2018
The burgeoning currency crisis in Turkey has investors on edge, but the probability of a more serious contagion remains low based on the country’s relatively minor linkage to global financial markets.
The Turkish lira has fallen to record lows in recent days and is now down approximately 45% year-to-date, sparking a selloff in mainly emerging market assets, as well as European nations where banks have more exposure to Turkey’s debt.
The currency has been hit by Turkey’s weak economic fundamentals, a lack of confidence in its central bank, and more recently a growing spat with the United States, which has sanctioned the country over the detention of an American pastor.
While the pullback has been unsettling, Turkey only represents around 1%-2% of emerging equity indices and foreign ownership of Turkey’s bond market is relatively low around 20% compared to other markets such as Malaysia and South Africa that have approximately 40% ownership.
At the same time, many EM countries maintain smaller current account deficits than Turkey (or even have surpluses in some cases) that should help keep further selling in check. Moreover, most of Turkey’s trade and financial sector links are with the European Union rather than with other emerging markets.
History also shows that country-specific currency weakness has often resulted in an eventual rise in related stock prices. For instance, there has been several instances in the past 20 years in which an emerging market currency dropped at least 15% in a week, according to J.P Morgan research. And while, on average, these currencies continued to depreciate beyond that point, the MSCI Emerging Market Index within three weeks ended up rising 60% of the time.
All of this suggests Turkey’s woes can be contained as time goes on, but investors should still be prepared for some broad-based weakness and, at the very least, more volatility in the coming days.
Often this is what is needed to put pressure on politicians to act and already Turkey is promising to “take all necessary measures,” to bolster its financial system. This includes lowering the amount lenders must hold at the central bank and will also ease rules on how they manage lira and foreign currency liquidity.
While we realize Turkey has a long road ahead to fix its structural imbalances and restore financial stability, these measures are a step in the right direction and believe that conditions will improve, leading to a rise in equity markets and the lira over time.
Regina Chi is a vice president and portfolio manager at AGF Investments Inc. She is a regular contributor to AGF Perspectives.
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