August 14, 2018, 20:29 / Economics

Could Türkiye be the harbinger of a crisis?

The government's mistakes will become more expensive amid tightening monetary policy of central banks Roger Blitz Jonathan Whatley

Could Türkiye be the harbinger of a crisis? / Photo Burhan Ozbilici / AP

The relatively small size of the Turkish economy - about 1% of global GDP - could limit the impact of the lira's depreciation. But investors and analysts are starting to look at the crisis in Turkey as a harbinger of what's to come as central banks wind down monetary stimulus.

As access to dollar liquidity becomes worse, investors will be less forgiving of government mistakes, and borrowers who have accumulated large debts in US currency will face difficult decisions. “After 10 years of anesthetic monetary policy, the number of skeptics is growing,” says Alberto Gallo of Algebris Investments.

The Institute of International Finance (IIF) estimates that developing countries' total debt has risen by about $40 trillion to nearly $70 trillion in the 10 years since the global financial crisis. Some emerging markets look the most vulnerable.

Argentina had to ask for help from the International Monetary Fund (IMF) in June. Analysts also note risks for South Africa and Brazil associated with their debts. That's why the South African rand fell 10% in trading on Monday, while the Brazilian real has weakened 4% over the past four trading sessions. “Traders are now avoiding countries where dollar bonds pose a risk,” says Swissquote analyst Peter Rosenstreich. He notes that Chile, Mexico, Indonesia, Russia and Malaysia are among the countries with high levels of non-bank dollar borrowing relative to GDP.

China has the largest debt load. Its debt rose from 171% of GDP at the end of 2009 to 300% of GDP in the first quarter of 2018, according to the IIF. Although most of it comes from domestic debt.

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The example of Argentina shows how investors can react to government mistakes. Just a year ago, Buenos Aires issued $2.75 billion in 100-year dollar bonds, but in the second quarter of 2018, the Argentine peso began to fall rapidly as the dollar strengthened. Therefore, the country's authorities urgently raised interest rates and agreed with the IMF to receive assistance. “We noticed the first cloud and bought a large umbrella,” notes Argentine Prime Minister Marcos Peña.

These measures helped stabilize the peso until last Friday. But since then its exchange rate against the dollar has fallen by 7%, and on Monday Argentina's central bank raised interest rates by 5 percentage points to 45%.

Argentine authorities may have managed to restore investor confidence, which sets them apart from Turkey. The problem with the latter is that “investors have no confidence in its institutions,” says Timothy Ash of BlueBay Asset Management.

Meanwhile, the European Central Bank is winding down its bond-buying program, and investors say confidence will also be critical. With investors worried about the budget Italy's populist coalition government will present, its 10-year bond yield rose 11 basis points to 3.09% on Monday. Algebris Investments' Gallo said markets will judge Italy by the same standards as Argentina and Turkey. Italian Deputy Prime Minister Luigi Di Maio told the Corriere della Sera newspaper that the government “cannot be intimidated” by the markets.

In Asia, "economic fundamentals are stronger and central banks are very vigilant" after the region's financial crisis in 1997, said Trinh Nguyen, senior economist at Natixis. She said authorities there are more willing to take difficult steps to keep inflation and exchange rates under control, even if it means sacrificing economic growth. Nguyen acknowledges that China could suffer if the trade war with Washington escalates, but she sees rising U.S. interest rates and a stronger dollar as a bigger factor: "What's really driving emerging markets is the decline in dollar liquidity."

Translated by Alexey Nevelsky