Snapshot

Is Turkish turbulence a taste of things to come for EM?


Rising inflation and a general shift towards higher real bond yields, led by the US, has brought loose monetary policy in emerging markets (EM) under the microscope.

In Turkey, the decision to raise rates proved terminal for central bank governor Agbal. Local financial markets came under heavy pressure after his sacking. Incoming governor Kavcioglu will face a tough task to steady the ship. However, fears of contagion are likely to prove exaggerated, given that Turkey is a fairly specific story and as most other EM have more solid external positions.

The debt view: James Barrineau, Global Head of EMD Strategy

The decision to remove Agbal comes after he had solidly begun to establish credibility in markets. Our positioning data showed investors had added to lira exposure aggressively as Agbal was given free reign. That suggests that the currency could fall for some time. Local rates have also jumped and the evisceration of the hard-won credibility will surely lead to higher rates, a weaker currency, and higher inflation. Although unlikely, we would not rule out capital controls as a way to mitigate foreign exchange reserve outflows.

The equities view: Nicholas Field, Global Emerging Market Equity Strategist, EM Equities

During the 2018 currency crisis in Turkey we opined that, “In order to arrest the crisis, Turkey needs to regain the confidence of potential foreign funding sources. To do this would most likely require a combination of aggressive interest rate hikes, action to shore up the banking system and fiscal discipline….”

As it happened, in the autumn of last year, Turkey seemed to take some of these actions with the appointment of Naci Agbal as central bank governor and the reintroduction of monetary orthodoxy, culminating in the 200bps rate rise during the week of 15 March. Agbal’s replacement, Sahap Kavcioglu, appears to have unorthodox views on policy which leaves the future direction of policy deeply unclear. It is hard to see how he will be able to create the confidence necessary to be able to manage Turkey’s large funding needs over the coming months, and hence it is hard to see how pressure on the currency is alleviated.

Contagion to other EM is unlikely

Events in Turkey sent a ripple through other EM on 22 March, with high beta currencies such as the Brazilian real, Mexican peso and South African rand coming under pressure. However, any talk of contagion is likely to prove exaggerated.

For a start, the sacking of Mr Agbal is a risk specific to Turkey that is unlikely to be repeated across EM. Meanwhile, fundamental external positions are generally much better elsewhere in the emerging world. As we noted earlier this year, Turkey and Colombia were two economies that stood out as having poor external positions. But on the whole, other EM are on a far more stable footing and do not face foreign currency liquidity issues in the way that Turkey does. For example, as the chart below shows, total short-term external debt is less than half of foreign exchange reserves in the vast majority of EM offering insulation from any contagion.

Most EM have solid external positions

20210330_hk_eng_chart_1.jpg

Source: World Bank, Refinitiv Datastream, as at 22 March 2021

Nonetheless, all of this underscores the need for active management to differentiate across the emerging markets.

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