After a brief recovery, the pressure on the Turkish currency and government bonds has increased again. A series of rating downgrades served to put additional strain on a situation that was already far from good. As a result, the question of whether the Turkey crisis could become contagious and spread to other emerging markets is back firmly in the limelight.
In terms of the real economy and the financial world, the escalation of the crisis should not result in appreciable risks of contagion. Turkey is not a very substantive trading partner for the relevant emerging market players. Russia, Bulgaria or Romania are all of a certain significance as regards foreign trade and a sharp drop in Turkey’s GDP would probably strain growth there, but would not result in a manifest crisis. Moreover, it would seem, or so BIS data shows, that the credit relations are more with banks in the industrialized nations than in the emerging markets. We likewise discern little danger of contagion along this channel.
In the event of the crisis in Turkey intensifying, the risk of an enduring and less differentiated turnaround in sentiment could be a critical factor. For example, the currency turbulence in Argentina is often associated with the situation in Turkey. While the respective situations in the two countries are clearly very different in a variety of areas, and (unlike Turkey) the Argentines responded to the turbulences with sharp interest rate hikes, the two countries do in fact have one thing in common: Both have a very weak external position, as is reflected amongst other things in a high current account deficit, a meagre cushion of foreign exchange reserves, and relatively high debt levels carried in foreign currency. A weak external position is also to be founded, albeit not to a comparably critical degree, in countries such as South Africa or Indonesia. Furthermore, there are upcoming elections in Brazil and the danger of additional sanctions against Russia – although both of these countries clearly have sounder external positions. We cannot therefore exclude that if the Turkey crisis grows deeper it may also affect other countries.
However, it also bears emphasising that the list of problems Turkey faces is especially exclusive. For various factors have coincided, namely a very weak external position, a negative trend for its country rating, a high concentration of political power, double-digit inflation, a central bank with a restricted ability to act, and diplomatic conflicts with the USA, a pattern that is not repeated in any of the emerging markets we cover. This state of affairs does not simply amount to absolving the entire market segment of risk, and should instead prompt countries to avoid committing the “Turkish mistakes”. Moreover, crises can gain momentum over and above any set of data, in particular as US policy ensures there is a substantial shot of additional uncertainty afoot at present. Nevertheless, the situation in Turkey can be considered as very specific and not as a pattern for a broad crisis in the emerging markets.