THIS week, we discuss how the ongoing turmoil in Turkey may impact global markets and the portfolios we manage on behalf of clients.
While the Turkish lira’s collapse was initially sparked by the imposition of sanctions by the US on Turkey, its underlying causes run deeper than just geopolitics. Turkey is currently going through a classic emerging market crisis, and its economy displays all the vulnerabilities that preceded previously observed ones. Despite growing by more than 7 per cent this year, the economy suffers from an inflation rate three times higher than that of the central bank’s target. It has relatively high trade and fiscal deficits, which makes it relatively reliant on borrowing. Alongside that, it has a high level of foreign debt exposure, with a sizeable proportion of it having to be paid back quite soon. These problems make Turkey vulnerable: should investors get cold feet and stop lending to Turkey, the economy will have to adjust rapidly (and painfully), usually through a rapid fall in the currency.
It doesn’t help when Turkey’s institutions are widely perceived to be inadequate to the task of solving its crisis; a president that harbours a misguided view that higher interest rates cause higher inflation, a relatively inexperienced finance minister who is the son-in-law of the president himself, and a central bank which is no longer seen to be independent of political pressure.
The imposition of US sanctions merely acted as a catalyst for already-wary investors to dump Turkish assets en masse. The root cause of it was ultimately economic mismanagement. As with most emerging market crises, the ensuing outcome for Turkey’s capital markets is unsurprisingly ugly – year-to-date, the stock market is down by 20 per cent in local terms (50 per cent in dollar terms), the yield on a 10-year Turkish government bond has spiked by 8 per cent, and the cost of insuring against a Turkish default has risen to its highest level since the Great Recession.
The direct impact of Turkey’s crisis on the portfolios we manage is mild, owing to our low exposure towards Turkish assets. Our exposure towards Turkey stems mainly from our emerging market equity and debt holdings, leading to a combined exposure that lies within the low single digits. However, the crisis can affect our portfolios more indirectly through spillover effects into other non-Turkish markets.
The second indirect channel is via souring sentiment on emerging market assets. There are signs that the lira’s collapse has begun to spread to other emerging markets with similar vulnerabilities as Turkey, with other currencies like the Indonesian rupiah, the Argentinian peso and South African rand selling off in particular. A further deterioration in Turkish assets may weigh on market sentiment or spark further de-risking from investors, leading to more volatility within emerging market assets.
The future, as ever, is uncertain and past performance of investments is not a reliable indicator of future performance. The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.
:: Jonathan Sloan is a director at Barclays Wealth and Investments NI
