On the Minds of Investors
11/07/2019
Will Turkey drag down broader Emerging Markets?
In August last year, fresh U.S. sanctions and tariff threats against Turkey by the U.S. exacerbated an emerging market (EM) sell off driven by a hawkish Federal Reserve, strong U.S. dollar and Argentina’s economic crisis. High and rising inflation, worsening relations with the U.S. as well as an inadequate response from policy makers were just a few of the reasons why investors lost confidence in Turkey at that time. The investors’ views were reflected in the 30+% slump in the Turkish lira.
A series of recent announcements on the movement of top officials in some emerging economies has re-ignited the discussion of EM stability. On July 6th, Turkish President Recep Tayyip Erdogan dismissed central bank chief Murat Cetinkaya, prematurely ending his term more than an year early. Though the reason was not announced, President Erdogan has long blamed the central bank’s reluctance to lower interest rates for Turkey’s deteriorating economy, which has slipped into recession. We also saw the resignation of Mexico’s finance minister Carlos Urzua, who disagreed with the President’s political approach to fiscal policies.
Though reminiscent of the turmoil over Turkey last year, the market reaction this time around has not been as drastic. After the U.S. had announced sanctions and proposed doubling the tariff on steel and aluminum imports from Turkey in August last year, the Turkish lira saw its value fall by more than 30% against the U.S. dollar within a single week. In contrast, the recent dismissal of Centinkaya has led to a 1.7% fall in the Lira against the U.S. dollar within the first three days of trading. For both instances, currencies of other EM countries, especially EM Asia did not show much of an immediate impact. In fact, expectations of a U.S. rate cut recently has boosted several EM currencies including the Mexican peso, Argentinian peso and the South African rand.
Many politically driven events pose an idiosyncratic risk that have a limited impact beyond the domestic market. Faced with a rate of inflation three times that of the central bank’s target (15.7% year-over-year in June 2019), a shrinking economy, a rising current account deficit and a high proportion of foreign currency debt (30% of total government debt), fundamental weakness in the Turkish economy has been a longstanding concern.
The dismissal of its central bank chief only renewed doubts of the central bank’s credibility and independence, as well as its ability to rein in rampant inflation and support its ailing currency. However, such fundamental weakness is not replicated throughout the broader EM complex. As shown in the chart on the next page, many EM Asia countries have a current account surplus and maintain a fairly strong reserves position relative to other EM countries. Inflation within the region has also been fairly contained and foreign currency debt accounts for a small portion of total government debt.
EXHIBIT 1: Emerging market external positions
Current account positions, currency movements and reserve adequacy
Source: FactSet, IMF, J.P. Morgan Asset Management.
*Adequate reserves are stocks of a country’s foreign exchange reserves that can cover 3 months of imports (the amount of times available reserves can cover 3 months’ worth of imports) and cover short-term debt due in the next year (the amount of times available reserves can pay off debt maturing in the next 12 months and any payments on longer-term debt due in the next 12 months). The larger the bubble, the larger the amount of reserve coverage.
Guide to the Markets – Asia. Data reflect most recently available as of 30/06/19.
Investment implications
As emerging markets continue to differentiate themselves, opportunity arises among countries with an attractive long-term structural growth story, healthy fundamentals and a governing authority willing and capable of implementing value accretive reforms. Although the recent trade skirmish between the U.S. and China has dented the outlook, the long-term view for selected countries such as China and India remains positive. A dovish turn to the U.S. Federal Reserve further underpins support for EM assets. Furthermore, based on market reactions, the market in general has shown increasing capability to scrutinize individual EM economies, rather than punishing the entire EM bloc as before. Hence, investors should examine any negative news flow carefully, deriving any possible fundamental impact before making any investment decisions for their portfolio.
For more information, please call or email us. You can also contact your J.P. Morgan representative.