Turkey, Argentina and the parallels with 2018

  • The recent pressure on the Argentine peso and the Turkish lira has echoes of the currency crises both countries suffered in 2018. But there are also some important differences which mean that, even if Turkey and Argentina were to suffer outright currency crises, the fallout for other EMs would be much less severe.
  • Back in 2018, the lira and peso came under pressure in April and these falls continued in the months that followed. That triggered large interest rate hikes, a dramatic tightening of financial conditions and both economies fell into recession. Argentina turned to the IMF to ease strains in its balance of payments.
  • These currency collapses raised fears of a wider EM crisis. While that didn’t materialise, other EMs’ currencies weakened and there was a shift towards a broad-based rate hiking cycle. (See Chart 1.) This, in turn, caused financial conditions to tighten across much of the emerging world. (See Chart 2.)
  • The genesis of the problems in Turkey and Argentina in 2018 was that they both were running large current account deficits (due to excessively loose monetary policy in Turkey, and loose fiscal policy in Argentina). (See Chart 3.) A combination of rising oil prices and higher US Treasury yields then put currencies under pressure. Local factors added fuel to the fire – in Turkey’s case a dispute with the US, and in Argentina’s case an erosion of the central bank’s credibility after it lifted its inflation targets.
  • Events now have echoes of 2018. The lira has come under sustained pressure in recent weeks. And while Argentina’s official peso exchange rate hasn’t fallen as far recently, a large spread has opened up with the parallel market. (See Chart 4.)
  • There is a growing risk of full-blown currency crises in both countries. Despite large adjustments in currencies and current account positions in 2018 and H1 2019, macro vulnerabilities remain high. FX reserves are precariously low and falling in both countries. Turkey’s gross external financing needs are still very large as a result of the banking sector’s huge short-term external debts. And in Argentina, despite the recent restructuring, the sovereign debt burden looks unsustainable. Government FX debts are still large.
  • We are becoming increasingly concerned that Turkey’s central bank will not deliver the monetary tightening required to shore up investor confidence. And speculation is growing that a devaluation of Argentina’s official exchange rate is imminent as capital controls are becoming porous.
  • However, even if both countries do suffer renewed currency crises, there are two important differences with 2018 that should limit contagion risks to other EMs this time around.
  • First, investors have pared back their exposure to Turkey and Argentina significantly since 2018. Foreign investors holdings of Turkish equities and government debt is now less than half the size in 2018. (See Chart 5.) If either country were to suffer major stress, some EM assets would probably be hit hard (e.g. the usual suspects of the Mexican peso and South African rand). But absolute losses for holders of Turkish and Argentine assets would be smaller than in 2018, as would forced selling of other EMs’ assets. (See here.)
  • Second, the recent pressure on the lira and peso seems to have been driven by country-specific more than global factors (e.g. rising US Treasury yields). In Argentina, that reflects attempts to control the official peso rate and broader concerns about the climate for investors; in Turkey, the issue is foreign policy which seems to be stoking disputes with neighbours and major powers, raising the threat of sanctions.
  • There are ways in which domestic factors could trigger concerns in individual EMs. For example, were the governments of Brazil or South Africa to loosen the purse strings, debt concerns would spook investors. But if we are right in expecting US Treasury yields to remain low (see Chart 6) and global risk appetite to improve, capital flows to EMs more generally should continue to hold up reasonably well.
  • Third, most EM currencies don’t appear in need of adjustment. Current account positions have generally improved across the emerging world. Many countries, including perennial deficit countries such as India, Brazil and South Africa are currently running surpluses. (See Chart 7.) And gross external financing needs are not uncomfortably large in any major EM outside Turkey. (See Chart 8.)
  • Finally, even if other EMs’ currencies were to come under pressure, there’s little chance of a shift towards monetary tightening like there was in 2018. Output gaps are large, inflation (core and headline) is weak and economies need all the support they can get. And few have large foreign currency mismatches that could force central banks to tighten policy out of concerns about financial stability.

Chart 1: CE Interest Rate Diffusion Index

Chart 2: CE EM Financial Conditions Indicator* (Std. Dev.)

Chart 3: Turkey & Argentina Current Account Balance (4Q Sum, % of GDP)

Chart 4: Difference between Official & Unofficial Peso vs US$ (%, 3-day Moving Ave.)

Chart 5: Non-Resident Claims on Turkey ($bn)

Chart 6: 10-Year US Treasury Yield (%)

Chart 7: Current Account Balances (s.a., % of GDP)

Chart 8: Gross External Financing Needs
(% of FX Reserves)

Sources: Refinitiv, World Bank, Capital Economics

William Jackson, Chief Emerging Markets Economist, william.jackson@capitaleconomics.com

William Jackson Chief Emerging Markets Economist
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