A fundamental force behind the growing pressure on the Turkish lira is the economy’s widening current account deficit. But in most cases, the Covid-19 crisis appears to be causing current account deficits to narrow, which is one factor that should limit the downside risks to EM currencies in the coming months.
- A fundamental force behind the growing pressure on the Turkish lira is the economy’s widening current account deficit. But in most cases, the Covid-19 crisis appears to be causing current account deficits to narrow, which is one factor that should limit the downside risks to EM currencies in the coming months.
- A handful of EMs have now released balance of payments data up to June. And most have published trade figures up to that month, which can be used to gauge overall current account balances. Chart 1 helps to visualise these data. EMs in the top left quadrant are those where current accounts positions were in deficit prior to the crisis but have improved this year (in most cases due to imports falling by more than exports).
- The top right shows EMs where current account surpluses have increased (Poland stands out here). The bottom left indicates where deficits have deteriorated (Turkey stands out here), and the bottom right shows where surpluses have narrowed (in many cases due to smaller falls in imports as a result of shorter lockdowns, and larger declines in exports due to more persistent global demand weakness.
- Based on this Chart, three points stand out. First, the widening of Turkey’s current account deficit this year helps to explain the growing pressure on the lira. While the deficit should narrow in the coming months as tourism revenues slowly return, the bigger picture is that the deficit will remain uncomfortably large. And combined with Turkey’s large short term external debts, this will keep the pressure on the lira. For now, we expect the currency to weaken to 7.50/$ by year-end but, if tensions with the EU and/or broader concerns about policymaking in Turkey escalate, the risk of much larger and sharper declines would grow.
- However, the second point is that Turkey is an outlier. Most EM current account deficits have narrowed this year. And external shortfalls are likely to remain smaller than pre-crisis levels even as economies return to full employment. Indeed, despite rebounding since March’s lows, currencies of traditional current account deficit countries like Brazil, Mexico and South Africa are still down by 15-25% year-to-date. All this limits the risk of further large currency falls – although further appreciation from here may be limited.
- Third, Poland’s rising current account surplus is one reason why we’re not convinced that the central bank will be able to engineer a weaker zloty. Comments from policymakers suggesting that the zloty is too strong underscores why we expect the central bank to expand its asset purchase programme and begin FX intervention to weaken the currency. But given the growing current surplus and other signs that the zloty is not fundamentally overvalued, we think that the balance of risks are skewed towards further appreciation.
Chart 1: EM Current Account Balances1
Source: CE. 1) Horizontal axis measures CA positions prior to crisis.
|Vertical axes compares pre crisis levels to CE estimates for June based on latest data.|
Edward Glossop, Senior Emerging Markets Economist, +44 (0)7896064878, email@example.com