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18 August 2018

Plunge in Lira, Turkey’s Currency, Fuels Fears of Financial Contagion

By Jack Ewing and Alexandra Stevenson
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Turkey’s currency fell to another record low on Monday, hitting stocks in Europe and Asia and raising fears that the country is on the verge of an economic meltdown that could spread to other emerging markets. The crisis, caused by soaring inflation, economic mismanagement by the Turkish government and tensions with the United States, has raised concerns over whether emerging economies that have benefited in recent years from foreign investment may also be vulnerable. Rising interest rates in the United States and in Europe have made investors less tolerant of emerging markets. Foreign investors piled money into Turkish assets for years, lured by what appeared to be a stable economy and higher returns. But as interest rates rise in countries seen as safer, the relative attractiveness of riskier investments wanes. A crisis like the one in Turkey may be all it takes to send them fleeing.


Turkey’s central bank insisted over the weekend that it would “take all necessary measures” to preserve the country’s financial stability. But it has so far refused to raise interest rates, and the changes it has pushed through thus far have been limited in scope.

After the Turkish lira fell even further — one dollar bought 3.8 liras at the start of the year, but at one point on Monday it was worth 7.2 liras — investors dumped other emerging-market currencies. The Indian rupee dropped to a record low against the dollar, the Indonesian rupiah flirted with a three-year low, and the South African rand lost 2 percent after falling nearly 6 percent last week.

Stock markets across Asia, including in Hong Kong; Seoul, South Korea; Shanghai; and Tokyo, fell on Monday, with many exchanges dropping nearly 2 percent during the day. European markets fared only slightly better. The euro hovered around its lowest point against the dollar in a year.

The Standard & Poor’s 500-stock index lagged for much of the day, and closed down 0.4 percent. The Dow Jones industrial average fell 0.5 percent.

“Turkey’s woes can ripple out to hammer European Union institutions,” Carl Weinberg, chief international economist at High Frequency Economics in White Plains, N.Y., said in a note to clients on Monday.

Shares of European banks suffered some of the biggest losses, including BBVA of Spain and UniCredit of Italy, which have large holdings in Turkey, and lenders such as Commerzbank and Deutsche Bank, which do not have major operations there.

Investors were driven principally by fears of contagion, the notion that an economic or financial crisis in one country — in this case, Turkey — can quickly spread to other regions.

Problems in Turkey have been brewing for years, but Turkish assets have fallen steeply in recent days as questions have mounted over the country’s prospects. Price increases have quickened, and President Recep Tayyip Erdogan had undertaken increasingly authoritarian moves, from the appointment of a relative as an important minister to the erosion of the central bank’s independence.

Normally, a country in Turkey’s situation would raise interest rates to stifle inflation and stop the currency’s slide. But Mr. Erdogan’s popularity has hinged on rapid growth fueled by credit, and he has often spoken against raising interest rates.

Still, Turkey has political and economic problems not found elsewhere, and analysts were not yet ready to predict widespread panic.

“In the very short term, we are seeing what we would describe as ‘risk off’ toward emerging markets,” said Stuart Culverhouse, global head of macro and fixed income research at Exotix Capital, a research firm in London.

But “Turkey is following a path many other emerging markets aren’t,” he added. “I don’t think it’s going to lead to a more systemic problem across emerging markets

On Monday, Turkey’s central bank relaxed some of its rules on the money that commercial banks must keep on reserve, freeing up cash to deal with the currency crisis. The central bank also said that it would provide “all the liquidity the banks need.”

But it made no mention of raising the benchmark interest rate, which is already at 17.75 percent. Though high compared with other countries, it is only slightly above the rate of inflation and would have to be much higher to squelch rising prices.

In a speech in the city of Trabzon on Sunday, Mr. Erdogan called on businesses to show solidarity in supporting the lira.

“Do not prefer to rush to banks and buy foreign currency,” he said. “You would do the wrong thing if you resort to such options just to be on the safe side. You should know that it is both our and industrialists’ and merchants’ responsibility to keep this nation on its feet. Otherwise, we would have to implement Plan B or Plan C.”

Yet in a sign of nervousness in Turkey, rumors spread on social media that the Plan B or C would involve restrictions on foreign exchange bank accounts. The treasury and finance minister, Berat Albayrak denied the rumors in a post on Twitter late Sunday, and the semiofficial Anadolu news agency later reported that Turkey’s interior ministry had opened investigations into 346 social media accounts officials said had helped “manipulate perceptions” about the lira.

Compounding the fear in financial markets, there is a lack of information about which foreign banks may own Turkish government bonds or have lent money to Turkish companies. About 90 percent of Turkey’s public and private sector debt with foreign lenders is in foreign currencies, according to the International Monetary Fund.

Those debts in dollars, euros or other foreign currencies will quickly become unsustainable for borrowers that do not have corresponding revenue in those currencies.

A worsening diplomatic dispute with the United States has also piled on the pressure for Turkey. Though tensions initially centered on the detention of an American pastor, they have since spread into the trade arena.

President Trump pledged on Friday to double the rate of tariffs on steel and aluminum imports from Turkey. The comment, which was made in a Twitter post, spooked markets concerned that Mr. Trump could take a similar approach with other trading partners.

I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!

“The catalyst for market volatility has been geopolitical uncertainties and trade,” said Viraj Patel, a foreign-currency strategist at ING. “This is another knock for global markets and, taken together, it’s a pretty toxic environment.”

China’s currency, the renminbi, which has been a casualty of Mr. Trump’s trade policies for weeks, also weakened further against the dollar on Monday. The government in Beijing, which keeps a firm grip on the value of its currency, weakened the renminbi by 0.34 percent against the dollar, setting the benchmark rate for trading in Shanghai at its weakest level in 15 months.

China’s main stock index lost nearly 2 percent at one point on Monday, but it closed down 0.3 percent. The reaction was stronger in other Asian markets: In Tokyo, the main index fell 2 percent. Stocks in Seoul fell 1.5 percent. A broad index of Europe’s biggest companies was down 0.4 percent in afternoon trading.

A strengthening dollar is the biggest concern for officials in China and in other emerging markets. The upheaval in Turkey has fortified the dollar even further.

Despite the panic in markets, one economist at Deloitte said he believed that uncertainty about Turkey did not signal a global contagion, yet. Turkey’s economy is only the 17th-largest in the world, and it is not as integrated into the global financial system as countries like China and the United States.

“I’m a little concerned, but I wouldn’t be pressing the panic button,” the economist, Xu Sitao, said.

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