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Falling Turkish Lira Reminds Risks Facing Emerging Markets

The writer is investment director at GAM

On paper, 2021 should have been a great year for emerging market currencies and bonds as global growth recovers from the shocks of Covid-19. But the alarming fall in the Turkish currency this year has shown just how bad things can sometimes go in the emerging market world.

On the emerging market strength checklist are a series of ticks: strong export growth, accommodative monetary policy in large developed economies, rising foreign exchange reserves, and high commodity prices. Still, the JPMorgan Emerging Market Currency Index has fallen 9% this year and yields have risen.

This is due at least in part to the return of the “vigilance” effect in financial markets where countries that deviate from traditional economic orthodoxy or borrow too much pay the price for weak currencies and higher bond yields. students. In large developed economies, these forces are still inactive. This is not the case in emerging markets.

Turkey is the most obvious example after the pound fell 20% over the past two weeks following further rate cuts that have heightened concerns about Ankara’s economic management.

Turkey’s economic fundamentals are in many ways the best in years, but President Recep Tayyip Erdogan’s insistence on interest rate cuts has put pressure on the pound.

In July 2019, Erdogan sacked central bank governor Murat Cetinkaya. The lira appreciated over the next month and at the end of 2019 was pretty much unchanged. When Erdogan repeated action against Naci Agbal in March this year, the pound fell 15% in one day before recovering and has struggled ever since.

But a rate cut last week – the third since September – sent the lira plummeting, hitting 13 per dollar (up from 7.2 on Agbal’s last day in office). The worst day for the pound came after Erdogan reiterated his attachment to his unorthodox views that high interest rates cause inflation.

The case of Turkey is perhaps the most extreme, but there have also been investor uprisings in markets from Brazil to South Africa.

Emerging markets were dragged down by three factors. The first is the strength of the dollar. Emerging markets have always struggled when the US dollar is strong. This makes it more expensive to service the external debt and can stimulate investment outflows.

The second is the Covid. The deployment of the vaccine has been done and has disappeared in developed economies, causing euphoria and then disappointment. Emerging markets went straight to the disappointment. Vaccines took a long time to reach the poorest countries. Even when available, vaccination rates are low.

The third, and arguably the most intractable, is the price emerging markets pay for populist, sometimes unpredictable governments with a relaxed approach to budget spending.

Unlike large developed economies, emerging markets have much less flexibility on the political front. Residents of emerging markets are much more inclined to transfer their savings in foreign currencies and even abroad, resulting in revaluation of bond prices and exchange rates.

Beyond Turkey, longer-term bond yields in emerging markets raise doubts about fiscal sustainability. Brazil’s key rate is 7.75 percent, but 10-year bonds are yielding 12 percent. South Africa’s figures are 3.75 percent and 10 percent. South African bonds have struggled to recoup post-Covid losses as Brazilian investors assume the country is entering one of its periodic phases of rate hikes.

These countries indicate either higher credit risk in a few years or high long-term rates to stem capital flight. Even Russia – with a sovereign balance sheet that would leave most finance ministers green with envy – is paying almost 9% to borrow for 10 years.

These rates appear to be an anomaly in a world where G20 yields are still historically low. It appears that investors who are happy to pay stratospheric valuations for tech stocks or fraud-prone cryptocurrencies suddenly become sober and cautious of poorer countries. Emerging markets rarely get the benefit of the doubt.

This has not been uniform since the Covid outbreak – while emerging markets were sold with everything else in the initial outbreak, a strong rally at the end of last year generated a return of 9 , 6% of the JPMorgan Emerging Market Local Currency Debt Index in the fourth quarter of 2020 and the index hit an all-time high at the start of the year.

To an investor, the current path seems clear: Emerging market assets are cheap, but investments in them are best funded by currencies other than the dollar, and it’s best to stick with countries with governments. responsible.

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Tags : interest rateslong termlong timewall street
Margarita W. Wilson

The author Margarita W. Wilson