John Lynch Chief Investment Strategist, LPL Financial
It has been a complicated year for emerging markets (EM). After a healthy start to the year, the group has struggled, given slower demand from China, tariff concerns, and a firming U.S. dollar. Most recently, Turkey’s diplomatic and political struggles have devolved into a currency crisis that has weighed on the world’s developing markets, despite encouraging economic fundamentals that suggest an otherwise high growth trajectory for EM.
We’ve emphasized our expectation that the economic growth rate for EM this year will be the highest for any global region. We still believe this is the case, and we look for Turkey’s currency turmoil to be resolved in relatively short order as international pressure combines with the necessary monetary steps to address the economic, debt-service, and currency risks.
TURKEY’S CURRENCY CRISIS
The collapse of the Turkish lira, stemming from the country’s economic woes, is a variation on issues plaguing several EM currencies this year. The Turkish lira has plunged 16% in August to a record low relative to the dollar amid steep sanctions stemming from a diplomatic struggle with the U.S. The severity of the lira’s sell-off has unnerved investors around the globe with concerns about the possible contagion risk for the global economy, especially given the potential for an increased pace of capital flight from many EM economies. Turkish president Recep Tayyip Erdogan’s refusal to mollify the concerns of global investors regarding the independence of Turkey’s central bank has compounded worries, further pressuring EM currencies and financial markets.
These recent developments pose legitimate threats to Turkey’s economy if they persist. The lira’s weakness could raise prices in the country, and without the proper monetary policy response, runaway inflation could significantly curb output. Moreover, Turkey’s economic situation is especially fragile. Given the complexity and nuance of its debt markets, a variety of reports suggest Turkey holds in excess of $200 billion in dollar-denominated debt. This compares with $851.1 billion in gross domestic product at the end of last year (according to the World Bank). As the dollar strengthens against the lira, it becomes more expensive for Turkish corporations and the government to convert lira into dollars in order to service the debt, and an inability to service interest payments would no doubt weigh on global sentiment and increase capital flight. Turkey’s current account deficit is also one of the largest among EM countries.
Nevertheless, consensus expectations for Turkey’s economic growth are still optimistic, indicating that this storm may pass with minimal damage. Bloomberg consensus expectations are for Turkey’s gross domestic product (GDP) to grow 4.1% in 2018, down from a 4.2% median growth forecast in June. The median consensus forecast for Turkey’s GDP in 2019 has dropped to 3.4% (from 3.7% in June). Even if Turkey’s economic turmoil intensifies, it’s unlikely to derail global economic growth, considering Turkey’s GDP constitutes only about 1% of global GDP
EM’S GROWTH TRAJECTORY REMAINS STRONG
Turkey’s currency crisis is the latest reminder of the rough year EM currencies have endured. Trade discussions and global risk-off sentiment have roiled EM currencies, while the dollar has surged amid tightening U.S. monetary policy. Trade tensions, especially between the U.S. and China, have further complicated matters for EM.