From Our Briefings Newsletter
The article below is from our BRIEFINGS newsletter of 20 August 2018:
Briefly . . . on Turkey: A unique crisis?
A combination of domestic political and policy uncertainty, alongside a diplomatic dispute with the US, has contributed to the latest sell-off in Turkish assets and rattled emerging markets investors. We sat down with Goldman Sachs Asset Management’s Sam Finkelstein and Luke Barrs who shared their views on fixed income and equities, respectively, and with GSAM economist Prakriti Sofat, who just returned from a visit to the country.
Turkey’s lira has been falling against the dollar. Inflation’s in the double digits and the US has been hitting the country with sanctions and extra tariffs. How did we get here?
Prakriti Sofat: First, and most importantly, there’s been an erosion of policy credibility. The country’s double-digit inflation has been consistently above its target of 5% and the central bank has been unable to raise interest rates to get inflation in check. Second, Turkey is running a sizeable current account deficit compared with other emerging market countries -- put simply, it imports more than it exports and relies on foreign funding to finance this deficit. At a time when the US Federal Reserve is raising interest rates and the European Central Bank is tapering its quantitative easing, Turkey appears vulnerable to a withdrawal of global liquidity and a reversal in investor sentiment. Finally, the heated diplomatic dispute between Turkey and the US, involving the continued imprisonment of an American pastor, propelled Turkey into headlines and bought the country’s economic imbalances and institutional weaknesses to the forefront of investors’ minds.
Can Turkey’s crisis be contained? What’s next?
PS: What we believe needs to be done to potentially stabilize Turkey’s crisis is relatively straightforward. The market is looking for a comprehensive and coordinated policy package with significant rate hikes, a de-escalation of tensions with the US, a credible fiscal plan and an external funding agreement (with the International Monetary Fund, for example). These would go some way to alleviating investors’ concerns. While Turkey’s central bank has imposed some initial measures to manage financial stability risks, broader macroeconomic imbalances need to be addressed for the markets to stabilize.
The situation in Turkey has the hallmarks of an emerging markets meltdown. Is Turkey the canary in the emerging markets coal mine?
Sam Finkelstein: We think the problems in Turkey are somewhat unique to the country and don’t think the current situation is a bellwether for the broader EM complex. That said, continued volatility in Turkish assets is likely to rattle investor sentiment toward EMs in the near term. The underlying concerns driving the recent price moves, however, aren’t new. Many investors -- including us -- have been monitoring Turkey’s elevated USD funding needs for the past several years and look at whether countries have enough foreign exchange (FX) reserves to meet those needs. On this measure, Turkey appears vulnerable as its funding needs resemble those of riskier frontier markets and are similar to the needs of the Latin American countries in the 1980s or Asia in the 1990s. However, one silver lining is Turkey’s fiscal position. Turkey’s fiscal deficit and debt-to-global domestic product (GDP) ratio is around 2% and 28%, respectively, which is far lower than other EMs and is consistent with an A-rated EM sovereign. We would have to see a significant deterioration in Turkey’s fiscal standing before the sustainability of its external debt becomes a significant concern.
How will this affect investments in Emerging Markets?
Luke Barrs: Turkey’s impact on EM investors’ portfolios is small. In fixed income, it represents less than 3.5% of the dollar-denominated index and in equities it is less than 70 basis points. Broadly speaking, we remain constructive on EM equities. Recent weakness has been driven by general risk-off sentiment and weakness in EM FX. This is in contrast to broader macro fundamentals and the outlook for corporate earnings, both of which remain robust.
All investments contain risk and may lose value. Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change, they should not be construed as investment advice.