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Why is Turkey in news?
Turkey is just the latest developing economy to plunge into chaos. The Turkish lira has shed more than 40% since January 2018, while the country's stock market has been cut in half. The crisis began days after US President Donald Trump announced via Twitter a doubling of steel and aluminium tariffs on Turkey, as Washington pushed Ankara to release Evangelical Christian pastor Andrew Brunson, who is being held on terrorism charges.
The turmoil follows a similar currency crash in Argentina that led to a rescue by the International Monetary Fund. In recent days, the Russian ruble, Indian rupee and South African rand have also tumbled dramatically. Investors are waiting for the next domino to fall. They're on the lookout for signs of a repeat of the 1997-1998 Asian financial crisis that began when the Thai baht imploded.
What is causing Turkey's lira free-fall?
The recent overseas turbulence is being driven by a confluence of factors. The most obvious is the US Federal Reserve raising interest rates and shrinking its $4.5 trillion balance sheet in response to economic strength and warming inflation in the United States.
Removing easy money from the market has sent the US dollar soaring against rivals. That debt becomes ferociously expensive when a country's currency implodes the way the lira has. The dollar's strength has led investors to yank money from riskier markets in favor of safer American assets.
What is the role of populism and trade wars in this?
The emerging-market turbulence, especially in Turkey, also reflects the rise of populism around the world.
Turkey's troubles accelerated in May 2018 after President Recep Tayyip Erdogan indicated he wanted to take control of setting interest rates. After winning re-election, Erdogan installed his brother-in-law as finance minister.
Turkey's central bank then shocked the world by refusing to raise interest rates, despite soaring inflation. Investors, with their confidence in the central bank shattered, promptly fled the lira.
The situation in Turkey is a case study in the importance of independent central banks and finance ministers, especially in countries without the strong track record of the United States.
Trade and Tariffs:
The emerging market storm reflects another aspect of Trump's populism: tariffs. Trump's trade wars have caused investors to flee certain risky markets, especially ones with ties to China. Turkey's currency plunged as much as 18.5% after Trump vowed to double the steel and aluminum tariffs he imposed on Turkey. In retaliation, Turkey doubled tariffs on some imports from the US - such as passenger cars, alcohol and tobacco.
How are international markets reacting?
The weakness of the Turkish currency is starting to affect other emerging market economies. In August 2018, the Indian rupee hitting a fresh record low of 70.33 rupees to $1. A falling rupee helps exports - things like textiles and IT [information technology] services. But it puts up the price of India's imports, particularly oil, which in turn leads to inflationary pressure and widens India's trade deficit. The South African rand has also taken a hit.
The real catalyst is the sharp depreciation in the Turkish lira and also more importantly, the indirect spillover into the euro as well. There are concerns that some European banks have exposure to Turkey and that will be reflected in the balance sheets and P&L of some of these European banks.
What does this mean for Turks?
According to economic experts, in the short term, the lira's slide will increase inflation, which will hurt Turkey's poor. Sample this: The Turkish bakers’ federation in August 2018 announced a 15 percent increase in bread prices. Businesses are also concerned about higher import prices. However, it is worth noting that in 2001, a year before Erdogan became prime minister, Turkey's inflation rate was at 69 percent. In August 2018, it stood at 15.6 percent.
What is the effect of lira on Emerging markets?
The risk of contagion is pretty high, said Robert Subbaraman, an emerging market economist at Nomura in Singapore.
In a research note Mr. Subbaraman pointed to South Africa, Hong Kong, the Philippines, Chile and Mexico as having the most vulnerable economies. South Africa, for example, has significant levels of dollar debt and a sizable current account deficit.
A country runs a current account deficit if it takes in more money — in investments and trade — from foreigners than it sends to other countries. That leaves the country at the mercy of international investors to keep it afloat financially, and those investors could find other markets more enticing — particularly when emerging markets see their currencies lose value.
That is precisely what forced Argentina to go to the I.M.F., the first major emerging market to take such a step during this period of uncertainty. Pakistan may soon have to forge its own deal with the fund for similar reasons.
What is the optimistic news?
In the past decade, most of the large developing markets have established robust local institutions, such as pension funds, that have become the main buyers of corporate and government debt — in their own currencies.
That means when fretting foreigners sell their bonds, domestic institutions can step in and buy them, preventing a selling frenzy from becoming something worse.