With the tide of cheap liquidity beginning to abate, emerging markets need to return to structural supply side reforms or risk implosion.
While many emerging markets flirted with free market liberalisation, those ideas were often put to one side as soon as the flood of cheap credit was able to make up for any failings of a still government-directed economy.
As major central banks artificially held down interest rates through non-traditional monetary policy, capital flows pushed up prices of emerging market assets in a hunt for yields. At the same time, those emerging markets built an economy on export growth, happy to run ever-widening balance of payments imbalances.
But with relative tightening of monetary policy from the Fed and other central banks in the form of a tapering easing programme already in play, it will not be long before relative tightening of policy becomes real tightening of monetary policy. The result will torpedo those economies that have seen large capital inflows into domestic-focussed companies while running up dollar-denominated debts. And despite having been hit in recent memory by a BOP-driven Asian crisis, SE Asian economies such as Indonesia look set for another crunch.
Should the FOMC move to further taper Fed asset purchases from their current USD75bn-a-month levels, expect to see some further pain from EMs.
Part of Turkey’s current woes stem from the acronym craze that swept bulge bracket sell side research departments. First we had Jim O’Neill of Goldman Sachs who kicked things off with the BRIC economies of Brazil, Russia, India and China – all with fundamentally compelling growth stories. But then came along came the rest trying to coin the next big growth acronym, with the CIVETs (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa) and the MINTs (Mexico, Indonesia, Nigeria, and Turkey).
But while the likes of Nigeria, Mexico and Colombia have commodity reserves to back up the liberalisation of capital markets, Turkey doesn’t really have anything to back it all up. It has managed to ride on the wave of diversification out of volatile European assets in the 2007-2011 period, with access to debt on the same basis as its MINT stable mates. The problem is that Turkey now cannot pay the piper, nor is it likely in the next 20 years to achieve the required levels of prosperity to do so.
The current crisis engulfing Turkey is ostensibly one of government, showing the cracks in the supposedly reformed Turkish political system. But it is equally a breakdown of the illusion of growing prosperity built on cheap foreign debt.
The lira has lost 16 percent since the arrest of the sons of three cabinet ministers on 17 December. And the lira has dragged Turkish firms down with it, bringing to the fore just how dependent Turkey’s economy growth has been on foreign debt.
According to the latest data from the Central Bank of the Republic of Turkey, private sector borrow stands at USD193.5bn of which 57 percent is dollar-denominated.
To date, Turkish Prime Minister Tayyip Erdogan has firmly opposed any kind of rate hike – citing the usual scapegoats of “international speculators” trying to undermine the Turkish economy. However when the central bank meets today it may be forced to hike rates to stop the rot.
Long term, Turkey is going to need to go through a period of heavy deleveraging if it is going to escape seeing the end of any of the real growth that occurred outside of foreign debt access. There is no shortcut to long term economic prosperity outside “peace, easy taxes, and a tolerable administration of justice.”
The Turkish central bank has said it will release a statement on the outcome at midnight (22:00 GMT) today.