The 2018 calendar year is proving to be a wretched one for emerging market assets, with Turkey bearing the full brunt of the latest investor fallout.
Writer: Rhandzo Mukansi, Portfolio Manager
As has now been well documented, the Turkish crisis was catalysed by the imposition of US trade sanctions and tariffs given the souring of bilateral relations between the two nations. However, the founding of the Turkish crisis is rooted in the weakness of domestic fundamentals; particularly related to a wide external trade deficit largely financed by short-term borrowing, hampered macro policy credibility and questionable central bank independence.
Despite emerging market assets not being the monolithic beast of old, seemingly isolated emerging market risk events often result in broad peer group contagion. This point holds particularly true for those nations with relatable macroeconomic backdrops. A recent example of this is the Argentine debt crisis in May which resulted in the sizeable sell-off of the peso, rand and peer group sovereign currencies with comparable macro-economic fundamentals.
So then, does the Turkey crisis represent an idiosyncratic sovereign risk event or are the EM dominoes poised to tumble? If so, who’s next in line and how far might the strife stretch? We lean on our internal Emerging Market Risk Monitor in our analysis of the health of a basket of emerging market sovereigns and our assessment of economic strength and vulnerability.
Futuregrowth Emerging Market Risk Monitor:
Our analysis highlights the economic and financial vulnerability of likely bedfellows; Turkey, Brazil and South Africa and somewhat less likely peer comparators in Argentina, Ukraine and Venezuela. Of this list, Brazil and South Africa stand out to us as the likeliest to catalyse the next flight from emerging market risk assets. This view is based on the significant dependence on faltering Chinese growth for commodity exports, sizeable external accounts – particularly those funded by volatile portfolio flows, and high fiscal debt burdens in an increasing left-leaning policy environment. These economic vulnerabilities are compounded by high foreign investor holdings of local currency debt instruments across both sovereigns, the gradual tightening of global monetary conditions and the dangerous escalation of tit-for-tat trade tariffs between the US and China.
The erosion of policy credibility has previously been a harbinger to episodes of emerging market financial strife – and this is particularly relevant for both Brazil and South Africa at the moment given the amplification of pre-election leftist rhetoric. Public expenditure containment when confronted by an increasingly populist median voter is a crucial focal point for both nations.
Although the pressures of the Turkey induced emerging market weakness will soon enough fade, the common symptoms endure strongest in Brazil and South Africa. The opportunity for painful but necessary macro-economic reform remains open to policy makers in both countries – before a financial market rebellion starts to dictate terms.