Turkey’s economic red flags stand out among emerging markets

By Josh Zumbrun

Turkey might not be the tip of an global economic iceberg.

The collapse of the Turkish lira has investors worried the nation’s financial turbulence could spread to other countries, and the lira’s plunge in the past few days has hit other emerging-market currencies such as Indonesia’s rupiah, Mexico’s peso and South Africa’s rand.

But few other countries are troubled by as broad a constellation of economic problems as Turkey.

Its economic woes include one of the largest trade deficits of any emerging-market country, unmatched external debts, a currency vulnerable to decline, exceptionally high inflation, unorthodox monetary policy and very little international goodwill.

That is a recipe for market blowback.

A financial crisis is continuing to unfold in Turkey. The WSJ’s Gerald. F. Seib looks at three important reasons why you should care about Turkey’s economic troubles. Photo: Getty

“There are special factors in that country,” St. Louis Fed President James Bullard said of Turkey in an interview Monday. “I don’t think this is a situation that would lead to a generalized contagion at this point.”

Turkey runs an unusually large current account deficit, a broad measure of its balance between imports and exports and the income it earns on investments overseas.

When a current account is in deficit, it means the country spends more money on imported goods and services than it makes on what it sends abroad. This makes an economy dependent upon capital flowing into the country and prone to reversals in investor sentiment.

Turkey’s current account deficit is poised to hit $49 billion this year, according to the International Monetary Fund’s April forecasts, up from $32 billion in 2015.

Among emerging markets, only India is expected to run a larger current account deficit this year. But India’s economy is triple the size of Turkey’s. As a percent of gross domestic product, Turkey’s current account deficit is the largest among major emerging markets, forecast by the IMF at 5.4% in 2018. Argentina was close behind at 5.1%.

Turkey has financed this deficit by borrowing extensively in foreign currencies. According to data from the Institute of International Finance, a banking group in Washington that tracks emerging markets, Turkey has more nonfinancial private sector borrowing in a foreign currency than any other major emerging market.

It is largely corporate borrowing, in euros and dollars, even though many Turkish companies bring in most of their revenue in lira. The loan growth was encouraged by a government backstop called the Credit Guarantee Fund.
Turkey’s government also has issued debt in foreign currency amounting to 11% of GDP, according to data from the IFF. Foreign-denominated debts become hard to service as the Turkish lira falls.

The domestic economy has other challenges. Turkey’s central bank, bowing to pressure from President Recep Tayyip Erdogan, who has called himself the “enemy of [high] interest rates,” has kept rates low. Then inflation built as the economy heated up. The IMF has forecast that Turkey’s inflation rate will top 11% this year, about double the rate of any other major emerging market except Argentina.

Now interest rates are surging, which could punish the economy and Turkish banks. Turkey’s currency has been another financial red flag. Earlier this year, the IIF identified the currencies of Argentina and Turkey as exceptionally overvalued, meaning a sharp currency decline would be needed to bring their economies in line after years of running large trade deficits.

Satisfied with Argentina’s steps to rebalance its economy, the IMF rapidly completed a $50 billion bailout program for Argentina this year, moving with strong U.S. support. Mr. Erdogan enjoys little international goodwill. Other world leaders have publicly feuded with President Trump over steel and aluminum tariffs, but Mr. Trump singled out Turkey for added punishment, doubling those tariffs after Turkey retaliated against initial U.S. duties.

Mr. Erdogan is at odds with the U.S. over an American pastor being held in Turkey on charges related to a 2016 coup attempt. The pastor, Andrew Brunson, has denied any involvement planning the coup and Mr. Trump demands his release.

Mr. Erdogan also has disregarded IMF advice on best economic practices for his country-such as running an independent central bank-making it less likely that the Fund will rise to Turkey’s rescue, as it has during other emerging-market crises.

Robin Brooks, the chief economist of the IIF, said Turkey is an extreme case, but cautioned against taking too much comfort in its idiosyncrasies. Other countries have borrowed significantly in dollars or euros and have seen their currencies decline.

“Turkey is perhaps the biggest outlier in that respect, but it’s really just an example of a bigger theme,” said Mr. Brooks. “I’m really quite worried about emerging markets broadly.”
What makes Turkey stand out, however, is the combination of problems it faces.

India has a large current account deficit, for example, but does little borrowing in foreign currencies. Chile’s private sector has borrowed heavily in foreign currencies, but its government has borrowed half as much as Turkey’s and its current account deficit is much smaller.

A few other countries run large twin deficits, that is, both a large fiscal deficit and large current account deficit. Turkey stands alone for the extremity of its position, though Pakistan, Argentina and Egypt aren’t far behind. Among them, both Argentina and Egypt are already involved in IMF programs.

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