The dramatic unraveling of Turkey’s lira has ignited fear in markets around the world that the country’s currency woes could ripple through the world’s banks, notably in Europe.
Hand-wringing over Turkey’s economic health under the stewardship of President Recep Tayyip Erdogan is nothing new. Consternations about Ankara have been gathering steam since the 64-year-old won a sweeping, but disputed, snap-election victory in June.
Things came to an head on Friday, with the lira /zigman2/quotes/210561895/realtime/sampled USDTRY +0.6137% dropping 16% and breaching another key level when the U.S. dollar bought more than 6 lira, just a week after touching 5 lira for the first time on record, according to FactSet.
On Monday, the move continued towards 7 lira, with one dollar last buying 6.9355 lira, up from 6.4275 late Friday in New York. Similarly, the lira came off against the euro /zigman2/quotes/210561230/realtime/sampled EURTRY +0.8611% on Friday, and the shared currency bought 7.9079 lira on Monday, down 7.4%.
Here’s what the investors need to know about the Turkish lira and its potential impact on markets:
1. Emerging-market contagion?
The lira’s dramatic slide against its main rivals was symptomatic of a broader theme in emerging markets. Countries that rely heavily on foreign — mostly dollar-denominated — funding have been struggling with a strengthening U.S. currency, which has been on an upswing since April.
On top of that, rising interest rates in the U.S., where the Federal Reserve is expected to raise interest rates for an eighth time since late 2015 in September, has exacerbated the strain on emerging markets, which use local currencies to pay down their dollar-backed debts.
Turkey has led the pack of countries that maintain a high dollar-denominated debt burden. Argentina can also be counted among that contingent of troubled emerging-market economies, and analysts have long speculated that Ankara and Buenos Aires could become the first dominoes to fall in a wider emerging-markets unwind.
Turkey’s annual external financing needs, including both its current-account deficit and maturing debt, come to around $218 billion, according to the Institute of International Finance. That number could grow to $240 billion, representing 28% of GDP. More than half of that debt is dollar-denominated, according data from Eurizon SLJ Asset Management (see chart below).
Source: Eurizon SLJ Asset Managemen
According to a Financial Times report Friday, the European Central Bank has grown increasingly concerned about Turkey’s condition and a potential contagion of its problems, particularly with respect to its financial sector. This report sparked a selloff in European /zigman2/quotes/210599654/delayed XX:SXXP -3.54% and U.K. stock markets /zigman2/quotes/210598409/delayed UK:UKX -3.18% , also reflecting investors’ current worries about European banks’ exposure to the Turkish turmoil.