Turkey’s Economic Woes Fuel Fears of Contagion in Markets

Turkey’s Economic Woes Fuel Fears of Contagion in Markets

Turkey’s currency fell to another record low on Monday, hitting stocks in Europe and Asia and raising fears that the country is on the verge of an economic meltdown that could spread to other emerging markets.

The currency crisis, caused by soaring inflation, economic mismanagement by the Turkish government and a spat with the United States, comes at a perilous moment for poorer countries that have benefited in recent years from foreign investment.

Higher interest rates in the United States and in Europe have made investors less tolerant of the risks of emerging markets. A crisis like the one in Turkey may be all it takes to send them fleeing to safety.

There were already ominous signs on Monday. After the Turkish lira fell even further against the United States dollar, investors dumped other emerging-market currencies. The Indian rupee also dropped to a record low against the dollar. And in Indonesia, the rupiah flirted with a three-year low against the American currency.

Still, Turkey has political and economic problems not found elsewhere, and analysts were not yet ready to predict widespread panic.

“In the very short term, we are seeing what we would describe as ‘risk off’ toward emerging markets,” said Stuart Culverhouse, global head of macro and fixed income research at Exotix Capital, a research firm in London.

But, he added, “Turkey is following a path many other emerging markets aren’t. I don’t think it’s going to lead to a more systemic problem across emerging markets.”

Investors were clearly nervous, though. Stock markets across Asia, including in Hong Kong; Seoul, South Korea; Shanghai; and Tokyo, fell on Monday, with many exchanges dropping nearly 2 percent during the day. European markets fared only slightly better. Stocks opened in the red, though the losses were less severe than on Friday. The euro hovered around its lowest point against the United States dollar in a year.

Shares of European banks suffered some of the biggest losses. Those hit included not only the likes of BBVA of Spain and UniCredit of Italy, which have large holdings in Turkey, but also lenders such as Commerzbank and Deutsche Bank, which do not have major operations there.

Investors were driven principally by fears of contagion, the notion that an economic or financial crisis in one country — in this case, Turkey — can quickly spread to other regions.

Problems in Turkey have been brewing for years, but Turkish assets have fallen steeply in recent days as questions have mounted over the country’s prospects. Price rises have quickened, and President Recep Tayyip Erdogan’s increasingly authoritarian rule, underlined by the appointment of a relative as an important minister and by the erosion of the central bank’s independence, has worried investors.

Normally, a country in Turkey’s situation would raise official interest rates to stifle inflation and stop the currency’s slide. But Mr. Erdogan’s popularity has hinged on rapid growth fueled by credit, and he has often spoken against raising interest rates.

On Monday, Turkey’s central bank relaxed some of its rules on the money that commercial banks must keep on reserve, freeing up cash to deal with the currency crisis. The central bank also said that it would provide “all the liquidity the banks need” and “take all necessary measures to maintain financial stability.”

But it made no mention of raising the benchmark interest rate, which is already at 17.75 percent. Though high compared to other countries, the rate is only slightly above the rate of inflation and would have to be much higher to squelch rising prices.

Compounding the fear in financial markets, there is a lack of information about which foreign banks may own Turkish government bonds or have lent money to Turkish companies. About 90 percent of Turkey’s public and private sector debt with foreign lenders is in foreign currencies, according to the International Monetary Fund.

Those debts in dollars, euros or other foreign currencies will quickly become unsustainable for borrowers that do not have corresponding revenue in those currencies.

“Turkey’s woes can ripple out to hammer European Union institutions,” Carl Weinberg, chief international economist at High Frequency Economics in White Plains, N.Y., said in a note to clients on Monday.

A worsening diplomatic dispute with the United States has also piled on the pressure for Turkey. Though the tensions were initially centered around the detention of an American pastor, they have since spread into the trade arena.

President Trump pledged on Friday to double the rate of tariffs on steel and aluminum imports from Turkey. The comment, which was made in a Twitter post, spooked markets concerned that Mr. Trump could take a similar approach with other trading partners.

“The catalyst for market volatility has been geopolitical uncertainties and trade,” said Viraj Patel, a foreign currency strategist at ING. “This is another knock for global markets and, taken together, it’s a pretty toxic environment.”

In early Monday trading in Asia, the Turkish lira had dropped to a new low against the dollar but later pared some of those losses after Turkey’s central bank took steps to bolster the currency and said in a statement that it would “provide all the liquidity the banks need” to stem huge fluctuations.

China’s currency, the renminbi, which has been a casualty of Mr. Trump’s trade policies for weeks, also weakened further against the dollar. The government in Beijing, which keeps a firm grip on the value of its currency, weakened the renminbi by 0.34 percent against the dollar, setting the benchmark rate for trading in Shanghai at its weakest level in 15 months.

China’s main stock index at one point lost nearly 2 percent, but closed down 0.3 percent. The reaction was stronger in other Asian markets on Monday. In Tokyo, the main index fell 2 percent. Stocks in Seoul fell 1.5 percent. A broad index of Europe’s biggest companies was down 0.6 percent in early morning trading.

Concerns about trade wars and geopolitical uncertainties, including the turmoil in Turkey and other emerging markets, may not yet be significant enough to weigh on all global markets, according to economists and market analysts.

“But taken together they create a toxic environment,” Mr. Patel at ING said. “At the moment, it’s less financial contagion and more general de-risking. This in itself could be an ominous signal.”

A strengthening dollar is the biggest concern for officials in China and in other emerging markets. The upheaval in Turkey has fortified the dollar even further.

Despite the panic in markets, one economist at Deloitte said he believed that uncertainty about Turkey did not signal a global contagion, yet. Turkey’s economy is only the 17th-largest in the world, and it is not as integrated into the global financial system as countries like China and the United States.

“I’m a little concerned, but I wouldn’t be pressing the panic button,” the economist, Xu Sitao, said.

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