Why Turkey will be the first of the emerging market dominoes to fall

John Hulsman
Turkey is entering a new era of greatly heightened political uncertainty (Source: Getty)
Like a lion ambling out of the mists of the Serengeti in search of its first meal of the day, first-rate political risk analysts must possess the sixth sense of always looking for the weakest water buffalo. Delving beneath the happy talk and self-serving comments governments invariably put about regarding their countries’ economic prospects, they must sense calamity before it is apparent. One portion sensory art, another intellectual rigour, they must decisively head off in a fixed direction before it becomes self-evident to the world.

As my December 2014 yearly prediction column for City A.M. made clear, this lion thought Turkey would emerge in the coming year as the weakest emerging market buffalo. In terms of macroeconomics, the country was already an unseen disaster; all it really had going for it was a dozen years of political stability. Now, following last week’s shattering parliamentary election, which decisively repudiated Turkey’s increasingly erratic and authoritarian President Recep Tayyip Erdogan, even that is gone, as the country enters a new era of greatly heightened political uncertainty. There is no doubt about it, the Turkish water buffalo is struggling to keep up with the global economic herd.

The shocking vote of last week was the first time in four general elections that Erdogan’s AKP saw a slip in its support. The AKP lost its overall majority in parliament, and must now try to cobble together a coalition with one of three parties that have all stated they will not work with it. As a result, either a very weak government will be formed or new elections loom on the horizon. In either case, Turkey’s vaunted political stability is no more.

Having moved mountains a decade ago when he was early in his term as Prime Minister, Erdogan now fulfils the definition of a tragic classical Greek hero: he is a man who has outlived his time and his usefulness. Obsessed with his enemies, increasingly dictatorial, and seeming to have little to no interest in further structural reform, the Turkish President is ripe for a fall at the hands of the capital markets, particularly given Turkey’s massive current account deficit.

Erdogan’s success has been built upon three substantial accomplishments. First, at the start, his mildly Islamist party seemed far less corrupt than its bumbling, secular forebears. Second, after a great struggle, Erdogan managed to tame Turkey’s generals, getting them out of politics and back into the barracks, a Herculean achievement. Third, beyond a shadow of a doubt, Erdogan presided over a decade of unparalleled economic growth, with Turkey morphing from perennial IMF basket case into a leading emerging market economy.

But Turkey is also one of the “Fragile Five” (along with India, Indonesia, South Africa, and Brazil), major emerging market economies dependent on massive foreign capital inflows. With the Fed committed until recently to a huge QE programme of injecting $85bn a month into the US economy, cheap money flowing across their borders became a narcotic for the Fragile Five.

This was already an unsustainable state of affairs, as evidenced by the economic swoon all five countries experienced when the Fed – somewhat maladroitly – signalled in 2013 that QE was not forever and began its taper. Now, monetary tightening is continuing, with US interest rates likely to rise from September this year.

The party for the Fragile Five is over. Some – such as India and to a lesser extent Indonesia – are far better prepared to ride out the storm. Others, like Brazil, South Africa, and especially Turkey, have simply not fixed their roofs while the sun shone, forgoing the structural reforms necessary to compete in the coming more dangerous global environment.

For Turkey’s decade-long economic success story is increasingly being called into question. The Turkish lira has slumped to a record low against the dollar, having lost 14 per cent of its value against the greenback this year alone. Turkey grew at a better than expected 2.3 per cent annualised in the first quarter of this year, but this is well down on the above 4 per cent rates it enjoyed as recently as 2013. Turkish firms’ net foreign exchange liabilities stood at $183bn at the end of 2014. The country remains highly dependent on foreign capital, with the current account deficit hitting a dangerous 7.9 per cent of GDP in 2013. It has since narrowed less than expected.

As I sensed in December, the Turkish water buffalo has run into real trouble; don’t be surprised if the market lion pounces over the next few months. And it could only be the first to fall.

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