The US has imposed sanctions on Turkey in a dispute over the arrest of a US pastor. This could have serious economic consequences for Turkey, but the current crisis has been a long time coming. The early warning signs were apparent in the 2013 “Taper Tantrum”, when the emerging markets responded negatively to the US Federal Reserve announcing its intention to withdraw Quantitative Easing. Many emerging market economies heeded the warning, but Turkey did not.
Turkey has been running a current account deficit of greater than 4% of GDP since 2005; therefore, the underlying problem is Turkey’s reliance on external financing. Turkey’s short-term funding requires foreign financing at approximately 18% of GDP and close to 450% of foreign exchange reserves. There are also question marks as to whether Turkey’s central bank is truly independent. The US raising interest rates has tightened global liquidity, which has exacerbated Turkey’s problems.
As always, the issue for the global economy and in particular emerging markets is contagion. The emerging markets seem to be suffering from guilt by association, with currencies, such as, the Mexican Peso, Indian Rupee, Russian Rouble and South African Rand, all weaker against the US Dollar. With minor financial and trade links, Turkey imposes limited risks to other emerging markets. However, there may be some risk to European banks, particularly in Spain and Italy.
The long-term impact of the Turkey crisis on the global economy may be limited; however, there are other emerging markets, with similar issues, that could surface, if there is a sudden economic shock.