Will the Turkish crisis affect China and APAC emerging economies?

28 Aug 2018

Focus on currencies for now

While China and other Asia-Pacific (APAC) emerging economies should prove resilient to any significant fall-out from the economic turmoil in Turkey, their currencies could still face pressure in the near term.

The Turkish lira dropped sharply against the US dollar from early August (exhibit 1) on financial market concerns over the country’s worsening economy and its deteriorating political relationship with the US.

As the crisis unfolds, investors have begun assessing the economic fundamentals of other emerging markets to understand if any of them may be economically susceptible to what is happening in Turkey.

Exhibit 1: Turkish lira / US dollar exchange rate

exhibit-1-Turk-lira-USD-exch-rate

Source: CEIC, BNP Paribas Asset Management (Asia), as of 17/08/2018

 

Investor confidence in Turkey under pressure

The principal economic fault lines under scrutiny include each economy’s current account balance, fiscal balance, external debt and inflation rate. Typically, the recipe for a crisis involves current account and fiscal deficits, large foreign debt and high inflation combining in a ‘perfect storm’ to trigger a loss of investor confidence. With its twin deficits, significant external debt and elevated inflation, Turkey faces the full monty of crisis indicators (exhibit 2).

By contrast, these are absent in China. Its current account is in surplus, inflation is below 2%, its fiscal deficit is only slightly above 3% of GDP and its foreign debt is less than 15% of GDP, well below its currency reserves of 25% of GDP. Most importantly, the renminbi is not convertible, so China’s risk of being exposed to a currency attack is small. Thus it looks unlikely that events in Turkey would affect China in any meaningful way (exhibit 2).

Exhibit 2: APAC EM macroeconomic stress indicators (2017)

exhibit 2 APAC EM Macro-stress indicators

 

Source: CEIC, UBS, BNP Paribas Asset Management (Asia), as of 17/08/2018

Indeed, the APAC region’s emerging economies generally appear resilient. India, Indonesia and the Philippines do have twin deficits, but their inflation rates are much lower than Turkey’s and their foreign debt is much smaller (table 1). While Malaysia’s foreign debt is larger than Turkey’s, it runs a sizable current account surplus and has significantly lower inflation.

Table 1: APAC EM macroeconomic stress indicators (2017)

table 1 APAC EM macro-stress indicators

Source: CEIC, UBS, BNP Paribas Asset Management (Asia), as of 17/08/2018

 

APAC EM currencies exposed

However, APAC emerging market currencies could still face near-term pressure from the weakness in the euro, reflecting market concern over European banks’ exposure to Turkey, and renminbi weakness due to worries over China’s domestic growth, given the current trade tensions with the US.

Crucially, our research shows that in recent years the correlations in the movements between the renminbi and major Asian currencies have increased – at the expense of their correlations with the US dollar and the euro.

 

Fall-out contained for now

On the corporate side, while there are Chinese companies operating in Turkey in the logistics, electronics, energy, tourism, finance and real-estate sectors, they are not major players. China recently agreed to invest in Turkey under the Belt and Road Initiative, but no major projects have been launched. In total, China has amassed USD 2 billion in foreign direct investment in Turkey in the last 15 years. And Turkey’s annual imports of some USD 26 billion worth of goods and services from China represents just 1% of China’s total exports. All of this suggests that there is unlikely to be any direct major impact from the Turkish crisis on China.

More serious for China and elsewhere would be the second-round impact should the Turkish situation trigger a global economic shock and financial market turmoil, but this is far from certain and not a base case for global investors at this point.