Turkey's deepening currency crisis is putting pressure on emerging markets amid growing fears of a banking crisis.
Asian stock markets have fallen on Monday, as concerns about contagion fuel investor demand for safe havens, including the US dollar, Swiss franc and yen.
The lira has fallen more than 40% this year on worries over Turkish President Tayyip Erdogan's influence over the economy and deteriorating relations with the US, which last week doubled tariffs on steel and aluminium imports.
"The decline is caused not only by a weak external position in terms of current account deficit and inadequate currency reserves, but also the challenging political environment, which exacerbates the vulnerabilities in the lira," says Kerry Craig, JP Morgan's global market strategist.
He suggests a mid-meeting interest rate hike and tightening of monetary policy may go some way to helping avert the lira’s decline.
What Does it Mean for Emerging Markets?
Andrew Kenningham, chief global economist at Capital Economics, believes the lira's plunge will "push the Turkish economy into recession and it may well trigger a banking crisis".
"This would be another blow for emerging markets as an asset class, but the wider economic spillovers should be fairly modest, even for the euro zone," he added.
JP Morgan's Craig also believes any potential flow-on effects to other emerging markets would be only short-term: "The drivers of the lira’s decline are very specific to Turkey – therefore it should not derail the positive fundamentals in other emerging markets over a longer-term".
He notes the rise in the US dollar is a greater risk to Asian emerging markets in particular – the US-dollar index is up almost 4.5% this year. "However, we expect the US economy to slow as a result of supply constraints and monetary policy, leading to a depreciation in the greenback over the medium term," Craig says.
Japan's Nikkei lost 2% and MSCI's broadest index of Asia-Pacific shares outside Japan eased 1.4% in trading today.
The lira has sat at all time lows, buoying slightly when Turkish Finance Minister Berat Albayrak said the country had drafted an action plan to ease investor concerns and the banking watchdog said it limited swap transactions.
Kenningham notes that Turkey's annual gross domestic product of around $900 billion was just 1% of the global economy and slightly smaller than the Netherlands, there was still a risk of impact to the wider market, saying: "Turkey's troubles are a further headwind for the euro and are not good news for EM assets either."
How Other Currencies are Faring
Against the US dollar, the euro touched its lowest since July 2017 at $1.137. It was last at $1.139 and still a long way from last week's top at $1.162. The Argentine peso and South African rand were also caught in the crossfire.
"Contagion risks centre on Spanish, Italian and French banks exposed to Turkish foreign currency debt, as well as Argentina and South Africa," warned analysts at ANZ.
"Turkey's massive pile of corporate debt denominated in foreign currencies, but a rapidly sliding currency - and inflation that's threatening to go exponential - is a toxic combination."
In commodity markets, gold had found little in the way of safety flows and was last stuck at $1,211.80 an ounce.
Oil prices edged higher with Brent up 5 cents at $72.86 a barrel, while US crude added 15 cents to $67.78.
