SINGAPORE (Oct 1): The dramatic collapse of the Turkish lira woke up investors from the dog days of August complacency. Analysts have been warning about macroeconomic imbalances in Turkey for years, but after the recent selloff, investors are now wondering whether the collapse in the lira is down to Turkey-specific issues or if Turkey is a canary in the coal mine. We say the answer is both — Turkey is idiosyncratic, but also a symptom of larger issues that could hit emerging-market (EM) countries more broadly as they deteriorate.

Why now?

If analysts have been warning about Turkey for years, why did the wheels finally fall off the cart now? The immediate trigger was US President Donald Trump’s threat of sanctions against Turkey for the country’s refusal to release an American pastor from custody. The underlying causes include the government running the economy as hot as possible in the run-up to the June 2018 general elections, a reliance on foreign capital to finance domestic infrastructure projects, a significant amount of borrowing in US dollar-denominated debt and an appreciation of the US dollar (USD), a high current account deficit (estimated to be above 6% of GDP in 2018)1 and external debt burden, strong man President Recep Tayyip Erdogan with unorthodox economic policies (particularly his opposition to higher interest rates), a central bank that seems to lack independence and the weakening of some of Turkey’s other government institutions (as evidenced by the appointment of Erdogan’s son-in-law as finance minister).

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