SINGAPORE (Aug 20): It has been a dramatic week for emerging markets — in particular, Turkey. And, while the unfolding carnage has parallels with what happened in Southeast Asia almost exactly 20 years ago, I cannot help thinking that things will not turn out quite so well this time around.
On Aug 10, US President Donald Trump pushed Turkey further towards a financial crisis by tweeting: “I have just authorized a doubling of tariffs on steel and aluminum with respect to Turkey as their currency, the Turkish lira, slides rapidly downward against our very strong dollar.” The lira, which was already sinking, immediately tumbled nearly 20%. It has since recovered somewhat, after Qatar said on Aug 15 it would invest some US$15 billion ($20.6 billion) in Turkey. But the rebound is unlikely to last if Turkey does not begin addressing its economic shortcomings.
Turkey shares many of the vulnerabilities that some Southeast Asian countries had two decades ago: Its economy has been growing fast and its inflation is high, it has a sizeable current account deficit and its corporates are laden with debt. With US dollar liquidity tightening, it really was a financial crisis waiting to happen. Turkey is not the only emerging market nation in the throes of a crisis. Venezuela has been sliding into an economic and political abyss ever since the leader of its “socialist revolution” Hugo Chavez died in 2013, and oil prices abruptly tanked in the middle of 2014. By some estimates, inflation in Venezuela could reach one million percent this year. Venezuela continued to make headlines this past week, as its current president Nicolás Maduro — who recently survived a bizarre drone attack — said petrol subsidies would have to be curbed to deter smuggling.
Meanwhile, Argentina increased its benchmark interest rate this past week to 45% from 40% after its peso tumbled in the wake of domestic political turbulence as well as the deepening crisis in Turkey. Argentina’s response to its economic troubles stands in sharp contrast to what Turkey appears willing to do. In June, Argentina’s President, Mauricio Macri, secured a US$50 billion bailout from the International Monetary Fund (IMF) and pledged to accelerate the reduction of the government deficit and bring inflation under control.
On the other hand, Turkey’s President, Recep Tayyip Erdogan, seems reluctant to do anything that might hurt economic growth, judging from his public statements.
He has even been quoted as saying that cutting interest rates could help reduce inflation. Now, some market watchers fear that he might attempt to stave off the crisis in Turkey by implementing some form of capital controls.
The different paths Argentina and Turkey appear to be taking echo what happened during the Asian financial crisis of 1997/98. While Thailand, South Korea and Indonesia turned to the IMF, Malaysia chose to impose capital controls, fix its exchange rate and attempt to reflate its economy — which drew howls of derision from analysts, rating agencies and the financial press. Yet, Malaysia as well as all the other casualties of the Asian financial crisis were well on their way to recovery by 1999.
Looking back, I am not at all sure whether the IMF prescription was any better or worse than the less conventional route that Malaysia took. In my view, the key to the recovery of all the casualties of the Asian financial crisis was simply that their depreciated currencies significantly improved their export competitiveness, which helped pull their economies back to health.
Sinking currencies risk sanctions?
The world is a very different place today, though. Trump found his way to the White House with his “America First” message. The way he seems to see it, countries that run trade surpluses with the US are benefiting at the expense of Americans.
Since the beginning of this year, the US has imposed tariffs on everything from washing machines to solar panels from China. In response, China has slapped tariffs on automobiles, pork and soybeans imported from the US.
While some market watchers say there are no winners in a trade war, China does appear to be suffering more than the US, judging from the weakness of its currency and stock market. Like the Southeast Asian “miracle” economies, and the Asian “tiger” economies before them, much of China’s economic rise in the last two decades has been the result of its effectively tapping into the global trading system. One could argue that China is far more heavily invested in the whole concept of globalisation than the US is and has more to lose if globalisation were to stall.
Whatever the case, it seems unwise to bet that countries vulnerable to financial crises in the face of tightening US dollar liquidity will rebound on the back of an export boom as easily as the likes of Indonesia, Thailand, South Korea and Malaysia did two decades ago. In fact, countries that now suffer steep declines in their currencies in the face of rising US interest rates could find themselves drawing the ire of Trump and getting hit with higher trade tariffs, as Turkey did this past week. Notably, some market watchers fear that the steady decline in China’s renminbi over the last few weeks could well exacerbate its trade war with the US.
Rising return on US dollars
Against this backdrop, I would not be in a hurry to get into emerging market stocks, despite some analysts saying they already offer relatively good value. Even if globalisation is not on the verge of reversing, it seems to me that a refreshed narrative on emerging markets is needed to draw investors back.
The fundamental attraction of emerging markets is the growth potential they offer on the back of secular trends that are tapped out in developed markets. These include demographics that support the creation of a huge base of middle-class consumers as well as the potential for urbanisation and knowledge-led productivity gains.
Globalisation enabled many Asian countries to quickly leap ahead, but it also evidently led to global economic imbalances that have spurred anti-trade, far-right political sentiment in developed markets. In the long term, however, it is still the rising incomes and living standards of the huge number of people in emerging markets that will matter to investors. The challenge is to identify a new crop of emerging markets poised to achieve this even if globalisation slows.
In the meantime, instead of trying to catch the proverbial falling knife in emerging markets, or hoping for further gains in relatively expensive developed markets, it might be better to just ride the tightening US dollar trend. While US dollar deposits once yielded almost nothing, it is possible to earn as much as 2.5% per annum holding the currency now. I am not suggesting that we should abandon stocks altogether, of course. But it is worth keeping in mind that the opportunity cost has gone up.
This story first appeared in The Edge Singapore (Issue 844, week of Aug 20)