Will the Turkish crisis affect China and APAC emerging economies?

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The value of Turkish lira against the US dollar started dropping sharply in early August (Exhibit 1) on concerns about the country’s worsening economic situation and the deterioration in its political relationship with the US. As the crisis unfolds, investors are assessing the economic fundamentals of other emerging markets to understand if any of them may be economically susceptible to what’s happening in Turkey.

Exhibit 1: Turkish lira to USD exchange rate

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

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 is a twin (current account and fiscal) deficit, large foreign debt and high inflation all combining in a ‘perfect storm’ to trigger a loss of investor confidence. With its current account and fiscal deficits, significant external debt and high inflation, Turkey has the full monty of crisis indicators (Exhibit 2).

In contrast, China has none of them. Its current account is in surplus, inflation is below 2%, its fiscal deficit is slightly more than 3% of GDP, and its foreign debt is less than 15% of GDP, well below its FX reserves of 25% of GDP. Most importantly, the renminbi is not convertible, so its risk of being exposed to a currency attack is very small. It is thus unlikely that any fall-out from Turkey would affect China in any meaningful way (Exhibit 2).

Exhibit 2: APAC EM macroeconomic stress indicators (2017)

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

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

Table 1: APAC EM macroeconomic stress indicators (2017)

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

However, APAC emerging market currencies could still face near-term pressure from the weakness in the euro, reflecting the fears about European banks’ exposure to Turkey, and renminbi weakness, due to concerns about 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[1].

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 & 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 which 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.

[1] See “Renminbi Displacing the US Dollar by Stealth”, Chi Lo, BNP Paribas Investment Partners, 3 January 2013.

To read more content written by Chi Lo, click here.

Chi Lo

Senior Economist for China

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