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Currency traders were back at work on Monday August 27 in Istanbul and went back to selling the lira. Although nerves have calmed somewhat from the panic that gripped currency markets in recent weeks, as there is still no coherent rescue plan, emergency rate hike or convincing statements that Turkey’s central bank will stick to a more orthodox monetary policy, FX traders are still jumpy.
That is bad news for the rest of the region as Turkey’s currency woes are having a spillover effect on its neighbours. While the sell off in Turkey has been particularly sharp – the lira has lost some 40% of its value against the dollar YTD – economists believe that its economy is simply not big enough to cause “contagion” and start a broad sell off in emerging markets, similar to the 1997 Asian crisis that triggered crises in other markets – especially Russia, which collapsed a year later.
“The sell-offs in Turkey and Argentina this time round have been particularly sharp. The falls in their currencies and rise in their bond yields (both dollar and local currency) have only been matched in scale by the declines in Russian asset prices during the ruble crisis of late 2014,” William Jackson, the chief emerging markets economist at Capital Economics said, adding that the size of the currency falls were in line with previous crises, and the rise in local currency bond yields was larger, but the widening of spreads to US T bills was smaller. “Overall, then, it has been a large sell-off, but perhaps not as dramatic as some headlines have suggested,” Jackson concluded.
However, the effect of Turkey’s problem on its neighbours is more noticeable as it has been playing an increasingly important role in the Caucasus. Hopes that following the collapse of the Soviet Union the west would come to the aid of the newly independent states with massive investments to bring their economies up to western standards have largely fallen on stony ground. But more recently regional blocks have formed where like-minded neighbours have been investing into each other and building up regional trade blocs.
In the same way that Russia has become, what former EBRD chief economist Erik Berglof and the current holder of the same job Sergei Guriev dubbed, an “investment node” for the rest of the Commonwealth of Independent States (CIS), Turkey has taken on the same role in the south of Europe thanks to its proximity and the shared language and cultural heritage. A “
” of co-investment and trade has appeared in particular between Turkey, Georgia and Azerbaijan, manifest in the new Baku-Tbilisi-Kars (BTK) railway link opened last November.
Turkey’s trade with the entire region has flourished, exposing the participating countries to Ankara’s current problems. Kyrgyz and Kazakh trade has been growing steadily, despite some hiccups caused by the creation of external tariff barriers under the Moscow-led Eurasia Economic Union (EEU). Ankara’s business ties with Tajikistan, which does not share a Turkic language like the other Central Asian states, have also developed and more recently Uzbekistan, after the death of former president Islam Karimov opened up the economy of the one-time hermit state.
Turkmenistan is insulated from the lira’s fall as it is maintaining its dollar peg policy for the currency for the meantime. And Armenia’s lack of meaningful contact with Turkey has isolated it from the meltdown as there is little trade or investment between the two countries.
Russia has been in the front line with its currency falling some 17% since the start of this year in parallel with the Turkish lira’s tumble. However, while the two countries are connected through trade and banking, the fall of the ruble has more to do with the threat of “crushing” sanctions that the US has threatened to impose in the autumn.
A new set of, largely symbolic, sanctions on Russia’s defence sector went into force on August 27 – the Defending Elections from Threats by Establishing Redlines Act (DETER) sanctions proposed earlier this year – but the really damaging sanctions will be the Defending American Security Against Kremlin Aggression Act (
) that were tabled a week ago. In the draft version of the bill are bans on US citizens (or firms with US business) on buying, trading or holding Russian sovereign bonds.
While the Russian state issues few Eurobonds these days (there is a provision in the budget for $7bn Eurobonds issues in most years) foreign investors have flocked to the high-yielding ruble-denominated local treasury bills, the OFZ, since Russia’s capital market was hooked into the international capital markets in 2012. Foreign investors share of these bonds rose to a record 34% of outstanding bills at the start of this year, or about $20bn, but has been declining since then as the threat of new sanctions rises and is currently 27%. If the DASKAA bill is passed in its current form then foreign investors will have to sell off their OFZ holdings causing chaos for the Russian Ministry of Finance, which is planning to raise a whopping RUB2.5 trillion ($37bn) next year to fund president Vladimir Putin’s RUB8 trillion spending extravaganza, announced in April, to transform the Russian economy.
The ruble has sold off to levels not seen since 2016 and growth forecasts have already been cut. However, analysts say that the drop in the ruble will be limited and the government can weather the storm thanks to its healthy currency account surplus and large hard currency reserves.
Russia’s current account surplus increased to $60.7bn in 7m18, versus $53.2bn in the first half of 2018, according to preliminary data from the CBR. The trade surplus also rose to $104bn from $90.6bn, thanks to higher than expected oil prices.
At the same time Russia’s gross international reserves (GIR) have been rising and were just shy of $460bn as of the start of August – more than enough to cover 17 months of imports, when economists say the minimum needed to ensure the stability of the currency is three months. And the Russian budget is on course to run a budget surplus of as much as 2% of GDP after several years of deficits.
With these reserves the fall of the ruble will be limited and the main effects will be to drive up inflation mildly from its current record lows of 2.5%, prevent the Central Bank of Russia (CBR) from cutting interest rates again this year, which will in turn slow growth from the already modest 2% predicted this year and make it harder for the government to raise badly needed investment.
However, because of the pivotal role Russia plays in the economy of the region, the fall of the ruble will have spillover effects on countries across the region and those in the south of Europe are exposed to both Russia’s and Turkey’s problems.
Thanks to their close ties the fall of the lira (TRY) has had the most noticeable effect on the Georgian lari (GEL) and the Azeri manat (AZN), but in Georgia’s case the strength of the economy has limited the damaged.
“Prudent macroeconomic policy-making and strong growth in external earnings helped the GEL remain immune to the sell-off in regional currencies until early August 2018. However, the TRY’s collapse on August 10 affected the GEL through the expectations channel when the currency lost 3.9% in one day against the $trading at 2.57 on Bloomberg. Taking into account the ongoing currency crisis in Turkey and sour global sentiment in EM currencies, we expect the $/GEL rate to weaken to around 2.7 compared to our previous 2.6 projection for end-2018,” Tblisi-based investment bank Galt & Taggart said in an August 13 update on the impact of the crisis.
The problem for all these countries is the lira has fallen so far and so fast that it has altered the terms of trade, forcing the local currencies to adjust as their exports to Turkey become much more expensive and imports from Turkey much cheaper. The same is true for their relations with Russia, another key trading partner, where the ruble has lost some 17% against the dollar this year. The double whammy of these currency shifts is causing limited devaluations across the entire region.
“The gradual adjustment in the $/GEL rate is likely a necessary correction to rectify the GEL’s real gains against the TRY and RUB – Georgia’s two largest trading partners. We also believe that depending on FDI/tourism inflows and import performance, pressure on the GEL might subside in August–September 2018,” Galt & Taggart added.
The booming tourism industry in Georgia will assay the devaluation pressure somewhat as an independent source of foreign exchange earnings, but this support will wear off in the next month as the tourist season comes to an end. However, Georgia is unlikely to feel as much pain as Turkey: in the deep devaluations suffered by Russia in 2014 and Ukraine in 2015, the currencies fall was cushioned by the almost complete collapse of imports that took the pressure off the current account and so braked the fall of the currency. It remains to be seen what a de facto leap in import prices will have on imports, and to what extent the cheaper exports will rise, but similar forces will be at work to cushion the pain.
Certainly Georgia’s trade account has been more than robust in the first half of this year with double-digit growth in exports (28.5% y/y), growing remittances from Georgians working abroad (18.3% y/y), and impressive tourism inflows (+28.9% y/y) that lead to a 5.7% appreciation of the lari against the dollar. The central bank took advantage of the balmy climate to add an extra $87.5mn to its gross international reserves (GIR) of just under $3bn, wand this cushion can now be used to soften the devaluation pressures if needed.
Although the lira and ruble crashed at the start of August the lari’s fall was a much more modest 0.8% between August 1-9 before stepping down 3.4% in a day on August 10 to GEL2.57 against the dollar, but analysts believe that this was probably enough of an adjustment for the meantime and the currency remains competitive.
Azerbaijan is much more exposed to Turkey’s woes thanks to its hydrocarbon-heavy economy. The government has been on a protracted campaign to diversity the economy but the non-oil part remains very small against oil and is more exposed to currency fluctuations.
Moreover, the Turkish crisis will also hit the country’s oil sector, according to Azerbaijani economist Gubad Ibadoglu in comments to Eurasianet:
Socar is one of the biggest investors into Turkey having committed $19bn, but this investment is denominated in lira so the state-owned oil company has been badly wounded by the lira’s loss in value.
At the same time Baku’s sovereign wealth fund, the State Oil Fund of the Republic of Azerbaijan (SOFAZ) has around 0.9% of its holdings in Turkish government bonds, which have also tanked this year.
And finally Azerbaijan is exposed to the Turkish banking sector via the Turkish subsidiary of Azerbaijan’s Pasha Bank, which issued
$25mn in new bonds
The text is written with the support of the
Russian Language News Exchange