The meltdown in the Turkish lira is finding its way into other markets. Who’s looking most vulnerable? Our analysis puts Colombia and South Africa at the top of the list. 
n Our emerging market vulnerability scorecard shows Argentina, Colombia, Mexico and South Africa join Turkey as the weakest links. 
n Argentina and Mexico offer higher than average risk-adjusted returns – leaving Colombia and South Africa as the most likely candidates for contagion from Turkey.


Emerging market 
vulnerability scorecard
It’s August: The month for school holidays, beach reading, the start of the soccer season. And the regular wake-up call that the risk of financial crisis is alive and well. The centre of this year’s action is Turkey, which is rapidly descending into a full-blown currency crisis.
The fault line in Turkey has been its large and persistent current account deficit, which has led to the accumulation of sizeable external debt. Policy mistakes aggravated the situation: Instead of slowing the economy to reduce imports, they ran it hot and caused out of control inflation.


New Fragile Five
Is anyone likely to follow Turkey? We scanned major emerging markets for signs of vulnerability along the lines of the Turkish model and flagged countries with large current account deficits, sizeable external debt, weak governance and high inflation.
On this score: Argentina, Colombia, South Africa and Mexico stand out as fragile. They exhibit similar symptoms of weakness to Turkey, although not as extreme.
At the other end of the spectrum, South Korea, Taiwan and Thailand are relatively robust. They run current account surpluses, have low external debt, appear – in varying degrees – well governed and have low inflation.


Risk compensation
From an investor’s perspective, a country might be risky but could offer juicy returns to make it worthwhile investing there.
Still, even from a risk-return perspective, Turkey doesn’t seem very appealing – offering much less than other countries. An investor might be pocketing 17.75% in nominal rates, but high inflation (15.9%) will erode much of the return. The investment will also be very risky because the lira is one of the world’s most volatile currencies.
(Total real return is the policy rate minus inflation, divided by the currency’s six-month implied volatility.)
How about the 2018 version of the Fragile Five? Despite its risky profile, Argentina is paying a higher than average return. That’s because its central bank raised rates to 40% (following a crisis of its own) and is offering high risk-adjusted return.
Mexico is also one of the fragile five, but its risk-adjusted return is in line with countries that are similarly vulnerable.
This leaves Colombia and South Africa as the main weak spots – being both fragile and not offering investors enough returns to tempt capital inflow. As such, it’s time for their policy makers to act if they want to avoid a crisis.