Turkey is just a drill.
A push by major central banks to reverse crisis-era policies is primed to accelerate into 2019 amid plans for higher interest rates and smaller balance sheets. So-called quantitative tightening then risks sucking dollars and euros from nations whose governments and companies binged on cheap debt without improving the fundamentals of their economies.
The Federal Reserve is already letting some of its bond holdings mature and the European Central Bank plans to cease purchasing assets in December. That leaves Bloomberg Economics predicting net asset purchases by the three main central banks will dwindle to zero by the end of this year from close to $100bn a month at the end of 2017.
The looming pivot from easy money means that investors could switch from worrying about idiosyncratic factors in markets such as Turkey and Argentina to displaying broader nervousness around emerging economies hooked on cheap liquidity. Poland and Malaysia, for example, have external debts equivalent to about 70% of their gross domestic product, according to the International Monetary Fund and World Bank.
“There’s still complacency across EM,” Alberto Gallo, a money manager at Algebris Investments in London, told Bloomberg Television. “EM debt has been flashing red.”
The Institute for International Finance estimates the debt of households, governments, corporations and the financial sector in the 30 emerging markets it tracks increased to 211% of gross domestic product at the start of this year from 143% at the end of 2008. For 21 of those, dollar-denominated debt jumped to around $6.4tn from $2.8tn over the same period.
The IMF estimates public debt in emerging markets and middle-income economies now averages almost 50% of GDP, the most since the 1980s debt crisis. Levels top 70% in one-fifth of such countries.
Perhaps most worryingly, the Bank for International Settlements calculates dollar-denominated corporate liabilities alone total $3.7tn in emerging markets, double the amount in the same period of 2010.
Against such a backdrop, Bloomberg Economics tags Turkey, Argentina, Colombia, South Africa and Mexico as the most vulnerable to investors turning tail, given a potentially toxic combination of fast inflation alongside bloated current-account and budget deficits.
“The governments, corporations, banks, and households in EM have dollar liabilities that will become a problem as the dollar rises,” Stephen Jen and Joana Freire of London-based hedge fund Eurizon SLJ wrote in their latest report to clients. “One gets a hangover only after she stops drinking.”
To be sure, not every emerging economy faces the same risk and many sought to insulate themselves in the last decade. In the main, average inflation rates are at record lows and current-account balances are improving. An early casualty of the Asia crisis of the 1990s, Thailand, now boasts healthy reserves and a rare current-account surplus. Bloomberg Economics also rates South Korea and Taiwan as relatively robust.
Still, there is pressure to respond even for those emerging economies in Asia that are bolstered by strong reserves and robust fundamentals.
India’s policy makers caught some reprieve from tightening pressure earlier this week as data showed inflation subsided last month. India’s rupee and Indonesia’s rupiah, meanwhile, remain the two weakest currencies in Asia this year.
Indonesia’s central bank surprised most economists on Wednesday by raising its benchmark interest rate a fourth time since May. In some of the other action this week, the Bank of Thailand said it is monitoring any spillovers from the Turkish crisis and Argentina’s central bank jacked up its already highest-in-the-world interest rate by 5 percentage points to 45% Monday.
Strategists at Morgan Stanley look to the Bank of Japan’s decision to cut its balance sheet in early 2016 as a case study, noting it can take months before investors react to lower liquidity and risk.
“Within a world of ample liquidity, recent EM developments would have a far smaller impact on price fluctuations and local liquidity,” Hans Redeker and Gek Teng Khoo said in a report on Tuesday. “What we have experienced in EM over recent weeks is the outcome of tighter global liquidity conditions.”
The problems in Turkey may be emblematic of wider risks as key central banks inch away from their policy accommodation, said Jim Reid, global head of credit strategy at Deutsche Bank AG.
“Financial crises are always likely to happen somewhere in a Fed tightening cycle, especially when a lot of money chased high yielding assets in the easing stage of the cycle,” he said. “The latest developments are therefore familiar to global investors even if there is always a hope that this time is different.”

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