Volatility in Turkish markets especially the currency that plunged 20% against the USD on Friday last week has led to the INR falling to record lows against the USD today. The Sensex and Nifty were down on worries of capital outflows while the 10 year Gsec yield was higher. Why is Turkey having an effect on Indian markets?
The reason is largely through exposure of European banks to Turkey, leading to a drop in the Euro on fear concerns of contagion effect, much like how Greece caused volatility to markets across the globe. Markets will settle down going forward as economic momentum will replace risk aversion but Turkey noise will continue for a while.
Like many other countries around the world, Turkey is also at odds with the Trump administration and has been hit with the U.S. sanctions. A worsening dispute between the United States and Turkey reverberated through the global economy on Friday, escalating a broad flight of money from emerging markets and making global financial market nervous amid fear that the emerging-market troubles could spillover to the rest of the world. The fear of market contagion was somewhat justified after reports surfaced that the European Central Bank was assessing its exposure to Turkey.
Indian benchmark indices started the week on a weak note because of negative global cues, causing the Indian rupee to collapse to a record low of 69.62 against the USD depreciating by 0.95%. The BSE Sensex was down by 0.6%, trading at 37,640, while the Nifty was trading 0.65% down at 11,362.
The European Central Bank is worried about non-hedged exposure of European banks to Turkish companies and if Turkish banks fail, there’s no question that it will affect markets around the world. Data from the Bank for International Settlements showed that banks in Spain, France and Italy had the highest exposure to the Turkish economy at the end of the first quarter, adding up to USD 81 billion, USD 35 billion and USD 18 billion respectively.
The recent crisis in Turkey erupted after President Donald Trump on Friday tweeted that he had authorized the doubling of steel and aluminium tariffs “with respect to Turkey.” Trump said the tariffs on aluminium imports would be increased to 20% and those on steel to 50% as the Turkish Lira “slides rapidly downward against our very strong Dollar!”. He also wrote that “Our relations with Turkey are not good at this time!”.
However. On Friday President Recep Tayyip Erdogan declared his refusal to bow to U.S. political demands and market pressures forcing Turkey to enter full-blown financial meltdown. The lira plunged as much as 17% on Friday alone, bringing its loss for the year to 45%. The currency drop is particularly painful for Turkey because the country finances a lot of its economic growth with foreign money.
As the currency drops, Turkish companies and households with debt in foreign currencies see the cost of repaying loans rising, which coupled with an inflation rate of nearly 16% could cause severe damage to the local economy. Foreign investors will try to pull their money out, reinforcing the currency drop and potentially leading to financial instability.