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Han De Jong, Chief Economist at ABN AMRO, suggests that there clearly is always a contagion risk from Turkish crisis that international investors will dump their holdings of other Emerging Markets assets, triggering sharp falls of these markets, threatening financial stability in these countries, which in turn, will affect these economies at large and eventually also markets and economies of advance countries.

Key Quotes

“But I think cautious optimism is the right position here. Contagion is more likely to occur if the causes of the problems hitting one country are also characteristic for other countries, if the fundamentals of economies are poor and if their currencies are overvalued.”

“It seems to me that the key problems for Turkey are not shared with many other countries. The key problem for Turkey is that the country has a large external financing requirement due to a combination of a large deficit on the current account of the balance of payments and a large amount of short-term debt (mostly owed by corporates).”

“On top of that, president Erdogan has centralised a lot of power in himself. The independence of the central bank has been curtailed and the new finance minister is his son in law. This has done little for the confidence financial-market participants have in the policymakers.”

“Furthermore, president Erdogan’s unconventional views on economic policies aren’t particularly helpful either. The deteriorating relationship with the US adds to the mix. Other EMs don’t tend to share all of these issues, although many countries have fallen out of favour with the American president and EMs generally feel negative consequences of rising US interest rates.”

“Another reason to be cautiously optimistic is that many other EMs that are potential contagion candidates have much improved economic fundamentals these days. In most of these countries, external deficits have been reduced sharply or even turned into surplus in recent years and the public finances are in reasonable health. Inflation tends to be at reasonable levels and central banks tend to follow policies that support confidence.”

“What should also help limiting contagion, in my view, is that currencies have weakened in recent years and it cannot be argued that there is widespread overvaluation, which would make currencies great candidates for wholesale selling.”

“On balance, therefore, I think the contagion effects will remain limited. Unfortunately, one cannot guarantee this.”