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R&R Weekly Column

Turkey’s Debacle and Wider Contagion Risks

by Brunello Rosa

13 August 2018

The Turkish Lira (TRY) collapsed last Friday, losing around 15% of its value against the dollar in a single day.  The Lira’s loss against the dollar has now reached almost 45% since the beginning of the year. 

We have been following Turkish developments very closely in the last few months, so this crisis did not come unexpected. On August 9th, we warned that the risk of a full-blown balance of payments crisis was rising, thus increasing the downside risks to the muddle-through scenario, which was considered until recently the most likely course of action (chiming with our previous analysis). The volatility we expected to increase ahead of the elections of June 24th, which gave President Erdogan increased political powers deriving from the 2017 constitutional referendum, has persisted even after the elections. This volatility has occurred especially as a result of statements and appointments made by Erdogan, which have reduced the independence of Turkey’s central bank (as discussed in our column on July 23rd) and the credibility of Turkey’s Ministry of Finance.

The repercussions of the Turkish crisis for international markets can be divided into two fronts: emerging markets (EMs), and financial markets in general. For the former, our working paper published today (Turkish Lira Tumbles, Contagion Risk Rises) suggests that contagion from Turkey to other emerging markets is increasing. The impact of Turkey on stocks in India, Brazil, Russia and South Africa has been marginally negative. In the fixed income space, 10-year government bond yields have increased in India, Russia, and especially Brazil (+28bps, to 11.76%) and South Africa (+17bps, to 8.86%). EM currencies have depreciated in China, India, Brazil, Russia and South Africa. This is the result of the increased fragilities we discussed in our recent EM outlook and strategic asset allocation paper.   



Somewhat more worrying, however, is the contagion risk that Turkey might pose to financial markets and economic performances in general, in particular via exposure to Turkish banks. As discussed in a recent press report, European banks (especially in Spain, Italy and France) own significant stakes in the Turkish banking sector, which in turn carry an exposure of more than USD 130bn to the Turkish non-banking private sector. In particular, three major lenders— France's BNP Paribas (holder of 72.5% of the retail bank TEB), Spain's BBVA (49.9% of Garanti bank) and Italy's UniCredit (40.9% of Yapı Kredi bank) lost 3.0%, 5.3% and 4.7% of their share value on Friday, respectively. The European Central Bank expressed concern about the three banks’ exposure to Turkey; the Turkish market accounts for 14% of BBVA’s total loans, 4% of Unicredit’s, 3% of ING’s and 2% of BNP Paribas’. 

This situation could be especially concerning for peripheral Eurozone countries, such as Italy, which are already the focus of investors’ concerns as a result of their own domestic issues. Italy’s “populist” government is in the process of drafting its first budget, even as it faces serious divisions within the governing majority. The Turkish crisis is yet another reminder of the interconnectedness of financial networks; of how a crisis in one area of the global economy can quickly affect wider markets.   

Latest research

TRAVEL NOTES - TURKEY: The Risk of a Full-Blown Balance of Payments Crisis Is Rising

by Nouriel Roubini 

9 August 2018

REVIEW: BOE Ends Up Delivering A Dovish Hike

by Brunello Rosa

2 August 2018 

The Geopolitical Corner by John Hulsman

How The World Really Works (Part 1)

15 August 2018 

 Introduction: Context is the big reason you can be right in terms of political risk

Turkey’s economic fall from grace was inevitable, but only, as Sherlock Holmes would say, if you actually bother to observe. At my political risk firm, we blessedly do—Turkey’s economic collapse was one of our 2018 projections in our global predictions column which begins the year—but having read the vast majority of ‘serious’ newspapers (and seen the prognostications of most of my political risk rivals), lately they seem laughably and perpetually surprised when anything important happens.

There are actually people who are still taken seriously in my profession who were wrong about Brexit, wrong about Trump, wrong about the completed Dutch, Italian, and Colombian referenda, people whose record ought to make them recoil with shame, who actually still make a living at geopolitical analysis.

If the world is ever become a better place, part of the answer is that both capitalism and accountability have to smash their way into the sacred chamber of the foreign affairs elite, with those who actually know what they are talking about thriving because of this, while the others are no longer awarded lucrative jobs without the consequence of ever having to be right. For without merit mattering, without analytical excellence driving things and being rewarded, mediocre statesmen will continue to listen to charlatans and buy their snake oil, with all the usual disastrous consequences.

So how does one observe, in order to do global political risk the right way? A first, vital step is to know how the world we live in right now actually works (and does not), to keenly understand its basic structure and those powers that are rising and falling within it. To understand this is to have the Rosetta Stone, a key that can decipher what is actually going on in our new era. So without further ado, here are three global realities (with six more to follow in the next weeks) that can help us plot the compass points to make our journey in this new beguiling world a rewarding one.

1)  The Turkish crisis doesn’t change the overall historical trajectory of our time one jot. The headline of our age is clear: this is an unsettling, revolutionary era, as the Emerging Market powers rise, while the West’s 500-year dominance of the world comes to a definitive end.

When I was young—as had been true in the earlier age of Kissinger and Brzezinski--all the best international relations students studied transatlantic relations. This made eminent sense as this is where the action lay; the two superpowers of the Cold War era lay at the edges of the European continent—either by geography or culture—and the Old World itself (particularly in the guise of Berlin) was the cockpit of the bipolar struggle, easily the most important political, economic, and geostrategic prize for both Washington and Moscow.

This is very much no longer the case. My best students at St. Andrews and SAIS were focused on learning about political economy, mastering Mandarin or Farsi, and zeroing in on Asia as an area study. Again, academics is merely following the action, as it should be beyond clear by now that in our new era, Asia is the area of the world with by far the greatest economic potential for future growth and also the part of the world with the most political risk. Aspiring superpowers China and the US are just ginning up to spend the next few generations competing over Asia in an effort to see which of them will emerge as the greatest power of the twenty-first century.

But this is about more than China. For ‘China’ has become short-hand for the rise of a plethora of non-traditional powers such as India, Indonesia, Vietnam, South Africa, Brazil, Argentina, Ethiopia, Turkey, Iran, Israel, and Mexico, amongst others. While all these emerging powers will not prove to be successful in the next generation (and some like Turkey may actually fall off the economic and geopolitical map), enough will be to put an end to the fantasy that in the end, only China and the US will ultimately matter in our new age. Look over time for India, Ethiopia, Mexico, Israel, and South Africa to continue to (unevenly but definitively) move ahead at the very least.



2)  NATO is over; transatlantic relations will never be the same.

It is not that the US will dramatically stalk out of some future North Atlantic Treaty Organisation (NATO) meeting, definitively rending asunder the rightly storied transatlantic alliance that brought the West victory in the Cold War, and continued global dominance for the past 70 years. Life is far more mundane than this. In fact, the alliance is already ending with a shrug, with President Trump’s threatening call for European free-riders to actually spend significant funds on their own defence or else simply amounting to a last American primal scream after being bamboozled for decades by a decadent Europe, eager to pretend that carrots (rather than sticks) are all that are needed in a post-modern world.

Unfortunately for Europeans, carrots alone only work in a world populated entirely by rabbits. And whatever one thinks of them, Presidents Trump, Putin, Xi, and Prime Minister Modi are not rabbits. It is time to face facts. Europe will never hit the totemic two percent GDP spending NATO is now requiring its members to attain, for the simple fact it does not want to do so. Defence spending is the 15th of most European States’ Top Ten priorities. This is especially true of great European powers Italy, Spain, and Germany. So let’s get real. A rapidly declining Europe, a continent full of lotus eaters, is not about the make the changes necessary to revitalise NATO; the last 20 enervating years are all the facts you need to reach this obvious conclusion.

Time for the US to send a Deputy Assistant Secretary of State with some free time to politely listen at a North Atlantic Council meeting to the Europeans drone on about human rights, indulging in their usual virtue signalling to no earthly avail, and to instead focus on winding things practically down, ending this over-fixation with a continent obviously headed towards a decadent absolute decline.

3)  The Middle East does not matter.

One of the great unsung stories of the past few years is how the Shale Revolution has transformed America from an energy mendicant to a superpower rivalling Saudi Arabia and Russia. The best part of this (assuming President Trump does not commit economic and political suicide over re-negotiating the NAFTA accord, and recent signs are favourable) is that a single energy market of American shale, Canadian tar sands, and a quasi-liberalised Pemex in Mexico means North America will have as close to energy independence (political risk free) as it is possible to have in our interdependent world.

This means the US can at last largely exit the thankless snake pit of the Middle East, reimagining itself as an off-shore balancer, only getting seriously involved in the area if one of the many regional powers (Turkey, Israel, Egypt, Iran, Saudi Arabia) comes to dominate the others. As there is absolutely no sign of this happening, America will at last be able to turn its gaze from a no-win region with decreasing strategic value (and almost no strategic upside) to Asia, where everything is to play for.

President Obama understood this, and with the Iranian nuclear deal, had begun this process of deleveraging. Sadly, Donald Trump has reverted to past American form, unimaginatively (and in knee-jerk fashion) actively siding with the Saudis in their endless (and fruitless) efforts to dominate Iran, this time through the guise of a regional Sunni-Shia geostrategic schism. But Trump too shall pass. The geostrategic and global energy realities of the new era mean that in the medium-term, look for the US to finally realise that its primary interests do not included endlessly banging its head against the Middle Eastern wall, all to absolutely no avail as the region itself matters less and less.

These are the first three compass points of how the world really works, the map that explains why my firm is consistently at the forefront of predictions about our new era (and why our opponents are not). Next week, I will delve into the next three data points about deciphering our fascinating new era.

This article was originally published on the Author's LinkedIn Page. John Hulsman's new book, To Dare More Boldly: The Audacious Story of Political Risk, was published by Princeton University Press in April 2018. 

Looking Ahead

The Week Ahead

Week  13  - 19 August 2018


In the US, retail sales (ex-autos) are expected to remain stable (July m-o-m, c: 0.4%; p: 0.4%). 

In Europe, both GDP growth and inflation are expected to remain largely unchanged: (EZ GDP Q2, y-o-y, c: 2.1%; p: 2.1%); (EZ CPI July, y-o-y, c: 2.0%; p: 2.1%). 

The European Central Bank (ECB) expressed concern about EZ banks’ exposure to Turkey. EZ banks own significant stakes in the Turkish banking sector: France's BNP Paribas (holder of 72.5% of the retail bank TEB), Spain's BBVA (49.9% of Garanti bank) and Italy's UniCredit (40.9% of Yapı Kredi bank) are under pressure: the Turkish market accounts for 14% of BBVA’s total loans, 4% of Unicredit’s, 3% of ING’s and 2% of BNP Paribas.  

The Quarter Ahead

Global growth and inflation will gradually lose momentum. In the US, inflation is stabilizing (CPI July y-o-y, a: 2.9%; c: 3.0%; p: 2.9%). In the UK, Q2 GDP y-o-y growth was at its lowest level since Q2-2012 (a: 1.3%; c: 1.3%; p: 1.2%). In the EZ, Germany’s manufacturing orders fell 4.0% m-o-m (c: -0.4%; p: 2.6%). In the GCC, UAE’s GDP growth declined from 3.0% in 2016 to 0.8% in 2017. 

In the US, the Fed will continue to tighten, but EM market volatility will likely reduce expectations of further hikes. The likelihood of “at least two additional hikes in 2018” declined to 67.0% (pw: 68.5%), driven by concerns about EMs. 

Turkish authorities will gradually adopt measures to stabilize the economy. The markets are currently expecting: a) the CBT to hike interest rates by at least 500bps; and b) an initial agreement with the US to reassure investors and avoid a full-blown economic crisis. 

The risk of contagion to Europe will remain elevated. European lenders accumulate more than USD 130bn of exposure to the Turkish non-banking private sector. 


Italian assets will suffer the TRY turbulence. The 10y Italian bond yield rose by 6bps w-o-w (to 3.00%), as concerns about Italian banks exposure to Turkish assets added to worries over tax cuts and increased fiscal spending. 

Tariffs are set to escalate, but will likely not lead to a trade war. Tariffs on Turkish and Chinese exports are expected to be softened or eliminated as countries show willingness to accommodate US demands. 

Sanctions will create further instability in Iran. The first batch of US sanctions came into effect on August 6th, and causing episodes of unrest in Iran. A second wave of sanctions will be adopted in November. In the near term, Iran will refuse to negotiate with the US. 

EMs will continue to suffer outflows due to: a) declining USD liquidity; b) rising US interest rates; c) a stronger USD; and d) trade war fears. 

EM volatility will have a negative impact on Brent oil price. Concerns about global growth stemming from EM instability weighed on prices (-0.5% w-o-w, to 72.8 USD/b).      

Last week's Summary (6 - 12 August 2018)

TRY Collapse

The TRY suffered a 26.5% w-o-w decline against the USD ... reaching USD/TRY 6.427, after experiencing a 15.5% d-o-d decline on Friday, August 10th. The fall was mostly provoked by external factors, in particular: i) rising tensions with the US—e.g.: the US imposed sanctions on members of the Turkish government and Trump doubled tariffs on Turkish steel and aluminium, to 50% and 20% respectively. The US wants the Turkish government to free US pastor Brunson and to reduce Turkey’s cooperation with Iran and Russia; and ii) monetary policy tightening in the US support “periphery-to-core” flows. Internal factors aggravate the depreciation: i) a growing C/A deficit (from 5.1% in 2017 to 6.1% in 2018); ii) declining reserves (-25.5% since the July 2014-high); iii) a rising fiscal deficit (from 1.5% of GDP in 2017 to 2.0% in 2018); and iv) uncertainty about economic policy and concerns about the independency of the CBT. 

And Global Risk Aversion

   …fuelling a wave of global risk aversion. Equity markets weakened w-o-w across the board: globally (MSCI ACWI -0.7%); US (S&P500 -0.2%); EZ (Eurostoxx 50 -1.6%, led by banks with exposure to Turkey); and EMs (MSCI EMs -1.0%). Volatility rose only moderately (VIX, +1.6 points to 13.2—52w avg.: 13.6; 10y avg.: 19.6) The USD appreciated w-o-w against a currency basket (DXY 96.4, +1.2%, reaching a one-year high) and the EUR (EUR/USD 1.141, -1.4%). Rising demand for US bonds reduced 10y yields by 9bps to 2.86%. EM currencies (MSCI EM Currency index) weakened by 1.0% w-o-w and by 4.5% y-t-d versus the USD.  

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