Turkish lira weakness prompts fall in EM currencies

The Turkish lira has lost 40% of its value over the last year.  With national elections approaching, the central bank prompted the overnight offshore swap rate above 1300pc to defend the lira.

Turkish banks and corporates have become overstretched on short-term lending, having exploited dollar liquidity to push the country's external liabilities $234bn. Of this, about $150bn is short-term debt required repayment or refinancing within 12 months.

Turkey's reserve cover, the ratio of short term debt to net reserves, is now around 500%, the weakest amongst emerging market countries, according to Capital Economics.

One possible response from banks is to shrink their balance sheets and sell off foreign currency assets. This could trigger a credit crunch.  CDS on Turkey have spiked 150bp to 454.

Despite the situation being contained in Turkey, traders have responded by trading out of Argentine peso, Brazilian real and South African rand as well.

Arg Peso Crisis As Pres Macri Invokes Austerity as Leliq Rate Rises to 60%, Brazil Struggling

Argentina has announced sweeping reforms to kill the budget deficit in the wake of the peso crisis and to create conditions to enable a $50bn funding opportunity from the IMF. 2018 has seen the peso slide to 50% of its value against the dollar. The raising of USD interest rates has made it harder for certain countries, Argentina included, to pay its dollar-denominated debts. Argentina's central bank  (BCRA - Banco Central de la Republica Argentina) also raised its benchmark Leliq rate to 60% at the end of August to stablise the currency. With the Turkish lira down 44% against the dollar talk of an emerging market contagion is worrying investors. The Brazilian real is the third-worst performing EM currency down 20% against the dollar.

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