Turkey, as a member of the G20, has experienced a substantial exchange rate depreciation while pushing for monetary easing against the global trend. On November 23, the lira plummeted by more than 15%, the largest drop since the peak of the currency crisis in 2018. Since 2021, when inflation reached 20%, the Turkish lira has fallen by 42%, depreciating by 22% in the past week. The economic and financial situation of Turkey, as an emerging market economy, shows the increasing possibility of stagflation.
The 2018 crisis led to a sharp recession in the Turkish economy, with economic growth falling below average for three consecutive years, and its inflation has reached double-digit. The COVID-19 has also had a huge impact on the Turkish economy. Although the Turkish economy maintained positive growth last year, in response to inflation, the Central Bank of the Republic of Turkey (CBRT) started raising interest rates. The policy interest rate had even reached a high of 18%. Turkey's inflation level reached 19.25% in August, a record high. Under the intervention of Turkish President Recep Tayyip Erdoğan, the CBRT has cut interest rates by a total of 400 basis points since September. Such policy will lead to inflation and a vicious currency devaluation. Although the current surge in inflation has stimulated short-term economic demand, allowing Turkey to maintain a certain economic growth rate, the situation will deteriorate significantly next year. Recently, Fitch raised Turkey's growth forecast for this year from 7.9% to 9.2%. However, Fitch pointed out that Turkey’s gross domestic product (GDP) growth is expected to slow to 3.5% in 2022, then return to 4.5% in 2023. The agency estimates that Turkey’s inflation rate this year will be 17.2%. It will be 13.4% next year and 10.5% in 2023. The fall in economic growth and high inflation mean that Turkey will inevitably suffer from stagflation.
Changes in the capital inflow is a worrying development for Turkey as it will worsen the economy while the sharp depreciation of the Turkish lira is already dampening the situation. With the Federal Reserve’s interest rate hike expectations heating up and U.S. inflation remaining high, this possibility is increasing. ANBOUND’s collaborating scholar Xu Weihong believes that when the U.S. starts to reduce easing, emerging markets are more likely to experience panic. He said that looking at the Turkish financial market in November, some similarities appear in Turkey to that in South Korea's during the 1997 Asian financial crisis. With the appreciation of the U.S. dollar and the devaluation of emerging market currencies, emerging market countries face the same risk of capital outflow or "capital returning to the United States" similar to the 1997 Asian financial crisis. This is bound to bring about economic and financial turbulence in some emerging markets.
Looking at the recovery of the global economy, under the uncertainties of the COVID-19 pandemic, it has become more divergent. On the one hand, the U.S. economy has recovered rapidly under its stimulus policies and is gradually widening its gap with Europe and Japan. On the other hand, as COVID-19 continues to spread in emerging market countries, the extent of their economic recovery this year is still significantly lagging. Due to the improvement of the U.S. economy and rising inflation, the Fed’s process of reducing easing may accelerate. Considering the position of the U.S. dollar in the international monetary system, if it tightens liquidity, the economy of some economies that has not recovered this time will see increased pressure of exchange rate depreciation. Since the beginning of this year, in addition to the Turkish lira which has fallen to a historical low, Argentina’s currency has depreciated by 16%, while the currencies of Thailand and South Korea have also depreciated by more than 7%, and the Japanese yen has depreciated by more than 9%. This is a sign of an impending crisis.
To cope with inflation and currency devaluation pressures, some emerging economies have started the process of raising interest rates this year. Brazil has the highest interest rate hike. This year, it has raised interest rates by 575 basis points, followed by Russia and Ukraine, which have also raised interest rates by 325 basis points and 250 basis points respectively, much higher than other economies. The Brazilian Ministry of Economy raised its forecast for 2021-2022 inflation growth from 7.9% to 9.7% on November 17, and at the same time lowered its forecast for GDP’s growth from 5.3% to 5.1%. With U.S. dollar remaining strong, the exchange rates and emerging economies markets are likely to face greater impacts. Countries with slower economic recovery and higher foreign capital inflows, in particular, will face a more severe situation. This means emerging market countries will in general, face a more daunting stagflationary challenge than developed economies.
Of course, for most countries in the world, stagflation in 2022 will not be catastrophic. In Xu's view, the United States, as the world's largest economy, maybe the least affected, and it will still benefit from the capital return brought by a strong U.S. dollar. A Barclays analyst believes that with the gradual maturity of global expansion and the gradual withdrawal of unconventional stimulus measures, the degree of differentiation of emerging market assets will increase. Structural factors such as certain commodity risk exposures will also affect asset selection. However, in the context of various potential pressures in 2022, a comprehensive assessment of the fragility of emerging economies and their exchange rates will allow countries to avoid some losses.
For China, despite the downward pressure on the economy, its domestic situation is still relatively stable, hence the impact of external shocks on the economy is relatively limited. However, Xu mentioned that emerging market countries repeating the risk of the 1997 Asian financial crisis will be the biggest potential systemic risk in 2022. Many of them are partner countries of China’s Belt and Road Initiative (BRI) and contribute to the growth of China’s foreign trade growth potential in the future. Therefore, achieving a win-win situation between China and these countries, while avoiding risks and crises are not only a challenge for the Chinese economy in 2022, but also brings the opportunity to the country.
Final analysis conclusion:
With the rise in global inflation and the Fed reducing easing, the appreciation of the U.S. dollar and the flow of capital will lead to the possibility of stagflation and crises in some emerging markets. Such external uncertainty also poses certain impacts and challenges for China.
