Aside from the impact on a few small neighbouring countries, most notably Bulgaria, the direct risk of contagion from Turkey’s crisis to other emerging markets (EMs) is fairly low, a recent report issued by Capital Economics concluded.
However, the report noted that Turkey’s problems may add to the accumulating negative sentiment towards EMs in general, and this in turn could make financial conditions more difficult for emerging economies in the coming months.
The lira is down by 7% against the dollar so far last week, and it has lost almost 20% of its value since the start of the month.
The fall in the lira appears to have caused sentiment towards EMs more generally to deteriorate. Most EMs currencies are down by 0.5-1.5% against the dollar and central banks in India and Indonesia have reportedly intervened in foreign exchange markets in response.
The direct economic impact of the crisis in Turkey on other EMs should be limited, the report added.
Trade ties with Turkey are not large either, so a sharp downturn in Turkey should not be damaging for EMs exports. Aggregate EMs exports to Turkey amount to just 0.3% of EMs gross domestic product (GDP). Of course, some countries are more vulnerable than others. Bulgaria’s exports to Turkey are close to 5% of the GDP, while those from Russia, Vietnam, and Central Europe stand at 1-2% of the GDP. For most, the fallout should be manageable.
A potentially bigger threat to EMs lies in contagion. History suggests that a crisis in one emerging market can spread to others which share similar vulnerabilities. This occurred during the Taper Tantrum when the ‘Fragile Five’ (Brazil, India, Indonesia, Turkey, and South Africa), all of which had large current account deficits, suffered the largest currency falls.
“However, as we have argued before, Turkey’s vulnerabilities appear to be unique. Most EMs’ current account deficits have narrowed significantly since the Taper Tantrum and are generally small. Argentina has a precarious external position, but the government’s decision to turn to the IMF for help after a currency crisis in April and May seems to have stabilised the situation there.”
“What’s more, the fragilities in Turkey’s banking sector that are now grabbing attention are more acute than in most other EMs. Among major EMs, only China has seen a larger credit boom over the past decade. And risks there are mitigated to an extent by the fact that lending has been financed by domestic deposits (not by foreign wholesale markets as in Turkey) and a closed capital account.”
That said, this is another headwind facing EMs that has arisen in the past few months. China’s economy is now slowing, EMs are now tightening monetary policy and a trade war is escalating. This could worsen investor sentiment towards EMs and also strengthens our view that EMs growth will weaken.
Meanwhile, a separate research note issued by Beltone said that Saudi Arabic inclusion in the Morgan Stanley Capital International (MSCI) EMs index would have a minimal effect on Egypt’s stock market as a sell-off in the second biggest market in the region has already carried out.
The MSCI announced the inclusion of Saudi Arabia in the MSCI EMs Index effective June 2019, representing a weight of approximately 2.6% of the index with 32 securities.
This will follow a two‐step inclusion process, the first of which will coincide with the May 2019 Semi‐Annual Index Review, while the second will be in August 2019 Quarterly Index Review.
The MSCI also announced the reclassification of the MSCI Argentina Index from Frontier Markets (FMs) to EMs status.
In addition, the MSCI announced that it will include the MSCI Kuwait Index in its 2019 Annual Market Classification Review for a potential reclassification from FMs to EMs status.
“This marks a strong acknowledgement of the reforms undertaken by the Saudi government, which included lower restrictions on international investors and the introduction of short-selling and T+2 settlement cycles,” the report noted.
The decision was anticipated since the beginning of the year as the MSCI praised Saudi’s efforts to introduce capital market reforms that aimed at opening the local equity market to international institutional investors.
Index provider Financial Times Stock Exchange (FTSE) Russell upgraded Saudi to EM status in March 2018.
The CEO of Saudi bourse expects minimum foreign inflows of $10bn from passive funds (PFs) with up to $40bn over the next year from the inclusion, and he added during an interview with Bloomberg, that Tadawul is aiming to increase the foreign participation in the market from a current 5% to 20-25% in the next two years.
“We do not only see the inclusion as increasing foreign presence in the market and improving liquidity, but also as enhancing the quality of the flow entering the market, which we believe will be more geared towards long-term institutional investors that will provide a fundamental growth in the Saudi market,” the report added.
The report added that Aramco IPO will be another key trigger for the market, with a potential $50bn of assets into the market.
Saudi is the third Gulf Cooperation Council (GCC) country to be granted an MSCI EM status, as the UAE (0.4%, upon inclusion) and Qatar (0.45%) were included in 2013.
According to market reports, the UAE and Qatar weights are currently much higher than when they were included in 2013.
The Egyptian Exchange (EGX) 30 has been seeing outflows over the past two months, dropping 9.2%, reflecting the potential inclusion of the Kingdom of Saudi Arabia (KSA) (TASI was up 3%), thus we see a minimal impact from the materialization of the decision on the local market.
The Dubai Financial Market (DFM) and the Average Directional Index (ADX) were also down 5.2% and 3.3% respectively during the same period.
In addition, Egypt’s weight is relatively small, at less than 0.15%, which we believe could go down when the inclusion of Saudi Arabia becomes effective.
“We note Egypt’s weight was 0.25% of MSCI EM index in 2013 before the UAE and Qatar were upgraded to EM status,” the report concluded.
