Amid the recent havoc in emerging markets, Tuesday delivered a significant (and somewhat surprising) piece of good news as Turkey raised the average rate at which banks can borrow by 2.8%. Considering that the US Federal Reserve rarely adjusts the federal funds rate by more than 0.5% at one time, this is obviously a very large increase. This news is surprising not only because of the magnitude of the rate hike, but also because Turkey’s central bank had previously been so reluctant to raise rates. We believe that Turkey did the right thing, as higher rates should help protect the Turkish lira, which has fallen nearly -25% over the past year, from dropping further, and help bring back foreign investment.
What this means
Interest rate adjustments are an important monetary policy tool, and their effects can be widespread. In the case of Turkey, some are calling Tuesday hike a “symbolic” loss for Prime Minster Erdogan, who has campaigned against a rate increase in the face of upcoming elections that may see him (and perhaps his party) voted out of office.
The rate increase will have a mixed effect on the Turkish economy. On the plus side, it should strengthen the lira, making imports less expensive because the same number of lira now buys more goods in other currencies. This is particularly important for Turkey, which is a net importer of goods. However, businesses that export from Turkey may find it harder to sell abroad, as a stronger lira also makes exports more expensive. Most importantly, a stabilized lira should help bring back foreign investment, and along with higher interest rates, help keep investors from dumping their Turkish bonds.
Remember, though, that the problems in Turkey are also political, with a major corruption scandal undermining the legitimacy of the Erdogan government. Partly for this reason, contagion to a large number of other emerging markets, as we saw back in 1997, seems unlikely at this point. Yet so far this year, investors don’t seem to be distinguishing between more stable and more troubled emerging markets, dumping everything indiscriminately (the MSCI Emerging Markets index is down -6.6% since 12/31). We suspect that investors will soon stop painting all such markets with the same brush, and realize that the developing world does not march only to Turkey’s drumsticks (sorry!).
Unless the situation in emerging markets shows signs of a true economic crisis (and not just a “crisis of confidence”), we remain comfortable holding the assets of several emerging market countries. While we aren’t (yet) planning to increase our clients’ exposure to emerging markets, we aren’t succumbing to the panic and selling assets in the face of a temporary headwind.
We’ll end on a Warren Buffett quote we’ve used many times: “Be fearful when others are greedy and greedy when others are fearful.”
Until next week,
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Director of Business Development – Kenfield Capital Strategies (KCS)
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