Investment update 20 August 2018

Last week in the markets

Over the past week Australian shares rose 1.3% with small company shares up 0.7%. Shares in developed countries fell 0.1% while the US market was down 0.6%. Shares in emerging markets fell sharply, down 3.7%. The Australian dollar rose slightly, up 0.2% to 73.13 US cents. The Australian 10-year bond yield fell to 2.55% while the US 10-year bond yield dropped to 2.86%. The oil price fell 2.5% to 65.91 US dollars per barrel.

Is Turkey facing challenging times or a financial crisis?

At best, Turkey is facing economic challenges, and at worst, a financial crisis. It can be hard to understand how a country of 80 million people can find itself in this situation. We’ll try to explain by comparing some of Turkey’s statistics with those of Australia:

  • The Turkish economy has been growing very fast. Economic growth over the past twelve months has been 7.4% compared to 3.1% in Australia.
  • This has been accompanied by high inflation, 15.9%, compared with 2.1% in Australia.
  • The Turkish Central Bank (TCMB), appears to be heavily influenced by Turkish President Recep Tayyip Erdogan. In contrast, Australia’s central bank, the Reserve Bank of Australia (RBA), operates independently of the Government.
  • Until recently the TCMB had been maintaining a ‘low’ official cash rate of 8%. It’s described as ‘low’ because interest rates appear to be set to promote economic growth rather than control inflation. Currently, the RBA has maintained a cash rate of 1.5%.

Meanwhile, the Turkish Government runs sizable ‘current account’* and government deficits, has large foreign debts in foreign currencies and relatively low currency reserves.

So, what happened? A combination of rising US interest rates, widening borrowing costs and a falling currency means that there’s an increased fear that Turkey won’t be able to meet its debt payments, especially those in foreign currencies.

This has flowed into further increases in borrowing costs and capital withdrawals which caused the Turkish currency, the lira, to drop further. It’s a spiral that can be extremely difficult to escape from. In response, official cash rates were recently lifted to 17.75% to try and slow inflation and stabilise the currency, but this will most likely hurt economic growth.

The near-term outlook therefore looks challenging for Turkey.

Signing off

David Bell | Chief Investment Officer

*'Current account' refers to a measure of trade between a country with the rest of the world.

Past performance isn't necessarily an indicator of future performance.

Data sourced from Bloomberg, Trading Economics and CNBC.