The Currency Crisis of 2018?
It’s not too early to consider whether what’s happening in Turkey is simply a Turkish matter.
By Jacob L. Shapiro
What do the Turkish lira, the Iranian rial, the Russian ruble, the Indian rupee, the Argentine peso, the Chilean peso, the Chinese yuan and the South African rand all have in common? They’ve all declined steadily this year, and some have depreciated dramatically in the past two weeks alone. But this isn’t the whole story. The whole story is that each of these countries is sitting on a ticking time bomb of U.S. dollar-denominated debt.
This story has been long in the making. In the 1990s, many countries began to accumulate large amounts of debt denominated in U.S. dollars. It was an effective way to kick-start economic activity, and so long as their own currencies remained relatively strong against the dollar, it was fairly risk free. From 1990 to 2000, dollar-denominated debt tripled from $642 billion to $2.17 trillion.
The problem may now be coming to a head. Dollar-denominated debt has ballooned. In its latest quarterly report, the Bank of International Settlements found that U.S. denominated debt to non-bank borrowers reached $11.5 trillion in March 2018 – the highest recorded total in the 55 years the bank has been tracking it. Meanwhile, the dollar has strengthened amid a tepid global recovery from the 2008 financial crisis. As the currencies of indebted countries weaken against the dollar, it is becoming harder for some countries to pay their debts. This could be a bubble waiting to pop, especially if vulnerable countries don’t have the monetary policy options to protect themselves.
Turkey Isn't Alone
Such was the case for Turkey, which is particularly susceptible to the vagaries of currency depreciation. The value of the lira had been declining for some time, but it dropped dramatically late last week. At nearly $200 billion, almost 50 percent of Turkey’s gross external debt is denominated in dollars. (Turkey’s General Directorate of Public Finance, which, unlike BIS, accounts for financial borrowers, puts that figure at nearly 60 percent.) The situation became progressively more dire through a combination of political uncertainty, unorthodox monetary policy and, most important, U.S. interest rate hikes. Turkey’s dollar-denominated debt is now almost twice as much as its total foreign reserves.
But Turkey isn’t alone. A number of emerging market currencies that were already down on the year nosedived as the news of the lira’s demise began to circulate. The starkest decline was the Argentine peso, whose value against the dollar dropped 9.5 percent in just a week, and the South African rand, which fell roughly 8 percent. Other currencies have been affected too – the Chilean peso, for example, has fallen 3.4 percent in the past week, while the Indian rupee hit a record low on the dollar during trading on Aug. 14.
What these countries have in common is that they are all on a 13-country list released by the Bank of International Settlements. Together, they constitute 62 percent of all dollar-denominated debt held by emerging market economies. Turkey was one of the most vulnerable on the list, but there are four other countries facing similar challenges: Argentina, Mexico, Chile and Indonesia. Argentina’s peso is already in free fall. The government announced on Tuesday that it would sell $500 million worth of reserves and raise interest rates to stop the peso’s fall.
Then there is Mexico, which, at $271 billion, holds more dollar-denominated debt than any other country on the list except China. This far exceeds Mexico’s official reserves. As with Turkey, dollar-denominated debt is a disproportionately large share of Mexico’s gross external debt, at roughly 60 percent. (For perspective, Mexico’s gross external debt to GDP is 39 percent, so the dollar’s influence over Mexico is particularly strong.) So far, the Mexican peso has held steady; it is slightly up on the year, and down just 0.3 percent in the past week. But if the Mexican peso begins to weaken on the back of tougher-than-expected NAFTA negotiations, political instability surrounding the new president or any other contingency, Mexico could be as bad off as Turkey is now.
The story is similar for Indonesia and Chile. Of the two, Indonesia is in slightly better shape. Its gross external debt is 35 percent of GDP, and 47 percent of that is denominated in dollars. But Indonesia doesn’t have a lot of reserves, and its currency has been showing signs of weakness, down almost 10 percent against the dollar this year. Chile’s percentage of dollar-denominated debt as a proportion to GDP is the highest of all BIS reporting countries – a whopping 36 percent. Chile’s gross external debt-to-GDP ratio is 66 percent. Most concerning, however, is that Chilean reserves totaled just $37 billion in June 2018, equal to about a third of its total dollar-denominated debt of $100 billion.
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