Emerging economies face threat of Turkey knock-on effect

NEW YORK (Reuters) - As Turkey’s financial markets spiral down, threatening the country’s economy, investors are gauging whether emerging markets as an asset class are in danger of falling out of grace. The following selection of data points indicate there is relative weakness in Argentina and South Africa, while Asia and Mexico show strength.

Turkish lira banknotes are seen in this picture illustration in Istanbul, Turkey August 14, 2018. REUTERS/Murad Sezer/Illustration

A plunge in the Turkish lira has set off a wave of selling across emerging market assets, reviving fears of contagion that has been the sector’s Achilles heel for decades.

Stock prices fell significantly while government bond yields rose across emerging markets. The bout of selling has taken prices and spreads near their 15-year average, indicating further declines could turn out to be good buying opportunities.

(Graphic: EM Equity valuations, bond spreads:

Most countries listed here import more goods than they export, in value terms. Argentina, with the largest net deficit on this list, is one of the markets usually expected to suffer under continued U.S. dollar strengthening.

(Graphic: Import/Export balance in key EM economies:

Foreign direct investment (FDI) supports economic growth in most cases and can make up for a current account deficit. Combined with data on import/export balances, the FDI data highlights South Africa as a likely weak spot if concerns over Turkey spread globally.

(Graphic: Foreign direct investment, net inflows:

Emerging market equities measured in U.S. dollars are strongly linked to the performance of local currencies. The lira’s troubles so far this year are comparable only to Argentina’s peso and both have made for sharp negative stock returns in greenbacks. The Mexican peso is one of the few emerging market currencies to rise this year and its stock market has outperformed the MSCI Emerging Markets index by over 900 basis points.

(Graphic: Emerging markets equity performance:

(Graphic: Select EM currencies YTD:

Argentina and Turkey are ahead again in a measure of the government debt yield spread to U.S. Treasuries. As their currencies weaken and their ability to grow their economies comes into question, investors demand more and more yield to hold these countries’ debt.

(Graphic: EM sovereign bonds in hard currencies, spread (EMBI Glb.Div):

Reporting and graphics by Rodrigo Campos; Editing by Daniel Bases and Rosalba O’Brien