The deepening currency crisis is putting pressure on emerging markets amid growing fears of a banking crisis, with mixed views on the potential for contagion.
Asian markets slipped and the euro has hit one-year lows as a fresh fall in the Turkish lira fuels demand for safe havens, including the U.S. dollar, Swiss franc and yen.
The Turkish currency has fallen more than 40% this year on worries over President Erdogan's increasing control over the economy and deteriorating relations with the United States, which last week doubled tariffs on steel and aluminium imports.
"The decline is caused not only by a weak external position in terms of current account deficit and inadequate currency reserves, but also the challenging political environment, which exacerbates the vulnerabilities in the lira," says Kerry Craig, global market strategist at JP Morgan. He suggests a mid-meeting rate hike and tightening of monetary policy may go some way to helping avert the lira's decline.
Andrew Kenningham, chief global economist at Capital Economics, believes the lira's plunge will "push the Turkish economy into recession and it may well trigger a banking crisis. This would be another blow for EMs as an asset class, but the wider economic spillovers should be fairly modest, even for the eurozone," he added.
JP Morgan's Craig also believes any potential flow-on effects to other emerging markets would be only short-term: "The drivers of the lira's decline are very specific to Turkey, therefore it should not derail the positive fundamentals in other emerging markets over a longer term."
He notes the rise in the U.S. dollar is a greater risk to Asian emerging markets in particular; the U.S.-dollar index, which measures the value of the U.S. dollar against a basket of six major world currencies -- is up almost 4.5% this year. "However, we expect the U.S. economy to slow as a result of supply constraints and monetary policy, leading to a depreciation in the greenback over the medium term," Craig says.
Japan's Nikkei lost 2% and Hong Kong's Hang Seng Index eased 1.5% as markets across the region turned red on Monday.
The Turkish lira slid to all-time lows around US$0.1382 at one point during the day before rebounding to US$0.1461 at the close, having found a sliver of support when Turkish Finance Minister Berat Albayrak said the country had drafted an action plan to ease investor concerns and the banking watchdog said it limited swap transactions.
Kenningham notes Turkey's annual gross domestic product of around US$900 billion was just 1% of the global economy and slightly smaller than the Netherlands. "Nonetheless, Turkey's troubles are a further headwind for the euro and are not good news for EM assets either."
How other currencies are faring
Against the U.S. dollar, the euro touched its lowest since July 2017 at US$1.137. It was last at US$1.139 and still a long way from last week's top at US$1.162. The Argentine peso and South African rand were also caught in the crossfire.
"Contagion risks centre on Spanish, Italian and French banks exposed to Turkish foreign currency debt, as well as Argentina and South Africa," warned analysts at ANZ. "Turkey's massive pile of corporate debt denominated in foreign currencies, but a rapidly sliding currency -- and inflation that's threatening to go exponential -- is a toxic combination."
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