Turkey Is The Epitome Of What Can Go Wrong In The Emerging Markets

The Turkish lira (TRY) fell to new record lows on Friday.

Many of Turkey's current problem relate to risks that even novice emerging market investors should know about. So in many ways, Turkey is arguably the epitome of what can go wrong in an emerging market.

"One way to illustrate what can go right in DM and what can go wrong in EM is to use the UK versus Turkey narrative," wrote Morgan Stanley's Joachim Fels.

A corruption probe launched in December, which led to the resignation of three Turkish cabinet members and eight MPs from the ruling party, is among the events that have raised investor concerns.

But Turkey's political sphere has been rocky since the demonstrations in Istanbul's Gezi Park last year, which mushroomed into wider anti-government protests.

Economic concerns

Turkey's woes go beyond political concerns too.

The country had long been one of the most exciting emerging markets in the world thanks to favorable demographics and attractive interest rates for bond investors. But now growth is slowing and investors are worried about the country's wide current account deficit, which stands at aroun 7% of GDP.

In a note written earlier this month, Morgan Stanley's Tevfik Aksoy writes that he has been approaching Turkey with caution "due to its sizable external funding need and its dependence on low-quality funding simply because of the anticipation of Fed tapering."

And of course there are concerns that Turkey's central bank could move to raise interest rates to shore up the lira even as economic growth is slowing

"Broad deterioration in market sentiment is of course leading to the TRY's decline, but the problem is being compounded by the lack of more aggressive monetary tightening from the Central Bank of Turkey," writes Morgan Stanley's Rashique Rahman.

Where does this leave Erdogan?

For those concerned about Turkey's political crisis, Nomura's senior political analyst Alistair Newton thinks "the risk to medium-term political stability is being overstated in some of the media - a tendency, which is likely to persist near-term as events continue to unfold."

He expects the ruling Justice and Development Party (AKP) party to do well at the March 30 elections and expects Erdogan "to remain the dominant political figure for the foreseeable future, as either prime minister or the country's first directly elected president."

Financial market volatility, high debts, and elevated corruption risks are all taught in emerging market risks 101.