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 share markets are slipping and the euro has hit one-year lows as a fresh fall in the Turkish lira fuels demand for safe havens, including the US dollar, Swiss franc and yen.

The currency has fallen more than 40 per cent this year on worries over Turkish President Tayyip Erdogan's increasing control over the economy and deteriorating relations with the US, who 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, JP Morgan's global market strategist.

He suggests a mid-meeting rate hike and tightening of monetary policy may go some way to helping avert the lira’s decline.

Modest spillover potential

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 euro zone," he added.

Turkey Erdogan lira currency

There are differing views on EM and broader market effects of Turkey's currency crisis

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 US dollar is a greater risk to Asian emerging markets in particular – the US-dollar index is up almost 4.5 per cent this year. "However, we expect the US 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 0.95 per cent and MSCI's broadest index of Asia-Pacific shares outside Japan eased 0.3 per cent as bourses across the region turned red on Monday.

EMini futures for the S&P 500 were off 0.15 per cent, while Treasury yields dipped further.
Much of the early action was in currencies with the euro gapping lower as the Turkish lira took another slide to all-time lows around 7.2400 at one stage.

It was last at 6.8450, having found just 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 $900 billion was just 1 per cent 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

Indeed, the single currency sank to a one-year trough against the Swiss franc in early trade around 1.1300 francs, while hitting a 10-week low on the yen around 125.45 .

Against the US dollar, the euro touched its lowest since July 2017 at $US1.13715. It was last at $US1.1392 and still a long way from last week's top at $US1.1628. The US dollar eased against the safe haven yen to 110.65, but was a shade firmer against a basket of currencies at 96.388.

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."

In commodity markets, gold had found little in the way of safety flows and was last stuck at $US1211.80 an ounce.

Oil prices edged higher with Brent up 5 US cents at $US72.86 a barrel, while US crude added 15 US cents to $US67.78.


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Glenn Freeman is senior editor, Morningstar Australia.

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