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Turkey crisis may have rocked markets but investors are still ‘buying the dip’ in emerging economies

Key Points
  • The sell-off from the crisis in Turkey has spread to other emerging market economies but that hasn't stopped investors from buying emerging market assets.
  • Latest EPFR data shows inflows into Turkey hit its highest level since January 2013
  • Analysts have said that while the crisis has spread to other assets, a stronger U.S. dollar may limit the risk. 
Turkish Lira banknotes
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Investors are still "buying the dip" in emerging markets despite the financial crisis in Turkey, according to a report from UBS.

Even with its ongoing currency crisis, last week Turkey saw its highest weekly inflows since the first week of January 2013, according to recent weekly data from EPFR Global. With a total inflow of $191 million, Turkey continues to remain a top-pick for investors.

"Based on our flows-based investor positioning model, Turkey replaced Colombia as the most crowded emerging market, while Brazil replaced India as the second least crowded market after Russia," the report said.

While China also reported an inflow of over $100 million, Brazil had the largest outflow, by far, at $407 million. South Africa and Mexico saw the next-biggest leakages of $47 million each. Meanwhile, overall outflows from Global Emerging Markets (GEM) equity funds slowed to $187 million last week.

The lira has lost more than 40 percent of its value this year, hit by concerns over President Recep Erdogan's influence over the country's monetary policy and a deteriorating relationship with the United States. The crisis has spread off to other emerging market currencies and stocks across the globe, with some currencies like the South African rand and the Indian rupee hitting record lows.

"Contagion risks from Turkey have impacted emerging markets with most high-yielders and consensus-long positions coming under material pressure in recent days," Mark Dowding, a senior portfolio manager at BlueBay Asset Management, said in a note late last week. "Countries with large current account deficits and substantial short-term funding needs appear the most."

Traffic in New Delhi.
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However, some analysts have said that a stronger dollar could limit the spread of this crisis.

Holger Schmieding, chief economist at Berenberg, said in a research note to clients late last week that the contagion to other emerging markets is not widespread.

"The direct exposure of other emerging markets to Turkey via trade or the banking sector is very small. A stronger USD and, in some cases, the risk of U.S. sanctions, remain serious concerns for the most exposed countries."

Schmieding further explained that big current account deficits coupled with high levels of foreign currency debt can be a "recipe for a crisis." However, due to strong economic growth since the financial crisis of 2008/2009, many emerging markets benefit from improved private sector balance sheets and elevated forex reserves.

"This should help most of them to withstand the Turkish tremors with little damage," Schmieding said. "China looks safe while high oil prices and an independent central bank support Russia."