As the US, European and UK central banks drenched the world in dollar, euro and pound QE liquidity 2010 to 2016, developed market interest rates fathomed record lows and their currencies weakened relative to many emerging market currencies. In response, emerging market borrowers reached for lower interests rates with foreign denominated loans (primarily dollars). Today, according to the Institute of International Finance, corporate debt in foreign currencies is the highest ever at $5.5 trillion.
A standout in this area, Turkey fueled a period of rapid growth by borrowing foreign-currency debt (mostly dollars) more than any other major emerging market. With the Lira losing 40% against the dollar in August so far, it is already clear that many borrowers cannot repay their dollar-denominated loans.
Turkey is not the only country now swamped with skyrocketing borrowing costs and spreading defaults, see Indian rupee tumbles to record low amid spillover from ‘full blown currency crisis’ in Turkey and Fall of the Turkish Lira raises concerns for emerging markets. This has broad domino risks through highly levered sectors like real estate, banking and financial markets, globally.
As we have been noting for some time, the payback for reckless financial choices is inevitable and will not be ‘contained’. With debt and asset valuations at obscene levels in most countries today, the global financial system is more fragile than ever. It has only been a question of which spark will set off the next contagion. Emerging market debt defaults have served that role many times in the past, they may well serve sufficient this cycle as well.
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