Protests spark capital flight

Turkish markets were spooked this week when the country was gripped by a wave of protests. The cause a peaceful demonstration about an urban development in central Istanbul was innocuous enough, but the heavy-handed police response, which left scores injured, fuelled a nationwide protest of tens of thousands across 40 cities. An ineffectual government response, which has veered from appealing to protestors to insulting them, has merely prolonged the crisis.

On Monday, the Istanbul 100 stockmarket index fell by 7.5%, Turkish government bonds suffered their biggest ever one-day sell off, and the value of the lira fell by 2%. The ongoing protests threaten to keep markets under pressure.

For investors, the turmoil comes at a difficult time, says Stefan Wagstyl in the Financial Times. Turkey looks exposed "because it has been among the biggest beneficiaries of investors' global rush for returns, with both the Istanbul bourse and Turkish bonds at record levels So, for some investors, the market was already ripe for profit-taking, even before the demonstrators poured into Taksim Square." As Ambrose Evans-Pritchard notes in The Daily Telegraph, it's not just Turkey that's at risk of investor flight. "The political crisis comes at a highly sensitive moment as emerging markets across the world face intense pressure, with a sudden exodus of capital flows from those deemed most at risk from trade deficits and political risk."

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So how solid is Turkey's macroeconomic position? At first glance it looks stable, says Pritchard. Moody's upgraded it to investment-grade' status last month, citing a fall in public debt to 36% of GDP, a shift from foreign-currency funding to lira-denominated debt, and a lengthening in debt maturity to 4.6 years, as well as a shift to nuclear power to reduce energy imports. It's also expected to grow by 4% this year, far more than Russia or Brazil.

But look deeper and cracks emerge. The external debt of local banks stands at 14% of GDP the highest for 20 years. If political woes continue, refinancing those loans could get harder. Turkey's current-account deficit of 6% is also likely to widen if political troubles frighten capital away from the country. If the protests deteriorate, or there's a wider panic about emerging markets, Turkey looks very vulnerable.