The topic of the summer seems to be the heightened market uncertainty. At this time of year, we usually see higher price volatility as the market tries to assess the size of the harvest amidst the vagaries of weather forecasts, yield threats and the latest Tweets from crop tours. This year the great dynamic of multiple trade disputes, with a particular focus on the U.S. and China, has been added to the discussion.
While these factors have dominated the grain market headlines all summer, including this most recent glimmer of hope that the U.S. and China may make some progress later this month, an equally significant risk has been percolating underneath the surface. This one that has started to rear its head more substantially – sizeable emerging market debt in the face of a rising U.S. dollar.
Turkey came into particular focus earlier in the week as the Lira saw a dramatic decline, bringing the losses to over a third in the past year relative to the U.S. dollar. The root of the problem is that Turkey has a tremendous amount of debt denominated in a foreign currency. This debt becomes increasingly difficult to service when its currency falls. It was estimated that Turkey’s cost to service its debt had risen to the highest level in nine years. Some calm was restored as the week wore on, but their underlying structural problems remain.
A collapse in Turkey on its own would be significant enough – it is a critical power in the ever-volatile Middle East, and Europe is viewed as being particularly vulnerable through the exposure of its banks and due to the risk of an increased flow of migrants. However, an even more significant concern is the risk of contagion to other emerging market countries.
Turkey has the largest external debt-to-GDP ratio of the large emerging economies, but other nations are also under pressure, particularly as their currencies further weaken as well. Argentina, Brazil, and Russia all have an external debt-to-GDP ratio of over 30 per cent.
India and China are lower, at 20 per cent and 15 per cent, respectively, but are at the disadvantage of being major crude oil importers, an expense that is also gone up over the past year. The Indian rupee is trading at a historical low. China is showing the strain of its trade war with the U.S., as consumer spending and industrial production weaken, and the yuan makes a 15 month low.
It’s not inevitable that the situation in these countries spins out of control. It may well be that we see some moderate correction as imbalances get realigned, and the emerging markets resume being a key growth engine for the world. But we also can’t ignore the risk of a more profound setback, mainly as a combined currency and debt crises can create a negative feedback loop. In addition to the fact that some of these countries are critical markets for Canadian crops (China – canola; Turkey – lentils; India – pulses in a normal trade environment), a full-blown panic would cause turmoil in broader financial markets, to which the agricultural markets are not immune.