Emerging market crises in recent years have been constrained to modest, marginal countries such, but last year saw concern for two heavy-hitters. First, Turkey’s lira fell sharply as a credit-fuelled construction bubble turned to bust, then Argentina’s peso collapsed amid excessive foreign debt and skyrocketing inflation. While it may sound unreasonable, any sensible EM investor will now concentrate efforts on building exposure to these two countries. The question is which one to go for. The scale of the hurt wreaked on both countries last year was tremendous.
The dollar value of Turkish local currency debt dropped 29 percent, while Argentina’s dropped 53 percent. But history teaches that when EM currencies collapse, there are opportunities for vast returns once conditions stabilise. On average, local-currency markets generate triple the average yield in the year following a crisis. On paper, the possible gains on offer are dramatic, specifically contrasted to the skinny yields in core-established markets.
The origins of the countries’ problems vary. In Turkey, banks gorged on foreign credit, injecting a credit bubble that climaxed at an annual increase of 30 percent in credit expansion. The country’s construction sector doubled its proportion of the economy. Argentina also experienced excessive credit growth, but there the headache stemmed from the public sector side. As the cycle peaked last year, Argentina was running a budget shortfall of 6 percent of GDP. The country’s lengthy history of excessive inflation and capital controls has thwarted attempts to borrow in peso at sustainable rates, and the country’s debt burden is overwhelmingly in dollars.