In May 2013, the U.S. Federal Reserve made the unexpected decision to begin scaling back, or “tapering,” the bond-buying program it had adopted in the wake of the financial crisis. The move triggered a sharp sell-off of assets from emerging markets, which had been the greatest beneficiaries of the ultra-loose monetary policies of the world’s main central banks. That was bad news for those countries that had used the easy money to fund themselves. The “taper tantrum,” as it became known, recalled the American investor Warren Buffet’s old line, “You only learn who has been swimming naked when the tide goes out.”
Nearly one and a half years later, the Fed is fully ending its asset purchases and preparing to raise interest rates sometime in mid-2015. Once again, Fed policy is revealing which emerging markets have strengthened their defenses against a tightening in U.S. monetary policy and which remain vulnerable.
For its part, Turkey is firmly in the latter camp.
Although Turkey’s economic fundamentals are incomparably stronger than in 2001, when it suffered a major banking crisis, the country has thrown caution to the wind -- even after Morgan Stanley singled it out last year as one of several risky emerging markets known as the Fragile Five. The countries on this list -- Brazil, India, Indonesia, South Africa, and Turkey -- are, to varying degrees, overreliant on foreign capital to finance their current account deficits. When the Fed signaled its intention to start withdrawing monetary stimulus, these deficits became more difficult to finance as international investors reduced their exposure to emerging markets.
Turkey was the most fragile of the five. At the end of 2013 -- about half a year after the Fed announced the taper -- Turkey’s current account deficit amounted to nearly eight percent of GDP -- more than double the shortfalls of India and Indonesia. More worryingly, the bulk of Turkey’s current account deficit was financed by short-term capital inflows -- that is,
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