Turkey becomes first domino for emerging market debtors as politics split country

“In emerging markets (EM) you can get away with bad macro-fundamentals if the politics are good, but once the politics turn ugly you can’t muddle through any more. We think Turkey is the most vulnerable of the EM countries,” he said.

Data from the Bank for International Settlements show that Turkey’s foreign liabilities have reached a net $430bn.

• Turkey election: What you need to know

Turkish banks alone must roll over $95bn in external debt over the 12 months. They may have to refinance just as the US Federal Reserve starts to raise rates for the first time in eight years and transmits a tightening shock through the global financial system.

“This is going to be existential for the Turks and I am afraid the crunch is coming soon,” said one hedge fund specialist.

“They have been running massive current account deficits for years and now they have lost control. They can’t devalue their way out of this because that will make it even harder to pay off the dollar debt. Turkey is trapped,” he said.

Ahmet Akerli from Goldman Sachs said the country’s gross external financing requirement has widened to 26pc of GDP this year – the second worst in the EM nexus after Malaysia – and the country risks a repeat of the two Fed-linked ‘taper tantrums” experienced in May 2013 and January 2014.

Central bank reserves are just $35bn, leaving a wafer-thin safety margin of just two months’ import cover. The ratio of foreign liabilities to reserves has reached 12, double the level in Brazil, Indonesia, and South Africa, which themselves are stretched.

The central bank has tried to steady the lira with direct intervention but analysts say the efforts are doomed without a sharp rise in interest rate, triggering a recession.

Fitch Ratings warned that political gridlock could lead to “erratic” policies, including fiscal slippage or political pressure on the central bank. “Further erosion of policy coherence and credibility would be negative for the sovereign credit profile,” it said.

The election is a victory for Turkey’s liberal and secular forces, and for the Kurds. It has become much harder for Mr Erdogan to change the constitution and establish an authoritarian presidency.

His AKP party is still dominant with 41pc of the vote and may have to form a coalition with right-wing nationalists, a combination that spells trouble for foreign creditors. It is still in power, but will rule a splintered country.

Mr Erdogan’s showcase “Muslim democracy” lost its shine long ago. His regime came off the rails altogether in 2013 when police fired on demonstrators in Istanbul’s Taksim Square and cities across the country, reportedly with live bullets, killing six and injuring 8,000. Amnesty International flagged human rights violations on a “huge scale”.

Mr Erdogan then purged prosecutors, judges and police, prompting warnings from EU officials that his government is in breach of the EU’s Copenhagen Criteria on democratic rights, and therefore that Turkey’s accession bid is in doubt.

The leader of the industry lobby group Tusiad was accused of treason when he alleged publicly that companies are routinely pressured by Mr Erdogan’s operatives through abuse of the tax system, and warned that the rule of law had broken down.

Turkey’s economic prospects have been deteriorating in parallel. The International Monetary Fund said in its latest Article IV report that the country could face a “sudden stop” in capital flows if global conditions tightened.

The net international investment position has worsened by 25 percentage points to 54pc of GDP since 2008 because of trade deficits and a chronically low savings rate, a textbook case of a country living beyond its means.

The IMF said the exchange rate is 10pc to 20pc overvalued. The banks’ reliance on external funding has jumped from 5.5pc to 18pc of GDP in five years. “These trends are not sustainable, and if they are not redressed, Turkey could sooner or later suffer a sharp adjustment,” it said.

Goldman’s Mr Akerli said the great spurt of catch-up growth in the early years of the last decade has sputtered out as total factor productivity growth turns negative and the country drifts into the “middle income trap”.

This is by now a common story in Latin America, Asia and the near East, where populist regimes have relied on credit growth to mask the lack of reform and obsolete development models.

The spillover effects from zero interest rates and quantitative easing (QE) in the US kept the illusion going for another three or four years after the Lehman crisis but the underlying deformities have become clear in a string of countries, including Brazil, Russia, and increasingly China.

Emerging markets have borrowed $2 trillion in US dollars since the Lehman crisis, pushing their total dollar debts $4.5 trillion. Much of it was borrowed at real interest rates near 1pc.

The IMF warned in April that those countries that drank most indiscriminately from this pool of excess liquidity in the QE era could face a crippling squeeze on two fronts and a “cascade” of woes if the dollar spikes yet higher and rates climb back to anywhere near historic norms.