The impact of the fall in the value of Turkish assets will feed through to emerging and developed markets, according an analyst.
Agathe Demarais, a Turkey country analyst at the Economist Intelligence Unit, said western banks with strong ties to the country would feel the effects of this "within a few months".
Investors have been fleeing Turkey, which has been expressed most notably through a sharp sell-off of the country’s currency, the lira.
Ms Demarais said: "So far the impact of the lira crash has been limited in Europe and the rest of the world. However, within a few months western banks that have strong ties with Turkey will feel the impact of the crisis as Turkish corporates will struggle to repay debt in foreign currency (the sharp depreciation of the lira has almost doubled the local currency value of external debt repayments since the start of the year); about a third of the debt of Turkish corporates is foreign currency denominated.
"To date, non-performing loans have remained around 3 per cent; however, this metric is set to increase in the coming months."
This is partly the result of Turkey-specific issues related to the Turkish president's appointment of his son-in-law to the role of finance minister and Turkish government's view that higher interest rates create inflation. Conventional economic theory argues that higher rates reduce inflation.
Turkish president Recep Tayyip Erdogan has claimed high interest rates make "the rich richer and the poor poorer".
The shares of European banks have fallen as the crisis in Turkey has deepened, as investors fear the consequence of those loans issued to Turkish companies.
The other reason Turkey’s currency is declining is that as an emerging market it is vulnerable to higher US interest rates because they reduce the supply of US dollars in the financial system, making dollars more expensive.
Most emerging markets, including Turkey, have extensive debt denominated in dollars, so higher rates put borrowing costs up and hamper economic performance.
On top of this, the rise in US interest rates has led to the yield on the 10-year US government bond rising to 3 per cent and if investors can get a higher return on a risk-free asset, they have less incentive to invest in emerging markets in search of higher returns, and so withdraw their cash.
Edward Park, investment director at Brooks Macdonald said: "We believe this is a Turkey-specific problem. However, the actual root cause is shared by quite a few nations, of which Argentina is the most obvious example.
"Turkey has tripled its US dollar liabilities in the last 10 years, taking advantage of cheap money to refinance itself.
"However, at the start of the year the US federal reserve started to embark on quantitative tightening, essentially withdrawing its liquidity, at the same time as raising rates, which means it is much more expensive to finance in US dollars which is a problem for emerging markets."
He added that markets have been spooked by the severe reaction of Turkish assets to a dispute with the US, and said the market was worried minor events could cause a similar shock in other emerging markets.
Professor Reto Foellmi of the University of St Gallen in Switzerland said a weak lira would not help the Turkish economy.
He said: "Turkey’s recent crisis is reminiscent of the Asian crisis 20 years ago. The vibrant growth of Turkey relied heavily on financing in foreign-currency debt.
"While Turkish exports get cheaper, Turkish companies face higher repayment obligations of the loans which hurts banks as well. As the lira has a reputation as a weak currency, Erdogan’s rhetoric puts oil into the fire. With a further weakening of the lira, Turkey faces a downward spiral, where default could be the end."
Chris Beauchamp, senior market strategist at IG Group said at notable feature of the last emerging market crisis was the relatively weak performance of gold, and he expected this to be a feature of the present emerging market turmoil.
david.thorpe@ft.com
