The fast-moving currency and financial crisis that has engulfed Turkey shows signs of spreading to other emerging market economies. This calls for decisive action, most importantly from Turkey, but also from other countries that may be vulnerable to collateral economic damage. Hit by surging capital outflows and asset sales, and despite a rally over the past two days because of new restrictions that prevented short-selling, the Turkish lira has crashed by more than 34 per cent against the US dollar this year, with most of the decline occurring during the last week. However, nervous investors have also been bailing out of other emerging market assets. The MSCI Emerging Market Index - the key equity benchmark - has fallen by more than 20 per cent this year. Emerging market bonds have also corrected sharply.
These are early signs that, as in the Mexican "Tequila" crisis of 1994 and the Asian financial crisis of 1997, investors are punishing not only the economy at the epicentre of the problem, but emerging markets in general - although some are worse hit than others. As we have learnt from past crises, a failure to take decisive and early action carries the risk of the crisis intensifying and spreading further. With the US dollar rising, countries with high levels of external debt, high inflation, large current account deficits and relatively low levels of international reserves will be the most vulnerable.