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A handful of emerging markets has gorged on U.S. dollar debt over the past decade – a situation that could lead to a “vicious cycle” for borrowers as the greenback strengthens, a new research note says.

Turkey is especially exposed, where non-bank borrowers – a broad group including government, households and most corporations – held US$195-billion in debt denominated in U.S. dollars at the end of last year, “or a stunning 23 per cent of [gross domestic product],” according to National Bank Financial. In 2008, such debt amounted to 12.4 per cent of Turkey’s GDP.

This situation is raising widespread concerns over how some companies will service ever pricier debt payments as emerging market currencies swoon against the greenback. The Turkish lira, in particular, is down 41 per cent this year amid concerns over the country’s financial stewardship and a continuing spat with the United States.

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“The dollar’s appreciation this year is concerning in the sense that it can lead to a vicious cycle by making it harder for borrowers to service USD-denominated debt, reinforcing default risks and hence leading to more capital outflows from emerging markets,” senior economist Krishen Rangasamy wrote.

He noted that “defaults and hence a recession in Turkey are becoming increasingly likely,” and “ditto for Argentina,” which has seen its U.S.-dollar debt surge to 18.4 per cent of GDP versus 6.7 per cent two years ago.

The lira perked up on Tuesday after Turkey’s central bank unveiled measures to boost liquidity. However, several concerns remain – notably, whether the central bank is truly independent as President Recep Tayyip Erdogan tightens his grip on the country’s institutions. Meanwhile, Turkey and the United States are mired in a dispute over the detention of an American pastor facing terrorism charges related to a failed coup attempt in 2016. In response, U.S. President Donald Trump last week announced plans to double tariffs on imports of Turkish steel and aluminum.

Although Indonesia and Mexico have seen run-ups in U.S.-dollar debt, Mr. Rangasamy sees less risk on that front, noting “better current account balances and foreign currency reserves … have so far helped limit the wrath of foreign investors.”

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