The MSCI has had enough of Argentina and Turkey’s inability to maintain financial and economic stability and is contemplating dropping them down to frontier market status. Argentina fell to yet another sovereign default in May earlier this year after which it imposed a string of capital controls. Turkey on the other hand has a currency which has lost 80% in value in 3 years due to a combination of its involvement in the Syrian Civil war and poor currency control (in our opinion). After which Turkey’s president Erdogan also imposed strict capital controls due to what he believes where ‘attacks‘ on the country’s currency in 2018.
The MSCI is not a fan of capital controls in the slightest even though they are used by central banks to protect their currency. The problem is they prevent the smooth exchange of money between countries. But how do capital controls work? Let’s take Argentina for example; $65 billion of defaulted debt and a currency which has weakened 55% since Nov 2019. An unappealing sight for any investor or Argentinian business operating in Argentine Peso. So what tends to happen in these scenarios is called a flight to quality where people will rush to sell peso in exchange for a stronger (‘quality’) currency like the dollar as it has more purchase power in the Argentinian market. To prevent the dumping of peso-backed assets worth billions the central bank will engage intense capital controls to prevent any Peso from being exchanged and hence weakening the currency even further.
The bigger picture here is that if Argentina and Turkey are demoted to frontier market countries, they will struggle to attract much business as an inclusion in the MSCI Emerging Markets index is almost a gold stamp for global approval.