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Against the backdrop of soaring CDS spreads for the likes of Greece, Portugal and Spain, certain central European countries–namely Poland and the Czech Republic–continue to garner increased attention from investors looking to flee risk but still earn appreciable yield. As Dominik Radziwill, Poland’s deputy finance minister, who helped place a €3bn 15-year bond issue last month, told the FT on Friday, “we are a safe haven. We have become an alternative for investors who are looking at the periphery of Europe. We can see an increase in interest on the part of foreign investors in Polish debt.”
Some observers tout the virtues of Polish debt both in the short and long term. According to Baron Chan, an emerging-market strategist with Credit Suisse Group AG in London, in regards to the government’s vow to limit spending growth and speed up asset sales in order to bring the budget deficit in line with euro-adoption standards, “the idea of acceleration in fiscal consolidation will be good for the risk profile of Poland and should support the zloty.” Credit Suisse, for one, anticipates the euro/zloty, now at 4.11, to trade around 3.75 by year end. Meanwhile, Investec Asset Management touts the long end of Poland’s yield curve, noting thje country’s “good fundamentals and flows supporting bonds.” In particular, some analysts forecast the 10-year Polish bond yield to fall around 30 basis points in the first half of 2010 from 6.1%.
As for the PIGS label, it seems Ireland has replaced Italy, for those keeping tabs on the acronym.
Traders patiently watching the zloty’s climb against the dollar in 2009 have fairly good evidence of an imminent reverse trend. A glance at the five-year chart shows that USD/PLN has now twice bounced off some fairly important support levels. Furthermore, intuitively the breakdown makes sense. Per a Bloomberg report today, Ulrich Leuchtmann, head of foreign- exchange research at Commerzbank in Frankfurt, opined that currencies in eastern Europe were starting to come under pressure. “It’s a natural correction from the very upbeat sentiment that we saw recently. From a fundamental point of view such a quick recovery didn’t make much sense,” he said. Thanks to JB3 over at Xtrends, by the way, for pointing out this setup.
One commentator today noted that “in many ways, what’s happening now across Eastern Europe – including Russia – is reminiscent of the Asian economic depression that began in Thailand in July 1997.” Foreign currency loans taken out during the boom years through 2007, when economic growth averaged more than 5% (“mainly from Austria and other EU members that included leveraged mortgage loans tied to low interest rate currencies like the Swiss franc”), coupled with precipitously falling local currencies and low currency reserves, has spelled disaster for even Eastern and Central Europe’s largest economies, which serve as core manufacturing hubs for Western Europe, as well as for Balkan states and the Baltic Republics. The IMF, which has already bailed out Latvia, Hungary, Serbia, Ukraine and Belarus, warned last month that bank losses may widen as “shocks are transmitted between mature and emerging market banking systems.”
One reason to bet against a complete and utter collapse of the East, however, is the fact that the de facto foundation for the EU–Germany and, to a lesser extent, France–have quite a vested interest in its survival and long-term health. Over 25% of Germany’s exports head to Eastern Europe, and particularly in regards to those countries that are already part of the single currency euro-zone–continued solvency is a must for the Euro’s continued viability and also for its members relatively low financing costs.
Moreover, some commentators say the fear of collapse is overstated. Concerns that east European borrowers will default on foreign-currency loans, triggering bankruptcies among western lenders that have caused a sell-off of emerging- market assets are “overdone,” said a UBS report published on Tuesday. Per the report:
More than half the outstanding short-term external debt is owed by larger countries such as Russia, Poland and Turkey, which are less impaired due to a lower rate of leverage in the economy and better growth prospects. [However], smaller economies such as Lebanon, Latvia, Estonia and Bulgaria face the highest repayments in the coming 12 months, each at more than 40% of their GDP.
Standard & Poor’s, while admitting that the effects will differ country-by-country, warned of especially dire consequences for the Baltic’s Latvia, Estonia and Lithuania, as well as Bulgaria, Hungary and Romania. S&P contrasted their positions with that of the Czech Republic, Poland and Slovakia, for instance, which it argued are better placed to emerge “stronger and more competitive” from the crisis.
With this in mind, punters interested in the Polish or Czech debt market, or even its default swaps, may be rewarded. The cost of protecting payment on Poland’s debt has risen more than six times in the past six months, credit-default swaps show, which is roughly the same as on contracts linked to Serbia, which is rated three levels below investment grade at BB- by S&P. And both Polish and Czech government debt, among the highest rated in emerging markets, has already been downgraded by bondholders.
The Kazakhstani tenge, or KZT, the currency of Kazakhstan, is affectionately known by London traders as the ‘Borat’, according to Macro Man, a local punter. Wednesday, the Kazakh central bank decided to allow the tenge to drop by roughly one-fifth, in a devaluation it alleged was triggered by falling world oil prices (which are some 60% of Kazakhstan’s foreign exchange income) and the sharp depreciation of the Russian ruble which decreased the competitiveness of its Kazakh produced goods. Hitherto, the bank had used approximately $6bn of its foreign exchange reserves since October defending the tenge, including $2.7bn in January alone, according to the Financial Times. The situation can be contrasted with that of the ruble, which has fallen by one-third against the dollar since last summer, but which is still being defended by Russia’s central bank, to the chagrin and surprise of some who lament the wasting of reserves against what might be considered the currency’s inevitable decline. The ‘Borat’ will now be allowed to fluctuate by about 3% around a new level of 150 against the dollar, a level which Katya Malofeeva, chief economist at Renaissance Capital in Moscow, guessed it should be able to hold.
Per Macro Man, the fall from grace has tarnished yet another ‘sexy long’:
“Yet another emerging market currency has been splattered today, as the Kazakh tenge has finally been devalued by 20% after months of pressure. The KZT was in vogue a couple of years ago as a sexy long, but another one of Macro Man’s rules of thumb is never to trade a currency named after a movie character. The pressure on the KZT has been mirrored in “real” markets, where the (Central and Eastern European) currencies such as HUF and PLN have been obliterated in the past few days, with market liquidity collapsing. So the Great Unwind has further to go.”
So what will bring sexy back in 2009? Anything?
Interesting Q&A in the Financial Times with Marcus Svedberg, chief economist at East Capital, an independent asset manager specializing in eastern European financial markets with approximately 3.2 billion under management.
- “Equity markets in eastern Europe have corrected sharply and rather indiscriminately this year . . . The result is that many markets are very attractively priced at this point and although I expect the volatility to stay in the short term, it is possible to enter the markets at very interesting valuations. I also think that the crisis will lead to a better investment climate in the future. The competition for investments will be much tougher and emerging markets in general will be forced to improve the bureaucracy, transparency, the fight against corruption and other areas foreign (and domestic) investors care about.
- “Many analysts are arguing that Russia should face the facts and devalue the Rouble. Few Central Banks have managed to defend a currency under pressure and it just wastes reserves before having to devalue in the end anyway. Although I agree with this on a general note, Russia is not a typical devaluation case since it (still) has large forex reserves and a current account surplus. The pressure on the Rouble is primarily an effect of the falling oil price and I think Russia will continue to favour the gradual depreciation approach.”
- Value will trump growth in Eastern Europe in 2009: “Although some markets, sectors and companies will continue to grow, the growth opportunities will be much less obvious next year compared with the previous years. On the other hand, the valuations of many stocks or entire sectors have come down substantially and many companies are very attractively prices at this point.
- “The short-term outlook for the Ukrainian economy is not very good, as growth probably will come to a standstill next year and there are some difficult external imbalances that need to be financed.”
- “The number one short-term vulnerability for Bulgaria is the high current account deficit. The longer term challenge for Bulgaria is to continue to reform the economy and make it more competitive and transparent.”
- “Although the geopolitical situation in Georgia before the summer might not have been sustainable, I don’t think the political outlook is better now. The issues at stake are very complicated and I do not think we will see any comprehensive solutions in the near future. Multinationals had started to come to Georgia before the conflict and it is difficult to assess when they are willing to return.
- “Hungary was in the middle of an economic restructuring process when the global financial crisis broke out and was thus in a more vulnerable position than many of the neighbouring countries in eastern Europe. Hungary has been plagued by high budget deficit and sovereign debt levels for some time.”
Fitch Ratings downgraded the sovereign ratings of Hungary (to BBB from BBB-plus), Bulgaria, Kazakhstan (by one notch to BBB-, the lowest investment-grade level) and Romania (by two notches to BB-plus from BBB) on Monday while warning that the ratings of South Korea, South Africa, Russia and Mexico are also in jeopardy. European Union members Hungary, Romania, Bulgaria and the Baltic states “may not be able to handle their large foreign debt burdens, which could spark financial crises,” Fitch said, adding that problems in advanced economies “triggered extreme volatility in emerging market asset prices” and prompted “liquidity strains”.
It lowered its outlook on South Korea, Mexico, Russia and South Africa to negative from stable, while that of Chile and Malaysia were cut to stable from positive.