Market Commentary

By TMS Brokers

During the financial crisis the countries from Central and Eastern Europe suffered a dramatic capital outflow that pushed their CDS spreads up and increased the yields of the zero coupon bonds. The main reason behind the capital flight from the region was a high foreign indebtedness level of the local economies and poor situation of the public finance sector. The capital outflow affected almost all of the regional economies in the same way, no matter if there were any differences in the economic fundamentals between them. The investors treated the local economies as a whole and while selling the assets of the troubled Ukraine or Hungary, they were also selling the Polish securities. That is why the zloty weakened a year ago to almost 5 PLN for EUR despite much better economic situation in Poland then in other regional peers.

Poland

During the financial crisis the countries from Central and Eastern Europe suffered a dramatic capital outflow that pushed their CDS spreads up and increased the yields of the zero coupon bonds. The main reason behind the capital flight from the region was a high foreign indebtedness level of the local economies and poor situation of the public finance sector. The capital outflow affected almost all of the regional economies in the same way, no matter if there were any differences in the economic fundamentals between them. The investors treated the local economies as a whole and while selling the assets of the troubled Ukraine or Hungary, they were also selling the Polish securities. That is why the zloty weakened a year ago to almost 5 PLN for EUR despite much better economic situation in Poland then in other regional peers.

The beginning of the current year brought a change of the situation. We could see a significant improvement of the investment sentiment on the European emerging markets. As a result of growth of the investment appetite and fall of the risk aversion, CDS spreads came back to the levels form 2008 and the yield curves went down. Moreover, the investors' approach to the region became recently more sophisticated - now they treat the economies individually and not as the whole investment basket. The main beneficiary of this change was the zloty that was the best performing currency in the region during two fist months of the year. A very good sign is the fact that the zloty proved to be very resistant to the fiscal problems of Greece, that deteriorated the investment sentiment across the Europe.

CDS spreads

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Source: Thomson Reuters

Countries from Central and Eastern Europe still suffer some problems including negative GDP rate or high deficit of public finance. On this background the outlook of the Polish economy is positive. Poland has avoided recession in the year 2009 as the only European economy. The GDP rate in the whole 2009 amounted to 1,7%, mainly thanks to the strong domestic demand. Foreign investors have finally appreciated the strength of the Polish economy what was evident in the gradual appreciation of the zloty. The EUR/PLN rate after few months of lateral trend has finally managed to break the level of 4,0000. From the beginning of the 2010 the declines of the EUR/PLN gained on strength. Further appreciation of the zloty against the euro was limited by the important support level 3,8600 set by the 61,8% retracement of the long run upward movement. The last days of March brought however continuation of the zloty's appreciation and the EUR/PLN has fallen below the aforementioned support.

Zero-coupon bonds
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Source: Thomson Reuters

The appreciation of the PLN is however slowing down mostly due to the weakening of the investors' expectations for tightening of the monetary policy in Poland. The Monetary Policy Council after some hawkish commentaries at the beginning of March, suddenly became more dovish. The MPC members recognized that the dynamic appreciation of the zloty is mostly a result of the strong expectations for interest rates hikes in the next few months. A sharp strengthening of the PLN can pose a risk to the sustainable growth of the Polish economy by influencing negatively the price competitiveness of the Polish export. Therefore there are some signals that the zloty's value will be one of the major factors (apart from inflationary pressure) taken into consideration by deciding about the interest rates level. The MPC could refrain from tightening the monetary policy, if the interest rate hike expectations induce dynamic appreciation of the Polish currency.

EUR/PLN
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Source: Thomson Reuters

The main risk for the investment sentiment on the Polish market and therefore for the zloty, comes from the possible deterioration of the situation in the public sector. The relation of the public deficit to GDP should amount in 2010 6,9% of GDP what exceeds the Maastricht norm more than twice. The rise in deficit is mostly the result of the crisis, as a slower GDP growth caused a fall of the budget tax revenues. According to the latest convergence plan, till the year 2012, the deficit should fall below 3% of GDP. This plan is however very ambitious, as the Polish economy has not regain its usual strength yet. The labour market is still weak and any unexpected worsening of the situation could bring a fall of the domestic demand and accordingly dampen the GDP growth. Also, as already mentioned, too dynamic appreciation of the PLN can pose a risk for the pace of the economical expansion in Poland. For now however the situation seems to be under control. Some negative pressures on the zloty's market can eventually arise in the middle of the year, when an alteration of the current budget is possible.