German manufacturing orders fell by 6.1 per cent in October from September according to the latest figures from the German Economy Ministry. Those figures were much worse than the 0.5 per cent decline expected by analysts.
While this is, of course, a significant indicator of the health of the Euro Zone, it’s perhaps doubly important for new European Union members like Hungary and Poland, who depend on Germany as one of their main export markets.
Analysts have viewed Hungary as a relatively risky investment for quite a while because of its double deficits. Poland, however, was until quite recently viewed very differently. Many analysts considered the economy to be fairly resistant to the world’s credit woes due to minimal subprime exposure and a much lower percentage of mortgages per capita versus the rest of Europe. But things changed in October when the world realised to what extent the country was exposed to foreign exchange fluctuations.
Considering the above it’s worth taking a look at this chart from Bartosz Pawlowski at TD Securities for an indication of what we might expect next. The chart shows factory orders in Germany versus the 6-month moving averages of industrial output for Hungary, Poland, South Africa and Turkey.
As can be seen there is a clear correlation between German orders and Hungarian and Polish output. Pawlowski’s view, accordingly, is that the worst is yet to come for CEEMEA manufacturing, specifically in Hungary and Poland where manufacturing contributes to roughly one third of GDP.
Correlation between the numbers coming from Germany and the CEEMEA region is hardly surprising, but today’s data from Germany is particularly worrisome. At the end of 2001, when factory orders in Germany were hitting the bottom, industrial production data in CEEMEA was weaker than currently. Admittedly, increases in productivity over the last few years (particularly since Poland and Hungary entered the EU) have been spectacular, but the current situation in Germany is much worse than 7 years ago. Additionally, it is unlikely that the German economy has already reached a trough.
As emerging economies, both Poland and Hungary have been heavily dependent on FDI to fund their current account deficits. Research from Bank of America spells bad news on this front too. The BoA team writes (our emphasis):
Within EM-EMEA, the CE-3 will likely experience a particularly significant drop in FDI. In Poland, the pipeline is drying up, as inward pending deals are being completed, while new inward deals were at a six-month low in November. This is a particular source of concern for the PLN, as Poland’s current account deficit used to be largely FDI-financed. Hungary’s pipeline is even more limited, at $350mn, after the withdrawal of a $15.8bn deal in the oil sector in August. Moreover, net announced deals turned negative for the first time in five months in November. In the Czech Republic, net pending deals remain larger ($2.3bn), but depend entirely on one single deal in the pharmaceutical sector, with no new inward M&A deals announced last month .
BoA also estimates that most portfolio equity flows to Eastern Europe since mid-2005 have now nearly completely exited (see charts below):
The fact both countries can no longer rely on FDI to finance their sizeable current account deficits suggests to BoA both PLN and HUF will inevitably have to weaken further, even if the most rapid depreciation process may now be over. Pawlowski agrees.
However, he calls it the opportunity to invest in Polish and Hungarian bonds:
The bond curve has strengthened substantially in the recent days but there still seems to be value for long positions. As is the case in Turkey and South Africa, risks for the currencies are tilted towards a weaker side but we would be inclined to use such opportunities to build long positions in bond markets in Poland and Hungary, particularly on the 2yr segment.