While the search for yield is setting most emerging markets ablaze in terms of institutional money flow, there is one EM area that appears noticeably excluded from the flow party: Emerging Europe.
As Bloomberg noted on Monday, Emerging Europe — “where currencies and equities combined to produce total dollar-denominated returns of about 50 per cent this year” — is increasingly putting off investors with its soaring debt load. This is true even of the region’s best performer, Poland. As Bloomberg wrote:
Swelling public deficits have forced European Union members, including Poland and Latvia, to shelve euro adoption targets. Romania and Hungary have had to implement budget cuts that exacerbated their recessions to meet requirements for loans of 20 billion euros ($30 billion) each to finance their current- account and budget deficits.
On the matter of Poland, Erste Bank warned on Monday that recent government promises to reduce the deficit had failed to present a viable strategy for doing so – leaving too much uncertainty in the run up to the 2010 presidential elections. As they noted:
It is unclear at the moment how the government plans to achieve that reduction. In light of upcoming presidential elections in 2010 – the president is elected directly by the people), it will not be easy to push through any drastic measures.
Meanwhile, there was now the serious threat that Poland might breach its first EC prudential limit, according to Erste, something which would automatically trigger the saving measures defined in the Public Finance Act. As Erste explained:
If the public debt were to exceed 50% of GDP in 2009, the deficit-to-revenue ratio in 2012 could not be higher than in 2011. If in 2010 the 55% limit were to be breached, the state budget deficit for 2012 would have to ensure a reduction in the State-Treasury-debt-to-GDP ratio compared to 2010.
Of course, the existence of safety limits making sure Polish debt cannot exceed 60 per cent of GDP should be seen as a positive for the bond market, according to Erste, as it means future issuance will have to be cut back.
There’s also another factor that acts in Poland’s favour: the government’s macroeconomic assumptions (MF) relating to its debt management strategy, which have been relatively conservative compared to consensus. As Erste tallied up:
But even so, Erste acknowledged there were still risks, including the contribution from the government’s ambitious privatisation plan. As the analysts noted:
…the government is counting on privatization revenues from the sale of state assets worth PLN 36.7bn (about 2.7% of GDP) by the end of 2010. Of that, about PLN 10bn should be sold this year and the remaining 26.7bn (about 2% of GDP) in 2010. Given how close the projected debt is to the 2nd prudential limit, even a relatively small disruption in privatization plans could lead to breaching the safety level.
They also warned there was some degree of currency exposure due to the government’s foreign-denominated debt issues this year:
Weak zloty: Significant undervaluation of the zloty has also contributed to increasing debt, as about one-quarter of Polish debt is denominated in foreign currencies. On the other hand, if the zloty were to finally undergo a correction (which is our baseline scenario), it would help to keep public finances under control.
Related links:
It’s all Greek to the European bond market – FT Alphaville
A CEE stress snapshot - FT Alphaville