Reuters: US Dollar Report: CEE MONEY-Chasing EU core, Poland skips past euro laggards

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CEE MONEY-Chasing EU core, Poland skips past euro laggards Jun 29th 2012, 10:00 Fri Jun 29, 2012 6:00am EDT * Polish 10-yr bond yields falling since early 2011 * Euro convergence play turned on its head * But spred to Germany almost 4 times higher than 2007 By Marcin Goettig WARSAW, June 29 (Reuters) - When Poland had fifty percent of its communist-era debts written off in 1991 and 1994, there seemed little prospect that within two decades it would be a safer bet for bond investors than European Union stalwarts Italy and Spain. Yet that is what has happened as the euro zone crisis has wrought its will on its debt-laded southern periphery. Poland remains a long way from converging with core Germany, but is leap-frogging some of the rest. The low-debt and robust growth of central and eastern Europe's largest economy has become symbolic of how investors' attitude to so-called "higher-risk" emerging economies is being turned on its head. Helped by a combination of tough fiscal moves by the government since re-election last October and a cumulative 16 percent economic expansion since 2008, Warsaw's 10-year yield has been falling steadily for more than a year. It hit its lowest since April 2007 last week at 5.1 percent compared with Italy's 5.9 percent and Spain's 6.5 percent, and investors are still gobbling the paper up. "It is not just Poland that has seen falling yields, but it is also markets such as Mexico, Brazil, and even South Africa," said Thanasis Petronikolos, head of emerging market debt at Barings Asset Management, who oversees $140 million in assets. "Emerging countries give you access to credit quality which is much better than those of mature economies. At the same time you are getting much more attractive yields." It is all in stark contrast to the play that dominated investors in eastern Europe before the collapse of Lehman Brothers - ironically a major player in the region - in 2008. So-called "convergence" funds drew in Western investors seeking to profit from an increasingly convincing march by the former communist bloc to bring living standards and asset values into line with those in Western Europe. DIVERGING FOCUS Poland's recent performance, however, might have been even better were it not for investors' widespread scrambling for safety in core euro zone debt such as Germany That underlying push is continuing, but there remains the question of how to bet hopefully on an equalising of yields with the euro zone when much of the currency bloc has been going in the opposite direction. By rights, given a healthy fiscal picture which has debt at less than 60 percent of annual national output, Polish bonds should be heading more in the direction of Germany than Spain. "The big trade really is to exit peripheral Europe and to seek a safe haven for bonds," said Padhraic Garvey, the global head of developed debt and rates strategy at ING. "Most of the flows are going in to safer markets like AAA-rated Scandinavia, Australia, Canada than CEE. But it is true that there is a small flow going into central eastern Europe." Sure enough, the broader picture of risk aversion that has hammered many emerging debt markets since 2008, means that the Polish spread to German Bunds is still almost four times what it was in 2007. It stood at around 360 basis points on Friday. Barings' Petronikolos argues that that leaves more room to get into the trade. "I do expect the spreads (versus German bond) to come down in the medium and long term," he says. But that all still remains subject to the euro zone - more crucial for eastern Europe than other emerging markets because it is where they sell their goods - avoiding a collapse in the mean time. There was some hope on that front in leaders' agreement on Friday to use rescue funds to stabilise the euro zone's bond markets, but risks from a cycle of poor growth and high debt in several economies are still stacked up against the single currency. BET ON AN UPGRADE A weakening of Poland's free-floating zloty currency and a steady inflow of EU structural funds have been at the heart of the country's ability to head off recession twice in four years when all around it were sinking. But the currency risk that comes with that always threatens returns for bond investors and the economy's symbiotic relationship with a teetering euro zone has undermined efforts to improve its credit rating. Prime Minister Donald Tusk's centre-right administration has cut the 2012 deficit to 2.9 percent of GDP from nearly 8 percent in 2010, frozen public wages and taken the hugely unpopular step of raising retirement ages. "I run a series of ratings models and lot of the Central European economies could be rated higher than they currently are, for example the Czech Republic and Poland, not so much Hungary," said a strategist at one major European bank. "Generally speaking, you have got low debt levels on the government side and you have got low private sector leverage as well. And this crisis is a debt crisis and central Europe does not have those problems," the strategist added. Link this Share this Digg this Email Reprints

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