2010: a year of turbulence?

 

 

Admittedly, there is reason to celebrate. Government spin doctors will likely greet the publication of very robust GDP growth figures for 2009 with their new slogan: “Poland: the economic tiger of Europe”. Indeed there are strong signs that in 2009 the country achieved economic growth of 1.5-2.5% y-o-y, with the highest rate of expansion recorded in the fourth quarter. The result was thanks in large part to a weak zloty, which supported exports in the first half of last year, as well as a resilient domestic market and the absence of any major crises in the country’s financial system (the one exception being the crisis over toxic currency options contracts). In the second half of last year, when the zloty strengthened substantially, domestic demand began gradually to regain its role as the main engine of economic growth.

In examining latest economic data, we should note the excellent industrial output figures for November, which showed production up by 9.8% y-o-y, as well as strong retail sales growth over the same period (up 6.3% y-o-y). These figures show that Polish companies are beginning to believe in an upcoming recovery, while consumers are less worried about losing their jobs (gloomy forecasts predicting that the unemployment rate would rise to 13-14% proved wrong).

The data are another confirmation of the reliability of Purchasing Managers’ Index (PMI) values, which gauge business sentiment, as an indicator of economic performance. In November, the PMI for Poland calculated by Markit Economics and HSBC surged to 52.6 points, surpassing the key 50-point barrier. The average time lag between PMI indications and actual performance is one to two months. A similar situation obtained with respect to PMI values in Europe and the ISM index in the US.

 

Yet if Prime Minister Donald Tusk’s aides indeed go for the “Poland: the economic tiger of Europe” slogan, it may prove the proverbial shot in the foot. That is because the happy coincidence of factors that has worked to Poland’s advantage (a weak zloty and a domestic demand less vulnerable to phases of the global economic cycle) is beginning to unravel. It is expected that most European countries will register positive GDP growth this year. For Poland to remain near the top of the pack, its economy would have to expand by 4-5% y-o-y in 2010, which means that it would have to approach its so-called potential rate of GDP growth. Even the most optimistic forecasts of the finance minister do not expect such a result (the official projection included in the 2010 budget bill envisages growth of 1.2% y-o-y).

But these conservative assumptions may prove to be a very good move. For assuming that the actual rate of economic growth is higher than that, the finance ministry will automatically gain more than PLN 10bn (€2.4bn) in extra revenues, mainly thanks to higher-than-expected receipts from indirect and direct taxes. And this is very important in view of the biggest problem facing Poland in 2010, i.e. a sharp rise in public borrowing. The 2010 budget bill approved by the Sejm in December envisages a doubling of the budget deficit to about PLN 52.2bn (€12.6bn), but some experts reckon that its actual value will reach PLN 67.5bn (€16.3bn), a figure that includes both the domestic budget as well as the balance of EU transfers, which will be separated for the first time this year.

Furthermore, there is considerable uncertainty over actual proceeds from privatisation, which are assumed to bring as much as PLN 25bn (€6bn). However, the government’s attempts to sell several large state-owned companies in 2009 (power group Enea, the Warsaw Stock Exchange) met with little interest from potential buyers. The explanation is simple: even global heavyweights have problems of their own and are not very keen to embark on costly M&A deals (most of the companies put up for sale by the Polish government will require substantial additional investment outlays). Yet, as some analysts are pointing out, the whole 2010 budget actually hinges on privatisation revenues, and if the envisaged sales of Treasury stakes do not proceed well, the government will face serious problems in funding it.

As a result, public debt could rise above 55% of GDP, which might trigger a sell-off of Polish assets, especially that investors will this year be particularly sensitive to risks associated with rising debt in many countries. This could also force changes in the bond market, if fund managers start demanding higher premiums for Polish bonds.

 

December witnessed a depreciation of the zloty to 4.23 against the euro and 2.95 to the US dollar. This was not a result of any domestic developments (macroeconomic data were strong) but reflected events in the external environment. The woes besetting the Greek economy exerted a negative impact on the euro’s performance on global currency markets, and investors became more sensitive to risks associated with excessive debt in emerging markets. Furthermore, the nationalisation of an Austrian bank with significant exposure to Central and Eastern Europe (CEE) and a cautious report by the European Central Bank that highlighted continued uncertainty about the economic outlook for the CEE region provided a good basis for a sell-off in the zloty. That is because investors use proxy-hedging, whereby the zloty – being the most liquid currency in the region – acts as a proxy for exposure to Central and Eastern Europe as a whole. As a result, concerns about any CEE economy increase the risk of a rise in the supply of the zloty.

But the crucial factor in December was a strengthening of the dollar. This undercut speculative carry trade strategies premised on a weak dollar that dominated in the autumn of 2009. A string of better macroeconomic data in the US heightened expectations that the Federal Reserve might bring forward the tightening cycle, and set off a veritable domino effect, as the scale of short-selling of the US dollar had been enormous. Suddenly, speculative dollar positions began to be closed, further stimulated by a desire to realise the huge profits before the end of the year. The main loser were emerging markets, considered as more risky compared with old developed economies.

The reduction of short positions and the associated appreciation of the dollar could well last until the spring of 2010, especially that there is growing talk about a possible correction on equity markets in the first quarter. A euro-dollar rate of 1.35, and perhaps even lower, is an increasingly probable scenario. For the zloty this could mean the prospect of further weakening. My baseline scenario is that by March 2010 the euro will rise to 4.40 against the zloty and the WIG20 blue chip index will drop to around 2,000 points.

 

I do not expect a return to recession in the US in 2010, therefore the second half of this year should be good for equity markets. There is a chance that they will gain an average of 10% by the end of 2010 compared with December 2009. A better result may be achieved by the stock markets of the G-10 countries, helped by a stronger dollar and fears about the level of public debt in smaller economies. However, we should be braced for considerable volatility, including on Polish assets. Success will lie with investors who abandon the buy & hold strategy in favour of active timing, i.e. capitalising on shorter movements in the markets with a several-week horizon. Polish assets may prove weaker compared with other emerging markets if investors begin to question the probability that the government will implement deficit-reduction measures in 2011-2013. We should remember that the years 2010-2011 will be a period of intense political campaigning, hardly an opportune time for advocating the need for a new social contract to cut public spending or for bold public-sector reforms. But the real economy should do well, and there is a chance that Poland’s gross domestic product will grow by 2-2.5% y-o-y in 2010.

 

 

Marek Rogalski

Analyst, Dom Maklerski Banku Ochrony Srodowiska (www.bossa.pl)