Bloomberg News

World’s Third-Worst Bonds Show Collateral Damage: Poland Credit

October 03, 2011

Oct. 3 (Bloomberg) -- Poland, a bond-market darling in the second quarter, is leaving foreign investors with the third biggest losses worldwide as the euro region’s debt crisis slows growth in eastern Europe’s biggest economy.

Polish bonds, the world’s third best for the three months through June, tumbled 15.7 percent in dollar terms during the third quarter, according to indexes compiled by the European Federation of Financial Analyst Societies and Bloomberg. The losses were more than double those of Spain, one of the euro zone’s most indebted nations, data compiled by Bloomberg show. Yields on Polish benchmark 10-year notes were little changed on the day at 5.91 percent as of 4:58 p.m. in Warsaw, having risen from as low as 5.53 percent a month ago.

While the central bank forecasts economic growth will slow to 3.2 percent next year from 4.2 percent in 2011, the zloty’s 16.9 percent retreat against the dollar last quarter is keeping policy makers from lowering interest rates on concern that an even weaker currency would spark inflation. Traders expect the credit picture to worsen as credit-default swaps on Poland’s debt have doubled this year to as much as 314 basis points.

“People are pulling money from the Polish market because of fears of contagion as the euro zone is Poland’s major trading partner,” said Ronald Schneider, a fixed income fund manager at Raiffeisen Kapitalanlage GmbH in Vienna, in an interview on Sept. 28. He helps manage the equivalent of $1.1 billion in emerging-market debt, including Polish bonds.

The slump increased the extra yield on Poland’s dollar bonds compared with U.S. Treasuries to a 2-1/2 year high of 331 basis points, or 3.31 percentage points, on Sept. 23, according to JPMorgan Chase & Co. indexes. The spread stood at 309 basis points on Sept. 30.

Yield Spreads

The additional yield on the country’s 10-year bonds in zloty compared with their German equivalent in euros reached the widest gap since November 2002 at 443 basis points on Sept. 22. The spread was 411 basis points today.

Poland’s $157.4 billion government debt market, which is 33 percent the size of its gross domestic product, is 89 percent smaller than Germany’s. Poland is rated A- by Standard & Poor’s and A2 by Moody’s Investors Service. That’s higher than South Africa and Brazil and lower than Israel and Spain.

Losses on the country’s bonds in dollar terms compare with a 5.4 percent drop for Spain in the third quarter, and declines of 16.8 percent for Hungary and 30.3 percent for Greece. In the second period of the year, Poland’s government debt with maturities of more than one year returned 6.7 percent, behind New Zealand with a 12.9 percent gain and Switzerland with an 11.2 percent advance, according to the Bloomberg/EFFAS indexes.

Default Swaps

The cost of protecting Polish bonds against default for five years climbed 143 basis points during the third quarter to 296 basis points on Sept. 30, after rising as high as 314, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The swaps pay the buyer face value for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Polish contracts are trading 42 basis points below the average for governments in eastern Europe, the Middle East and Africa included in indexes compiled by Markit. The extra cost compared with Germany, Europe’s biggest economy, rose 72 basis points during the last three months to Sept. 30, within 21 basis points of the highest in 29 months, according to data compiled by Bloomberg.

Economic growth in the euro area, the destination for 55 percent of Poland’s exports, fell to 0.2 percent in the second quarter from the previous three months, the slowest pace since the bloc’s 2009 recession. The International Monetary Fund cut its forecast for Poland’s expansion next year to 3 percent on Sept. 20 from 3.8 percent in May.

Consumer Prices

While countries from Brazil to Turkey are lowering borrowing costs to help their economies weather the global slowdown, Polish policy makers’ “hands are tied” because a weaker zloty may drive up inflation, Krzysztof Madej, the head of debt investments at Amplico PTE SA in Warsaw, who helps manage the equivalent of about $5.3 billion in assets, said in an interview on Sept. 28.

The zloty slumped to the lowest level in 27 months before the central bank intervened to strengthen the currency on Sept. 21 for the first time since the exchange rate was allowed to move freely in April 2000. The currency advanced 0.6 percent to 4.3926 per euro today.

Consumer prices in Poland rose 4.3 percent in the year through August, exceeding the 3.5 percent upper limit of the central bank’s preferred range for an eighth month. The bank targets inflation of 2.5 percent, plus or minus one percentage point.

Weaker Growth

The decline in the zloty may be helping Prime Minister Donald Tusk to sustain growth by making exports more competitive, said Dmitri Barinov, who helps manage about $2.7 billion in fixed-income European assets at Union Investment Privatfonds in Frankfurt.

International investors increased holdings of Polish bonds by 122 percent to 154.3 billion zloty in the two years through August, more than either Polish pension funds or banks, data on the Finance Ministry’s website show. Foreign funds resumed buying in August after withdrawing 4.5 billion zloty in July, the most since the collapse of Lehman Brothers Holdings Inc. in September 2008. They also bought more Polish debt than they sold so far in September, Piotr Marczak, head of the Finance Ministry’s public debt department, said on Sept. 30.

“The growth may be weakening right now but it’s still far away from a recession-like scenario,” said Barinov, adding that he may buy Polish bonds should prices fall further. “Bonds may weaken on a shorter horizon but in the longer term they are a big buy.”

Currency Options

Central bank Governor Marek Belka said that the weaker zloty makes it more difficult for the National Bank of Poland to control inflation, according to comments posted on its website on Sept. 22.

“The high volatility of the zloty exchange rate makes forecasting difficult and increases uncertainty for participants in the economy, which in turn reduces their propensity to invest and hurts potential growth,” he said.

The central bank increased borrowing costs four times from January to June, lifting the main interest rate by 1 percentage point to 4.5 percent. The Council will announce its next rate decision on Oct. 5.

Investor concern that Tusk’s plan to cut the budget deficit below 3 percent next year may be hampered after elections on Oct. 9 is also weighing on the outlook for Polish assets. Traders predict bigger swings in the zloty than any other European developing-nation currency, based on implied volatility on options.

‘In Denial’

Support for Poland’s ruling Civic Platform party fell 2 percentage points to 34 percent, while that of its closest rival, Law & Justice, fell three percentage points to 29 percent, according to a Sept. 28 poll by MillwardBrown SMG/KRC for TVN24 television. No margin of error was given for the poll of 1,000 people, according to the station’s website.

The new government must reduce the general deficit to 3 percent of gross domestic product in 2012 from estimated 5.6 percent this year to meet European Commission requirements for candidates planning to join the euro. Poland’s effort to narrow the shortfall is based on a forecast of 4 percent economic growth next year.

While Finance Minister Jacek Rostowski said on Sept. 27 the deficit reduction plan is realistic, Citigroup Inc. said the government is “in denial” as slower growth will reduce tax revenue, according to a Sept. 14 report by economists Piotr Kalisz and Cezary Chrapek.

“The economic outlook for Poland will keep on deteriorating” said Ernest Pytlarczyk, chief economist at Warsaw-based BRE Bank, Poland’s third largest by assets. “The weaker zloty and elevated inflation rate are going to keep the central bank” from cutting interest rates, he said.

--Editors: Nathaniel Espino, Stephen Kirkland

To contact the reporter on this story: Piotr Skolimowski in Warsaw at

To contact the editor responsible for this story: Gavin Serkin at

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