Bloomberg News

Yields Below Italy as Tusk Cuts Elude Berlusconi: Poland Credit

October 14, 2011

Oct. 14 (Bloomberg) -- Poland’s borrowing costs fell below Italy’s for the first time in two months after Prime Minister Donald Tusk won re-election on budget cuts and Prime Minister Silvio Berlusconi lost parliamentary support.

Polish 10-year domestic yields declined 19 basis points this month to 5.73 percent as of 4:47 p.m. in Warsaw, while the equivalent rates in Italy jumped 28 basis points to 5.82 percent, data compiled by Bloomberg show. Poland’s yields were 184 basis points above Italy’s on average for the past 10 years.

While ranked as a bigger credit risk than Italy by Standard & Poor’s and Fitch Ratings, Poland has debt equal to 55 percent of gross domestic product, less than half Italy’s 119 percent. Tusk extended his coalition’s parliamentary majority with promises to reduce his government’s budget deficit to below the European Union ceiling of 3 percent next year from a record 7.9 percent last year. Berlusconi won a parliamentary confidence vote today to avert the collapse of his government.

“It’s a change in mindset that’s happening” in the bond market, said Simon Quijano-Evans, the London-based head of research for Europe, the Middle East and Africa at ING Groep NV, the biggest Dutch financial services company. “You have this rating convergence and this has woken up a lot of people to the fact that emerging Europe is doing pretty well.”

The difference between credit ratings assigned to the EU’s western and eastern nations is the narrowest on record, based on averages of S&P and Moody’s rankings compiled by Bloomberg.

Italy Downgrade

Moody’s Investors Service cut Italy’s rating for the first time in almost two decades on Oct. 4, reducing it by three steps to A2, the same level it has kept Poland at since 2002. S&P downgraded Italy to A from A+ and kept a negative outlook since Sept. 19, citing the “fragile” government. Fitch reduced its assessment to A+ on Oct. 7. Both companies have kept Poland two steps lower at A- since 2007.

Under Tusk, the EU’s largest eastern economy tightened expenses this year by reducing state contributions to private pension funds, freezing wages of government workers and pledging to cap spending growth at 1 percentage point above inflation. His government also raised the value-added tax rate by 1 percentage point to 23 percent. The measures will help make up for an 8.8 percent decline in budget revenues in 2010 and cut the deficit to 5.6 percent of GDP this year, according to Finance Ministry plans.

‘Twice as Fast’

Tusk, 54, said in a televised address following his election victory on Oct. 9 that the next government will have to “act twice as fast,” compared with the previous four years because the country faces “even bigger challenges.” The coalition of his Civic Platform and the Polish Peasants Party will control 235 seats in the 460-member parliament.

Berlusconi, 75, is facing four criminal trials and calls from the opposition to resign while struggling to cut Europe’s second-largest debt after Greece and reverse surging borrowing costs that risk making Italy the biggest victim of the euro-area debt crisis. Berlusconi said he’s innocent of all charges and that Italian judges are out to destroy him.

“Italy has literally twice as much debt as Poland does, so changes in the interest rate environment for Italy are literally twice as important,” Kieran Curtis, who helps manage $3.5 billion in emerging-market assets at Aviva Investors Ltd., said by phone from London. While Tusk’s re-election had spurred market optimism of fiscal tightening in Poland, Italy’s yields are being pushed higher by its “political situation,” he said.

Deficit Cuts

Italy’s government won approval last month for deficit- cutting measures that persuaded the European Central Bank to buy Italian bonds. The purchases have helped stem borrowing costs that surged to euro-era records. Italy sold 6.18 billion euros ($8.5 billion) of bonds yesterday, amid ECB support, according to three people familiar with the transactions.

President Giorgio Napolitano had urged Berlusconi on Oct. 12 to address Parliament to clear up “questions and concerns” about the government’s support after the lower house failed to rubber stamp the 2010 budget report in a vote the previous day.

“The problem is nobody wants to buy Italian bonds apart from the ECB as there are still a lot of risks there,” said Viktor Szabo, a Budapest-based portfolio manager at Aberdeen Asset Management, who helps manage about $7 billion in emerging market debt. “The idea is really appealing to see some flows from problematic core European countries to countries that have the better growth outlook that Poland definitely has.”

Domestic Debt

Poland’s domestic bonds with maturities of more than one year returned 0.7 percent so far this month while Italian debt lost 1 percent, according to indexes compiled by the European Federation of Financial Analysts Societies and Bloomberg.

Poland, which gets 55 percent of its export revenue from the euro region, is the only EU economy to avoid a recession since the start of the global crisis in 2007. Western Europe has helped by making Poland the biggest recipient of EU funding in the 2007 to 2013 budget, providing 67 billion euros in aid to help reduce the difference between richer and poorer regions in the bloc.

Italian growth has lagged behind the euro-region average for the last decade, making it harder to cut debt. Last year Italy’s GDP grew 0.8 percent, compared with 4.3 percent for Poland. Italy’s budget deficit widened to 5.4 percent of GDP in 2009 from 1.5 percent in 2007 and was 4.6 percent of the economy last year.

‘Out of Reach’

While Tusk has vowed to cut Poland’s budget gap to 2.9 percent of GDP next year, the goal is “practically impossible” because of near-zero economic growth in the euro zone, Dariusz Filar, a member of his Council of Economic Advisers, said in an interview this week. The deficit goal “might be out of reach,” putting Poland’s rating outlook at risk without a contingency plan, Jaime Reusche, an analyst at Moody’s Investors Service, said this week.

Poland’s credit-default swaps fell to 248.5 basis points today from 252.5, according to London prices from data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts are up from 151 basis points on July 1. Italian swaps increased 4.2 basis points today to 451.2.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

“I don’t think there are big flows from developed markets to emerging markets,” said Martin Blum, co-head of asset management at Ithuba Capital in Vienna. “My bias is actually for Italy versus Poland spreads to narrow from here and eventually move back into negative territory.”

German Spread

The additional yield on Poland’s 10-year bonds in zloty compared with their German equivalent in euros fell 10 basis points to 354 percentage points today. The gap reached the widest level since 2002 at 443 basis points on Sept. 22.

The extra yield investors demand to hold Poland’s dollar bonds rather than U.S. Treasuries fell eight basis points to 254 today.

“We could see some more yield compression but we are at the stage where markets are really looking for fiscal action,” said ING’s Quijano-Evans. “People will now turn their focus to what the government will do to secure a viable debt-to-GDP level.”

International investors increased holdings of Polish bonds by 103 percent during Tusk’s four years in power to 154.3 billion zloty as of August, data on the Finance Ministry’s website show. Foreign investors own 30 percent of all domestic bonds, according to the data. Their holdings increased by 1.5 billion zloty in September and foreign capital inflows continued in early October, Deputy Finance Minister Dominik Radziwill wrote in an e-mailed statement on Oct. 10.

--With assistance from David McQuaid in Warsaw, Jason Webb in London and Chiara Vasarri in Rome. Editors: Wojciech Moskwa, Laura Zelenko.

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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