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Monday, 11 December 2017

What recession?

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Poland has shied away somewhat from euro-denominated issues over the past year, thanks to the southern European economic crisis, but has had little trouble meeting its targets. However, international investors are eying its relatively high budget deficit. Denise Bedell reports.

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Poland’s capital markets activity was heavily influenced by southern European economic woes last year, which had a profound effect on spreads for both southern and Central and Eastern European Eurobonds. With these problems in mind it focused its capital raising efforts on the US dollar markets, along with some domestic debt issuance.

However, the sovereign did take advantage of a yield trough last autumn to launch a euro deal. It came to market in September with its first euro-denominated issue in six months after the fiscal problems faced by EU members such as Greece caused spreads to widen for all southern and CEE countries. The Polish Ministry of Finance took advantage of falling yields to launch a €1bn, 10-year transaction with a 4% coupon that priced at 120bp over mid-swaps.

Indicative of investor confidence in the country, the deal priced tighter than a similar Spanish issue around the same time – which came in at 145bp over, despite Spain at the time having a higher long-term credit rating. The Polish transaction reportedly had a book of €4bn upon launch.

In April this year, the country launched a US dollar bond – tapping US and international investor interest in its paper. The US$1bn bond, maturing April 2021, has a 5.125% coupon and priced at 179bp over US Treasuries. Poland’s Ministry of Finance, in a release about the bonds, said the allocation centred on investors from the US, who took 54% of the paper, with Europeans taking 30%, Asian accounts claiming 11% and Polish investors taking 5%. More than half of the issue was taken up by asset managers.

This was followed up with another US dollar-denominated issue in June – a US$1bn addition to its April transaction. The 10-year deal came in at 170bp over Treasuries – slicing a few basis points off the pricing on the April launch.

Investors are keen on Poland thanks to its strong performance during the downturn, said Anthony Thomas, analyst at Moody’s Investors Service. “It is the only EU country not to have a recession,” he said.

With its strong domestic as well as export sector, Poland was not nearly as badly hit by the drop in world trade as other medium-sized countries. “Poland seems to be on trend at about 3.5%-4% growth, which is very encouraging,” said Thomas. As a result of this strong growth and worries of economic overheating the National bank of Poland –  Narodowy Bank Polski – began to elevate rates to manage inflation.

Real interest rates are low now, but will return close to the long term average by the second half of next year, assuming no new major commodity shock hits the economy, predicted Rafaella Tenconi, analyst at Bank of America Merrill Lynch. “The spread over the European Central Bank refi rate will stand at 300bp if the ECB tightens to 1.75% this year,” she said. This is above the historical average of 250bp seen between 2003 and 2008.

One concern on the minds of many global investors is the deterioration in the Polish budget deficit. Last year it stood at 7.9%, and this year it is expected to drop to around 6% – still well above the 3% limit set by the EU.

“That is high, but not concerning, for a couple of key reasons,” said Thomas. Government debt is relatively affordable, and the sovereign faces no difficulties servicing it, given much of its debt is domestically-funded at long maturities and attractive interest rates. This is indicative of the deep domestic investor base.

It is constitutionally mandated that the government reduce the deficit in the following budget year if it breaches 55% debt-to-GDP. The risk here is that Poland is now close to that point, and with about a third of outstanding debt held in foreign currencies, any change in the strength of the zloty could push it beyond the legal limit.

However, outstanding government debt came up from rather low levels in the past, and there is a concerted effort on the part of the government to bring it down, with both main parties committed to bringing the deficit down. But international investors will be keeping a keen ear open post-election for how exactly that reduction will come about.

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