Greece contagion for CEE seen only for short-term

10. February. 2010
Reuters

The euro zone's fiscal woes have spooked investors in Europe's emerging east into fleeing short-term bets on currencies but few expect a repeat of the selloff that marked the height of the crisis last year.

It was that stampede, which wiped a third off the Polish zloty and caused debt yields in the bloc's euro zone outsiders to spike, that has given the market a better understanding of the region's risks and a reason not to fly for the exits.

Safety nets cast by international lenders, more manageable debt piles, expectations that growth will outpace the euro zone, and an obligation for euro zone entry mean the bulk of long-term investors have not budged.

Those factors have not prevented slides in currencies, which have also been hurt by weak U.S. job figures, disappointing production data out of the euro zone, and other indications the global recovery may be losing steam.

But bigger moves over the past week were mainly due to the closing of short-term positions and market watchers say the main story of convergence with the richer West -- the bet where most portfolio investment is found -- is on track.

"So far we've had the initial flavor of depositioning, those that have been more speculative and short-term in nature. That is not a real money change," said Koon Chow, a strategist at Barclays.

"The question is do the risks down south (in Greece, etc.) have the potential to make investors say 'hang on', and change their thinking. I would argue in the long term, no."

SHORT-TERM JITTERS

One measure of the relative risk attached to the region is that it now costs investors less to insure against a debt default in Hungary -- bailed out by the IMF in 2008 -- than it does in Greece.

With base interest rates of 8.5 percent, Hungary's 10-year bond yields are still a touch higher than Greece's but Poland, and the Czech Republic all borrow at much cheaper rates, reflecting the relative credibility of their public finances.

While Greece's spreads against German government bonds have jumping almost 140 basis points to nearly 350 since January 11, Polish spreads are up just 23 points to 275. Portugal's have more than doubled to 155 points, compared to the Czechs' 133.

Much of that is based on the difference in debt loads. According to data compiled by brokerage Cheuvreux, Portugal's total foreign debt is about 210 percent of GDP.

Even Greece (149 percent) and Spain (140 percent) exceed the worst-off EU newcomer, Hungary, whose debt pile amounts to 138 percent of its annual economy, while Poland and the Czech Republic have loads more around the 40-50 percent mark.

"The lower public sector debt/GDP and external debt ratios in Emerging Europe versus the euro zone periphery are a supportive factor for all asset classes in the region, with Poland, Czech Republic, Russia and Turkey the best placed," said Cheuvreux economist Simon Quijano.

But that hasn't stopped the region's currencies taking a hit in the last week as the euro zone jitters escalated.

Hungary's forint and Romania's leu are down about 0.7 and 0.9 percent since February 2. The region's worst hit currency in last year's crisis, the zloty, was up in January but has fallen 2.8 percent since the start of this month.

Peter Montalto, an economist at Nomura, said he expected the jitters over southern Europe to create a "soft risk patch" for the next few weeks.

But he added: "There's no fundamental shift in the long-term investment type decisions for eastern Europe ... If you look at what happened last year, it's a different situation."

EURO ZONE RISKS

Another advantage is that all of the countries that have joined the EU since its 2004 expansion into the former communist bloc are required to adopt the euro.

That process that will require slashing budget deficits to 3 percent of GDP beforehand and reining in public debt. It also gives Brussels more leverage over aspirants to the single currency than it has on current euro zone members.

And market watchers say that, although the economic crisis and lagging reforms has delayed euro entry -- now no EU newcomer except Estonia is expected to join the bloc before around 2015 -- they do not think that the pressure the Greek crisis is putting on the euro zone can torpedo its eventual expansion.

"We're arguing very strongly that the Greece situation does not affect convergence," Nomura's Montalto said.

One risk that overshadows everything, though, is that a combination of political choices and market moves may magnify the trouble in Athens, Lisbon or other capitals into a broader crisis for the euro and spark wider panic in risky assets.

"We still will have some increase of volatility, and volatility is not usually something positive for risky assets and high-yielding currencies," said Murat Toprak, emerging markets strategist at Societe Generale in London.

"Beyond that, it is going to create lots of opportunities to buy. We are cautious short-term but bullish medium-term."