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EM Europe – low growth but strong fundamentals

Emerging Europe is seeing less capital inflows than other, higher growth EM geographies. The low growth environment means that the region’s fundamentals are relatively strong, as there has not been much capital expenditure, but fears over an ECB or US Fed hiking cycle could negatively impact debt from the region, particularly in Poland’s case.

Oct 7, 2016 // 6:58AM

Total portfolio inflows into EMs in September amounted to around US$25bn according to a report by the IIF, up from around US$20bn each in July and August, with fixed income being the main beneficiary.

Figures from the report show that lion’s share of these inflows have been taken by EM Asia, with US$12.5bn and LatAm with US$9.1bn. EM Europe received a lesser share of these inflows at US$3.5bn, albeit significantly more than Africa which saw US$0.3bn.

Of the total amount received by emerging Europe, Turkey and Poland received the most substantial inflows. The latter is expected to remain the best performer in the region – and the IIF expects the country to post 3% GDP growth this year, compared to 1.2% growth across the region this year and 2.1% for next year.

The problem with emerging Europe is that the growth drivers for the region’s economies are lacking – a trait not helped by the fact that the region is closely linked to the Eurozone, which is one of the most anaemic parts of the World economy.

“The region is an aged economy, and if you look at Poland – which is still classed as an EM, its demographics are no different to Germany’s,” said Tatha Ghose, senior EM economist at Commerzbank.

The IIF also noted that Czech GDP growth is likely to fall from 4.5% last year to 2.8% this year, whilst Hungary’s GDP growth is expected to fall to 1.8% from 2.9% in 2015.

Ghose stated that there were no typical drivers in the region like in other EMs. “They don’t have typical EM ingredients.”

This does not mean however that the region is in bad shape. A lack of activity – and therefore low levels of leverage – has contributed to the region’s strong fundamentals.

“Banks are flush with capital because they have had nowhere to lend and demand for credit has been weak. They are sufficiently capitalised to the point where balance sheets have been able to be cleaned up organically,” Ghose said, adding that debt levels and fiscal deficits have fallen noticeably and current accounts have also improved on sluggish imports.

These factors position Poland, along with Romania, as the strongest performers in the region, as they have sufficient growth drivers to play catch up with other EMs.

Ghose noted that Turkey would also be a strong performer in the region if it was not for ongoing events in the country negatively impacting the economy – although conversely this can make its debt more attractive.

The risk factors of CEE (excluding Turkey) are in-line with those in developed Europe. This keeps the spreads very low across the region.

However, reports that the ECB could ease off on its bond buying programme have seen yields rise across emerging Europe.

According to Reuters, Poland’s 10-year government bonds saw yields rise 4bp, and yields across the rest of the curve also rose 2-3bp. In Hungary, yields rose 3bp and 1bp respectively for similar debts.

“Polish yields have steepened recently because the Central Bank seems to play off the ECB, and with no further easing they even talk about the timing of their first rate hike,” Ghose said, adding that there could be phases where such a spike negatively affects the country’s bond market, which could pose a ‘clear risk’.

Fears of an ECB and US Fed rate hike have are already mounting just as the country’s Finance Ministry sold PLN6bn (US$1.5bn), including a new 10-year note at 3.098% at an auction today according to Bloomberg.

The sale is the first of four to be conducted by the end of the year as part of a plan to sell PLN28bn to finance budget needs and campaign pledges of the Law & Justice party.


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