Poland will no longer be able to obtain funding as cheaply as before

07.10.2013
Changes in the pension system are neutral for Poland’s present rating but may limit upward mobility of Poland’s rating from the current A2 level. Such a degree of reform reversal  would not be likely in countries with the highest rating, says Jaime Reusche, an analyst in the group of sovereign credit risk at Moody’s Investors Service.

The FED sooner or later will taper its quantitative easing program. Should Poland, an emerging market with the net foreign debt equal to 70 percent of the GDP, fear the flight of capital to more developed economies?

When looking at this topic we see two opposing forces. One is the resilience of the Polish economy which created this “safe haven status” in the CEE region. This attracted a lot of capital, particularly from 2010 to the first part of 2013, which led to significant yield compression and an increased presence of non-residents, who have actively participated in the domestic sovereign debt market. On the other hand, we have the planned tapering of QE, which indicates that there will be less capital inflows.

It is hard to judge which of these forces is stronger, but unquestionably we won’t see the same level of yields that we saw in this extraordinary period of 2011, 2012 and 2013. The Polish authorities are aware of the fact and have been trying lately to extend the average debt maturity, however higher debt financing costs will soon become an every-day reality.

Why have markets been treating Poland much better since the beginning of the year than the recent stars – the BRICS countries? The Polish Zloty has remained stable in contrast to the Indian Rupee or Turkish Lira.

The markets expect much more policy stability and credibility from Poland than from Brazil, Turkey or India. This process began with the EU accession and now Poland is considered a more transparent country, with lower corruption, better institutions and more predictable policies than other more volatile emerging markets economies.

In one of its reports, Moody’s has compared Poland with Brazil. It turns out that we owe our three notches higher rating to the quality of institutions, as you said. Is this really the deciding factor, or perhaps it is the fact that Polish GDP per capita is about 10,000 dollars higher than Brazil’s?

The fact that institutions are clearly stronger in Poland’s case than in Brazil is an important factor but not the only one. As you said, there are other factors that we have to take into account when rating sovereigns. It is important to remember that we are not really rating “country risk”, rather, we are rating the government’s ability and willingness to repay its debt. GDP per capita is an important factor, but we also look at future growth prospects, the composition of the government debt, quality of fiscal management, the levels of debt, and of course the strength of external finances.

Do not the government’s efforts to marginalize private pension funds and suspend the first safety threshold spoil this image of institutional stability in Poland?

The answer is not clear-cut. On the one hand, the government’s proposal is nearly a reversal of the 1999 reform that created the private pension funds and it raises questions about the overall stability of the institutional framework. That doesn’t take away from the fact that, comparatively speaking, Poland’s institutions still remain pretty strong relative to other emerging markets.

However, comparing to developed nations with generally higher ratings – the UK, Canada, Australia–this degree of reform reversal is not as likely. That is an aspect that sort of limits upward mobility of Poland’s rating from the current A2 level. On the other hand, the pension changes will certainly improve public finances and the fiscal outlook in the near term.

Maybe this will allow the rating to rise? Transfer of all assets, apart from equities, from private funds into the subaccounts in ZUS (Social Security Institution) is expected to lower government debt by around 10 percent of GDP.

These changes would likely result in increased contributions to the state social security scheme, which would boost short-term fiscal revenues and lower debt figures, but they are also exposing the sovereign to larger future contingent liabilities. On balance – the positives and the negatives don’t really weight too much on the rating.

What must Poland do to deserve the A1 rating?

During the crisis there was a substantial increase of debt and a weakening of the fiscal position. It is getting much harder at present to narrow the fiscal imbalance, to narrow the deficit. That has become a persistent challenge. Even though with the pension changes, the government debt will decrease, the fiscal accounts are not as strong as they were pre-crisis. There is still the issue of external finances, although these are improving, they are still a weak point relative to other sovereigns in the A category.

The question that remains is: will substantial structural reforms be forthcoming in order to preserve Poland’s high growth rates or even enhance them? Poland used to grow at around 4 percent, now growth is beginning to recover to perhaps 2 percent, maybe in longer term the economy can grow at rates of around 3 percent, but it is still below potential growth level. Substantial progress in all these three aspects will clearly mean an improvement in creditworthiness, and potentially, a higher rating in the future.

According to the government, Poland’s GDP will grow by 2.5 percent in 2014; 3.8 percent in 2015 and 4.3 percent in 2016.

It is hard to forecast the growth in Poland beyond 2014 because of the unsettled external environment, and the fact that many variables must be considered. Our expectation is that the Polish economy will grow at around 2.5 percent in 2014, perhaps even slightly higher than that. In 2015 and 2016 Polish growth may be closer to around 3 percent.

Is there a risk of exceeding the second safety threshold  –  55 percent of GDP?

It seems unlikely at the present time because of the pension fund changes. We project that debt will fall below 50 percent of GDP on a general government basis, either this year or next year, whenever the changes do take effect. It then might continue to rise slightly above 50 percent of GDP level, but it is highly unlikely that it will reach the 55 percent threshold, as growth returns to the economy in the coming years.

When can we expect a decision on the rating of Poland? When does a review of country ratings usually take place?

There is no set time, the process is always ongoing, and so it can happen at any point. But for now, we don’t foresee any changes to the current A2 rating and stable outlook in the near future.

By Marek Pielach

OF

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