BBH MarketView: Poland Fundamentals Strong but Political Risk High

BBH MarketView:  Poland Fundamentals Strong but Political Risk High

Poland goes to the polls this coming weekend, and the outcome could have significant repercussions on the nation’s outlook.  Even though a change in government to a less-market friendly one should be partially priced in already, it will increase the degree of uncertainty from the policy side and could become a medium-term drag on the outlook for Poland.

POLITICAL OUTLOOK

Poland will hold general elections on October 25.  After the surprise win by opposition Law and Justice candidate Duda in the May presidential elections, the ruling Civic Platform appears likely to lose these parliamentary elections.  The most recent polls show that Law and Justice is poised to take power for the first time since, with support averaging around 35% vs. 23% for Civic Platform.  Both parties have siphoned off support from independent presidential candidate Kukiz, whose popularity has dimmed to around 6% after his strong showing in May.

Most projections suggest that both major parties are unlikely to win an outright majority in the 460-seat parliament.  However, some polls show Law and Justice winning a slight majority.  Party leader Kaczynski has said he would prefer not to rule by coalition, but circumstances may force his hand.

If it wins, Law and Justice will likely follow a more populist, nationalistic, and anti-EU policy stance.  Spending is likely to go up, at least if its campaign promises are any indication.  Law and Justice leaders have already said that the lending banks would bear a greater burden with regards to the Swiss franc-denominated loans.  Indeed, Law and Justice’s platform has already forced the ruling Civic Platform to tilt more populist in an effort to regain popular support.

ECONOMIC OUTLOOK

The political status quo is being roiled even as the economy remains robust.  GDP growth slowed to 3.3% y/y in Q2, but remains near the top of recent ranges.  Unemployment fell to a multi-year low of 10% in August, the lowest since December 2008.  Retail sales remain strong, helping to offset the drag from weak exports.  There are some signs in the September data that the economic slowdown is deepening, however.

In addition, deflation risks persist as CPI came in at -0.8% y/y in September.  Poland has posted y/y deflation since July 2014, which suggests further easing may be needed ahead.  Rate cuts might not be seen until 2016, however, when virtually the entire MPC will be replaced as their terms expire.  If Law and Justice were to win the election, we suspect the party would nominate pro-growth dovish candidates for the MPC.

The external accounts have improved this year, but are starting to worsen again, albeit modestly.  The current account gap is still expected at only -0.5% of GDP this year vs. -1.5% last year.  This is very zloty-supportive.

Fiscal policy is the biggest question mark ahead, and that’s due to the elections.  Some of the proposed measures will put upwards pressure on the budget deficit, such as reversing the recent increase in the retirement age, increased child benefits, and several others. The budget deficit is expected to come in under -3% of GDP this year for the first time since 2007, but there is a risk that the gap rises in 2016 under Law and Justice.

INVESTMENT OUTLOOK

The zloty is one of the best performers in EM,  up 1% YTD against the euro.  Most of the CEE currencies are firmer against the euro YTD, as well as some selected Asian currencies.  Despite what we see as continued outperformance, EUR/PLN is likely to test the year’s high near 4.3675 from January, as well as the December 2014 high near 4.40.

Polish equities are also outperforming within EM.  MSCI Poland is -7.6% YTD, and compares to -9.8% YTD for MSCI EM.  Our EM Equity model has just moved Poland to a recommended VERY OVERWEIGHT position based on the underlying macro factors.

Polish bonds have held up well.  The yield on 10-year local currency government bonds has risen 18 bp YTD.  This is in the middle of the pack in EM.  Compare this to the worst performing group that includes Brazil (+352 bp), Turkey (+199 bp), Peru (+194 bp), and Colombia (+90 bp).  With deflation likely to continue and rising risks that the NBP will resume easing, we think Polish bonds could start performing better.  The offsetting risk here is that expansionary fiscal policy under a new government could push up borrowing cosmorets .