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Pimco Sees Euro-Contagion Risk for Poland on Complacency

Poland’s risk of contagion from the euro-area debt crisis is rising because the country isn’t doing enough to cut its budget gap, said Michael Gomez, an emerging-markets fund manager at Pacific Investment Management Co.

Failure to solve the Greek crisis may widen the spread between Polish government bond yields and those of countries such as Belgium, and a “big disruption of the markets” may force Poland to tap its $30 billion flexible credit line from the International Monetary Fund, Gomez said yesterday by phone.

“The chance of a disruption to the euro zone’s peripheral economies is getting larger,” said Gomez, the Munich-based co-head of emerging markets at Pimco, the world’s biggest manager of bond funds. “Poland is still in a relatively good position to navigate difficulties, but there are signs of policy complacency and the Polish economy wouldn’t be immune to an acute global disruption.”

Euro-area leaders meeting today in Brussels may accept a temporary Greek default and ease the terms of bailouts to Greece, Portugal and Ireland to resolve the debt crisis, two officials familiar with the negotiations said. In Poland, the European Union’s largest eastern member, Prime Minister Donald Tusk will seek a mandate from voters in October to cut the budget deficit to less than the bloc’s limit of 3 percent of economic output next year from 7.9 percent in 2010.

Pimco invests in Polish government securities including fixed-coupon bonds maturing in 2014 and 2015, as well as the zloty, according to Bloomberg data.

Zloty, Bond Spreads

The zloty has weakened 1.1 percent against the euro in the past three months, the sixth-worst performance among more than 20 emerging-market currencies tracked by Bloomberg.

The Polish currency strengthened today on investor optimism about the talks in Brussels, advancing to 3.9861 per euro at 5:18 p.m. in Warsaw from 3.9977 late yesterday. The yield on the five-year government bond fell to 5.264 percent from 5.296.

The spread between Poland’s five-year benchmark bond and Belgian bonds maturing the same year narrowed to 172 basis points today from 278 on Nov. 4, when a government stalemate in Belgium increased political risk. Poland has the EU’s sixth-biggest economy, just ahead of Belgium.

Poland sold 3 billion zloty ($1.1 billion) of 10-year Treasury bonds at today’s auction, matching the maximum amount offered, at an average yield of 5.803 percent, the Warsaw-based Finance Ministry said in an e-mailed statement.

It “wouldn’t be damaging in and of itself” for Poland to tap the IMF credit line, Gomez said. “I would view it a source of liquidity and insurance that the Polish economy has at its disposal. Of course, if Poland were to tap the FCL that would imply that we have seen a big disruption of the markets, which would obviously be negative.”

Credit-Default Swaps

Poland’s five-year credit-default swaps, used to protect investors from non-payment or speculate on a borrower’s credit worthiness, are trading at around 170 basis points, compared with 58 for Germany, the EU’s largest economy, according to figures from data provider CMA. Poland is rated A- by Standard & Poor’s, one step below the neighboring Czech Republic.

While Poland, which accounts for more than a third of the output in the EU’s eastern states, was the only country in the 27-nation bloc to avoid recession in 2009, public finances have deteriorated.

The budget deficit has more than quadrupled since 2007, pushing public debt to 52.8 percent of gross domestic product last year, according to Polish accounting standards. Breaching 55 percent would trigger mandatory austerity measures.

Deficit-Cutting Plan

The government has said it aims to cut the deficit to 2.9 percent of GDP next year, counting on 4 percent economic growth. The central bank last week lowered its forecast for 2011 economic expansion to 3.2 percent from 3.6 percent. The European Commission said in June the government’s deficit-cutting plans were based on “slightly too favorable” growth forecasts.

Tusk is seeking to become the first premier since the communist regime was overthrown in 1989 to win a second term in office. Poland can reach its deficit goal “without any changes” to the government’s plans, Tusk said this month.

Support for Tusk’s ruling Civic Platform was unchanged at 34.5 percent, while backing for the opposition Law & Justice party increased 1.8 percentage points to 29.1 percent, according to a poll conducted July 15 by researcher Homo Homini, Polskie Radio reported. Homo Homini surveyed 1,100 adults by phone. No margin of error was given.

“The policy stance has been more accommodating over the recent cycle than we would expect it to be and we look for tighter policies going forward,” Gomez said. “There hasn’t been any severe disruption in Poland because of its strong initial conditions, but policy needs to tighten up. The country’s susceptibility to contagion rises the longer it waits.”

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