First-Ever Downgrade Shows Polish Power Grab Is Bad for Markets

  • Commerzbank cuts the nation's Eurobonds to underweight
  • Rabobank and Capital Economics see zloty testing record low

The cracks are starting to appear in Poland’s image as a haven from the turmoil in emerging markets.

Markets buckled Friday after Standard & Poor’s shocked investors by cutting the nation’s credit rating by one level even though the debt had a positive outlook. The zloty suffered its biggest rout since September 2011, while on Monday the government’s local-currency bond yields jumped the most in more than two years. Commerzbank AG immediately recommended selling Polish Eurobonds, while Rabobank and Capital Economics Ltd. said the currency is headed for record lows.

"Poland had been seen as a bright spot in emerging markets, this puts a dark cloud over that," said William Jackson, a senior emerging-market economist at Capital Economics in London. "Polish assets are likely to perform poorly over the course of this year."

First-ever Polish downgrade spurs analysts to predict zloty will revisit record lows
First-ever Polish downgrade spurs analysts to predict zloty will revisit record lows

The downgrade to BBB+, the third-lowest investment grade, is a signal Poland will struggle to retain its status as a haven from turbulence in emerging markets if Prime Minister Beata Szydlo’s Law & Justice party presses on with steps to strengthen its control over institutions. Since winning elections in October, the government pushed to overhaul the constitutional court and public media, moves that drew criticism from the European Commission. It also revamped the anti-corruption agency and named a ruling-party lawmaker to lead the nation’s largest refiner.

‘Shock’ Move

Banks such as Bank Zachodni WBK SA and ING Groep NV were predicting S&P would merely lower the outlook on Poland’s debt. Not only did the ratings company announce an outright downgrade, it attached a negative outlook to the new assessment. The zloty, which weakened by 1.5 percent within 20 minutes of S&P’s cut, gained 0.5 percent against the euro to 4.4573 on Monday.

“I’m still recovering from the initial shock," said Piotr Matys, a strategist for emerging-market currencies at Rabobank in London, said on Friday, predicting the zloty to revisit its 2011 low of 4.60 per euro. "S&P’s unexpected downgrade confirmed that Poland’s status of a country with stable fundamentals and rational politics has been seriously undermined by controversial laws implemented by Law & Justice."

Polish Finance Minister Pawel Szalamacha said over the weekend the decision was unjust and didn’t reflect the country’s economic fundamentals. He called the assessment “dishonest” and said he’ll invite S&P analysts to Warsaw to get a more in-depth view of the facts. 

The new leaders have "initiated various legislative measures that we consider weaken the independence and effectiveness of key institutions,” S&P analysts including Felix Winnekens in Frankfurt wrote in a report on Friday.

Bonds Slide

Investors have also been concerned by the new government’s pledges to increase social spending and tax banks, although Szalamacha said the new outlays wouldn’t exacerbate the fiscal shortfall beyond the European Union’s target of 3 percent of gross domestic product.

Yields on 10-year local-currency notes, which had stopped trading for the day on Friday before the S&P decision was released, climbed 17 basis points to 3.16 percent at 2:35 p.m. in Warsaw, the biggest increase in more than six weeks. The nation’s $1.1 billion of euro-denominated bonds maturing May 2027 slid the most since they were sold last year, pushing the yield up 23 basis points to 2.05 percent.

In a separate decision on Friday, Fitch Ratings kept its assessment of country’s creditworthiness unchanged. It, too, warned of rising political tensions sparked by the administration’s “confrontational policy stance.”

Currency weakens most since 2011 after S&P cuts rating
Currency weakens most since 2011 after S&P cuts rating

The zloty fell 2.6 percent last week to 4.4806 per euro, bringing its depreciation this year to 5 percent, the fourth-biggest drop among 24 emerging-market currencies.

"There are worries that institutional effectiveness and the independence of the central bank may deteriorate," said Rafal Benecki, an economist at ING Bank Slaski SA in Warsaw. "We expect a sharp weakening of the bonds. So far the bond market was really resonant and mainly the currency depreciated. The bond market will catch up."

The European Commission took a first step last week to discipline Poland’s new ruling party for seizing heightened control over the state, fueling a debate about whether eastern Europe is slipping back into its authoritarian past. Law & Justice’s sin, in the eyes of mostly western critics, was to pass legislation undercutting the independence of the high court and public broadcaster after winning an absolute majority, a rarity in European parliamentary systems.

"This is a new era in ratings, where ratings agencies are telling us that they increasingly care more about politics and the reform outlook than any positive economic fundamentals that may support a country’s story," Simon Quijano-Evans, chief strategist in London at Commerzbank, said in an e-mailed note. He reduced Poland’s Eurobonds to underweight from market weight.

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