beyondbrics

The currencies of central and eastern Europe are on a roll.  In the last month, the Polish zloty is up 3.4 per cent against the euro, the Hungarian forint 2.6 per cent, and the Romanian leu 2.6 per cent.

Even allowing for bigger gains in some other emerging market currencies – Brazil’s real is up 6.5 per cent against the US dollar since mid-March – these are eye-catching numbers for a fairly stable region. What do they tell us about the CEE economies and where do they go from here?

One broad driver of CEE currency appreciation has been the strong German economy, generating orders for CEE export-oriented manufacturers, not least those which are German-owned – such as VW, with its  plants in the Czech Republic, Hungary, Slovakia and Poland.

Another attraction is rising interest rates, with central banks implementing hikes in response to inflationary pressures similar to those developing elsewhere and primarily generated by rising global prices for food and oil.

Compared the eurozone’s policy rate of 1.25 per cent (up 25 basis points this year),  Poland’s is 4 per cent (up 50 bps), Hungary’s 6 per cent (up 25 bps),  and Romania’s 6.25 per cent (no change). In Serbia, where the currency is up 2.7 per cent since mid-March, the policy rate is a whopping 12.5 per cent (up 1 percentage point), the highest in Europe. Plenty to go for in the carry trade, now that concerns of currency depreciation are fading.

But the story varies a bit between countries, creating trading opportunities for investors familiar with the ins and outs of the region’s economies.

The clearest case is Hungary, which has seen the strongest increase this year, due to the export surge combining with a sharp swing in investor sentiment from very gloomy to middling positive.

The country has had such bad headlines for so long that investors judged the only position to have in the forint was short.  Budapest had it all: local economic crisis, global economic crisis, International Monetary Fund/European Union rescue, weak leftist-led government, maverick right-wing government, arguments with the Fund and the EU and so on.

But around the turn of the year, investors judged  that on the key short-term questions of current account and fiscal stability Hungary was making progress.  Long-term, the outlook remained difficult, with weak domestic demand. But that didn’t matter for the moment even though the government had plugged the budget by raiding the state-backed private pension funds.

Romania has a similar tale. Hit hard by the 2008 global crisis, the government turned to the IMF/EU for rescue aid, rammed through austerity packages, and stabilised the economy, albeit at a low level of growth. With domestic demand weak but exports growing, the current account is improving – and investors are buying the currency.

Serbia ditto, with the added bonus of a particularly aggressive central bank that presides over the highest interest rates in Europe. Earlier this month it raised its key rate 25 basis points to 12.5 per cent, in the third increase this year and the ninth since last summer. That’s a good yield for euro- dollar- or sterling-based investors.

Poland, is a a bit different. Unlike the other three countries, it posted a gain in its currency against the euro last year (of 3.6 per cent). But this year it has gained only 0.3 per cent, with the increase since mid-March offsetting a sharp drop earlier.

Investor sentiment has switched from ultra-positive last year to a little bit cautious. Last year Poland was seen as the top-performing economy in the EU, posting solid GDP growth of 3.8 per cent.

This year, attention has focused on persistent budget deficits – 7.9 per cent of GDP in 2010 and 5.6 per cent forecast for this year – and thecurrent account gap. This officially stands at abn estimated 4 per cent, but could be twice as big if fears materialise that the numbers have been underestimated.

Also, Warsaw little wiggle-room, with the public debt/GDP ratio close to 55 per cent, a level at which the government is legally obliged to make swingeing deficit cuts.

Nor has Poland benefited quite as much from the recent upswing in German imports (up 22 per cent in January and 24 per cent in February).  Polish exports are indeed up – by 11 per cent for each of the first two months of 2011. But Hungary’s are up much more – 20 per cent and 21 per cent – and Romania’s by even more than that – 30 per cent and 31 per cent.

Meanwhile, Poland’s domestic demand has remained bouyant – unlike Hungary’s and Romania’s where it is stagnant. That is bad for Romanian and Hungarian consumers but it depresses imports, doing wonders for current account balances.

The zloty has made up an 8 per cent loss it posted against the euro before mid-March but the worries in the currency markets aren’t going away.

Timothy Ash, economist at the Royal Bank of Scotland, says: “There’s growing negative perception about the zloty. There are concerns about the errors and omissions on the current account. The central bank is hard to read. Perhaps the zloty will struggle.”

But Ash is bullish on the Hungarian forint and the Romanian leu, with both countries’ central banks committed to keeping interest rates high to fight inflation.

At Barclays Capital, Christian Keller says:

Investors have generally still been underweight / short CEE — perhaps with the exception of Poland and interestingly the zloty did not do as well as other currencies. Thus, for example, there has been a large rally into Hungarian assets, including local bonds, which, assuming not all such purchases are hedged, leads to a stronger HUF.

Similarly, some investors seem to be warming up even to the less liquid local markets such as Romania and even Serbia. Knowing that positions are not “crowded” yet as elsewhere in EM gives investors confidence.

Looking to the rest of 2011, Keller adds:

Where next? I think CEE currencies definitely have gained some stability and over time could gradually strengthen against EUR. However, many still have a lot of legacy leverage issues [ for example, high household foreign currency debts]  and the portfolio flows CEE receives these days may prove more fickle than the flow of FDI and bank credit of the past. This will make the type of appreciation trends we have seen in pre-Lehman years very unlikely.

Standing back a little, investors can be seen to be reassessing their views of 2010. A bit more caution about Poland, a bit more optimism around Hungary and Romania. But overall the prospects are for steady progress rather than the spectacular gains which might be made in some other EMs outside CEE. But in return the CEE states have the reassuring benefit of EU membership.

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