Central Europe is looking a safest port in EMs storm

The Warsaw Stock Exchange is seen in Poland. The bourse has been the region’s only loser this year, down more than 2% and 14% since May. Reuters/LondonWith purring economies that have few connections with China or commodity markets, Central Europe is for once looking like the safest port in a storm for emerging market investors. Normally unglamorous Hungary is the world’s top performing equity market this year in dollar terms and its bonds are in the top four too. Hungarian stocks and bonds have been on a roll since January – shares are up almost 40% – when Hungary’s move to relieve families of costly Swiss franc mortgages at the expense of the banks, looked a masterstroke after the Swiss National Bank suddenly abandoned its currency cap. Economic powerhouses Poland and the Czech Republic, meanwhile, are posting impressive growth and central European currencies are also holding firm - even the leu, despite a corruption scandal that is rocking Romania’s government. “There is some really good data coming out of eastern Europe,” said Jan Dehn at emerging market fund manager Ashmore. “The Czechs have just revised up their (growth) forecasts, Hungary continues to do well getting to terms with its foreign currency debt and Poland as usual is producing very strong growth.” The region’s minimal ties with China are also helping, something that makes a welcome change from recent years when the debt crisis in its biggest trade partner, the eurozone, has acted as a bit of a turn-off. China’s troubles have played a big role in the commodity rout that has hammered emerging market big boys Brazil, South Africa and Russia over the last 1-1/2 months. Central Europe imports most of its oil and metals so the price drop is a boon and IMF data shows China buys not much more than 1% of Czech, Polish, Hungarian or Romanian exports, versus the roughly 30% that go to Germany, which looks to be picking up. Optimism towards the region, however, is being tempered by pockets of rising political uncertainty. In Poland, central Europe’s biggest economy and its long-time anchor of stability, eyebrows are being raised ahead of parliamentary elections that look likely to usher in a change of government in October. The Warsaw stock market has been the region’s only loser this year, down more than 2% and 14% since May, partly on worries about the more euro-sceptic stance of the opposition Law and Justice party (PiS), which is the front-runner in opinion polls.  There was another big jolt lower for Polish bank stocks and bonds on Thursday as a Hungary-style move to make banks pay for the bulk of losses on Swiss franc mortgages was approved. Some investors see it a sign of a growing appetite for more interventionism at a time where markets are already facing challenges. “Very low spreads give little protection against risks from higher core market yields and with asymmetric political risks until October’s parliamentary elections,” analysts at JP Morgan said in a recent note, recommending investors keep their holdings of Polish bonds to a minimum. Romania, where stocks have jumped 10% this year, is in the spotlight again too. Its Prime Minister, Victor Ponta, is embroiled in a corruption scandal but still pushing through big tax cuts branded a reckless ahead of elections next year. Those doubts are however being largely offset by the region’s solid finances. Analysts at Morgan Stanley on Friday described the current account picture across central Europe as “extremely healthy”. Every country now runs an external surplus. In Hungary, which is angling for an investment grade rating, it is 9% of GDP. That is a big difference to many rival emerging markets and a key change from the pre-financial crisis days when central Europe used to run large deficits, often funded by ‘hot money’ portfolio inflows, FX loans and foreigners snapping up property. Domestic demand looks to be hotting up. Erste Bank said on Friday it was the prime reason why Central Europe was faring “substantially better” than the rest of Europe. The bloc’s currencies could also be a draw. Like most of the world they have lost out to the dollar this year, though average falls of around 7-8% look manageable compared with 24, 16 and 11% slumps for Brazil, Turkey and Asia’s worst performer Malaysia. At the same time most are up versus the euro and expected to keep going now that it looks like the region’s central banks have all completed their interest rate cut cycles. That’s a potential negative for bonds, especially if a US rate hike lifts global borrowing rates. But the potential currency gains could be enough to draw in eurozone investors who are seeing their returns squashed by European Central Bank bond buying. “I think the whole region has been trading relatively well because growth is well supported, inflation is pretty low and because they are being helped by the ECB’s low rates,” said Viktor Szabo at Aberdeen Asset Management.