Friday, December 17, 2010

Emerging Markets Briefer ( Poland, Czech , Hungary )

Poland  Macro outlook 
• The Polish economy continues to show strong growth. In Q3 economic growth rose to
4.2% y/y from 3.5% y/y in Q2. This was significantly stronger than we had expected
and we have therefore revised up our GDP forecast for this year and next. We now
expect Polish GDP to grow by 4% y/y (previous forecast 3.1% y/y) this year and
4.8% y/y (previous forecast 4.6% y/y) next year.
• The high economic growth is primarily driven by high consumption growth. Both
private and public consumption increased further in Q3. The high domestic demand is
weakening the current account balance. We expect the Polish current account deficit
to increase to 3% of GDP this year and further to 3.5% of GDP next year.
• Although recovery in the Polish economy seems to be relatively robust it is notable
that the composition of growth has become less “healthy” as strong private and public
consumption is outpacing investment and net export growth. Longer term this could
pose a key risk to the recovery.
• Despite the relatively strong recovery, the budget deficit is likely to be about 8% of
GDP in 2010 and there is clearly a need for a rather substantial tightening of fiscal
policy in the coming years. This is likely to weigh on domestic demand going forward
and give some downside risk to growth.

Monetary policy outlook 
• Polish inflation has been inching up in recent months and with an upcoming VAT
hike it could inch up further in early-2011. Consequently, we now expect Polish
inflation to hover around 3-3½% during 2011. That said in the longer term we expect
Polish inflation to start to inch down back toward the Polish central bank’s inflation
target of 2½% and therefore we do not see an enormous need for monetary tightening
in Poland.
• It has been rather frustrating to follow Polish monetary policy in recent months as the
communication from the Polish central bank’s Monetary Policy Council (RPP) has
been rather unclear. Hence, the RPP has been far from “one voice” – different RPP
members have been sending rather conflicting signals on the outlook for monetary
policy. That said, it seems clear that the majority of RPP members do not see a need
for a substantial tightening of monetary policy. Rather we believe that the RPP might
only adjust the rate and deliver only one signal hike of 25 basis points during 2011 –
probably in the first half of the year.

FX outlook 
• The worsening in the outlook for the Polish current account situation as a result of
overly loose fiscal policy and strong growth in private consumption is beginning to
worry us somewhat in terms of the longer term outlook for the zloty. Therefore, it is
now more difficult to imagine EUR/PLN trading significantly below 4.00 in the
longer run. Furthermore, the short-term indicators also remain rather bearish for the
zloty – especially due to a negative technical outlook. That said we are not in any way
forecasting a major negative correction in the zloty and hence see the EUR/PLN
trading at about 4.10 throughout 2011.

Czech Republic Macro Outlook 
• Economic activity continued to improve in Q3 10, albeit moderately. Final Q3 GDP
was revised lower to 2.8% y/y compared with the flash estimate of 3% y/y. The
breakdown of the number shows that the economy was driven by the export-oriented
manufacturing sector. Private consumption also contributed positively and gross fixed
capital creation made a strong contribution to growth in Q3, which was primarily due
to a one-off investment in photovoltaics. With the release of the Q3 GDP, we have
revised up our GDP forecast for 2010 to 2.1% y/y (previous estimate 1.9% y/y).
However, the impact of fiscal consolidation can be expected to take some steam off
from growth next year. We now expect 2011 GDP growth of 2.3% y/y (previously
2.7% y/y). We see 2012 GDP growth at 2.9% y/y.  
• Both industrial production and retail sales were very disappointing in October.
Industrial production grew much less than expected by 6.9% y/y, down from the
revised 12.4%. Retail sales showed negative growth and dipped by 0.7% y/y. Both
numbers indicate that the recovery in the Czech economy is losing some momentum.  
• Inflation in November was unchanged on the previous month at 2.0% y/y. Although
consensus had been expecting inflation to ease slightly in November, it remains
contained and at the central bank inflation target of 2%. Our revised macro forecasts
for 2011 and 2012 point to slightly higher inflation (compared with our old forecasts).
We now expect Czech inflation to average 2.2% y/y in both 2011 and 2012.

Monetary Policy Outlook 
• The last monetary policy setting meeting this year, which will take place on 22
December, will be close to a non-event as it is broadly expected that the Czech central
bank (CNB) will stay on hold. Nonetheless, the CNB is getting increasingly dovish
and it seems fairly certain that it will keep rates on hold for most of 2011.

FX Outlook 
• The Czech koruna is currently trading at levels that we consider to be undervalued
relative to our ‘fair value’ assessment. Nonetheless, we have become fairly bearish on
the CZK in the short term (three to six months) due to significant negative carry and
the technical picture, but also now due to the deterioration of macroeconomic
conditions weighing negatively on the prospects for the CZK in the short run. Hence,
we see the CZK as increasingly becoming a funding currency for the regional play,
given that the CNB will keep interest rates at record lows for a long time. However,
on a 12-month horizon, we expect the CZK to gain some ground, albeit only

Hungary Macro outlook 
• We have revised up our growth forecast for 2010. We now expect the Hungarian
economy to grow by 0.3% y/y in 2010. We expect the Hungarian economy to grow by
2.1% y/y in 2011. In general, we are now more pessimistic on the recovery outlook
for the Hungarian economy than for the other ‘core’ CEE economies.
• However, the external balances have developed quite positively. There is a large
surplus on the trade balance and this should continue going forward. Furthermore, the
current account balance – which has seen a large deficit over the past two years – has
moved into positive territory and we expect a surplus in the next couple of years. This
is clearly adding to macroeconomic stability in Hungary.
• The biggest risk for the recovery in the Hungarian economy is unquestionably the
rather interventionist and highly erratic policies of the Hungarian government. Hence,
investor’s attitudes toward Hungary have undoubtedly been hurt a lot by the policies
and rhetoric of the Fidesz government.

Monetary policy outlook  
• The Hungarian central bank (MNB) is conducting monetary policy in an extremely
challenging environment. Not only does a high level of foreign currency lending
among households and corporations in Hungary make it difficult to avoid “ignoring”
currency fluctuations, but the significant rise in political uncertainty also creates
excessive volatility in Hungarian markets. Therefore, monetary policy seems to be
directed toward “countering” these risks rather than toward ensuring low inflation and
supporting growth. It is in the light of this that the recent surprise 25 basis point hike
to 5.75% should be seen. Looking forward there is much uncertainty regarding the
outlook for monetary policy – especially because the government is soon to appoint
new members to the MNB’s Monetary Council.

FX outlook 
• There are some very obvious risks to the stability of the Hungarian forint. One just
needs to mention foreign currency lending, possible rating downgrades (Moody’s
already downgraded Hungary on 6/12) and interventionist policy from the Hungarian
government. However, in our view the forint is already trading at significant discount
to its peers in the region and hence we would argue that these risks are already priced
into the forint. Further, Hungarian fundamentals have improved substantially since
the previous government passed significant  fiscal reforms in 2006. Therefore, even
taking the obvious risks into account we believe that the forint could even strengthen
over the long run and we have 12-months of 270 on EUR/HUF.
Full report: Emerging Markets Briefer ( Poland, Czech , Hungary )

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