Ill-prepared Poland falls out of favor

by Aleksander Nowacki and Timothy Sifert

Last week's flood of negative news on the state of this country's economy and its preparations for European Union membership, has drawn mixed responses from some of this country's top bankers. Worried about the rising costs of issuing and servicing debt, market watchers see Standard & Poor's downgrade of the złoty-denominated Treasury bonds from A to A- as more significant than the scathing report released last week by the European Commission (EC).

While hitting the headlines, the EC assessment of this country as the worst prepared of all accession states seems to have had a relatively minor impact on the thinking of investors.

"I think that investors really consider Poland a part of the EU already," says Paweł Gricuk, president of JP Morgan Chase, adding that the negative calls from Brussels would have little effect on investors this late in the day. While the report's strong wording is uncharacteristic of the Commission's diplomatic approach, many investors will fail to spot the full significance of this, as they are not aware of the complexities of the negotiating process. That is not, however, to say that it does not contain potentially explosive elements. The report is highly critical of this country's court system, drawing attention to its "conspicuous inefficiencies". As Gricuk points out, investors might be spooked to find out how court cases can hinder their operations, especially in bankruptcy proceedings.

The report, the last before the May 2004 accession, is a regular evaluation of all the accession countries' progress towards legislative and practical alignment with the Union. This month's report, released last Tuesday, takes a broad sweep at all this country's shortcomings, expressing concern that the largest of the ten new members is also the least prepared for accession.

Bankers agree that it contains few surprises for anyone with even a basic knowledge of the local conditions, citing the charge that the progress on the path of reform has practically stopped since autumn of last year.

"That is no more than a statement of fact," says Maciej Stańczuk, president of West LB, adding that this widely shared perception has already been reflected in the actions of investors. This in turn, Stańczuk says, adds to the difficulties in raising funds to close the yawning budget hole.

That is the issue that seems to worry financial market watchers most of all.

"Portfolio investors pay more heed to such issues as budget deficit and I see the S&P downgrade in this context," says Piotr Chudzik, head of corporate finance at Deutsche Bank. "There is no doubt that investors are watching that development very closely." West LB's Stańczuk concurs, pointing out that the downgrade, announced last Wednesday, comes in the wake of a tumultuous couple of weeks on the government debt market. Yields on Treasuries have shot up 150 to 200 basis points, making the costs of servicing debt an even heftier strain on the already troubled budget. Stańczuk points out this undermines investors' confidence in the government's ability to reduce deficits in the years to come, creating a vicious circle.

"Portfolio investors have duly reacted to these developments and given clear signals of their negative sentiment," he says. Stańczuk adds that the falling liquidity on government bonds is also an extremely worrying development, making it increasingly difficult to float papers, even as yields are growing. In this vein, the EC has "called into question the government's readiness to implement the necessary reform of public finance."

Yet Chudzik is cautious as to the actual effect these words will have on investors, saying that the report should be seen more as a warning signal to the government, urging reform, than as a message to investors.

What is more, while Stańczuk seems to see S&P's downgrade as an obvious step in the context of the negative news regarding next year's budget and medium-term spending cuts (or lack thereof), JP Morgan's Gricuk says it is "a little aggressive."

"Yes, there are risks, such as the political softening of the Hausner economic plan," he says. "But the economy is improving", with the weaker currency further strengthening exports.

The negative international publicity is widely seen as an attempt to step up pressure on the government to resume the path of economic and in particular, financial reform. But rating agencies are not in the business of furthering reform in troubled countries, so the downgrade of long-term złoty-denominated debt is last week's worst piece of news by far. As an investment banker who declines to be named says: "The worst thing is that the government will not take even this seriously. What I am expecting now is the blame game to resume. We will be told yet again it is all the analysts' fault."