Analysis-Polish markets at crossroads on rocky road to election

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© Reuters. FILE PHOTO: Shadow of the supporter is pictured during the election convention of Law and Justice (PiS) party, before Sunday’s parliamentary elections, in Przysucha, Poland October 9, 2023. REUTERS/Kacper Pempel/File Photo

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By Karin Strohecker and Marc Jones

LONDON (Reuters) – An unpredictable race in Poland’s high-stakes election has left markets in Europe’s largest emerging economy in limbo.

Pre-election polls point to a win on Sunday for the ruling nationalist Law and Justice party (PiS), but one that sees it fall short of an outright majority.

That might lead to fragile coalitions or potentially even a political vacuum, which could augur more pain for the zloty, a domestic bond sell-off and pressure on Polish stocks, which have all had a mixed year so far.

“It is the most important election we have this year in Europe,” said Viktor Szabo, portfolio manager at asset manager abrdn, adding markets had not priced in scenarios such as a hung parliament or the possibility of an early election.

“If we get months of stalemate that would not be good for Polish assets at all,” Szabo added

Future ties with the European Union, the outlook for monetary policy and domestic borrowing as well as spending plans are all high on investors’ watchlists.

Foreign investors have pulled $2.3 billion from domestic government bonds and in July held less than 15% of outstanding bonds, the lowest level in well over a decade and below the historic average of 20%, JPMorgan calculations show.

Both PiS and its mainstream rivals are promising even more generous spending, possibly creating more inflationary pressures against a backdrop of a rate cutting central bank.

EU TIES

The dominant concern among investors is the outlook for relations with the EU after PiS spent most of its eight years in power at loggerheads with Brussels over rule of law issues.

“In the event of a PiS coalition win, it is likely to mean a continuation of both current economic policy and a gradual deterioration of Poland’s relationship with the European Union,” said Daniel Wood, a portfolio manager at William Blair.  

Some 110 billion euros ($116 billion) earmarked for Poland from the EU Cohesion funds in the 2021-2027 budget and the Recovery and Resilience Facility (RRF) remain frozen over the government’s record of undercutting liberal democratic rules.

Investors widely expect that if the opposition liberal Civic Coalition (KO) grouping were to win, a rapprochement with the bloc could see some of the funding unlocked. Such a scenario would be a key positive for both the currency and Polish equities, said Anna Zadornova, an economist at UBS.

“Banks could be a beneficiary given their macro proxy-like behaviour and thus positive impact of improved sentiment, larger investments and lower cost of equity,” she said of this outcome.

JP Morgan data shows Polish stocks had sucked in $273 million of foreign investor money by June, but while they have posted a more than 10% rise in dollar terms year-to-date they still lag peers in Romania and Hungary with 20% plus gains.

The percentage of emerging market fund managers looking to put their money to work on Poland’s bourse has risen to more than 50% by end-August, from just over 40% in April 2021, Copley Fund Research calculations show.

ZLOTY SLIDE

Meanwhile the zloty could strengthen to 4.2 to the euro under an opposition-led government, a level last seen more than five years ago, while under a PiS administration, the zloty could weaken to 4.85 by year-end, Zadornova at UBS said.

The zloty trades at 4.5 to the euro, within a whisker of fair value at 4.45 as calculated by Goldman Sachs.

Poland’s currency has been subject to political maelstrom.

Central bank governor Adam Glapinski, a PiS ally, delivered a surprise outsized rate cut in September, despite double digit inflation, sending the zloty sharply lower and raising fresh charges of letting politics influence monetary policy.

While some investors are concerned about central bank independence, a strong sovereign balance sheet and healthy foreign direct investment flows have offset some worries, especially for those exposed to Poland’s hard-currency bonds.

Investors broadly expect the central bank to return to a more committed stance to bring inflation back to its target in the wake of elections, regardless of who wins.

“Ultimately there is a point where you need to yield to the economics and how things are going,” said Kaan Nazli, a portfolio manager at Neuberger Berman.

($1=0.9461 euros)

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