Expect long-run zloty strength
THE euro has gained ground in the last week, but with fears of a double dip returning and doubts raging about the rigor of the EU’s banking stress tests, the rally seems unlikely to last. So if the euro does fall back against most major currencies, what does this mean for eastern European forex?
Intuitive wisdom might suggest that when the euro drops against the yen and dollar, it would similarly fall against its eastern neighbours, the most easily tradable of which are the Polish zloty, the Hungarian forint, the Czech koruna and the Romanian leu. After all, investors on the eastern side of the continent have to put their money somewhere.
But history suggests that the correlation is in fact entirely in the opposite direction: when the euro plummets against the dollar and the yen, it actually rises against eastern European currencies, and vice versa. This peculiarity stems from the fact that in bad times it is often perceived risk, rather than hard realities, that drive currency fluctuations. And so, perversely, the risks to growth posed by Eurozone sovereign debt crises actually make forex traders even more nervous about the euro’s smaller economic neighbours than it makes them anxious about the Eurozone itself. If investors are unwilling to take a punt on the euro, they become ever more unwilling to bet on the leu.
Given the likelihood of ongoing euro weakness against supposedly “safe haven”
currencies, traders should therefore anticipate euro strength vis-a-vis the leu or forint. But
Capital Economics’ Neil Shearing stresses that this correlation is not the only reason why eastern European currencies will weaken. More fundamentally, anaemic global growth will hit their exports as they, like developed economies, struggle with deficit problems. Societe Generale’s Gaelle Blanchard adds: “If the Eurozone countries slow down it’s not good for the Czech Republic, which is a good exporter. In Poland, there is strong domestic demand and they suffer less if trade weakens, but still they need to export right now.”
But although these currencies often move together in relation to the euro, there are some fundamental differences among them. On the one hand, there is Hungary and Romania, both on IMF-mandated programmes to control their debt and forecast to have negative or below 1 per cent GDP growth until 2012. Hungary also has the worst debt-to-GDP ratio in the region at close to 80 per cent, and though Romania’s public debt is relatively low at 35.5 per cent, its deficit is forecast to swell to 5.55 per cent of GDP this year.
Poland and the Czech Republic are in different situations. While they are certainly still exposed to the Eurozone crisis, they have manageable – if high – public debt-to-GDP ratios, and governments with mandates to take tough action on their deficits (although this could change in next year’s Polish parliamentary election). Shearing also highlights that the zloty alone bucks the regional currency norm of overvaluation in relation to its 10-year average.
So while the short-term should see most eastern European currencies weaken against the euro, this could provide a good buying opportunity for investors to take advantage of likely long-term strength in the zloty and Czech koruna. Societe Generale expects to see the zloty rise to around 3.80 versus the euro by the end of the year (versus 4.10 now), while it forecasts the koruna strengthening to 26.5 (from 25.5 now).
The outlook for the forint and the leu remains less certain, but if both governments are
able to stick to their IMF programmes, there is potential for very gradual appreciation.
Nonetheless, asked which eastern European country’s currency they would buy, most
analysts single out Poland without hesitation. It might not be viewed with as much confidence as its namesake “zloto” – Polish for gold – but as a long-term investment, the zloty looks like a good bet.