Moody's warns that Central European populism could hit ratings

Moody's warns that Central European populism could hit ratings
Jaroslaw Kaczynski, whose Law & Justice party is pushing a number of populist measures.
By Robert Anderson in Prague April 14, 2016

Moody’s Investors Service is worried about the rise and spread of populist parties in Central Europe and could take rating action if this leads to adverse changes in policymaking.

“What would be important for us is the policy implications of these changes. Is there an element of political risk emerging in this region which could lead to some fiscal policy loosening, some retrenchment in structural reforms that have taken place over the years?” Yves Lemay, managing director of Moody’s sovereign risk group, told the rating agency’s 10th Anniversary Credit Risk Conference in Prague on April 13.

In response to a question he added: “If political risk materialises, it could affect the country’s prospects, fiscal policy, investor perceptions. Political risk is an important element that we need to incorporate as it might affect other parts of our analysis.”

Rival rating agency Standard & Poor’s controversially downgraded Poland to 'BBB+' with a negative outlook in January, following the election of the populist Law & Justice party in November. Neither Fitch Ratings nor Moody’s (which rates it 'A2') has yet followed.

In an outlook issued alongside the conference on April 13, Moody’s said that “Poland’s 2015 elections led to credit negative policy developments”, such as amendments to the fiscal framework that loosened policy, as well unorthodox policymaking.

“The political shift in the CEE region has been most notable in Poland, where policies have been informed to a greater extent by short-term objectives that have adverse fiscal and economic effects beyond the term of the new administration, together with a more marked inclination towards state intervention and a reduced role for independent bodies,” Moody’s said.

More widely, Moody’s highlighted the rise of populist movements throughout Central and Southeastern Europe that could heighten political risk in the future. “The political landscape in Central and Eastern Europe is evolving,” said Lemay. “The emergence of alternative parties raises the potential of shifts in economic and fiscal policy in the coming years.”

Moody’s outlook said growing voter dissatisfaction, together with austerity and reform fatigue, had led to tensions over implementing fiscal and economic policies. This was reflected in declining and volatile election turnouts, more fragile coalitions, a more limited policy consensus and the rise of anti-establishment parties, which “are expected to be a feature of the CEE political landscape going forward”.

“This is likely to lead to greater policy unpredictability with a lack of policy continuity posing a risk to further structural reforms required for continued improvements in macro fundamentals and their fiscal position,” Moody’s said.

The report highlighted recent elections in Poland and Slovakia that had led to the rise of anti-austerity and Eurosceptic political movements. “These parties increase domestic political risk and have the potential to reverse fiscal improvements, implement unorthodox economic policies and weaken cooperation and integration within the EU,” the outlook said. 

Ironically, Hungary – the most entrenched populist government in the region, which has been followed as a model by Poland and other countries – was given a strong hint that its rating might be upgraded this year. “We see the potential for an uprating of the 'Ba1' rating for Hungary,” Lemay said in answer to a question. Moody's already has Hungary on a positive outlook.

The Hungarian government has been pressing rating agencies to return the country’s sovereign rating to investment grade, which is finally expected to happen in the next few months. S&P disappointed Budapest last month by keeping its rating at 'BB+', after Moody's failed to issue a review scheduled for March 4. Moody's currently rates Hungary five notches below Poland.

Hungary was downgraded six notches to junk by Moody’s in the aftermath of the global financial crisis and the rise to power of Viktor Orban’s populist rightwing Fidesz movement, which pursued unorthodox economic and fiscal policies, and attacked constitutional checks and balances, as well as foreign investors.

But these unorthodox policies – notably the forcible conversion of banks’ foreign currency retail loans – have reduced its external vulnerabilities. “Hungary stands out in the CEE-8 because it has recorded the strongest improvement in its external position,” Moody’s outlook reported.

It highlighted how the government had reduced the country’s reliance on external financing and the external debt burden, which has fallen by 54 percentage points since 2009. Hungary’s combined current and capital account surplus of around 10% of GDP compares to deficits of 8-10% before 2008, Moody’s points out, while it had accumulated a sizeable foreign exchange buffer of around 30% of GDP at the end of 2015.

Meanwhile, the Fidesz government now appears to be attempting to mend fences with foreign investors by, for example, cutting the banking levy. “We are now seeing a retrenchment of some of their policies which will be more supportive to economic growth,” Lemay said. “Will the government extend the new policy direction or will it fall back on the unorthodox policy of previous years?” he asked.