Visegrad sovereign debt rush set to fade

Visegrad sovereign debt rush set to fade
Analysts expect Czech issuance to drop by half compared with the first quarter to around CZK100bn for the rest of the year.
By Tim Gosling in Prague April 19, 2017

Visegrad sovereigns have made hay in early 2017, pushing debt issues while flows of cheap money, improved economic prospects, and falling perceptions of geopolitical risk persist. However, borrowing volumes are likely to dip through the year.

Debt issues came thick and fast in the first quarter of the year, and sovereigns have fulfilled large chunks of their full year borrowing plans already. The effort has been helped by relatively strong fiscal positions across Visegrad and current accounts that are either close to balance or in impressive surplus.

Almost all CEE countries were either at or above their proportional issuance plans by the end of March, while cash buffers were also substantial in many cases, note Juraj Kotian and Zoltan Arokszallasi at Erste Group in a recent report. The Czech Republic, Poland and Slovakia are at or above 50% of their annual issuance plans.

The European Central Bank’s bond-buying programme continues to drive markets by propping up demand. The policy is expected to remain in place to the end of 2017, helping counterbalance rising risk in the EU from elections in France and Germany, and rate hikes in the US.

Meanwhile, a surge in inflation around the turn of the year has raised yields less than expected. The market appears to agree with the view expressed by central banks across the region that price growth is largely driven by stabilised oil prices and the low base from 2016, and that the momentum will continue to fade after the pullback seen in March.

Investors, therefore, are convinced that Hungarian and Polish monetary policy will not tighten through 2017.

“Investor demand for V4 bonds in [local currency] remains in place as decent risk premia (vs bunds and treasuries) were re-established in the fourth quarter of 2016 and have been maintained through the first phase of the global reflation trade,” points out Gunter Deuber at Raiffeisen Bank International. “As we have seen a large parts of the reflation story already unfolding locally and inside the euro area, downsides remain limited from here.”

Yet inflation is clearly back following three years or so of ultra-low price rises or deflation. With the Eurozone economy accelerating also, the ECB is set to raise discussion of its plans to taper the bond-buying programme through the year.

This suggests issuance will decline in the coming months. That should help keep a lid on yields in Visegrad, although spreads to bunds and nominal yields are expected to rise around the turn of the year.

“Sovereigns are aware of the fact that current generous market conditions are unlikely to prevail much into 2018 or so,” adds Deuber. “Hence, we see a lot of pre-funding and also ambitions to place ultra-long bonds like in case of Slovakia recently.”

While Slovakia - as the only member of the Eurozone in Visegrad - remains an exception, the rest of the region continues to concentrate on local currency debt.

While Hungary has struggled to gain much traction in reducing its overall state debt burden – at around 75% of GDP it’s by far the highest in Visegrad or even CEE – Budapest has successfully suppressed the ratio of foreign currency debt in its portfolio. The reduction in exposure to external shocks was key in earning Hungary an escape from ‘junk’ at the three major ratings agencies last year.

“Debt management agencies want to use the current generous conditions to develop local markets further and to decrease foreign participation via external bonds or non-resident holdings,” says Deuber.

Local currency remains king

The Magyar Nemzeti Bank continues, meanwhile, to use unconventional monetary policy to raise banking liquidity and drive lenders to use it to buy government debt. Still, political risk, and the heightened deficit and debt load keep yields elevated compared to peers. The 10-year benchmark sits at around 3.3%, the spread to bunds having risen by approximately 20bp to 330 through the first quarter.

Poland is performing a similar trick to quash yields, wielding the bank tax introduced in February 2016. Local debt is exempt from the asset base used to calculate the tax. Still, the combustible nature of the PiS government drove down the long-standing spread between Polish and Hungarian yields in 2016, to hand forint bonds a 10bp advantage currently.

Poland is unlikely to see that reverse this year. Analysts at BZWBK worry that the bank tax may have a greater impact on the real economy than thought, noting that it has “incentivised banks to restructure their portfolios away from investing into the private sector and instead towards just sitting on a growing pile of government debt”.

Erste expects to see the yield on Hungary’s benchmark move out towards 3.7% by the end of the year, but driven by Warsaw’s ongoing fight with the EU, upcoming impact on state finances of the reduction of the retirement age, and the potential for a downgrade from Moody’s, the Polish equivalent is forecast at 4%.

Although also driven by local monetary policy issues, the Czech Republic - long the safe haven of the region - illustrates the effects of political risk and looser fiscal policy in neighbouring countries. Yields on the Czech benchmark are forecast to inch 0.02bp lower through 2017 to finish at 0.83%.

However, shorter maturity bonds and T-bills look set for a sharp hike. Czech debt up to 3-years has traded at negative yield for over a year on the back of the central bank’s cap on the koruna. That policy was scrapped in early April.

The bulk of the huge volume of speculative capital that arrived in a bet on a jump for the currency – the CNB had been forced to spend as much as €80bn in interventions since late 2013 – is thought likely to be looking for an exit for some time.

“The sale of bonds with shorter maturities by foreign investors will lead to upward pressure at the short end of the yield curve,” predict Kotian and Arokszallasi. “However, many foreign investors will have problems finding an appropriate counterparty at a favourable exchange rate (capital waiting for the exit is much higher than the natural demand for korunas). For this reason, we expect a significant share of foreign investors to have to wait for a couple of quarters or even years, which will let yields flatten only gradually.”

However, the Czechs continue to offer greater stability than their peers in political, fiscal and economic terms. Elections in October mean the budget, which recorded a record high surplus last year, is set to return to deficit, but that should not affect the outlook.

Esrte predicts overall gross financing needs for 2017 at CZK230bn-270bn (€8.6bn-10bn), the majority to cover redemptions. The end of the koruna cap should see a change in strategy from the Ministry of Finance, with longer dated bonds to the fore after heavy short-dated and T-bill issuance in recent months as it chased negative yields. The Austrian bank’s analysts expect issuance to drop by half compared with the first quarter to around CZK100bn for the rest of the year, with proceeds to cover CZK210bn in redemptions from short-dated issues mainly.

Green and furry?

Those conditions make foreign-currency issues from Prague very unlikely. In fact, local currency redemptions dominate in all Visegrad countries.

Meanwhile, Slovakia, which has also enjoyed negative-yield short-dated debt for over a year, is due to redeem a total of €7.2bn this year. While, the governing coalition has offered signs that it could slow fiscal consolidation, the deficit has still been reduced towards just 1% or so of GDP, and plans are in place to continue towards a balanced budget in 2019.

However, with the ECB bond-buying programme due to be unwound, yields are set to rise strongly in 2017, Erste suggests. The 10-year benchmark is forecast to rise from early April’s 1% to 1.4% by the end of the year.

There may be exceptions to the local currency concentration, however. It would be no surprise if Poland – and to a lesser extent Hungary – launched foreign currency issues this year.

Poland is expected to offer another issue of CYN3bn in Chinese yuan following last year’s debut Panda bond – a clear effort to help build ties with Beijing as part of the ongoing regional competition to attract investment and trade with the eastern giant. Meanwhile, Warsaw has Eurobonds denominated in USD, CHF and JPY maturing later this year, and finance ministry officials say issues are being mulled.

Warsaw also became the first sovereign to sell green bonds – which direct proceeds to investment in environmental projects – in December. Officials suggest another such issue could also be in the pipeline.

Hungary is, meanwhile, flirting with suggestions of a euro-denominated paper. However, the MNB and finance ministry continue a highly public fight over such a move, with the central bank keen to maintain its push to reduce external debt, having quashed it to around 25% of gross state debt by the end of last year.

“Hungary has always had FX issuance in its annual plans, but has failed to conduct any for years,” note the Erste analysts. “It remains to be seen whether Hungary will opt for a Eurobond sale. Even if the planned EUR1bn sale is conducted, the nominal outstanding stock of FX debt will fall, given that redemptions amount to around €2.4bn this year.”