How will the zloty react to Moody's decision? [CINKCIARZ.PL ANALYST]
Since the January reduction of Poland's loan credibility that was made by Standard & Poor's, the market speculates about possible similar steps of other agencies. On Friday, we will know the decision of the Moody's agency. Has the downgrading of the rating really been decided? How will it impact the zloty? Marcin Lipka, Cinkciarz.pl analyst, explains this matter.
The situation concerning the Polish rating is a dominating topic in the financial market. Moreover, the closer it gets to Moody's decision, the higher the tension. The mid-January downgrading by Standard & Poor's was determined to a significant degree by an institutional evaluation. This caused more political, rather than economic, discussions.
Moody's announcement from the past year is crucial for estimating the agency's forthcoming decision. It says that the evaluation of Poland's loan credibility may be under pressure, “if the government significantly abandons the consolidation targets, and if it leads to a deterioration in the debt dynamics. Moreover, we negatively evaluate a significant increase in external and financial weaknesses, as well as a decreasing growth potential.”
We can assume that the above mentioned condition is being fulfilled to a certain degree. According to the past year’s Convergence Program, the deficit of the public finance sector was supposed to be at the level of 1.8% and 1.3% of the GDP in 2017 and 2018, respectively. After April's revision, these estimations are now 2.9% and 2.0%, respectively. This is significantly more. Moreover, the external environment has been neutral.
Between the reports, the agencies often use the statements from their representatives as an additional signal for the market participants. Recently however, these statements were far from optimistic. Marco Zaninelli, a Moody's analyst, claimed in October that the result of the elections in Poland, reduces the predictability of the economic policy. Moreover, it may endanger the image of Poland as the region's safe coast. Zaninelli took note of the modification of the expense regulation, as well as of the dropping of the idea of an increase in retirement age. He also emphasized that, “these factors may have a significant impact on the fiscal stability in the mid-term.”
Zaninelli also mentioned the matter of the conversion of loans denominated in the Swiss franc. In his opinion, it could endanger the stability of the Polish bank system and its abilities to finance the economy. The agency's representative also thinks that integration between the Polish public utility enterprises and mines, may be negative for Poland's credit evaluation.
At the end of January, shortly prior to Standard & Poor's decision, the Moody’s analysts wrote that they can see the risk related to a further fiscal easing in 2017, “due to a strong obligation of the government to keep the election promises.” It was also said that there might still be a danger regarding next year's income side of the budget, “due to the institutional and legislative changes, which deteriorate the sentiments of the companies, as well as the investment atmosphere.”
Two weeks later, Moody's representatives referred to the plan of the conversion of loans denominated in the Swiss franc, which was presented by the Chancellery of the President of the Republic of Poland. Simone Zampa and Arif Bekiroglu, wrote that the cost of this operation will cause the losses at the level of 36 billion PLN. Moreover, it will be negative for Poland's loan credibility. At the beginning of April, Bloomberg quoted an analysts of Moody's, who claimed that the constitutional crisis in Poland is negative for the country's loan credibility.
Thus, in comparison to the past year, the agency's announcements show many new dangers for Poland's rating. It is most likely that Friday's decision will be negative for Poland. However, the question about the scale of this evaluation remains.
Hypothetical impact on the zloty
There are four basic scenarios regarding Moody’s Friday decision. The agency may leave the rating unchanged, reduce the rating's perspective, cut the loan credibility, or combine the rating's downgrading with a negative perspective, just like Standard & Poor's did.
Even though an unchanged rating seems very unlikely, we cannot completely exclude such a scenario. Moody’s is often considered as an institution which reacts calmly on current events. At the same time, it is worth noting that Poland's credibility has not been revised for more than thirteen years. Moreover, two years ago there were speculations about upgrading the rating. If this scenario is fulfilled, we can expect a depreciation of the euro, the dollar and the franc within the range of 0.05-0.10 PLN.
The reduction of only the loan credibility from neutral to negative, is an optimistic but yet realistic scenario. The market should show a positive reaction and allow the zloty to strengthen against the main currencies by approximately 1-1.5%. Moreover, some of the foreign investors could consider the January decision of Standard & Poor's as too pessimistic. This would probably cause a part of the capital to return to the Polish assets.
The base case scenario is a reduction of the rating by one level – from A2 to A3. This decision would be easy to justify, regardless of the institutional matters mentioned by Standard & Poor's. Moody’s will probably focus on the new expense obligations of the government administration. They include the 500+ program, an announced decrease in taxes, as well as the return to the previous limit of retirement age.
On the other hand, the impact of the announced taxes will not cover the new obligations of Poland. The Ministry of Finance Convergence Program, which was updated in April 2016, expects an increase in deficit to 2.9% of the GDP in 2016. This is despite the fact of an increase in perspective of the economic growth to positive 3.9% y/y, as well as inflation to positive 1.3% y/y. This means that, despite the growth at this level, which is consistent with the potential, the relation between the debt and the GDP will increase to 52.5% from the current level of 51.3%. In the current business cycle, the debt should depreciate at least 1-2%.
This decision may cause minor changes on the zloty. Recently, the Polish currency clearly hasn’t been only losing value against the euro and the dollar, but also against the Hungarian forint. Thus, this base case scenario should be included in prices to a significant degree. However, this news is negative for the long-term. It would actually confirm the attitude of Standard & Poor's from January. Moreover, the market will continue to speculate before the coming revision of the rating by the three main agencies. This may cause the decreased pressure on the zloty to sustain.
The most pessimistic scenario is the reduction of the rating by one rank, combined with the negative perspective. An increased risk of another downgrading may cause a visible decrease in pressure on the zloty. It is also possible that the euro will cost approximately 4.5 PLN, and the dollar – 4 PLN.
This decision could significantly deteriorate the general reception of Poland's loan credibility. The foreign capital may consider the two downgrades and two negative perspectives since the beginning of the year as a clear warning about a visible deterioration of Poland's financial perspectives. Additionally, this would significantly increase the anxieties before the decision of the Fitch Ratings (planned for the 15th of July), as well as extend the negative pressure on the zloty. Moreover, the Polish currency would definitely be more sensitive to any external disturbances.
In conclusion, the most likely scenario is that the Moody's agency will downgrade Poland's rating by one rank. This decision should be included in the current prices of the zloty to a significant degree. Thus, it will probably not change the short-term situation on the zloty. However, in the long-term the market will become afraid of new downgrades, especially if there is a risk that the economic growth in forthcoming quarters will be lower than expected. This may sustain the decrease of pressure on the zloty. Moreover, the average exchange rate for the euro will be probably higher, and will be exposed to even bigger changes than it did in past years.
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