Sunday, 13 May 2012

Europe is quivering, while Poland is holding strong.

It has been kind of nerve-racking week on financial markets. Last weekend abounded in political events that could affect the future of the eurozone – presidential election was held in France and Greeks elected members of their parliament.

The latter has drawn much more controversy than the former. The south-European nation has already had enough of severe austerity programme pursued by the previous government and this time backed mostly the parties that have opposed aggressive retrenchments, without which Greek government would have gone bankrupt long ago. Votes have been scattered among many parties, yet they have failed to form a coalition. Today leaders of victorious parties and the president are making a last-ditch attempt to bring together a government. Most observers hold the view the talks are doomed to bring no coveted results and new election will be called for June.

It is almost sure the same parties will win the election, only share of votes gleaned by each of them might differ. At the end of the day, populist politicians elected by irate Greeks will be trying to pull back from the spending cuts that on one hand reduce the pace in which Greek public debt increases, but on the other send the Greek economy into a deeper recession.

Greek bondholders have already agreed on a debt swap with a haircut of 53.5%, yet even such debt relief has not put the Greek government out of trouble. Its indebtedness is whopping and its capacity to pay it off in foreseeable future is highly questionable. Since the very inception of the Greek crisis, it has been clear that insolvency of Greece is just a matter of time. One of the rating agencies downgraded Greece’s rating to C, pointing out, rightly, the big write-down is in fact a form of controlled default. The full default, encompassing freezing almost all public spending is conceivable. This scenario can materialise if the new government backs out of austerity measures on which financial drip from the EU and the IMF is conditioned. If access to this money is cut off (such move is at creditors’ discretion), Greece will be unable to service its debts and maybe this is what many Greeks want. Probably they do not care they would bear a brunt of insolvency, since suffer anyway, so why not spite creditors? When I look at that uncivilised nation, I cannot believe those barbarians accustomed to living beyond their means claim to be heirs of cradle of democracy. No, these must not be the descendants of ancient Greeks.

So called ‘financial markets’ are totally aware Greece is even no longer on its knees; it is lying with its head buried in the sand and breathing through a pipe held by the EU and the IMF, consequently I dare to claim a full-blown bankruptcy would not trigger a sell-off similar to that witnessed in August 2011. There is no evidence for it, but at the end of last year I predicted an ‘earthquake’ on financial markets in the second quarter of 2012. I can concede my mistake if WIG20 does not fall below 2,000 points. Now it needs to go down by some 7% - 8% to hit that barrier so the this can done within a one-day solid tumble.

In France Mr Hollande deposed Mr Sarkozy from the presidential office. Markets’ reaction was anything but amiable. Many feared the new president would soon set out to follow out his leftist agenda, including increasing tax rate for the richest and imposing an extra tax on profitable companies which lay off workers to push up their earnings. I have never really liked Mr Sarkozy, his celebrity-like style of wielding power was not my kind and I will not cry after him. With time some elements of leftist agenda take my fancy. Marginal tax rate of 75% is an exaggeration which will rather cause the wealthiest people to migrate to the UK than help raise tax revenues, but to my proposal of tax system based on flat rate and high tax allowance I would add a higher tax bracket for individuals earning more than six times average salary. I also cannot resist liking for an additional tax on companies firing staff to boost profits. In the coming week my company is announce who will be laid off. At least they pledged to give very generous severance packages and some employees are coming forward to leave…

But wait, wait, who gave ‘financial markets’ power to punish people for the choices they are making? I know yields on government debt should be correlated with risk of its default, I know valuation of stocks depends on tax rate, but do not some price movements express markets’ displeasure? Who gave them authority to mete out punishments? Is this part of legacy of Thatcherism commendable?

Meanwhile on Wednesday the central bank of Poland raised its benchmark interest rate by 25 basis points, to 4.75%. While many European economies are threatened with recession, for Poland inflation above central bank’s target of 2.50% +/- 1.00 p.p., is a bigger problem than economic slowdown (projected GDP growth in 2012 is ca. 3%, 1.3 percentage points lower that actual GDP growth in 2011). Again I’m proud Poland’s monetary authorities have proved a forward-looking wisdom. Given the fragility of economic conditions with our trade partners, it is not clear whether the hike was just a one-off move, or a beginning of the second part of monetary tightening cycle initiated in January 2011. For sure higher rates mean good news for savers who keep their money in banks and slightly worse for all borrowers.

Depositors can cheer up even more, as Polish banks have begun to adjust their funding structure to Basel III requirements, taking effect on 1 January 2013. In practice this means many banks will have to match maturities of their assets (what they lent to households and enterprises) and liabilities (what they owe depositors or creditors). For many banks this might be a bit of a problem, as they finance long-term assets (i.e. 30Y mortgages) with short-term liabilities (i.e. up to 1Y time deposits). This means banks will be competing to garner long-term deposits from the market by bidding higher interest rates and will have to cut down on long-term lending, which essentially are mortgage loans. This means excellent news for the housing market. Property prices in Warsaw have fallen off the peak in early 2008 by some 15% in nominal terms (30% in real terms) and the market is stuck in a standstill. Banks, in order to comply with supervisor’s regulations, have curbed mortgage lending, creditworthiness criteria have been tightened, and buyers have finally noticed property prices are still steep, especially when compared to earnings. So the market may be heading only in one direction. The process of adjustment will take a few months, as sellers are unwilling to take on board that their hapless assets’ (for which many of them paid over the odds) intrinsic values are much lower than asking prices and buyers refuse to pay so much, or their mortgage applications are turned down, so few transactions are finalised. This also proves mortgage availability is the key driver of price trends on property market. May the adjustment run well and property prices should decrease by some 20% within two years – the substantial decline which began in 2011 will continue (transaction price of 1 sqm in Warsaw dropped by 11% year-on-year in April 2012), but fundamental factors point the pace of decline should speed up! Great news!

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