Crisis limits Eastern European FX’s upside

FOR more than a decade, eastern European countries enviously looked west, chasing the desirable single currency membership that would signal that they had shaken off their Soviet-era shackles and were at a critical stage in their economic and political development.

After more than 10 years of trying to achieve acceptance to the exclusive club that is (or perhaps was?) the Eurozone, these same countries are watching the debt crisis unfold.

Sadly, non-membership of the single currency does not mean that Eastern Europe is immune from contagion. Currencies such as the Polish zloty and the Hungarian forint have been under severe pressure over the past week or so, falling 4.4 and 2.6 per cent respectively against the euro.

They are facing a double whammy, says Neil Mellor at the Bank of New York (BNY) Mellon. Not only is the Eurozone crisis undermining risk appetite, but these countries also suffer from their proximity and linkages with the Eurozone. He believes Eastern European FX will stay under pressure as long as the sovereign debt crisis and associated uncertainty rumbles on, partly because of the heightened risk aversion and also because they are so intertwined with the euro.

Once the jitters over the periphery subside, both Mellor and Citigroup’s FX strategists think QE2 liquidity will instigate renewed risk appetite, supporting emerging European currencies. However, given that there is little clear end in sight to the sovereign debt crisis as yet, traders should avoid making calls on this assumption.

In the meantime, traders ought to focus on where contagion will affect Eastern Europe the most. Raffaella Tenconi, economist at Bank of America-Merrill Lynch, says: “Contagion from a potential escalation of the Eurozone fiscal crisis will affect mostly the countries with tight balance of payments funding and falling political will to reform.” The countries most vulnerable include Hungary, Bulgaria, and Romania. Among those more insulated are Poland and the Czech Republic.

Tenconi is cautious on the forint but expects the zloty and the Czech koruna to outperform. Not only does Poland show resilient growth, the zloty and the koruna are also the least vulnerable fundamentally – the former given its more diversified/large economy and the latter given its low leverage. But she warns that if Portugal or Spain were to get into trouble, the zloty could underperform given the much heavier investor positioning.

The dream – or indeed the desire – of joining the Eurozone may have vanished but Eastern European states have spent so long getting close that they will not escape unscathed in the short-term. Those that have spent enough time navel-gazing as well as looking wistfully west – such as Poland and the Czech Republic rather than foolhardy Estonia – will see their currencies outperform.


Estonia is scheduled to join the Eurozone on 1 January 2011.

About two-thirds of household debt in Hungary is denominated in foreign currencies, with the majority in Swiss francs.

In Poland, foreign currency loans make up only 36 per cent of total lending.

The Czech banks were more conservative and did not offer more exotic products. Therefore, foreign exchange loans are now not a problem.