"Polexit" and EU sanctions: The "Polexit" leaves the markets cold

The big issues also move the small markets: Corona, inflation and interest rate developments are not only the euro-dollar exchange rate, but also the players on the capital markets in Central and Southeastern Europe, which belong to the EU but not to the euro area: Poland, the Czech Republic , Hungary and Romania. This week there is particularly great interest in the Hungarian central bank. On Tuesday, because of the annual inflation that had risen to 5.3 percent, it raised the key interest rate to a surprisingly large extent for some: by 0.30 points to 1.20 percent. The Czech central bank has also announced further steps in this direction, Poland and Romania are still holding back.

However, general political considerations are increasingly creeping into the macroeconomic view of business expectations, production and labor market data for the valuation of bonds, stocks and currencies.

The long, festering dispute between the EU Commission and Poland and Hungary over the rule of law and the independence of the courts has led to heightened vigilance.

As early as mid-June, when there was no “polexit” debate, the Fitch rating agency had dealt with the issue of worries about the undermining of institutions, independent controls and the lack of an effective system of sanctions on credit ratings EU countries.

Their conclusion: The greatest concerns are about Poland and Hungary.

They exist to a lesser extent because of poor governance standards in Bulgaria and Romania.

Question about the rule of law

Fitch points out that “in recent years” in Central Europe no rating has been “changed” due to legal issues.

The sentence ends with a clear indication: Rule of law and governance considerations tended to have a negative effect on Hungary and Poland and tended to have a positive effect on the Czech Republic.

There was also anger there with the EU over illegal subsidies to the Agrovert group, which belongs to the Czech Prime Minister Andrej Babiš.

But the debate never reached the level of controversy with Warsaw and Budapest.

The EU Commission sees the rule of law in Poland and Hungary in danger.

Poland is about judicial reform and the question of whether the country will recognize the case law of the European Court of Justice.

In Hungary there is a law that is supposed to protect children from sexual indoctrination, but in the background there are also many solo attempts by Prime Minister Viktor Orbán and allegations of corruption even in the highest circles.

The EU sets deadlines, threatens with fines and thus possibly withholding payments from the reconstruction fund (NGEU).

Investors in Hungary are more sensitive

Seriously nobody expects that. Accordingly, this is not reflected in the prices of Polish Eurobonds, writes DZ Bank analyst Daniel Lenz and warns: “However, since any further escalation is not reflected in the market prices, the reaction could be noticeable and abrupt if Warsaw does not give in Brussels will also stop the NGEU disbursements. ”In the short term, he would rather be on the safe side with the“ low-risk bonds ”and advises“ to be cautious and to underweight Polish Eurobonds ”.

And Hungary?

"The effects on the market could possibly be even stronger in the case of Hungary than in the case of Poland", says Lenz of the FAZ Hungary's credit rating (average: BBB) is worse than Poland's;

the risk premium of the Eurobonds per se is higher.

"Since Hungary is also more indebted than Poland, investors could react even more sensitively to any delays in the disbursement of funds." This did not prevent Orbán from imposing conditions on the EU to accept the corona aid funds in the pre-election year.

No long-term effects yet

Commerzbank analyst Tatha Ghose points out that it is a long way to go to financial sanctions and that they are also “not so easy to implement”. Gunter Deuber, head of the national economic analysis at Raiffeisenbank International, sees great pressure from the EU to tighten the thumbscrews, "even if first verbally". He is calm about the possible effects of financial sanctions. Short-term implications on the bond and foreign exchange market are rather minor. The central banks could provide local support by raising interest rates. Regional stock markets, on the other hand, could "react a little more sniffly, since the long-term growth potential could be lower without EU funds".

In the medium to long term, there could be pressure on the ratings if the grants were no longer available and had to be replaced by loans.

"For a real market influence, however, it took a comprehensive blockade of EU funding for years," says Deuber.

He believes that Poland “could be ready to compromise very quickly in case of doubt”.

Last but not least, the EU could pay out money to governments to individual groups such as farmers, medium-sized businesses and civil society - and thus increase the pressure on governments.