Some have described S and P’s recent move to downgrade Poland’s long-term foreign currency rating by 1 notch to BBB+ with a negative outlook (and its local currency rating to A- from A) as a ‘shock’ or a ‘surprise’. We would beg to differ: Poland fails our ‘wealthy nation’ test having a concerning level of net foreign liabilities (“NFL”) to GDP (82.2% in 2012 using Stratton Street’s estimates). We avoid investing in countries with NFL / GDP greater than 50%; IMF research indicates levels above this threshold are associated with increasing risk of external crises.
S and P cited the erosion of Poland “institutional checks and balances” following the 2015 election and that they “no longer expect Poland’s fiscal metrics will improve as previously forecast” as reasons for the downgrade. They “anticipate a very gradual reduction of Poland's external debt because the current account deficit will be funded largely through non-debt inflows. …Nevertheless, with net external liabilities at 125% of CARs [current account receipts] in 2015, a prolonged deterioration of external sentiment or increased volatility on global financial markets could weaken Poland's ability to finance its net external liabilities. Our base case is that gross external financing needs will remain fairly constant at approximately 86% of CARs and usable reserves until 2018.”
Using our NFA analysis we made a list of 11 countries to avoid investing in 2009 which were vulnerable due to their NFA positions: Estonia, Hungary, Latvia, Bulgaria, Portugal, Greece, Lithuania, Poland, Romania, Australia and Spain. Subsequently, only 3 of these countries (Australia, Estonia and Romania) have avoided downgrades from S&P or Moody’s on their foreign long term debt.
The problem is following the GFC policy responses have been overly reliant on central bank driven QE and not done enough on structural reform, improving the effectiveness of fiscal policy and reducing over-extended debt levels. As we have highlighted before, the McKinsey Global Institute (MGI) Report of February 2015 showed there has not been any deleveraging since 2008, other than in a few small cases. Between 2007 and 2Q 2014 global debt increased by USD 57 trillion raising the ratio of global debt to GDP to 286 percent. They note “that high debt is associated with slower GDP growth and higher risk of financial crises.”
More recently, countries we highlighted in February 2014 as likely to suffer a 'dip' in fortunes, are those where weak fundamentals have been 'brushed' aside or ignored, but are nonetheless vulnerable. Our view of ongoing deleveraging ‘paints’ a very negative view of countries with large net foreign liabilities, otherwise collectively known as "paintbrush". These “PAINTBRUSH” countries, in no particular order of level of concern, are Poland, Australia, Indonesia, New Zealand, Turkey, Brazil, Romania, Ukraine, South Africa and Hungary. As a guide, since February 2014 Indonesia is the only country where the currency is showing a positive return against the dollar.