Earlier this week, Jean-Claude Trichet, the former President of the ECB between 2003 and 2011 and Governor of the Bank of France from 1993 to 2003, made some interesting comments in an interview with AFP. He said "There is now agreement that the excessive debt level in advanced economies was a key factor in the triggering of the global financial crisis in 2007 and 2008," and that "The growth in debt, especially private debt, in advanced countries has slowed, but this slowdown has been offset by an acceleration of emerging country debt." In Trichet’s opinion: "This makes the entire global financial system at least as vulnerable as it was in 2008, if not more so."
Our investment approach favours creditor nations and those with net foreign liabilities (NFL) less than 50% of GDP as IMF research indicates NFL above this threshold are associated with increasing risk of external crises. Countries with net foreign assets are less reliant on foreign inflows than those with net foreign liabilities and over the longer term creditors’ currencies tend to appreciate while those of heavy debtors tend to depreciate. Back in February 2014 Stratton Street highlighted a list of vulnerable countries with large net foreign liabilities which we collectively named as ‘PAINTBRUSH’. These 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 the end of February 2014 none of these countries’ currencies (spot rate) are showing a positive return against the US dollar with the Romanian Leu the best of a bad bunch declining 18.6% and the Turkish Lira down 67%.
The Polish Zloty, which has declined by 19.4% is holding up relatively well for a nation with net foreign liabilities of 59% of GDP if we were to use Eurostat calculations. Our own figures show a much weaker external position for Poland than official figures as we ignore any positive changes due to a revaluation of assets and liabilities as these can change rapidly during a crisis.
We rate Poland as a 2-star country and whilst this is better than Portugal or Greece this should provide very little comfort for investors. 2-star rated countries are those with liabilities above 50% of GDP and in periods of deleveraging, like the one we are currently going through, the currencies of countries with liabilities above the 50% threshold are particularly vulnerable. To illustrate this point consider the currency returns against the dollar between the end of July 2008 and February 2009 which was the period of maximum strain. If we use the Bloomberg function WCRS and rank the currencies by returns against the dollar that function displays the 10 best performing and 11 worst performers (why they show 11 we are not sure). If we look at the bottom 11 currencies, 8 of the 10 PAINTBRUSH countries appear in that list with the Polish Zloty the second worst performer declining 44% over that timeframe.
Holders of funds with significant Polish Zloty exposure (there are lots around) would like to think that Poland’s fundamentals have improved since 2008 but in terms of net foreign liabilities, that isn’t the case. Unfortunately for them, Poland had net foreign liabilities of 58% of GDP going into 2008, virtually the same level as is the case today. To adapt Trichet’s earlier comment and taking into account Stratton Street’s weaker NFL number for Poland, the Zloty is at least as vulnerable as it was in 2008, if not more so.