Antagain
The iShares MSCI Poland ETF (NYSEARCA:EPOL) is substantially exposed to Polish financials. There were some idiosyncratic legal issues going on with Polish financials that we won’t rehash in this article as they were detailed in our previous coverage. The overhangs were subsiding at any rate, which means that we can focus exclusively now on the issue of the Polish Zloty or the PLN, whose strength is essential for the net performance of these financial exposures. Rates should remain high but inflation is attenuating. Deposit beta should be avoided by Polish banks and income should continue to grow healthily. High rates and attenuating inflation should mean a strong Zloty, with the new government also having to take a stand against potentially politicised dovishness prior to the election.
Breakdown of EPOL
Expense ratios are around 0.59% as this is a somewhat unusual market with a currency that isn’t especially accessible. Operating costs rise here due to higher exchange fees and so forth.
Sectors (iShares.com)
Financials are the primary exposure and therefore will be the focus of the discussion. The majority of these financials are banks with large retail businesses.
There are some reserve effects associated with legal issues, but that aside we want to focus on macro. Financials are domestic businesses with total exposure to the Zloty. The Zloty needs to perform well for strong net performance for foreign investors. As financials, they also depend on interest rates which having risen substantially support higher net-interest incomes. The Zloty also depends on higher rates. At some point deposit beta will kick in and the cost of funding will start to rise. Bank EBIT is still forecast for strong growth in 2024, so the effects would have to start later. Much like Saudi exposures, the ability to develop a long-term and high rate asset base and then for rates to eventually fall is an ideal situation for banks. During this high rate period, loan growth allows banks to improve the duration gap before interest rates fall again. Duration gaps were not great in developed markets after a long period of relatively low rates. Poland’s resilience and lack of exposure to the systemic effects of the financial crisis means that its duration gap was better than other developed market peers, but rates had still been low for some time, even if it’s not as much as other European markets.
The high rate period is needed. Polish proximity to the Ukraine war and its supply chain effects have caused major inflation. Inflation is coming down but it still runs hot. A hawkish policy would be entirely reasonable, but there was a strange moment where the CB in what has been alleged as a politicised move, turned suddenly dovish before elections of the incumbents, who lost. With an investigation of the head of the CB possibly initiating, the new line is clearly hawkishness, which is consistent with the data. This has been good for the Zloty.
On the political front, there has been more support from the Zloty in that the new government of Poland is more pro-EU, and are looking to unlock frozen EU funds that had been locked under the previous government due to some apparently anti-democratic changes to Polish laws. These funds will be important to support Poland and will mean a lot of Euro being exchanged for Zloty to spend domestically.
We mentioned deposit beta. Rate declines will need to eventually happen for banks to continue growing income. When this will be is still unclear, as inflation is running hot and wage growth is way ahead of inflation still, which is basically an indication of marginal inflation. There are upside CPI risks in H2, and that means easing won’t start till next year for Poland. That’s good for the Zloty at least, but it could become a problem for financials as time goes on and prevailing rates transmit through deposit beta to cost of deposits.
Bottom Line
Inflation remains high, policy restrictive, which is good for financials and good for the Zloty, which has already appreciated considerably.
We think the wage data, coming in at average wage growth ahead of 12% in January, will keep policy restrictive, probably with higher for longer than the US and the rest of Europe. Zloty should continue to perform well.
Financials will also perform well on higher NIs this year. This could start becoming an issue though towards the end of 2024 when cost of deposits might start coming up more meaningfully. Non-bank competition for funds is greater than it used to be on a secular basis, so deposit beta could be higher than what it might have been since the last hiking cycle some decades ago. But for now Polish financials look solid also as legal overhang diminishes.
