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No relief yet as C. Europe debt markets limp into 2009

  Central Europe’s crippled bond markets are set to limp into the new year, and investors who have fled the region are not likely to return in force until the second half of 2009 when markets should find a bottom.

The escalating credit crunch ripped through the region’s debt markets in October, prompting foreign and domestic funds to dump emerging market bonds in a rush for cash. This forced countries like Poland, the Czech Republic and Hungary to scale back debt issues.

With manufacturing data indicating a darkening picture for the region’s export-heavy economies, demand for new emerging government issues is low, suppressed further by investors awaiting huge issuance next year from top-rated sovereigns like the United States and Germany.

“For the time being there is no ability or willingness to take risk on books from the investor side... This will be at least for the first quarter,” said Michael Ganske, head of emerging markets at Commerzbank. “People still have to reassess what they did last year; they have to absorb losses and then there will be global asset reallocation.”

Policymakers across emerging Europe have followed the lead of the world’s major central banks with deep cuts to interest rates to boost economies on the verge of recession. The Czechs and Poles still expect growth of above 2% next year -- a drastic slowdown from over 6% each last year -- although many economists expect a recession. Those countries have also been less enthusiastic than some of their western counterparts in pursuing fiscal stimulus.

But analysts said the outlook for lower interests rates, as well as an expected end to a slide in the region’s currencies -- the Polish zloty has lost almost 30% since August -- could boost bonds if and when risk appetite picks back up. “We expect recession in Hungary and the Czech Republic, and almost in Poland,” said Miroslav Plojhar, economist with JP Morgan. “In this environment government bonds will be a good alternative to normal private credit.”

ROAD TO RECOVERY

The prospect of lower interest rates boosted Hungarian and Polish government papers in December, with yields in Hungary falling to below 10% after climbing to as much as 13% since October when Budapest turned to the International Monetary Fund to stave off a financial crisis.

But dealers say liquidity is still low and yield spreads over German bonds remain wide following autumn’s rush by investors to safer bunds and US and euro zone bonds. The yield on Poland’s 2-year government bond has narrowed around 100 basis points to about 350 basis points above the German 2-year bund, but still trades around 1 percentage point above summer levels.

Analysts say it will take some time for the region to recover as a whole, particularly those countries such as Romania or Hungary, where a heavy reliance on foreign borrowing has fuelled gaping external deficits. “The huge imbalances in most central and eastern European economies need to be adjusted,” said Lars Christensen of Danske Bank. “We are looking for some kind of recovery in 2009 but we do not see that until the second half of the year... both in debt and other markets.”

Another problem for jump-starting stalled debt markets is a flood of expected issues from the United States and western European countries that will borrow for stimulus packages they see as vital to recovery. The US government could issue as much as $2 trillion of debt through next year as it continues to bail out the financial system and tries to kick-start its flagging economy.

Germany plans to issue a record €323 billion worth of bonds and treasury bills in 2009, surpassing the previous record from 2006 by almost €100 billion and providing investors a bigger supply of less risky debt than bonds from EU newcomers. And emerging European credit default swaps, which indicate the cost of insuring a country’s debt, have soared, indicating investors are still shy on the region.

Hungary’s two-year CDS spreads are bid at 415 basis points -- meaning it would cost €415,000 to guarantee €10 million of Hungarian state debt. That is a huge spike from just 49 basis points in early October and compares with Polish two-year CDS spreads bid at 187.7 and Romania’s 560.8.

Hungary has resigned itself to tapping part of its $25 billion IMF rescue package to cover its needs. The Czechs, whose CDS spreads have jumped to around 114 basis points, from 19 in September, have also taken a cautious approach. “The strategy will be to put off borrowing as much as they (governments) can and wait for recovery in risk appetite so they can get a better price for their debt,” said Neil Shearing, emerging Europe economist with Capital Economics. (Reuters)