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Poland currency woes.

Interesting article in light of the falling Polish zlote!


Feb 12th 2009
From the Economist Intelligence Unit ViewsWire

The government of Poland contemplates upsetting investors, as companies' bets on the currency go wrong


Polish companies are potentially facing losses of US$4.4bn on currency options contracts taken out when the currency was worth nearly 40% more versus the euro than today. In response, the government is threatening to pass a regulation scrapping those contracts and thus saving big companies, a number of which are state-owned, from additional financial loss. This is a risky step that threatens to undermine the country’s reputation among investors, could provoke legal action from the European Commission and will harm the country’s banks, which are the counterparties in the currency option trades.

Poland’s government will soon pass a law enabling some companies to walk away from or renegotiate currency option contracts, the economy minister, Waldemar Pawlak, said on February 10th. His comment came barely a week after public attention was focused on the losses faced by Polish companies as a result of currency option contracts taken out last year. The zloty strengthened steadily against the euro during the first seven months of 2008, hitting a record high of Zl 3.2:€1 in the second half of July. Around that time, on the assumption that the currency would strengthen further and thus harm the price-competitiveness of Polish exports, a large number of companies took out currency options contracts to insure themselves against further currency appreciation.

As financial markets seized up, however, the zloty went into reverse. It crossed Zl 3.5:€1 in September and reached Zl 4:€1 in December; in early February the currency has been trading at Zl4.4:€1, equating to a 37% loss in value against the euro compared with its 2008 peak level.

Poland’s financial services authority estimated last week that companies faced losses of Zl 5bn (US$1.5bn); this estimate has now been raised to Zl 15bn-20bn, with Zl 15bn being the most widely quoted figure. Already steelmaker Odlewnie Polskie has filed for bankruptcy because of its losses on the currency contracts, while appliance-maker Zelmer has set aside Zl 18.6bn for bad debts and construction firm Erbud has cut its profit forecast for 2009 by 80%. The drag imposed by currency options has also been blamed for chemicals giant Ciech announcing its first quarterly loss since going public. State firms lost money too. According to a treasury minister spokesman cited by Rzeczpospolita, 48 state-run companies were involved in currency option deals and half of these have incurred losses as a result. Coking coal giant Jastrzebska Spolka Weglowa estimates that its losses may amount to Zl 100m this year.

Debt dissolution by decree?
Faced with sizeable losses, some companies had already indicated that they would take legal action against their counterparties on currency options, on the basis that the products had been mis-sold because the risks were not spelt out. Mr Pawlak, however, is seeking to trump this by passing a law to help companies avoid the obligations that they undertook. He says this would be consistent with the EU directive on financial services, that Poland has not ratified, and existing Polish law.

There is an element of party politics in this. Mr Pawlak is the leader of the Polish Peasants Party (PSL), which is the junior party in government and is more populist than the liberal Civic Platform (PO) of Prime Minister Donald Tusk. Mr Tusk has indicated that the government as a whole supports the Pawlak plan, but in the current circumstances he can scarcely do otherwise. The PSL has indicated that if government support was not forthcoming, it would take the measure directly to parliament. In the current circumstances, with industrial output contracting and job worries intensifying, it would be politically damaging to oppose measures designed to support the country’s largest companies.

Risky course
The scale of the problem in Poland appears to dwarf that in other EU states, and perhaps explains why the Polish government is alone in toying with such a radical measure. However, there are three obvious downsides to the government’s intended legislation.

First, it risks damaging investor confidence and could trigger a wave of arbitration cases. The companies entered into these contracts freely; if they were mis-sold, existing Polish legislation should offer sufficient protection. The fact that the government intends to pass legislation, after the fact, sends a negative signal regarding the stability, predictability and investor-friendliness of the Polish environment. In the currently troubled financial climate, this could harm the country’s interests.

Second, the law could quite conceivably trigger action from the European Commission. As there is no text of the law available for scrutiny, it is difficult to comment on potential legal difficulties. However, the broader the scope of such a law, to be applied retrospectively, the more likely it is to create a legal minefield.

Third, it will harm the counterparties in the currency option trade—most of which are Polish banks. BRE Bank’s fourth quarter earnings were at the lowest level in four years as a result of losses in the companies to which it lends arising from currency options gone wrong. Collectively, banks have written off Zl 2.25bn to make provision for losses. Yet if a sizeable number of contracts are annulled by the government, bank losses will be much higher.

Early days
Much remains uncertain: the level of losses from currency options to which Polish companies are exposed; the percentage of these that could be eligible for contract cancellation under government proposals; and the impact this would have on the country’s banks. It is conceivable that the banks would in any case have been willing to negotiate a restructuring of some contracts, in order to keep their clients in business and so protect future income. Yet by meddling directly and retrospectively in contracts freely concluded between companies and banks, Poland’s government is taking a step without precedent in the EU context—and it may suffer for it.

Re: Poland currency woes.

Few things in modern life are as annoying and as damaging as politicians meddling in economics.

If they absolutely insist on entering into the fray the solution is in the form of seven year bonds guaranteed by the government.

The banks would receive the bonds as assets to cover their position in any currency trades already entered into. The banks can either await the maturity of the bond and collect interest or sell the bonds at a discounted rate.

The businesses with the currency contracts would be subject to paying the interest on the bonds and the face value at maturity. They would be able to write off their currency losses over seven years and still exercise the original currency contracts.

Doubtless there will instead be a useless round of political demagoguery with everyone assigning blame and no one acting responsibly.

Re: Poland currency woes.

Hold on a moment, let me think.

The Polish government gets tens of billions of EU funding in euros, right?

And it's worried that it will have to sell these billions of euros at a high rate against the zloty, thereby maximising its purchasing power for projects in Poland - roads, rail, sewers, water treatment stations, stadia etc???

It should be celebrating by selling all its euros at the current high levels - I would.