Strategy Note /

Poland-EU dispute: Slower growth may dictate a de-escalation

  • Dispute with EU, over rule of law, imperils timely release of funding equivalent to about 2% of annual GDP

  • Slow growth post-Covid, Russia-Ukraine war likely drives Poland to de-escalate but maybe not until after 2023 election

  • Polish equities have already underperformed European EM peers and are left cheaper versus historic average

Poland-EU dispute: Slower growth may dictate a de-escalation
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
18 October 2022
Published byTellimer Research

The ongoing dispute between Poland and the EU, confirmed by the EU on 17 October, is putting at risk EU funding equivalent to about 2% of annual Polish GDP until 2027.

Clearly, delays to EU funding would negatively affect investment and growth and may trigger additional government borrowing to compensate.

However, fears over a permanent loss of funding, let alone an eventual "Polexit" look overblown.

After Covid and the Russia-Ukraine War the growth outlook is now too weak and the risk to fiscal outlook too acute for Poland to go it alone.

This likely prompts an ultimate de-escalation by the Polish government, led by rightist PIS (Law and Justice).

Yet there may not be any public u-turn before the next election, which is due by November 2023 — opinion poll support for PIS has been stable.

Polish equities have already underperformed most European emerging market peers year to date and are left looking cheaper versus historic average.

Poland accounts for 53bps and 63.6%, respectively, of the MSCI EM Global and MSCI EM Eastern Europe indices.

EU dispute

The total of EUR111m at risk is split approximately one-third post-Covid recovery funds (NextGeneration EU) and two-thirds approved EU budget investments (2021-27 Multiannual Financial Framework).

The dispute relates to the EU's concerns over independence of the judiciary, media freedom, and human rights, specifically the October 2021 ruling by Poland's highest court, the Constitutional Tribunal, ruled against the supremacy of EU law.

Poland: Rule of law deterioration in the last decade

The rightist PIS-led government's ability to test the limits of EU tolerance is weakened by the tougher external environment related to the Russia-Ukraine War, lower global growth, and higher global cost of funding.

On the other hand, it is emboldened by the EU's desire to maintain unity on both the sanctions regime on Russia and the financial, military, and logistics support to Ukraine.

There are echoes here of the Hungary-EU dispute — see Hungary promises reform again as EU funding imperiled, Sep 2022.

Poland: Post-Covid recovery jolted by Russia-Ukraine

Poland: Fiscal deficits dented by Covid and Russia-Ukraine

2023 election

The next parliamentary election is due before November 2023. Currently the government coalition has a slim majority in the lower house (51%, of which PIS is 42%) and a minority in the upper house (47%, of which PIS is 38%). The parliamentary opposition is significantly more fragmented than the governing coalition.

Poland: PIS government slim Sejm majority, Senat minority

The PIS-led government has suffered almost no impact in its opinion poll ratings following both the the October 2021 legal ruling and the Russia-Ukraine War – its support has remained in the range of 36-39%, compared to that of Civic Coalition, its centrist rival, in the range of 26-28%.

Poland: Government opinion poll support has not suffered after anti-EU court ruling or Russian invasion of Ukraine

Relatively cheap equities

Polish equities (WIG index) are down 43% ytd in total US$ return terms, significantly underperforming European EM peers, except for Hungary (down 38%) and Ukraine (down 61%).

A combination of factors, centred around spillover from the Russia-Ukraine War, have driven this:

  • Risk to EU funding over rule of law breaches;

  • c7% of Polish total energy was dependent on Russian gas imports prior to the war;

  • c7m refugees have transited through Poland, with 1.4m staying in Poland (source: UNHCR, 4 Oct 2022), equivalent to 3.6% of the resident population;

  • Inflation has spiked – the latest yoy inflation reading of over 17% and policy rate of 6.75% implies a real interest rate of negative 10.5%;

  • Real GDP growth is slowing sharply from 5.9% to 3.8% to 0.5% in 2021, 2022, and 2023 respectively, according to IMF forecasts;

  • Twin deficits, according to IMF forecasts, for 2023 with fiscal balance of negative 3.1% and current account balance of negative 3.3%;

    • Gross government debt to GDP is c50% (IMF estimate for 2022f) and

    • Total public and private sector external debt to GDP is c60% (IIF estimate for 2021a).

All of these headwinds have left Polish equities looking cheap relative to historic average, more so than most of the European EM peer group.

  • Trailing price/book is 0.8x (for 16% ROE), a 30% discount to the 5-year median.

  • Forward price/earnings (2023f) is 6.3x (for 13% consensus earnings decline but 5.0% dividend yield).

  • Spot FX rate has 8% upside should the real effective exchange rate (REER) move back to 100 and is at fair value, if judged by a REER in line with the 10-year median.

Poland equities cheaper vs history than European EM peers