POLISH FINANCIAL SECTOR OK; THE REAL WORRY IS THE

UNCLAS SECTION 01 OF 02 WARSAW 001217 SENSITIVE SIPDIS TREASURY FOR STEPHEN WINN; COMMERCE FOR MIKE ROGERS E.O. 12958: N/A TAGS: ECON EFIN PL SUBJECT: POLISH FINANCIAL SECTOR OK; THE REAL WORRY IS THE REAL ECONOMY REF: ROME 1247 ¶1. (SBU) Summary: After months of denial that worsening global economic conditions would have a significant impact here, Poland,s economic elite is wakening to increased risk. Poland does not appear to share the immediate risk to its bank balance sheets that is crippling global finance, though parent banks - like Unicredito and Commerzbank - are transmitting weakness and uncertainty into the Polish financial system via their local subsidiaries. Despite markets' inclination to treat Central Europe's emerging economies alike, Poland shares neither Hungary's macroeconomic imbalances nor its risk of insolvency. Concern here is for the real economy, as weakness in Poland's trade and investment partners take their toll in the form of reduced production, restricted credit, and lost investment opportunity. End Summary. The Financial System -------------- ¶2. (SBU) Over 70 percent of Poland's banking system (by assets) is managed by subsidiaries of parent banks based in the EU-15 and the United States. The subsidiaries remain focused on profitable credit intermediation in the Polish market. Our contacts universally agree that local banks' balance sheets are strong, with few illiquid assets of the kind weighing down global financial markets. However, we have heard concern about some banks' need for continuing access to short-term foreign currency loans from their parents, used to finance longer-term mortgage lending (duration risk). Non-performing loans make up only 3.1 percent of existing credit and 90 percent of bank credit is covered by domestic deposits. Moreover, the domestic market for assets like consumer credit and mortgages is sufficiently immature - mortgages came on offer only four years ago - that derivative instruments based on them have not emerged. ¶3. (SBU) Though Polish banks are healthy, their parent companies are under tremendous pressure at home, pressure all our contacts agree the parents are transmitting to their subsidiaries. Polish bankers regard orders from the home office to restrict commercial and real estate lending, for example, as a reaction to weakness in home markets rather than in Poland. Orders to restrict lending in the domestic interbank market - rather than mistrust among local affiliates - have led to higher interbank rates and a liquidity imbalance in the generally liquid zloty market. One bank's chief economist told us that, though the parents cannot directly and openly siphon capital from their subsidiaries, "they can find ways". Market-leader Pekao denied widespread rumors that its parent bank - Unicredito - had extracted over $350 million in capital from Pekao, but suspicion of just that kind of capital siphoning remains widespread. ¶4. (SBU) The National Bank of Poland (NBP) introduced a "Confidence Package" October 14, both to restore smooth functioning of the interbank market and to facilitate banks' foreign currency borrowing needs through foreign currency swaps. Though the Package is welcome and did lower interbank rates, our contacts agree trust and calm will not return to local financial markets until calm has returned to international markets. They also agree that, while financial turmoil is a problem to manage, the real threat to Poland is weakness in its trade and investment partners. The Real Economy -------------- ¶5. (U) That weakness is already sapping growth here. Local economists are quickly revising downward their GDP growth estimates for 2009, to 3-4%, down from 4.5-5.0%. Industrial production and construction are already contracting, though overall domestic consumption - the driver of growth in recent years - remains stable. ¶6. (SBU) On the ground level, the story is darker. GM's plant in Gliwice (protect) has already reduced production by 15-20%. GM Manufacturing's Managing Director fears he will soon have to begin layoffs, though some of his pain may be absorbed by higher-cost GM plants elsewhere in Europe. Aspect Energy of Denver had begun laying the groundwork for a natural gas exploration and production investment here, following a similar successful project in Hungary. Aspect's CEO canceled his trip to finalize the project at the last minute, having been notified by his lenders and partners to WARSAW 00001217 002 OF 002 halt all investment projects. Cargill's local alcohol production business relies on local short-term credit to buy input, which it repays out of cash flow. However, Cargill now reports recent difficulty obtaining what, until recently, was a routine loan. ¶7. (SBU) Slower growth in Poland is not by itself a bad thing. Into September, local economists welcomed lower GDP growth as relief for wage-driven inflation pressures - until recently seen as the principle threat to Polish economic stability. However, the scale of weakness in Poland's partners and the uncertainty surrounding the financial crisis have Polish economists wondering if they are about to experience once again the pain of Russia's collapse in 1998. As the situation develops, we are particularly watching three vulnerabilities. Vulnerabilities -------------- ¶8. (SBU) Currency Risk: Between 50 and 60 percent of the Polish mortgage market is denominated in Swiss francs (CHF). While lower foreign interest rates and the rising zloty made this a good, affordable bet for many borrowers in recent years, those borrowers are now paying much more for their loans than in August. A homeowner who borrowed in CHF is now paying 17 percent more every month. Banks too have assumed risk in this process since they finance their long-term foreign currency lending with short-term borrowing. That borrowing must be rolled-over, but short-term foreign currency loans are increasingly expensive and hard to come by in the midst of crisis. ¶9. (U) The Diaspora: Though good estimates are lacking, well over a million Poles have taken advantage of their ability to work in higher-wage, lower-unemployment Europe. Should increasing unemployment in Britain and Ireland send Poles there back home, Poland would see a spike in the number of job seekers just as the job market here begins to soften. ¶10. (SBU) Confidence in Markets and Potential GoP Response: Polling data suggests most Poles fear the crisis could come to Poland -- and they also doubt their government's ability to respond. Politically, as the Deputy Mayor of Gliwice told CG Krakow, Polish leaders know that Poland will suffer some degree of pain in the crisis, but they do not want to sow panic among workers by announcing that. However, some bankers have complained to us privately that by keeping quiet to avoid panic, the government is actually increasing uncertainty and losing credibility. Comment -------------- ¶11. (SBU) Poland is no Iceland, nor is it Hungary. With its conservative banking subsidiaries, small mortgage market, and strong macroeconomic fundamentals, Poland is not likely to suffer severe direct effects of the global financial crisis. Growth will slow exports, investment, and domestic demand decline, though those effects could be moderated by zloty depreciation and production shifting from higher-cost Europe. We will keep a close eye on three X-factors - Poland's European Diaspora, Swiss franc-denominated mortgages, and government management of uncertainty - but for now, we expect to see ahead old-fashioned, unpleasant economic weakness. QUANRUD