Brexit warnings grow louder for East as Commerzbank cuts bonds

[LONDON] Post-communist countries in the European Union are looking more like a no-go zone as investors brace for Britain's vote on whether to leave the bloc.

Commerzbank AG downgraded bonds from Poland, Hungary and Croatia this week, saying the countries are most vulnerable to Brexit risks. The recommendation to cut holdings comes after Citigroup Inc singled out the zloty as among the hardest hit from a potential loss of subsidies, while Societe Generale SA cautioned against Hungarian local bonds and the forint in the run-up to the UK's June 23 referendum.

"Before June 23, markets are likely to trade cautiously in my view, which is why I made the adjustments." said Simon Quijano-Evans, Commerzbank's chief emerging-market strategist in London. "I expect them to underperform versus others."

Strategists have grown more wary toward eastern Europe as Britain's departure threatens billions of euros in EU funding that poorer countries use to build highways and other infrastructure, as well as potentially limiting the funds sent home by workers in the UK as migration becomes restricted. Bonds from Poland, Hungary and Romania have underperformed most of their emerging peers this month amid warnings from central bankers that the vote may spur market turbulence.

EU RELIANCE

Mr Quijano-Evans cut his recommendation Poland's local currency bonds to underweight to match its stance on the country's Eurobonds. He lowered Hungary's foreign-currency and forint notes, as well as Croatian Eurobonds, to market weight, according to an April 27 report.

The brokerage raised Brazilian and Thai domestic debt to market weight.

Brexit poses risks because of the "negative implications this could have for flows from the EU budget and also net remittances" Mr Quijano-Evans said April 28.

Poland, Hungary, Romania and Czech Republic rely on EU subsidies to underpin growth. With its US$545 billion economy and 38 million people, Poland is scheduled to receive 114.7 billion euros (S$154.3 billion) of funds between 2014 and 2020, the most of all 28 states in the bloc, the EU website shows.

The UK was the third-largest net contributor in 2014, adding 7.1 billion euros to the budget, according data from the Treasury in London.

HAVEN STATUS

While Britain's exit from the EU is a "marginal consideration," local assets in central and eastern Europe are vulnerable to Brexit, which can temporarily weaken their haven perception compared with emerging-market peers, Societe Generale said in a March report.

"Trading will be choppy ahead of the event in line with the roller coaster reflected by the polls," Roxana Hulea, an emerging-market strategist at Societe Generale in London, said on April 28. "Hungarian government bonds and forint rates tended to trade disconnected to peers and outperforming the region, and we think they are most likely to sell off."

Citigroup's Luis Costa said Brexit risks add another "layer of complexity" to Poland, where fixed-income instruments don't trade well anymore and "economic policy is still flirting with market-unfriendly measures." Poland's currency has been the worst-performer among major emerging markets this month, sliding 3.6 per cent against the euro.

Zloty-denominated sovereign bonds handed investors losses of 4.7 per cent in dollar terms in April, the most among 31 nations in the Bloomberg Emerging Market Local Sovereign Index. Romanian and Hungarian notes have also declined, compared with gains for Turkey and Russia.

"For now, I think it's sentiment-related, the fear of the unknown," said Richard Segal, a London-based emerging-market analyst at Manulife Asset Management, who prefers Serbian and Croatian assets and is less optimistic about Poland.

BLOOMBERG