Voting with their wallets The volatility of Eastern European politics often makes headlines but how much should political risk be factored into investment pricing? By David Thame
Chaos and car crashes, poisonings, bribes and political plots: the politics of Central and Eastern Europe are far from dull. Be they plain bonkers or downright dangerous, local politicians matter to investors because Central and Eastern Europe promises the kind of returns no longer possible in the more mature markets of the West. But how much should political instability be factored into returns?
The most conspicuous threats to the stability investors crave come from governments in Poland, Russia and, for different reasons, Hungary.
From his office in Vienna, Andreas Ridder, CB Richard Ellis’s managing director for Central and Eastern Europe, has a safe vantage point to watch the region’s frantic political gyrations.
Ridder is clear that he is dealing with some decidedly difficult politicians: the identical twins Lech and Jaroslaw Kaczyinski, who now run Poland, are a particular concern, not least because their hostility to the European Union could seriously undermine the appeal of Poland for foreign investors.
“The twins are worrying, making the life of the EU a nightmare,” Ridder declares, adding that the Czech Republic is in a “fantastic mess” and that the Hungarian government, faced with riots and a public sector financing scandal, risks forcing the country into recession.
Yet the lesson Ridder draws is that there are boundaries between politics and economics that ought to give investors comfort.
“The fact that Poland’s politics are in a mess, and so is the Czech Republic, doesn’t make much difference to the economics,” he says. “Even in Russia, which gets less democratic with every year that passes, the economy is working well.
“Political risks are the biggest concern investors have, because they fear that changes in government will mean changes in the laws governing private property, or that the government will run the economy in a way that causes recession.”
But the overall view is that politics in Central and Eastern Europe is not really affecting economies – there seems to be two worlds, politics and economics. The exception might be Hungary, where huge budget deficits have led to an economic slowdown and high interest rates (see box).
Even in Russia (see feature, p185), where political opponents can face difficulties, and where international oil giant Shell and local big-name corporation Yukos have both felt the firm hand of Kremlin disapproval, Ridder thinks politics and economics can be, to some extent, disentangled.
“A lot of what Putin is doing is helping the Russian economy,” says Ridder. “The impression I get talking to the big funds in Moscow, and even to senior US figures there, is that as long as you stay out of the oil business, the gas business and the media, you can assume you’ll be allowed to run your business free of government interference.”
Warsaw-based Mike Atwell, head of capital markets in Poland for Cushman & Wakefield, agrees that the political risks of investing in Eastern Europe are exaggerated. He says that, despite the deep disarray in the Polish government, the economy remains strong. Investors turn a blind eye to politics and, generally, that is the wise thing to do, he says.
Atwell explains: “When I’m making presentations to new funds and investors, I always find it hard to describe the political situation in Poland – I suppose ‘interesting’ is the best word.
“But whatever you think of the political situation, the fact is that it is having minimal effect on the economy, which may have slowed but is still going like a train. GDP is rising, unemployment falling, and the economy is outperforming expectations. That is because everything is priced in euros, not zlotys, so the biggest problem we face is not local politicians but shifts in the euro interest rates.”
He adds: “Of course you get some overpaying by new investors, you get some poor research and you get failures to do enough due-diligence work, but you get that everywhere, not just in Poland.”
Yet according to Dr Paul Kennedy, head of European research at Invesco Real Estate, drawing too firm a line between politics and economics could be short-sighted. While most political changes do not make much difference to investors, some do.
Dr Kennedy says: “However weird a government gets – and the government in Poland has got quite weird – they would have to take the dramatic step of leaving the European Union to have a real effect on property investment. In the meantime, the issue to look at, if the aim is to reduce or control risk, is lease structures.”
Given that well-let properties in central Warsaw are priced in euros – or, although it is increasingly rare, in US dollars – a property investor is effectively purchasing a euro-zone (or dollar) bond.
“The result,” he explains, “is that you are getting some protection from local conditions and protection of property rights through EU laws, but at the expense of exposure to euro-zone interest rate fluctuations.”
Unusually stable
And what is true of Poland is true, many times over, of Russia. The EU’s writ does not run in Moscow, and Dr Kennedy recommends more caution. Despite galloping inflation, the rouble-dollar exchange rate has remained unusually stable – a paradox investors must learn to understand.
He also recommends that investors acquaint themselves with the curious Alice-in-Wonderland world of Russian yields.
“Political risk is priced in the yields,” he says, “but the problem in Russia is not so much the risk premium as the number to which you add the risk premium in the first place.
“It is not possible to disentangle the Russian economy from Russian politics,” he says, “because the political establishment owns most of the economy. But you must be careful not to judge Russian political standards by our own – it will always need strong leaders and it will always be centralised, and that is not necessarily bad.”
Investing in Eastern Europe, it seems, need not be a political risk.
Trouble at the top in Eastern Europe
For the two years since eccentrically right-wing twins Lech and Jaroslaw Kaczyinski (pictured) took over the government of Poland as president and prime minister, the country has been in a state of crisis. The general election to be held on 21 October, amid loud complaints that the government has been spying on opponents, is not expected to make things any better.
The Hungarian government has been in turmoil for almost as long, after it was revealed that it lied systematically about a gargantuan budget deficit. Months of protest, even a riot, did not produce any resignations, and the economy is still the sickest in Europe.
The Czech government has been teetering on the edge of collapse since the day it was elected in June 2006. In August 2007, Mirek Topolanek took over as prime minister and has since been struggling to unite his right-wing Civic Democratic Party behind tax reforms intended to slash rates of personal tax. For strangely complicated reasons, the reforms will in fact increase tax rates in 2009.
