While developed economy stock markets suffered losses, the exchanges in central and eastern Europe have put in an impressive performance. As of late November stock prices in dollar terms had risen by 32% year to date in Hungary and 24% in the Czech Republic. Even Poland, which had seen poor returns over the year because of depressed corporate earning, prices edged up 1%. Currency appreciation across the region has also contributed to these high returns.
The star performer, in global as well as regional terms, was the Ljubljana Stock Exchange, where prices increased by 60% this year in tolar terms. The market has grown as a result of good corporate results of previously undervalued companies, capital markets liberalisation allowing inflows of foreign capital, privatisations which included the flotations of the banks SKB and Koper, and take-over activity, notably that of the pharmaceutical company Lek by Novartis. “If we have further consolidations and company take-overs, then the market could grow by a further 20–30% in the next year,” adds Saso Ivanovic, portfolio manager at KD Investment Asset Management Company.
Slovenia excepted, these developments appear lost on retail fund buyers, who opted in 2002 to pull out of equities regardless and move into bonds. “We ourselves no longer offer a local equity product but have switched to regional funds including Poland and the Czech Republic to offer more diversification,” adds Peter Holtzer, CEO of OTP Investment Fund in Budapest. The region’s stock markets remain beset by low liquidity and an inadequate selection of stocks, exacerbated more recently by delistings: for foreign strategic owners, invariably listed on a larger exchange, it makes little financial sense to maintain an additional listing on a smaller bourse when the parent company can provide capital. The Prague market, in any case, has only seen two IPOs to-date, while Slovakia’s stock market has negligible business. Only the Warsaw Stock Exchange can match middle-sized west European bourses. It has long been used by companies for raising new capital through IPOs and additional money through rights issues and additionally has a captive market of domestic institutional investors, the second-pillar pension funds, who are obliged to invest 95% of their assets in local markets. However, prices have lagged the rest of the region for the last two years. “There is a lack of supply,” complains Cezary Iwanski, chief investment officer at Pioneer Pekao Investment Management in Warsaw. “Privatisation virtually stopped in 2002 and private investors are not eager to be listed.”
Despite the faster economic growth, the region’s exchanges have not remained immune from global sentiment, especially in Hungary where non-residents have long been the dominant class. They accounted for 72% of exchange-traded shares as of the third quarter of 2002 according to National Bank of Hungary data, but sold off HUF 37bn (E157m) in the second and third quarters, bringing their down from 75% at the beginning of the year. However, local sentiment still remembers the regional collapse in 1998 following Russia’s financial crisis and remains suspicious.
While the regional stock markets have outperformed western Europe and the US, the bond and T-bill markets have likewise provided good returns because of sharp falls in interest rates, which coursed downwards in line with inflation. There is a general assumption among the candidate that after EU membership in May 2004, euro membership is only a matter of time. The Hungarian forint is pegged to the euro, as are the currency boards of Estonia and Lithuania, while the Czech republic, Slovakia and Slovenia have managed floats against the euro. Most of the candidates came close to convergence of inflation and interest rates stability, two of the five Maastricht criteria. In the Czech Republic interest rates are already below those of the Euro-zone.
Poland, as the largest of the CEE candidate countries, has the largest bond market, with some E30bn excluding T-bills, and also the most liquid, especially in the five year tenor, with the lowest spreads. Maturities of government bonds have also lengthened, up to 20 years in the case of Poland and 15 years in Hungary, enabling insurance and pension funds to provide a better match for their liabilities. Bond portfolio investors, however, do not always appreciate the inherent risks. In mid-2002 Hungarian long-term rates rose, causing losses for portfolios with longer term securities. In the run-up to the second Irish referendum on the Nice Treaty in October 2002, which until the last minute threatened to repeat a “No” vote and delay any EU enlargement, international sentiment on CEE bonds weakened. “There was a lot of uncertainty and hedging activity, after which money flowed back into the local currencies,” says Ronald Schneider, fund manager at Raifeissen Capital Management in Vienna. Schneider remains positive on the region’s fixed-income market. “The convergence story is now on track and will support the market further, while the central banks, especially in Hungary and Slovakia, are trying to prevent the further appreciation of their currencies, which could lead to further interest rate cuts.”
Not all the fundamentals point in this direction. In Hungary, with a poor outlook on the budget deficit, interest rates may need to rise again. In the Czech Republic there are likewise questions over the sustainability of the sizeable fiscal deficit. As one fund manager put it, “most investors focus on total returns and don’t understand the impact of rising rates on bonds”.

Topics