EU Begins Economic Warfare Against Poland With Politicized S&P Ratings Downgrade

This rating of BBB+ is indicative of an obligor that has adequate capacity to meet its financial obligations but one that the ratings agencies perceive has a higher probability of seeing adverse economic conditions developing in the intermediate future. S&P suggests there is a one-in-three probability of a further downgrade over the next 24 months if a reversal of policy is not undertaken. This rating, BBB+, in particular is at a level that if downgraded another level could have much further reaching implications for the Polish economy. As recently as one day after the election on October 26th S&P reaffirmed their positive outlook for Poland and maintained the relatively sanguine view they have held since 2007. They did suggest that if populist election promises (lowered retirement age, stipends for parents) saw follow through and expenditures were increased without offsetting revenues raised then a revised outlook from “positive” to “stable” could be in order in the future but did not hint at any impending downgrades nor delineate what would trigger one (suggesting that it was not even on their radar at that time).

Yet, on Friday, before any of these campaign-promised fiscal policies have even seen draft legislation proposed S&P enacted a full ratings change and went from a “positive outlook” to a “negative outlook.” It is not possible that this move was grounded in economic analysis as GDP projections have not deviated materially since the election, the economy has not deteriorated at all, and inflation is trending modestly upward which is a healthy sign and proof that there is no deflation in the economy (unlike in other, larger, EU economies). Moreover, only a few months ago (Sept 30th) Marcin Petrykowski, S&P’s Warsaw based Managing Director in charge of the Central and Eastern European region, was raving about the fundamentals of the Polish economy which he saw as ideally positioned for the intermediate and long term and containing a hybrid, “best of both world’s” dynamic of mature, developed European economic stability yet also possessing the growth prospects of an emerging and developing economy. In fact, S&P had strengthened their outlook on Poland from “stable” to “positive” in February 2015 and suggested there might be an upgrade coming in the intermediate term. Petrykowski stated in this September interview “Poland is in a good moment is what we are telling investors.”

I cannot remember ever seeing (in a decade managing portfolios for hedge funds in New York) within one year a total reversal in outlook from “positive” to “negative,” accompanied by a credit downgrade without warning and without any actualized economic data to justify it. The only time this happens this rapidly, without an outlook change presaging a ratings change, is when there is a major geopolitical event such as a coup (not merely the rhetorical allusion to one such as what has been emanating from the EU technocracy). Moreover, with regard to the Polish economy, Petrykowski, in an interview with Parkiet on December 4th (as analysts tend to provide guidance on their perspectives so as not to spook the markets with low visibility surprise) stated that: “Despite the change of power, fundamentals of the Polish economy remain stable.” All of these data points further suggest that this was a politically motivated ratings downgrade.

Poland’s rating of A-, with its accompanying positive outlook, has been maintained for many years as a reflection of its low relative debt and consistent GDP growth that has seen not a single quarterly contraction since coming out of communism in 1989. This is a unique and impressive dynamic. Poland weathered the global crisis during 2008-9 and the Greek driven European crisis from 2010-12 exceedingly well with its flexible exchange rate and labor force and relatively unlevered sovereign, banking sector, and consumer balance sheets. During these previous crises many European economies, both developed and emerging, saw periods of negative growth and recession. Poland was the only EU nation that did not experience any negative quarterly GDP prints and at no point entered recession.

During this period Hungary experienced a political shift that led to economic instability and a downgrade to BB+ which is three further notches below Poland’s new rating. Hungary currently holds a rating that is considered “speculative” and is referred to colloquially as “junk” due to its higher perceived risk of default and reduced investor base. Its outlook is stable which suggests that rating will not be changing anytime soon. By enacting this downgrade on Poland as a sovereign credit, S&P is firmly suggesting that there is now a higher likelihood of the proverbial “storm rolling in on the horizon” and that negative economic outcomes will manifest as a result of political considerations, as it did with Hungary. Theoretically, this prognostication by S&P is suggestive that Poland’s ability to make payments in this intermediate future time period could become impaired.

What is so odd about this Polish downgrade is both the timing and manner in which it came about. As suggested above, the economic rationale for the downgrade is nonexistent by S&P’s standard practices and the statements made by the regional managing director. Thus it surely seems like a politically motivated action rather than an economic one. Usually when a rating of this threshold is changed from “investment grade” with a “positive outlook” down to one notch above “non-investment grade” with a fully reversed outlook to “negative” a sovereign borrower and the global investor class lending the sovereign capital would see a warning issued before this rating change is executed. This would be termed being placed on “credit watch” or “negative watch” and the outlook would be revised from “positive” or “stable” to “negative” before the change. As these ratings changes directly affect borrowing costs this gives the sovereign an opportunity to reverse course in its fiscal or monetary policy and its political and legislative behavior. This warning was not given to Poland. Again, this begs the question: why?

The rationale that S&P offered was that “Poland’s new government has initiated various legislative measures that we consider weaken the independence and effectiveness of key institutions.” Of course in theory this could have derivative economic implications but this certainly has not been borne out and thus one would think at most there might be a change in outlook before a downgrade which at this stage seems more than a little unusual. This rationale offered by S&P reads like it might have been uttered by Martin Schulz, Frans Timmermans, or Gunther Oettinger; three vociferous European Union critics (the latter two: unelected) of the recent Polish government’s politics, policy, rhetoric, and as of last week, legislation. Also seemingly more than a little coincidental is that this is coming off the heels of (merely 48 hours after) Brussels’ evident failure in invoking the Article 7 mechanism that has been threatened to punish Poland for falling out of line, in the EU viewpoint, with “shared European values” (yes, they actually use those words).

The example cited by both the EU and S&P relates to Poland’s new media law which gives the Polish government more control over the public sector media that is paid for by the Polish taxpayer out of the Polish treasury. This normalizing of control over that for which the new government has budgetary oversight has been deemed “censorship” by the Eurocrats and the Western press and most Poles recognize it is thusly deemed NOT because of a lack of pluralism but because now for the first time in eight years there IS pluralism and an anti-EU viewpoint IS being permitted in public media as per the will of the people (as evidenced by the electoral mandate).

Secondarily cited by both the EU and S&P is Poland’s recent reform to its uber-crooked judiciary, the Constitutional Tribunal, which was previously stacked by the last ruling coalition government (PO/PSL). An Article 7 enforcement action, which would see the recipient lose its voting rights in the European Council, was created to punish those who stray from shared “European values” (whatever the hell that means). Given the epic Lisbon debacle it seems like quite the cop-out from a group that has never demonstrated any real consistent democratic values, only ad-hoc policy meant to control its member states and prevent them from acting in their own rational self-interest (Greece and Italy being prime examples thereof).

Article 7 has never been invoked before now and was only written into EU statutory law in reaction to Brussels failure to curb Hungary’s “illiberal” (Brussels verbiage) shift to the right after the Viktor Orban election. The current threat of invocation with respect to Poland was stymied from the get go as Hungary’s Orban telegraphed that he would exercise Hungary’s veto right as a default. Moreover this was probably never more than a threat as the precedent that it would set would no doubt lead to further political instability all over the continent. Smaller nations would rethink how deeply integrated they would want to be into a dictatorial super state run primarily by the not-so-democratic French, Germans, and Belgians (and a Luxembourg politically dominated by one power hungry megalomaniac, Jean Claude Juncker, who has stated publicly that “when it becomes serious, you have to lie” and that Eurozone monetary policy should be discussed in “secret, dark debates”).

The really despicable irony in all of this, and further proof of the politicization of this action, is that S&P cites a rationale that they should have just as readily applied in the last 24 months in Poland, if today’s rhetoric of “weakened independence of key institutions” is to be accepted as authentic. During this period Poland was led by a Brussels-allied Eurocentric government, comprised primarily of the self-interested looters of the Civic Platform (PO), and with the “independence” of the same “key institutions” cited by S&P not mattering at all under their rule.

What transpired in the last two years of PO/PSL coalition rule was much more economically undermining than recent PiS actions and proof that the corruption premium was rising, and as I have argued in the past, why GDP growth slowed as much as it did in recent years. Demonstrable examples of this breakdown of rule of law included brazen voter fraud, the development of a propagandist media supported by the state (both in the private and public sector with private players receiving bail-outs and crony advertising deals all while consistently rallying around Brussels and fully committing to actively censor Eurosceptic views), the nationalization of the private sector segment of the pension system (thus proving how lax private property protections were under the last government, and in part showing a double standard with pro- and anti- Brussels governments as Hungary did the same thing which further catalyzed the ratings downgrade to “junk” but under the PO/PSL ruling government it was never even addressed), the arrests of critical journalists and the abrogation of free assembly and protest rights, and most importantly as an economic consideration (and what amazingly S&P cites in their report as their primary concern going forward) maintaining the independence of the central bank (the National Bank of Poland- NBP). One is left to wonder how this downgrade, based on today’s disclaimed metrics, did not occur sooner under the last government. The last example especially called into question the stability of the supposed free market economy under PO/PSL.

In 2014 the constitutionally-mandated independent NBP head Marek Belka was caught on tape coordinating monetary policy with an emissary of the corruption-plagued PO government (Interior Minister Bartlomiej Sienkiewicz). They were discussing how to be most accommodative in the NBP’s monetary policy ahead of the elections to make sure that no recession could take hold before PO won reelection. If that meant borrowing more and spending more in districts where the vote was going to be close- so be it. This is exactly what S&P claims they are worried about with the new government but it had already happened and was ignored by S&P entirely (and as I have argued, was the kind of political behavior that did in fact slow GDP growth and reduce the aggregate GDP opportunity). The ubiquity of double standards tells investors all they need to know about the honesty of S&P’s ratings changes.

This would not be the first time that S&P’s integrity is called into question with regard to politically currying favor with its rating changes. On Wall Street it has been commonly accepted for years that many of their actions are driven by political considerations. In Europe this was never more evident than during the multiple Greek crises from 2010-12 and the frequent ratings upgrades and downgrades that occurred catalyzing Troika (EU, ECB, IMF) intervention and mandatory negotiations. In April 2010 a downgrade of Greek debt to “junk” forced Greece to negotiate a rescue plan with the Troika (finalized in May of that year) which put Greece under control of these external financing parties. The crisis was far from solved (at the time it was merely a band-aid on a gunshot wound) and more ratings actions by S&P forced Greece back to the table. Each time Greece had to cede more of its sovereign decision making capacity to “global finance” on whose behalf the Troika was negotiating. These upgrades and downgrades were used to keep Greece at the mercy of its creditors and prevent it from restructuring in the manner which would have saved the Greek people from socially crippling austerity in favor of the predominantly German banking interests who were fearful of having to take write downs on their Greek debt portfolio holdings.

Before the European debt crisis had reared its ugly head S&P had already garnered a fair amount of infamy for its role in the American housing bubble (largely seen as one of the major enabling players of the entire crisis) which, when it burst, led to the deepest recession since the global depression of the 1930’s. Ironically, these events have just been immortalized in the last couple of weeks in the new film “The Big Short” where the main characters refer to the ratings agencies (of which S&P was the largest and most complicit in the now proven fraud and was made to pay out a record almost-$1.4bn fine, settled after the SEC originally sought $5bn) as “whores.” It dawns on them when talking to an emissary of S&P, who is avoiding downgrading impaired bonds, the entire business model of the ratings agencies is simply selling their ratings to the investment banks and the underlying issuers securitizing the mortgage bonds. This is a well-earned depiction of their corporate citizenship as they were being paid by these issuers (besides the banks selling them to investors, mortgage brokers lining up the consumer loans, specialty finance and lending companies, insurance companies like AIG, etc.) to “bundle” high risk mortgages into tranches of pooled securities with the (highly flawed) logic that the default risk was mitigated through “diversification.” In this way they were able to obtain higher ratings than were mathematically warranted (about 75% of these mortgage pooled securities achieved a gold standard AAA rating). The rating agencies also helped catalyze this whole financial debacle to by lobbying the political class vociferously for relaxed financial regulations. So as one can see, the ratings agencies, and especially S&P as the leader of the big three, was no stranger to being in bed with politicians in quid-pro-quo arrangements to make profit at the expense of the integrity of the system (this was not capitalism by any means but cronyism in its purest forms).

Given the preponderance of evidence of deep political engagement by S&P it is clear that they have behaved frequently as a tool of Washington and Brussels. This further lends credence to the theory that the Polish downgrade was exercised at the behest of an EU that wanted to punish Poland. The fact that a move to a negative outlook and being put on a credit watch was not the extent of S&P’s actions says a lot about the motivation of this downgrade. An outlook change would have offered the positive optionality of catalyzing a pivot by the political class, and a reversal of proposed legislative policies, before the damage of increased deficits is inflicted on the economy. This would allow for a preservation of the original credit rating and preservation of the existing market for Polish sovereign bonds at current interest rates. A “holding steady” of borrowing costs and not having to issue debt at higher interest rates to compensate bondholders for the added risk of default that higher deficits (partially resultant from the higher borrowing costs that are catalyzed by the ratings change itself) bring is GDP protective. Unfortunately Poland did not receive this logical market driven courtesy from S&P despite the fact that the overhangs on the economy they cite in their “rationale” are abstract and legislation that might lead to higher deficits has not even been formally proposed in the legislature yet.

It is important to note a few other data points. Firstly, Fitch, the third largest rating agency (Moody’s is #2 to S&P’s #1), generally considered to be the most responsible and least politicized of the big three ratings agencies, reaffirmed its A- rating and maintained its stable outlook on Poland. Apparently Fitch is not taking its marching orders from Brussels and is sticking, with discipline, to its process. In addition to Fitch, the World Bank and IMF also reaffirmed their stance on Polish economic fundamentals and did not sound the alarm.

Citibank, with one of the most widely respected global macro research desks focusing on FICC (fixed income, currencies, and commodities) on Wall Street put out a research note shortly after the downgrade expressing shock and surprise at the action. They viewed the S&P rating change as “harsher than expected” and would not have felt that way with merely an outlook change that would have allowed economic data to be actualized before taking action that would spike borrowing costs for a democratic sovereign.

Thirdly, and most tellingly, the Minister of Finance (Pawel Szalamacha) stated after the downgrade that he was not approached to discuss S&P’s economic assumptions, which given the magnitude of S&P’s formal sentiment shift was more than a little odd. However, according to respected financial reporter Wojtek Surmacz, S&P did speak to two high profile Polish public sphere economists unofficially; Mateusz Szczurek and Ryszard Petru. Szczurek was the last Minister of Finance under the recently vanquished government and now opposition party, Civic Platform (PO). Petru is the leader and founder of a new opposition party Nowoczesna (NPL), and a particularly self-serving economist with a horrible track record in economics and an even worse track record in integrity who has been trying to claw his way into a political position saying whatever he thinks will glean him support. These data points really make one think about S&P’s actions this past Friday.

Unfortunately this punishment Brussels has meted out to Poland ultimately will lead to higher borrowing costs for the nation and its citizens and will have direct negative impact on the Polish economy. Poland will have less capital to invest in Poland for Poland and its citizenry. This capital that will now go to fund higher borrowing costs would have been useful for infrastructure development or social welfare or any one of many other initiatives that the growing Polish democracy is eager to engage to see its economy further develop. An unfortunate potential result from the higher financing costs may also be higher deficits, if revenues cannot be raised, which in turn will attract less FDI (foreign direct investment) as well.

So Brussels has just proven that they are willing to engage in economic warfare and concerted efforts at GDP destruction against the citizens of free nations and democratically elected governments as punishment for not following their political mandates. If this is not technocratic tyranny I do not know what it is. Davos begins this week and the Eurocrats will no doubt be patting themselves on the back for a job well-done in keeping those pesky Poles, with their free elections, in check while the EU elite all dine on champagne and caviar…at taxpayer expense of course.