CEE and Greece Macro

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1 Macro, CEE and Greece 21 October 216 CEE and Greece Macro Evaluating the coming political risks As we are two weeks away from the US presidential elections and only months from the probable start of the UK formal process of exiting the European Union, we believe this is a good time to refresh our projections and discuss our main concerns on each event. The dollar. We expect a modest USD rally in the event of a Clinton victory, while we see 2% depreciation of the USD if Trump wins, in the immediate period after the elections (three-to-six months). We expect CEE currencies to also weaken against the EUR, but the depreciation pressure is likely to be modest, in our view, and within the trading ranges seen in the past year. Current account positions have improved significantly since the last crisis and external debt roll-over risks are minimal, in our view. Our picks in the event of a Clinton victory would be the refiners (PKN Orlen, Motor Oil, Hellenic Petroleum), as their margins are denominated in USD and their costs in local currencies, or companies with exposure to the US (Titan) or with sales denominated in USD (like small-cap aluminium producer, Mytilineos). In the case of a Trump win, our picks would be airlines (Wizz Air is our top pick) and upstream firms (OMV, Petrom, Romgaz), as the winners of a weak USD. In addition, a weak USD would be positive for commodities (we prefer NLMK). Growth. A Trump victory would be likely to sap private sector investment plans and global demand, given the perceived risk that his leadership would disrupt trade agreements and ignite geopolitical tensions. Our assessment suggests that this could cost CEE 1.5-2% lower growth in 217E than would have otherwise been the case. In the event of a Clinton victory, we do not expect US growth to deviate much from the current c.2% trend; thus, we would expect a healthy CEE growth trajectory ahead. In particular, we flag: Hungary: we have upped our forecast for 217/18E to 2.9%, above the current consensus expectations. Poland: domestic tax changes under review poses severe downside risks for both our and the consensus growth expectation of c.3% in the coming years. Czech Republic: the CNB seems to be heading for the removal of the CZK floor, regardless of the US election result. Romania: the strongest growth performer, but large flows of returning workers from the UK may sap wages. Greece: heading for c.1% growth in 217/18E, the bailout remains the key factor for the recovery. In our view, CEE is an ideal place to look for dividend plays and a safe haven to hide in case of short-term turbulence in the market. In the financial sector, Moneta is our top dividend story in the region, while Romania remains a paradise for dividend-hunting investors. Russia. Tensions between Russia and the US, and Russia and the EU have been building up for the past two years, and the increase in NATO s military presence in CEE and the Baltics near the Russian border is accentuating the attrition. Although a Clinton victory would be likely to be positive for growth in the near term, we are concerned that her appointment would also increase the likelihood of an escalation of tensions close to the Russia-EU border. In particular, whilst a Trump victory would open the door for some easing of the sanctions against Russia, at least from the US, a Clinton administration, in our view, would make an extension and possible increase of both US and EU sanctions a risk. In terms of international trade, Poland is still the most exposed to a further souring of relations with Russia. Eurozone economic strength. A disruptive Trump administration would have an impact on global demand, which would also weigh on Eurozone growth. However, we believe that there would also be a subtler impact, which may well turn out to be an important positive one: the aggressive fiscal easing planned by Trump may persuade Eurozone leaders to consider a bolder, and hopefully better, targeted fiscal policy. The current Eurozone fiscal framework, in our view, is not reducing the fiscal risks, it is simply delaying the problem: it allows countries with high growth to spend too much (Romania), while preventing countries that desperately need to lift potential growth from aggressively addressing the problem (Italy). We believe that this fiscal strategy is fuelling divisions among the Euro member states and is not helping to boost potential growth. Perhaps greater competitive pressure from the US could help to turn things around. Brexit. The UK EU referendum result has not had much of an impact on economic developments in CEE/Greece thus far. We are of the view that the bulk of the structural effects will only be seen from 22E, in the event that the UK indeed leaves the European Union; thus, our projections for 217/18E only price in some headwinds for capex in the second half of 218E. We stress that two years appears to us to be too little time for the UK to appropriately address all of its trade agreements, implying a high risk of trade disruptions. EQUITY RESEARCH Analysts: Raffaella Tenconi, Alex Boulougouris, Research Team London: raffaella.tenconi@wood.com, alex.boulougouris@wood.com Website:

2 Contents Our initial assessment of the macro implications of the US elections... 3 The outlook for CEE... 5 Czech Republic... 9 Hungary... 1 Poland Romania Greece Detailed macro forecasts central scenario Important disclosures Closing Prices as of 19 October by WOOD & Company Financial Services, a.s. All rights reserved. No part of this report may be reproduced or transmitted in any form or by any means electronic or mechanical without written permission from WOOD & Company Financial Services, a.s. This report may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published without written permission from WOOD & Company Financial Services, a.s. Requests for permission to make copies of any part of this report should be mailed to: WOOD & Company Financial Services a.s. Palladium, Namesti Republiky 179/1a, 11 Prague 1 Czech Republic tel.: fax: http//: Macro, CEE and Greece 2 WOOD & Company

3 Our initial assessment of the macro implications of the US elections US stuck at 2%, at least for now The results of the upcoming US Presidential elections are fraught with uncertainties. Therefore, our initial assessment of the medium-term (two years) macro impact necessarily requires some bold assumptions and simplifications. Here, we do not draw conclusions on the long-term impact of either candidate on US potential growth, which may well be significant it is simply too early to comment on this, in our view. We believe that the average real GDP growth performance of the US in E may prove similar regardless of who wins the presidency, and remarkably similar to the current trajectory: stuck close to 2%, in our view. The yearly performance, however, is likely to be different for the two candidates. If Clinton wins, we expect US growth of close to 2% next year, with an acceleration to 2.5% in the following year. Clinton should benefit from an initial boost of confidence (globally) as she is generally perceived to be the least policy disruptive candidate; indeed, her policy plan is, in many ways, a clear continuation of the Obama administration. The status quo would thus imply that, as the labour market continues to tighten, this would also eventually mean higher private consumption growth compared with what we have seen so far. In our view, some of her proposals, such as increasing the minimum wage and expanding social support for the weaker income classes, would have a positive impact in terms of addressing social tensions and lifting consumption in those segments of society. However, the implementation of these changes is likely to be very slow, particularly since she is likely to have to deal with a Republican Senate opposing several of her plans. In addition, growth headwinds are likely to materialise as a result of the dollar appreciation, the perceived uncertainty of a higher tax bill for higher-income earners and large corporations, and the ongoing Fed tightening intentions. If Trump wins, we expect to see a growth slowdown, driven largely by the (global) confidence hit, as most are likely to want to wait and see the actual policy stance of the new president. This effect is likely to be compounded by the fact that UK Prime Minister May has decided to trigger Article 5 early next year, in the same year of the German and French elections (more on this below). A Trump victory, in our view, would come as a significant surprise to the market, and would be likely to trigger a large currency adjustment initially because of the perceived significant uncertainty over the new president s genuine foreign policy stance. This, in our view, means that the economy would actually benefit from the weaker USD effect and a more dovish stance by the Fed. At this juncture, it is important to make a clarification, in our view. Although presidential candidate Trump has spoken often against the current low interest rate policy of the Federal Reserve, we do not believe that this implies a necessarily more hawkish Fed under his presidency. Quite the contrary, we suspect that his fiscal laxity would actually find support in a dovish Fed which, at the end of the day, needs to abide by its pro-growth mandate. US growth prospects under the two scenarios Real GDP Policy rate 216E 217E 218E 216E 217E 218E US Bloomberg consensus Clinton Trump EZ Bloomberg consensus Clinton Trump Source: Bloomberg, ADA Economics in association with WOOD Research. Policy rate for the Eurozone refers to the deposit rate for which there is no Boomberg consensus Beyond the initial reaction, we expect a fairly sharp recovery of US growth in 218E, led by the effect of the spending increases and tax reductions suggested during the Trump campaign. In our view, Trump will first need to focus on strengthening the economy a necessary condition to please the electorate and implement his foreign policy strategy. Our central scenario is that, despite Trump s comments on potentially withdrawing from NAFTA, in reality he is likely to toughen trade negotiations, especially with the US large trading partners, but this would not translate into an immediate inward-looking shift. This, in our view, is more in line with the Trump businessman strategy: maximising the gain from the legal loopholes, rather than dogmatically going against standards. In addition, we believe that the tax amnesty proposal to bring back corporate earnings is likely to be among the priorities of the administration and Macro, CEE and Greece 3 WOOD & Company

4 Jan-1984 Apr-1985 Jul-1986 Oct-1987 Jan-1989 Apr-199 Jul-1991 Oct-1992 Jan-1994 Apr-1995 Jul-1996 Oct-1997 Jan-1999 Apr-2 Jul-21 Oct-22 Jan-24 Apr-25 Jul-26 Oct-27 Jan-29 Apr-21 Jul-211 Oct-212 Jan-214 Apr-215 Jul-216 Oct-217 could lead to a sharp positive impact on the currency, as well as tax revenues (EUR 2.5trn estimated earnings kept abroad we assume that 3% of this could return to the US during the presidential term). If GDP growth continues to hover around 2%, which is, de facto, the US s potential growth rate, the economy will not build up much capacity constraints going forward and therefore not many of the demand-led prices pressures needed to support a multi-year monetary tightening path. As a result, our policy rate outlook is remarkably flat for the next two years, suggesting that, despite the Fed s hawkish stance, it will actually be very difficult to deliver more than a 25bps rate increase per year (assuming that commodities prices are fairly stable). We would expect a modest and fairly short-lived rally of the USD against the EUR to 1.5 in the event of a Clinton victory; while a sharp sell-off of the USD to 1.3 against the EUR would be likely in the event of a Trump victory, in our view, in the immediate period after the election results (three-to-six months) as the market will be unclear on the geopolitical implications of the new president s policies. US output gap remaining close to zero in the next two years, implying little inflation rise 8 Sticky CPI ex shelter LHS CPI LHS 6 Output gap Clinton Output gap Trump Source: Macrobond, ADA Economics in association with WOOD Research Macro, CEE and Greece 4 WOOD & Company

5 The outlook for CEE Below, we present our growth scenarios depending on the US election outcome and a few important considerations about how the UK decision to leave the European Union may affect Central Europe and Greece. We have assumed that Eurozone growth would be close to 1.2% in 217/218E if Clinton wins, while it would slow to.8% in 217E and recover mildly to 1% in 218E in a Trump scenario. In the latter case, we are concerned that the hit to global confidence, coupled with the Euro appreciation and the political uncertainty surrounding the elections and the UK exit, could have a material impact on the monetary union s growth. We expect the ECB to continue (and increase) the QE programme until the end of 218E. Detailed macroeconomic projections can be found at the end of this report. Brexit: not much impact visible yet The outcome of the UK referendum on EU membership is an important multi-year process. The consequences are not yet visible in the data: there is no clear downward trend showing in business surveys on hiring appetite or production expectations. EU fund flows have been low this year, but this is connected with the initial phase of the 214/22 EU budget phase, rather than any impact from Brexit. Hiring intentions are steady Production expectations softened in August, but rose in Sept CzR Po Ez Hu Ro CzR Po Ez Hu Ro Jan/14 Jul/14 Jan/15 Jul/15 Jan/16 Jul/16 85 Jan/14 Jul/14 Jan/15 Jul/15 Jan/16 Jul/16 Source: Macrobond, ADA Economics in association with WOOD Research Triggering article 5 unlikely to have an impact immediately, but poses steep challenges from 2H18E The UK Prime Minister announced recently that the UK will formally begin the process of exiting its European Union membership by activating Article 5 of the EU treaty by 1Q17E. This process will mean that the UK will have two years to negotiate the details of its departure, as well as, ideally, the new relationship that the country will have with the union. The EU Treaty envisages a possible extension of the negotiations only if supported by all remaining EU member states. As long as the UK is a member of the union (that is, the new agreement is reached and ratified by all member States), the UK will have to continue contributing to the EU budget, as well as complying with all the EU regulations, including freedom of movement and equal treatment of EU citizens. The UK s decision to activate the formal process of exiting so quickly implies two major hurdles, in our view. First, the UK will try to negotiate one of the most difficult processes amid a packed election schedule: German federal elections probably taking place in October 217; the French Presidential elections due in May 217, and the Italian general elections scheduled for May 218, just to name a few key events. As a result, it is possible that the UK will not be able to advance quickly in its negotiations by the time the deadline begins to approach. The second key problem is that the two-year window is extremely tight in practice, in our view. The UK will need to put in place trade arrangements for goods and services with the EU and WTO, as well as all the other free trade agreements currently in place (there are 148 potential agreements that will need to be reviewed, on top of the EU/WTO 1 ), as these will deteriorate as a result of the UK s exit from the union. This implies that, notwithstanding the increase in staff at the UK Trade department, the UK will, in any case, be under very severe strain to put in place all the agreements it needs to maintain the status quo; in fact, we see a very high risk of disruptions to goods and services trade flows if no extension to the negotiations is put in place. 1 The UK Trade Landscape after Brexit, E. Lydgate, J. Rollo, R. Wilkinson - Chatham House Macro, CEE and Greece 5 WOOD & Company

6 EU workers in the UK big outflows not disastrous, Romania may be most hit The UK Office of National Statistics estimates that 5.4m non-uk citizens work in the UK (17% of total employment); 43% of these are EU member states citizens. Among CEE, Poland is the most represented in the UK, followed by Romania. In our view, only a few of these workers will leave the UK in the coming year and may not leave at all until clearer guidance on the UK-EU deal on migration has been struck. The experience of the post-28 crisis shows that, once migrant workers are integrated in a higher-wage country, they do not leave quickly during times of economic strain. That said, should a large share of these workers exit, the impact on the domestic labour market would be meaningful, but not disastrous, if the current labour market conditions were to be in place at the time of the exodus. To highlight this, the table below shows the current unemployment rate and wage growth. We have assumed that 5% of those working in the UK will go back to their home countries as unemployed, and we have thus shown the rates of unemployment and the associated wage growth in recent history. The biggest drop in wage growth is in Romania, despite a minor change in the unemployment rate. This is partly because the jump in wage growth is due to further recent public sector wage increases, and probably as the official unemployment rate estimate is not very representative of those that are genuinely unemployed, which leads to big swings in wage pressure for seemingly small changes in unemployment. Labour and EU funds Immigrants working in the UK, by country of origin, as of 1Q16 Employees (ths) Employees in the B/A EU funds GDP (214, C/D (A) UK (ths) (B) (EURbn) (C) EURbn)(D) Bulgaria 2, % % Czech Rep. 4, % % Greece 3, % % Latvia % % Lithuania 1, % % Hungary 4, % % Poland 15, % % Portugal 4, % % Romania 7, % % Slovakia 2, % % Source: ONS, EU inforegio, ADA Economics in association with WOOD Research Unemployment and wages: currently and changes if 5% of workers in the UK go home Unemployment rate Wage growth 5% flow back unemployment rate Wage growth CZ c.1.2ppts 3.5% PL c.2ppts 3.5-4% Hu 5 7 c.1ppts 6-6.5% Ro c.1ppts 5% Gr* 23.2 c..6ppts Source: Macrobond, ADA Economics in association with WOOD Research. *No good estimate of wage growth available Employment in the UK by country of origin ( ) Cz RO HU PL RHS Source: ONS, ADA Economics in association with WOOD Research Remittances: difficult to monitor, but UK-generated flow is modest According to World Bank data, remittances have gained importance in the past few years, and the biggest recipient of net flows relative to GDP is Hungary (2.6% of GDP). Alas, remittances are not easily monitored accurately. A very rough proxy that can be used is the compensation of employees data from Macro, CEE and Greece 6 WOOD & Company

7 the balance of payments, which is very volatile and is showing an abnormal 29% yoy drop in August in Hungary. From the World Bank s (WB) latest bilateral remittances data (214), we know that the share of flows from the UK to CEE accounts for 22% of net flows in the case of Poland, 19% for Czech, 1% for Hungary, 3% for Romania and 2.8% for Greece. Another rough proxy that may be used to attach some magnitude to the possible hit ahead is to estimate the lost flows if we assume that 5% of the CEE workers in the UK return home, each forfeiting c.eur 4k per year of remittances (we have taken the results of a 215 WB survey, which showed that Romanians sent home GBP 3,5 per year on average, and simply assumed that all workers sent home the same amount (EUR 4,375 given the exchange rate at the time of the study)). The forgone flows in this case are minimal relative to GDP: the highs are for Poland and Romania at.3% of GDP, and a low of.4% in the Czech Republic. As a result, we believe that even a severe slowdown of remittances in the near term would not have a big impact on growth overall, especially as long as the labour market is strong. However, we caution that many of those working in the UK and sending money home may be using the cash to invest in real estate and, thus, a drop in Sterling could cause some cooling off of real estate prices. Net remittance flows as a % of GDP 3.% 2.5% PL Ro Cz Hu GR 2.% 1.5% 1.%.5%.% -.5% -1.% Source: World Bank development indicators, ADA Economics in association with WOOD Research EU funds: no impact yet, but losses of c..5% of GDP from 22E The eventual departure of the UK from the EU will mean that, at some point, the UK will no longer contribute to the EU budget. Assuming that the remaining member states opt not to top up the missing amounts, and that the cost is spread equally, CEE stands to lose between.4-.7% of GDP annually of EU-funded investment for the budget. In our view, this is likely to happen from 22E at the earliest (as it cannot happen before the two years of negotiations and the ratification of the agreement), and may even take longer as the EU may demand that the UK continues to pay its share until the closure of the current investment plans. We stress that the available EU funds will, in any case, probably drop sharply in the next budget allocation (221-27) as the appetite of member states to contribute to these funds has been falling in recent years. On a positive note, it cannot be ruled out that at least part of the lost funds will be replaced by other means. For example, the current Junker investment plan, worth EUR 315bn overall, could be a vehicle used to make up part of the structural funds loss. Summing it all up: rough estimates Our initial assessment of the growth cost from these factors is a 1% hit to trend growth at least in the initial phase of actual Brexit (that is, once the UK has left the union). Downside risks to this view stem from the possible disruption to global trade if the UK were to leave the union without putting in place all the necessary agreements. Upside risks could materialise from a strong local fiscal impulse aimed at partially offsetting some of the lost capital inflows. The fiscal space, however, may be very constrained in those countries that have Constitutional debt limits, such as Poland and Hungary. Macro, CEE and Greece 7 WOOD & Company

8 EU funds decelerating this year Construction sentiment down in CZ/HU this year 9% 8% Hu PL 7% Cz Ro 6% 5% 4% 3% 2% 1% % -1% CzR Hu Po Ro 85 Jan/14 Jul/14 Jan/15 Jul/15 Jan/16 Jul/16 Source: EU funds flows proxied using transfers data from the Balance of Payments, 12m rolling sums as a % of GDP. ADA Economics in association with WOOD Research # Share of exports to GDP (current prices) 2Q16 Do not forget Russia Clinton may accentuate tension in the region In our view, the results of the US elections will have important implications for the sanctions and geopolitical tensions related to Russia. In the event of a Trump administration, some of the current sanctions may be lifted, at least those coming from the US that depend on a presidential mandate. In the case of a Clinton administration, the geopolitical tensions between Russia and its neighbouring countries may escalate, and result in either explicit/implicit trade limitations with EU members, or further intensification of the invasion of airspace. As a result, in our view, we cannot rule out that a Clinton administration could increase the probability of an extension and/or increase of the current sanctions. The tables below are a reminder of how much openness in terms of exports has evolved since the 28 crisis and the direction of goods trade. Poland has the highest share of exports to the UK and to Russia (even after the sanctions). Czech Poland Hungary Romania Greece EZ Exports of goods Exports of services Q8 Exports of goods Exports of services Source: Macrobond, ADA Economics in association with WOOD Research Direction of trade EU EZ UK RUSSIA R. pre-sanctions* CZ HU PL RO GR Source: Macrobond, ADA Economics in association with WOOD Research Macro, CEE and Greece 8 WOOD & Company

9 Czech Republic In the event of a Clinton victory, we expect the Czech economy to outperform the consensus forecasts, growing by 3% in 217E, up from 2.9% this year, then moderating to 2.4% in 218E. We expect household consumption to continue to strengthen, boosted by the tight labour market and modest fiscal stimulus next year. We believe that investment growth is likely to stay at low single digits but, as long as expectations on global growth remain buoyant, next year s performance should again be helped by high inventories accumulation. We expect local borrowing costs to remain at historically low levels throughout our forecast horizon as the inflation outlook is benign. Our alternative scenario of a Trump administration sees GDP growth easing to 1.2% in 217E, then rebounding to 2.5% in 218E. In our view, borrowing costs should remain low and the labour market should soften somewhat (we have priced in a 1ppts increase in the unemployment rate), but still strong overall from a historical perspective. This means that household spending growth would not accelerate, but neither would it grind to a halt. Instead, we would expect investments and inventories to take the brunt of the hit, as well as export growth. In our view, net exports would function as a strong stabilising factor. We stress that this forecast is subject to significant uncertainty as the GDP performance could differ significantly depending on whether private sector confidence drops or rebounds in 218E, or whether it stays weak (which would affect the unemployment rate and investment every.5ppts of higher unemployment rate equals c..2ppts lower GDP growth), as well as depending on the exchange level (a 2.5% appreciation of the CZK equals c..2ppts lower GDP growth). The Czech Republic s central bank (CNB) has operated a currency floor, set at 27 against the EUR, since November 213, which will be dropped in mid-217e, according to the CNB. Our inflation projections suggest that a delay in this to 218E is likely, as the economy maintains meaningful spare capacity and, thus, demand-led inflationary pressures remain muted. Regardless of the exact timing of the floor removal, we expect the initial market reaction to push the currency to the lows reached in 211 at 24 against the EUR, but to subsequently stabilise around 26.5 in a buoyant global backdrop. The balance of payments has strengthened significantly in recent years: the current account surplus was 1.9% of GDP on a 12M rolling basis in the first half of the year, well above the 3.6% deficit in the same period of 28. The funding side of the balance of payments shows steady FDI and record portfolio inflows, reflecting the market expectation of currency appreciation. We suspect that, once the floor is removed, part of these flows will leave the country. The CNB s stance towards the currency floor is highly uncertain in a Trump victory scenario as the potential slowdown in global growth should argue for a delay in the currency floor elimination but, as long as the economy grows at 2% or more, it would be continuing to operate around its potential rate, which may be enough for the MPC, currently led by a more hawkish governor, to bet on an exit of the currency floor anyway, perhaps hoping that the market will have a depreciation bias during a time of turmoil. Wood s real GDP growth estimates in Clinton & Trump scenarios 216E 217E 218E Bloomberg consensus Clinton Trump Source: Bloomberg, ADA Economics in associations with WOOD Research FX reserves soaring (EUR bn) Little increase in expected pricing power Business price selling exp Consumers 12m ahead exp -3 CPI RHS Source: Macrobond, CNB, ADA Economics in association with WOOD Research Macro, CEE and Greece 9 WOOD & Company

10 6/7 1/8 8/8 3/9 1/9 5/1 12/1 7/11 2/12 9/12 4/13 11/13 6/14 1/15 8/15 3/16 Hungary We forecast real GDP growth at 2.9% in both 217E and 218E if Clinton wins the elections: above what we see as Hungary s current potential growth rate at 1.5-2%, above the current Bloomberg consensus projections of 2.5% and 2.7%, respectively, for the next two years. In our view, two key factors will drive the upside surprise. First, the labour market is tightening and wage pressures are accelerating rapidly: 7% yoy. Secondly, we are entering the election campaign, with presidential elections next year and the general elections in 218. The budget performance has been very strong this year, which leaves space for fiscal stimulus in the next two years. The government is budgeting for a deficit of 2.4% of GDP next year, up from our forecast of 1.4% of GDP this year. We assume that the government will not deploy all the planned stimulus next year, but save some for 218E as well (we have priced in a.7% fiscal boost in 217E and 1.4% in 218E). In the event of a Trump administration, we estimate next year s growth at 1.1%, then rebounding to 3.1% in 218E. A partial drag from net exports and falling investment would be the two main sources of headwinds, and we expect that this would sap some of the consumption recovery, which rests in any case on solid wage growth and low borrowing costs. We note that the support for EU investment would increase gradually going forward, as the EU budget enters the strongest part of its cycle. The current account surplus has been surprising on the upside steadily in recent years, reaching 4.5% of GDP on a 12M rolling basis in the first half of the year, compared with a 6.5% of GDP deficit in the same period of 28. Exports of goods and services have risen to 92% of GDP in the 12M to the first half of this year, while imports stand at 82% of GDP the gap is so wide that it would take a major domestic boom for the current account to swing close to balance. In our view, this makes the forint far less vulnerable to bouts of global risk aversion compared with previous periods of financial instability. External debt has fallen sharply in recent years and it is close to the pre-crisis level, having dropped by 4% of GDP from the peak to 15% of GDP in 2Q16, while the short-term external debt stands at 12% of GDP, the lowest value since 23. Our views on the outlook for monetary policy do not differ much between a Clinton or a Trump victory as, either way, inflation would undershoot the MNB s 3% target which motivates the easing bias but the MNB has made it clear in any case that it prefers to use liquidity operations at this juncture rather than interest rates. We believe that bouts of global risk aversion may push the forint to 32 against the EUR, but the strong current account backdrop is likely to support a quick recovery. Wood s real GDP growth estimates in Clinton & Trump scenarios RGDP 216E 217E 218E Bloomberg consensus Clinton Trump Source: Bloomberg, ADA Economics in associations with WOOD Research Rising wages and steady production expectations NFCs net financial balance has improved sharply Prod expectations -7 Net wage RHS % 15% 1% 5% % -5% -1% -15% -2% -25% -3% -35% Source: Macrobond, MNB data, the net financial balance of non-financial corporations (% of GDP) is an indicator of financial strength, the sharp turnaround is a welcome step ahead for Hungary, in our view. ADA Economics in association with WOOD Research Macro, CEE and Greece 1 WOOD & Company

11 Poland The outlook for the Polish economy is fraught with uncertainties, both domestic and external, in our view. Our current estimates show that the economy is on track to grow by 3% this year and 3.5% next year, if the budget confirms the net fiscal stimulus that the government had been signalling until recently and EU funds absorption recovers as signalled by PM Szydlo. Alas, the government s genuine fiscal stance has become less clear in recent weeks. It is working on four programmes, which could easily cut growth by 1%, if not more, in our view. First, the government is working on a reform of the personal income tax system, which may raise the tax burden for middle- and high-income earners, including the self-employed (as many as 1m workers overall, we estimate), from 218E. Secondly, the government is considering changing the corporate tax base to total turnover instead of profits from 218E, with the clear intent of penalising large (foreign companies). This may sap domestic investment and FDI, as well as undoing the benefits of the SMEs corporate tax reduction. Third, the government is aiming to reduce VAT evasion in itself a laudable objective, but one that might already be a factor behind the low capex appetite. Last but not least, the government is planning to start a housing affordability programme from 217E, with the aim of building 3, flats over three years. This is a very significant increase in supply (currently around 15, a year), which may depress house prices and further compound the CHF loan restructuring, itself still under uncertain legislative territory. In the case of a Trump administration, the slowdown in net exports would be likely to compound the domestic uncertainty, triggering a rise in the unemployment rate (we assume a 2ppts increase), in our view. In this case, we would expect GDP growth at 1.5% next 217E and a partial recovery to 2.1% in 218E without taking into consideration the potential increase in taxes for the middle- and high-income classes. The balance of payment position has improved noticeably in the past year and a half as the deficit has shrunk to.6% of GDP on a 12M rolling basis to the end of 1H16, down from the already contained 2% of GDP in 214 and -6.4% of GDP in the same period of 28. That said, the zloty remains exposed to significant bouts of global risk aversion as the share of non-residents holdings of local bonds remains meaningful at 34% of the total, compared with 2% of the total at the beginning of 28. The NBP has adequate FX reserves to partially support the conversion of the banks CHF loan books, but not enough to do that and intervene aggressively and consistently in the FX market, in our view. Wood s real GDP growth estimates in Clinton & Trump scenarios RGDP 216E 217E 218E Bloomberg consensus Clinton Trump Source: Bloomberg, ADA Economics in associations with WOOD Research High confidence, but small spending rise 12M cumulative changes in PLN government bond issuance and holdings of those bonds by local banks vs. non-residents Confidence LHS Nominal retail sales -5 Real retail sales Banks Non-residents Total T-bonds Source: ADA Economics in association with WOOD Research Macro, CEE and Greece 11 WOOD & Company

12 Romania Romanian GDP growth is the strongest among the CE4, reflecting major fiscal stimulus, a structural shift to lower borrowing costs in local currency and double-digit wage growth. Under a Clinton administration, we expect that the economy would expand by 5% this year, 4.5% in 217E and 3.8% in 218E. The main downside would be due to the possible slowdown in EU funds absorption ahead, as well as the increasing drag from net exports. In the case of a Trump administration, we would see growth easing to 3% in 217E, then rebounding to 3.8% in 218E. We stress that these estimates assume that a potential Trump administration would trigger a reduction in global confidence temporarily, but not a protracted slowdown in global demand. Two important tail risks are worth highlighting, in our view. First, the number of Romanian workers in the UK are not as high as for in Poland, but Romanian workers tend to fill the lower-qualification positions, which may be the ones to see quicker job losses as the UK economy slows down due to Brexit. This may lead to lower remittances and some return of workers to their home countries, which could pose some downside risks for the consumption boom. The second issue is that one-third of loans remain in FX and, although they pose a non-systemic risk, as we approach the general elections in December 216 and the 219 presidential elections draw closer, legislators may be tempted to take further bolder steps to address the FX loan stock, as we have seen recently in Romania, and in other neighbouring countries in the past few years. Bold measures to convert loans with exceptionally favourable conditions for borrowers would weigh on banking sector profits, and thus on lending and growth more broadly. Romania is the only one of the CE4 with a meaningful current account deficit of 2.3% of GDP this year, rising to 3% of GDP in 217E and 3.8% of GDP in 218E, on our estimates. We see no significant risk to the currency as a result of the current account deficit as, at this stage, it remains easily funded by FDI and the share of non-resident bold holders locally is modest (1.6% of all local bonds as of June 216). Importantly, the NBR traditionally intervenes to tame the currency volatility and we believe that this time will be no different. Things could prove more challenging if the external environment were to deteriorate for a protracted period of time, whilst fiscal policy remains aggressively on an easing bias in Romania, especially if coupled with further measures affecting the banking sector which would imply a faster widening of the current account deficit and, therefore, bigger currency risks. Despite the strong recovery, Romania is experiencing deflation this year (-1.7%) and a modest inflation pick-up next year (.9%), which represents the fourth year of undershooting the NBR s inflation target. The low inflation is largely the result of the aggressive VAT cuts introduced by the government, as well as the reflection of the low commodities prices. We believe that this backdrop makes the NBR very slow to normalise interest rates, especially as the policy rate, at 1.75%, is well above what the other regional central banks have in place at the moment. We see rates on hold in 217E, regardless of whether we see a Clinton or a Trump administration next year. Wood s real GDP growth estimates in Clinton & Trump scenarios RGDP 216E 217E 218E Bloomberg consensus Clinton Trump Source: Bloomberg, ADA Economics in associations with WOOD Research High wage growth and high spending Favourable shift into RON-lending and away from FX 4% Retail sales (ex cars) 3% Real wages 2% 1% % -1% -2% % 8% RON 6% FX 4% 2% % -2% Source: Macrobond, ADA Economics in associations with WOOD Research Macro, CEE and Greece 12 WOOD & Company

13 9/7 3/8 9/8 3/9 9/9 3/1 9/1 3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15 3/16 9/16 9/7 3/8 9/8 3/9 9/9 3/1 9/1 3/11 9/11 3/12 9/12 3/13 9/13 3/14 9/14 3/15 9/15 3/16 9/16 Greece The Greek recovery has outperformed expectations this year, thanks to more resilient than expected private sector confidence and consumption. Our outlook under a Clinton victory scenario is for a recovery from -.1% this year to 1.5% growth in 217E, followed by a decent (but not great).9% rise in 218E. The crux of the problem is the following, in our view: non-financial corporations are eroding their savings in order to carry on, while profits have stayed negative or barely positive so far in the aggregate. This equilibrium is not sustainable in the long run, and limits Greece s ability to invest and improve its potential growth rate. As a result, we have priced in very small improvements in investment, led mostly by the expected positive effects from the privatisation plans and the slow recovery of the banking sector. Additional austerity is planned for 218E, which should keep a lid on spending, but should not prevent a small improvement then, in our view. We assume that, in the upcoming negotiations, Greece will be granted some respite on austerity and modest fiscal slippage will not require further measures. In the event of a Trump presidency, we expect that the initial risk-off phase would delay Greece s privatisation schedule and thus investments, and put a dent in some of the consumption recovery. The good news is that Greece has modest trade links with the UK (and Russia), but it is meaningfully exposed via tourism receipts. UK tourists account for c.1% of total visits (14.3% of receipts in 215 vs. Russia accounting for 3% of the total) and the weak pound may weigh on tourism inflows already from next summer, flagging downside risks to our projections. In any case, the Greek outlook is likely to remain heavily influenced by the unfolding bailout programme and the slow recovery of the banking sector. The fiscal execution has been strong this year, and the primary surplus is running slightly ahead of expectations thanks to both high revenues and modest spending. However, we remain concerned that the bailout conditions are too tough, especially as the growth rebound projected by the EU looks very ambitious to us in both the nearer term and the medium term. We maintain the view that the Syriza government will continue to cooperate with the EU and gradually execute the programme at least until the middle of next year. We do not see any upside from early elections, at least not before Greece completes the debt restructuring negotiations, which may happen next spring. We expect Greek bonds to be included in the ECB s QE programme once the current review has been completed and the debt negotiations settled. Wood s real GDP growth estimates in Clinton & Trump scenarios 216E 217E 218E Bloomberg consensus Clinton Trump Source: Bloomberg, ADA Economics in associations with WOOD Research Consumers fear of price rises abating, construction & industrial pricing power on a small recovery Hiring appetite holding up for the industrial sector 6 4 Consumers Industry Construction 4 2 Industry Construction Source: Macrobond, ADA Economics in associations with WOOD Research Macro, CEE and Greece 13 WOOD & Company

14 Detailed macro forecasts central scenario Hungary E 217E 218E Real GDP, yoy -1.6% 2.1% 4.% 3.1% 2.1% 2.9% 2.9% Households -2.1%.3% 2.5% 3.4% 3.5% 4.% 4.% Government -1.5% 4.1% 4.5% 1.% 1.% 2.% 3.% Investment -7.% 5.8% 9.8% -2.5% -2.% 1.5% 3.% Exports -1.8% 4.2% 9.8% 7.7% 6.5% 6.5% 6.% Imports -3.5% 4.5% 1.9% 6.1% 7.% 7.% 7.% Nominal GDP, EUR bn HUF vs. EUR avg CPI, avg 5.7% 1.7% -.2%.1%.4% 1.1% 2.% Policy rate, avg Budget balance % of GDP Current account % GDP Source: Macrobond, Eurostat, ADA Economics in associations with WOOD Research Czech Republic E 217E 218E Real GDP, yoy -.8% -.5% 2.7% 4.5% 2.9% 3.% 2.4% Households -1.3%.5% 1.8% 3.1% 2.5% 2.8% 2.3% Government -2.% 2.5% 1.1% 2.% 2.% 2.5% 2.% Investment -3.9% -5.1% 8.6% 1.% 1.5% 3.1%.8% Exports 4.3%.2% 8.7% 7.7% 5.8% 5.% 5.% Imports 2.7%.1% 1.1% 8.2% 4.3% 5.% 4.5% Nominal GDP, EUR bn CZK vs. EUR avg CPI, avg Policy rate, avg Budget balance % of GDP Current account % of GDP Source: Macrobond, Eurostat, ADA Economics in associations with WOOD Research Poland E 217E 218E Real GDP, yoy 1.6% 1.3% 3.3% 3.6% 3.% 3.5% 2.7% Households.7%.2% 2.4% 3.% 3.2% 3.5% 2.8% Government -.4% 2.2% 4.7% 3.4% 3.% 3.5% 4.% Investment -3.9% -5.8% 12.8% 4.5% 1.% 1.5% 1.% Exports 4.6% 6.1% 6.4% 6.8% 6.3% 5.8% 5.% Imports -.3% 1.7% 1.% 6.3% 5.8% 5.% 5.% Nominal GDP, EUR bn PLN vs. EUR avg CPI, avg Policy rate avg Budget balance % of GDP Current account % of GDP Source: Macrobond, Eurostat, ADA Economics in associations with WOOD Research Romania E 217E 218E Real GDP, yoy.6% 3.5% 3.1% 3.7% 5.% 4.5% 3.8% Households.8% 2.6% 4.2% 6.% 6.% 7.% 8.% Government.4% -4.6%.8%.3% 1.% 2.% 2.% Investment -4.8%.5% 1.7% 7.6% 9.5% 7.% 7.% Exports 1.% 19.7% 8.% 5.5% 7.% 6.% 6.% Imports -1.8% 8.8% 8.7% 8.8% 9.8% 9.8% 12.% Nominal GDP, bn RON vs. EUR CPI, avg Policy rate Budget balance Current account % of GDP Source: Macrobond, Eurostat, ADA Economics in associations with WOOD Research Macro, CEE and Greece 14 WOOD & Company

15 Greece E 217E 218E Real GDP, yoy -7.3% -3.2%.7% -.2% -.1% 1.5%.9% Households -8.% -2.3%.5%.3% -1.3% 1.% 1.% Government -6.% -6.5% -2.6%.% -3.% -3.% -2.% Investment -24.% -1.8% 9.9% -13.1%.% 5.% 3.% Exports 1.2% 2.2% 7.5% -3.8% -1.5% 6.5% 4.% Imports -9.1% -1.9% 7.7% -6.9% -8.% 3.% 3.% Nominal GDP, bn EUR/USD CPI, avg Budget balance % of GDP Current account balance % of GDP Source: Macrobond, Eurostat, ADA Economics in associations with WOOD Research Macro, CEE and Greece 15 WOOD & Company

16 Important disclosures This investment research is published by Wood & Company Financial Services, a.s. ( Wood & Co ) and/or one of its branches who are authorised and regulated by the CNB as Home State regulator and in Poland by the KNF, in Slovakia by the NBS, in Italy by the CONSOB and in the UK by the FCA as Host State regulators. Explanation of Ratings BUY: The stock is expected to generate total returns of over 15% during the next 12 months as measured by the target price. HOLD: The stock is expected to generate total returns of -15% during the next 12 months as measured by the target price. SELL: The stock is expected to generate a negative total return during the next 12 months as measured by the target price. RESTRICTED: Financial forecasts, and/or a rating and/or a target price is restricted from disclosure owing to Compliance or other regulatory/legal considerations such as a blackout period or a conflict of interest. NOT RATED: Suspension of rating after 3 consecutive weekdays where the current price vis-à-vis the target price has been out of the range dictated by the current BUY/HOLD/SELL rating. COVERAGE IN TRANSITION: Due to changes in the Research team, the disclosure of a stock s rating and/or target price and/or financial information are temporarily suspended. Equity Research Ratings (as of 21 October 216) Buy Hold Sell Restricted Not rated Coverage in transition Equity Research 5% 41% 9% 1% N.A.% 7% Coverage IB Clients 1% 1% N.A. N.A. N.A. N.A. Securities Prices Prices are taken as of the previous day s close on the home market unless otherwise stated. Valuation & Risks Analysis of specific risks to set stock target prices highlighted in our investment case(s) are outlined throughout the report. 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Fondul Proprietatea S.A. 1, 4, 5 Getin Noble Bank 5 GTC 5 ITG 1, 3 Immofinanz 5 IPF 5 JSW 5 KGHM 5 Komercni 5 mbank 5 Millennium 5 Netia 5 Orange PL 5 Pekao 5 PGE 5 Philip Morris 5 PKO BP 1, 2, 3, 5 PKN 5 PZU 5 RC2 4 Romgaz 5 SIF2 1 SNP 3, 5 O2 CR 1, 4, 5 Transilvania 5 Transgaz 1 WSE 1 Warimpex 1, 5 # Description 1 The company currently is, or in the past 12 months was, a client of Wood & Co or its affiliated companies for the provision of investment banking services. 2 In the past 12 months, Wood & Co or its affiliated companies have received compensation for Corporate Finance/Investment Banking services from this company. 3 In the past 12 months, Wood & Co or any of its affiliated companies have been lead manager, co-lead manager or co-manager of a public offering of the company s financial instruments. 4 Wood & Co acts as corporate broker to this company and/or Wood & Co or any of its affiliated companies may have an agreement with the company relating to the provision of Corporate Finance/Investment Banking services. 5 Wood & Co or any of its affiliated companies is a market maker or liquidity provider in relation to securities issued by this company. 6 In the past 12 months, Wood & Co, its partners, affiliated companies, officers or directors, or any authoring analyst involved in the preparation of this investment research has provided services to the company for remuneration, other than normal course investment advisory or trade execution services. 7 Those persons identified as the author(s) of this investment research, or any individual involved in the preparation of this investment research, have purchased/received shares in the company prior to a public offering of those shares, and the price at which they were acquired along with the date of acquisition are disclosed above. 8 The authoring analyst, a member of the authoring analyst's household, or any individual directly involved in the preparation of this investment research has a direct ownership position in securities issued by this company. 9 A partner, director, officer, employee or agent of Wood & Co and its affiliated companies, or a member of his/her household, is an officer, or director, or serves as an advisor or board member of this company. 1 As of the month end immediately preceding the date of publication of this investment research Wood & Co or its affiliate companies, in the aggregate, beneficially owned 1% or more of any class of the total issued share capital or other common equity securities of the company or held a material non-equity financial interest in this company. 11 As of the month end immediately preceding the date of publication of this investment research the relevant company owned 1% or more of any class of the total issued share capital in Wood & Co or any of its affiliated companies. 12 Other specific disclosures as described above. Macro, CEE and Greece 16 WOOD & Company