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Looking for Currency Yield? Try New Europe

Investors looking for exotic currencies that still offer high yields might want to take a look around Central and Eastern Europe. But they should know the regions are a mixture of bright spots of convergence to the strong euro zone and some bad apples, analysts told CNBC Europe.

The Czech Republic, Slovakia and Poland are good examples of convergence. Allhave small current account deficits and their economies are still doing well.

Their high rates of growth and low labor costs compared with richer peers in the European Union attract foreign investors, and they are also getting billions of euros in EU funds to help them attain the level of the bloc's most developed economies.

"The Czech crown continues to be seen as a safe haven on the emerging markets front, even compared with the Hungarian forint or the Polish zloty," Luis Costa, emerging markets debt strategist at Commerzbank Securities, told CNBC.com.

The Hungarian forint has one of the most alluring yields in the region, as interest rates are at 8.25 percent with the central bank trying to fight inflation currently running at 6.6 percent.

“We now see risk/reward in favor of buying three-year Hungarian government bonds funded in local currency,” UniCredit analysts wrote in a market note.

But despite the tempting yield, those putting their money into the Hungarian forint should be careful because of political uncertainties and "many inflationary pressures, like in a lot other countries in the region,” Costa said.

“The convergence of spreads could be gradual; there will be no rally over there,” he added.

Poland, a Good Bet

Costa is bullish on the Czech currency, the Slovak crown "is already there," while the Hungarian forint has bounced back, but "will be more volatile."

Poland also looks like a good bet, with economicgrowth for 2008 expected to average about 5 percent, mostly generated by domestic consumption, and with a housing rally unlikely to end as the credit expansion still looks solid.

“Firms are growing 25 percent year-over-year in real terms, so there’s still substantial growth in credit,” said Bartosz Pawlowski, an economist at TD Securities. “No one is talking about a bubble or an imminent crash of house prices."

One reason is that economic growth has increased the Poles' real earnings and their credit worthiness and banks are still eager to lend out money, Pawlowski said.

The zloty’s rise of over 10 percent against the euro in the year may have dented exports slightly, but unlike Hungary, the Polish economy is the least dependent on exports in the region.

The most important signal for the country would be a clear indication from the government that it will enter the euro's waiting room, the ERM II, by 2009, analysts say.

With Polish government bonds currently yielding some 2 percent more than German bunds, there is great opportunity, according to Pawlowski: “The expectation is clearly that the two will converge.”

Risks

But there are risks to growth, analysts say, as these countries may suffer if the euro zone, their main trading partner, slows down too sharply in the credit crunch fallout.

The Baltic states, whose currencies have fixed exchange rates, and also Hungary, are already slowing down, while the three bright spots the Czech Republic, Poland and Slovakia are likely to start slowing more meaningfully in the coming three months, UniCredit analysts said.

Romania, although its economy has been growing robustly, risks slowing down quite significantly, the European Bank for Reconstruction and Development warned recently.

The Romanian leu, which until the summer of last year was the darling currency of investors, has suffered a hard blow because of the credit crunch, with speculators shrugging off the country’s impressive economic growth to pay more attention to the yawning current account deficit.

“If I have to establish a negative on a currency, that would be it,” said Costa. “Fundamentally speaking, that’s the weakest link. Three-sixty-five (against the euro) can still be cheap.”

Contact Europe: Economy

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