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Foreigners in Markets May Be Poland's Next Problem

The Polish capital is a bustling city, with new cafes and restaurants appearing almost every week on its large boulevards.

Despite the fears in Western Europe over the crisis in the euro zone turning into a full-blown recession, the Poles are optimistic.

Warsaw's Castle Square
Antonia Oprita
Warsaw's Castle Square

"People in Poland don't feel the crisis that much," Kamil, a 23-year old student, told CNBC.com in Warsaw. "Polish people don't borrow as much as Americans, for instance. Their debt is smaller, they save money."

But in spite of the ordinary people's optimism, the central bank had to intervene for the first time in more than a year in the currency markets to prop up the zloty and bond prices last Friday because of a selloff by foreign investors prompted by a general fear of risk.

Some analysts have dubbed Central and Eastern Europe a safe haven – due to relatively low risk, because the countries have reformed, and relatively high yields, as they are still seen as emerging markets – but the risks are increasing.

Poland, with a population of 38 million, is the biggest in the region and has enjoyed growth boosted mainly by domestic demand both in its goods and services but also in the capital markets.

The country, which holds parliamentary elections on October 9, is likely to face two big challenges in the next couple of years, analysts told CNBC.com. One of them is slower growth caused by a slowdown or even recession in the euro zone, and another is the public debt, which has quietly grown over the past years.

By law, the Polish government must balance the budget if public debt hits 55 percent of gross domestic product and the country's constitution sets a maximum limit of 60 percent.

According to Eurostat figures, the 55 percent ceiling was reached in 2010 but under the Polish methodology, which is slightly different, it is actually somewhere around 53 percent of GDP.

To make sure the limit is not exceeded, the Polish central bank will have to intervene again to defend the currency and the bond yields, as around 28 percent of debt is held by foreign buyers, analysts said.

"Of course the markets will try to test the level [of the zloty]," Pawel Tamborski, head of investment banking at Wood & Co, told CNBC.com. "There will possibly be more intervention, the statement from the central bank was strong."

Central Bank Governor Marek Belka told Reuters on Friday that if the bank "decides there is a danger of severe volatility in the rate, it will intervene."

Foreigners at the Gates

Higher foreign participation in the domestic market – at a record this year – increases the risk of a selloff and consequently the risk to servicing the debt looking forward, Mateusz Szczurek, ING chief economist for CEE, told CNBC.com.

However, Szczurek added, on the plus side, Poland issued debt well ahead of its scheduled financial needs and it could be absent for at least a quarter from the market.

It also had the benefit of having a private pension fund system in place, and these funds invest in domestic debt. As part of structural reforms two years ago it slashed some early retirement rights for some groups like teachers and journalists, thus saving some money, he explained.

Even with the reforms put in place and its strict laws regarding debt, Poland is not in the position it was in back in 2009, when it could swiftly stimulate the economy and kept growing even as Central and Eastern European peers went through deep recessions.

Eastern Europe - A CNBC Special Report
Eastern Europe - A CNBC Special Report

"Growth would be impossible without a new stimulus," Jan Filip Stanilko, an expert in political economy at the Sobieski Institute in Warsaw, told CNBC.com.

But Stanilko agrees with other analysts who point out that Poles have much fewer loans than Western Europeans and relatively fewer loans in foreign exchange than peers in Eastern Europe.

But with low growth the government would not be able to raise taxes back to where they were before the stimulus, so there is a danger that the debt would have to increase further because of insufficient revenue to the state budget, analysts said.

Another reason for worry is that the sale of the so-called national champions – big state-owned companies – which had been advertised as a good way to increase revenue, is not likely to bring as much money as hoped.

"This is going to end, there aren't many national champions left," Stanilko said.

Poland's structural reforms and its counter-cyclical fiscal policy have served it well, but the central bank's intervention on Friday showed that even reforms are not enough when it comes to dealing with market forces.

The trouble is, analysts said, the central bank cannot keep baring its teeth every time foreign investors decide they want to reduce exposure to Poland.

"Intervention cannot be repeated without limits. They can do that one, two times a year, maybe more," Stanilko said.

But he added that Poland doesn't face the same risks a more developed country would face if it were attacked by speculators: "we're lucky this market is shallow, you wouldn't earn much on speculation."

- Robert Pelka in Warsaw contributed to this story