ERSTE BANK Analýza UROKY

Erste Group Research
CEE Bond Market Report | CEE | Fixed Income

18. July 2022
Approaching turning point

CEE central banks have intensified their fight against inflation in recent months. Inflation is to
peak in 3Q, but the timing of the peak could be affected by the government’s price policies. CEE
central banks will end their tightening in 2H22 and LCY yield curves will become more inverted.
Analyst: Central banks used more ammunition
Juraj Kotian
juraj,kotian@erstegroup.com
We have seen an unprecedented increase in LCY bond yields in CEE this
Government bond yields year, which, in combination with the weakening of currencies, has led to
current 2022Q3 2022Q4 2023Q1 2023Q2
Croatia 10Y 3.2 3.6 3.6 3.6 3.6
huge losses in the value of these assets for non-resident investors. In recent
spread (bps) 202 203 199 196 201 months, as inflation continued to surprise to the upside, driven by increasing
Czechia 10Y 4.5 4.4 4.3 4.2 4.0
spread (bps) 334 287 270 254 237
food and energy prices, central banks have also been intensifying their
Hungary 10Y 9.1 8.5 8.4 7.8 7.2 efforts to fight inflation. Since March, the CNB has increased rates by 200bp
spread (bps)
Poland 10Y
795
6.7
691
7.0
681
6.8
618
6.7
563
6.6
and since May has started to use balance sheet operations – FX
spread (bps) 558 540 520 501 497 interventions, to reduce excess CZK liquidity. The Hungarian central bank
Romania10Y 9.2 9.0 8.8 8.5 8.3
spread (bps) 803 743 714 686 666
more than doubled its interest rates, surpassing Czech rates. Hungary is
Slovakia 10Y 2.1 2.5 2.7 2.9 2.9 currently running the highest interest rates in the region (9.75%).
spread (bps) 100 93 109 121 131
Slovenia 10Y 2.19 2.60 2.60 2.70 2.70
spread (bps) 106 103 99 106 111 However, going forward, we see the current yield levels of LCY government
Serbia 5Y 6.7 6.5 6.3 6.0 5.7
spread (bps) 557 493 469 436 411
bonds as attractive, given that inflation and interest rate increases are close
DE10Y* 1.13 1.57 1.61 1.64 1.59 to their peaks and yield curves should turn even more inverse, especially if
* Spreads based on Bloomberg consensus forecast
signs of an economic slowdown start to materialize. Prices of metal and
Source: Erste Group Research
agricultural commodities corrected strongly in recent months. The UN Food
Prices as of July 15th, 2022 and Commodity World Index has fallen 10% since March. Only gas prices
remain elevated, due to the ongoing Russian war in Ukraine and fears that
the temporary halt of gas supply through Nord Stream 1 (due to scheduled
Contents maintenance work) will become permanent.
Central banks used more ammunition .......... 1
Windfall tax revenues followed by higher
expenditures ................................................ 2 A visible correction on bond markets has already taken place in Czechia
Inflation to peak in 3Q22 .............................. 3 and Poland, which are two countries where the end of tightening is expected
End of tightening is looming ......................... 4 in 3Q. 10Y yields are already about 110bp down from their highs reached
Bonds ready to bottom out ........................... 5
Croatia ......................................................... 7 in June. In our baseline, we expect 10Y LCY government bond yields to fall
Czechia ....................................................... 9 30-150bp by next summer, while yields for EA members (Slovakia,
Hungary ..................................................... 11 Slovenia) should edge up 40-60bp, due to the very late start of
Romania .................................................... 13 normalization of monetary policy, which includes rate hikes and the end of
Serbia ........................................................ 15
Slovakia ..................................................... 17 QE.
Slovenia .................................................... 19
Rating agencies have already appraised Croatia’s euro adoption and all of
them delivered at least one-notch upgrade (Fitch to BBB+ from BBB, S&P
to BBB+ from BBB- and Moody’s to Baa2 from Ba1). Croatia’s ratings from
Fitch and S&P now sit one notch above those for Hungary and one notch
below those for Poland. In the second half of July, Fitch is supposed to
CEE Macro & FI Research issue its assessment of Hungary, in which it may raise concerns about the
Juraj Kotian (Head) unresolved situation regarding access to EU funds and mounting twin deficit
issues by changing the outlook to negative. In Romania, despite very limited
Katarzyna Rzentarzewska
(Chief CEE Analyst) progress on the fiscal side, we do not expect a downgrade to non-
Katarina Gumanova investment grade this autumn.
(CEE Macro Analyst)
Note: Past performance is not necessarily

indicative of future results.
CEE Macro & FI Research Page 1
For the exclusive use of Erste Group Client. (Erste Group)

18. July 2022
Windfall tax revenues followed by higher expenditures
While very high inflation increases the risk of stagflation, the impact on
public finances might be positive in the short run. This is because inflation
boosts tax revenues, but an increase of public expenditures comes with a
delay, as indexation of wages and pensions is based on ex-post inflation.
We can see this happening in CEE, where governments are enjoying
double-digit tax revenue growth at the moment. When it comes to public
debt, countries with a higher level of debt (i.e. Croatia, Hungary, Slovenia)
are going to observe a visible decline of debt ratios, as they benefit
proportionally more from a higher deflator (nominal GDP), thus outweighing
the contribution of the deficit to public debt ratio.
General government balance Gross public debt

% of GDP % of GDP
Source: Erste Group Research Source: Erste Group Research
Nevertheless, along with the anti-inflation and inflation relief programs, CEE
governments have started to think about fiscal consolidation measures to
get their deficits under control. The Hungarian government, which, due to its
huge pre-election spending and pre-financing of missing EU funds, boosted
YTD cash-based public expenditures by 35% y/y (as of May), has now
unveiled its consolidation plan, which strongly relies on sector taxes, tax
increases for small businesses and lower capital expenditures. Romania
also came up with a consolidation package, which is rather small (0.1% and
0.7% of GDP in 2022 and 2023, respectively). Hungary and Romania, the
two countries that were running the highest fiscal deficits in the region last
year, show clear symptoms of twin deficit issues. That obviously puts
pressure on both the currencies and foreign financing.

18. July 2022
Currency structure of public debt Financing from RRF

% securities and loans EUR bn
Source: Erste Group Research, Bloomberg Source: Erste Group Research, EC
Indeed, given the high financing costs on the domestic market, both
Hungary and Romania were tapping foreign markets in 2Q. However, given
that the sovereign bond market in the Euro Area was also under pressure,
while European institutional investors have a clear preference for assets
with strong or firm ratings, the appetite for buying Romanian and Hungarian
debt was rather lukewarm. That is why both governments opted also for
issuance in USD. In both countries, the share of FX debt in overall debt has
been growing in the last 12 months. At this moment, Hungary is more under
pressure, as it faces the highest borrowing costs on the domestic market
and at the same time does not have access to NGEU funds. Other countries
(apart from Poland) have already received their pre-financing part (13%);
Croatia has received the first tranche of grants and Romania took a loan
from the RRF at very favorable conditions. Poland is expected to receive its
pre-financing soon.
Inflation to peak in 3Q22
Driven by increasing food and energy prices, inflation continues to surprise

to the upside, reaching new heights. Czech inflation climbed to 17.2% in
June and Polish MPC member Kotecki warned that inflation may peak at
around 20% in 1Q23. We forecast that, in principle, inflation is to peak in
3Q22, and in some cases the timing of the peak could be affected by the
phasing out of price subsidies or delayed energy price increases. However,
the high inflation has already dented real wages and left its mark on
consumer confidence in CEE, which should be seen soon in the weakening
of demand. Due to rising fears of global recession, supply-driven inflation
may ease as well. Prices of metal and agricultural commodities corrected
strongly in recent months. The UN Food and Commodity World Index has
fallen 10% since March. Only gas prices remain elevated, due to the
ongoing war of Russia in Ukraine and fears that the temporary halt of gas
supply through Nord-Stream 1 (due to scheduled maintenance work) will
become permanent.

18. July 2022
Average inflation to go up to 12.4% in 2022 Changes in commodity prices

Average inflation, % % in USD, last three months4
Source: Erste Group Research Source: Bloomberg (GLCO), Erste Group Research
All in all, inflation should average 12.4% in CEE, with visible risks to the
upside. Next year, CEE inflation should moderate somewhat, but remain
above the target (7.1% on average) in all CEE countries.
End of tightening is looming
CEE central banks have intensified their fight against inflation in recent
months. The Czech National Bank raised its key rate to 7% at its last
meeting before the changes to the MPC (including the leadership) took
place. It is a well-known fact that new Governor Michl has not been a
supporter of rate hikes and openly advocated for an end to the tightening.
Since May, the CNB has started to be more active in reducing excess CZK
liquidity via its balance sheet operations (FX interventions). These should
allow the central bank to stop raising interest rates and unwind large CZK
positions built during the era of the FX intervention floor and finally shrink its
balance sheet. The Hungarian central bank is in a different position, due to
the external vulnerabilities of Hungary (rising twin deficit issue) and no
access to RRF funds (and the regular EU funds from the new programming
period) until the resolution to the rule of law objections is found. The
Hungarian central bank had to deliver a 200bp emergency rate rise in early
July (bringing both the key rate and 1-week deposit rate to 9.75%) in an
effort to stop the forint from a free-fall. We expect the MNB to raise rates to
12% by the end of this year. We expect the central banks of Poland and
Serbia to finish their tightening cycle already this autumn, with the key rates
reaching 7.5% and 3%, respectively. Romania’s key rate is expected to
peak in 4Q22 at 6.5%.

18. July 2022
Intensified tightening in recent months Peak of tightening cycle in sight

Key rates (%), rate increases (bp) Key rates, %
Source: Bloomberg, Erste Group Research Source: Central banks, Erste Group Research
Bonds ready to bottom out
We have seen an unprecedented increase of LCY bond yields in CEE this

year, which, in combination with the weakening of currencies, has led to
huge losses in the value of these assets for non-resident investors. It was
no surprise that, in the last couple of months, non-residents have been
underweighting their exposure to CEE, due to their expectations of more
aggressive tightening by central banks and worries about the negative
impact of the Russian conflict on the region, especially thanks to its high
dependence on Russian gas. Hungarian bonds have been hit hard, as the
growing twin-deficit issue and still unresolved problems with the rule of law
(endangering future EU fund inflows) weaken the HUF.
10Y government bond yields YTD performance of 10Y bonds

yields and forecasts (%), YTD change (bp) %, measured in EUR
Source: Erste Group Research, Bloomberg Source: Erste Group Research, Bloomberg

18. July 2022
However, going forward, we see the current yield levels of LCY government
bonds as attractive, given that inflation and interest rate increases are close
to their peaks and yield curves should turn even more inverse, especially if
signs of an economic slowdown start to materialize. Such a development
has already started in Czechia and Poland, where yields are already about
110bp down from their highs reached in June. In our baseline, we expect
10Y LCY government bond yields to fall 30-150bp by next summer, while
yields for EA members (Slovakia, Slovenia) should edge up 40-60bp, due to
the very late start of normalization of monetary policy, which includes rate
hikes and the end of QE.
Spreads on EUR-denominated Eurobonds

Spreads vs. mid-swap (bp)
Source: Erste Group Research, Bloomberg (April 15)
Spreads on Eurobonds have shown some divergence among CEE countries

in recent months. Croatia’s Eurobonds have been traded more tightly
compared to Hungary, on the anticipated positive assessment of the Euro
Area membership. Rating agencies have already reflected this qualitative
step forward for Croatia and all of them delivered at least one-notch upgrade
(Fitch to BBB+ from BBB, S&P to BBB+ from BBB- and Moody’s to Baa2
from Ba1). Croatia’s ratings by Fitch and S&P now sit one notch above
those for Hungary and one notch below those for Poland. In the second half
of July, Fitch is supposed to issue its assessment of Hungary, for which it
may raise concerns about the unresolved situation around the access to EU
funds and mounting twin-deficit issues by changing the outlook to negative.
In Romania, despite very limited progress on the fiscal side, we do not
expect a downgrade to non-investment grade this autumn.

18. July 2022
Alen Kovac
Chief Economist Croatia
Erste Bank Croatia
Supply and demand factors
Following business as usual in 1Q (EUR 1bn local market tap), 2Q

Eurobond issuance reflected a less supportive external environment,
translating into EUR 1.25bn issuance (our pre-war baseline was issuance in
the region of EUR 2bn). On the local front, in addition to standard T-bill
auctions (HRK 3.4bn, approx. 90% rollover), we also saw EUR 1.035bn in
1Y EUR T-bill issuance (against EUR 1.2bn maturing). Finally, 3Q kicked off
with another EUR-linked EUR 1.2bn local issue, with the 4Y tenor
accounting for EUR 400mn and the 10Y accounting for the remaining EUR
800mn. Solid demand (EUR 1.8bn) confirmed a stable local demand profile,
with the deal priced at 2.17% and 3.47%, respectively. In total, this brings
the issuance to EUR 3.45bn, i.e. still short approx. EUR 0.8bn from the FY
budget target (EUR 4.25bn). Hence, we are not ruling out additional
issuance in the post-summer period, with the size likely being fine-tuned for
fiscal performance, as the current growth/inflation mix bodes well for the
revenues outlook.
Global developments continue to set the tone as far as the demand side
goes, and this especially holds true for global investors amid the absence of
a home-market bias. While, once Croatia joins the EU, we still lack clarity as
to whether the ECB would play a role on the demand side, a strong
investment profile and wider investor base should provide some anchoring
in the current volatile environment. On the local front, the alignment of the
prudential regulation and lowering of the reserve requirement (from 9% to
1% in two steps) would provide a liquidity boost and likely boost the risk
appetite towards sovereign from the banks' side. Unsurprisingly, pension
funds would maintain their supportive role and have the potential to take
additional exposure. The bottom line is that, with YTD issuance, deposit
buffer (6% of GDP) and the above-mentioned factors, we consider the
financing prospects to be smooth.
Yield curve development over time Foreign investor ownership of T-bills/bonds

% %
Source: Erste Bank Croatia Source: Erste Bank Croatia

18. July 2022
The green light from ECOFIN removed the last formal obstacle and the
stage is set for EMU membership from 2023. Schengen Area membership,
another important milestone (especially for tourism), also looks to be a done
deal for 2023 and the icing on the cake as far as key integration goals are
concerned. As advocated earlier, rating agencies are appreciating these
steps, especially as embedded external vulnerabilities related to high
euroization would greatly diminish and crisis resilience improves. On that
note, Moody's pre-announced a two notch upgrade upon the formal
ECOFIN decision, while Fitch delivered one-notch upgrade right after the
decision. S&P follow a day later with two-notch upgrade.
The bond market remained a roller-coaster ride throughout 2Q. The external
environment, especially ECB rhetoric and the market digesting the inflation
and recession risks, continued to set the overall tone. Hence, we saw the
longer end of the EUR curve moving above 3.5% and even closing the gap
towards 4%, before pressures recently subsided, as we saw approx. 50-
60bp mostly reflecting strong benchmark repricing and bringing the longer
end back closer to the 3% mark (currently trading at around 3.2-3.3%), i.e.
approx. 80-90bp higher q/q. On the spread side, developments were
steadier, as risk premia predominantly moved in the 180-220bp region and
here we think that local specifics came into play. As far as the outlook is
concerned, global/external factors will continue to play a detrimental role
with regard to inflation/recession risks and continue to shape the volatility
swings. As far as the fundamentals are concerned, we see limited downside
from current spread levels, while the integration story remains strong upside
risks, although remaining shaped by the global risk appetite.
Yield and spread development

Yield (%), spread (bp)
Source: Erste Bank Croatia

18. July 2022
Jiri Polansky
Macro Analyst Czechia
Ceska Sporitelna
In May, the central government budget deficit increased significantly to CZK

189.3bn. In this year, we expect the deficit to come in at CZK 320bn (4.7%
of GDP), mainly due to the higher than previously expected expenditures
associated with the consequences of the war in Ukraine. Among them, the
planned energy tariff for households could mean higher expenses by more
than CZK 60bn. However, the detailed description has not been revealed
yet. Moreover, the government has launched several other programs
(housing benefits, subsidies for firms or cancelation of the road tax, etc.)
and plans to increase the wages of public sector employees.
The central government budget deficit will remain high in the next two years,
for which we expect CZK 285bn (4% of GDP) and CZK 220bn (2.9% of
GDP), respectively. This is affected by the current structural deficit, which
could be close to approx. CZK 200bn now. From a medium-term
perspective, this will probably result in tax increases; on the expenditure
side, the room for significant cuts is not so high, while there will probably be
high military and energy investments in the next few years.
For the rest of 2022, financial needs could be around CZK 200-250bn. In
2H22, the small volume of maturing bonds and relatively significant amount
of cash funds available will have an impact, lowering the needs, but the
government will have to finance the rising support to the economy. In the
coming two years, financial needs will gradually decrease (CZK 500bn in
2023 and CZK 390bn in 2024), mainly due to lower budget deficits.
The MoF will continue to focus on bonds denominated in CZK. Recently, the
MoF has started issuing bonds with shorter maturities or T-bills, mainly due
to the very high yields at the long end of the curve. If yields at the longer end
of the curve fall in the coming months, which we expect, the MF could again
increase the share of bonds with longer maturities.
Government securities maturing till Jan-2023 LCY yield curve forecasts

CZK bn Yield, %
Source: MinFin, Ceska Sporitelna Source: Bloomberg, Ceska Sporitelna

18. July 2022
Other factors
Before the June CNB meeting, the yield curve shifted significantly upwards.
The excessively optimistic expectations of a part of the markets that the
CNB could move rates up to almost 8% contributed significantly to this. In
June, the CNB delivered 125 basis points and the curve (especially its long
end) corrected significantly downwards. However, we still consider the
longer end of the curve to be too high in relation to the fundamentals
A new CNB bank board took office in July, but we still do not have detailed
information about its stance. However, we assume that the new board would
not be as hawkish as the previous one, and therefore we see the stability of
rates as the most likely scenario. We expect the first cut in rates already in
November, mainly due to the gradual slowdown of inflation and subdued
development of the Czech economy. In addition, in November 2022, when
setting rates, the CNB will look at the expected inflation development in
November 2023, when inflation should already be steadily falling towards
the target. In the coming years, the CNB should gradually return rates to a
neutral level, which we estimate to be around 2.5%. Falling CNB rates will
then be a key factor behind the gradual decline of the curve and its return to
a positive slope.
The risks are both-sided. On one hand, there will be further growth in energy
prices in the second half of the year, and the CNB may therefore want to
wait a little longer before lowering rates. Higher than expected wage growth
would also act in the same direction. On the other hand, the risks of a worse
development of the global economy are increasing, which would affect the
Czech economy very significantly. It cannot be ruled out that, in the event of
a deterioration in economic development, the CNB could incline to lowering
rates even earlier.
Expected 10Y yield development

Yield (%)
Source: Bloomberg, Ceska Sporitelna

18. July 2022
Orsolya Nyeste
Chief Macro Analyst Hungary
Erste Bank Hungary
Janos Nagy Supply and demand factors

Junior Macro Analyst
Erste Bank Hungary The YTD fiscal deficit amounted to HUF 2,892bn in June, equal to 91.7% of
the FY CF-based target. Details are available until end-May, showing that,
thanks primarily to surging inflation, fiscal revenues increased by 25.4% y/y.
The expenditure side, however, exploded to a much larger extent, by 35.3%
y/y. Huge pre-election spending and pre-financing of missing EU funds were
the main reasons for the spectacular expenditure growth. At the end of May,
the government revealed the details of its fiscal consolidation plan. A
generous part of it is based on windfall taxes, creating additional upward
pressure on inflation. However, the overall size of the package would
comfortably ensure the planned reduction of the fiscal deficit, in our view.
We expect the 2022 ESA-based deficit - in line with the government’s plans
- at 4.9% of GDP, provided that the planned EU fund inflow is ensured.
In 1H22, 64% of the FY financing plan was completed. On the wholesale

bond market, 65% of the primary HUF bond issuance and 24% of the switch
auction plan was fulfilled. From the newly introduced 10-year green HUF-
denominated bond, the issuance was HUF 121.8bn (the FY plan amounts to
HUF 240bn) and the ÁKK issued HUF 15bn from the 30Y green bond. In the
modified financing plan, the planned yearly amount of gross forint bond
issuance remained unchanged at HUF 2,225bn (without switch auctions).
Stock changes of main retail papers Fulfilment of HUF wholesale bond issuances in 1H
in HUF bn in HUF bn
Source: AKK, Erste Bank Hungary Source: AKK, Erste Bank Hungary
On the other hand, due mainly due to the increasing costs of forint financing,
the ÁKK raised the gross FX bond issuance target up to EUR 5.1bn for
2022. In parallel with this, the ÁKK issued Eurobonds worth EUR 3.5bn
altogether and then bought back nearly USD 1.2bn in USD bonds maturing
in 2023-24. Given the issuances of Samurai bonds in 1Q and the drawdown
of FX loans, overall, the foreign currency financing plan was fulfilled 72%
(HUF 1,798bn) in 1H22. The ÁKK does not plan to issue additional USD- or
EUR-denominated bonds. However, smaller transactions (e.g. the issuance
of the green Panda bond, private placements and project loans) may take
place later.

18. July 2022
Regarding retail financing, the achieved gross issuance of retail papers

amounted to HUF 2,572bn in 1H22, 60% of the FY gross issuance plan. The
ratio of the face value end-of-interest-period redemption option of the MÁP
Plus increased to 20.3% of the outstanding amount by end-June. However,
a decisive part of the MÁP Plus redemptions was reinvested in inflation-
linked retail bonds. This process contributed strongly to high gross issuance
figures in this segment. However, overall, the amount of retail securities
owned by households declined slightly compared to end-2021. Thanks to
surging inflation, maintaining the attractiveness of fixed-rated retail papers
should remain a challenge for ÁKK. Thus, the FY net growth of retail
financing will likely be lower than the planned HUF 1,000bn.
Other factors
In June, the MPC closed the gap between the policy rate and the one-week
deposit rate and the two rates were aligned at 7.75%. However, due to the
freefall of the forint, the MNB had to carry out another emergency rate hike,
increasing the one-week depo rate to 9.75% on July 7 and aligning the
policy rate a week later. Double-digit short-term rates are on the horizon, as,
according to forward rate agreements, the market expects effective rates to
reach 13% in three months.
Despite carrying out the large tightening to curb inflation, domestic bonds
have remained under pressure, due to many internal and external risks.
Among internal risks, the lack of EU fund disbursement is the most
significant, leading to exploding risk premiums. Even in the case of a
positive outcome of this conflict, the unblocking of funds should not be
expected before the year-end, keeping risk premiums at elevated levels for
some time. Lower forint bond issuance in the remainder of the year should
support the bond market and might curb further relevant yield increases.
However, as market sentiment is deeply negative towards Hungary,
extremely volatile movements will likely remain. As a result of the incoming
MNB rate hikes, the shape of the yield curve should become even more
inverted.
Spread development
10Y spread over 10Y Bund (basis points)
Source: Bloomberg, Erste Bank Hungary

18. July 2022
Eugen Sinca
Senior Analyst Romania
BCR
Budget execution performed well in January-May, with the cash deficit at

1.57% of GDP vs. 2.22% of GDP in the corresponding period of 2021.
Public revenues reached a record high at 13.5% of GDP during the first five
months, propelled by high inflation and strong economic growth.
At the beginning of July, the MinFin presented a series of fiscal measures
for raising budget revenues and complying with the EC’s requests. The
increase in revenues is estimated by the government at 0.1% of GDP in
2022 and 0.7% of GDP in 2023. We think that the government will use the
additional budget revenues for a mix between financing higher expenditures
(social benefits/subsidies, public wages/pensions and CAPEX) and cutting
the budget deficit. Higher inflation, faster fiscal consolidation and a lower
burden on monetary policy are the main implications of the planned fiscal
changes.
By the end of June, the MinFin covered 41% of this year’s gross funding
needs without including the loans received under RRF. If we add RRF
loans, the coverage ratio improves to around 47%. ROMGBs issuance fell
behind the plan in 2Q22, with June particularly weak; the MinFin borrowed
75% of planned volumes in the second quarter. Primary market issuance
was concentrated at the long end of the ROMGBs curve, with 77% of bonds
having residual maturity above five years in 2Q22 vs. 73% in 1Q22 and 53%
in 2021. The backdrop improved later and ROMGBs auctions attracted
stronger demand at the beginning of July.
The share of offshore investors’ (mostly index trackers) holdings in

ROMGBs decreased by 0.9pp to 15.8% between December 2021 and April
2022, with net outflows of RON 1.7bn. Offshore’s relative exposure to
ROMGBs is close to historical lows. Private pension funds (pillar II) also
reduced exposure to ROMGBs to 59.9% of their assets as of May 2022,
below the long-term average.
ROMGBs ownership structure (outstanding) Spread between 3Y and 10Y ROMGBs

Share, % bps (rhs)
Source: MinFin, BCR Research Source: Bloomberg, BCR Research

18. July 2022
Other factors
In July, the NBR hiked the key rate by 100bp to 4.75%, above our
expectations and the market consensus (Bloomberg/Reuters surveys), both
at 4.50%. The credit facility rate, which is the relevant operational policy
instrument for keeping firm control over money market liquidity, was raised to
5.75% (+100bp).
The NBR signalled that it aims to reduce the key interest rate gap vs. peers
(Poland) going forward, while keeping market rates broadly in line with CEE
norms by tightly managing money market liquidity to keep the RON stable.
Given the latest hawkish twist from the NBR, we see the terminal rate at
6.25% for the key rate by year-end and 7.25% for the credit facility, with the
latter remaining the relevant operational policy instrument under the firm
liquidity management policy.
We expect the NBR to hike its key rate at the remaining three meetings for
this year: by 75bp in August, 50bp in October and 25bp in November. Over
the medium term, the NBR governor said that, assuming the correct fiscal
policy and structural reforms, he sees CPI and the key rate converging
towards each other within a year.
June inflation is likely to mark the peak at 15.05% y/y, while the core CPI
should peak in December this year. Headline CPI is likely to drop
substantially in July, after a temporary fuel price cut, and bounce back in
August, due to an increase in excise duties for tobacco and alcohol. The
downward inflation outlook, government steps to enhance fiscal discipline
and frontloaded rate hikes by the NBR should increase the attractiveness of
back-end ROMGBs for offshores, supporting gradually lower yields in 2H22.
The size of the NBR’s bond purchases in the secondary market was rather
insignificant in 2022, at RON 367.3mn in March and RON 36.6mn in May.
We see the central bank actions aimed at providing liquidity to the bond
market and backstopping selloffs rather than targeting certain yield levels.
Given the depth of the Romanian financial markets, these objectives could
be reconciled with FX stability over a reasonable period.
Public debt is expected to be little changed this year at 48.3% of GDP vs.
48.8% of GDP in 2021, courtesy of the strong nominal increase in GDP.
Positive developments are expected for the coming years as well, with
public debt capped at 49% of GDP.
All three major rating agencies have scheduled reviews of Romania’s

sovereign rating in October. Fitch is likely to feel some time pressure for an
upgrade of the outlook to stable from negative, as the cut in the outlook took
place more than two years ago. The global backdrop is not supportive,
though.

18. July 2022
Mate Jelic
Senior Macro Analyst Serbia
Erste Bank Croatia
The narrative regarding the refinancing story remains intact. Local auctions
are still few and far between, while repricing of global yield curves cooled off
the MoF from international issuance for now; hence, a large portion of FY22
gross refinancing requirements (EBCe: EUR 6.3bn) remains uncovered. The
country issued RSD 23.3bn in dinar bonds in 2Q, thus slightly overshooting
the modest quarterly planned amount (RSD 20.8bn), but having issued just
17% of the planned amount in EUR papers means that the total issuance in
the quarter of EUR 210mn was below both the planned (EUR 243mn) and
maturing (EUR 519mn) amounts. Just two RSD auctions planned for 3Q
suggest that the summer lull has already begun.
It is rather obvious by now that the MoF will not be able to issue the
budgeted EUR 2bn locally this year. In our last bond report, we projected
issuance of around EUR 1.2bn, and that still seems like a decent bet.
Underperformance at home will have to be replaced with more bilateral
credit lines and a Eurobond launch, which we expect to happen in the last
quarter. The MoF has a cash buffer of around 6.6% of GDP, but given the
high uncertainty related to the energy crisis, they likely prefer to keep that
flexibility. We continue to think that the fiscal gap will be wider than
budgeted (4.5% of GDP vs. 3%), due to the slowing economic activity,
inflation related support packages and continous subsidies for EPS and
Srbijagas. The two state-owned companies are the biggest fiscal risk, as the
government will continue to cover their losses, given the disparity between
market and regulated prices.
Issuance of local RSD and EUR T-bills/bonds Share of foreign investor in RSD securities
Issuance below maturing needs Ongoing downward trend
Source: Public Debt Administration Source: Bloomberg
Other factors
Monetary policy continued to tighten further, albeit at a slower pace. After

the NBS delivered three consecutive 50bp hikes, the July meeting brought a
25bp hike to 2.75%. The general sentiment is that the NBS would prefer to

18. July 2022
end the rate hiking cycle as soon as possible, but such an action might bring
another episode of pressure on the currency. While total FX reserves
remain adequate (EUR 16.4 bn), spending another EUR 3bn to keep the
dinar stable, as was the case in 5M22, does not seem sustainable in the
long run. When assessing the global environment, fears of persistent
inflation and rising inflation expectations have trumped recession fears.
Hawks on the ECB Governing Council are winning the debate for now with a
25bp hike expected later this month, followed by another 50bp hike at the
September meeting. We expect another 25bp hike from the NBS at next
month’s meeting, while a significant deterioration in the inflation outlook
would be needed to lift the key rate above 3%, in our opinion.
One month ago, S&P slashed Serbia’s outlook from positive to stable as a
result of expected negative spillovers from the war. The lack of a meaningful
market reaction implies that investors already acknowledged that obtaining
an IG rating is off the table for now, given the deteriorating external balance.
Illiquidity remains the biggest drag on local bonds. The further you go up the
curve, the less likely it is you can secure a decent bid. Given that appetite
for local bonds is low and unstable, and the government is falling behind the
issuance plan, the NBS decided to shake things up a bit, giving local banks
a chance to mitigate negative effects on bank capital due to possible losses
on local bonds. The new temporary regulation measure allows local banks
to exclude 70% of net unrealized losses stemming from trading of
government bonds from the calculation of CET 1 capital. We have yet to see
any kind of a positive reaction. Since our last report in April, the LCY curve
moved up 130-160bp, while Eurobond yields are up 60-100bp. Bottom line,
in the current environment, characterized by still high inflationary risks, with
global CBs focused on reining in high prices and willing to look past
somewhat deteriorating growth outlooks, the spread vs. core is likely to
remain elevated until we get a clearer picture of whether inflation is ready to
roll over.
Local yield curve over time

Risk-off sentiment triggered sell off
Source: Bloomberg

18. July 2022
Matej Hornak
Macro Analyst Slovakia
Slovenska Sporitelna
Currently, the anticipated scenario of the war in Ukraine lasting only a few
months seems unlikely, which suggests that the higher fiscal needs will last
longer than previously expected. As of the beginning of July, almost 80tsd
refugees from Ukraine had asked for so-called temporary refugee status in
Slovakia, allowing them to work here without further permits. The inflow of
refugees also means higher costs to secure a standard of living and decent
living conditions – nearly 11tsd children are participating in schooling, with
more than half in elementary schools (as of May), and 45tsd refugees in
different types of accommodation. Part of the refugees have managed to
find a job (almost 9tsd), which could be a consequence of the successful
placement of children in schools, as most of them are children and women.
The conflict in the neighboring country may also cause higher military
expenditures, as border protection has become a high priority. A further
effect of the Russian invasion is an elevated inflation rate, pushed mainly by
food and energy items, resulting in new government measures to mitigate
the negative impact on citizens. We thus expect the fiscal deficit to reach
5.5% this year, 0.5pp lower than previously anticipated, as humanitarian
expenditures will be partially covered by the EU.
As a result, covering the new debt and maturing securities, gross financial
needs will amount to EUR 6.7bn. Part of the post-pandemic recovery fiscal
stimulus will be financed by NGEU funds, of which the first two tranches
expected this year could reach EUR 1.2bn. So far, this year´s auctions
covered around 43% of the total expected financing needs. In 2022, two
new syndicated sales with mid-term and long-term maturity are expected,
together up to EUR 3bn. Around EUR 1.3bn worth of securities were due in
April and May, consisting of two Eurobonds held in CHF (0.18bn) and USD
(1.5bn). The government cash buffer decreased significantly, from EUR
5.3bn in February to EUR 1.6bn in May, indicating high liquidity needs.
However, since no auction is planned for summer, cash flow should be
sufficiently covered e.g. by June auctions and additional tax declarations.
Ownership structure of Slovak government bonds 10Y Slovak government bond yield
As of June 2022 Yield, %
Source: ARDAL, SLSP Source: Refinitiv, SLSP

18. July 2022
Yield outlook
The persisting inflationary pressures experienced in the last months may

have an impact on longer-term inflation expectations. The complicated
situation in the supply chains, disrupted by the pandemic and post-
pandemic economic development, has been exacerbated by the Russian
invasion of Ukraine, contributing to the already existing pressures on
consumer prices. In response to that development, the ECB announced a
tightening of the monetary policy at their June meeting with the expectation
of the winding down of net asset purchases and first rate hike in July; further
ones should follow throughout the rest of the year. All of this has been
causing a sharp increase in Slovak bond yields since the turn of the year,
approaching 3% in mid-June, albeit moderately subsiding in recent weeks
after the Eurozone central bank announced a new anti-fragmentation tool to
mitigate the negative impact on bonds and stagflation concerns that have
arisen.
The ECB is thus gradually changing its monetary policy setting, in line with
expectations. Persisting inflationary pressures, the uncertain economic
outlook and expected ECB steps may continue to push bond yields
upwards. We expect yields to reach 2.7% at the end of this year, with the
potential for a further increase to 3.2% in the coming year.

18. July 2022
Alen Kovac
Chief Economist Slovenia
Erste Bank Croatia
The 2021 fiscal position improved, as the budget deficit narrowed to 5.2% of
GDP, while public debt declined towards 74.7% of GDP. Going forward, we
expect to see a further consolidation effort in 2022-23, mainly due to better
control of the expenditure side as anti-corona measures unwind. However,
this progress should be slowed down by the government's response to the
energy crisis, suggesting certain pressure on the budget performance. While
the ex-government introduced several measures to soften high energy
prices (including support payments for households, businesses, and cuts in
excise duties on electricity and energy products), the newly formed
government, led by Mr. Golob, has already highlighted that tackling rising
energy and food prices is among the top priorities on their agenda.
YTD issuance has been on a steady track, as the active 1Q22, in which the
MoF issued a total of EUR 2.5bn divided into 4Y, 10Y, 29Y and 40Y bond
maturities, resulted in Slovenia covering approx. 60% of its planned
financing for 2022 already in 1Q22. Going into 3Q, Slovenia additionally
increased the issuance of three bonds for a total of EUR 405mn, which
marked the first long-term borrowing under the new government of Robert
Golob. The MoF also maintained the smooth roll-over of T-bills, placing a
total of EUR 0.7bn during 1H22. Besides regular T-bill papers coming due,
the coming months are marked by the absence of any major maturities, with
the remainder of bonds maturing in the last quarter of 2022. However, with a
strong issuance pace thus far in the year, Slovenia has already covered a
large chunk of its 2022 financing needs (estimated around 9% of GDP),
resulting in coverage of more than 70%. This put Slovenia in a relatively
good position as far as additional placements are concerned, with current
issuance allowing for sufficient maneuvering space when it comes to timing.
Regarding the cash buffer, it remains hefty following post-corona events,
amounting to approx. 19% of GDP as of May 2022.
Foreign investor and bank exposure Yield development
Source: Erste Bank Croatia Source: Erste Bank Croatia

18. July 2022
The demand side stayed pretty much unchanged, as foreign investors still
play a dominant role in the structure profile, although their share has
decreased to 53% of total government papers, suggesting reduced
exposure, given the current environment. Having in mind the ending of the
bond purchase scheme, however, we still see the ECB remaining overall
supportive in its refinancing role. On the local side, domestic demand
remains driven by the banks, with current exposure on their books standing
at EUR 2.6bn, 7% of overall public debt (as of 1Q22). While the adverse
effects triggered by the geopolitical turmoil pushed investors’ focus towards
lower-risk investments, we see demand for Slovenian bonds remaining in
place.
Yield outlook
The strong yield increase continued in recent months, as ongoing volatility

on global markets, coupled with the ECB’s ending of the stimulus scheme,
resulted in the Slovenian 10Y curve moving to the 2.8% mark during 2Q22,
up 140bp from 1Q22 eop, while also showing further spread widening vs.
Germany (currently around 100bp). However, going into 3Q22, yields
started to show some stabilization towards the 2.2% mark, aligning with the
benchmark DE movements. We expect yields to stay at more elevated
levels in the following period, remaining largely determined by global
developments and sensitive to the DE footprint. However, the stable
fundamental story, i.e. steady growth profile and fiscal developments,
should allow for some spread stabilization vs. Bunds.

18. July 2022
Forecasts1
Government bond yields
current 2022Q3 2022Q4 2023Q1 2023Q2
Croatia 10Y 3.2 3.6 3.6 3.6 3.6
spread (bps) 202 203 199 196 201
Czechia 10Y 4.5 4.4 4.3 4.2 4.0 FX
spread (bps) 334 287 270 254 237 current 2022Q3 2022Q4 2023Q1 2023Q2
Hungary 10Y 9.1 8.5 8.4 7.8 7.2 EURHRK 7.51 7.52 7.53 7.53 7.53
spread (bps) 795 691 681 618 563
Poland 10Y 6.7 7.0 6.8 6.7 6.6 EURCZK 24.49 24.70 24.50 24.36 24.29
spread (bps) 558 540 520 501 497
Romania10Y 9.2 9.0 8.8 8.5 8.3 EURHUF 400.94 395.00 390.00 385.00 375.00
spread (bps) 803 743 714 686 666
Slovakia 10Y 2.1 2.5 2.7 2.9 2.9 EURPLN 4.78 4.57 4.53 4.47 4.44
spread (bps) 100 93 109 121 131
Slovenia 10Y 2.19 2.60 2.60 2.70 2.70 EURRON 4.94 4.97 5.00 5.02 5.05
spread (bps) 106 103 99 106 111
Serbia 5Y 6.7 6.5 6.3 6.0 5.7 EURRSD 117.33 117.50 117.60 117.60 117.60
spread (bps) 557 493 469 436 411
DE10Y* 1.13 1.57 1.61 1.64 1.59 EURUSD 1.01 1.08 1.10 1.13 1.15
* Spreads based on Bloomberg consensus forecast
3M Money Market Rate Key Interest Rate

current 2022Q3 2022Q4 2023Q1 2023Q2 current 2022Q3 2022Q4 2023Q1 2023Q2
Croatia 0.05 0.05 0.05 0.05 0.05
Czechia 7.33 7.10 6.50 5.74 4.98 Czechia 7.00 7.00 6.50 5.75 5.00
Hungary 11.48 11.45 12.20 12.20 10.45 Hungary 9.75 11.25 12.00 12.00 10.25
Poland 7.00 7.80 7.80 7.75 7.75 Poland 6.50 7.50 7.50 7.50 7.50
Romania 7.09 8.15 9.05 8.25 7.75 Romania 4.75 5.50 6.25 6.25 6.25
Serbia 2.59 3.12 3.12 3.12 3.12 Serbia 2.75 3.00 3.00 3.00 3.00
Eurozone 0.07 0.48 0.48 0.56 0.73 Eurozone 0.00 0.50 0.75 0.75 1.00
Real GDP growth (%) Average inflation (%) Unemployment (%)

2020 2021 2022f 2023f 2020 2021 2022f 2023f 2020 2021 2022f 2023f
Croatia -8.1 10.2 4.9 2.1 Croatia 0.1 2.6 10.0 5.6 Croatia 7.5 7.6 6.3 5.9
Czechia -5.8 3.3 1.6 2.4 Czechia 3.2 3.8 14.3 4.4 Czechia 2.6 2.9 2.7 3.5
Hungary -4.7 7.1 5.5 2.8 Hungary 3.3 5.1 10.9 7.2 Hungary 4.1 4.1 3.6 3.5
Poland -2.2 5.9 4.2 3.1 Poland 3.4 5.1 13.1 8.1 Poland 5.9 5.9 5.3 5.2
Romania -3.7 5.9 5.1 4.0 Romania 2.7 5.0 12.4 8.3 Romania 6.0 5.6 5.6 5.5
Serbia -0.9 7.4 2.5 3.7 Serbia 1.6 4.0 9.6 5.6 Serbia 9.7 11.0 10.1 9.7
Slovakia -4.4 3.0 2.0 3.0 Slovakia 1.9 3.2 11.4 7.8 Slovakia 6.7 6.8 6.6 6.2
Slovenia -4.2 8.1 3.9 3.1 Slovenia 0.0 1.9 7.2 3.3 Slovenia 5.0 4.8 4.3 4.1
CEE8 avg -3.7 5.7 3.9 3.1 CEE8 avg 2.8 4.5 12.4 7.1 CEE8 avg 5.4 5.4 5.0 5.0
Public debt (% of GDP) C/A (%GDP) Budget Balance (%GDP)

2020 2021 2022f 2023f 2020 2021 2022f 2023f 2020 2021 2022f 2023f
Croatia 87.3 79.8 71.5 69.0 Croatia -0.1 3.4 0.7 -1.2 Croatia -7.4 -2.9 -2.5 -2.5
Czechia 37.7 41.9 43.4 44.3 Czechia 2.0 -0.8 -1.2 0.5 Czechia -5.8 -5.9 -4.4 -3.1
Hungary 79.6 76.8 73.2 70.8 Hungary -1.1 -3.1 -5.9 -4.9 Hungary -7.8 -6.8 -4.9 -3.5
Poland 57.1 53.8 55.0 52.0 Poland 2.9 -0.6 -1.3 -0.3 Poland -6.9 -1.9 -3.9 -3.5
Romania 47.2 48.8 48.3 49.1 Romania -5.0 -7.0 -8.0 -7.9 Romania -9.3 -7.1 -6.7 -5.7
Serbia 57.0 56.5 54.6 54.0 Serbia -4.1 -4.4 -9.6 -8.9 Serbia -8.0 -4.1 -4.5 -2.5
Slovakia 59.7 63.1 63.6 62.3 Slovakia 0.1 -2.0 -1.7 -1.3 Slovakia -5.5 -6.2 -6.0 -4.0
Slovenia 79.8 74.7 73.4 72.5 Slovenia 7.4 3.3 1.5 2.6 Slovenia -7.8 -5.2 -4.5 -3.5
CEE8 avg 56.9 55.9 55.8 54.2 CEE8 avg 0.7 -1.9 -3.0 -2.2 CEE8 avg -7.2 -4.4 -4.7 -3.8

Prices as of July 15th, 2022
1
Note: Forecasts are not a reliable indicator of future performance.

18. July 2022
Statistical Appendix
Debt and deficit figures (% of GDP)

18. July 2022
Redemptions in next 12 months by type and currency of issue

18. July 2022
Holding structure of local currency debt securities
Source: Country MinFins, Debt Management Agencies, Erste Group Research

18. July 2022
Annual redemptions in LCY and Total (EUR)

18. July 2022
Redemptions in upcoming 12 months (monthly breakdown, EUR)

18. July 2022
Credit ratings of sovereigns

18. July 2022
Yields and rates (%)
Source: Bloomberg, Erste Group Research

18. July 2022
Group Research
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18. July 2022
Disclaimer
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ERSTE BANK Analýza UROKY

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Erste Group Research

CEE Bond Market Report | CEE | Fixed Income

Approaching turning point

Note: Past performance is not necessarily

CEE Macro & FI Research Page 1

For the exclusive use of Erste Group Client. (Erste Group)

Windfall tax revenues followed by higher expenditures

General government balance Gross public debt

Source: Erste Group Research Source: Erste Group Research

CEE Macro & FI Research Page 2

For the exclusive use of Erste Group Client. (Erste Group)

Currency structure of public debt Financing from RRF

Source: Erste Group Research, Bloomberg Source: Erste Group Research, EC

Inflation to peak in 3Q22

Driven by increasing food and energy prices, inflation continues to surprise

CEE Macro & FI Research Page 3

For the exclusive use of Erste Group Client. (Erste Group)

Average inflation to go up to 12.4% in 2022 Changes in commodity prices

End of tightening is looming

CEE Macro & FI Research Page 4

For the exclusive use of Erste Group Client. (Erste Group)

Intensified tightening in recent months Peak of tightening cycle in sight

Bonds ready to bottom out

We have seen an unprecedented increase of LCY bond yields in CEE this

10Y government bond yields YTD performance of 10Y bonds

CEE Macro & FI Research Page 5

For the exclusive use of Erste Group Client. (Erste Group)

Spreads on EUR-denominated Eurobonds

Source: Erste Group Research, Bloomberg (April 15)

Spreads on Eurobonds have shown some divergence among CEE countries

CEE Macro & FI Research Page 6

For the exclusive use of Erste Group Client. (Erste Group)

Supply and demand factors

Following business as usual in 1Q (EUR 1bn local market tap), 2Q

Yield curve development over time Foreign investor ownership of T-bills/bonds

Source: Erste Bank Croatia Source: Erste Bank Croatia

CEE Macro & FI Research Page 7

For the exclusive use of Erste Group Client. (Erste Group)

Yield and spread development

Source: Erste Bank Croatia

CEE Macro & FI Research Page 8

For the exclusive use of Erste Group Client. (Erste Group)

Supply and demand factors

In May, the central government budget deficit increased significantly to CZK

Government securities maturing till Jan-2023 LCY yield curve forecasts

Source: MinFin, Ceska Sporitelna Source: Bloomberg, Ceska Sporitelna

CEE Macro & FI Research Page 9

For the exclusive use of Erste Group Client. (Erste Group)

Expected 10Y yield development

Source: Bloomberg, Ceska Sporitelna

CEE Macro & FI Research Page 10

For the exclusive use of Erste Group Client. (Erste Group)

Janos Nagy Supply and demand factors

In 1H22, 64% of the FY financing plan was completed. On the wholesale

For the exclusive use of Erste Group Client. (Erste Group)

Regarding retail financing, the achieved gross issuance of retail papers

Source: Bloomberg, Erste Bank Hungary

CEE Macro & FI Research Page 12

For the exclusive use of Erste Group Client. (Erste Group)

Supply and demand factors

Budget execution performed well in January-May, with the cash deficit at

The share of offshore investors’ (mostly index trackers) holdings in

ROMGBs ownership structure (outstanding) Spread between 3Y and 10Y ROMGBs