(Bloomberg) -- Poland’s re-embrace of the European Union mainstream is making it the turnaround story of the year for some investors.

Bets on a successful remake of the EU’s biggest eastern economy by Prime Minister Donald Tusk, who took over in December after eight years of divisive nationalist rule, have become money winners for investors. One of the favorite plays has been to buy the zloty against its regional peer, the forint.

With Viktor Orban still building his self-described “illiberal” regime in Hungary, the comparison helps gauge how markets price the cost of isolationist, nativist policies and — in this instance — reward a country’s tack back from the populist brink. The widening risk premium between the countries has become a “key regional thematic,” according to Malin Rosengren, a London-based portfolio manager at RBC Bluebay.

“Poland is poised to be the ESG turn-around story of the year,” she said. Tusk’s ability to unlock EU funds suspended for infringements under the previous cabinet have “inspired investor goodwill,” Rosengren said. 

Furthermore, improvements in environmental, social, and governance standards will help lift Poland’s economic potential over the longer-term, which will “gradually feed into pricing,” she added.

Political Trajectory

The zloty has been one of the best performing emerging-market currencies since October’s election shifted Poland’s political trajectory, strengthening 6% against the euro and 8% to the dollar. Warsaw’s WIG20 stock index has gained 26% while benchmark government bond yields fell despite the pricing out of interest rate cuts.

The latest bout of global risk aversion Friday hit the forint especially hard, dropping 0.7% against the euro by 2:56 p.m. in Budapest, while the zloty was barely changed.

With the Polish currency trading at a four-year high this week, Tusk basked in the glow, saying the country’s reputation hasn’t been this good in nearly a decade while touting ample demand for government bonds and a “great atmosphere in Brussels” regarding efforts to tap EU funds. 

After hitting a record high against the forint in March, the zloty gave back some ground as a row over monetary policy in Hungary de-escalated just as Tusk and his allies started a process to probe Poland’s central bank boss Adam Glapinski.

“We had found the optimism surrounding Polish assets since Poland’s October 2023 election quite overdone, which made us anticipate that a pull-back in PLN-HUF was overdue,” said Tatha Ghose, senior emerging-market economist at Commerzbank AG. 

Tusk himself has argued that the zloty’s rally shouldn’t be exaggerated for fear of putting Poland’s exports at risk. The yield on Poland’s 10-year local-currency yields jumped to a 2024 high on Thursday amid a broader selloff across east European debt, still trading about 130 basis points below Hungary’s.

EPFR data tracking flows to funds whose mandates allow them to invest in these two countries show Poland’s relative outperformance since the elections. Since mid-October, Hungarian bond and equities funds have seen nearly $600 million in outflows, with Polish equivalents losing about half that amount.

The forint regained some ground when Orban retreated in key disputes with the EU and the central bank in Budapest, two issues which had weighed on Hungarian assets in the past year.

That hasn’t been enough to persuade investors of a turnaround, with executives complaining of government interventionism in the private sector. The economy has also been slow to recover from last year’s recession, with the cabinet struggling to plug gaps in public finances.

Read more: Hungary to Delay $1.9 Billion in Investments to Control Deficit

“Constant interference in the economy, centralization and weakening competition due to fewer players in many industries may keep inflation and inflation expectations persistently high,” said Daniel Moricz, chief investment officer at Hold Asset Management in Budapest, who helps oversee $2.2 billion. “There are also risks to the actual disbursement of EU funds.”

In the latest intervention in the market, Economy Minister Marton Nagy on Thursday reprimanded refiner Mol Nyrt., one of Hungary’s biggest listed companies, for charging too much for vehicle fuel.  

Economic Outlook

In the longer term, the outlook for the Polish economy is simply better, justifying the appreciation of the zloty, according to Moricz as well as Frantisek Taborsky, a strategist at ING Bank in London. 

Taborsky expects the zloty to strengthen to 4.2 against the euro by mid-year from 4.26 this week on the back of a hawkish central bank, the region’s best current-account balance and the renewal of EU inflows. 

A lot of the factors have already been priced in so far in 2024, Hold’s Moricz said, adding that he expects “some further Hungarian underperformance this year, both in bonds and FX.” 

--With assistance from Selcuk Gokoluk.

(Updates with fresh data on forint extending its slide)

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