* Investors no longer taking traditional "convergence bets"
* Focus shifts to fundamentals rather than euro target dates
* Investment flows not likely to return to peak levels
* Czech debt seen more attractive than euro periphery
By Michael Winfrey and Sujata Rao
PRAGUE/LONDON, Feb 24 (Reuters) - Investors in the European
Union's east have mostly abandoned "convergence bets" based on
when they think the bloc's emerging members will adopt the euro
and are instead focusing on the fundamentals of each economy.
Greece's debt blowout and ballooning budget gaps have
wrongfooted many forecasters who must now decipher murky signals
on euro zone enlargement from both the currency's core countries
and its aspirants.
Latest Reuters polling shows most economists see the biggest
candidates -- Poland, Hungary, the Czech Republic, Romania and
Bulgaria -- joining in 2015 at the earliest, mostly a year later
than they did late last year.
Those dates, though, are not necessarily reflected in market
augurs that once served as the best indicators of expected
adoption, so money managers are taking a country-by-country
approach.
"Any talk of euro convergence is totally on the backburner
when people are questioning the future of euro in the first
place and second, when there is a possibility that one member of
the euro zone may be thrown out," said Jason Manolopoulos, who
manages $100 million in emerging Europe at Dromeus Capital in
Athens.
"I like some of the stories like Poland, but I go in there
not for the convergence but for the relative value."
The picture is a contrast from five years ago, when fund
managers piled into the region with an eye to a date, not too
far off, when the countries would join the euro, their interest
rates and bond yields converging with those of the euro zone.
FORWARDS DIVERGE
Convergence has never been just about joining the euro. All
of the region's emerging economies are expected to make steady
progress in bringing wages, purchasing power and asset values in
line with their developed neighbours and the idea of such
"convergence" has drawn investors for about a decade.
A popular trade involved five-year five-year forward bond
and interest rate swaps, showing at what level the market
believes five-year interest rates will be five years from now.
For a country expected to adopt the euro in five years, they
would show its rates close to the euro zone's. But even with the
steady retreat on euro entry targets, this trade has been hugely
profitable given that, for example, Polish 10-year bond yields
were 13 percent in 2000, versus about 6 percent now.
That points to a bigger issue: much of the convergence of
asset values is already done for some countries.
There is still room for the Poles and Hungarians to converge
toward core euro interest rates -- on bunds or French bonds --
but the Greek crisis has underlined that there is now a greater
difference in fiscal balance sheets and 10-year bond yields
between some euro members than with those countries outside of
the zone. Polish 5- and 10-year bond yields are already lower
than those in Greece.
"You don't know if the euro is going to be there in five
years and, second, we have increasing deconvergence within euro
area so are you converging towards Greece or the Netherlands?"
said Danske Bank Chief Emerging Markets Analyst Lars
Christensen.
Another issue is that the candidate states themselves are
not that keen on shackling themselves to a currency they cannot
let depreciate to boost competitiveness in times of crisis.
The Reuters poll showed only Estonia likely to join any time
soon -- next year -- while its Baltic neighbours are set for
entry in 2014. The others are seen in 2015 or later but analysts
say in reality there is as little if not less certainty now than
there was when Poland and Hungary were forecasting they would
join in 2008. [] (for graphic:
http://graphics.thomsonreuters.com/0210/EZ_EMUPL0210.gif)
A string of elections, lack of clarity in the economic
recovery and public appetite for the cost-cutting reforms needed
to meet euro zone criteria also cloud estimates.
"Any forecast you have to take with a large pinch of salt,"
said Nigel Rendell, a strategist at RBC. "There are so many
variables, and each variable is unpredictable, with politics
being the biggest element."
None of which is to say the convergence trade is completely
dead. Joining the euro still has advantages -- low interest
rates, a stable exchange rate and less exposure to speculative
attacks.
Societe Generale fixed income strategist Esther Law expects
both Warsaw and Prague could adopt the euro by 2015 and suggests
receiving Polish 5y5y forward versus euro from around 130 bps.
She says the Polish five-year yield in five years time
should be 5.6 percent if Poland joins the euro -- 120 bps below
the current 5-year bond yield five years forward.
"Convergence may not make sense but that doesnt mean spreads
won't come in," said Danske Bank's Christensen.
(For the latest poll on EMU enlargement [])
(Writing by Michael Winfrey and Sujata Rao; Graphics by Scott
Barber; editing by Patrick Graham)
