Ukraine crisis may shift balance of Polish politicsThe Oxford Analytica Daily Brief - Monday, April 28 2014Prime Minister Donald Tusk has become one of the biggest political beneficiaries of the rapidly escalating crisis in Ukraine. Poland's prominent role in the West's response to Russia's annexation of Crimea and support for separatists in eastern Ukraine has boosted the popularity of Tusk's ruling Civic Platform (PO) party, which now leads the opposition Law and Justice (PiS) party in the run-up to European parliamentary elections on May 25. PO should also benefit from Poland's economic recovery, with domestic demand picking up amid subdued inflation and favourable sentiment towards Poland -- despite mounting concerns about the 'Emerging Europe' region as a whole. _Impact1. Issues of national and European security may trump domestic economic concerns in what could prove to be a game-changer for Polish politics.1. However, this raises the stakes for PO, given significant divisions within the EU over how to respond to events in eastern Ukraine.1. An entrenched recovery based on a pick-up in domestic demand would bode well for the government over the coming electoral cycle.What nextWhile PO remains vulnerable given its long spell in office and the after-effects of a period of extremely weak growth, Tusk's narrow focus on security issues and growing tensions in East-West relations will make it more difficult for PiS to mount a credible challenge to the government. The rapidly escalating crisis in Ukraine has the potential to be a game-changer for Polish politics, allowing PO to campaign on a platform of national security and shifting the political debate away from economic issues. Polish assets are likely to remain resilient to a downturn in investor sentiment towards emerging markets (EMs) because of the country's stronger fundamentals. AnalysisHaving trailed in the polls behind the conservative PiS, headed by former Prime Minister Jaroslaw Kaczynski, PO has overtaken its arch political rival for the first time in nearly a year (see POLAND: Threat of instability remains after reshuffle - December 3, 2013), as the Ukrainian crisis plays into the hands of Tusk. Ever since the crisis in Ukraine erupted at the end of February, Tusk has played a key role in the West's response to Russia's annexation of Crimea and its support for separatists in eastern Ukraine. Tough on UkraineAmong Europe's leaders, Tusk has been the most vocal in calling for a robust political, military and economic response. He has been pushing for a stronger presence of NATO troops in Poland and, in the Financial Times on April 22, called for the creation of a 'European energy union' to reduce the EU's dependence on Russian gas. Poland, which for historical and geo-political reasons is, along with the Baltic states, an ardent supporter of a strong and independent Ukraine, has been warning of the dangers of appeasing Moscow. This contrasts markedly with the positions of several other Central-East European countries, in particular Hungary, which are wary of imposing tougher sanctions on Russia (see EUROPE/RUSSIA: CE four will cut ties if EU says so - March 13, 2014). _PO pulls ahead of PiS in polls as recovery takes hold According to the latest opinion polls, PO has pulled ahead of PiS. In the last four surveys, with European Parliament elections about to take place on May 25, average support for Tusk's party has risen to 28%, compared with 26% for PiS. Over two-thirds of respondents are satisfied with the government's handling of the Ukrainian crisis, while just over one-fifth believe it is insufficient. Improving economyThe recent improvement in Poland's economy, and favourable sentiment towards Polish assets, should also help PO in the run-up to Poland's own parliamentary elections, which are due to take place in September 2015. 1. Although retail sales grew by a weaker-than-expected 3.1% in March, domestic demand -- the mainstay of Poland's economy -- has picked up noticeably over the past several months. Industrial production expanded 5.4% in March, while output in the construction industry, which contracted 12.0% last year, surged by 17.4%; growth in Poland's manufacturing sector -- which is tightly integrated into the German supply chain -- is recovering strongly. 1. GDP growth surpassed 3% year on year in the first quarter of this year, according to PKO Bank Polski data, with private consumption and investment forecast to expand by 2.5-3.0% and 6.0% respectively. 1. Moreover, inflationary pressures remain subdued, with consumer prices rising by just 0.7% in March, significantly below the medium-term inflation target of 2.5% set by the National Bank (NBP). NBP has stressed that its key reference rate -- which stands at a historical low of 2.5% -- should remain unchanged at least until end-September. Markets are currently pricing in less than 20 basis points (bp) of rate hikes in Poland over the next year, compared with more than 120 in South Africa and 55 in Hungary. _3.3% Government economic growth forecast for 2014According to the government's update Convergence Programme, which was adopted by the cabinet last week, Poland's economy will grow by 3.3% this year, 3.8% next year and 4.3% in 2016-17. By 2017, Poland's GDP per head will, according to the government, reach nearly 75% of the EU average -- up from just over 55% in 2008. Market confidence_Ukraine crisis poses risks to market sentiment However, the dramatic escalation in the East-West standoff over Ukraine is weighing on investor sentiment, with so-called safe-haven assets, such as US Treasury bonds and the Japanese yen, gaining amid a sell-off in global equities and risk assets at the end of last week. Sentiment towards the Emerging Europe region remains a tale of two halves: 1. Since April 1, ten-year swap rates have fallen in Central Europe, by 9 bp in Hungary and the Czech Republic and by 4 in Poland.1. They have risen in Russia and Turkey by 29 and 25 basis points respectively. For the time being, sentiment towards Polish assets remains extremely favourable. The yield on Poland's benchmark ten-year local bonds has fallen to 4.1%, from nearly 4.7% in January. Polish stocks, meanwhile, have risen by nearly 8% over the past three months, compared with a 14% fall in Russian shares.

The risk is that Russia could intervene more forcefully and overtly in eastern Ukraine -- still an unlikely scenario, but one that appears more probable than a fortnight ago. Since markets are increasingly sensitive to developments in Ukraine, this would knock sentiment severely, putting considerable strain on EM assets. However, even under such a scenario, it is likely that Poland would still fare better than other EMs given its stronger underlying fundamentals.