On January 15, Standard & Poor’s unexpectedly downgraded Poland’s credit rating from A- (positive) to BBB+ (negative), or just three notches above junk. In its report, the agency said that Poland’s new ultra-conservative government – led by President Andrzej Duda – has weakened the independence of the nation’s institutions.

The key trigger was a perceived lack of effectiveness of Poland’s key institutions, particularly the National Bank of Poland.

While a BBB+ rating is still considered investment grade, S&P has indicated that it could cut the rating further in the next two years, if the credibility of Poland’s monetary policy is undermined.

Statements from Moody’s and Fitch also pointed to a deterioration in Poland’s perceived creditworthiness.

While Fitch held the rating at A- stable and Moody’s chose a grade of A2 stable – which is higher than the other two – both have assessed Poland’s change in fiscal strategy, governance issues, and bank tax as credit negative.

The rate cut was S&P’s first for Poland’s hard currency debt. It’s a major hit to the nationalist-minded government of the Law and Justice (PiS) party, which won the October 2015 election by promising greater welfare and shared economic prosperity.

Investors Feel the Fear

Poland, which joined the European Union (EU) in 2004, gained a reputation as an exemplar of European post-communist transformation. The nation registered the highest economic growth in the bloc over the last decade while attracting billions of dollars in foreign direct investment.

Since 2007, Standard & Poor’s held Poland’s rating at A- and even increased the outlook to positive in 2015 based on Poland’s declining deficits and uninterrupted economic growth over the last 20 years.

Thus, the credit downgrade caught economists and traders off-guard, and the markets reacted immediately. The zloty fell 1.5% to a four-year low versus the euro, and the yield on Polish 10-year government bonds shot over 3.2%.