Under-water franc loans threaten Polish growth miracle

* Franc swing means loans reaching tipping point

* Thousands now owe more than homes worth

* Likely to worsen economic slide, burst growth bubble

* Officials expect problem still not on scale of Hungary's

By Karolina Slowikowska and Filip Kochan

WARSAW, July 31 (Reuters) - Poland's economy, finally starting to flounder after defying a Europe-wide downturn for four years, faces a growing threat from foreign currency loans that have left thousands of households owing more than their homes are worth.

About half of all mortgages held by Poles are denominated in Swiss francs, and a combination of currency swings and falling house prices means 47 percent of these loans are now worth more than the properties they were used to buy.

While Poland had robust growth - it is the only European Union economy to have avoided recession since the 2008 financial crisis - the burden of these loans, even with rising repayment costs, was manageable.

But with growth slowing to less than 3 percent and the housing market sinking, mortgages are turning into a liability that could drag the EU's biggest ex-communist state into a downward spiral of falling consumer confidence and spending.

"I dream of selling my flat and buying and moving to a bigger one," said Agnieszka, a 27-year-old saleswoman at a Polish bank who is typical of the generation now stuck with foreign currency debt.

"But the market situation means this would pretty much be a miracle."

Poland's experience with Swiss franc mortgages goes back to the middle of the last decade. Young Poles, with aspirations to upgrade from the cramped Soviet-era apartments they grew up in, snapped up the home loans in large numbers.

At the time, the difference in interest rates and the exchange rates meant that by borrowing the money in Swiss francs and transferring it into Polish zlotys, borrowers paid 30-40 percent less monthly than for an equivalent loan in zlotys.

The franc, known at the time for its relative stability compared to the euro or dollar, also seemed a good, stable bet that was unlikely to soar against the zloty.

Two years of crisis in Europe has turned that on its head.

The franc has become a safe haven for investors desperate to hide their money from worries ranging from a U.S. budget squeeze to debt problems in Europe and slowing Chinese growth.

That has driven a rise in the Swiss currency that means Poles who took mortgages in 2007 and 2008 can be paying sometimes even close to double what they did then - and owe much more in total.

"The FX (foreign currency) loans are a serious threat. They risk a spill over to the entire macroeconomic situation," said Piotr Szpunar, director of the central bank's financial system department.

"Because people's mortgages cost more, they have less disposable income. That means lower consumption. This means lower growth, a weaker zloty, and the spiral begins," he said.

MORE DEBT, FEWER ASSETS

Polish household borrowing remains far lower overall as a percentage of national income than in the West and, unlike many subprime mortgages in the United States, most of the loans were given to a growing middle-class more capable of managing the debt.

Authorities have already taken steps to cut down on how many franc mortgages are issued and most banks have all but stopped offering them to ordinary customers.

That, and the responsible fiscal management which has kept public debt far lower than for some of its neighbours and made its financial markets more robust, mean Poland is unlikely to follow eastern European peer Hungary in having to take emergency steps to prevent a huge wave of defaults.

But it is cold comfort to those like Agnieszka, who remains chained to a house and a debt that she took on with her now former fiance.

"Unless we sell it (the apartment), none of us can buy a new one because we have a mortgage together and own a property which is totally illiquid," said Agnieszka.

"I wanted this flat to be a temporary solution but in fact, I could end up living there for many, many years."

DAMPENER

It is difficult to gauge the scale of the impact of the mortgages on growth in coming years, but there are substantial arguments for the trend - and the future weakness it implies for the property market - being a major drag.

Loans in foreign currencies - there are also some in euros and even Japanese yen - now have a value of 200 billion zlotys ($58.41 billion). That is equivalent to 13 percent of Polish GDP and 60 percent of the total value of outstanding Polish mortgages. The Swiss franc figure is 49 percent of the total.

A 15 percent fall in house prices since 2007 - and lessons learned from credit-sponsored property booms in the West - also add to the argument for consumers to scale back purchases now.

The key is how Polish households respond.

Savings rates shrank to 3.9 percent of disposable income last year from 6.4 percent a year earlier as Poles dipped into their backstops to cover spending, reducing their cushion against financial calamity but also reflecting pressure on day-to-day finances that should weaken consumer demand.

Others are defaulting. The proportion of "bad" mortgages - where the borrower fails to make repayments - rose in May to 2.6 percent from 2 percent a year earlier.

Mostly though, home-owners are shouldering the burden, denying themselves more to cover the rise in the monthly cost of their homes, although domestic demand overall is still growing.

"This is a dramatic situation when, once all the loan instalments are paid off, you can't afford to buy your child an ice-cream," said Iwona Jakubowska-Branicka, a sociologist from University of Warsaw.

Another pillar of growth - the public investment in last month's Euro 2012 soccer tournament - has also disappeared and all but a couple of the country's main export markets in Europe are sinking into recession.

The result is an expected slowdown in overall growth to 2.9 percent this year and 2.1 percent next year, from 4.3 percent in 2011.

"There won't be fiscal easing, there will even be fiscal tightening. There won't be much investment, consumers have more and more debt and less and less savings," said Marcin Mazurek, senior economist at BRE Bank.

"This all means that the path out of the slowdown will be nothing but flat. It won't be anything like (the recovery) we had after the 2009 slowdown."

($1 = 3.4241 Polish zlotys) (Editing by Christian Lowe and Patrick Graham)