Poland - Macroeconomic Overview
Poland’s economy has impressed over the past seven years, especially when held up against its slow-moving EU neighbours. But with a shock result in the May presidential election that saw PiS candidate Andrzej Duda win, and a general election due in October, the domestic and international financial communities are reluctantly having to get used to political uncertainty in Poland. Philip Moore reports.
The Polish electorate is hard to please. According to data published by the Warsaw Stock Exchange (WSE), accumulated growth in the Polish economy between 2008 and 2014 reached 24.2%, which was the strongest rate of growth among major European economies by some distance. More recently, the economy has continued to outperform its sluggish EU neighbours, growing at an annualised rate of 3.5% in the first quarter of 2015, compared with an EU average of 1.4%.
Over a much longer time horizon, the performance of the Polish economy has perhaps been even more impressive. GDP per capita is now 70% of the EU average, compared with a little over 30% when General Jaruzelski’s Communist government collapsed in 1989.
True, unemployment remains stubbornly high, especially away from the major metropolitan regions. But the jobless number has been showing clear signs of improvement, reaching 11.2% in April, according to the Central Statistics Office. That was down from 13% in April 2014, and was below the 11.8% forecast for December 2015 in the budget.
None of this, however, was enough to keep the gaffe-prone Bronislaw Komorowski in his job when the Poles went to the polls in May’s presidential election. In a result that some economists thought to be even more surprising than the Conservatives’ victory in the British general election, Poland’s opposition candidate, 43 year old Andrzej Duda, won with 52% of the vote.
It was a small margin of victory, but one that appeared to spook investors, with the zloty as well as Polish bonds and equities all falling immediately after the exit polls. Warsaw-based economists say that this was a knee-jerk reaction. They also say that it was hard to assess how much of the falls in Polish assets were a response to the election result rather than a function of Europe-wide jitters over Greece.
PiS — bad news for banks?
Nevertheless, there were several good reasons why investors took fright at the shift in the political climate in Poland. The success of the opposition Law and Justice Party (PiS) is clearly bad news for the banks. Aside from calling for new taxes on foreign-owned banks, Duda favours converting Swiss franc mortgages into Polish zloties at the rate at which the loans were originally issued. As a worst case, says Société Générale, this could cost the banks as much as Z44bn (over €10.5bn). Alternatively expressed, the banks’ current Swiss franc denominated mortgage book represents about 8% of GDP, according to Standard & Poor’s.
Forced redenomination of this book, say some analysts, could drive several banks to the wall, while many of those that survive would need to be recapitalised. No wonder Polish bank stocks retreated by 3.4% the day after the presidential election.
Duda’s victory in May’s election may also be bad news for some foreign direct investors, notably in the retailing sector. He may be perfectly justified in saying that large supermarkets pay “peanuts” in taxes, but by singling our retail chains owned by foreign groups, President-elect Duda may not be sending out the most constructive message to existing or prospective investors.
The outcome of the election is also bad news for those who think Poland should join the euro. The writing was on the wall for Poland’s europhiles in any case, with 70% of the electorate reported to be opposed to Polish membership of the single currency in an April survey. But the ousting of Komorowski, whose Civic Platform (PO) favours closer monetary integration with the EU, puts that writing in a bolder script.
For holders of Polish debt, however, the principal concern arising from the success of PiS in the presidential election appears to spring from the party’s track record of fiscal laxity and its lavish spending promises. “The previous PiS government lowered taxes without reducing expenditure,” says Daniel Hewitt, senior EMEA economist at Barclays in London. “The result was that when the PO returned to power after the election in 2007, it was presented with a budget deficit to tackle.”
Since then, PiS may have changed its fiscal spots. “We don’t think PiS is necessarily a threat to holders of Polish debt,” says Agata Urbanska-Giner, CEE economist at HSBC in London. “Hungary has proved that it is possible to have a political agenda based on higher spending matched with higher taxes, which meets tight budgetary targets. We haven’t heard PiS talking about higher budget deficits.”
Voters that have not shared in the economic prosperity generated over the last decade won’t lose much sleep over PiS’s fiscal record. To the poorest sections of society, Duda’s pledges to reverse the increase in the retirement age to 67, raise the minimum threshold for income tax and introduce a range of child benefits may all sound very appealing.
But Radoslaw Bodys, chief economist at PKO Bank Polski in Warsaw, speaks for much of the financial community when he says that this schedule of promises amounts to an unaffordable wishlist. The numbers speak for themselves. The finance ministry has reportedly calculated that the measures proposed by PiS could cost as much as Z400bn. To put this figure into context, it is not far short of half of Poland’s total outstanding debt at the end of 2014.
Local economists say that there are several reasons why investors should take the PiS promises with a large pinch of salt. Maciej Reluga, chief economist at Bank Zachodni WBK in Warsaw, says that one of these is that the presidency itself is something of a blunt economic instrument in Poland. “The main impact of the election from an economic perspective is that it means the opposition has a higher chance of winning the parliamentary elections later this year,” he says. “It won’t have an immediate impact because the president himself can do almost nothing to influence economic policy.”
Others agree, although they say that there will inevitably be some added volatility in Polish assets in the run-up to the parliamentary elections this autumn, not least because knife-edge politics may open the door for mavericks such as the anti-establishment former rock star, Pawel Kukiz. He won more than a fifth of the vote in May, which may strengthen his chances of playing some role in a future coalition. This unsettles some Warsaw-based economists. “Kukiz is popular with younger voters, but he has no real programme for the economy,” says one.
What does seem clear is that there is likely be heightened volatility between now and the parliamentary elections. “The main change is that after a very smooth and calm eight year period we are probably moving towards a more volatile and noisy political landscape in the short term,” says Bodys at PKO.
Spending safe from politicians
Even if the opposition is as successful in October’s parliamentary elections as it was in the presidential polls, the Polish constitution gives the government little room for manoeuvre on fiscal policy. “It is important to remember that under Polish law we have very strict expenditure rules that mean a significant increase in the deficit-to-GDP ratio will be impossible, at least over the next year or so,” says Jaroslaw Janecki, chief economist at Société Générale in Warsaw. “Our expenditure rule is even stricter than the Maastricht criteria, because it prevents the government from increasing expenditure by more than the average GDP growth rate for an eight year period made up of the previous six years plus the current year and the GDP forecast for the next year. Of course the new government could change this law, but not immediately.”
Barclays’ Hewitt agrees that even a PiS government is unlikely to meddle with a legislative fiscal restriction that has served the economy very well in recent years. One reason he gives is the rap on the knuckles that Poland was given by the European Commission in the form of the excessive deficit procedure (EDP) announced in July 2009.
In May, the EC recommended that Poland be removed from the EDP, which certainly appears to be warranted by the progress it has made in reducing its deficit. This is projected by the EC to fall from 3.2% in 2014 to 2.8% this year and 2.6% in 2016. “I can’t see Poland risking going back into the excessive debt procedure,” says Hewitt.
None of this is to suggest there are cast-iron guarantees against modest fiscal slippage over the next few months in the run-up to the election, but this should not be enough to jeopardise Poland’s rating. In a note published immediately after May’s presidential election, S&P commented that its rating already incorporated estimates of “a certain degree of pre-election spending, including a projected deficit of 3%, which contrasts with the government’s forecast of 2.7% of GDP.”
At BZ WBK, Reluga points out that leaving the excessive deficit procedure gives the government some leeway on fiscal policy. “The government originally planned to reduce VAT by 1% at the start of 2017, because it did not expect the deficit to fall to below 3% until 2015,” he says. “Because the deficit adjusted for pension reform was reduced to under 3% in 2014, changes in fiscal policy originally planned for 2017 may now be possible one year earlier, and the preparation of the budget for 2016 will coincide with campaigning for the parliamentary elections. It now looks as though the government has decided not to lower VAT one year ahead of the plan, but to allocate additional resources of Z2bn to public wages that have been frozen since 2010. Overall, I don’t think these changes will be significant enough to affect the rating.”
Others agree. At Citi in Poland, chief economist Piotr Kalisz has been arguing for a while that an upgrade of Poland’s sovereign debt rating is long overdue. As he commented in a recent note, Fitch and S&P have left their ratings on Poland unchanged for eight years, while it is now 13 years since Moody’s last adjusted its rating. “We find arguments against rating upgrades increasingly inconsistent with medium term economic trends,” Citi commented in April.
“In the past, one of the most frequently mentioned obstacles to a rating upgrade for Poland was the large current account deficit,” the Citi note explained. “However, a CA adjustment has been underway for some time already and the combined current and capital accounts are now firmly in positive territory.”
This note was written before the presidential election, but Kalisz sees no reason to alter his prognosis on the Polish rating following the Duda victory. “The election may change the time-scale for a likely upgrade,” he says. “But the factors that are important for the rating agencies, such as the constitutional restriction on public debt, are unchanged. We don’t think the election changes much in terms of macroeconomic fundamentals or the economic outlook.”
Kalisz says that Citi’s forecasts for growth are a little above consensus, at 3.9% this year and between 3.5% and 4% in 2016, which he says compares with Poland’s potential of between 3% and 3.5%. Among other research teams, Morgan Stanley is looking for 3.7% in 2015, rising to 3.8% next year, while Barclays’ forecast of 3.5% is at the lower end of the consensus range.
“There’s obviously nothing wrong with growth at 3.5%,” says Hewitt at Barclays. “But FDI inflows have been flat and much of the growth is still driven by EU inflows. The word has it that Poland has been using these inflows more effectively than the rest of central and eastern Europe to build important infrastructure facilities. But I don’t see any real take-off in the Polish economy, or any compelling argument for a ratings upgrade.”
Others are altogether more upbeat. “This is the first time for many years that I have been so positive about the performance of the Polish economy for two main reasons,” says Marcin Mrowiec, chief economist at Bank Pekao in Warsaw. “The first is the situation in the labour market, where we are seeing a 1% year-on-year growth in employment in manufacturing.”
“Another is the increase in wages, which in the last few quarters have been rising by 3%-3.5%,” he adds. “Given that we had a deflation rate of minus 1.6% in February, this has equated to a rise of as much as 5% in real terms. I expect this strength to be maintained as the investment cycle gathers momentum next year. Companies have high cash balances and the lowest level of corporate debt in the EU, which should drive an investment boom going forward.”
Positive on investment
At Citi, Kalisz is equally upbeat about the prospects for investment. “Fixed investment growth was about 9% at year-end, which was stronger than expected,” he says. “PMIs are still well above the 50 point level, which suggests that the manufacturing sector is comfortable about continuing to expand.”
Enthusiasm about the outlook for domestic demand is shared by Société Générale’s Janecki. “Private consumption is being driven by low interest rates, deflation and improved conditions in the labour market,” he says.
Fast-growing wages suggest that deflation is unlikely to be a risk in the medium term. “We’ve had some technical deflation but this has been imported from the disinflationary momentum in Europe, twinned with weaker commodity prices,” says Bodys at PKO BP. “It’s not a sign of weak demand.”
This echoes the view publicly articulated by central bank governor Marek Belka, who is on record as saying that he expects deflation to be over by year-end. But there is little indication that this need presage any alarming rise in inflation. “We expect monetary policy to remain supportive,” says Citi’s Kalisz. “At some point, interest rates will need to rise, but this is still a long way off.”
Confidence about the prospects for a rating upgrade is also strengthened by the resilience of the economy in recent years. One indication of this has been the performance of Poland’s exports. “Over the last couple of years, exports have been a major driver of Poland’s economic outperformance,” says Reluga at BZ WBK. “In the last 20 years, the share of exports in GDP has doubled, while Poland’s share of exports in international trade has risen by 2-1/2 times.”
Reacting to Russia
This increase has been especially noteworthy in light of the economic crisis in Russia, historically one of Poland’s main trading partners. “Exports to Russia have declined by close to 20% since sanctions were imposed, while those to Ukraine have fallen by 30%-40% on an annualised basis,” says Bodys at PKO BP. “But these markets are now much less important to Poland than Germany. Russia and Ukraine represent about 5% and 2.5% of Poland’s total exports respectively, and for even less in terms of value added, whereas Germany now accounts for about a quarter of the total.”
As Bodys adds, it is a testament to the flexibility of Poland’s exporters that they have been quick to explore new markets when demand from traditionally important trading partners has slowed.
Against that backdrop, and given rising confidence about economic recovery across the eurozone, it is perhaps surprising that exporters are downbeat about their immediate prospects. According to the latest update from the National Bank of Poland (NBP), export forecasts in the corporate sector are at historically low levels.
Bodys says that much of this is a reflection of a significant decline in export values across the emerging market universe, coupled with the strength of the dollar. More broadly, say others, it is all the more reason for the Polish corporate sector not to lower its guard in terms of investment. “Currently, a large share of our exports are of components which are then used for further production in countries like Germany and re-exported,” says Reluga. “We now need to elevate Polish exports to the next level, which calls for more investment in innovation and R&D.”