COMMENT: Poland an island of stability, but pressure grows to reform

By bne IntelliNews November 4, 2009

Gunter Deuber of Deutsche Bank Research -

Unlike other Central and Eastern European (CEE) countries and the majority of the EU15, Poland's economy is remarkably robust, exerting a stabilising effect on the entire region and many Eurozone banks. However, the economic and financial crisis has also highlighted structural weaknesses that require determined reform efforts.

Poland has coped well with the global crisis. This holds true in comparison with other emerging markets such as Brazil, Mexico, Russia, South Africa and Turkey, as well as other CEE countries and the majority of the EU15. Of all these economies, Poland will be among the very few that will achieve growth in 2009. The Polish state enjoyed more or less unlimited capital market access in 2009, even before seeking access to the International Monetary Fund's Flexible Credit Line (FCL) in May. The FCL, with its restrictive criteria, is additional confirmation of Poland's economic soundness, which rests on the following four pillars:

* Poland has registered solid growth without going to extremes in the areas of consumption and credit growth, as was the case in other CEE countries;

* Thanks to structural factors, Poland is better equipped to fend off external shocks than other economies. Its large and emerging economy is benefiting from the large share of domestic demand and consumption in overall demand. Foreign trade plays only a minor role;

* Measures to stabilise the economy have proved successful. At the onset of the crisis, the government, financial supervisory bodies and the central bank (NBP) acted to safeguard banking sector liquidity. In addition, the NBP made use of its monetary leeway by slashing key interest rates. There have been no major discretionary measures to stimulate the economy. The only measures taken were tax cuts, which had already been passed prior to the crisis. The at times strongly expansionary fiscal policy makes sense - to a certain extent. Besides stimulating consumption through tax cuts, fiscal policy measures have also aimed to leverage EU funds to support public investment;

* As regards the timing of the global crisis, Poland happened to be lucky. While other CEE countries had seen growth based heavily on external demand and credit finance for nearly a decade, Poland moved only partly in this direction from 2005, as it was still recovering from the 2001-02 recession. This kept the country from becoming overly optimistic. Moreover, the NBP quickly raised credit standards for foreign-denominated and mortgage loans.

Poland is benefiting from the fact that it is more stability-oriented than most other CEE countries. Thanks to its relative stability, the largest of the CEE countries exerts positive external effects, thus helping to prevent a deep crisis of confidence in the region. The main beneficiaries are Eurozone banks, which - at 90% of the total - dominate cross-border lending to clients in the CEE countries. This is especially true as European banks also have a substantial claims portfolio vis-a-vis Polish debtors. Among all the emerging markets of Europe (which, according to the Bank for International Settlements, include Russia and Turkey), Poland ranks first with cross-border bank lending of $243bn or 18% of total cross-border credit. The direct effects of Poland's stability on other CEE countries are minor, as all these economies are strongly geared towards Western Europe. Thanks to its being the seventh largest EU economy and having extensive ties with many EU15 countries, Poland also has an indirect stabilising effect on the entire EU and many European companies.

Besides its own merits, Poland is also a beneficiary of fiscal expansion in the Western European EU member states and, above all, Germany. Moreover, the current crisis and its effects should not be overestimated. After growth in the order of 4-6%, economic expansion of around 1% feels like recession in Poland. All in all, the country will have to prepare for a period of slower growth. Expected strains on banks will rein in lending, which is still heavy. The fiscal impetus will expire. And the global crisis has highlighted a number of medium-term vulnerabilities. Government finances, delayed structural reform of the social-security system and the labour market - all interdependent - are the Achilles' heel of Poland's economy, and have led to budgets quickly spiralling out of control.

Improvements needed

The weaknesses outlined need to be addressed in order to support recovery. This holds true particularly, as Poland is benefiting less directly than other CEE countries from the stabilisation in Western Europe owing to its low degree of trade openness. Sustained recovery will only be possible if Poland addresses its further weaknesses in comparison with the leading CEE countries and other major emerging markets that are ahead in this respect. The following areas ought to be tackled first: improvements of the business climate and private-sector regulation, infrastructure and the diversification of energy supply. Poland not only lags behind other CEE countries, but also several large emerging markets such as the BRIC economies (Brazil, Russia, India and China), Mexico, South Africa and Turkey. The quality of Poland's infrastructure compares poorly with that of countries such as Mexico or South Africa, and the labour force participation rate is lower than in the other large emerging markets, with the exception of South Africa. On a medium-term horizon, Poland would even need to climb a steeper growth path than the EU15 and other CEE economies to catch up; at present it is one of the poorest EU members. However, recent long-term surveys do not forecast such a sufficiently steep growth path given the structural weaknesses mentioned above.

Poland's current economic situation is actually quite comfortable for a country that was considered an uncertain candidate for the EU's 2004 enlargement. The global crisis even offers the chance to cement this position if the measures that helped Poland achieve its resilience to the crisis are recognised. In this respect, the cap on public-sector debt and the independence of the central bank should remain inviolable. Also, structural problems such as the low participation rate, the large share of the shadow economy and unreformed social-security programmes should now be tackled with vigour. As this will allow fiscal consolidation, the upshot might be a rapid return to fiscal credibility and a more realistic perspective regarding euro membership. However, these challenges show that Poland's current stability is by no means assured and can only be maintained by means of reforms that will be hard to push through domestically. These reforms will only materialise if the presidential and parliamentary elections, to be held in 2010 and 2011 respectively, bring an end to the current stalemate between the government and the president.

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