Luck of the Polish

By bne IntelliNews September 15, 2009

Jan Cienski in Warsaw -

Poland's economy grew at an annual rate of 1.1% in the second quarter, and although that number is far from the growth rates being enjoyed in rapidly rebounding Asia, it makes Poland the fastest growing economy in the EU. The government now reckons the economy will grow by 0.9% this year, while the European Commission on September 14 revised up its forecast for 2009 growth to 1.0%.

Poland ended up with Europe's strongest economy through a series of unrelated coincidences, not because of a particularly skilled crisis strategy. "In many ways, we were simply lucky," says Witold Orlowski, an economist with PricewaterhouseCoopers, the consultancy.

The first piece of luck was the structure of Poland's economy. While other Central European countries like the Czech Republic and Slovakia are enormously export dependant - with exports accounting for almost 80% of GDP - Poland, with 38m people, has a much larger domestic market, and exports account for less than 40% of GDP. While the rest of Central Europe was pummelled when the German economy fell into recession, Poland's economy was less affected.

Crucially, Polish consumers did not slam their wallets shut when the crisis hit the region a year ago. Poles have become significantly richer over the last two decades of economic transformation; GDP per capita came to about $6,000 in 1989 and now is above $17,000, and Poles enjoyed double-digit wage increases during the final years of the boom. That made them flush enough to continue spending. Retail spending is showing continued signs of improvement, with sales in July showing a 5.7% annual increase.

Spending and investment were also maintained thanks to continued inflows of EU funds into Poland, particularly for infrastructure projects like highway construction.

Another factor helping the economy was the steep depreciation of the zloty earlier this year. The Polish currency lost almost a third of its value to the euro and the dollar as risk-averse investors fled the region. While the zloty's fall may have caused palpitations for the many Poles who have home mortgages denominated in foreign currencies, the weaker zloty proved to be a boon to exporters. Furthermore, by making imports more expensive, Poland's balance of payments improved rapidly. "The fall in the value of the zloty acted as a shock absorber for our economy," says Waldemar Pawlak, Poland's deputy prime minister and economy minister.

Tax break

The government also got lucky in that the tax reductions passed by the previous government came into force just as the crisis hit. The former right-wing Law and Justice government lowered Poland's income tax rate from three bands with a top rate of 40% to two bands with a maximum rate of 32%. That did cause problems with the budget deficit, but ensured that Poles got an extra dose of cash to spend.

Poland has also seen a milder dose of economic malaise than Western Europe because of the relative unsophistication of its economy and financial institutions. Poland's banks, 70% of which are foreign owned, did not really dabble in exotic US mortgage-backed securities, sticking instead to taking deposits and making loans. That has left banks able to ride out the global crisis. In addition, the size of the banking sector is smaller than in more developed economies. Total borrowing comes to less than half of GDP, a third of the level seen in Western Europe.

Although the wider economy has avoided falling into a technical recession this year, the dramatic slowdown in economic growth is wreaking havoc with the country's current account and public finances.

On September 11, Poland published its balance of payments data for July, which showed the current account situation fell into to a deficit of €565m, a turnaround from than the surplus of €459m posted in June and much worse than the consensus expectation of a surplus of €215m. The deterioration in the current account was driven by both weaker-than-expected exports and stronger-than-anticipated import growth. In addition, the data showed that net foreign direct investment (FDI) posted an outflow of $197m in July, which compares with the $900m net inflow in July 2008. "It affirms the view that FDI inflows overall to the region are running significantly lower year-on-year as foreign investors react to a more difficult funding environment, but also obviously a less robust outlook for growth," says Tim Ash of Royal Bank of Scotland.

The public finances have been helped by a determined effort by the state treasury to extract as much in dividend payments as possible from companies in which the state has a large stake, like PKO BP, the country's largest bank, and PZU, its leading insurer. That was possible because of the profits raked in by those companies in 2008, the last year of the boom. That will change next year, leaving the government strapped for cash.

With tax revenues falling and spending increasing due to rising unemployment, the government is predicting that the budget deficit for next year will almost double from this year to PLN52.2bn (€12.5bn).

The key issue for the government is to avoid public debt from breaching 55% of GDP - it is currently just below 50%. At that level, Polish law mandates painful steps to but the budget back in balance, steps which would be unlikely to enhance the electoral prospects of Donald Tusk, the prime minister, in next year's presidential elections.

In order to keep the deficit at even those levels, the government is planning an ambitious, but politically controversial, mass privatisation programme that could raise PLN25bn next year.

Poland may have skirted a recession, but the economy still has a difficult year ahead.

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