Markets worry over Poland's new economic direction

Markets worry over Poland's new economic direction
By Wojciech Kosc in Warsaw November 13, 2015

When Poland’s new ruling party, Law and Justice (PiS), presented its government on November 9, the media focus was on the controversial throwbacks appointed to the ministries of justice and defence. However, the ministers in charge of the economy seem less prone to carrying out what markets would consider non-standard policies.

The new leadership of the finance and treasury ministries appears to be a conscious attempt to alleviate the markets’ worries that the PiS government will ignore budgetary and fiscal constraints in trying to fulfil its promises during the election campaign. These worries grew even bigger after it turned out that PiS had won an outright majority in the parliament, the first time in democratic Poland.

With PiS widely tipped to seize power for months, markets have had time to get used to its proposed economic course. That is likely why the reaction to the Prime Minister Beata Szydlo’s announcement of her cabinet on November 9 did not appear dramatic, encouraging commentators to claim that investors have accepted suggestions PiS will moderate its policy promises now it is actually in office.

However, it's been more a slow burn since Andrzej Duda kicked off the party's apparently unstoppable rise back to power with victory in the presidential election in May. That left the WIG20 with little distance to fall before it breached 2,000 points for the first time in six years on the same day Szydlo unveiled the government. Despite having gained against the euro since then, the zloty has weakened persistently since May.

If there is a bottom line to what analysts have said about the incoming government, it is that its ideas are unlikely to do harm in the short run, but the longer the horizon, the more doubts rise about the impact on Poland's economy and finances.

The majority in parliament means that PiS' campaign pledges will meet little resistance should the government decide to push them. The populist conservative party’s officials have subsequently been saying that key ideas, such as a tax on banks and large retailers, or a new child benefit, will now be implemented.

To execute those points of their programme, the party bet on less well known names to be responsible for how and over what time frame these proposals will be executed. This is in line with the party’s tilt towards the idea of a “moral fix” to the Polish state, with economic issues and modernisation important, but not fundamental. That at least was the tone of PiS chairman’s Jaroslaw Kaczynski’s speech during Independence Day on November 11.

PiS picked an outsider – Mateusz Morawiecki, former CEO of BZ WBK bank, part of Spanish banking group Santander – to head the government’s economic policy, in a move seen as a concession to the markets. In his past interviews for the Polish press, Morawiecki comes out as a fairly strong proponent of the state taking an active role in economic development. He would like the state to support those Polish companies that have a chance of becoming important exporters. He argues no country in recent history achieved economic success without helping exports.  

Morawiecki also thinks Poland’s consumption-fuelled growth is not a long-term solution for the country. He would like to follow the example of Germany, France, Japan or Korea, which invested 30% of their GDP at times of their fastest growth. “We are too consumerist, while we need investment a lot more today,” he told Gazeta Wyborcza in 2014. That may not go down too well with many Poles, whose growing wages have long been described as the motor of economic growth, even if participation in the consumption boom has not been truly widespread.

Yet with hardly any previous ties to PiS, there remains a question as to how strong Morawiecki’s real position will be in the government. As soon as the PiS government takes over, he might find himself dealing policies that he would be likely to shun as a banking CEO.

For the party’s flagship proposals, Capital Economics recently concluded that their benefits appear to be more immediate, while their shortcomings will become more apparent in the mid-term and longer horizon.

The benefit of increased social spending – which apart from a higher child benefit will include hiking tax-free income more than twofold and increasing the minimum wage – would be a clear boost to households’ incomes. A similar effect should come from conversion of Swiss franc (CHF) loans, relieving households from high debt service costs. Also a programme of cheap financing for Polish SMEs – which produce about half of Polish GDP – could boost domestic demand and investment, Capital Economics note.

These programmes are costly, however, and could increase pressure on public finances in the mid-term. PiS plans to address that issue by introducing a tax on banking assets – or one on financial transactions – and another levy on large retailers. But these new taxes, alongside CHF conversion, are likely to make banks tighten lending conditions and lead to a deterioration of the overall business environment.

“It’s worth noting that when the Fidesz party imposed similar taxes in Hungary, investment fell significantly. Lower investment could, in turn, lead to weaker growth prospects over a five to 10-year horizon”, William Jackson of Capital Economics noted on November 6.

PiS’ nominee for the position of finance minister Pawel Szalamacha admitted in early November that the budget deficit “may be increased”, but not beyond the point of exceeding 3% of GDP, the EU threshold that the outgoing Civic Platform government had achieved. “The budget will implement our flagship announcement [of raised child benefit] and at the same time will keep its macroeconomic stability," he told PAP on November 10.

A danger is that “public investment spending will be squeezed to accommodate higher welfare spending”, Jackson noted.

PiS could also have a large influence on the Monetary Policy Council (MPC) of the central bank. With nine out of 10 MPC members – including central bank governor Marek Belka - to be replaced by June, the new council is expected to become more prone to execute a dovish policy. As is with other PiS’ proposals, the immediate effect of a cut in rates is unlikely to be a problem. But it may become one in the mid-term.

“If it was clear that nominations to the council were based on the propensity to ease policy, this would undermine the central bank’s credibility. Inflation expectations might then become unanchored,” Jackson wrote.

Perhaps one of the most worrying campaign pledges was a "Central Bank Programme" similar to the European Central Bank's quantitative easing. The cheap financing plan, PiS said, would bring hand PLN350bn to Polish companies to spur investment. 

The idea has been derided by economists and members of the MPC alike as "superfluous" in the context of strong bank lending and a record low benchmark of 1.5%. “Money supply is not an issue in the Polish economy today,” wrote the NBP’s financial news website in late October.

PiS may now be having second thoughts along the same lines, having gone a little quiet on the issue in recent weeks. On the other hand, it may just be waiting until it gains control over the MPC in the next few months.