Patricia Koza in Warsaw -

Poland struggles to define its place in the EU.

Poland has had a rough 16 months since it joined the EU. Unlike most of the other nine new entrants that have meekly fallen into line with Brussels, it seems to delight in picking fights.

Sitting at top table for the first time, Poland threw its weight around in last year's battle over the EU constitution, until the French and Dutch voters' decision to reject it completely made the issue moot.

And Poland has received a series of slaps on the wrist after missing several financial targets. The European Commission rebuked Poland for dawdling over public finance reform and refusing to set a eurozone entry date, then it was warned its budget does not meet the Maastricht criteria.

Even when Poland tried to comply with EU rules, its flippant disregard for protocol got it into trouble. The introduction of a draft energy security treaty could have been a promising initiative, but fell flat because Poland missed the submission deadline for a March meeting of the European Council of Ministers. Then when the H5N1 bird flu virus was found in Poland, the news was publicised within hours - earning a Commission reprimand for pre-empting the EU laboratory in the UK where the tests were conducted.

Most of Poland's gaffs could be ignored as the older members of the EU like Germany, France and Italy routinely thumb their noses at Brussels' directives. However, the latest dust-up is far more serious and calls into question Poland's commitment to the basic principle of EU integration. It is one thing to miss a deadline or be a bit quick with a press release; it is another to block the free flow of capital, tamper with the financial system's infrastructure and build up national energy companies so they can capitalise on EU deregulations.

PRIVATISATION AGREEMENT

“The actions of the Polish government do not have enough maturity for Europe,” Austria's finance minister, Karl-Heinz Grasser, grumbled during an EU finance ministers' meeting in mid-March.

Poland has refused to allow a merger between the nation's second and third largest banks, Pekao and BPH. Both now belong to Italy's UniCredito following its €17 billion takeover of German financial group HVB earlier this year in the EU's biggest ever cross-border banking tie-up. The Commission's competition authorities approved the merger last October, but Poland's government has refused to let UniCredito complete it. A new centre-right Polish government was voted into office in September and is keen to prove its mettle. It claims the merger would lead to the monopolisation of the market and price hikes, as well as destroy 6,000 jobs in a country with 17% unemployment.

It also worries transfer pricing could siphon €1.5 billion to €2.5 billion out of Poland annually.

And perhaps not incidentally, the merged bank would oust stateowned PKO Bank Polski from the top slot in the banking sector.

While these charges smack of protectionism, the government is likely to have more legal traction with the claim that the deal violates the 1999 privatisation agreement UniCredito signed to acquire Pekao in the first place, where it promised not to compete with Polish banks.

Still, Poland cannot be accused of knee-jerk protectionism when foreigners already own 70% of its banking sector - the highest foreign ownership concentration in the EU-25. The merger would give the country's top five banks — all but PKO Bank Polski foreign-owned — control of 49% of assets in the Polish market. The next highest concentration in the EU is France's 45%, but in that case the banks are locally owned.

Both sides were revving up for a long legal battle. No fewer than five international law firms have advised or are advising the Treasury Ministry on the matter.

“I'm not aware of any EU law that would take precedence over the actions of a government prior to its accession,” said Wladek Rzycki, a partner in Hogan & Hartson in Warsaw, who specializes in commercial law. “UniCredito apparently agreed in the privatisation contract not to compete with other Polish banks; and it seems that the EU laws are simply inapplicable to such a private contract in this regard.”

HOWLS OF PROTEST

Then things got worse. On March 8, Poland's Banking Supervision Commission (KNB) sat down to what should have been a routine meeting to decide if UniCredito could vote its 71.2% stake in BPH.

Poland's banking inspectorate had already signed off on UniCredito's right to exercise shares and the KNB only had to review the deal to see if it presented any threats to the banking system or if the parties face financing issues.

But the meeting was far from routine. KNB's chairman and president of the National Bank of Poland, Leszek Balcerowicz, decided to bar Deputy Finance Minister Cezary Mech from the meeting in order to protect the KNB's impartiality.

Balcerowicz was acting on a motion proposed by UniCredito, as Mech had been a vocal opponent of the merger.

The meeting sparked a major scandal and Balcerowicz's decision was met with howls of protest. The government is now calling for a special commission to investigate all the bank supervisors' decisions over the last 16-years - many of which were made by Balcerowicz, who is the leading architect of Poland's 'shock therapy' transition to a market economy.

“Leszek Balcerowicz has broken the law in a major way,”

declared Prime Minister Kazimierz Marcinkiewicz. “It is beyond any doubt that he should explain himself to the investigative committee after it is established.”

The government has also fasttracked legislation to combine three independent financial regulatory institutions - the securities commis- sion, the insurance and pension watchdog, and KNB - into a superagency under the direct control of the prime minister. One minor right-wing party even pushed, unsuccessfully, to put Balcerowicz on trial before the State Tribunal.

“No institution is so independent as to be independent of state interests,” said Marcinkiewicz, whose minority coalition government is dependent on the support of two minor Euro-sceptic and populist parties. Meanwhile, the KNB put off its decision until April 5.

COMPROMISE

The Commission was not happy and launched its own legal proceedings against the Polish government, warning that if it insists on continuing to block the merger, it will be hauled before the European Court of Justice.

“The Commission believes that including a clause banning competition in the Pekao privatisation agreement is a restrictive instrument, breaching the free flow of capital and entrepreneurship rights,”

the Commission said in a statement.

Along with Internal Market Commissioner Charlie McCreevy's finding that Poland is blocking free capital flows, Competition Commissioner Neelie Kroes has questioned Warsaw's delay in complying with its October go-ahead for the merger. “We will be closely looking at each attempt to block transnational mergers by the national governments,” she warned on March 16.

Brussels gave Poland two months to resolve the standoff. The Polish Treasury Ministry countered by giving UniCredito until May 1 to sell its shares in BPH or it will annul Pekao's privatisation. In an attempt to trump the EU, Poland has also filed its own case with the European Court of Justice - against the Commission.

Meanwhile, the Prime Minister and his aides were quietly meeting with UniCredito head Alessandro Profumo and his staff, and on April 5 a compromise was reached.

Unicredito agreed to sell 200 BPH branches to “an independent third subject through an international and transparent process,” according to a Treasury Ministry statement. The remaining assets will go into Pekao.

The agreement calls for no layoffs before March 31, 2008 and will put two Treasury-chosen representatives on the BPH supervisory board.

Score one for Polish hard-headedness, zero for the EU and its threats.

HEROES AND VILLAINS

The row over the proposed merger is bad enough, but it could undermine the entire financial infrastructure, especially the assault on the central bank's independence.

“The independence of the central bank of Poland is of extreme importance,” Jean-Claude Trichet, the president of the European Central Bank, declared on March 14.

Economists are undecided if Poland's actions are prompted by politics or simple ignorance. But Poland is earning a reputation as a difficult customer. The Centre for European Reform surveyed progress made by the 27 signatories to the 2005 Lisbon Strategy in March, which outlines changes that are needed to make the European market more completive. Poland was second to last on the list and was listed as a “villain” in eight of the survey's 13 classifications.

“Poland's reputation, it's a pity to say, is justified,” says Rafal Antczak, senior economist at the independent thinktank CASE, which, incidentally, is run by Balcerowicz's wife. “The general problem is that many politicians in the current leadership simply don't understand how the new EUinspired regulations can be implemented - they still believe they can steer the country.”

BATTLES TO COME

As the “banking war” continues to rage, the government is already opening a new front in its battles with the EU with its plans to restructure the energy sector, the last sector dominated by state ownership.

The plan envisages the consolidation of power producers and distributors with coal companies into four vertically integrated power groups. The leading group will be an entity built around power and mining group Belchatow-Opole-Turow Gornictwo i Energetyka SA, or BOT, and will include the power grid Polskie Sieci Elektroenergetyczne, or PSE, (minus the transmission system operator); the country's fifthlargest power producer Zespol Elektrownia Dolna Odra; and eight central and southern distribution companies. The merged group would control more than 50% of the Polish market. A second mega-group would be built around the number two power producer Poludniowy Koncern Energetyczny, or PKE.

Both groups would be floated on the Warsaw Stock Exchange by 2008, but the state would retain a controlling stake.

The plan drew flak from all sides even before it was published. The Commission is sceptical of the idea of consolidating producers and distributors in general. In a report released February 15 outlining problems of market concentration in the EU energy sector, Brussels specifically mentioned Poland, warning that vertical integration “reduces the incentive to trade on wholesale markets,” and so drives up costs. The report also said that long-term power contracts, or PPAs, between the PSE grid operator and generators, which currently govern more than half of Poland's energy market, have a similar effect.

In March, the Commission formally launched an investigation into whether they should be characterised as an illegal form of state subsidy worth an estimated €1.8 billion. And on April 4, the Commission issued formal warnings to Poland and 16 other member states for failing to open their energy and gas markets by the July 2004 deadline.

The Commission warned that if the relevant regulations are not implemented, the European Court of Justice may impose financial penalties.

Critics accuse Poland of trying to create national champions that will benefit unfairly from the single European energy market once it is fully liberalised in July 2007. Poland is not alone in this - both Spain and France are also planning to merge domestic energy groups ahead of the liberalisation, rebuffing approaches by foreign companies.

Polish consumers are also not keen on the plan which they say will push up already high energy costs even higher - Polish households already spend nearly three times as much on their power bill as the European average. At the same time they worry changes to the powers of the tariff watchdog, the Office of Energy Regulation, will make it less effective and so clear the way for more price hikes.

“In order for real competition to exist, a sufficient number of players are needed on the market,” says Przemyslaw Chojnowski, president of the Energy Sector Private Employers Union.

GROWING PAINS

Poland is making little progress at improving competitiveness in the energy sector; if anything it is going backwards as the number of players in the market will decrease, not increase. The government has already suspended the privatisations of two big power complexes set for later this year.

Poland is being a prickly new member of the European family, but many observers say this is all part of the EU's growing pains. The optimists point to Spain, which went through a similar teething period after joining the EU in 1986, and expect Poland to become easier to work with once its politicians have got used to dealing with Brussels.

“Conflict with the Commission is a no-win situation and will not lead to anything,” says Danuta Huebner, EU commissioner for regional policy who previously represented Poland in the EU for several years. “In my opinion, Prime Minister Kazimierz Marcinkiewicz is aware of that.”

BOX: Poland's STRANGE POLITICAL BEDFELLOWS

Prawo i Sprawiedzliwo (Law and Justice Party) –

Headed by Jaroslaw Kaczynski, the twin brother (and chief behind-the-scenes advisor) of President Lech Kaczynski, this center-right party leads a minority coalition with the two extreme right-wing parties listed below. It was elected in September 2005 on a platform of cleaning out communists and ending corruption. In its first 100 days, it has resolved neither issue and is continually in danger of seeing its coalition collapse. President Lech has already threatened to dissolve parliament four times; the last time, he says, his brother talked him out of it.

Samoobrona (Self Defense) –

The radical farmers' party created and dominated by Andrzej Lepper, whose claim to fame is his criminal record for dumping manure, blocking roads with grain imported from the EU and calling ministers “bandits and idiots.”

A former pig farmer and pugilist who once belonged to the old communist party PZPR, his popularity is attributed by analysts to his pandering to malcontents.

Samoobrona's party song embraces his philosophy: “This land is our land, and we won't let anyone punch us in the face.” He's run for president three times, the last time gaining over 10% of the vote, and he could end up deputy speaker of the parliament if the ruling party's worst fears are realised.

He once praised Nazi propaganda chief Goebbels for his mastery of the media, Hitler for his 'economic policy,' and has made anti-Semitic remarks in the past, but lately has cleaned up his image and is considered a serious politician.

Suspicious of both US capitalism and EU interventionism, Samoobrona opposes privatization.But Lepper's an animal lover: he has vowed to “stop the concentration camps” of modern farming methods in Poland. Aw…

Liga Polskich Rodzin (League of Polish Families) –

A Christian far-right party with the distinction of being the only group in parliament that unconditionally opposed Polish membership in the EU. Its platform is populism, patriotism, and pummeling advocates of abortion and gay rights. Founded in 2001, its leader is Roman Giertych, a history and law major who became a national figure in 2004 for his relentless questioning of witnesses during nationally televised hearings into scandals at PKN Orlen, Poland's biggest oil company. The party appeals to voters who are attracted to traditional social values and the Catholic faith, but support is dwindling and it would likely be dropped from representation in Parliament in snap elections.