Country Report Poland
Poland’s economy regained steam in the second half of 2013, as domestic demand gradually picked up. Yet, depending on the decision of the Constitutional Court on a major pension reform, growth could be dampened by additional fiscal austerity measures.
Strengths (+) and weaknesses (-)
(+) A relatively large and diversified economy
Compared to its smaller regional peers, Poland’s economic resilience towards external shocks is underpinned by a sizeable domestic market and a lower economic openness. Still, close supply chain integration with neighboring Germany contributes to business-cycle synchronicity.
(+) A stable, profitable and well-capitalized banking sector
Poland’s largely foreign-owned banking sector managed to further boost its already strong capital adequacy ratios, while keeping credit quality amid the recent economic slowdown stable.
(-) Elevated public debt levels limit fiscal space
Driven by recurrent sizeable budget deficits and weaker economic growth since the onset of the global economic crisis, Poland’s public debt level is approaching constitutional limits that impose pro-cyclical fiscal consolidation measures.
(-) A sizeable external funding requirement
Given an external funding requirement of about USD 155bn (29% of GDP) in 2014, considerable foreign participation in the local banking sector and rising foreign ownership of złoty-denominated government debt, Poland remains exposed to the withdrawal of foreign financing.
1. Economy rebounds in the second half of 2013 as domestic demand strengthens
Poland’s economy continued to gain steam in the second half of last year, expanding 0.6% qoq in the third and likely 0.5% qoq in the fourth quarter, as domestic demand and private consumption in particular rebounded. Yet, owing to lackluster growth in the first two quarters of the year, growth in 2013 as a whole is estimated to have slowed to 1.6%, following a weak 1.9% expansion in 2012. While net exports supported growth throughout last year, domestic demand contracted by 0.2%, as fixed investment fell by 0.4% (compared to a 1.7% decline in 2012) and private consumption expanded by a weak 0.8% amid a worsening labor market. Improving consumer confidence on the back of the gradual stabilization of unemployment rates, as well as rising real wages seem to have boosted household consumption in the third and fourth quarter, while fixed investment growth picked up as Poland’s central bank kept interest rates low. Provided the positive momentum of domestic demand extends into 2014, economic growth could strengthen to about 3% this year. While exports will likely remain the backbone of Poland’s economic recovery, a renewed weakness of domestic demand poses a downside risk to the outlook, particularly so if the government was forced to implement additional austerity measures in case the Constitutional Court were to deem considerable parts of last year’s pension reform unconstitutional (see next paragraph).
2. Constitutional Court assesses last year’s pension reform
Following the approval of a controversial pension reform by both chambers of parliament, President Komorowski signed the bill into law early this year. While stressing that he would not have signed it in case of serious doubts regarding its constitutional conformity, he sent it to the Constitutional Court to clarify remaining issues. In essence, the reform prescribes the transfer of all public debt holdings (USD 37bn, about 50% of total assets) and associated pension liabilities of Poland’s Open Pension Funds (OFEs) to the government-run Social Insurance Institution (ZUS), while restricting the OFEs from buying EU sovereign bonds. The Constitutional Court was asked to take a closer look at the investment restrictions imposed on OFEs and the consequent requirement to heavily invest into stocks, as well as the abolition of a guaranteed return on investment for future pensioners or the ban on OFE commercials. Given that the views of both the government and its critics are supported by constitutionalists, the Court’s eventual assessment remains uncertain. Yet, given that the administration likely consulted with the 10 (out of 15) judges it had appointed in recent years, at least partial support for the reform looks relatively likely. Yet, OFEs may file lawsuits regarding possible breaches of EU legislation. Pending the likely approval of the public debt transfer, Poland’s public debt ratio is expect to decline to 51% of GDP (ESA95-definition), well below Poland’s constitutional debt ceiling. Consequently, short-term fiscal space will improve, but this gain comes at the cost of deferred future public pension expenses and a smaller domestic debt market.
3. Cabinet’s declining popularity clouds outlook for structural reforms
Painful structural reforms in the run-up to the 2015 parliamentary elections are becoming increasingly unlikely, as prime-minister Tusk will likely focus his policy efforts at boosting domestic demand in the short-term in order to improve his chances at re-election and reduce the risk of further defections endangering his cabinet’s parliamentary majority. Driven by a combination of Poland’s recent growth slowdown and considerable internal strife within Mr. Tusk’s party, public support for the coalition tumbled last year and his Platforma Obywatelstwa (PO) party still trails the opposition Prawo i Sprawiedliwość (PiS) party by a wide margin. Responding to this challenge, prime minster Tusk replaced various ministers last November, including finance minister Rostowski. While major policy changes are unlikely, the prominent role of the new minister of infrastructure suggests an increasing focus on EU co-financed infrastructure investments, which would boost local employment and thereby improve the cabinet’s popularity.
4. Poland hardly affected by emerging market turbulence
Poland escaped the emerging market sell-off of early 2014 relatively unscathed, as the złoty remained stable vis-à-vis the euro and the USD and government bond yields hardly moved since mid-December 2013, when the US Federal Reserve announced to start scaling back its stimulus. Solid fundamentals, particularly Poland’s strongly reduced current account deficit, its favorable growth outlook, and its track record of prudent economic policies support investor confidence. Meanwhile, foreign borrowing of banks and corporates, oftentimes intercompany lending, recovered last year, illustrating ongoing commitment by foreign parent companies. Still, given its large external financing requirement, Poland remains exposed to the risk of rising foreign fund outflows.
With a nominal GDP of USD 524bn in 2013 and a population of 38.5m inhabitants, Poland is the largest economy in the Central and Eastern European region. In contrast to its smaller peers, like the Czech Republic or Hungary, Poland benefits from a relatively large domestic market, which improves its resilience vis-à-vis external shocks. Nevertheless, the local manufacturing sector is increasingly integrated into German supply chains, which contributes to rising business cycle synchronicity between the two countries. In line with this development, Poland’s exports and imports are dominated by intra-industry trade, primarily with Germany. Notwithstanding these close ties, Poland avoided following Germany into recession in 2009 and managed to post continuous positive economic growth since the end of Communism in the early 1990’s. Convergence of GDP per capita levels between the two countries is far from complete, however, illustrating Poland’s considerable catch-up potential. Poland is expected introduce the euro in the coming years, but given its failure to meet the Maastricht treaty budget deficit criterion (3% of GDP) and the ongoing uncertainty regarding the euro area sovereign debt crisis, no definite accession date has been set yet. Consequently, it will likely keep its freely floating złoty in the years to come, whereby the central bank may at times opt to stabilize the exchange rate, given the country’s exposure to foreign-currency denominated debt. Poland’s social situation is stable and the current government enjoys a slim, yet shrinking, parliamentary majority. Still, it remains to be seen whether prime minister Tusk, whose re-election for a second term has been unprecedented in Polish history, can avoid early elections if parliamentary support were to weaken further, as several previous cabinets had to resign following successful no-confidence votes.