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Country Report Poland

Country Report

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Poland’s economy continued to rebound strongly in the first half of this year, but growth is likely to weaken amid mutual EU and Russian sanctions. As prime minister Tusk heads for Brussels, a new cabinet may be nominated as soon as early September.

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 maintained its strong capital adequacy ratios, while keeping credit quality stable amid last year’s economic slowdown.

(-) Elevated public debt levels limit fiscal space

Poland’s public indebtedness remains relatively high, even as last year’s pension reform reduced public debt to about 50% of GDP. As public debt approaches legal debt thresholds, available fiscal space to boost economic growth becomes constraint.

(-) A sizeable external funding requirement

Given a gross external funding requirement of about USD 150bn (27% of GDP) in 2014, large 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.

Key developments

1. Economic momentum slows as Ukraine crisis hits confidence

While Poland’s economic rebound which had started during the second half of 2013 continued in the first two quarters of this year, the recent escalation of tensions between the EU and Russia and the ensuing implementation of reciprocal trade bans weighs on Poland’s growth outlook for the remainder of the year. Economic growth accelerated to a seasonally adjusted 1.1% qoq in Q1 (3.5% yoy), the fastest qoq-growth rate in more than 2 years, but slowed to 0.6% qoq (3.2% yoy) in the second quarter. In both quarters, growth was mainly driven by domestic demand, as export growth weakened markedly. While private consumption was boosted by improving employment, markedly rising real wages and a pick-up in złoty-denominated household credit, public and private investment benefitted from strengthening credit growth to corporations and EU transfers. Meanwhile, export growth was weighed down by the crisis in Ukraine, as moderating external demand from the EU hardly compensated for a 7% decline in exports to Russia and a 25% contraction in exports to Ukraine in the first half of this year, as exports to both countries accounted for about 8% of total exports in 2013.

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: Main export destinations
Figure 2: Main export destinationsSource: EIU, GUS, Rabobank

Meanwhile, industrial production growth slowed markedly in Q2, while Poland’s PMI declined to contractionary territory. Going forward, the conflict in Ukraine will likely weigh on Poland’s economic growth via both the trade and confidence channel, which would lead to weaker domestic and external demand. Exports will likely take a hit from a further slowdown of the Russian and Ukrainian economies, as well as weaker growth in the EU, while the impact of the Russian ban on EU food imports (affecting about 0.6% of Poland’s total exports) should be limited. Given Poland’s very tense bilateral relations with Russia, further Russian sanctions that are particularly directed against Poland cannot be excluded. Meanwhile, domestic demand may be hit by declining consumer confidence if tensions between the West and Russia remain high or weaker export growth were to lead to a deterioration of the labor market situation. However, thanks to recent mild deflation and increased fiscal space in the aftermath of the 2013 pension reform, policymakers have some monetary and fiscal policy space to dampen the expected slowdown. Based on the current situation, economic growth is expected to reach 2.7% this year before rising to 3.4% in 2015.

2. Progress in fiscal consolidation and pension reform provide some fiscal space

Following last year’s widening of the budget deficit to 4.3% of GDP from 3.9% in 2012, Poland’s fiscal consolidation is back on track. Strong economic growth boosted government revenues in the first half of this year. Also, the cancellation of public debt through last year’s pension reform lowered the interest expenses. Combined with additional consolidation measures worth 0.5% of GDP, these effects should reduce this year’s budget deficit (net of asset transfer of public debt from private pension funds (OFEs) to the public sector) to 3.3% of GDP. Barring a major decline in economic growth, next year’s budget deficit is expected to decline to 2.9% of GDP, in line with the EU Excessive Deficit Procedure’s (EDP) demand to reduce the deficit to 3% of GDP in 2015. As this year’s budget deficit is therefore likely to come in below the target of 3.9% agreed under the EDP and the transfer of OFE assets reduced public debt to about 46% of GDP (national definition), below the recently lowered public debt limit (48% of GDP), the government gained some fiscal space to address a possible growth slowdown. It will be limited, however, by concurrently introduced restrictions tying spending growth to medium-term nominal GDP growth. The planned increase in defense spending by 0.2% of GDP to meet the NATO target of 2% of GDP, and recently announced increases in social spending also reduce the recently gained fiscal space.

3. Search for a new prime minister as Donald Tusk becomes European Council president

Poland’s governing Platforma Obywatelska (PO) party is looking for a successor for prime minister Donald Tusk, who will become the next president of the European Council in December 2014. Since Mr. Tusk has dominated Polish politics for almost a decade, there is no obvious successor, which leaves some room for the competing PO factions to fight for influence until a suitable candidate has been found. As the PO currently trails the opposition Prawda i Sprawiedliwość (PiS) party by about 6ppt in recent opinion polls, it will likely settle for a compromise candidate and a major cabinet reshuffle in order to unite the party ahead of next year’s presidential elections in May and parliamentary elections in autumn. Following the embarrassing leakage of taped conversations of PO politicians, infighting over the position of the prime minister could further undermine the PO’s chances at wining next year’s elections. While the names of several candidates have circulated in the press, Ewa Kopacz, the current speaker of the lower house of parliament (Sejm) seems to be the most likely successor. While her nomination may allow Mr. Tusk to continue to exert influence within the party, her possibly reshuffled cabinet is unlikely to embark on new reforms, as policy efforts will focus on boosting support for the PO.

Factsheet of Poland
Factsheet of PolandSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

With a nominal GDP of USD 518bn 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 constant positive economic growth since the end of Communism in the early 1990s. 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 comprising the centrist Platforma Obywatelska (PO) party of prime minister Donald Tusk and the Christian-democrat Polskie Stronnictwo Ludowe (PSL) enjoys a slim parliamentary majority. Even though Mr. Tusk will leave the government since he will become president of the European Council in December, his departure is unlikely to trigger a snap poll ahead of the 2015 elections.

Economic indicators of Poland
Economic indicators of PolandSource: EIU, *European Commission Spring forecast 2013*, **IMF
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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 64053

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