Poland - a fair or a clouded future?
by Wojciech St. Moscibrodzki (firstname.lastname@example.org; wojmos.no-ip.info/wojmos)
Note: this is my study on Poland's BOP as a exam on MBA course. Page liti is 5 pages only, so this is only a brief article.
The questions raised in the exam descriptions can be divided into three parts. Firstly, we want to investigate current Poland’s balance of payments and comment it. Then, we would like to examine the BOP correlation with fluctuations of exchange rates (and other external factors, like oil prices). Finally, we will address the needs for government policy in short and medium terms. Two first aspects will be examined mostly by study on Poland’s real economy. The final one should take into account more wide view, including fiscal policy and politic conditions.
2 The balance of payments
2.1 Overall view
Polish economy is growing at a steady rate, despite many structural problems (significant role of obsolete agricultural sector, troubling budget deficits, extreme unemployment rate and social insurance issues) and political fluctuations. The positive trend is supported by still relative low (in comparison to UE medium level) labor cost, foreign investment and potential capacity of a country’s market. The recent UE expansion merged Poland into powerful economic organization and opened promising perspectives of UE transfers (which can be used for vast improvements of infrastructure).
2.2 The Current Account
As with most emerging Eastern Europe markets, the net value of Current Account shows deficit (Fig.3,4,5). However, its value shows a long-term decreasing trend (Fig.6), even though significant distortion appeared in 2004. This fluctuation can be linked to UE accession process. Major changes can be found in incomes of equity - a part income account (-14098 mln PLN in 2003 vs -42010 mln PLN in 2004 – see Fig.8, Fig.9). However, the overall score if promising, as the export grows at a faster rate than import. Poland’s CA/GNP is around -1.7% (negative value denotes deficit), but the index is better than neighbor new UE members.
Positive symptoms of the Current Account can be also derived from relative value of net–to-total volume (Fig.14) which clearly shows that Poland’s economy is acting better and better (the net deficits lowers while total volume of real economy sector is rising quickly).
The total volume of current account rose by 100% in 5 last years (Fig.7), even though political problems with Russia caused significant troubles with bilateral trade . Fortunately, the UE expansion in May 2004 encouraged faster shift in trade markets from east to west.
There are four sub-accounts in CA: goods, services, income and current transfers (Fig.8,9). Goods and income show deficits, while services and current transfers run on surpluses.
2.2.1 The Current Account: Goods
Roughly, goods cover approx. 80% of overall flows both on credit and debet sides – Fig. 12, 13. However, the deficit (negative net value) on goods decreases swiftly (5 times since 2000!) which means that Poland’s export is at a stable growing rate and the merchandise is quite competitive . This trend is hoped to remain stable, despite some experts point to appreciation of currency as possible treat in future (this will be discussed later). For now, imports rose by 50% since 2000, along with 100% rise in exports. Moreover, the government actively tries to shape the amount and specifics of imported goods. Recent downfall of import growth is usually linked to law regulations concerning import of old used cars .
2.2.2 The Current Account: Services
After the EU expansion, the share of services in total CA remains roughly at 2000 level (depends on currency). This is a result of significant increase in 2005 which allowed filling a gap created in 2001-2004, when account values drop by almost 50%. The interpretation of that fact is that strengthening the relations with UE and positive changes in European law regulations stimulate the exchange of services.
The services account consists of 3 subaccounts: transportation, travel and other. The last one is further divided into subcategories (according to IMF BOP structure). For clarity reasons, we have incorporated this into a structure of 12 subaccounts.
There are 4 subaccount that play major role in creating net value of service account (Fig.18): transportation, travel, royalties and license fees and other business services. The two first are running on surpluses and their trends show slight increase. The transportation factor (according to IMF standards this account cover all services offered by residents that relate to passenger and goods transportation, excluding insurances and rentals of carriers without crew) could even raise its growth speed if Poland is to rebuild its infrastructure and offer better opportunities as a part of main east-west road (and important north-south route) in Europe. This account rises despite the global recession on air-transport market (Poland is one of the very few markets that are developing, mostly thanks to potential capacity and problems with the quality of road system). Moreover, sea transport is at brilliant 30% growth trend which drives this transportation to higher volumes.
The travel account also shows growth trend, which can be expected to remain stable in short and medium terms. This is supported by price inequality between Poland and nearby EU members, thus encouraging foreigner visits and consumption (many people in Germany tend to do their shopping in the polish boundary cities). Data from variety of sources show that approx 90% of foreign visits in Poland come from its neighbors and 75% of foreign visits are 1-day long.
The service account plays an important role in filling the CA gap, second to international transfers. We can expect positive trend in that sector.
The two main deficit subaccounts are royalties and other business services. The royalties include patents, copyrights, trademarks, payments for know-how and franchises (after the implementation of SNA agreement, those liabilities fall into services, not income account). Deficit means that Poland is acquiring know-how from foreign countries . Other business services, like expenditure for local goods by foreign companies, add some deficit to overall service account, but its value decreases in time.
After accession to UE the construction services also rises on surplus side, which can give some bonuses to BOP, but this account should be assessed in next few years. This account cover works performed on construction and installation (as described by IMF standards).
2.2.3 The Current Account: Income (Investment Income)
Income account covers two main aspects: compensation of non-resident employees (usually short-term workers) and investment incomes (property income as defined in SNA). The latter include payments which come from ownership of financial assets (dividends and interests). The investment income subaccount consists of three groups: direct investment (dividends, reinvested earnings and interest on debts), portfolio (equity and short term debt interest) and other incomes.
Poland’s income account shows significant net deficit, which tends to go deeper after 2003. The major influence on that tendency comes from reinvested earnings and dividends (Fig. 19,20,21). Beside of some distortion on that trend, the payments from dividends are on the steady grow (deficit is deeper). As the polish stock is in constant development and many foreign entities have expressed the interest in that field, we can expect this factor becoming even more important in the future. Another cause for that situation is a large volume of public debt which is financed by government bonds. Foreign investors are eager to invest in that papers and rising expenditures follow that process.
2.2.4 The Current Account: Current Transfers
The decrease of CA deficit is significantly stimulated by the current transfers account. This consists of two subaccounts: government and non-government transfers (which cover both typical private transfers and local autonomies). Both subaccounts are running on surpluses. The government account benefits mostly from UE payments (Poland is a net benefactor), even though quarterly values can drop below zero (this happens when inflows and outflows are not matched in time). On the other hand, the non-government account is supported not only by UE funds for regional development, but also by a growing source of polish emigration. This factor appeared when UE lowered protection for employment (Ireland, UK, Portugal, Spain etc.) – estimated show that 0.5-0.8 mln Poles found their jobs abroad. Their help for families left behind (significant share of this job emigration is formed by single persons leaving partners in Poland) will influence current transfers. This trend probably will have even more dynamics (the credit side of non-gevt transfer rose 3 times, while debit remain roughly at the same level) when Germany would open its market for Polish workers in short future.
2.3 The Capital Accounts
The capital account reflects some of bilateral UE-Poland payments (as well as the Current Account). Formally, the capital account should consist of two subcategories: capital transfers and acquisition or disposal of nonproduced, nonfinancial assets, but Poland’s Central Bank is publishing the data according to previous standard, where these accounts have not been distinguished.
Anyway, the Capital Account is less important to the global net values of BOP, as is 3 times smaller than lowest Current Account subcategory. On the other hand, it started to bring surpluses since Q2 2004, as the accession took place and UE-Poland transfers emerged. This account will be stable by mid-term means.
2.4 The Financial Account
According to ?, the financial account gathers information on four subcategories: direct investments (the investors seek possibilities to actively manage their acquisitions), portfolio investments (transactions other than direct investments, usually when investors do not want or do can’t manage their acquisitions), reserves (foreign financial assets available to and controlled by monetary authorities) and other.
2.4.1 Foreign Direct Investments
The FDI subaccounts (Fig.25) shows constant trends, which cannot surprise, because of two reasons: Poland entities usually lack the capital to invest abroad (surpluses are invested into the local operations) and its economy is incentive for foreign investors. The advantage of FDI inflows is clearly visible (Fig.26) – as the outflow/inflow ratio in last few years stays roughly at 15-20 times level.
As for FDI coming out of Poland (polish investment abroad) - interesting possibilities in Poland’s emerging market mean that local investments are competitive against risky foreign operations. On the other hand, growing enterprises (both of large scale and small ones) seek opportunities in investment on eastern-european markets . This subcategory is further divided into 3 lower entities: equity, reinvestment and other (mostly loans). The equity one shows the biggest volume, but one should still remember that this account is so small, that it brings relatively little to the total BOP.
The FDI investment into Poland present large volumes and its share in the BOP is significant. Poland is a target of steady FDI capital inflow, supported by both new capital and reinvested earnings (Fig.27). The account’s structure has changed after UE accession as many barriers were removed and political stability – since 2004 all three subaccounts note significant surpluses. The only exception is Q4 2004 but as ? denotes this was caused by a major, yet one-time operation in which foreign enterprise resold its large share in polish entity to another polish company.
2.4.2 Portfolio Investments
Portfolio investments cover both residents’ investment (Portfolio Assets Subaccount) and foreign investment in Poland (Portfolio Liabilities). Not surprisingly, the total volumes on foreign account are much higher (5-10 times, esp. after 2004) – (Fig. 28,29)
Portfolio investments in Poland show increasing interest in both equities and debt instruments, but the volumes on the last category is 10 times higher. The main share goes for government sector, which is linked to the budget situation in Poland, which is discussed later. Debt subaccount (bond and notes) is further divided into NBP (national bank), MIF (international finance units), general government sector and other. In Poland’s BOP government sector plays main role, followed by MIF.
Residents are operating mostly on debt instruments, rather than on equity market (the volume is roughly 3 times higher). A close examination shows that finance entities prefer bonds and notes while other sectors shares interest on bond with operations on money market.
2.5 Errors and Omissions
The errors and omissions account is roughly at the same level of 6-10% of total volumes of BOP. It is worth mentioning, that Poland’s BOP values can be used for exact estimations of Poland’s economy only since last few years, because earlier, the situation was either too unstable (economy transition period from central planning to freemarket, high inflation rate etc.) or the measurements were made not with accourdance to IMF rules (thus they were less comparable to other countries).
2.6 Official Reserves Assets
Official reserve assets are significantly raising last years (with most significant delta in 2005). That means that Polish currency (“zloty” ) is becoming more safe from speculations on money market.
The IMF’s standards of BOP are quite a new tool for Poland. Before 1989 the economy was led by central planning means, and calculations were totally incompatible. Then, in early 90’s the economy suffered dramatic changes, and the transformation blurred the overall image. Therefore, estimations of late 90’s can also be somehow misleading. However, since 2000 measurements are more and more fit to IMF standards.
The BOP shows positive trends in Current Account – the total values are continuously rising, and the UE expansion brings new possibilities to the country’s economy. The Capital and Financial Accounts are typical for emerging market in UE – they show both inflows of investment (FDI and portfolio). The FDI subaccount volumes in last few years were comparable to portfolio’s but in 2005 the last category slightly raised its part. However, it is still rather not a source of concern, because official reserves are high and economy has very strong base for development (Fig. 32-34).
3 Exchange rate issues
The correlation of exchange rate (both USD and EUR) and BOP depends on particular accounts. Obviously, the error account show least correlation, while the larges coincidence can be seen in current account. The capital account volumes are, on the other hand, significantly smaller, co even small disturbance in absolute volumes bring much distortions (Fig. 36-43).
The correlation in Current Account (vs. exchange ratio) (Fig. 44) examined by means of PLN/USD or PLN/EUR shows that total volumes of trade is slightly more linked to EUR fluctuations. The interpretation is, that Poland’s economy is more dependant on eurozone markets, which can be also checked by investigation in exports markets.
4 Further Economic Policy suggestions
This chapter is dedicated to research on existing signs of possible crisis and policies that can prevent it. As this is quite large area, only a few most important factors are pointed to (due to limit of 5 pages), including: public debt and budget problems, inflation, unemployment, social affairs and political issues.
4.2 Fiscal side of the economy
The budget targets a deficit of 35 bln PLN (US$11bn) which is 3.7% of GDP), but it is probably undershot. However, a precise estimation is difficult due to interpretation of the open pension funds. On the EU’s European System of Accounts (ESA 95) definition, the deficit is expected to be around 3.4% of GDP while it would be around 5.4% of GDP if the pension funds are classed outside the government sector. The analysis of early 90’s polish budget deficit is also fuzzy because of changes in calculation formulas which were caused by alteration of privatization inflows ?. The transformation process pushed Poland into accepting IMF standards, as described into GFS (Government Finance Statistics).
Polish debt level is high which threatens to trigger constitutional rule, that no further bond can be issued (threshold level is 60% of GNP). If that situation emerges, the economy would suffer a dramatic shift.
The zloty strengthened to below the Zl 4:€1 barrier in September 2005 on hopes that the parliamentary and presidential elections would lead to the election of a strong government with the ability to push through economic reforms. However, the Polish currency now appears vulnerable to a correction, if, as we expect, the new government fails to make much progress in bringing down the budget deficit. After rising sharply in 2005, the real effective exchange rate is expected to rise only marginally in 2006 and a little more in 2007. The zloty is unlikely to enter ERM2 under a PiS-led government, and the delay to Poland’s membership of the euro zone may lead some foreign financial investors, who had been hoping to benefit from the “convergence trade”, to pull their funds out of Poland.
After hyperinflation emerged in 80’s Poland has put a great effort in controlling inflation’s level. On the other hand, the serious countermeasures known as “Balcerowicz’s Plan” affected the quality of living, so many accuse former Minister of Finance (and current National Bank leader) of being too “inhuman”. That made possible the rise of political movements based on criticism of Balcerowicz’s reforms.
Current level of inflation in Poland is very low, reaching 0.2%-0.3% per month. The maintenance of such a level can play a major role in mid future, when switching to euro currency is expected.
One of the main factors of Poland’s economy is very large unemployment rate, which floats around 20%. This has significant influence on economy both by direct (GNP, social expenditures etc.) and indirect means (overall expectations, political shifts and threats of populists demands).
4.5 A short glance at the Polish political system
In late 2005 two elections took place in Poland: presidential and parliamentary. It was obvious that 4 years governance of left SLD party, full of corruption scandals will be put to an end. Two major opposite parties played the main role: PO (liberal centrists) and PIS (central right, conservative) announced that they will form a union government. However, after a convincing win of election, both parties fell into disagreement as PIS turn sharply right and raised social, anti-market ideas.
Supported by the newly elected president (which is party leader’s twin brother) the PIS could not make a coalition with PO. That led to a 7 months of a weak minority government with no real reforms or market policy. The PIS however, in a hope to save some support from PO electors, acquired some of PO head experts. The Ministry of Finance was offered to Zyta Gilowska, who was well known for free market politics (Ministry of Foreign Affairs and Ministry of Public Health were both given to persons of similar poses).
The President did not dismiss the Parliament and PIS looked for other options. The next big player was Samoobrona (Selfdefence), a ultra-populist movement led by A. Lepper - charismatic peasants’ labor union activist (known for calling for unrealistic economic policies and a few sentences). Both parties persuaded another peasant party (PSL) to join, but their still did not take majority. However, the PIS’s move to right has put the party close to ultra-conservative, nationalist LPR.
In early May the four parties established a coalition of 270 of 460 seats. This caused a resignation from both Minister of Foreign Affairs and Minister of Public Health. Both were protesting against heading towards strange mixture of ultra-conservative, anti-UE policy and socialistic policies (note, that before election both PIS and PO claimed open, free market approach).
In late May Poland has entered a period of political instability. Even though the government has a majority, it is supported by potentially inconsistent parties. It is widely claimed, however, that as long as Minister of Finance will remain ad her position, the macroeconomic policy won’t change dramatically. On the other hand, the Selfdefence’s leader is recognized by his personal grudges against the chief of Polish Central Bank (L. Balcerowicz) and will try to attack the bank’s independence. His desires are not thrown away from PIS leaders, so future of NBP is not clear.
To sum it over: the government of Poland is unbalanced by populist demands expressed by its supporters and achieved a state of crawling instability. It is believed, that personal ambitions of charismatic leaders will pose a constant threat to the permanence of authority (many experts expect new election before 2007). In that situation no serious reforms will be done and public finance problems will not be solved. Free-market policy will be supported as long as Z. Gilowska will carry on with her mission??. Is she is to resign - the escalation of unreliable demands will come to reality. Moreover, the weakness of the government is an incentive for rising social demands from a variety of groups (right now we witness strikes from health care personnel and other will surely follow).
4.6 Summary: What they should do and what they can do
The main problem areas are clearly visible: heavy structural finance deficit, high unemployment, complicated tax system and significant level of corruption. General suggestions for the polish government are almost the same like before 2005 ?: strong commitment to fiscal and structural reforms, aimed especially at ensuring long-term sustainability of public finances, improvement the flexibility of economy and removal of protectionist barriers, creating and development of labor market and reviving the privatization process. A course on the euro adoption, forcing quick reforms would be also advisable (even if the acquisition of new currency is prolonged). However, the current government even understanding those suggestions will face difficulties in implementation, because all the election campaign was based on opposite statements (protective and expenditure-driven budget).
Unfortunately, the conservative and populist government seems rather to drift to interventionism and social-oriented, expansionist policy. Therefore, fiscal policy goals can be set at non rational targets (particularly when probability for new elections will rise) or unsupported by parliament. Privatization is suspended and the trend of central control is maintained. However, it is still time to reform the policy and people start to realize that populists promises are based empty words (this is clearly visible in latest polls and surveys).
Conclusion: if – and only if – only public finances are to be healed, Poland can expect a period of fair development. If not, the financial crisis may emerge in 3-4 years, with all the typical effects: outflow of investments, shift in exchange ratio and stagnation of economy.