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Quarterly forecasts of the economic development of Poland (January 2002)
[This forecast was prepared for and is published courtesy of Reuters Polska.]

Economic developments during the second half of 2001 were, generally, similar to our expectations. Economic slowdown continued, mainly due to the falling investment demand, and the industrial output was shrinking. The slow-down was accompanied by the very strong currency. As the central bank does not react to such a situation by easing monetary policy, both the CPI inflation rate and the current account deficit are falling to very low levels. The tension between the government and the central bank over the conduct of the monetary policy slightly eased after the meeting of the representatives of the both sides. That raises hopes for the significant interest rates cut, aimed at weakening the currency and revitalizing the domestic demand. In our view, however, the actual impact of the cuts on the GDP growth will be very moderate. Effects of the cuts in the official rates will be partly offset by the increased government demand for the deficit financing. Therefore, the fall of the market rates will be much more modest than the reduction in the NBP rates. Given the long delay observed in reactions to the changes in the rates, and given the general fall in the propensity to invest due to the pessimistic expectations of the firms, one should not expect any visible acceleration of the investment expenditures and GDP growth before the end of 2002. The exchange rate, on the contrary, is likely to adjust to the new situation. After financial markets estimate that the period of cuts is over, some temporary outflow of the portfolio capital may lead to the depreciation of the currency. That, in turn, will lead to some increase in the inflationary expectations. Somehow surprisingly, given the deteriorating external environment and the very strong currency, the Polish export performance remains strong. That is possible mainly due to the productivity gains recorded by the Polish industry. However, the pressure to increase productivity in the manufacturing sector led to the deep reduction in employment, increasing the unemployment problems. In our view, the export performance of Poland is already showing first signs of deterioration. If the poor growth prospects of Western Europe realize, the dynamics of the Polish exports must fall.

The positive factor that should be noted is the likely acceleration of the negotiations with the EU, making the accession as early as 2004 quite possible. One should keep in mind, however, that many problems still remain unsolved and the most sensitive issues, included the agriculture and the support from the EU budget were not even discussed.

The economic growth 2001 was characterized by the following factors:

1. The domestic absorption contracted, mainly due to the sharp fall in investment activities. In our view, such a slowdown can not be explained just by the high level of real interest rates, but reflects also the growing uncertainty about the medium-term development prospects, and about the social and economic stability, that led to the slowdown in both the domestic and foreign investment. Therefore, rebuilding the confidence of the markets is the first task of the new government.
2. The improvement in the balance of payments continued, with the current account deficit going down to below 4% of GDP. Obviously, under the exchange rate regime of the pure float such a decrease is just a reflection of the slowdown in capital inflows. However, one should also note the remarkable export performance of the Polish firms, and a sharp deceleration of the demand for imports.
3. The real exchange rate of the Zloty remained at a very high level. A phenomenon of the weak real economy and strong currency can be explained by the adverse effects of the macroeconomic policy mix, with the loose fiscal policy and overly tight monetary policy. Extremely high real interest rates still attract the portfolio capital, although the growing risk makes the horizon for investment shorter.
4. The fiscal crisis has been, at least temporarily, addressed by the fiscal package of the government. However, any success in the medium-term stabilization of the fiscal finance requires decisive and unpopular steps towards the public sector reform.
5. Another set of unpopular reforms should be aimed at the liberalization of the labor market. The economic program of the government – to be announced probably in February – will put some more light on the plans in this area..

The outlook for 2002 looks rather gloomy. The unfavorable policy mix, in particular the restrictive monetary policy accompanying the fiscal tightening will lead to continuation of the low investment demand, reducing the growth rate of GDP to less than zero in the first half of 2002. The disinflation process, quite remarkable in 2001, will be probably temporarily reversed by the serious devaluation of the currency. We expect that Zloty may lose as much as 15% of its value vis-ŕ-vis the major world currencies during the first half of 2002. The biggest worry, however, will be unemployment growing to 20% by the end of the year, even if some acceleration of the GDP growth appears.