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

Economic developments in the last two quarters were similar to our expectations. The real economy was very week, and the currency remained very strong. It is an outcome of the institutional arrangement in which the central bank remains fully independent and concentrated on the direct inflation targeting. Despite the growing output gap the central bank counteracts any weakening of the currency by the policy of very high interest rates. Therefore, a natural reaction of a small open economy to the demand-side driven slowdown or recession, based on weakening the currency that supports exports and discourages imports, does not materialize. That, in turn, on the one hand limits the scale of the improvement in the trade balance that could lead to faster recovery, on the other hand enhances the restructuring pressure in the tradable sector leading to productivity increase in the manufacturing sector, reduction in employment and further increase in unemployment.

As a result, the economic slowdown continued, mainly due to the falling investment demand, GDP remained all but flat, and the industrial output was shrinking. The economy was avoiding an open recession only due to the continuous growth of the consumer demand, resulting from the nominal stickiness of wages and social benefits, and the continuing export expansion. Together with the built-up of the output gap, both the inflation rate and the current account deficit were falling. The tension between the government and the central bank over the conduct of the monetary policy slightly eased, raising hope for some more interest rates cuts and weakening of the currency. In our view, however, the actual impact of the further cuts on the GDP growth will be very moderate. Effects of the cuts in the official rates on the market rates will be partly offset by the high government demand due to the deficit financing. 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. On the contrary, we maintain our view that the exchange rate is likely to adjust when only 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 and, together with high oil prices, fuel the inflationary expectations. In our view even a weaker currency is not able to counteract the continuing slowdown in exports, due to the poor performance of Western Europe. Therefore, the process of improvement in the current account is likely to be reversed when only the investment demand accelerates, leading to faster increase in imports.

The economic growth 2001 was characterized by the following factors:

1. The domestic absorption contracted, mainly due to the sharp fall in investment activities. The weak investment demand was both due to the restrictive monetary policy, as well as due to the growing uncertainty about the medium-term development prospects, that led to the slowdown in both the domestic and foreign investment. Therefore, rebuilding the confidence of the markets is the most important task for the government.
2. The improvement in the balance of payments reduced the current account deficit to below 4% of GDP. Obviously, under the exchange rate regime of the pure float such a decrease reflects mainly 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. High real interest rates were attracting the portfolio capital, although the growing risk of depreciation led to shortening the horizon for investment. The strong Złoty and the growing output gap resulted in the record-low inflation.
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 public finance requires further, irrevocable steps towards the public sector reform.
5. Unemployment was growing to dangerously high levels. That led, finally, to some agreement among social partners on the need to liberalize the labour market. In our view, the proposed packet of changes that make the labour code more flexible is just a first step in this direction.

The outlook for 2002 remains rather pessimistic. The fall in the investment demand, together with the slowdown in exports, will lead to stagnation of GDP – or even a slight fall - in the first half of 2002. The output may accelerate only in the end of the year when the interest rates cuts from 2001 will finally translate into the higher domestic demand. The disinflation process, quite remarkable in 2001, will be probably temporarily reversed by the higher prices of oil and possible weakening of the Złoty. We expect that Zloty may lose as much as 10% of its value vis-ŕ-vis the major world currencies. The biggest worry, however, remains unemployment that is likely to exceed 20% by the end of the year, despite some acceleration in the GDP growth.