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Quarterly forecasts of the economic development of Poland  (July 2001)
[This forecast was prepared for and is published courtesy of Reuters Polska.]

The economic performance of Poland in the second quarter of 2001 was much worse than expected. The domestic absorption further contracted, as the low dynamics of the consumer demand was accompanied by the falling fixed capital formation. The net exports remained, as in the last quarters, the main driving force behind continuing GDP growth. However, the extremely high level of the real exchange rate of zloty, prevailing over the majority of 2001, led to the serious deterioration of the profitability of exports. Continuation of this trend will, sooner or later, lead to the slowdown in the export expansion, particularly if combined with the weakening external demand. The current economic situation was mainly due to the excessively restrictive monetary policy. Doubts about the adequacy of the monetary policy restrictiveness to the situation of a slowing down economy in the second half of 2000 and beginning of 2001 was further enhanced by the correction of the fiscal data for 2000, showing much less of the public sector deficit than previously assumed. The current fiscal problems, albeit serious, do not represent, in our view, any treat for the macroeconomic stability. Moreover, the problems are, to a big degree, due to the monetary policy-induced economic slowdown. Very high real interest rates, combined with the strong real appreciation of the currency allowed for a spectacular drop in inflation, at the price of freezing the domestic demand.

The economic growth in the second quarter of 2001 was characterized by the following factors:

1. The domestic absorption was shrinking. That was mainly due to the falling investment demand, hurt by the restrictive monetary policy and by the general deterioration of the perception of the short-term economic prospects. The personal consumption dynamics was very low, due to the sluggish growth of real wages and incomes.
2. The export performance remained exceptional, particularly given the strength of the currency. One should note, however, that according to all the evidence the profitability of exports was falling. Moreover, due to the natural lags, the exports in the second quarter of 2001 was linked to contracts signed several months earlier, under the terms assuming much weaker złoty than in the mid-year.
3. The imports were growing on a much slower path, mainly due to the falling real domestic demand. As a result, the current account further improved.
4. Altogether, GDP growth slowed down to below 1%. The domestic absorption contracted, while the positive growth impact of the foreign trade continued. The slow growth was accompanied by the unemployment rising to almost 16%.
5. The CPI and PPI inflation were on the clearly deccelerating path, both due to the economic slowdown, as well as the strong złoty. In the case of the PPI, the deflationary trend appeared, raising fears about the possible prolonged industrial recession.
6. The fiscal performance remained the main concern. The government was forced to propose budget amendments increasing deficit, as overly optimistic assumptions about the tax revenues did not materialize, partly – but not exclusively – due to the slower than expected growth. However, we do not see the higher fiscal deficit as a treat for the economic stability. The scale of the expected deficit increase is rather modest (8 billion złoty, slightly above 1% of GDP), and the macroeconomic environment deflationary.

The outlook for the second half of 2001 is rather poor, although some acceleration of the economic growth may take place. The consumer demand should grow faster, partly due to the German compensation payments to the slave workers. Given the long-term factors behind the investment demand, and in particular the growing market competition, we do not expect the firms to cut seriously the investment activity. Export performance may be hurt by the slowdown in the major trading partners (mainly Germany). However, with the very low dynamics of the domestic absorption, the Polish firms will be desperate to sell goods abroad, even at the loss. Moreover, some weakening of the złoty in July 2001 slightly increased the profitability of export sales. All these factors, combined with the slow increase in imports, should lead to some acceleration of the GDP growth, possibly to ca.3%. The disinflation trend should continue over the second half of 2001, with a strong fall of the CPI inflation in July-August. The end-year CPI inflation should be well below the NBP inflation target. However, the unavoidable correction of the market value of the złoty, that we expect in the last quarter of 2001 or the first half of 2002, will push the inflation higher.

Our main conclusions about the likely outcome are as following:

1.· The dynamics of the domestic absorption will be very weak until the end of 2001, accelerating only in 2002.

2. Despite the strong złoty and weakening external demand, the export expansion will continue, albeit at a slower path. The import demand will remain rather weak.
3. As a result, the GDP growth in 2001 will reach ca. 2.4%, and may only slightly improve in the second half of 2002.
4. The industrial recession and undershooting the inflation target will force NBP to relax its monetary policy. Moreover, the pressure to continue with the relatively relaxed policy will be exerted by the new left-wing government that will probably take over the power in October 2001. In such a situation, we do not expect NBP to react strongly to the weakening of the złoty and the hike in inflation in 2002.