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Free Article - PMR Consulting Despite economic slowdown Poland still ranks among leading EU economies

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A vast majority of analysts expected low GDP growth in Q3 of 2012; consensus forecast indicated an increase of around 1.8% y-o-y. However, a preliminary release at 1.4% y-o-y, announced on 30th November 2012, has been an unpleasant surprise for most economists, as it seems that the Polish economy is doing rather worse than expected. However, it is worth looking at causes of this turn of events.

Reasons for economic slowdown in Poland

First of all, what caused the lower-than-expected GDP growth? There is no clear answer, with numerous contributing factors. The most surprising factor is the low – lowest since 1995 – increase in private consumption (0.1% y-o-y). The index has also been affected by the deteriorating labour market, declining employment growth, shrinking salary growth and therefore a low household income dynamics. The decrease in household income was due to high inflation in the first half of 2012 in real terms. While in 2010-2011 consumption growth was driven by a reduced saving tendency, this possibility has now been exhausted. Since the start of 2012 the gross savings rate has remained negative: according to the PMR’s calculations, it reached -0.6% in the Q1, and -0.2% in the Q2 of 2012. It is unlikely that it will contract further. In addition, the European Commision forecasts gradual increase of gross savings rate in years 2013-2014.

In the context of unfavourable drops, it is worth quoting the data published by the National Bank of Poland regarding the financial condition of the household sector in Q2 of 2012. These findings will help explain why the household consumption growth has become so low. Gross disposable income per capita dropped year over year in real terms. This was a result of a negative dynamic of income from hired labour and social benefits, which together with an increase in social insurance contributions prompted a drop in current consumption. The gross savings rate was negative for the second quarter in a row, which combined with a high investment rate of 7.6%, caused an increase in household debt and lowered the value of financial assets. As a result, we expect the consumption growth in the future to be lower, as financial resources are shrinking.

Structure of household finances

Another factor with a negative effect on economic growth in Q3 was a slowdown in infrastructure investment. Most of the projects that were connected with the Euro 2012, and were subsidised by the EU, took place in 2011 and the beginning of 2012, and are now gradually reaching completion. Due to the uncertain future of the economy in Europe, including Poland, enterprises are suspending larger investments. This has translated into a marked decrease in the volume of new projects in Q3 2012 compared to the same period in 2011.

The only factor with a positive impact on GDP growth has been net exports. The dynamic of both exports and imports is falling; nevertheless, the decrease is still much lower for exports than for imports, which means Poland still improve its trade balance. On the one hand, growth of exports to the EU member states, Poland’s key economic partners decline sharply. On the other hand, Polish exporters have concentrated more in non-EU markets, particularly in the east, what increased their sales on these markets. For instance, as in the first 8 months of 2012, exports to Germany grew only by 1.4%. exports to Russia went up by as much as 24%.

Economic slowdown has influenced the financial results of enterprises. In comparison to the results achieved in the first three quarters of 2011, revenues grew by 6.5%, but costs revenues were considerably higher – 7.6%. Consequently, the operating profit of enterprises dropped by 12.4% from the same period a year earlier, while net profit was 6.3% lower using the same measure. The poorer financial condition of companies was also reflected in the lower profitability figures for the analysed periods. The profitability index for the sales of products, goods and materials decreased by 1.1 percentage points (from 5.5% to 4.4%), and net revenue profitability – by 0.9 p.p., from 4.7% to 3.8%. The financial liquidity of enterprises is also in decline. In January-September 2011, the liquidity index reached 36.7%; in January-September 2012, it was 31.3%.

Gradual recovery in Poland’s economy likely to start in Q2 of 2013

Prospects for the Polish economy in the coming years are rather pessimistic. The value of the Business Confidence Indicators (source: OECD) for Poland is falling, but the rate of decrease is lower than for the same indicators in the entire eurozone. Also, consumer confidence indicators are decreasing, though again at a rate slower than in the eurozone. A growing number of industry sectors report negative production growth compared to the year before.

The eurozone will remain in recession, and the recovery forecast for the region next year is probably going to be very slight. In Poland, internal factors, such as low levels of public investment and household consumption, are going to have a negative effect on economic growth. As a result, in Q4 2012 GDP growth year on year is forecast to slow to 0.7%, and in the first three months of 2013 – to 0.6%. The probability of recession (GDP drop y-o-y) in the last quarter of 2012 reaches around 15%, and in the next two quarters, up to 20-25%.

GDP growth in Poland

In Q4 of 2012 and the first half of 2013 we expect real private consumption to decrease compared to the same period a year earlier. It will be a result of not simply the weak condition of the labour market (low salary growth and a drop in employment), but also the increase in savings rate which is forecast by the European Commission. A difficult situation in the eurozone economy and a drop in consumer demand are going to constrain private enterprises in Poland from investing in fixed assets. Business investments are therefore going to fall in the next three quarters. At the same time, net exports, and probably rebuilding inventories, are going to keep the GDP dynamics at a positive level.

As of Q2 2013, we expect a gradual recovery, triggered by the improving economies of key trade partners of Poland. This scenario is suggested by, e.g., the situation on the stock markets, which are usually ahead of the processes in the real economy. The WIG20 index is currently at the highest level it has been since August 2011. At the end of November and in December, the main indexes used for forecasting leading indicators (e.g. the PMI index for industry or Economic Sentiment Indicator-ESI) indicated a slight improvement in the condition of the eurozone.

An expected drop of main interest rate of National Bank of Poland (by at least 50 b.p., from the current NBP benchmark level of 4.25%) will translate into lower financing costs for enterprises, albeit with a delay, while an inflation decrease is going to have a positive impact on consumer purchasing power. As a result, assuming that the eurozone experiences a gradual recovery, the second half of 2012 should see a rise in both consumption and private investment. However, in our opinion the recovery rate is going to be limited. In H2 2012, year on year GDP growth is forecast to reach just 1.6%. Such a weak recovery rate will be caused by the curbed public investments and the expected (until H1 2014) rise in unemployment, following considerable staff reductions in the construction sector, as well as labour hoarding in 2012, which means that as the economy recovers companies will have significant reserves of production capacity, and will start hiring again only after a lag.

Risk factors that could hinder economic recovery in Poland

However, the uncertainty of many international and local factors means that the actual expansion of the Polish economy may differ from the basic scenario described above. Importantly, many areas of uncertainty are linked with factors that may have a negative impact on recovery.

The key risk factors are related to the development of the international situation, particularly in the eurozone. There are still risks connected with the collapse of the eurozone, the exit of Greece, or the insolvency of one of the heavily indebted European states (Spain or Italy), but the risks seem less serious than last year. Nevertheless, the process of mass fiscal consolidation, deleveraging of the private sector, and regaining competitiveness (by decrease of wages and prices) may turn out to be more painful than previously expected. As a result, the eurozone may be facing a lost decade.

Shocks in other parts of the world, of which the most serious is the so-called fiscal cliff and potential recession in the United States, may also have a negative impact on European economies, including Poland’s.

Among local factors, the main risks relate to fiscal policy and the level of public investments. A sudden growth in budget deficits due to slower growth may trigger the need of budget cuts(unfortunately also for investment outlays) and taxes hike, which will have a negative effect on consumption and private investment. The future of the EU budget for 2014-2020 is still uncertain, which will determine the infrastructure investment prospects in this period.

To sum up, the Polish economy is facing a difficult time. In the next two years it will expand below its potential, and a slight recession is likely. We will need to wait for a stronger recovery until at least 2015, when all the countries of the eurozone should leave recession behind, and Poland will receive EU funding from the new budget for 2014-2020.

Nevertheless Poland’s economic growth performance prevails in comparison with other EU economies continuously catching up with Western countries’ economies. Steady process of fiscal consolidation is highly appreciated by rating agencies (e.g. Moody’s). What is more, contrary to other EU countries Poland has retained the key instruments of monetary policy in order to fight the economic crisis.

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