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SectionsJanuary 2 2013

How Poland defied the EU's blues

As the only EU member country to record positive growth at the height of the global financial crisis, and one of the few to suffer no casualties in its banking sector, Poland serves as a good example of how stable monetary policy combined with sound financial sector supervision can make for a robust and crisis-proof economy.
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How Poland defied the EU's blues

In 2009, as a result of the global financial turmoil triggered by the collapse of Lehman Brothers, 26 of the 27 EU countries slid into a recession. Poland was the only one to record positive gross domestic product (GDP) growth. Since the onset of the global crisis, six EU countries have applied for financial assistance from other member states and/or the International Monetary Fund (IMF). Poland was not one of them. Instead, it gained access to the IMF’s Flexible Credit Line, designed as a lending instrument for countries with very strong policy frameworks and track records in economic performance.

During the past decade, several European countries fell victim to severe boom-bust cycles, posing a threat to their financial stability. Meanwhile, Poland’s GDP grew continuously at a stable pace. There might have been a problem with excessive foreign exchange lending, as there was in many central and eastern European (CEE) countries at that time, but Polish regulators and supervisors reacted decisively to shield the economy against this threat. The case of Poland is certainly worth examining more closely as the country’s economic success can provide lessons for its peers.

Balanced economy

For the past two decades, the Polish economy has been following a balanced growth path. Despite all the pitfalls of the convergence process, since Poland’s EU accession, the volatility of both inflation and the output gap has been the lowest among the new EU member states and has belonged to the lowest among the Organisation for Economic Co-operation and Development countries. Macroeconomic and financial stability have been preserved, even during the recent global crisis, due to a combination of various factors, including a stability-oriented monetary policy, a flexible exchange rate regime and, last but not least, sound financial sector supervision.

The Polish banking sector has not needed the government’s financial assistance during the crisis as it has remained profitable, well capitalised and liquid. The sector’s net earnings increased by 37.5% in 2011, and the average capital adequacy ratio hovers at about 13% to 14%, with high-quality capital representing about 90% of total capital.

Sustainable GDP growth has been reflected in the Polish economy’s ability to maintain a relatively low degree of external imbalance. Over the period from 1995 to 2011, the average current account deficit was one of the lowest among the new EU member states and was close to equilibrium level if one takes into consideration that catching-up economies are importing capital. The current account deficit has been relatively stable and, to a large extent, covered by net inflow of direct investment and capital transfers from the EU.

Sound economic policies and balanced growth have resulted in relatively low levels of both public and private sector debt in Poland. The public debt-to-GDP ratio is below the 60% Maastricht fiscal limit, despite the burden of the country's 1999 pension reform. Without the extra-budgetary cost of pre-funding of the future pensions, the debt-to-GDP ratio would not exceed 40%. Private debt, in turn, amounts to 80% of GDP; hence it is only half the 160% threshold determined for 2011 in line with the Macroeconomic Imbalance Procedure.

Attractive destination for capital

Moreover, Poland is an attractive place to invest, not only because it is the sixth largest EU country in terms of population and has a large internal market. Investors also appreciate Poland’s highly qualified workforce, its relatively flexible labour market and comparatively low labour costs. EU membership has enabled constant improvement in infrastructure. According to a recent survey by Ernst & Young, Poland is perceived as the second most attractive FDI destination in Europe, after Germany.

This perception is confirmed by the investment and export performance. Poland is the largest recipient of foreign direct investment among the EU's new member states and at the same time its outward foreign investment, though much smaller than the inward FDI, is the highest in CEE. Moreover, foreign investors have changed their attitude towards Poland, redirecting their investment from labour-intensive processes to knowledge-based activities exploring intellectual capital.

Taking total export value into account, Poland's is similar to Belgium and the Netherlands, two small but very open countries. Poland has become an important part of EU production chains, which is reflected by the trade structure dominated by intermediate goods, which constitute more than 50% of Polish exports and about 60% of imports. The country is generally oriented towards its European partners – the 15 founding EU countries currently account for 60% of both Polish exports and imports and the new member states for a further one-sixth and one-tenth of exports and imports, respectively. Moreover, the share of high and medium skill and technology-intensive goods in all exported manufacturing goods has increased significantly over the past few years and now amounts to almost two-thirds.

Notwithstanding all the strengths of the Polish economy, there are still major challenges ahead. The process of removing administrative barriers to business activity is still in progress. According to the World Bank's latest Doing Business report, Poland ranks 55th in the world for ease of doing business with the ease of starting a business the area in which it most needs to make improvements. Poland policy-makers are aware of those deficiencies and have an on-going improvement agenda related to the functioning of the product market.

One of the highlights of the latest Doing Business survey is that Poland was the most improved of the 185 countries included in the report. This was made possible by regulatory changes that make it easier to enforce contracts, pay taxes and resolve insolvency. Specifically, enforcing contracts was facilitated by amendments to the civil procedure code and by appointing more judges to commercial courts. The payment of taxes was made easier for companies by promoting the use of electronic filing and payment systems. Finally, the insolvency process was strengthened by granting secured creditors the right to take over claims encumbered with financial pledges in case of liquidation.

The challenging triangle

With regards to Poland’s prospects for the future, the convergence process is expected to continue for a long period, as was the case with Europe and Japan for decades after the Second World War. The real convergence process will enable Poland to weather unfavourable external conditions in the years to come. According to the latest forecasts of the European Commission, Poland’s real GDP will grow substantially faster than that of the rest of the euro area.

Looking into the future, as an EU member state with derogation, Poland is obliged to adopt the euro. This is a major challenge from the point of view of the convergence process. Specifically, the nominal convergence in a monetary union can occur only through a higher inflation in relation to the more advanced euro area economies, leading to a relatively low level of the domestic real interest rate. Consequently, the new EU member states with a derogation face a dilemma that we could term ‘a challenging trinity’.

As long as those countries’ GDP per capita relative to the euro area is low, they cannot simultaneously achieve three points of the triangle: the equilibrium interest rate, the equilibrium exchange rate, and membership in a monetary union. The experience of several EU countries – the Baltic countries and the euro area periphery – has shown that a persistently low level of the real interest rate may lead to boom-bust credit cycles. This risk must not be neglected, but it can be alleviated by sound financial sector supervision and well-designed regulations and institutions. This is why structural reforms strengthening the economy are the top priority for Polish policy-makers.

Marek Belka is president of the National Bank of Poland.

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