Notes from Poland, "A Green Island"
Market Commentary from Cumberland Advisors
The Global Interdependence Center (GIC, www.interdependence.org ), in partnership with the Economics Institute of the Polish Academy of Sciences and the National Bank of Poland, has just completed a conference, "Economies of the Baltic Region and Their Capital Markets", in Warsaw and Cracow. It included a session with governors and senior officials from eight central banks, a GIC first. Other participants were economists and financial-sector experts. The following Commentary will focus on Poland. A second note will take a broader look at the region and the challenges it faces, confronted with the financial turmoil in Europe and the uncertain future of the euro.
Poland is referred to as a "green island," because it has the only economy in the European Union that has been able to avoid falling into a recession in the period following the global financial crisis of 2008. Indeed, last year's GDP growth was a healthy 4.3%, almost 3 times the 1.5% advance registered by the Eurozone. Some slowing is expected for the Polish economy this year, perhaps to a little above a 3% annual rate, with a similar pace expected for 2013. These rates will continue to be well above the projected growth rates for the Eurozone, -0.3% and +0.8%, respectively.
A number of factors combine to account for this excellent performance in difficult times. Poland rapidly abandoned central planning and other socialist policies and undertook a program of mass privatization, once free of communist rule. It has followed prudent fiscal and financial policies. The debt-to-GDP ratio is a manageable 59%. As an example of its willingness to undertake needed reforms, the Polish parliament passed an increase in the age when pensions begin, to 67. While more labor reforms are needed, Poland's labor markets are relatively flexible. Another plus has been conservative banking practices. Poland's banks are sound and have avoided the problems facing Eurozone banks. Current-account deficits are small.
Excluding Russia, Poland's economy is the only one in Central and Eastern Europe that is large enough to "matter" to the global economy. The rest are of marginal economic significance. The large size of Poland's domestic economy provides an important stabilizing factor, a buffer to variations in export markets. Poland's exports amount to only 35% of GDP, about half the export share of other Eastern European economies. Poland's growing exports to Germany are linking those two economies more closely. One result is that Poland now leads the world in production of upholstery for automobiles.
The final important factor behind Poland's outperformance has been the flexibility of the exchange rate. The depreciation of the Polish currency, the zloty, has contributed to the competitiveness of exports. At the same time, it is the main factor behind Poland's relatively high rate of inflation, a great concern of the central bank. The bank's Monetary Policy Committee recently increased the policy interest rate by 25 basis points, despite signs that the economy is slowing.
Until recent developments in the Eurozone, Poland was on track to become a member in the near future. Poland had made a political commitment to join the zone and adopt the euro as its national currency, but it now appears this process will be delayed until the future of the euro system becomes clearer. So far, Poland has not suffered from being outside the Eurozone; indeed, it may have benefited. However, it appears there is strong Polish interest in being in a monetary union with Germany, France, and other economies of Northern Europe that, like Poland, generally follow sound economic policies. (We will have to see whether France under Hollande remains in this camp.) Views differ as to whether Greece will leave the Eurozone, but the commitment of European governments to do whatever proves necessary to maintain the euro does not appear to be in question. Poland will eventually adopt the euro and very likely will seek to do so before Hungary and the Czech Republic.
One might expect that, in view of the outperformance of Poland's economy, its equity market would similarly outshine that of the Eurozone. In the first quarter of this year, that was indeed the case. The MSCI Index for Poland's equity market advanced by 17.5%, compared with a +12.2% for the Eurozone. However, in the current quarter, as aversion to risk increased sharply, the tendency in such periods for investors to treat all emerging markets similarly, along with Eurozone concerns, brought Poland's equities down, erasing first-quarter gains. Polish equities are now down 5.7% year-to-date, just a little better than the Eurozone's 7.1% decline. We anticipate that Poland's outperformance will re-emerge later this year, unless there is serious further deterioration of conditions in Europe.