Important disclosures and certif ications are contained f rom page 7 of this report. www.dans keresearc h.c om
Investment Research — General Market Conditions
This note summarises the key findings of my trip to Warsaw last Thursday and
Friday, where I met corporates, private banks and policy makers.
Apart from a red-hot labour market and fast economic growth, the Polish
economy does not show signs of imminent overheating.
However, the above-potential growth, coupled with expansionary macroeconomic
policies, increases the risks over the next year.
We think a strengthening of the Zloty would help constrain the economy and we
lower our current EUR/PLN forecast path to 4.15 in 1M (4.17 previously), 4.13 in
3M (4.15 previously), 4.12 in 6M (4.14 previously) and 4.08 in 12M (4.12 prev.).
The Polish government is in cruise control ahead of next year’s election and may
be able to find a compromise with the EU on the Rule of Law issues.
Is the Polish economy on the brink of overheating?
• I visited Warsaw Thursday and Friday last week, seeing large companies, private banks
and policy makers. My visit focused on two key issues: 1) to what extent the Polish
economy is showing signs of overheating and 2) the political situation and the outlook
for a resolution of the conflict between the EU and Poland on the Rule of Law.
A key concern among private companies and banks was whether the Polish economy
is overheating. An overheating economy is normally characterised by fast economic
growth, accommodative fiscal and monetary policies leading to large credit expansion,
sharply rising wages and deteriorating domestic and external macroeconomic balances.
In such an environment, inflation is typically rising, which prompts the central bank to
step in and the currency strengthens in the case of a floating exchange rate regime. In
case of no adjustment, the real effective exchange rate would appreciate given higher
inflation aggravating the external imbalances further through lower net exports. The
risk is that without adjustment, an overheating economy would eventually fall into a
recession and/or experience a financial crisis.
• Parts of the Polish economy are indeed showing signs of overheating, notably in the
labour market:
o The Polish labour market is red-hot. About nine out of ten Polish companies are
reporting a shortage of skilled labour; this was confirmed in our meetings with
private companies. In response to these constraints, companies are either
considering cutting back on production or launching new projects. Profit margins
will also be under pressure. In the latest reading in November, gross wages rose by
almost 7% and most private companies and banks saw the wage growth increasing
to double-digit figures. However, the central bank cautioned that companies were
more likely to cut back on production, public sector wage growth remained subdued
and minimum wage growth was only 5%.
24 January 2018
Chief Analyst and Head of International Macro and Emerging Market Research Jakob Ekholdt Christensen +45 4512 8530
The Polish economy is hitting capacity
constraints
Source: Polish Statistical Office (GUS), Macrobond
Financial
As increasing # of companies cannot
find skilled workers
Source: Institute for Economic Research (Ifo),
Polish Ministry of Family, Labour & Social Policy
Prompting a surge in wages
Source: OECD, Poland Central Statistical Office,
Macrobond Financial
Trip report from Warsaw
Is the Polish economy on the brink of overheating?
2 | 24 January 2018 www.dans keresearc h.c om
Trip report from Warsaw
o The Polish economy is growing above potential . Last year, the economy grew by
about 4.6% while this year we and market consensus believe that the economy will
grow about 4%. We estimate the potential growth of the polish economy to be
somewhere between 2-3%. The above-potential growth means the capacity
constraints in the economy would increase further in 2018. As private consumption
growth is likely to level off somewhat in H2 this year, investment would
increasingly need to take over. While public investment is boosted by increasing
absorption of EU funds, private investment is still relatively weak owing to
uncertainty among companies about the tax regime and other regulatory factors.
The lack of workers was also mentioned as a reason for lack of investment in the
construction sector.
However, other indicators do not point to imminent problems of overheating for
the Polish economy:
o Still muted inflation pressures: While headline inflation briefly reached the
central bank’s 2.5% inflation target in November, it dropped to 2.0% in December.
Despite the rapid wage growth, core inflation has remained fairly modest , hovering
around 1% since April last year. This conundrum (normally the two are fairly
correlated, see chart) is explained by two factors: firstly, imported inflation is still
modest on items such as clothing, shoes, and appliances, partly as global inflation
is low (and the Zloty has appreciated quite substantially over the past year).
Secondly, there are signs that companies are reluctant to pass on higher costs to
consumers due to fears of losing market share, dating back to the financial crisis.
However, this may only last for a certain period and once companies start raising
prices, others may follow suit, creating a “ketchup” effect on CPI inflation. We
expect inflation to increase over the coming months and reach the 2.5% target
earlier than the Q3 2018 expected by the NBP.
o No real macroeconomic imbalances (yet): So far, both fiscal and current account
balances are holding up pretty well. In fact, the budget deficit is likely to be much
lower than expected around 2% of GDP in 2017 owing partly to the strong growth
in the economy and significant tax compliance gains (amounting to almost 1% of
GDP in 2017) reaped earlier than anticipated. The budget for 2018 foresees a deficit
of 2.7% (assuming a GDP growth of 3.8%), but may be lower due to a positive carry
over from the strong fiscal performance in 2017. Furthermore, the budget assumes
full implementation of spending targets, which are typically not the case. On the
external side, the current account balance is in surplus, aided by strong global
demand and remaining Polish cost competiveness (the central bank sees a
competiveness edge of about 10%), with company surveys pointing to an
equilibrium EUR/PLN rate below 4. However, the current wage differential relative
to Germany, a key trading partner, of about 4-5% would erode Poland’s competitive
edge over time.
Core inflation hasn’t picked up despite
rapid wage growth
Source: Polish Central Statistical Office (GUS),
National Bank of Poland, Macrobond Financial
But rise in inflation is so far modest.
Source: NBP, Macrobond Financial
No significant macro imbalances
Source: IMF WEO October 2017
No real credit boom taking place
Source: National Bank of Poland, Macrobond
Financial
3 | 24 January 2018 www.dans keresearc h.c om
Trip report from Warsaw
o Absence of a credit and housing boom. A key characteristic of many financial
crises is a significant credit and housing boom in the run-up to the crises. Currently,
neither credit to the economy nor house prices are growing strongly. In fact, house
prices have been almost flat since the financial crisis and the money and credit
growth are only a fraction of the pre-financial crisis levels.
All in all, the Polish economy is not showing signs of imminent overheating.
However, the combination of above potential economic growth amid a very tight labour
market situation, together with an accommodative macroeconomic policy mix, would
pose dangers for the Polish economy unless adjustments in macroeconomic policies
stem the demand pressures in the economy, in our view.
We believe that the first best solution to steer the economy away from overheating
would be tighter macroeconomic policies (notably fiscal and structural policies),
but this appears unlikely over the next year or so:
o Fiscal policy would actually be neutral to slightly expansionary in 2018 according
to our estimation and is unlikely to be tightened over the next year ahead of the
2019 election.
o NBP seems in no hurry to tighten monetary policy, with Governor Glapinsky
signalling unchanged rates this year. With real rates in negative territory, monetary
policy would become increasingly expansionary. Many see the MPC as overly
focused on growth, risking a significant overshooting of the inflation target. Our
base case however is that MPC will be forced to tighten its monetary policy in 2018
as inflation picks up, but there is a risk that it may react too late.
o Structural policies such as the 500+ programme and lowering of retirement ages ,
while effectively having a smaller impact on the labour supply than believed, still
promote consumption over investment and hence do not help raise potential growth,
which could have helped alleviate some of the capacity constraints.
What about the Zloty? In our base case of a tighter monetary policy in 2018, the Zloty
is likely to strengthen over the next year. We think a strengthening of the Zloty would
help constrain the economy and we lower our current EUR/PLN forecast path to
4.15 in 1M (4.17 previously), 4.13 in 3M (4.15 previously), 4.12 in 6M (4.14
previously) and 4.08 in 12M (4.12 previously). The stronger Zloty would reduce net
exports and help contain inflation pressures, but would also lead to a weakening of the
current account balance. There is a risk that the NBP stays put for too long and inflation
overshoots which would lead to a real appreciation (and worsening external balance
over time) through higher inflation. In such a scenario, the Zloty would weaken
eventually.
House prices fairly stable
Source: Polish Central Statistical Office (GUS),
National Bank of Poland, Macrobond Financial
After recent strength, the Zloty is
closer to its long-term fundamentals
Source: BIS, NBP, Macrobond Financial
4 | 24 January 2018 www.dans keresearc h.c om
Trip report from Warsaw
The PIS government in cruise control toward the next election
The PIS government is enjoying very strong support in the polls, both due to the
strong economy and also a relatively weak and disorganised opposition. The spat
with the EU had not weakened the support for the government, in fact it seemed to have
strengthened its support. Some noted that it was not so much a question of the PIS
government winning a second term in next year’s election but more about whether it
could get a third term. However, some observers cautioned that the tide could turn for
the government, but it would probably take a major scandal to change the fortunes of
the government given the strong Polish economy.
While the recent government reshuffling could open the door for a compromise
with the EU, some observers noted that Polish policies are likely to remain
unchanged. The government reshuffle has replaced older ministers with a younger
generation of politicians who may have less nationalistic views, which could help
improve the perception of Poland in EU circles. In the same vein, the three-hour
meeting between the new Polish Prime Minister Morawiecki and European
Commission President Jean-Claude Juncker was seen as a step toward a more
constructive relationship between Poland and the EU and closing the Rule of Law
(ROL) procedure (see Annex 1 on the evolution of the ROL procedure for Poland).
However, Jarosław Aleksander Kaczyński is in control of the government’s policies,
increasing the chances for presentation of new controversial policies.
• On the Rule of Law procedure, the base case is still that the EU fails to find
unanimous agreement among all other EU member states to determine the
existence of a breach (the second step of the preventive mechanism) given the
opposition of Hungary. With the government reshuffling in Poland, the chances of a
resolution have increased. Without a resolution in the near term, Poland would be
without important political capital in the upcoming EU budget discussions in late
spring/early summer this year, which would be particularly contentious in view of the
UK contribution falling out.
PIS enjoying very strong support in the
polls
Source: Wikipedia
5 | 24 January 2018 www.dans keresearc h.c om
Trip report from Warsaw
Annex 1: The Rule of Law Procedure
against Poland
The evolution of the Rule of Law Procedure against Poland
Source: EU Commission, Danske Bank
13 january 2016
4 recommendations!27 July 201621 December 201626 July 201720 December 2017
1 June 2016
20 December 2017, triggered by 1/3 of EU member states
This where we are now
6 | 24 January 2018 www.dans keresearc h.c om
Trip report from Warsaw
Different stages under the Preventive mechanism
Source: EU Commission, Danske Bank
Preventive mechanism of ROL procedure
To determine that there is a clear risk of serious breach of ROL
To determine the existence of seriousbreach of ROL
Sanctions against member states:Suspension of certain rights, incl. Rights of
the country in the EU council
This is where we are now:Requires 4/5 of member states i.e. at least 22 membersMight happen
EU council acting by unanimity i.e. all member states needto support the resolution: Poland counting on the support of Hungary here
Although risk of sanctions is small, Poland is wasting political capital:• EU budget negotiations• Future size of EU investments• Strategic partnerships in NATO, UN
7 | 24 January 2018 www.dans keresearc h.c om
Trip report from Warsaw
Disclosures This research report has been prepared by Danske Bank A/S (‘Danske Bank’ ). The author of this research report is
Jakob Ekholdt Christensen, Chief Analyst and Head of International Macro and Emerging Market Research .
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Trip report from Warsaw
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Report completed: 24 January 2018, 17:35 CET
Report first disseminated: 24 January 2018, 20:35 CET