A MEDIUM-TERM FORECAST FOR POLAND POLISH ECONOMY FOLLOWS THE SLODOWN IN THE EU.

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1 University of Łódź Institute of Econometrics Władysław Welfe A MEDIUM-TERM FORECAST FOR POLAND POLISH ECONOMY FOLLOWS THE SLODOWN IN THE EU. Paper prepared for the PROJECT LINK meeting in New York October 22-24, 2012 Łódź, September 2012

2 Władysław Welfe A MEDIUM-TERM FORECAST FOR POLAND POLISH ECONOMY FOLLOWS THE SLODOWN IN THE EU. 1. The initial conditions The outcome of the year 2011 has shown a recovery that continued in the first quarter of the year Despite the slowdown in many EU countries the rate of GDP growth exceeded 4% in the preceding year. It was associated with an increase in domestic activities especially in the strong recovery in investment activities (by nearly 9% after a two-year decline) and with exports expansion that lead to an increase in industrial output. These tendencies prevailed in the first quarter of the year However, the second quarter has shown a clear slow down in domestic activities following with substantial lag the slowdown in the EU. The strong rates of final domestic demand in 2011 were accompanied by relatively mild increase of private consumption that slightly exceeded 3.5%, declining in the second quarter of the year The nominal wages grew in 2011 at rates close to 7%, whereas real wages by 3% only, due to higher than expected rate of inflation. They declined in the year The real disposable incomes have shown in 2011 an increase by 3.9%, and the rising consumer credit ensured the final increase in private consumption over 3%. These rates of growth declined in the last quarter of the year The investment activities showed up the recovery only at the end of Both private and public investment increased in the year 2011 by 8.6%, higher than previously predicted. These rates of growth declined in the first half of the year 2012.The interest rates were raised in nominal terms but they did not change much in real terms. The recovery followed in the building industry, and machinery industries in 2011, slowing down in the last quarters. The exports were an important factor of growth. The recovery in the world trade positively changed the exports perspectives. They have shown a 13% increase in the year 2010 but much lower rate of growth in the year 2011 (7.6%) due to the slowdown in the EU. This rate slightly declined in the first half of the year

3 The imports followed the rates of growth of domestic activities. The mild recovery of the Polish industry associated with a partly appreciation of Zloty brought about a considerable change yielding a 11.0% increase in the year 2010 and a similar rate of growth in the year 2011 (12%). It showed a decline in the first half of the year 2012, following the slowdown of domestic activities. The domestic output of the manufacturing industry recovered in the year the volume of total industrial sales was showing a positive tendency all over the year, at ca. 10% that continued in the year In the year 2012 this rates of growth declined. It was followed by an increase in production of the building industry that came to its end in The agriculture output was at average levels. The services sector has shown a long-run tendency of a slow growth. The productive potential continued to grow at rates around 3%, due to the increase of investment activities in the past. It was associated with a moderate increase of labour productivity. In 2010 the number of employees started to grow mainly in the enterprise sector. This led to a decline of the rate of unemployment to nearly 11.3% in at the end of 2011, being above the previous expectations. This tendency stopped in 2012 and the rate of unemployment became more or less stable, approaching 13%. The rate of inflation started to increase up to 3.6% in 2011 and to 4% in the first half of The GDP deflator showed a lower rate of increase. The core inflation remained low. The above rates of growth of the CPI were increasing mainly due to external factors an increase in import prices of oil as well as of foodstuffs. The wage-cost pressures lost their impact by the years The principal interest rates were systematically raised in 2011 because of the growing rates of inflation, the Central Bank started to increase slowly the principal interest rates. The real interest rates were rather neutral. The increase of economic activities was followed by an increase in gross profits of the enterprise sector and an increase of incomes from taxes to the central budget, despite a drop of social taxes. The budget for the year 2011 had a low increase of incomes and expenditures, keeping the budget deficit under control. The fiscal consolidation was announced for the year 2012 and for the next two years in order to bring down the deficit of the financial sector. There were neither explicit fiscal rescue package nor serious expenditure cuts. It considerably increased the total government debt, being one of the major policy burdens in the next year. 3

4 2. Assumptions underlying the medium term economic policy The policy assumptions for the year 2012 were elaborated by the government by the end of the year 2011 and approved after the Autumn Elections to the Parliament. The policy assumption for the year 2013 elaborated by the government are rather pessimistic, taking into account the expected slowdown of the Polish economy. A slowdown was assumed following the deterioration of economic situation in the EU resulting in the decline in the projected rates of growth in the year 2012 to 2,5%. The policy assumptions for the year 2013 had to adjust to the expected risks. Hence, the rate of growth of GDP initially proposed at 3.5% level was reduced to 2.2%. For next years the National Development Plan was updated and presented to the EU. It was accompanied by elaboration of a 4-year Plan of Financial Development, accepted by the government in the mid of 2010, updated in A medium term forecast was presented in the Scenario of Development of the Polish economy up to the year All the documents present a rather optimistic picture of sustained growth, adjusted for the impacts of slow recovery. The rates of growth of GDP in the years 2012 and 2013 should oscillate above 2% but after the world and EU recession is over they might return to 5%. This would be accompanied by a temporary freeze of unemployment and its decline over the next years to 11%. The financial reforms should continue with some lags. The budget expenditures should show a limited increase (again without clear priorities to development expenditures). All this should lead to a further decline in budget deficit in order to fulfill the Maastricht criteria and open the way to negotiations aimed at joining the EMU after The external conditions in the next years are moderately pessimistic as compared with previous forecasts. The optimistic signals came from the United States where a mild recovery started first. The forecasts of international organizations, especially Project LINK were adjusted. However, the turmoil in the world financial markets in the year 2011, associated with slow growth in the USA and especially in Europe, has produced pessimistic expectations. The rates of growth for the EU are forecasted to be low (by ca 0-1 p.p.) but for China and India they seem to remain high, from 8% to 9% in The rates of growth in international trade recovered following the US imports spreading all over the world trade. The deterioration of the US $ exchange rate may speed this process, but on the other hand - increase the US exports. The increase of rates of growth of world prices, especially with respect to the foodstuffs and oil does 4

5 not seem to have arrived at its maximum levels. Because of international turbulences (revolutions in the Arab countries) and bad weather conditions their further increase is expected. 3. Forecast outline up to the year 2015 The assumptions of the economic policy outlined above, supported by our evaluation of the tendencies observed in the last quarters formed the basis for the construction of our updated forecast, extended up to the year It had to be downward adjusted because of the risks spreading in the coming two years. The previous forecast allowing for the impact of the world recovery assumed an increase to 3% rate of GDP growth in the year However, the recovery was stronger, raising the rate of growth in 2011 to over 4%. The full recovery previously expected in the year 2012 will not arrive because of the problems faced by the EU and especially EUROLAND, that negatively affected the Polish exports to that area. Hence, a decline in the GDP rates of growth is expected to 3% in 2012, which is rather optimistic as compared with official and other forecasts. It will be much less than previously predicted, however, still high as compared to pessimistic forecasts assuming a decline of the rate of growth to % in 2012 because of the rising risks.. It would be, however, favorably affected by the results of the implementation of the inflow of the EU funds. Investment activities recovery started late in the year It raised the annual rate in 2011 to 8.6%. In the next year a slow increase is expected (4%), coming in to rates of growth of 8%. We expect further inflow of foreign direct investment and of the funds from the EU to be spent mainly on improvement of infrastructure. Rates of growth of private consumption are forecast to increase by 2% in 2012, 2.6% in 2013, and to % in the next years. It will be partly due to an increase in nominal wages, decrease of unemployment and also due to the slow growth of incomes from private economic activities. Consumer credits will play significant role in financing the housing and durables expenditures in Public consumption after a decline to 03% in 2012 may show moderate rates of growth. All in all, rates of growth of the domestic final demand will be nearly 3% in 2012, showing in the next years higher dynamics. It is forecast that the exports rates of growth after having recovered up to 8% in the year 2011 will further grow in 2012 and return to the long-term 8% rates of growth in The dynamics of imports will depend on the dynamics of domestic activities and also to some 1 All forecasting computations based on the W model of the Polish economy were performed by dr Waldemar Florczak 5

6 extent on the rate of the likely appreciation of the Zloty. The recovery brought imports rates of growth to 12%. Hence, the negative balance of trade will be deteriorating. The current account deficit will also deteriorate, however, to a lower extent, taking into account the positive impact of growing remittances sent home by Polish emigrants. All this justifies the forecast of a decline of the rate of growth of GDP to 3.1% in 2012 and 3.3% in 2013 and its fluctuations in the last years around 4%. Bearing in mind the slowly growing rates of growth of potential GDP it is forecast that the rate of capacity utilization will increase in the immediate future. The impact of technological progress will be substantial. Total factor productivity (TFP) will be growing at rates exceeding 2% annually, mainly due to the imports of foreign R&D and growing human capital per capita. Hence, we expect labor productivity to rise at the rates of 3-4.5% annually. The increase of employment that started growing will again discontinue. In 2012 this will be associated with a temporary increase of unemployment. The latter will be negatively affected due to the slowdown but positively by a continued emigration and adversely by an immigration from the East expected in the last years of the forecast. The average unemployment rate is estimated to increase to 13% in 2012, and in 2013 and further decline in the next years to 12% by the end of the forecast. Table1. Rates of growth of the Polish economy in the years (constant prices 1995), if not indicated otherwise; symbols of variables in parentheses Category Years Domestic final demand (XFD) 5,98 2,95 3,1 4,39 4,79 Private consumption (C) 3,61 2,04 2,62 3,01 3,26 Public consumption (G) 2,63 0,32 0,1 2,5 2 Gross investments (JA) 8,62 3,4 4,25 5,94 8,07 Gross investments (% share in GDP); (JAXP) 24,35 24,22 24,36 24,95 25,94 Exports (E) 7,59 9,53 6,28 8,48 8,08 Imports (M) 11,91 9,01 5,8 9,11 8,91 Exports (% share in GDP); (EXPP) 40,8 42,59 43,33 43,06 44,07 GDP (X) 4,08 3,1 3,3 4,02 4,3 Potential GDP (XKMT) 3,59 2,02 2,35 4,02 4,3 Capacity utilization (WKM) 75,86 76,66 77,38 77,38 77,38 Fixed assets (machinery and equipment) (KM) 5,21 4,5 3,92 3,43 3,02 Working population (N) 1,11-1,5 0,18 0,83 0,8 Total factor productivity (TFP) 2,66 3,57 2,21 2,85 2,43 Labour productivity (WXNM) 2,94 4,67 3,11 3,16 3,47 Human capital per employee (HKLZ) 1,02 0,92 0,88 0,88 0,88 Unemployment rate, annual average (UNR) 11,27 12,89 13,11 12,58 12,01 Real average wages (W) 3,2 1,13 1,33 2,54 2,5 Real disposable income (Y) 3,91 1,52 1,46 2,79 2,71 GDP deflator (PX) 3,42 3,82 3,31 2,31 2,56 Private consumption deflator (PC) 3,63 3,82 3,43 2,43 2,6 Exchange rate USD/PLN (WZLD) -1,81-2,15-0,07-4,64-0,92 Current account balance (bill. of USD); end of year -15,42-26,63-26,76-27,42-29,05 State budget balance (% in GDP); end of year -1,68-2,19-3,02-2,84-2,67 Source: Own calculations based on model W

7 The rate of inflation is expected in the year 2012 to increase to 3.8% but decrease to 2.6% at the end of the forecast. Its increase was mainly due to the external factors, associated with a decline of labor cost pressures. In inflationary pressures will slightly increase. The interest rates are expected to stabilize in 2012 after they were raised in the year A temporary increase of the difference between current and PPP exchange rate will follow. It will be of importance during negotiations preceding the accession to the Monetary Union. We also forecast that in the next years the nominal interest rates will adjust to the level compatible with the other EU countries, especially to foster the investments. An increase of the rates of growth of economic activities in was followed by an increase of the rates of growth of incomes of the state budget. However, this will not be followed by a considerable increase in development expenditures, especially these of R&D. It is so because the government priority is to squeeze the deficit of the financial sector below 3% of the GDP in the years to come in order to constrain the further increase of national debt. Figure 1. Domestic final demand and GDP (% rates of growth) Private consumption Investment outlays GDP Public consumption Final demand 7

8 Figure 2. Foreign trade by national accounts (% rates of growth) Imports Exports Figure 3. State budget balance -25-1, , % share in GDP (left axis) Billions of zloties (right axis) -3,5 8

9 Figure 4. Unemployment , , , Thousands of people (left axis) Unemployment rate (right axis) Problems that remain The major short-term problem that remains is - in our view - how to keep up positive growth despite the unfavourable external conditions. It looks like the passive behaviour of the government as regards the economic policy will continue. In the past it did not stimulate the economic activities to increase beyond the achieved rates of GDP growth. No rescue fiscal packages were introduced (the increase of budget deficit may be regarded as a substitute). It remains a question - to be answered by the politicians of the government - whether the weakness of the economic policy should not be substituted by a policy initiating measures aimed at fostering recovery and in the next years stabilizing growth rates at 5%. At present the outlook is rather pessimistic as the main issue remains the constraining of the budget deficit. The reforms of public financial sector that have to be continued in order to increase the efficiency of the fiscal system seem limited to the changes in financing the pension funds. However, the social tensions may raise public expenditures, constraining the possibilities of reducing the budget deficit. Several fiscal proposals raised by political parties, such as an increase of indirect taxes (partly introduced in 2011) or introduction of linear tax system in household income taxes at the expense of abolishing major tax exempts might further endanger the expected growth. 9

10 The recovery in the world economy associated with a slowdown of the EU in the years will not increase Polish exports in the next future. The depreciation of the Polish Zoty helped in sustaining exports and decreasing imports. However, the recently observed appreciation may postpone this process. Hence, respective interventions might by expected. On the other hand, the world prices of oil and foodstuffs may increase the imports of inflationary pressures. In the years the rising uncertainties and risks may endanger the inflow of FDI, an important factor of investment growth and technology imports. The dangers that may arise from a departure from expansionary policies are twofold. Firstly, there might be a return to a conservative economic policy, i.e. to tight monetary policy (high interest rates) and conservative fiscal policy favouring rich families at the expense of lowincome families (introduction of linear income tax as mentioned above). That policy may again substantially constrain domestic consumer and investment demand and worsen the income distribution. As a consequence, the growth rates would decline and the chances to reduce the gap in living standards between Poland and the developed EU countries would be postponed. On the other hand, there exists also a danger to follow a populist economic and social policy. A rapid increase in wages and pensions could lead to a high increase in domestic demand, which might result in a considerable increase of inflationary pressures and market disequilibria. The unconstrained increase in consumer credit may strengthen these tendencies and lead to financial turbulences. This, in turn, may again induce an increase in the budget deficit and public debt, which might end up in a financial crisis. 10

11 APPENDIX Tables 1-9. Economic Development of Poland Table 1. Final demand - SNA (constant prices 1995, millions of zloties) DOMESTIC FINAL DEMAND PRIVATE CONSUMPTION PUBLIC CONSUMPTION INVESTMENT OUTLAYS NET EXPORTS AND LOSSES GDP Table 2. Main characteristics of growth (constant prices 1995, millions of zloties) INVESTMENT OUTLAYS FIXED CAPITAL LABOUR SUPPLY (thousands) LABOUR DEMAND (thousands) UNEMPLOYMENT (thousands) % RATE OF UNEMPLOYMENT

12 Table 3. Foreign trade - SNA (constant prices 1995, millions of zloties) IMPORTS TOTAL EXPORTS TOTAL IMPORTS TOTAL (MILL USD) EXPORTS TOTAL (MILL USD) NET EXPORTS (MILL USD) Table 4. Main characteristics of market situation and financial flows (millions of zloties) AVERAGE YEARLY WAGES REAL (in 1990 prices) PERSONAL INCOMES REAL (in 1990 prices) PRIVATE CONSUMPTION REAL (in 1990 prices) COST OF LIVING INDEX

13 Table 5. Deflators (1990=1.0) GDP PRIVATE CONSUMPTION PUBLIC CONSUMPTION INVESTMENT OUTLAYS IMPORTS EXPORTS COST OF LIVING INDEX ZLOTY / $ EXCHANGE RATE Table 6. State budget (current prices, millions of zloties) TOTAL INCOMES TOTAL EXPENDITURES BUDGET BALANCE BUDGET BALANCE / GDP (%)

14 Table 7. Structure of the Polish economy (% shares in GDP; current prices) CONSUMPTON/GDP (%) PUBLIC CONSUM./GDP (%) INVESTMENTS/GDP (%) EXPORTS/GDP (%) IMPORTS/GDP (%) NET EXPORTS/GDP (%)

15 Table 8. Foreign trade - SITC groups (millions of USD, current prices) IMPORTS TOTAL SITC SITC SITC SITC SITC - 5,6,8, EXPORTS TOTAL SITC SITC SITC SITC of which SITC NET EXPORTS (SITC) Table 9. Foreign trade - SITC groups (shares) IMPORTS TOTAL SITC SITC SITC SITC SITC EXPORTS TOTAL SITC SITC SITC

16 SITC of which SITC