nflation Report May 4 Warsaw, May 4
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Contents SUMMARY... 4 1. nflationary processes... 6 1.1. CP, HCP and core inflation indices... 6 1.. nflation expectations... 1 1.3. nflation target... 14. nflation factors... 15.1. Demand... 15.1.1. Household demand... 16.1.. Government demand... 16.1.3. nvestment demand... 18.1.4. External demand and current account of the balance of payments..... Output... 5.3. The labour market... 7.3.1. Employment and unemployment... 7.3.. Wages and productivity... 31.4. Other costs and prices... 34.4.1. mport prices... 34.4.. Producer prices... 36.5. Financial markets and monetary processes... 38.5.1. Asset prices/nterest rates... 38.5.. Exchange rates... 4.5.3. Credit and money... 43 3. Monetary policy in January May 4... 49 4. nflation prospects... 51 ANNEX A The voting of the Monetary Policy Council members on motions and resolutions adopted in Q1 4... 53
Summary SUMMARY 1. n Q1 4, the annual price growth rate stabilised at 1.6-1.7%. However, in April 4, inflation significantly accelerated to.%. The NBP expects its further increase in May. n the analyzed period inflation was primarily influenced by supply factors such as growing prices of food and raw materials. However, according to the NBP, the contribution of demand pressures to significantly faster price growth observed since April 4 increased. Stronger demand was partially related to expectations of price growth after Poland s accession to the European Union.. According to the NBP s forecasts based on data available in April 4, and conditional on the simplified assumption of the unchanged official interest rates, the probability of inflation exceeding the upper tolerance limit for deviations from the target of.5% +/- 1 percentage point is higher than 5%. Economic data published in May, as well as the continuing high oil prices, reveal processes increasing the risk of breaching the upper limit of acceptable deviations from the inflation target. 3. Consumers and bank analysts inflation expectations have been growing since the beginning of the year. Although in May they stabilised at a higher level, in the light of increasing current inflation further growth of expectations can be forecasted. nflation expectations of enterprises and their forecasts of own product prices have also significantly gone up. n April, the annual growth rate of producer price index (PP) amounted to 7.5% (with 3.5% in mining and quarrying), the highest level since October. Moreover, surveys conducted by the NBP in May show that enterprises plan further rise in their product prices in the coming months on the grounds of growing cost pressure. According to the NBP, the increasing inflation expectations of households may be largely related to Poland s accession to the European Union. Foregoing view seems to be supported by the growth of such expectations in some of the other new EU member states. Despite this, given the strong economic revival and negative supply shocks there is a significant risk that in the coming months of 4 inflation expectations may continue to grow, which in turn may stimulate further increase in inflation. 4. World prices of raw materials were still rising in the analysed period. World oil prices are expected to remain at the current high level until the end of 4. 5. Despite positive trends in the Polish economy, further weakening of the zloty exchange rate occurred in January-April, which, given the higher than expected economic growth, may feed through into inflationary pressure. Depreciation of the zloty was a result of the reduced disparity between Polish and major economies real interest rates and the increase in the required risk premium related to investment in zloty-denominated assets. An increase in risk premium was caused by uncertainty about the performance of the public finance consolidation program and - consequently about the ability to maintain public debt at a safe level. 6. n January-March 4 the annual growth rate of M3 money supply remained moderate, but it accelerated significantly in April. Enterprise loan market had not yet revived. ncrease in claims on households was primarily the result of the continued high growth rate of housing loans. A significant acceleration in the households credit growth rate in April was caused by increased purchasing resulting from the fear of price growth after Poland s accession to the EU. n the NBP s surveys banks informed about the expected rise in credit demand in both corporate (including longterm loans) and household sectors. ncreased interest in taking out loans is also indicated by business surveys. 7. The Polish economy has recently been growing rapidly, largely due to boosting exports. Economic climate and business conditions surveys confirm the above trends. Moreover, in 4 an increase in individual consumption, as well as new signs of investment demand revival have been observed. According to the NBP s forecasts, individual consumption growth is expected to remain at a high level, and investment dynamics should gradually increase. Economic growth rate in 4-6 will continue to be high, provided that public finance reforms have been implemented. 4 N a t i o n a l B a n k o f P o l a n d
Summary 8. Accelerating economic growth, rising inflation, increasing payroll fund, and the highest corporate profits since 1995 improve revenues of the central budget and other entities of the public finance sector. As a result, after four months the risk of budget receipts being lower than planned in 4 has diminished. However, the key period for evaluating the situation of public finance will be May-July 4 because of envisaged revenue shortfall and expenditure growth resulting from the introduction of settlements with EU budget from 1 May on. Despite public finance sector receipts being higher than expected in the period of January- April 4, it is highly probable that the sector s deficit in 4 will be significantly higher than in the previous year, which, when combined with the low receipts from privatisation, may lead to exceeding the second prudential threshold of public debt in relation to GDP. Moreover, postponing actions aimed at limiting and rationalization of public expenditure would lead to the crisis of public finance and economic growth breakdown. 9. n Q1 4, the trend of improvement in the current account balance continued. This was mainly a result of further reduction in the trade deficit in goods (caused by the higher growth rate of exports compared to imports), as well as increase in services trade surplus. mprovement in the balance of trade has to a large extent resulted from enhancing competitiveness of Polish manufacturers against their foreign counterparts. 1. According to preliminary data, the growth in gross value added in Q1 4 was higher than 6%. Like in 3, this was primarily caused by the increase in gross value added in industry and service sector. ndustries with high and growing export sales played the major role in the high growth rate of manufacturing output. Construction output annual growth rate, following the decreases in the first two months of 4, became positive in March and April, while the significant rise in April was related to VAT increase for construction material and services from May 4 on. 11. According to GUS data, despite the strong recovery in economy during the first months of 4, no increase in employment was observed in the corporate sector. However, data of Research on Economic Activity of the Population (Badanie AktywnoÊci Ekonomicznej LudnoÊci BAEL) indicate that employment in the economy might have grown even in 3. A gradual improvement in the labour market can be expected in the coming months. 1. n January-April 4, a significant acceleration in the annual growth rate of average nominal remuneration in the corporate sector and payroll fund were observed. Significant growth in labour productivity still outpaced that in remuneration, which was reflected in the lowering unit labour cost. 13. Since the beginning of the year factors which reinforce inflation pressure have been getting stronger, while the role of certain factors hitherto limiting the price growth rate has decreased. Therefore, in February and March 4, the Monetary Policy Council (MPC) signalled the possibility of shifting the monetary policy bias upside and, in April, put that change into effect. 14. Household inflation expectations, which had been rising since the beginning of the year, stabilised in May 4 at a higher level. Certain inflation expectation measures grew again in May, and the expectations of retail price increases had been the highest since 1997. n April, the producer price index went up significantly. Some manufacturers plan further significant price increases in the coming months. Though to a different degree, all core inflation indices rose. These factors, combined with the significantly higher than expected growth of economic activity, make further inflation increase highly probable. However, analyses show that some of the factors which have had impact on inflation expectations may be related to Poland s accession to the European Union, and as such are probably temporary. One may assume that forthcoming data will allow a better evaluation of the impact of transitory effects. With this in mind, at its meeting in May, the MPC voted not to change the official interest rates and to maintain the upside monetary policy bias. NFLATON REPORT MAY 4 5
nflationary processes 1 1 nflationary processes 1.1. CP, HCP and core inflation indices After the growth in inflation from.3% 1 in April 3 to 1.7 in December 3, in the subsequent months of Q1 4 the annual price growth rate stabilised at 1.6 1.7% (Figure 1). However, in April there was significant acceleration in inflation to.% y/y, which was caused mainly by the developments in the food and fuel markets (Figure, Table 1). Figure 1 Annual changes in CP and main price categories in the years 1 4 (%) 8 6 4 - -4 V V 1 X X V V X X V V X X 3 4 CP Regulated prices Food and non-alcohol beverages Other goods and services Source: GUS data, NBP estimates. Figure Annual CP breakdown 1 4 6 5 4 3 1-1 - V V 1 X X V V X X V V X X 3 4 Food and non-alcoholic beverages Regulated prices Other goods and services Source: GUS data, NBP estimates. 1 Measured with annual CP. The following abbreviations will be used hereinafter in the Report: y/y: analysed period compared to the corresponding period of the previous year; q/q: quarter compared to the previous quarter; m/m: month compared to the previous month. 6 N a t i o n a l B a n k o f P o l a n d
nflationary processes Table 1 Price growth in the basic groups of consummer goods and services 4 weights V % corresponding month of the previous year = 1 Total, of which 1. 11.6 11.6 11.7 1. Food and non-alcoholic beverages 7. 1. 1.7 13.3 14.6 1 Regulated prices 7.3 1.3 11.9 11.6 1. ncl. fuels 3.8 15.4 1.7 11.3 14.7 Other goods and services, of which 45.8 1.8 1.7 1.7 1.8 Non-food products 7.3 99.8 99.7 99.8 1. Services 18.5 1.4 1.3 1.1 1.1 previous month = 1 Total, of which 1. 1.4 1.1 1.3 1.8 Food and non-alcoholic beverages 7. 1.5 1.3 1.8 1.1 Regulated prices 7.3 1.6 1. 1.3 1.4 ncl. fuels 3.8 13. 11. 11.9 11.9 Other goods and services, of which 45.8 1. 99.9 1. 1. Non-food products 7.3 1. 99.6 1. 1.1 Services 18.5 1.5 1.3 1.1 1.3 Source: GUS data, NBP estimates. Analysed period was marked by a strong and durable revival of the Polish economy, which is supported by, inter alia, the results of business conditions and economic climate surveys. Economic growth was accompanied by a rise in payroll fund, which signifies an increase in individual consumption. Moreover, rising world prices of raw materials as well as weakening of the zloty led to an increase in costs, and in consequence in producer price index (PP). However, the above-outlined events had not yet been reflected in the rising prices of consumer goods and services. Factors which restrained the inflation pressure included labour productivity growth which had been observed for the last four quarters and accompanied by the decrease in unit labour cost. Another factor limiting price increase was growing competition, particularly in the retail market. Furthermore, according to the NBP s research, until February 4 the observable PP rise related mostly to export production. n addition, it must be stressed that cost and demand pressures usually pass-through into inflation with a certain lag. Despite factors restraining inflation, the demand growth rate outpacing that of its long-term trend, increasing capacity utilisation in manufacturing, and growing inflation expectations altogether give rise to the risk of accelerating inflation in the nearest future. Data of April 4 largely support the above scenario. The current inflation was primarily influenced by supply factors, although the role of demand pressures in terms of their contribution to significantly faster price growth in April 4 most likely increased. A surge in food prices in April 4 strengthened their upward trend observed for many months. This price group impacted on inflation growth the most in the period covered by the analysis (Figure, Table 1). The main sources of food price increases include the last year s crop harvest which was lower than the year before. Moreover, livestock production (pork) had been reduced for many months. High food (grain) prices in the European market were not conducive to limiting inflation pressure either. Moreover, the statistical base effect also influenced food prices Determinants of inflation processes in the analysed period are described in nflation factors chapter. NFLATON REPORT MAY 4 7
nflationary processes growth rate in the first four months of 4: in the corresponding period of 3, there was a downward trend of 3.4 3.5% y/y in this price group. 1 Another factor that contributed to growing food prices were the increased purchases of certain food products (including sugar) resulting from consumers fear of price increases after Poland s accession to the EU. This strengthened the inflation pressure, in particular in April, i.e. the month preceding the accession. According to the NBP, worse crop harvest compared to two previous years (which may influence prices before mid year), and the lower livestock production (mainly pork) will contribute to the food prices growth in the coming months. Gradual introduction of measures approved under EU Common Agricultural Policy and Common Customs Tariff will also influence domestic food prices. n the group of regulated prices, the major factor that influenced inflation in January April 4 was fuel price increases. During the first four months of 4, the total growth of fuel prices amounted to 8.%. These prices are highly volatile. Therefore, they can materially impact the CP level during certain periods. Growth of fuel prices in the analysed period was mostly the result of Figure 3 Changes in prices of other consumer goods and services (y/y, %) 1 1 8 6 4 - V V 1 X X V V X X V V X X 3 4 Non-food products Services Source: GUS data, NBP estimates. Table CP and core inflation indices 4 Y/Y change M/M change (%) (%) 4 V V CP 1.6 1.6 1.7..4.1.3.8 Core inflation indices after excluding: Regulated prices 1.3 1.5 1.7.3.3.1.3.9 Most volatile prices 1.1 1. 1.3..1.1..7 Most volatile prices and fuel proces.9 1.1 1.3.1...1.7 Food and fuel proces (net inflation) 1. 1.1 1.1 1....1. 15% trimmed mean 1.5 1.5 1.5...1.. Source: GUS data, NBP estimates. 3 The increase of petrol excise tax (by PLN./l) was lower than the decrease thereof which occurred in mid May 4 (by PLN.5/l). 8 N a t i o n a l B a n k o f P o l a n d
nflationary processes Figure 4 CP and core inflation indices (corresponding month of the previous year = 1) 13 1 11 1 1 99 V V V V 3 V X X X X 4 V CP Core inflation excluding regulated prices Core inflation excluding most volatile prices Core inflation excluding most volatile prices and fuel Net inflation 15% trimmed mean Source: GUS data, NBP estimates. Figure 5 CP and core inflation indices in 4 (Y/Y change, %).5. 1.5 1.. 1.7 1.7 1.6 1.6 1.5 1.3.3 1.3 1. 1.1. 1.3 1.1.9.1 1. 1. 1.1 1.1 1.5 1.5 1.5..5 CP Core inflation excluding regulated prices Core inflation excluding most volatile prices Core inflation excluding most volatile prices and fuel Net inflation 15% trimmed mean January February March April Source: GUS data, NBP estimates. the surge in oil world prices. Of much less importance were an increase in excise tax 3 and an introduction of fuel charge on 1 January 4. n energy, i.e. the category whose share in the group of regulated prices is the highest, hot water charges increased the most during the first four months of 4 (in total by.%; 3.9% y/y in April 4). New tariffs on gas and electricity were not introduced in this period. n January April 4, the annual price growth rate of other consumer goods and services group (excluding regulated prices) was significantly lower than in the previous year. This was a result of the observed since August 3 downward trend of prices of non-food products (Figure 3). During the first four months of 4, the most significant price falls in this category occurred in footwear (3.7%) and clothing (.3%). n the analysed period, a tendency of gradual decrease in the growth rate of services price continued. However, this was not the case for those services for which demand is little elastic, particularly those housing-related. The above-outlined description of factors which influenced inflation processes in January April 4 is reflected in the core inflation indices during the period covered by the analysis (Figure 4). NFLATON REPORT MAY 4 9
nflationary processes 1 From October 3 till March 4 none of them, whereas in April only one of the indices exceeded the annual price growth rate as measured by CP. This proves the significance of the proinflationary influence of prices excluded from core inflation indices. Figures presented in Table confirm that in the analysed months, it is food and fuel prices, as well as the most volatile prices and residential charges that influenced inflation most significantly. As shown in Figure 5, after the relatively stable levels of CP and core inflation indices in Q1 4, they increased steeply in April. The exception was net inflation, which proves that in this month price growth acceleration was caused mostly by rises in food and fuel prices which are excluded from this measure. nflation and the Maastricht criterion nflation acceleration since May 3 has been reflected in the systematic increase in the annual average price growth rate (up to 1.% in April 4), as measured by the harmonized index of consumer prices, HCP 4 (Figure 6). The reference value for the price stability criterion 5 (.5% in March 4) is still significantly above the current inflation in Poland. However, considering the characteristics of the annual average index, as well as both current and consistent with a level of the established inflation target future annual price growth rate exceeding 1.%, the trend in inflation for Poland calculated for the purposes of the Maastricht criterion fulfilment will be increasing. Figure 6 nflation in Poland (HCP, 1-month moving average) and the Maastricht criterion 1 9 6 3 X V V X X V V 1 X X V V X X 3 4 Average of the three EU countries with the lowest inflation Poland (HCP) Maastricht reference value Source: Eurostat data. NBP estimates. 1.. nflation expectations nflation expectations of consumers and bank analysts were continuing to increase during the first four month of 4 (Figure 7). They stabilised at a higher level in May. However, certain inflation expectation measures grew again, and the expectations of retail price increases had been the highest since 1997. 4 The basic difference between CP and HCP indices is that the latter one additionally accommodates foreigners spending on goods and services in Poland, estimated spending of people staying in institutional households (e.g. hospitals, prisons, old people s homes), as well as spending on games of chance. Although HCP and CP baskets have different weight structures, in practice the differences between these indices are insignificant. 5 The referential value is calculated on the basis of average inflation in three EU countries with the lowest average annual price growth rate (as measured by HCP), increased by 1.5 percentage points. An accessing country meets the price stability criterion if its average annual inflation does not exceed such referential value. More information about Maastricht criteria: Report on benefits and costs of Poland s accession to Euro zone. NBP, 4. 1 N a t i o n a l B a n k o f P o l a n d
nflationary processes Figure 7 nflation expectations of consumers and bank analysts between April 3 and April 4 6 (%) 3..5. 1.5 1..5..3...4.5.3.4..8.3.3.3.7.7.9.5 1.6.6.6.1..8.9.9.4.5.4.6.7.7.6 3. 1. V V V V V X X X X 3 4 V V forecasted y/y CP (December 4) banks current y/y CP (known at the time of the survey conduct) expected y/y CP (+1 months) consumers forecasted y/y CP (+11 months) banks Source: Reuters and GUS data, NBP estimates based on psos data Figure 8 Trend changes in prices expected by consumers in next 1 months net balance (%) 8 7 6 5 4 3 1 V V V V V V V 1997 1998 1999 1 3 4 Source: GUS, consumer economic climate survey. Figure 9 Forecasted price trend changes in construction, manufacturing and trade in next three months net balance 4 3 1-1 - V V V V V X X X X 3 4 V Construction Manufacturing Trade Source: GUS business tendency survey. 6 nflation expectations of consumers and forecasts of bank analysts are not completely comparable because of the different time frames bank analysts declare their forecasts for the month preceding the corresponding month of the following year, while consumers do so for the corresponding month of the following year. n addition, it should be taken into account that the inflation expectations of consumers are objectified i.e. they are quantified on the assumption that the respondents perceive price movements against the background of official inflation statistics. NFLATON REPORT MAY 4 11
nflationary processes Box 1. nfluence of Poland s EU membership on domestic prices Following Poland s accession to the EU, the NBP and the Office for Competition and Consumer Protection carried out a research on the effect of the accession on price changes in Poland. Results show that membership in the EU should not significantly influence prices of goods and services in Poland. Price changes may result from: 1 direct causes, such as: VAT or excise tax rate changes, approving Common Customs Tariff, and Poland s becoming subject to Common Agricultural Policy rules; prices liberalization and competition growth effects. t is estimated that price growth resulting from EU membership should impact on the 15% of goods and services purchased by an average household. n 33% of them there should be a price drop, and 5% of goods and services prices should not be affected by EU accession. Considering only the direct factors, it is estimated that the total effect of price changes on annual CP should not exceed.9 percentage point. The research emphasizes that despite the long-lasting development of the Single Market, there is still a high differentiation of goods and services prices between EU-15 countries, which applies to both food and industrial products. This is a result of differences in consumers purchasing power, degree of liberalization of individual markets, and their competition level. The following activities were performed in order to analyse price changes in the period before and after Poland s entry to the EU: launching a hotline to collect consumers information about observed cases of changing retail prices; creation of a system for monitoring prices of selected goods and services in the domestic market, implemented in the NBP Head Office and Regional Branches; as assumed, the price recording system is an important source of up-to-date information about trends in the prices of selected goods and services before and during the initial period of EU membership. Hitherto, price records reveal the following information: All price increases which can be contributed to EU regulations have already occurred; however, the expected price drops related to Poland s accession to EU has not yet fully materialized. Shifts in the prices of such goods as fuels, coal or fruit are not related to accession, but result from worldwide trends, administrative decisions, and seasonal changes. n a longer period, certain goods and services should become cheaper as a result of liberalization of certain markets and growing competition (this factor was not included in the analysis). This embraces, inter alia, telecommunications services and electricity. Domestic and EU-15 prices can even out only as the real income of the Polish society approaches the level of Western Europe countries. Table 3 Responses to the question on price changes in selected goods and services prices after Poland s accession to the EU Percentage of respondents who believe that after Poland s access to the EU, prices will: (1) increase () remain unchanged (3) decrease (4) difficult to say 3 4 3 4 3 4 3 4 A. Food 64 77 75 14 5 9 1 8 6 1 1 9 B. Clothing and footwear 5 58 61 1 13 14 18 14 14 14 1 C. Cars 1 35 5* 53* 18 17* 1* 3 14* 1* 17 19* 15* D. Electronics and 35** 36** 3** 34** 1** 1** 1** 17** household equipment 35 41 4 3 8 7 19 1 16 18 17 E. Houses 56 71 67 18 5 9 9 1 8 17 14 15 F. Telephone call charges 31 37 36 18 3 34 33 15 13 18 17 17 1 n January and February 4 this question was divided into two separate ones: * prices of new cars, ** prices of second-hand cars. Source: psos. 1 N a t i o n a l B a n k o f P o l a n d
nflationary processes Figure 1 Distribution of bank analysts inflation forecasts formulated with reference to the annual rate of inflation in the month preceding the corresponding month in the next year 3.5 3.3 3.1.9.7.5 1.3.1 1.9 1.7 1.5 minimum 1. quartile. quartile (median) 3. quartile 4. quartile December 3 January 4 February 4 March 4 April 4 May 4 Source: NBP estimates based on Reuters data. Figure 11 Businesses expectations of quarterly price increase in consumer goods and services in next 1 months (in %) 7 6 5 4 3 1 1 V V V 3 4 expectations mean expectations median Source: NBP. During the first months of 4, inflation expectations of enterprises and their forecasts of own product prices have also significantly increased. Also GUS business tendency surveys (Figures 8 and 9) point to the steeply rising expectations and forecasts of price increases. A major factor influencing consumers inflation expectations was the often unfounded fear of price increases after Poland s accession to the EU (Box 1.1). The fears got particularly strong during the final months preceding accession. Survey results show that price growth was expected in all examined product groups (Table 3). Growth in bank analysts inflation expectations was reflected in the upward shift of their inflation forecasts distribution. n May 4, stabilisation of average expected price growth rate was observed, which, however, was accompanied by an increase in uncertainty (widened declaration range between minimum and maximum forecasted inflation level, Figure 1). Median of enterprises expectations with regard to annual inflation rate for the coming 1 months has grown from.% to.4% (Figure 11). At the same time it must be stressed that for the first time since Q 1 over a half of surveyed enterprises intend to increase prices of their products. A steep rise in inflation expectations at the end of 3 and beginning of 4, as well as a possible continuation of this trend, particularly for consumers, pose a risk of an increased pressure on remuneration and consumption demand, which in turn would lead to accelerated price growth rate. NFLATON REPORT MAY 4 13
nflationary processes 1.3. nflation target 1 Despite the observed inflation acceleration since May 3, its current level remains in the lower part of the inflation target band. Also the inflation expected by households and enterprises does not exceed the upper limit of acceptable fluctuations, although banks inflation forecasts have already significantly exceeded the threshold of.5%. However, further increase of expected inflation in the environment of economic recovery and growing disposable income poses risk of increasing price growth rate even above the upper limit of acceptable deviations from inflation target. 14 N a t i o n a l B a n k o f P o l a n d
nflation factors nflation factors.1. Demand n January April 4, Polish economy was growing rapidly, largely due to boosting exports. At the same time, a rise in household consumption, as well as new signs of increased investment demand were observed. Economic climate and business conditions surveys confirm the above trends. n Q1 4, another increase in gross domestic product growth rate was recorded (Figure 1). n the analysed period, the GDP growth rate exceeded 6% y/y, compared to 3.8% for the entire 3, and 4.7% for Q4 3. Like in 3, the primary source of growth in Q1 4 were high Figure 1 Contribution of final demand components to GDP growth* 7.5 5..5. -.5-5. V V V 3..5. 1.5 1..5. -.5-1. -1.5 -. 1 3 4 Net exsport (percentage points, left-hand scale) Total consumption (percentage points, left-hand scale) GDP q/q seasonally adjusted (%, right-hand scale) Gross capitalization (percentage points, left-hand scale) GDP (y/y, %, left-hand scale) * n this report, TRAMO/SEATS deseasoning method has been used. Source: GUS data. Figure 13 Total demand forecast index* (net balance) and index trend** 5 15 1 5-5 -1-15 - -5 V 1999 V 1 V V V 3 4 ndex Trend * This is an index based on economic climate test method (difference between demand increase forecast rate and demand fall forecast rate) ** using x11 method Source: NBP. NFLATON REPORT MAY 4 15
nflation factors exports and household consumption. These factors are believed to have also increased the rate of economic growth in the analysed period. The NBP s analyses of business conditions indicate that already for the second quarter in a row weak demand is not regarded by enterprises as the main obstacle to their development (in March 4 it was the fourth most often listed factor). Significant demand improvement expected by enterprises is reflected in the growth of the expected in Q 4 total demand index to the highest level in the entire history of survey-based research, i.e. since 1997 (Figure 13). Although demand increase forecasts are more often given by exporters than enterprises selling exclusively for the domestic market, optimism growth is higher in the latter group of businesses. Moreover, among exporters, more optimistic forecasts were made by companies with a low (max. 5%) share of exports in their revenue. Therefore, the above factors reflect the marked demand improvement also in the domestic market..1.1. Household demand According to the NBP s estimates, consumption growth rate remained high in Q1 4. ts main source was an increase in household income resulting from economic recovery. Particularly high was the growth rate of income directly related to production results. For the first time since Q 1 the growth rate of primary income was higher than that of transfers whose y/y growth rate in Q1 4 decreased. The growth rates of income from paid employment and from own businesses in nonagricultural sectors were the highest since Q1. Growth of income from paid employment, estimated in Q1 4 to have exceeded 4% y/y (in nominal terms), was primarily the result of payroll fund increase in the corporate sector. n this sector, the growth rate of average remuneration was 5.5% y/y, the highest since Q4 1. Moreover, in the analysed period property income increased, largely due to the high growth rate of private owners income. Social security payments were 5.4% higher than in the previous year (in nominal terms), and welfare payments did not exceed the level of Q1 3. Payments of unemployment benefits and insurance benefits decreased. However, attendance allowances and child benefits slightly rose. A surge was recorded in pre-retirement benefits, although their share in transfers remains relatively small. According to the NBP s estimates, gross disposable income of households in Q1 4 increased in nominal terms by over 6% y/y, whereas their purchasing power was 4.5% higher compared to the previous year. This contributed to the increased household consumption whose growth rate was, according to the NBP s estimates, also above 4.5%. n Q1 4, a decrease in gross household savings was halted. Household investment growth was stimulated mostly by an increase in housing investment and expenditure of businesses classified as households. On the other hand, financial savings of households were almost 5% lower than in the previous year. This resulted from the decreases in household deposits in banking sector, and the increases in household debt (see chapter Credit and money). Undoubtedly, fears of price rises contributed to the growth in household consumption in the months preceding Poland s accession to the EU. This can be confirmed by, inter alia, the strong increase in retail sales during this period. Although the above effect can be transtiory, growing disposable income of households in the condition of economic recovery and gradual improvement in the labour market conditions should be reflected in the increased private consumption..1.. Government demand The analysis of the influence of public finance sector on domestic demand had to be limited only to the state budget. This results from the lack of information on the remaining segments of that sector 7. Data on the state budget in 4 do not allow comparisons with those of previous years because of system and methodology changes introduced in 4 (see Box.1). For the above reasons, a complete evaluation of the influence of the public finance sector on economic processes in the analysed period is difficult. 7 Data related to consolidated public finance sector are available only as annual reports, 5 months after the reporting period. 16 N a t i o n a l B a n k o f P o l a n d
nflation factors Box. n 4, the following system and methodology changes have been introduced in the state budget revenue and expenditure: n accordance with the amendment to the act on the revenue of local governments, new regulations on supplying them with funds from the central budget and a new division of tasks funded by central and local governments have been introduced. Consequently, the share of local governments in the central budget revenue from direct taxes has increased*. These measures are aimed at further decentralization of public resources and increase in the economic independence of local governments in managing their own resources. The way the Social Security Fund is reimbursed for the shortfall of receipts related to introduced social insurance reform (mainly transfers to compulsory funded pension pillar) has been changed. n 4, resources assigned for this purpose are classified as below-the-line financing item rather than expenditure. 4 is the first year of Poland s membership in the European Union, which caused the creation of new items in the central budget revenue, expenditure, and financing. As a part of settlements with the EU budget, the central budget will obtain special liquidity facility, but at the same time will increase own expenditure by the amount of membership contribution and resources required to co-finance the EU programs in order to absorb the expected funds from the EU. n addition, the budget will have to secure funds for pre-financing the programs which use structural funds, and for direct farming subsidies related to Common Agricultural Policy, this year only partially refunded from the EU budget. * Share of local government in the personal income tax has been increased in 4 to 45.7% compared to 3.1% in the previous year, and their share in the corporate income tax, from 5.5% to 4.1% respectively. The state budget influences domestic demand and its structure through budget expenditure and tax policy. Lowering corporate income tax in 4 to 19% (from 7% in 3), and enabling selfemployed to apply the 19-percent income tax rate might have encouraged entrepreneurs to increase their investment. At the same time, in 4 income tax brackets have been frozen, and certain personal income tax allowances and tax exemptions have been abolished. This limits disposable income of this group of taxpayers. Another factor which may cause a decrease in domestic demand in 4 is the further growth in the effective rate of indirect tax. n January April 4 the state budget recorded high tax revenues, mainly from indirect and corporate taxes. This was caused by, inter alia, pre-accession revival stimulated by increased purchases resulting from fears of rise in prices after accession; another cause was an improvement in corporations financial condition. This improvement also caused increased social contributions (Social Security Fund, Labour Fund) compared to previous year. n Q1 4 state budget expenditures, in comparable terms 8 (see Box.1), increased by.8% y/y, meaning that their contribution to GDP growth was positive, though significantly lower than in Q1 3 (1.8% y/y). nternal demand created by the state budget is dominated by consumption spending. An increase in such spending in Q1 4 (by approx..8% y/y) was a result of the growth in current expenditures of budgetary units on salaries (from January 1, 4, a rise in remuneration corresponded to their 3-percent real y/y growth), on goods and services, as well as on social transfers. At the same time, the state budget reduced funding of transfers, including subsidies and grants, as well as public debt servicing. Decreased growth rate of payments for, inter alia, pension and disability benefits, Labour Fund benefits, and lower compensation payments indicate smaller contribution of the state budget to the household consumption demand growth compared to the corresponding period of the last year. n the period covered by the analysis, 6% of investment expenditure planned for 4 was executed 9. Generally, this expenditure should increase by almost 18% compared to the previous year. Despite their growth in 4 in nominal terms (and consequently growth of their share in the state budget s total expenditure from 4.5% in 3 to 5.3%), their planned level for 4 is only 1.% of GDP, meaning that the state budget investment expenditure will not significantly contribute to the growth in investment demand in Poland. 8 State budget expenditures have been adjusted for subsidies to open pension funds. 9 Usually the use of these resources is very low in Q1, whereas approx. 6% of the expenditure is executed in the last quarter. NFLATON REPORT MAY 4 17
nflation factors Table 4 Central budget January April 4 4 3 4 Q1 Q1 Q4 Q1 Q1 Q4 Q1 Q4 PLN bln corresponding period percentage of the of the previous year = 1 annual plan % Total revenue, incl.: 36. 5.84 17.8 19.4 9.8 3.9 taxes 3.56 44.96 16.4 16.8 3.4 33. other 3.44 5.88 13.7 134.5 5.6 3.6 Total expenditure, incl: 47.8 61.83 97.9 96. 33.1 3.9 public debt servicing costs 4.99 6.33 91.9 86.7 7. 3.7 subsidies (Social Security Fund, Labour Fund, farmer social security fund FER) and general subsidies to local governments.47 8.18 94.4 91.8 38.8 4.1 Primary expenditure 4.81 55.5 98.7 97. 34.1 3.1 Central budget deficit -11.81-1.99 76.5 61. 46.4 4.3 Primary deficit -6.81-4.66 68. 43.7 89.6 5.1 Source: Ministry of Finance. n January April 4, budget expenditure was lower than in the previous year, which was a result of lower debt servicing costs, as well as reduced subsidies to social insurance funds and Labour Fund. Higher than expected revenue inflows of the state budget and other government units, as well as lower budget expenditure compared to previous years, reflected in the budget deficit in Q1 4 being lower than in the previous year, and in April 4 even a surplus of income was recorded (Table 4). However, the budget deficit still remains at a high level. Lack of political stabilisation and signs of weakening support for the program of limiting the excessive expenditure of public finance sector increase the risk of delaying the implementation of the public finance reforms. Maintenance of the significant imbalance in the public finance sector and, consequently, growing public debt and budget borrowing needs, would lead to the rise in long-term interest rates, increased investors uncertainty, and reinforced pressure for weakening the zloty. n the following months of 4 one can expect an increased role of public finance sector in the growth of domestic demand through higher expenditure resulting from, inter alia, activating resources for co-financing EU programs, and, at the end of the year, for direct farming subsidies. t will create additional borrowing needs of the budget, which may lead to the drain on domestic savings, whereas the higher demand for these resources will contribute to an increase in the cost of capital. After four months of 4, only 11.5% of the year s planned revenue from privatisation was received. Failure to receive the expected revenue from privatisation in 4 would increase the risk of exceeding another prudential threshold in public debt relation to GDP, i.e. 55%. This in turn would bear the risk of increased inflation pressure, restrained investment demand, and slowdown in economic growth..1.3. nvestment demand Contrary to earlier expectations, in Q4 3 investment demand growth did not accelerate. Gross fixed capital formation increased by.1% y/y compared to.3-percent increase in 3Q 3. GUS data, published in March 4, on corporate investment in was surprising. After a surge by over 7% y/y in Q3 last year, in Q4 investment of big and medium enterprises went down by over 18 N a t i o n a l B a n k o f P o l a n d
nflation factors Figure 14 Rate of change in investment outlays (comparing to the corresponding quarter(*) of the previous year, %) 1 5-5 -1-15 - -5 V 1 V V 3 V Corporate investment outlays Gross fixed capital formation * for enterprises, half of the year, Q3 and Q4 Source: GUS data. 3% (Figure 14). The most significant drop was in building and construction investment (by over 7% compared to growth of over 15% in Q3). This happened despite the fact that gross value added in construction in Q4 decreased to a lesser degree than in Q3, and construction output data showed improvement in companies performing construction investment works. Moreover, an approx. -percent decrease y/y was recorded in corporate investment in machinery. At the same time, a nearly 1-percent growth in means of transport investment could be observed, mostly due to the increased purchase of cars related to changes in tax regulations from May 1, 4. According to data of F-1 1 forms in Q4, and similarly to the entire 3, the strongest growth in investment (over 3% y/y) occurred in enterprises with dominating foreign ownership. Dynamic growth in investment in 3 (over %) was also observed in companies whose exports share in sales exceeded 5%. n the last three quarters of 3, the growth rate of investment in enterprises employing 5 5 people was also high; the dynamics for the entire previous year was over 14%. However, total investment growth rate was significantly lower due to the approx. 1.5% decrease in such expenditure in large companies, which accumulate most investment of the sector. t must be stressed that before GUS has published official national accounts data, any estimations of gross fixed capital formation in Q1 4 are subject to significant uncertainty and as such may only serve as an indicator rather than a firm figure. Based on initial available information, it may be estimated that in Q1 4 there was no significant increase in gross fixed capital formation growth rate. This view is supported by, inter alia, decreased construction output and lack of recovery in the corporate lending. Although in Q1 4 the sales of enterprises producing mainly capital goods went up by as much as 55% y/y, this was most likely due to the increased sales for the foreign rather than domestic market. n the following quarters, a gradual increase in investment demand is expected, with a stronger growth in the second half of the year. The percentage of surveyed enterprises which plan new investment has been growing since the end of. Forecasts for Q 4, based on the NBP s business conditions survey, indicate a significant revival in investment activities. Rising domestic and foreign demand should be conducive to investment growth. Also more optimistic are the expectations related to the prospects of marketing the production from new investment. Given the significant improvement in current and expected disposable income of enterprises, the opportunities of financing new investment increased. This is a result of growing profits (particularly of exporters), reduced corporate income tax, and the ability to make more favourable depreciation deductions. Growing capacity utilisation in manufacturing (Figure 3) 1 Filled in by enterprises which employ at least 5 people. NFLATON REPORT MAY 4 19
nflation factors Figure 15 Gross fixed capital formation 6 18 4 16 14 1 1 8 1995 1996 1997 1998 1999 1 3 18 16 Average annual share in GDP (%, right-hand scale) Gross fixed capital formation (1995=1, left-hand scale) Source: GUS data. limits the possibility of non-investment-based production growth in this sector. The NBP s surveys and the systematically falling (for over a year) level of surplus stock also point to an increase in investment demand. Another factor which makes the expected investment acceleration likely is the statistical effect resulting from the currently low level of investment. Gross fixed capital formation level corresponds to that of end 1997, and its share in GDP is the lowest since 1995 (Figure 15)..1.4. External demand and current account of the balance of payments n Q1 4, the trend of improving the current account balance continued. n January March 4 the current account deficit amounted to EUR.43 billion (preliminary estimates), while in Q1 3 EUR 1.64 billion. n Q1 4, the current account balance improved mainly due to increased surplus in trade in services and decreased trade deficit in goods and income flows. However, the surplus in current transfers was lower than in Q1 3 (Figure 16). mprovement in the balance of trade, as compared to Q1 3 (Figure 17), was a result of exports growth rate exceeding that of imports. n January March 4, exports value increased by 1.8% y/y, while imports value rose by 8.5%. However, the reduction in Poland s trade deficit was considerably smaller than in the corresponding period of previous year, which was due to the stronger acceleration in imports in 4. Figure 16 Current account of the balance of payments, monthly data (in EUR billions) 1..5. -.5-1. -1.5 V V V V V X X X X V V V V V X X X X 3 4 Balance on services Balance on current transfers Balance on income Balance on goods Current account * 3-month moving average Source: NBP data. N a t i o n a l B a n k o f P o l a n d
nflation factors Figure 17 Poland s foreign trade, monthly data (in EUR billions) 5.5. 5. -. 4.5 -.4 4. -.6 3.5 3. V V V V V X X X X V V V V 3 V X X X X 4 -.8-1. Exports (left-hand scale) mports (left-hand scale) Net balance (right-hand scale) * 3-month moving average Source: NBP data. Acceleration in Poland s foreign trade is also reflected in GUS data, although in this case the recorded imports growth rate is higher than that of exports 11. The continued (according to the NBP data) trend towards the improvement in Poland s trade balance is largely the result of enhancing competitiveness of Polish manufacturers against their foreign partners (Table 5). Contributing factors were the strong growth in labour productivity, accompanied by a significantly slower increase in remuneration 1, as well as weakening of the zloty observed since mid 1 13. An increase in sales to the European Union had the highest influence on exports in the first three months of 4 (Figure 18). According to forecasts, in 4 the EU-15 economy should develop faster than in 3, although these projections have been partly reduced compared to the previous year s ones (Table 6). The relatively strongest growth is expected in these countries exports and import demand, the latter already reflected in the increased (to %, y/y) growth rate of EU imports in Q4 3. However, in Q1 4 lower than expected industrial production and confidence indices indicate that EU economic growth forecasts are subject to a significant Table 5 ndices of Polish export and import competitiveness (% change in comparison with the corresponding period of the previous year) 3 Q1 Q Q3 Q4 Export prices / Unit labour cost* 13.1 18.6 11.1.9 mport prices / Producer prices 8.5 8.8 3.9 4.1 REER ULC** -15. -19.5-11.9-3. * Unit labour cost is calculated as the ratio of the remuneration cost growth rate per employee to the labour productivity growth rate, measured as output (volume) in manufacturing per person employed in this sector. ** Real effective exchange rate, unit labour cost-deflated; negative value denotes depreciation. Source: Own estimates based on the NBP, EC and GUS data; indices for Q3 are understated due to very strong, inconsistent with the trend, fall of export and import prices in September 3. 11 According to GUS initial data, in January March 4, imports value increased by 6.1% y/y, while exports by 3.6%. As a result of higher imports growth rate compared to exports, Poland s foreign trade deficit deepened to EUR 3,56 million, i.e. by nearly EUR 47 million compared to Q1 3. t must be emphasized, however, that initial estimates for the corresponding period of previous year showed 1.5% and 1.3% increases in imports and exports, respectively, while final GUS figures were significantly different: 3.1% and 5.6%, respectively. 1 See chapter Labour and productivity. 13 See chapter Exchange rates. NFLATON REPORT MAY 4 1