As the financial crisis has spread from the developed West to emerging-markets economies, few places have been hit as hard as Central and Eastern Europe. Countries in the area had financed a consumer and investment boom with cheap credit from abroad in recent years, and the evaporation of global liquidity is squeezing them hard. Hungary and Ukraine have turned to the International Monetary Fund for multibillion-dollar bailouts, and Romania is expected to do the same soon, while the Baltic states are suffering one of the most severe recessions of any region.
In this maelstrom Poland stands out as an island of relative prosperity. The economy, which grew at an average annual rate of 6 percent over the past three years, has slowed sharply in the past six months but at least continues to expand the government forecasts growth of 3 percent in 2009; private sector estimates fall mostly in the range of about 1 to 2 percent. In Warsaw tightening credit has put the brakes on the booming residential real estate market, but construction cranes still hover over glass office skyscrapers and sprawling shopping malls, tangible signs of relative optimism. Even if the global crisis brings economic growth down somewhat, it will still be higher than our neighbors, insists Henryka Bochniarz, head of Lewiatan, the countrys biggest business lobby. And unlike its European Union trading partners to the west, the government hasnt had to bail out its banking system. So far, so good our banks are still lending to each other, says Andrzej Sławi´nski, an economics professor at the Warsaw School of Economics and a member of the National Bank of Polands Monetary Policy Council.
But the current economic gloom has exposed a host of unmet economic reforms that are making Poland increasingly vulnerable to the global downturn and putting pressure on the government of Prime Minister Donald Tusk to take decisive action. The governments failure early in the crisis to set a clear timetable for adopting the euro has undermined confidence in the złoty, which has plunged by nearly 40 percent against the dollar since August. A long-stalled privatization process has burdened the country with inefficient state enterprises, deprived the private pension system of investment alternatives and earned rebukes from the EU authorities in Brussels. The government remains the biggest employer in Poland, with companies under its control accounting for 25 percent of GDP, says Jacek Socha, a former Treasury minister and now a partner at PricewaterhouseCoopers Warsaw office.
Can Tusk rise to the challenge? Many observers have their doubts. The veteran politician led his center-right Civic Platform Party to a victory in parliamentary elections in October 2007 by promising a sharp break from the right-wing nationalist policies of the Law and Justice Party of President Lech Kaczy´nski and his twin brother, former prime minister Jaroslaw Kaczy´nski. Tusk vowed to improve relations with the EU and Russia, put Poland on track to adopting the euro and press ahead with long-delayed economic reforms. But the prime minister has little to show for his first year in office. Tusks parliamentary majority isnt large enough to overcome the veto power of President Kaczy´nski, who blocked the prime ministers attempts to reduce the number of people taking early retirement and end control of public television by the Law and Justice Party. And Tusks team has dithered on other controversial issues, like privatization, apparently unwilling to risk any moves that could endanger his prospects of challenging Kaczy´nski in the 2010 presidential election.
Tusk is trying to maintain a high level of public support until then, says Zbigniew Kominek, the London-based country economist for Poland at the European Bank for Reconstruction and Development. But evading unpopular actions, such as cutting subsidies to the nearly bankrupt shipyards or selling off state companies to foreign investors, may not ensure the nearly 60 percent approval rating that Tusks coalition government now enjoys. People are starting to ask, If you were elected as reformists, then why arent you carrying out reforms? says Lena Kolarska-Bobinska, director of the Institute of Public Affairs, a Warsaw think tank.
Tusk has started to take a more activist stance in recent months in response to the global economic crisis, raising the hopes of reform advocates. In September he committed the government to adopting the euro by 2012, touting it as a source of stability in difficult times. He is hardly alone in that view, and that is not surprising given that euro countries enjoy low interest rates and exchange-rate stability with their neighbors. Hungary and the Baltic states aim to adopt the euro as soon as possible, and the government of the Czech Republic plans to announce a target date later this year.
Keeping Poland on track for the euro wont be easy, though. The global downturn will make it difficult for Tusks government to meet the economic criteria for entry, which include maintaining inflation and public deficits at low levels and pegging the złoty to the euro in the European exchange rate mechanism, known as ERM II, for two years. The Baltic states and Hungary, which previously had hoped to adopt the euro by 2010, have already had to postpone their plans because of domestic economic difficulties.
Tusk is also enmeshed in a political dispute over the euro with President Kaczy´nski, who argues that Poles must agree in a referendum to amend their constitution which stipulates that only the Polish central bank can issue currency and set monetary policy before the government embarks on a euro strategy. The prime inister believes Poland can peg the złoty to the euro in the first half of this year and defer constitutional change until later, but some analysts regard that as a risky strategy that could invite speculative attacks on the złoty. Having set his sights on the euro, arguably the biggest decision facing the government, Tusk cant afford to back down. If the Tusk government backslides on this issue, its credibility would be shot, says Preston Keat, the New Yorkbased head of research for Eurasia Group, a political consulting firm.
The Tusk administration has also pledged to jump-start Polands privatization campaign. Efforts to sell off government-owned enterprises have largely stalled since the first burst of privatization in the early 1990s; some 1,200 companies, which generate about 25 percent of Polands gross domestic product, remain in state hands. Thats far too high a proportion for healthy economic growth, Treasury Minister Aleksander Grad told Institutional Investor in a recent interview. His ministry has begun preparing more than 300 companies for sale and aims to privatizatize 750 firms by 2012, notwithstanding the turmoil on the global markets. If we cannot list them on the stock exchange, then we will sell them directly to strategic investors, he says.
Grad will have to start delivering to convince skeptics, though. The government met its 2008 goal of 2.3 billion złoty ($697 million) in privatization revenues only by selling its minority interests in four power companies to two state-controlled energy utilities, ENEA and PGE, for a total of zł1.4 billion in December. Despite the likelihood that market conditions will be as bad this year as last, the government insists it will achieve a much larger 2009 target of zł12 billion in privatization revenues. It is an incredibly ambitious plan that most analysts dont believe will be fulfilled, says EBRD economist Kominek.
One thing Poland can count on as it seeks to avoid the turmoil spreading through Central and Eastern Europe is a relatively healthy banking sector (see related story, Conservatism Pays Off at Pekao). Banks in Hungary and the Baltic states fueled consumer booms in recent years by lending heavily in euros and Swiss francs, which carry low interest rates. But a sharp drop in the value of those countries currencies over the past year has increased the burden of those loans, deepening the recessions there and leaving banks facing heavy losses. By contrast many Polish banks have tended to lend mostly in złoty, saving them from the effects of currency depreciation. Just 25.4 percent of all Polish consumer and corporate loans in the first half of 2008 were denominated in foreign currencies, compared with 53.2 percent for Hungary.
Foreign currency loans are not a systemic problem because they account for a relatively small percentage of our banks balance sheets, says the central banks Sławi´nski.
Still, Polish banks face a much tougher climate than in years past. In an article in the Dziennik newspaper last month, two top bankers, CEO Jan Krzysztof Bielecki of Bank Pekao and CEO Jerzy Pruski of PKO BP, warned that credit growth in the banking sector could fall by more than two thirds, from zł145 billion in 2008 to zł40 billion this year. They called on the central bank to increase liquidity by cutting reserve requirements and buying back central bank securities.
Entry into the euro zone would eliminate the risk of złoty depreciation and give Poland the benefit of lower interest rates, which explains the Tusk governments determination to adopt the currency. The National Bank of Poland cut its reference rate by 75 basis points last month, but that still left the Polish rate at 4.25 percent, well above the European Central Banks 2 percent.
To adopt the euro, Tusk must meet the EUs economic criteria and amend the Polish constitution to permit a change of currencies. On the economic front, Poland needs to bring down its inflation rate, contain the budget deficit and keep the złoty for two years in the ERM II, which requires the government to limit the currencys fluctuation against the euro to plus or minus 15 percent. Inflation is currently running at a rate of 3.3 percent, above the 2.4 percent required under the EUs Maastricht Treaty. In the meantime, the economic crisis is likely
to boost Polands budget deficit. The European Commission last month predicted that the countrys deficit would rise to 3.6 percent of GDP this year, above the 3 percent ceiling for states seeking to adopt the euro. There will be pressure on the deficit thats for sure because of shortfalls in privatization revenues and tax receipts, and potentially larger payments for unemployment benefits, says the EBRDs Kominek. The jobless rate reached 9.5 percent in December, up almost half a percentage point from November.
Under the 2012 timetable announced last year, Tusk wants to peg the złoty to the euro in the ERM II in the first half of this year. But that goal is being challenged both by the National Bank of Poland and the political opposition. In a recent Polish magazine interview, central bank Governor Sławomir Skrzypek asserted that Tusks timetable is too risky and that the złoty isnt strong enough to stay within the ERM II. In a situation of instability of financial markets and, especially, high volatility on the currency market, holding the złoty within the allowed grid would be either very costly or impossible, Skrzypek said.
Meanwhile, the Kaczy´nskis Law and Justice Party opposes early euro membership, and President Kaczy´nski contends that the government must win a referendum on a constitutional amendment before putting the złoty in the ERM II. He wants the vote to be held in June, to coincide with elections for the European Parliament. If Tusk goes along, that would push back the earliest date for adopting the euro to 2013. Winning a referendum will be no piece of cake, which is why some analysts suggest that the prime minister will instead try to settle the issue in Parliament, where a two-thirds majority can amend the constitution. The game plan now is to try to flip at least seven Law and Justice deputies either to cast votes in favor or abstain, says Eurasia Groups Keat.
Relaunching Polands privatization campaign poses another big challenge to Tusk and his team. To make serious headway, the government needs to unload the last two big money-losing state-owned shipyards, an issue that the prime minister, like his predecessors, sought to dodge until the European Commission forced his hand.
The Brussels-based executive agency has long argued that subsidies for the struggling shipyards in Gdynia and Szczecin violate EU competition rules. Since 2004 the government has extended a total of 662 million ($871 million) in direct aid and 1.485 billion in production guarantees to both shipyards, with the understanding that they would be restructured and sold off to private investors. Instead the money has been squandered on bloated job rolls and unprofitable long-term shipbuilding contracts.
In November the EC finally lost patience and gave Poland an ultimatum to sell the shipyards assets by May 2009 and use the proceeds to repay the yards creditors and refund the state aid.
Industrial Union of Donbass, a Ukrainian steelmaker, had offered to acquire the Gdynia shipyard and merge it with the famed Gdansk yard, which it bought in 2007, and a Polish-Norwegian joint venture company showed interest in Szczecin. But both made the offers contingent on the Polish states maintaining subsidies, conditions that the EC rejected. In December the government caved, passing a law appointing administrators to auction off the shipyards assets. We will try to ensure that the assets be sold as quickly as possible, says the Treasurys Grad.
At the Gdynia shipyard in January, more than 95 percent of employees agreed to early retirement and received payments ranging from zł20,000 to zł60,000. The workers at Szczecin are expected to soon follow suit.
The government has failed to resolve another lengthy corporate saga, the privatization of Powszechny Zaklad Ubezpieczen, better known as PZU. The state-controlled company is the largest insurer in Poland and in Central and Eastern Europe, and it has given fits to its foreign strategic investor, Eureko. The Dutch insurer, which owns 32.12 percent of PZU, first took a stake in 1999 with the promise that it would be allowed to take majority control, but various governments have repeatedly prevented it from doing so, even though Eureko has won two arbitration court rulings on the matter. Following the second ruling, in 2007, the Dutch company demanded 10 billion in damages from Warsaw.
After Tusk took power, the government restarted talks with Eureko in January 2008, but the two sides failed to reach agreement and broke off discussions in September. Now Tusks administration, like its predecessors, looks like it wants to push the Dutch out. Given the long history of this problem and the perceptions it has created among ordinary Poles, an amicable exit by Eureko from PZU seems to be the best solution, says the Treasurys Grad.
According to Michał Nastula, managing director of Eurekos operations in Poland, the company will drop its damages suit if the government agrees to sell it a majority stake in PZU. We would rather not be compensated by Polish taxpayers, he says. We still think coming here was worth it because PZUs value has risen and could have been even higher if all this hadnt happened.
The Polish insurer is a prize worth waiting for. PZU has a 35 percent share of the Polish insurance market, almost three times more than that of its closest competitors, and enjoys the best brand recognition of any financial institution in the country. Gross premium income rose 47 percent in the first three quarters of 2008, to zł17.3 billion, thanks mainly to the rapid expansion of life insurance. Net profits declined 34.3 percent, to zł2.2 billion, largely because of a 65.8 percent drop in investment income. It has also announced plans to spend as much as zł10 billion on acquisitions in Central and Eastern Europe, and has expressed interest in bidding for some of American International Groups operations there.
One reason the PZU privatization has dragged on for so long was the desire by previous governments to create a national financial champion by combining the big insurer with state-owned PKO BP, one of the nations two largest banks, with a market capitalization of 6.4 billion. The Tusk administration appears to have discarded that vision, though. The Treasurys Grad insists that the government aims to privatize the rest of PZU after reaching a settlement with Eureko and that it intends to reduce its 51.5 percent in PKO BP to about 25 percent and allow the bank to become a national champion on its own. Hungarys OTP Bank, whose chairman and CEO, Sándor Csányi, met in September with Grad, is rumored to be interested in PKO, but Grad insists that the Polish bank will remain independent. Of course, its possible that a foreign bank might make a takeover bid for PKO, but our stake would be strong enough to prevent this, he says.
Poland has made progress in privatizing parts of its energy sector. The Kaczy´nski government had resisted privatizing, contending that doing so could enable deep-pocketed Russian interests to gain tighter control of the sector. Russia already supplies 95 percent of Polands oil and 45 percent of its natural gas.
In November the government sold 18.7 percent of ENEA, Polands third-largest power producer and distributor, to Swedens state-owned Vattenfall for zł1.66 billion (then worth $613.4 million) as part of a $724 million IPO. Vattenfall says it wants to buy all of the Polish companys shares eventually. In an interview with newspaper Gazeta Wyborcza last month, Grad said he hoped to sell the governments remaining 76.5 percent stake in ENEA this year for about zł7 billion. The EBRD owns 2.5 percent of ENEA and private investors hold the remaining 2.3 percent.
Grad also tells II that the government wants to sell state-owned PGE, Polands largest power company, in 2009.
Delays in the privatization of big state enterprises have in turn slowed efforts to develop Polands pension system. The government in 1999 decided to launch private pension funds to supplement the pay-as-you-go state social security system. That meant there was an obligation to create private companies in which those pension funds could invest, says Socha, the former Treasury minister.
Instead, the private pension funds have become a cheap source of capital for the government while offering low returns to future retirees. Every year, the ten pension funds gather zł14 billion from their members. Yet by law the funds can invest only 5 percent of their assets in foreign equities; with few Polish companies on the Warsaw Stock Exchange, the funds are forced to funnel more than 65 percent of their money into low-interest government bonds. This isnt the asset allocation that you would normally see unless you expected all pension fund members to be on the verge of retirement, says the EBRDs Kominek.
The government did make an attempt at pension reform, but it was stymied by the president. In a bid to reduce the countrys high rate of early retirement fewer than 50 percent of Poles older than 50 work the government last autumn passed a bill that aimed to deny benefits to 760,000 of a potential 1.1 million early-retirement claimants in their 50s. Tusk gambled that President Kaczy´nski wouldnt dare veto the bill, but the president called the bluff and rejected the legislation in December, forcing Tusk to scramble to arrange zł4 billion in funding for early retirements.
Tusk and his government will need to show more resolve and political skill in the months ahead if they are serious about reviving economic reform.