The Polish economy in 2002 Frigyes Ferdinand Heinz Research Office (London) Bank of Tokyo-Mitsubishi Ltd.

2 Summary of main trends MAJOR TRENDS: Modest recovery of GDP growth is expected in the second half of Inflation remains on a stable downward trend. The central bank is likely to meet its 4-6 % year end target. Trade and current account deficit is likely to widen slightly to 6.5 and 4.5 % of the GDP respectively. KEY CHALLENGES: Unemployment continues to rise. Fiscal deficit is likely to remain high. The role of debt financing is increasing.

3 In 2001 the Polish economy slowed down sharply GDP slowed down from 4% in 2000 to 1% in 2001 The key reason for the slow down was the fall of domestic demand due to extremely tight monetary policy. The weak domestic demand and the global slow down undermined business confidence, that led to a 10% fall of investments. Negative growth was avoided due to resilient export growth.

4 A modest recovery is expected in the second half of 2002 GDP growth is likely to pick up slightly, reaching 1.3% in 2002 Consumer spending is on the rise, signalled by increasing retail sales and improving consumer confidence index. Export growth is likely to increase due to the pick up of EU demand. Investment growth will only improve slowly, as real interest rates are still high, and the downsizing of excess stock is still not ended.

5 Inflation is on a stable downward trend In 2001 average inflation was 5.5%, year end inflation was 3.6%. The key reason is the tight monetary policy. In 2002 inflation continues to decline. Core inflation figures show the decrease of trend inflation. The central bank, that continues its policy of small rate cuts (up to 50bps), is likely to reach its 4-6% year end inflation target.

6 Trade and current account deficit is likely to widen slightly Trade deficit was decreased from 8.2% of GDP in 2000 to 6.6% in At the same time CA deficit decreased from 6.1% in 2000 to 4% in In 2002, the CA deficit is likely to widen to 4.5% of GDP, because of –the increase of domestic demand –the still strong currency –the moderate recovery of German export markets

7 Challenge 1 : Rising unemployment Unemployment is on a rising trend since June Unemployment will continue to rise in the second half of 2002, due to –the weakness of recovery –the entering of a baby boom generation into the labour market –industrial downsizing There are also structural reasons behind the rise of unemployment, such as the strong rigidity of the Polish labour market.

8 Challenge 2 : Still high fiscal deficit Fiscal deficit increased from 2.6% of GDP in 2000 to 5.5% in 2001 Short term reasons: –slow down of the economy –overestimation of revenues and overspending due to election year –temporary effects of public finance reforms Structural reasons: –inefficient institutional structure of public spending –poor fiscal discipline of large state owned enterprises –permanent increase of social spending

9 Challenge 3 : The role of debt finance increases The role of debt finance increases, because fiscal deficit remains high and privatisation revenues are lower than before The fiscal deficit will be expected to increase slightly to 6% of GDP in 2002, because: –The 2002 budget managed to avoid a budget crisis by freezing and postponing expenditures. –However, no deeper structural measures took place, and budget deficit remained high –Growth remains below potential level.

10 Some policy implications What should the Polish government do ? –Take measures to decrease the rigidity of labour markets, such as using fixed-term contracts, differentiating minimum wage across regions, and for new labour market entrants. (addresses Challenge 1) –Continuing the reform of social security system, and decrease inefficient spending structures. This would make it possible to promote employment by decreasing non- wage labour costs. (addresses Challenge 1,2,3 ) –Go on with the restructuring and privatisation of large state owned enterprises. (addresses Challenge 2,3) What the government should not do ? –Decrease the independence of the central bank that would erode most of the hardly earned credibility of the anti-inflationary policy.