CE Financial Observer: What was the key factor based on which you decreased the Poland’s growth prognosis for 2016 (from 3.0 to 2.6 per cent ) and for 2017 (from 3.5 to 3,2 per cent) in the OECD November’s Economic Outlook?
Peter Jarrett: Poland is not an exception. The fundamental factor for the region – the Czech Republic and Slovakia – was the slowdown in the use of the EU funds. The EU has a seven-year financing window, and the end of that window came at the end of 2013. However, the countries had two additional years to spend the money. So, the effects of this process were [visible] in 2016. The new window opened in 2014, but all governments were busy trying to spend the old money and they are preparing projects for the new window now. That is why in 2016 there was a big decline in investments, in particular in governments’ investments. This is not a huge component of output of GDP but when it falls 20 or 30 per cent, as it did in these countries, it does have a noticeable effect on the overall growth. Everybody expects a rebound in 2017. Private investment also weakened, probably related to political uncertainty.
However, in the Economic Outlook you wrote that the current reforms in Poland will not strengthen long-term economic growth.
It’s a different matter. This is not the reason why we reduced the growth projections for 2016 and 2017. Those factors may enter into force in 2018 or maybe in the years coming after that. For Poland it is really important not to have people withdraw from the labor market. That means women but also older workers. If the pension system allows them or encourages them to retire earlier, it is not a wise decision because Poland has a demographic structure which positions the country as one of the most ageing societies in the OECD, due to the low fertility rates of the last generation or two. The current government wants to roll back the previous government’s reform which was to delay the retirement age. The justification for delay of the retirement age is that people are living longer and you have to have enough workers to make them, in a sense, pay for their future pensions (public or private). The earlier retirement causes intergenerational and potentially competitiveness problems.
Another problem is the situation of pension funds in Poland, started by the previous government, which took back a lot of the OFE (Open Pension Funds) assets and limited their investments possibilities. One option considered is to shut them down entirely. We have been opposing these moves because we do not think that it is a good idea for retirees to rely entirely on the unfunded government pensions and the uncertain future of the OFEs is hindering the development of the financial markets. A deeper stock market would be a good thing, as it would provide potential funding for the business sector. And that is quite important in Poland where the banks are rather conservative.
Central and Eastern Europe is being perceived by investors as emerging markets. If it is correct, according to your view, for how long will this will be like this?
These are just labels. What should distinguish an emerging market from another is how fast the economy is growing in terms of potential output and current output (which should be similar in normal times) and also how deep are the domestic financial markets. In both cases it is fair to say that Poland and some of its neighbors are, in that sense, emerging markets. They are still growing on average twice as fast as Germany, France and Italy. The financial markets, certainly bond markets, are undeveloped. Large corporations don’t do much borrowing in domestic markets. The stock markets are also very, very limited. For how long Poland and the CEE will develop faster than other markets? My feeling is that a lot remains to be determined by the policy environment. The main factor holding Poland back is demography. This is going to limit [the GDP] increase and will put downward pressure on the available labor force. The unemployment rate has dropped rather sharply. For now, the way we measure it, it is below 6 per cent. So, in the future it will be the productivity growth and the retirement age that determine how fast the economy can grow.
Do you see any other risks or threats to the economic growth that might be present in the CEE countries?
There are several large risks. The risks of policy errors in the US, Brexit in the UK, and the housing market and local government debt in China. The global financial market and the world trade also face a lot of risks. In particular, if Donald Trump and the US government decide on a protectionist policy stance, the risk is that other trading areas, like the EU, would be tempted to retaliate and we should not exclude a serious trade war. We cited the risks Poland faces in connection with the possible efforts to compensate all those who have mortgages denominated in CHF couple years ago. Some effort of the banking system to compensate people who had borrowed in CHF could be accommodated. If it goes too far, however, the banking system could be almost crippled. The banking system is extremely important because the corporate bond market is weak. If the banking system is suffering it can have serious repercussions on growth of Poland. Plus political uncertainty and tensions between Poland and the EU do not help.
Despite all of these risks do you think that the CEE will grow as fast as it does now and faster than the Western Europe in the coming years?
Yes, I do. Poland has grown up substantially since the end of the Soviet Union and its satellite countries. However, it has still a long way to go. There are no guarantees, though, and policy will determine when the catch-up process comes to an end. Whether Poland will have an average income per capita below the OECD average or above the average is hard to know. I am confident that for the next 5 to 10 years Poland and the region will continue to catch up if the world economy is growing without a major global recession or depression. After this period a lot will depend on government policies which may have a long-term and gradual impact on economic incomes.
Does this optimistic approach about the growth in the region concern all of its countries?
There are some countries which are more willing to defy the global consensus. From an economic point of view it is enough to say that there will be a catch up but it may be bigger in some countries.
Who is the region’s leader now?
The growth in Slovakia is very rapid (with approx.3.5 per cent of GDP growth). The country seems to be doing the best in the moment. Hungary is among the worst with only 2 per cent. However, even Hungary is catching up. Poland is around 3 per cent on average, a little bit weaker this year.
What is the main reason for Slovakia’s success?
They are pretty small, and they have won the competition for some big investment projects, mainly in the automotive sector. When these projects come on stream they will be able to export a lot more. They also have the most slack in terms of unemployment. It is more than 9 per cent and Poland’s is below 6 per cent, Hungary is below 5 per cent. The Slovaks therefore have more spare capacity in terms of labor.
In the Economic Outlook you wrote that Slovakia benefits from being a member of the Eurozone. Do you think that Poland is losing by being outside the euro group? Should Poland introduce the euro and if so, when? The situation in the Eurozone is not very optimistic.
Slovakia was one of the first from the region who joined the euro club. There are advantages and disadvantages of being in the Eurozone. There is no question about that. The big advantage is that interest rates are lower, allowing cheaper financing of investments: housing investments for individuals and business investments for companies. Having the euro eliminates the problem of depreciation of the national currency. On other hand, the biggest disadvantage is that if the country is hit by a specific shock or is unable to compete chronically like Italy or Greece then the currency can become overvalued. The only way you can gain competitiveness or react to the shock is to change domestic wages and prices. This is a very painful thing to do for any country. It is easier when the central bank, in conjunction with the government, can depreciate the currency. By giving up your interest rate you face an uncertain future. The European Central Bank (ECB), which makes monetary policy decisions in the Eurozone, is naturally dominated by the biggest countries, in particular by Germany and not by the smaller countries from CEE.
Poland doesn’t currently have problems with price stability and is not going to lose competitiveness from that point of view. On the other hand, the situation with public finances is less sure. Of course, it is much better than in Greece, Italy, France, Portugal and Spain. However, the Czech Republic has achieved budget balance. In Poland there might be pressure on domestic interest rates caused by the initiatives proposed by the current government, if the debt rises too quickly.
We will not be pressing Poland to join the Eurozone. The Czech Republic seems to be more likely a good candidate to introduce the euro than the other countries in the region.
Is it easier for a smaller economy, like the Czech Republic, to adapt to the Eurozone?
Not entirely. There is not much of a difference. Obviously, if you are a small country and you want to borrow, your long term interest rate can be somehow higher, I guess, because investors do not know much about your currency. In that sense smaller countries are enjoying larger gains by adopting the currency of larger countries.
In the Economic Outlook it is written that the Polish central bank, NBP, should start increasing interest rates towards the end of 2017, as underlying prices set to strengthen.
Peter Jarrett: We do not share the view that in Poland’s case there is any need to cut interest rates. Even though growth in 2016 has been disappointing, it is entirely understandable and largely coming from the public investment side. The fundamentals of the economy are doing well. There is no need to give a monetary push in addition. There was some room to do that earlier on because prices were falling. But soon inflation will resume at a modest pace. The risk is that by giving the monetary stimulus now there might be problems in 2018 and 2019. The interest rate would have to go up rather more sharply at that point.
What is the key message for Poland from the November’s Economic Outlook?
If I have to choose one single message I would come back to the retirement age, which reduces the potential output in coming years and reduces revenues for the budget.
However, the key message overall from the Outlook was that many countries have more fiscal space than they think they do, and this allows them to expand public spending. If countries do that systematically that would generate a global push. That stimulus spending would allow central banks to return to more reasonable monetary settings. Poland’s case is a little bit more complicated, though. Poland has already boosted the economy by providing extra benefits for families. There is room for further expenditures (especially by pulling forward public investment spending) if Poland succeeds in tax revenue increase as it hopes to do. Of course, the logic of supporting families is farsighted and good in the demographic context and its future effects on the labor market. The risk of these transfers is, however, that they may discourage women from working.
Maybe the family transfers will create some pressure for women’s wages that are still very low?
We do not want to see women, as well as elderly workers, to leave the labor market in Poland, as the country is getting close to running out of spare resources.
So, the pressure for wages is not good for the Polish economy now?
Anything that raises the real wages is good as long as it is not extreme and there remains an attractive margin for companies. But the productivity growth has to be there too.