Poland Economy Watch

Biting The Fiscal Bullet In Poland

2010-07-14T10:55:00.020+02:00

There is a good deal of speculation in the press at the moment over the tricky issue of whether or not Poland will be able to comply with its agreed deficit-reduction deadline on the basis of the latest budget proposals announced by the government there. Personally, I tend to agree with those analysts who feel the spending and revenue assumptions being made by the Polish government are rather unrealistic, and that they will this be unable to comply with the terms of the Excess Deficit Procedure as laid down for them by the European Commission: difficult territory this in the "post Greek crisis" world, but it would not be the end of the world were the slippage to be justified. Unfortunately, as I will argue below, I don't think it is justified, indeed I think it is just the opposite of what sound economic management principles would prescribe in the Polish case, and seems to respond more to the impact of impending political pressures than to the precepts of good policymaking. So I do agree with the consensus here in feeling that Poland needs to do a lot more to reign in the deficit (which means unfortunately spending cuts, since I think raising taxes which will crimp growth and raise inflation is most undesirable at this point), although my reasons for arguing this are actually rather rather different from those that are normally advanced.

One Fiscal Size Fits All?

The facts of the matter are, more or less, as follows: the European Commission has given Poland until 2012 to meet its deficit limit of 3 percent of gross domestic product, after Poland’s shortfall swelled to 7.1 percent of GDP last year as the impact of the global economic crisis depleted government revenue and increased expenditure costs. Next year’s budget assumes something like 3.5% GDP growth and 2.3% inflation, with nominal wage growth rising by 3.7% employment increase by 1.9%.

The EU Commission expect the deficit to only narrow to 7 percent of GDP next year following a 7.3 percent budget gap in 2010. But given that Poland's debt to GDP level is only around 50% of GDP, and that Poland is one of the few large EU countries to still have dynamic internal consumption, you might want to argue that stimulus should be maintained, if only to help Poland's export dependent neighbours.

I want to argue that this view is basically wrong, and that far from needing more in the way of stimulus, what Poland needs to do is contain an overdramatic expansion of credit based domestic demand, an expansion which, if unchecked, could very easily lead to the sort of structural distortions and competitiveness loss we have just observed in the South of Europe and Ireland.

Poland Largely Escaped The Great Recession

But first, lets step back a bit and see what the problem is.

Poland, as most observers note, escaped the worst of the 2009 great recession.

Poland was basically able to endure without too much bloodletting for three principal reasons.

In the first place the level of household indebtedness is still not excessively high. In the second place Poland had maintained a floating exchange rate which meant that it could let the zloty rise during the heady days of 2008, and then allow the currency to devalue when the crisis hit. An thirdly, the level of Forex lending never rose as high in Poland as it did in some of its East European neighbours, which meant that when the time came to devalue there was not such a threat of increasing the Non Performing Loan rate. As can be seen in the chart, it was starting to take off when the credit crunch came along and (fortuitously) stopped it dead in its tracks.

Interestingly enough then, it has been the very fact of not having gone for early Euro adoption that left the Polish monetary authorities with the flexibility needed to respond to the crisis in an appropriate manner. As the IMF put it in their latest Article IV staff report:

"Staff does not support early euro adoption. While this should remain an important goal, entering ERM2 any time soon would not be advisable in view of the uncertain global outlook and the rigidities in the macroeconomic policy mix discussed above. More importantly, the crisis has underscored the importance of being able to use the exchange rate to facilitate adjustment to external shocks. In staff’s view, the swift change in the real exchange rate was one of the key reasons for Poland’s not falling into recession in 2009".

Indeed, the very rapid way that using currency flexibility to resore competitivenes helped should be evident from the Real Effective Exchange Rate chart below:

As can be seen in the run in to the crisis Poland had been losing competitiveness with Germany, following a well known and well trodden path. But in 2009 the country was able to recover much of the lost ground, simply at the push of a (trader's) button - and the currency is now trading at something like 18% below its pre-crisis peak in real effective terms. This remedy is, unfortunately, no longer available to the likes of Spain, Greece, Portugal and Ireland. Even more interestingly, Poland has been able to carry through the devaluation process without provoking a very strong inflation spike.

Of course, there was another factor in Poland's ability to not fall from grace, the fiscal stimulus package. As the IMF put it:

Fiscal policy is providing significant counter-cyclical stimulus. There was a discretionary fiscal relaxation estimated at 1¾ percent of GDP in 2008 and 2½ percent of GDP in 2009, mainly due to tax cuts enacted in 2007 but coming into effect with a delay. While the government initially intended to offset revenue shortfalls to the extent needed to maintain the state budget deficit below the limit of Zloty 18 billion in 2009—through what would have been highly pro-cyclical expenditure cuts—it appropriately changed such plans at mid-year, when it raised the limit to Zloty 27 billion. As a result, the general government deficit increased from under 2 percent of GDP in 2007 to over 7 percent of GDP in 2009. The strong counter-cyclical stimulus provided by fiscal policy—through a combination of discretionary relaxation and the work of automatic stabilizers—was a major reason for Poland’s not falling into recession during the global crisis.

And it is, of course, the issue of just how to withdraw this fiscal stimulus that is the main topic of debate. Unlike many of its regional neighbours, the Polish economy is now in the process of returning to reasonable levels of growth. The levels will surely not be those (possibly unsustainable) ones seen before the crisis, but rates in the order of 3% for 2010 & 2011 do not seem unreasonable.

Monetary Policy In Times Of The Great Immoderation

The problem is, as the output gap gradually closes, the central bank will increasingly have to think how to formulate a response to the inflationary presures which will inevitably follow in the wake. Evidently, in a era of globalised capital flows, conducting monetary policy is not as simple as it used to be, since simply raising interest rates may prove to be counterproductive, and investors look to get the benefit of the increased yield margin on offer.

In fact, the IMF draw exactly the opposite conclusion, namely that if upward pressures on the zloty persist (see chart below), and inflation remains contained, then they argue that the policy rate should be cut. That is they prioritize (correctly in my view) competitiveness issues over the conduct of orthodox monetary policy.

The recovery in global risk appetite, not least in the demand for assets of countries that have weathered the crisis well, suggest that foreign demand for Polish assets could continue to build, resulting in further zloty appreciation. In that case, staff believes that the MPC should revert to an easing bias and cut the policy rate.

In fact with the central banks policy rate at 3.5% there is room for some easing, and room for increased carry too, if the rate stays were it is as risk appetite grows.

The Fiscal Arm Is The Only Effective One

And this is where the real argument for turning the fiscal screw comes in, not in order to simply comply with the EU's 60% gross debt rule (Poland's government debt to GDP is currently around 50%), but rather because in the absence of applying monetary tightening to contain excesses and avoid (further distortions) the government really do need to drain excess demand from the economy by resorting to fiscal policy.

As I have said, the Polish economy is now showing signs of a renewed burst of growth. Industrial output is up sharply (it is now more competitive with imports, among other things):

While retail sales are also strong

And credit growth has once more taken off again:

If this were to remain modest, then it would be a good sign, but continued growth, and monetary loosening, would surely run the risk of seeing the acceleration go too far. And as if to warn us, construction activity has just seen a strong lurch upwards:

Faced with the danger of all of this getting out of hand the authorities can basically do two things. They can tighten loan conditions for the banking sector, by making the deposits required greater (or the Loan to Value ratios lower), and the income criteria stricter, and starting to move people over from variable to fixed interest mortgage rates on the one hand, and by implementing stricter fiscal measures on the other. Some say this will be difficult for Poland in a pre-election period, but are Polish voters really that unaware of what has been happening in other EU countries in recent years that they would willingly go for a bit of extra consumption now at the price of being another Spain five years on down the road?

Once More Those Structural Economic Distortions

Despite, all that improvement in competitiveness Poland is still running a trade deficit:

And it has been running a current account one for more years than anyone cares to remember.

Maybe the deficit has not been large by prior regional standards, but who really wants to go where others have gone before. And with each new deficit the level of external indebtedness simply grows, and is now reaching the 60% of GDP mark. By no means critical yet, but surely it would be more interesting to turn south before it does go critical. And in any event, the presence of the external debt makes the Polish economy unduly dependent on external financial flows, a point highlighted recently when the IMF announced an agreement to renew the country's US$20.43 billion flexible credit line.

Poland is one of the few large EU countries (alongside France) where domestic demand is (for the time being at least) all but dead and buried. Some of the reasons for this are historic ones, some are just quirks of fate (the crunch came before Forex lending got out of hand) and some are demographic. Curiously Poland, like France, is rather younger than many of its regional neighbours.

So for all these, and as they say many other reasons, I think the Polish authorities would do well to think again, and produce a revised set of budgetary projections for the years to come. If not, someone somewhere will one day ask them: "why didn't you see it coming".

From Original Sin To The Eternal Triangle - Lessons From Central Europe

2009-08-14T11:03:00.001+02:00

The non-biblical concept of original sin, as Claus Vistesen notes in this post, when propounded in its standard Obstfeld & Krugman textbook version refers to the situation where many developing economies who are not able to borrow in their own currencies feel forced to denominate large parts of their sovereign and private sector debt in non-domestic currencies in order to attract capital from foreign investors - as evidenced most recently in the countries of Central and Eastern Europe. Well, piling insult upon injury, I'd like to take Claus's point a little further, and do so by drawing on another well tried and tested weapon from the Krugman armoury, the idea of the "eternal triangle".

As is evident, the reality which lies behind the current crisis in the EU10 is complex, and has its origin in a variety of causes. But one key factor has undoubtedly been the decisions the various countries took when thinking about their monetary policy and currency regimes. The case of the legendary euro "peggers" - the three Baltic countries and Bulgaria - has been receiving plenty of media attention on late, and two of the remaining six (Slovenia and Slovakia) are now members of the Eurozone, but what of the other four, Romania, Hungary, Poland and The Czech Republic? What can be learnt from the experience of these countries in the present crisis.

Well, one convenient way of thinking about what just happened could be to use Nobel Economist Paul Krugman’s Eternal Triangle” model (see his summary here), which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.

In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.

The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.

A second problem which stems from this "initial decision" has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.

The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.

So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions - to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to "grin and bear" higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.

Appendix

Here for comparative purposes are charts illustrating the varying degrees of economic contraction, inflation, and interest rates. GDP contraction rates actually present a little problem at the moment, since one of the relevant countries - Poland - still has to report. However Michal Boni, chief adviser to the Prime Minister, told the newspaper Dziennik this week that the economy expanded at an annual rate of between 0.5% and 1% in Q1. So lets take the lower bound as good, it is still an expansion.

The economy in the Czech Republic contracted by an estimated 4.9% year on year in the second quarter.

The Hungarian economy contracted by an estimated 7.4% year on year in Q2.

While the Romanian economy contracted by an estimated 8.8% year on year.

Inflation Rates

Poland's CPI rose by an annual 4.2% in July.

The CPI in the Czech Republic rose by an annual 0.3% in July.

Romania's CPI rose by an annual 5.1% in July.

Polands CPI rose by an annual 5.1% in July.

Interest Rates

The benchmark central bank interest rate in Poland is currently 3.5%.

The benchmark central bank interest rate in the Czech Republic is currently 1.25%.

The benchmark central bank interest rate in Romania is currently 8.5%.

The benchmark central bank interest rate in Hungary is currently 8.5%.

Polish Industrial Output Falls Again In February (Updated)

2009-03-18T15:50:00.005+01:00

Polish industrial production fell for a fifth month in February, offering just the latest signal that the European economic crisis is really having an impact on Polish domestic growth. Annual output dropped 14.3 percent, following a revised decline of 15.3 percent in January, according to the Central Statistical Office. Output was however up 2.7 percent month on month.

Industrial output is now declining across the export oriented economies of central Europe, including the Czech Republic, Slovakia and Hungary, as exports to the region’s main trading partners in western Europe drop and investment plans are halted, slowing economic growth and pushing up the jobless rate. We also learned yesterday that employment dropped in February ny 0.2 percent over February 2008, registering the first annual decline since 2004. At the same time, wages increased 5.1 percent, their lowest increase in 27 months.

Another interesting detail here, for those who study the details of economics, is that theindustrial output numbers are not that far removed from the picture painted in the Purchasing Managers' Index (PMI) since the PMI for the Polish manufacturing sector rose in February coming in at 40.8 (from 40.3 in January). Thus the slight improvement in February's situation was already evident in the PMI. Analysts at the time said the February PMI figure more than likely marked a rebound after earlier sharp declines and suggested a weaker zloty may have helped cushion perceptions of the downturn by making exports cheaper.

Polish Central Bank Cuts Rates

Poland’s central bank cut its benchmark interest rate by a quarter point on Wednesday, to a record low of 3.75 percent as concerns that the economy is stagnating offset worries that the zloty is weakening.

The bank, which has slashed official borrowing costs by 2 percentage points over the past four months, cut its 2009 economic growth forecast by more than half, to 1.1 percent, in February, with some rate setters saying there’s a risk of recession. JP Morgan and Bank of America expect a 1 percent contraction.

Poland’s inflation rate rose in February, the first increase since July, boosted by higher energy prices and a decline in the zloty. The annual rate rose to 3.3 percent from a revised 2.8 percent in January. Consumer prices increased 0.9 percent from the month before after gaining a revised 0.5 percent in January. The EU Harmonised rate was 3.6% in February.

The IPSOS Consumer Confidence Index fell by 4 points from the February level to 67 reach points. The decline is particularly marked in ratings for the economic climate, which fell by 7 points to 47. Such low ratings for the economic climate have not been seen since 1992. Poles evidently believe that the global economic crisis has now affected the heart of their country's economy.

How Not To Manage Eastern Europe's Financial Crisis (Part 1)

2009-03-04T20:52:00.001+01:00

"Saying that the situation is the same for all central and eastern European states, I don't see that......you cannot compare the dire situation in Hungary with that of other countries."
Angela Merkel, Brussels, Sunday

"Happy families are all alike; every unhappy family is unhappy in its own way"
Tolstoy

In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.
Paul Krugman

Bank regulators from Bulgaria, the Czech Republic, Poland, Romania and Slovakia met today and issued a joint statement, ostensibly to reduce the some of the impact of what they term "alarmist comments" from the Austrian government about how the regional banking system is now in such a precarious state that it requires urgent action at EU level to prevent meltdown. The Austrian government are, of course, concerned about the impact of any meltdown on their own banking system. The result of this "reassuring statement" can be seen in the chart below (10 years, HUF vs Euro).

Within minutes of the joint statement Hungary's currency plummeted to an all-time low against the euro and to a 6.5-yr low versus the US dollar. In fact the HUF rapidly depreciated to 312 per euro from 307.50 before climbing back in later trading to 310. And the reason for this swift reaction? Hungary was not invited to join the statement. As the forint plunged, Hungary 's banking regulator hurriedly signed up to the statement, blaming the original omission on a communications mess-up, but the damage was already done.

“Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region. It is thus important first to distinguish between the EU Member States and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups."

Well this just takes us back to Tolstoy, each of them have their own specific problems, but the underlying reality is that they all face problems, and are vulnerable, each in their own way.

Hungary's economic fundamentals are clearly much weaker than those to be found in the Czech Republic and Poland as things stand, but what about Bulgaria and Romania? And the Czech Republic and Poland are about to have a pretty hard time of it as a result of their export dependence on the West, and Poland has the unwinding of the zloty options scandal still to hit the front pages. So there is plenty of food for thought here before throwing Hungary to the wolves. A default in Hungary could very easily lead to contagion elsewhere, and then the impact in the West is very hard to foresee. We should not be playing round with lighted matches right next to our fireworks stock. "Hey, it's dark in here" and then "boom".

Yesterday it was Latvia's turn, and the cost of protecting against a Latvian default (Latvia is the first European Union member priced at so- called distressed levels) rose to a record following the announcement that the unemployement level rose from 8.3% in December to 9.5% in January, the highest level in nearly nine years. In fact credit-default swaps linked to Latvia increased nine basis points to an all-time high of 1,109 basis points, according to CMA Datavision in London. The cost is above the 1,000 level, breached last week, that investors consider distressed, and is now about 270 basis points above contracts linked to Lithuania, the next-highest EU member.

So two countries are being systematically detached here - Latvia and Hungary - and statements by EU leaders are unwittingly aiding and abetting the process. But we should all remember, after they have eaten Latvia and Hungary for breakfast, the financial markets will undoubtedly chew on other luckless countries over lunch (Romania's Q4 GDP data was out today, and it was a shocker, and S&P have already said they are "closely monitoring" the situation), before perhaps moving on to bigger game for supper.

And we should remember here, no one is too big to fall, and I have already been warning about the gravity of Germany's situation, with a rapidly ageing population, a hefty bank bailout of its own to swallow, and total export dependence for GDP growth. Final data from Markit economics out today showed that Germany's composite PMI fell to 36.3 in February from 38.0 in January. That was the lowest level registered since the series began in January 1998. And it means that the German economy - which is highly interlocked with the whole of Eastern Europe (Austria holds the finance and Germany the industrial exposure) - is certainly contracting more rapidly in the first quarter of this year than it was in the last quarter of 2008, and may well contract in whole year 2009 by something in the order of 5%. So maybe someone over there in Germany should be reading the poem you will see below aloud to "our Angela" right now (Oh, and if you don't speak German, you can find a translation here).

Als die Nazis die Kommunisten holten,
habe ich geschwiegen;
ich war ja kein Kommunist.
Als sie die Sozialdemokraten einsperrten,
habe ich geschwiegen;
ich war ja kein Sozialdemokrat.

Als sie die Gewerkschafter holten,
habe ich nicht protestiert;
ich war ja kein Gewerkschafter.

Als sie die Juden holten,
habe ich geschwiegen;
ich war ja kein Jude.

Als sie mich holten,
gab es keinen mehr, der protestieren konnte.

What Last Weekend's EU Summit Did And Did Not Achieve

2009-03-04T20:51:00.001+01:00

Well reading the press on Monday morning it would have been fairly easy to reach the conclusion that nothing really happened yesterday in Brussels, and that a great opportunity was lost. The latter may finally be true, but the former most certainly is not.

Let's look first at what was not decided on Sunday. The leaders of the 27 member countries in the European Union most certainly did not vote to back a proposal from Hungarian Prime Minister Ferenc Gyurcsany for a 180-billion-euro ($228 billion) aid package for central and eastern Europe. They did not back it because it was not even seriously on the agenda at this point. These people move slowly and we need to talk them throught one step at a time. So what was on the agenda. EU bonds for one, and accelerated euro membership for the East for a second. And once we have the EU bonds firmly in place, then that will be the time to decide how we might use the extra shooting power they will bring us (boosting the ECB balance sheet would be one serious option they should consider, see forthcoming post from me and Claus Vistesen). That is when the emergency blood transfusion Gyurcsany was rooting for might come into play, but on this, as on so many items, the details of how we do what we do as well as the "what we do" will become important, so the moves we do take need to be well thought out, and systematic, they need to get to the roots of the problem, and not simply respond to problems on a piecemeal, reactive basis.

As Paul Krugman puts it "In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral." Amen to that!

But let's look at little bit deeper at what has been decided, or if you prefer, at what has been floated, and may be "decided" at the next meet up. Well for one, we have promised not to be protectionist, and for another, The World Bank, The European Bank for Reconstruction and Development (EBRD) and The European Investment Bank (EIB) have launched a two-year plan to lend up to 24.5 billion euros ($31.2 billion) in Central and Eastern Europe. This sounds a bit like trying to drain an Ocean with a teaspoon, and it is, so predictably the financial markets were not too impressed, expecially when they learned that not much of what was promised was going to be new money (as opposed to theacceleration of existing commitments), and especially when we take this sum and compare it with the likely quantities which are needed to "take the bull by the horms". EBRD President Thomas Mirow (who is more likely to give a low side estimate than a high side one) recentlly told the French newspaper Le Figaro that in his view Eastern European banks could need some $150 billion in recapitalisation and $200 billion in refinancing to stave off the risk of a banking failure in the region. At least.

"(It) sounds like a lot of money, but when (commercial) banks have lent Eastern Europe about 1.7 trillion dollars, 25 billion is peanuts," said Nigel Rendell, emerging markets strategist at Royal Bank of Canada in London. "Ultimately we will have to get a much bigger package and a coordinated response from the IMF, the European Union and maybe the G7."

So let's now move on to the positive side of the balance sheet, since as we know our leaders are a slowish bunch when it comes to grasping what is actually going on here, and an even slower group when it comes to acting on that knowledge once it has been acquired. The biggest plus to come out of last weekend's thrash is most definitely the fact that the idea of accelerating membership of the eurozone for the Eastern countries has now started to gain traction, if with no-one else then at least with Luxembourg Prime Minister (and Finance Minister, he is a busy man) Jean-Claude Juncker, aka "Mr Euro", who was quoted by Reuters on his way into the meeting saying he did not expect any early change to accession criteria for the single currency.

"I don't think we can change the accession criteria to the euro overnight. This is not feasible," Juncker told reporters as he arrived for a summit where non-euro eastern countries are due to call for accession procedures to be accelerated after their local currencies have taken a hammering on markets.

While in the news conference following the meeting he said that there was now a consensus that the two-year stability test required for a currency of a country hoping to join the euro zone should be discussed.

"I can understand that there may be a slight question mark over the condition that one needs to be member of the monetary system (ERM2) for two years, we will discuss this calmly," Juncker told a news conference after a meeting of EU leaders.

So something actually went on during the meeting, even if we are largely left guessing about what. Angela Merkel also left a similar impression that movement was taking place. "There are requests to enter ERM 2 faster," Merkel is quoted as saying. "We can have a look at that."

Now I have already spelt out at some length why I think the Eastern Countries should be offered accelerated membership of the eurozone forthwith (see this post) as has Wolfgang Munchau (in this FT article here).

The Economist, in a relatively sensible leader which I have already referred to, divides the Eastern countries into three groups. Firstly there are those countries that are a long way from joining the EU, such as Ukraine, Turkey and Serbia. As the Economist points out, while it would be foolhardy practically and hard-hearted ethically to simply stand back and watch, European institutions are pretty limited in what they can do apart from offereing some timely financial help or some sound institutional advice, and it is entirely appropriate that the main burden of pulling these countries back from the brink should fall on the International Monetary Fund.

Then there are those East and Central European Countries who are themselves members of the Union, and here it is the EU that must take the leading role. A first group of these is constituted by the Baltic trio (Estonia, Latvia and Lithuania) and Bulgaria, who have currencies which are effectively tied to the euro, either through currency boards, or pegged exchange rates. Simply abandoning these pegs without euro support would both bankrupt the large chunks of their economies that have borrowed in euros and deal a huge psychological blow to public confidence in the whole idea of independent statehood. Yet devalue they must (either via internal deflation, or by an outright breaking of the peg) and either road is what Jimmy Cliff would have called a hard one to travel. As the Economist itself suggests, these countries have suffered the most painful part of being in the euro zone—the inability to devalue and regain competitiveness—without getting the most substantial benefits of participation, so although none of them will meet the Maastricht treaty’s criteria for euro entry any time soon (and since they are tiny - the Baltics have a population of barely 7m, and Bulgaria is hardly bigger), letting them directly adopt the euro ought not to set an unwelcome precedent for others and should certainly not damage confidence in the single currency (any more than it already is, that is).

On the other hand unilateral adoption of the euro is a rather more difficult issue for the third group of countries, those who are EU members, are not in the eurozone and have floating exchange rates: the Czech Republic, Hungary, Poland and Romania. None of these is here and now, tomorrow, ready for the tough discipline of a single currency that rules out any future devaluation, and they are large enough collectively (around 80 million) that their premature entry could expose the euro to more turbulence than it already has on its plate. But so could simply leaving the situation as is, since if these economies enter a sharp contraction (more on this in a coming post) then the loan defaults are only going to present similar problems for the eurozone banking system as their currencies slide. The big vulnerability for Western Europe from the Polish, Hungarian and Romanian economies, arises from the large volume of Euro and CHF denominated debt taken on by firms and households, mainly from foreign-owned banks. As the Economist puts it "what once seemed a canny convergence play now looks like a barmy risk, for both the borrowers and the banks, chiefly Italian and Austrian, that lent to them".

So we now have several EU leaders opening the door for the first time to the possibility of fast-track membership of the eurozone. As we have seen German Chancellor Angela Merkel said after the summit that we "could consider" accelerating the candidacy process, French President Nicolas Sarkozy said that "the debate is open", and Luxembourg Prime Minister Jean-Claude Juncker, who heads the Eurogroup of eurozone finance ministers, said he was willing "to calmly discuss" such a possibility. So the debate is open. When will the next meeting be? On Sunday I hope. A week in all this is a very long time for reflection in this hectic world. We need proposals, and concrete ones for how to move forward here. Especially since at the present time all our attentions seem to be focusing on the East, and there is also the South and the West (the UK and Ireland) to think about. Perhaps our leaders will be able to make time from their crowded agendas for a series of mid-week meetings on this topic.

And while the leaders dither, the markets react, and as Bloomberg reports the dollar surges as everyone seeks a safe haven during the coming storm.

The dollar rose to the highest level since April 2006 against the currencies of six major U.S. trading partners.... and .... The euro dropped to a one-week low against the greenback as European Union leaders vetoed Hungary’s proposal for 180 billion euros ($227 billion) of loans to former communist economies in eastern Europe. The Swedish krona fell to a record versus the euro on speculation the Baltic region’s borrowers may default, and the Hungarian forint and Polish zloty tumbled.

The Hungarian forint led eastern European currencies lower today, falling 3.1 percent to 243.86, while Poland’s zloty lost 3 percent to 3.7796. The forint fell to a 6 1/2-year low of 246.32 on Feb. 17 as Moody’s Investors Service said it may cut the ratings of several banks with units in eastern Europe. The zloty touched 3.9151 the next day, the weakest since May 2004.

EU leaders spurned Hungary’s request for aid at a summit in Brussels yesterday. Growth in Poland, the biggest eastern European economy, will slow to 2 percent, the slackest pace since 2002, the European Commission forecasts.

Let The East Into The Eurozone Now!

2009-02-22T21:25:00.000+01:00

“It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again.”
Robert Zoellick, World Bank president, in an interview with the Financial Times

(Click On Image To View Video)

World Bank president, Robert Zoellick, made a call this week - in an interview with the Financial Times - for a European Union-led and co-ordinated global support programme for the economies of Central and Eastern Europe. I agree wholeheartedly, and even if I have, reluctantly, to accept the point made last week by our Economy & Finance Commissioner Joaquin Almunia that our pockets, though deep, are certainly not bottomless (and thus it is probably beyond our means right now to rescue the non-EU Eastern states), I still feel we should make good on our responsibilities to those who are EU members, and to do so by opening the doors of the Eurozone to those who wish to join. Since this proposal is fairly radical, the justification that follows will be lengthy.

This is not a view I have arrived at lightly, but looking at the extent of the problem we now have before us, a problem which is growing by the day, and taking into account the fact that the origins of the economic crisis in the East must surely rest (at least in part) in the decision to make euro participation a condition for EU membership for these countries (a possibility which was subsequently withdrawn in the critical moment, when the going started to turn rough), and then assessing the risk to the Western European banking system which would be posed by simply sitting back and watching it all happen, I think this move is not only the least damaging of the policies we can now follow, it is the in effect the only viable path left to us if we are to keep the eurozone as an integral entity together.

If this proposal were accepted a new set of membership criteria would need to be drawn up, of course, but the underlying principle would have to be one of offering the certainty of entry as guaranteed forthwith, for those who chose to accept. Rules were made to be broken, and nothing should be so inflexible - not even the Maastricht eurozone membership criteria - that it cannot be ammended as circumstances dictate. And at this point even the undertaking that this - like the long awaited US Stimulus programme - was on the table, would be sufficient to provide immediate, and much needed relief. Flirting with doing nothing here is, in my opinion, flirting with disaster, both in the East and in the West.

Existing Maastricht Criteria

Convergence criteria (also known as the Maastricht criteria) are the criteria for European Union member states to enter the third stage of European Economic and Monetary Union (EMU) and adopt the euro. The four main criteria are based on Article 121(1) of the European Community Treaty. Those member countries who are to adopt the euro need to meet certain criteria.

1. Inflation rate: No more than 1.5 percentage points higher than the three lowest inflation member states of the EU.

2. Government finance:

Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.

Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.

3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devaluated its currency during the period.

4. Long-term interest rates: The nominal long-term interest rate must not be more than two percentage points higher than in the three lowest inflation member states.

The Dimensions Of The Problem

European governments, the European Union and international financial organizations need to act fast on risks stemming form banks’ exposure in the eastern part of the continent to avert an escalation of the credit crisis, Nomura Holdings Inc. said. East European countries are struggling to refinance foreign- currency loans taken out by borrowers during years of prosperity through 2007, when economic growth averaged at more than 5 percent. The International Monetary Fund, which has bailed out Latvia, Hungary, Serbia, Ukraine and Belarus, warned on Jan. 28 that bank losses may widen as “shocks are transmitted between mature and emerging market banking systems.” “Swift action is needed to restore confidence and prevent trouble” to financial and economic stability in the euro region and emerging Europe, said Peter Attard Montalto, an emerging markets economist at Nomura International in London. “Any move should be quick. The situation has begun to decline more rapidly since the end of last year and there is risk that any action may come too late.”
Bloomberg

Robert Zoellick is far from being a lone voice in the wilderness about the current level of risk to the coutries in the East, and indeed precisely those EU banks who have been most active in emerging Europe are now busily trying to convince EU regulators, the European Central Bank and Brussels itself to coordinate new measures to counter the impact of the financial crisis confronting the region. The problem in the East certainly now adds a new dimesion to the problems facing us here in Europe, since West European governments are now being simultaneously hit on a number of fronts, and the situation is become more complicated by the day.

In the first place most West European economies are now either in or near recession, and their domestic banking systems are, to either a greater or a lesser extent, struggling. The West European states are thus, by and large, already feeling stress on their own sovereign borrowing capacities. But, with greater or lesser effectiveness, these countries are still able to increase their debt, even if sometimes the surge in borrowing is very dramatic, as in the case of Ireland, which will see gross debt/GDP shooting up from 24.8% in 2007 to a projected 68.2% in 2010 (EU January 2009 Forecast).

The situation in Eastern Europe is very different, and their economies and credit ratings evidently can't support such dramatic increases in their debt levels. Thus, in the case of those countries with a significant home banking presence, like Latvia's Parex, or Hungary's OTP, the support of external organisations (the IMF, the World Bank, the EU) becomes rapidly necessary when the bank concerned starts to have liquidity problems. But as a result of the consequent bailout the debt to GDP ratio starts to rise in a way which then places even subsequent eurozone membership in jeopardy. Latvia's Debt/GDP is, for example set to rise from around 12% of GDP in 2007 to over 55% in 2010. With a 10% plus GDP contraction already in the works for 2009, it is clear that Latvia's debt to GDP will rise beyond the critical 60% level. Hungary's debt/GDP is already above, and rising. If we don't do something soon, these two countries at least are being launched off towards sovereign default.

But the other half of this particular and peculiar coin turns up again in a rather unexpected way, and that is in the form of those West European banks who have subsidiaries in CEE countries, and who find now themselves faced, not with bailouts, but with ever rising default rates. This difficulty evidently and inevitably then works its way back upstream to the parent bank, and to the home state national debt, as the bank almost inevitably needs to seek support from one West European government, or another (in fact Unicredit, which has difficulty getting money from an already cash-strapped Italian government is talking of applying for support from the Austrian government via its Austrian subsidiary).

Austria is, in fact, a very good case in point here, since, as Finance Minister Josef Proell recently indicated, the country had some 230 billion euros of debt outstanding in Eastern Europe, equivalent to around 70 percent of Austria's GDP. The Austrian daily "Der Standard" have also reported the analysts view that a failure rate of 10 percent in Eastern Europe's debt repayments could lead to serious difficulties for Austria's financial sector. And this is no hypothetical "what if" type problem since the European Bank for Reconstruction and Development (EBRD) has estimated Eastern Europe's bad debts could go over 10 percent and could even reach 20 percent in the course of the current crisis. Underlining the mounting concern in Austria, Proell tried last week to convince EU finance ministers to provide 150 billion euros is support to CEE economies as a first step in trying to contain the growing wave of defaults.

The total quantity of debt outstanding is hard to put a precise number on, but the Bank for International Settlements estimated that, as of last September, more than $1.25 trillion had been leant by eurozone banks, and if you add in U.K., Swedish and Swiss bank liabilities the number rises to $1.45 trillion.

Western Europeean banks have a very important market share in the East, ranging from a low of 65 percent in Poland to almost 100 percent in the Czech Republic. This basically means two things, that the region's businesses and consumers are extraordinarily dependent on uninterrupted capital inflows from the West, and that some West European banking systems are extremely sensitive to rising default rates in the East. Of course the problem goes beyond the EU's borders, and while EU bank market shares in the Community of Independent States is rather less significant than in the EU12, due to the still substantial domestic ownership which exists there, exposure to defaults is not unimportant, especially in Ukraine, Kazakhstan and, of course, in Russia itself. Further, there is South East Europe to think about, and countries like Serbia and Croatia.

Large Banks Take The Initiative

Getting near to desperation, some of the largest banks involved - Italy's UniCredit and Banca Intesa, Austria's Raiffeisen International and Erste Group Bank, France's Societe Generale and Belgium's KBC - have launched a common initiative to try to lobby for an EU wide solution to the problem.

UniCredit is the largest lender in Poland and Bulgaria, while Erste is number one in Romania, Slovakia and the Czech Republic, with KBC occupying the position in Hungary, Intesa in Serbia, and Raiffeisen in Russia and Ukraine. Hungary's OTP Bank, emerging Europe's number 5 lender and the largest one in its home country, does not formally belong to the group. On the other hand OTP is actively looking for support.

OTP Bank Nyrt., Hungary’s biggest bank, said it’s in talks over a “role” for the European Bank for Reconstruction and Development, as it announced a 97 percent drop in fourth-quarter profit and “substantial” job cuts. As well as a possible EBRD involvement, OTP may also seek funds from Hungary’s emergency loan package from the International Monetary Fund, the European Union and the World Bank to “better serve the economy,” Chairman and Chief Executive Officer Sandor Csanyi said at a press conference in Budapest today. “There’s a chance the EBRD will assume a role in OTP, but I must stress that we plan no issue of new shares,” he said. OTP “doesn’t need to be saved,” Csanyi added.

Chancellor Angela Merkel, while expressing support for the bank initiative, has stopped short of offering concrete assistance or suggesting measures beyond those which are already in place.

The president of the European Bank for Reconstruction and Development, Thomas Mirow, wrote in the Financial Times this week the bank proposals "deserve full support as a worsening crisis in emerging Europe will threaten Europe as a whole".

The Austrian government has already announced it is trying to raise support for a general European Union initiative to rescue the region’s banking system. The government has set aside 100 billion euros in cash and guarantees to stabilise its banking sector. Next in line in terms of exposure are Italy ($232 billion), Germany ($230 billion) and France ($175 billion).

Unicredit is publicly rather dismissive of the problem (as can be seen from the slide below which from a presentation they gave earlier this week, please click on image to see better), but Italian investors are far from convinced by their arguments, as witnessed by the fact that their stock has plunged 41 percent this year, and by the fact that they were forced to sell 2.98 billion euros in 50 year bonds this week to shore up their Tier I capital after investors only bought about 4.6 million shares, or 0.48 percent, from their most recent rights offer. UniCredit, which said last month it is considering asking for government assistance, has also been disposing of assets to raise money and it plans to pay shareholders their dividends in yet more shares. Nationalisation of banks to supply credit lines to the private sector is one hypothesis currently being studied by Silvio Berlusconi, according to a Financial Times report this morning.

(Click on image for better viewing)
The Austrian proposal includes funds from the European Investment Bank, the European Central Bank and the EU Cohesion Fund. The Austrian government has offered money of its own and has been urging Germany, France, Italy and Belgium as well as the EU itself to contribute. One feature, however, stands out in all of the proposals which have so far been advanced: they are loan based-support. What Soros calls the "tricky question" of fiscal allocation from Europe's richer member states has not so far been raised, but it will be, since it will have to be.

And of course, Austria's concern is far from being altruistic, as Austria's economy and sovereign debt stability depend on finding a solution. It is hardly surprising to learn that credit-default swaps linked to Austrian government debt soared this week - by 39 basis points to a record 225 - on concern the country will need to bail out the domestic banks itself as they report losses and writedowns linked to eastern European investments. Erste, which said last week that full-year profit probably slumped by almost 26 percent, is in talks with the government to get 2.7 billion euros ($3.4 billion) in state aid. RZB has asked for 1.75 billion euros.

The European Central Bank on the other hand, seems reluctant to extend emergency financial help to crisis-hit countries beyond the 16-country eurozone. The ECB did not have “a mandate to be a regional United Nations agency”, Yves Mersch, governor of Luxembourg’s central bank, recently told the Financial Times. Such comments reveal the level of resistance which exists within the ECB’s 22-strong governing council to the idea of offering financial support to countries outside the zone.

The ECB has so far offered loans to Hungary and Poland, but has attached what some consider to be excessively strong conditions on facilities allowing them to borrow up to 5billion and 10billion euros respectively. Mr Mersch, whose views are thought to be widely shared in the ECB, suggested the central bank was worried about setting precedents if it relaxed its stance on helping individual countries. While some euromembers might favour assisting nearby nations, “we must not forget that other people might be sensitive to different countries”.

Who Bails Out The West European Banks In The East?

Governments and EU officials are struggling to formulate a coherent response to the economic and financial turmoil that has started to engulf the eastern part of the old continent. EurActiv presents a round-up of national situations with contributions from its network. Leaders of EU countries from central and eastern Europe will meet on 1 March ahead of an extraordinary summit on the same day with the bloc's other members, it emerged on Thursday (19 January). Polish Prime Minister Donald Tusk has invited his counterparts from the Czech Republic, Slovakia, Slovenia, Romania, Bulgaria, Lithuania, Latvia and Estonia for the talks to ensure the 27-nation meeting on the financial crisis is not dominated by the interests of Western member states. See full Euractiv article on background.

The EU has so far provided emergency balance-of-payments assistance to two of the East European member states in difficulty - Hungary and Latvia, and EU ministers did agree in December to more than double the funding available for such emergency lending to 25 billion euros ( so far Hungary has been allocated 6.5 billion and Latvia 3.1 billion). It is also quite probable that such lending will now have to be extended to the two newest southeast European members, Romania and Bulgaria, since their ballooning current account deficits and dramatic credit crunches mean that they are steadily getting into more and more difficulty.

The core of the problem is that the East European economies enjoyed strong credit driven booms, which fuelled higher than desireable inflation and lead to strong foreign exchange loan borrowing which simply bloated current account deficits. Now capital flows into emerging Europe have dried up as the global financial crisis has raised investors' risk aversion and prompted them to dump emerging market assets, leaving foreign-owned banks as the only source of loans for companies and consumers.

Italy's UniCredit, the biggest lender in emerging Europe, warned at the end of January that there was a clear risk of the global credit crunch gripping the region. UniCredit board member Erich Hampel stated at a Euromoney conference in Vienna that the bank was committed to fund its subsidiaries in the CEE countries and would continue to lend, but at the same time made absolutely clear that in order to do this his bank would need government support, whether from Austria, or Poland, or Italy itself.

Hampel said Bank Austria would decide during the first quarter whether to tap the Austrian government's banking stability package for fresh equity. " he said. "Our budget is under discussion now and clearly assumes growth in lending and in funding to the East. "

And according to a report from the Austrian central bank the fact that a relatively small number of Western European groups - including three Austrian ones - own most of the banks in Central and Eastern Europe means that there is the risk of a "domino effect", implying the crisis would spread quickly from one country to another. "How capital flows into (emerging Europe) will develop depends on the financial strength of the parent groups and of the sister banks, and on whether the parents are willing and able to fund their subsidiaries," the bank's half-yearly Financial Stability Report said. "The risks to refinancing are increased by the danger of a domino effect, because a large part of the foreign capital in many countries comes from a relatively small number of Western European banks," .

"What we see is that the emerging European economies have lost all sources of funding but banking," said Deborah Revoltella, chief economist for central and eastern Europe of UniCredit, the region's biggest lender. The task to carry whole economies through a downturn comes at a time when parent banks already face a double challenge: a likely sharp rise in loan defaults at their eastern subsidiaries and more difficult and expensive refinancing for themselves. "The international banks cannot solve this situation," Revoltella said. "They can do their part, and it's fundamental that they do their part but we have to take care of the other sources of funding which are missing now."

And it isn't only Austria who is worried, since Greek central bank governor George Provopoulos warned Greek banks only last Tuesday against transferring funds from the country's bank package to the Balkans, where they have invested heavily.

Regional Risks

In our view GDP growth is like to be negative in all CEE countries this year. In those countries least affected by the crisis (i.e. Poland, the Czech Republic, Slovakia and Slovenia) GDP is like to drop at least 2-5%, while those countries worst affected (i.e. the Baltic States, Bulgaria, Romania and Ukraine) are likely to face double digit declines in GDP. In other words, in terms of expected output lost in the region this is as bad as or even worse than the Asian crisis of 1997-98.
Danskebank - CEE: This Looks Like Meltdown

The problem that the EU has in adressing the situation in the Eastern member states is that what we have on our hands is not only a banking crisis, there is also a strong credit crunch at work, one which is now having a severe impact on the real economies in the region. Most of the economies in the region are already in recession, and those that are not soon will be (I have intersperced a number of relevant graphs throughout this post which should give some general impression of what is happening). Thus these countries are all taking multiple hits at one and the same time.

1/ In the first place they have an economic contraction on their hands, in some cases becuase they are struggling with a steep decline of export demand from western Europe, in others because their externally financed credit boom has now come to a sharp and painful end.

2/. Most countries in the region have some form of foreign currency exposure, although at present this is largely household and corporate rather than sovereign. In a number of countries -notably Hungary, Romania, Bulgaria and the Baltics this is particularly onerous since most of the mortgages were taken out in euros or Swiss Francs, and the default risk is now rising as their economies either deflate (internal devaluation) or their currencies fall as part of the regional sell-off. The danger is that as the bailouts are implemented at local level this exposure is steadily transferred over to the sovereign level, creating a dangerous dynamic which can endanger future eurozone membership. States which default will be unlikely candidate members.

3/. These countries are also suffering the impact of significant asset writedowns, as those assets bought at very high prices during the boom - some at up to six times their book value - now have to be written down, further weighing on earnings and weakening financial and corporate balance sheets.

4/ Finally there is significant contagion risk. The comparatively small number of foreign lenders involved has lead IMF economists and the credit ratings agencies alike to repeatedly warn of how the risk that a seemingly isolated incident in one country may rapidly spread right across the region.

"I don't think it's an exaggeration to say that the whole banking sector and financial system (in the region) rests on the response of parent banks," said Neil Shearing, economist at Capital Economics. "If they withdraw funding it's not very difficult to see how there would be a very severe financial crisis sweeping across the region, and the whole region en masse would have to go to the IMF," he said.

Governments in the region have already taken what measures they can. Most increased deposit guarantees from 20,000 to 50,000 euros following the EU October Paris meeting. Lithuania went further and upped the limit to 100,000 euros, while Slovakia, Slovenia and Hungary all now offer unlimited protection. But this begs the question, who guarantees the government guarantees in the event they are called on.

So the problem has now become a very delicate one, since the banks want to maintain their presence in the region even while almost every factor imaginable is working against them. The latest such factor is the threat of credit downgrades for their core business in Western Europe, and Moody’s Investors Service warned only this week that some of Europe’s largest banks may be downgraded because of loans to eastern Europe, a warning which sent Italy's UniCredit to its lowest level in the Milan stock market in 12 years.

Moody’s argues there will be “continuous downward rating pressure” in the region as a result of worsening asset quality and western banks’ reliance on short-term funding. UniCredit’s Bank Austria subsidiary earned almost half its pretax profit from eastern Europe in 2007, Raiffeisen International Bank-Holding almost 80 percent and Austria’s Erste Group Bank more than 60 percent, according to Moody’s.

“The most risky parts of the western European banks’ businesses are in eastern Europe and when you decide to cut risks, you cut back on the most risky assets first,” Lars Christensen, an analyst at Danske Bank A/S in Copenhagen, said by telephone today. “This could add further risk in the region as the economies there may face large current account deficits if funding from western European banks is withdrawn.”

As a result last Tuesday we saw a surge in the cost of protecting bank bonds from default, lead by Raiffeisen International Bank-Holding and UniCredit. Credit-default swaps on Vienna-based Raiffeisen climbed 26 basis points to a record 369 and those for UniCredit soared 23 basis points to an all-time high of 213, according to data from CMA Datavision in London. Credit-default swaps on Erste increased 24.5 to 307, Paris- based Societe Generale rose 6 to 116 and KBC in Brussels was unchanged at 240, according to CMA prices.

The rising cost of insuring against default by a “peripheral” European government is likely to weigh on the euro, according to Merrill Lynch & Co. “This remains an important background negative for the euro,” Steven Pearson, a strategist in London at Merrill Lynch, wrote in a note today. “European banking-sector exposure to Eastern Europe, often via foreign currency lending, is an additional euro negative story that is gaining air-time.” Emerging market central banks may move away from holding European government bonds in their reserves as widening yield spreads between debt of different euro-zone economies makes bonds more difficult to trade, Pearson said.

So Why Would The Euro Help?

Well, in the first place, four of the Eastern economies - Bulgaria, Latvia, Lithuania and Estonia, are effectively stuck, since their currencies are pegged to the Euro. They are in the unenviable position of being stuck between the proverbial rock and the hard place. They are now faced with US depression type economic slumps, and massive internal wage and price deflation all at the same time. Would Euro membership help? Well lets look at what the IMF said in their most recent report on the stand-by loan arrangement for Latvia.

Accelerated adoption of the euro at a depreciated exchange rate would deliver most of the benefits of widening the bands, but with fewer drawbacks. Unlike all other options for changing the exchange rate, the new (euro-entry) parity would not be subject to speculation.

By providing a stable nominal anchor and removing currency risk, euroization would boost confidence and be associated with less of an output decline than other options.Euroization with EU and ECB concurrence would also help address liquidity strains in the banking system. If Latvian banks could access ECB facilities, then those that are both solvent and hold adequate collateral could access sufficient liquidity. The increase in confidence should dampen concerns of resident depositors and also help stem non resident deposit outflows.

However, this policy option would not address solvency concerns and has been ruled out by the European authorities. If combined with a large upfront devaluation, there would be an immediate deterioration in private-sector solvency, which could slow recovery. Privatesector debt restructuring would likely be necessary. Finally, the European Union strongly objects to accelerated euro adoption, as this would be inconsistent with treaty obligations of member governments, so this option is infeasible.

Basically, devaluating the Lat and entering the euro directly was the IMF's preferred option for Latvia, "euroization with EU and ECB concurrence" was the second option, and keeping the peg and implementing massive internal deflation only the third. The problem was that the EU, in its wisdom felt euro adoption "would be inconsistent with treaty obligations of member governments" - as would I suppose bailing out Austria and Ireland be "inconsistent with treaty obligations of member governments under the Maastricht Treaty. Go tell it to the marines, is what I say!

And this is not just Latvia, but four entire countries (little ones, but still countries) that are effectively being thrown to the wolves here.

Downward Pressure On Currencies, Upward Pressure On Interest Rates

Nor is the position of those with floating currencies - Poland, Hungary, the Czech Republic and Romania - much better, since their currencies are now coming under substantial pressure, and as a result defaults are growing, defaults which will only work their way back upstream to the Western Countries whose banks will have to stand the losses.

At the same time, the risk of a sharper, 1997 Asian-style adjustment cannot be excluded, given the similarities between Asia before the eruption of the crisis there in 1997 and the situation in emerging Europe. Beyond any considerations about valuation, the FX market may overreact as it did during the Asian or Russian crises in 1997 & 1998. To halt the downward spiral of currency depreciation, a substantial rise in interest rates combined with a tight fiscal policy under an IMF programme could be necessary.
Murat Toprak & Gaelle Blanchard, Societe Generale

Obviously there is now a sense of urgency here, and the warning signs are everywhere, for those who know how to read them. According to Zbigniew Chlebowski, the chairman for the Polish ruling party’s parliamentary group speaking in an interview earlier this week, the Polish government has been in official talks with the European Central Bank over joining the pre-euro exchange-rate mechanism “for several days.” So consultations are getting to be fast and furious.

And Hungarian, Polish and Czech government debt, which has been among the highest rated in emerging markets, is now being downgraded by bondholders. Investors are currently demanding 20 basis points more yield to own Hungary’s bonds than similar-maturity Brazilian debt, which is rated four levels lower by Moody’s Investors Service, according JPMorgan bond indexes. The risk of Poland defaulting is currently running at about the same as Serbia, ranked six levels lower by Standard & Poor’s, based on credit-default swap prices, while Czech 10-year bonds yield the most compared with German bunds since 2001.

“Everybody is running for the door,” said Lars Christensen, head of emerging-market strategy at Danske Bank A/S in Copenhagen. “The markets have decided the central and eastern European region is the subprime area of Europe.”

The currencies of these currenciies are tumbling on investor concern the region’s economies are among the most vulnerable to the global credit crisis. Poland’s zloty has fallen 35 percent against the euro since August, the forint - which has fallen around 13% since the start of the year, and about 25% since last August -weakened to a record low of 309.71 this week. At the same time the Koruna hit the lowest level since 2005.

(Chart above - Polish Zloty vs Euro)

The zloty has risen - against the previous trend - by 3.2 percent this week, following a decision by the Finance Ministry to enter the market (on Wednesday) and started selling euros from European Union funds for zlotys. Prime Minister Donald Tusk said yesterday the currency must be defended “at any cost.” The Czech central bank stated it regards the buying and selling currencies to manage the koruna as an “exceptional” tool that it’s resisted using since 2002, with the implication that it may not be able to resist much longer, although interest rate hikes (as practised in Hungary) seem to be the more likely approach in the Czech Republic. Such gains as have been obtained for the zloty are likely to be short lived (intervention is a tool of desperation, not of strength, and rarely has any lasting effect) and they can hardly exhaust EU funding they badly need to spend on stimulus type projects in the face of the downturn defending the indefensible, as Russia has been learning to its cost in another context.

“It [currency intervention ]is for us an exceptional tool at our disposal,” Tomas Holub, head of its monetary policy department, said in a telephone interview today. “Of course it’s one of the potential tools, but so far no decision has been taken in this direction.”

After intervention the only real tool left is interest rate policy, and fear of further currency falls is now acting as a serious brake on monetary policy as the pace of economic contraction gathers speed in one country after another. “A lowering of interest rates at the current levels of the exchange rate is completely out of the debate,” Deputy Governor Miroslav Singer told E15 newspaper earlier this week. “The question is whether to raise, and by how much.”

Really the suggestion that all these countries simply traipse off to the IMF (one after the other) in search of help is shameful. There is simply no other word for it, shameful. As Oscar Wilde put it, losing one child may be an accident, but losing all your children, now that has to be negligence! Let them in, and let them in now, before the whole house of cards collapses on top of each and every one of us.

Postcript

This article is the second in a series of five I am in the process of writing on ways forward with Europe's financial and economic crisis.

The first was Why We Need EU Bonds.

Subsequent articles will deal with:

a) The need for Quantitative Easing In The Eurozone
b) What might a new Stability and Growth Pact look like?
c) Why as well as rewriting the banking regulations we also need to do something about Europe's demographic imbalances.

Update: The Danskebank View

With which I wholeheartedly agree.

This week the crisis in the CEE markets has intensified dramatically after the publication of a number of reports putting a negative focus on Western European banks exposure to the overly leveraged CEE economies. The crisis is clearly developing in an explosive fashion and there is a very clear risk of an Asian crisis style meltdown. The economies in the region are already in free fall, and at least one country Ukraine is dangerously close to sovereign default. Rapidly rising concerns have led policy makers across Europe to call for immediate action to avoid a dangerous collapse that potentially could spill into the euro zone. However, policy makers seem very divided on what to do in the current situation.

Earlier this week Lithuanian Prime Minister Andrius Kubilius called for coordinated action from the EU to try to solve the problems in CEE. Later in the week the World Banks president Robert Zoellick echoed Kubilius cry for help.

However, the EU Commission does not seem very excited about a coordinated effort to avoid meltdown. Rather Joaquín Almunia, EU monetary affairs commissioner, this week said that he would prefer a country-by-country approach to crisis management. In our view, a country-by-country approach to crisis management entails a number of risks, as there is a strong potential for contagion from one CEE country to another due to the significant integration in the financial sector across the region. Therefore, we think that there is urgent need for a more coordinated effort to stabilise the situation otherwise this crisis will drag out and uncertainty remain elevated for an extended period.

Central Europe's Manufacturing And Consumers In A State Of Shock

2009-02-02T15:28:00.000+01:00

Central Europe's economies continued to contract in January - lead by their manufacturing industries - under the combined weight of a credit crunch and a slump in demand for their exports. My feeling as all three economies - Poland, the Czech Republic and Hungary - are now in recession. Hungary's is clearly the worst case, and events are moving rapidly and negatively there, but the slowdown in the Czech Economy is also very pronounced, and Poland seems finally to be falling into line, following some internal financial chaos back in October. Based on back of the envelope type calculations derived from the PMIs I would say their economies were contracting at the following pace in January.

Q-o-Q Y-o-Y
Hungary -1% -4%

Poland -0.7% -3%

Czech Republic -1% -4%

These are only provisional assessments based on the PMIs and Consumer Confidence Indexes. They will be subject to calibration as we move forward and receive the real data, but all this should give us some general idea of what is happening, something which is badly needed in view of the suddenness of the change.

Hungary PMI

Hungary's manufacturing purchasing manager index (PMI) fell once again to a all-time low of 38.6 in January, down from 40.8 in December, according to the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM) today. Any PMI index figure above 50 indicates expansion while a figure below 50 shows contraction in economic activity. The index hasd been above the critical 50 mark for more than three years before it dropped below (to 42.6) in October last year.

The January figure is the lowest recorded since September 1995 and is a further sharp drop from January. The last time the January index was below 50 was in 2005 (48.5) and then in 1997 (49.1), but these contraction were much softer.

“In view of the current situation we can confidently say that the five month negative record of 1998 will be broken. We are facing the gravest crisis of the manufacturing industry in almost 15 years," the HALPIM said.

GKI Confidence Index

Economic sentiment also plunged in January with the GKI index falling to a record. The overall index fell to minus 39.8, the lowest since measuring began in 1996, from minus 36.7 in December. The sub components for business and consumer confidence also fell to new lows.

The outlook for industrial production and orders led a decline in the business confidence index to minus 30.5 from minus 28.2 in December. The outlook for export orders improved “minimally,”. Fifty-eight percent of exports are sold in the euro region, which is in its worst recession since the single currency began trading a decade ago. Concern about future job losses dragged the consumer confidence index to a record of minus 66.1 from minus 60.8 in December.

Polish PMI

Morale in Poland's industrial sector rose for the first time in almost a year in January, but output growth remained mired firmly in negative territory, according to a purchasing managers' index survey published Monday. The survey of 300 industrial companies prepared by Markit for ABN AMRO showed Polish manufacturing PMI increased to 40.3 in January, from 38.3 in December. This is an improvement, but the contraction is still a strong one.

"Though slightly improved from the exceptionally weak December data, the latest survey findings underline the headwinds confronting Polish manufacturers in January. Output, new orders and employment all contracted sharply and, overall, the first batch of 2009 PMI data point to further aggressive rate cuts by the central bank in the first quarter following greater than expected reductions in the main policy rate in both November and December. Inflation concerns have eased despite the falling zloty, as the PMI showedfurther falls in price pressures in manufacturing." - Trevor Balchin, Economist at Markit Economics

Polish Consumer Confidence

Poles have become much more pessimistic about the outlook for their economy in recent months and the Ipsos Consumer Confidence Index fell by 11 points to 84.17. The assessment of the current economic climate suffered the most serious deterioration.

(Please click over image for better viewing)

The consumer rating of the current economic climate plummeted by 15 points to hit 69.59. This is one of the lowest levels since Poland joined the European Union. Consumers are worried about the future of the Polish economy, and their worries are linked particularly to the situation on the job market. Currently some 52% of Poles expect unemployment figures to rise over the coming 12 months, while only 6% expect them to fall. This is a radical change, particularly when compared with January 2008, when only 13% expected a rise in unemployment and 39% expected a decline.

The deterioration in consumer sentiment was also to be seen in the ratings for willingness to buy, which in January fell by 8 points to 93.88 (the lowest level for 3 years). In particular expectations regarding the material situation of one's own household deteriorated. Ratings of the current situation in regard to buying durables also weakened somewhat. Nevertheless, consumer appetite is far from dead, and there are more people still considering this a good time for buying than those who disagree.

Czech Republic PMI

Czech industry continued its steep decline in January with the Czech Purchasing Managers' Index falling to dropping below the 50 mark (to 31.5) for the seventh consecutive month. As compared with December (32.7), the PMI was hit by series-record declines in new orders and employment, while deflationary pressure was also evident as both input and output prices continued to fall sharply, according to the report from Markit Economics and ABN Amro. The figure for output rose for the first time since September, to 29.5, indicating a slightly weaker rate of contraction than in December but still the second lowest in the survey's history.

Czech Consumer Confidence

In January 2009, the Czech economic sentiment indicator decreased by 3.2 points m-o-m (it was down by 8.6 points down in December). The business confidence indicator fell by 2.8 points and the consumer confidence indicator dropped 4.8 points. Compared to January 2008, the composite confidence indicator balance was down 30.8 points, the confidence of entrepreneurs is 34.7 points down and the confidence of consumers is down by 15 points. Indicators were thus at their lowest levels in almost ten years.

The survey taken among consumers in January indicates that, compared to December, consumers expect for the next twelve months worsening of the overall economic situation and a slight decrease in their own financial standing. In January, the share of respondents expecting a rise in unemployment increased again. The percentage of respondents planning to save money decreased. The consumer confidence indicator decreased by 4.8 points, m-o-m; it is by 15 points down, y-o-y.

Poland's Economy Contracts In Q4 2008

2009-01-29T21:26:00.009+01:00

Poland is probably sliding into a “technical recession” as the slowdown in its biggest trading partners batters the economy in the largest of the European Union’s eastern members, Citigroup Inc. said.

Poland’s economy probably contracted as much as 0.2 percent in the fourth quarter from the prior three months and will shrink about 0.5 percent this quarter, according to Citigroup’s Warsaw-based economist Piotr Kalisz. The slump may mean the government risks missing its budget-deficit goal of less than 3 percent of gross domestic product, he said.

“The slowdown could be a surprise to the government, which still counts on almost 2 percent economic growth,” Kalisz said. “The Polish government could be forced to revise the budget in mid-2009 and raise the deficit ceiling. However, the government prefers to stick to fiscal discipline rather than fiscal stimulus,” limiting the size of the revision, he added.

Poland’s central bank lowered its key interest rate by three-quarters of a percentage point as slowing economic growth forces companies to cut investments and employment, capping inflation. The Narodowy Bank Polski lowered the seven-day reference rate to 4.25 percent.

“The recent macroeconomic data justify such a scale of reduction as a reaction
to slowing economic growth and waning inflationary pressure,” said Jaroslaw
Janecki, chief economist at Societe Generale in Warsaw. “We expect the end of
the easing cycle in May or June, with the key interest rate at 3.5 percent.”

Barlinek SA, Poland’s largest maker of wooden floors, fell in Warsaw trading after a decline in the zloty caused losses on its hedging transactions.

Barlinek declined 0.06 zloty, or 3.8 percent, to 1.52 zloty, after earlier declining to a record low. The WIG Index rose 0.9 percent.

Kielce, southeast Poland-based Barlinek said its loss on currency deals that will be settled in 2009 and 2010 stood at 51.3 million zloty ($15.6 million) as of Dec. 31. The company recorded a profit of 10.4 million zloty on currency contracts settled in 2008, it said in a regulatory statement yesterday.

Echo Investment SA, a real-estate developer also controlled by investor Michal Solowow and based in Kielce, gained 0.05 zloty, or 2.6 percent, to 1.96, rising for the second time this week and recovering from a 10 percent drop.

Echo had a total loss of 238.6 million zloty on zloty contracts last year, it said in a regulatory statement yesterday. Net income for the year will be at least 100 million zloty because the company increased the value of property on its balance sheet.

“The information” from Echo “is positive for investors, since until now it wasn’t known what type of hedging the company had,” Maciej Wewiorski, an analyst at Dom Maklerski IDMSA, said by phone today. “It’s apparent that the company didn’t speculate on currency moves,” he said, adding that the hedging strategy was “very clear” and it “worked as it should.”

Cersanit SA, Poland’s largest producer of bathroom fittings, also controlled by Solowow, fell 0.3 percent to 9.75 zloty after falling 6 percent yesterday.

The company’s loss on outstanding currency contracts stood at 52.9 million zloty at the end of 2008 and it recorded an 11.7 million-zloty loss on deals settled last year, it said in a regulatory statement after the close of trading yesterday.

The Forex Lending Crunch Means Trouble Is Looming Large In Poland

2009-01-21T08:39:00.003+01:00

Poland now looks set to become the latest shoe to drop in the ongoing crisis which is steadily extending its reach from one country top another, right across the whole of Central and Eastern Europe - the latest and possibly the last in the sense that if Poland does role belly side up this will probably be the one which finally does turn the apple cart well and truly over.

Italy's UniCredit, the biggest lender in emerging Europe, said on Wednesday there was a clear risk of the global credit crunch gripping the region and it was up to international banks to help to avert it. UniCredit board member Erich Hampel said in a presentation at the Euromoney conference in Vienna that the bank was committed to fund its subsidiaries in those countries and would continue to lend to consumers and companies. It called on other banks active in the region, the European Union, the International Monetary Fund, other institutions and the countries concerned to launch a joint plan to stem the threat that funds could stop flowing and choke economic growth. "The international financial crisis is questioning future developments and the risk of a credit crunch is clear," said Hampel, who steers most of UniCredit's emerging European units as head of its Bank Austria arm. "A number of interested parties are involved and the support to the region should come from all of them together," Hampel said. "Coordination is essential and a 'Plan for CEE' should be designed."

Eastern Europe is - as Unicredit's Eric Hempel argues in the extended quote above - quite simply falling headlong into a very severe credit crunch, as funding for bank lending steadily dries up. And, unfortunately, as the evidence mounts that Poland is caught in the teeth of this crunch, its real economy falls deeper and deeper into the dreaded pit with each passing day. FT Alphaville's Izabella Kaminska has the forex loan story here (see also see here last Friday). Basically all I have to add are some charts (and some real economy analysis) to add a bit more weight to the point and illustrate more explicitly the speed with which things are now moving forward.

How Important Are Forex Loans In Poland?

Poland’s exposure as to foreign-currency lending has already been extensively documented and analysed on this blog, but just in case there is still anyone out there who holds defiantly onto the view that the extent of such lending in Poland is simply too small and too recent to have any sort of severe impact on the economy, let's take a look at the recent progress in such lending, at least as far as household behaviour goes. As can be seen in the first chart below, since the middle of 2007, the rate of growth in zloty loans has slumped steadily, while forex borrowing has gone up and up, until..... until last November, when the whole thing turned. It now pretty clear that something quite important happened to the Polish banking system back in October - as I attempted to analyse in this post which was written at the time.

The extent of the transition can also be seen from the monthly chart for outstanding household loans, where again zloty loans can be seen to have have virtually stagnated, while forex ones went shooting up and up, till they seem to have hit a something akin to a "dead stop". Nor does the loan "revaluation" argument help us here, since during the period under consideration the zloty has been falling (see chart below) and hence the book value of the capital stock of forex loans should rise, not fall. (I mean, unfortunately, and from a large number of comments I have received on my blogs over the last 18 months, I have to say that this is the part of the story that many of those who have taken out unhedged forex loans in Eastern Europe simply do not "get", it isn't so much the payment stream you need to look at (influenced by the relative interest rates in the two currencies being compared) but at what happens to the capital value - that is what happens to the outstanding sum you owe, as measured in your own local currency, or at least in the currency in which you are paid.

And for those who are interested in how domestic monetary policy works these days (ie how effective central bank interest rate policy is at containing lending in a small or medium sized open economy with access to global finance) it should not come as a surprise to find in the chart below that the uptick in enthusiasm for forex loans really started to gain momentum after the Polish central bank started to raise interest rates, as the short term interest rate differential with Swiss Franc loans simply grew and grew under the impact of monetary tightening.

Systematic Slowdown In Industrial Activity

This application of standard monetary policy by the Polish central bank did have one result, however, and that was that the value of the zloty shot up (in particular here when compared with the euro, which is what really matters for exports), and with it the relative cost of Polish industrial products. And what did this lead to? Well, a steady deterioration in the trade deficit for one thing.

And, of course, an ongoing contraction in industrial output for another. Poland's industrial output continued to fall in December, with statistics office data showing today (Tuesday) that output fell 4.4 percent year-on-year, after dropping 9.2 percent in November. In month-on-month terms, industrial output also fell 3.7 percent, (following a whopping 15.4% drop in November over October) while seasonally adjusted output fell 7.4 percent year-on-year, showing business conditions are quickly deteriorating.

Wage and employment data for December on Monday also suggested companies, in response to falling demand for their products, were starting to lay people off. The pace of wage growth in December was the lowest since 2006.

Business confidence in Poland's industrial sector fell in December to its lowest level since surveys began in June 1998 as plummeting new orders depressed output and employment, according to the latest 300 industrial company survey prepared by Markit Economics for ABN AMRO. The survey also found that the Polish manufacturing purchasing managers index dropped for the seventh consecutive month - to 38.8 from 40.5 in November.

The new business indicators dropped at the fastest rate in survey history, and the new orders index fell to 32.2 in December from 35.6 in November, with new export orders decreasing to 31.4 from 40.1. So we can obviously expect the January result to be even worse.

Previously, as can be see in this chart for the EU Economic Sentiment index, Poland had been faring rather better than some of its Central European neighbours (like Hungary and the Czech Republic). But the downward movement is now evident and pronounced.

This slowdown in industrial output has also been accompanied by a levelling off in construction activity, which has been trending down in year on year terms since the late summer, but which even fell back month on month in November (by 1% over October) for the first time in many months.

In fact if we look at the actual index, rather than the year on year growth numbers, we will see that activity levels have been pretty stagnant for six months or so now.

After the sub-prime crisis banks became more restrictive in their lending policies. It is hard for real estate companies to get loans for their projects. Developers have to delay significant part of their pipeline projects, in most cases till an unspecified date in the future. The significantly tightened lending policies for households will worsen already weak demand for housing. Additionally, the already anemic investment activity should deteriorate further. It should be more and more difficult for real estate developers to sell their projects in the market and this source of money is also drying up.
Polish Equity Market Monitor - Citi Poland - January 2009

Retail sales levels have also flattened out recently, although they have continued to rise slightly in recent months. November 2008 retail sales grewth by just 2.7% year on year confirmed a fast slowdown in domestic consumption following 7.9% growth in October and 11.6% growth in September. While the Penkon consumer confidence indicator is now showing its lowest readings since 2005.

It is most likely that the good times for the retail industry are over. The drivers that fuelled sales and margins of Polish retail companies – rising consumer vdemand and strong Zloty, have disappeared and we do not expect them to return within foreseeable future.
Polish Equity Market Monitor - Citi Poland - January 2009

The Credit Noose Tightens

The core of the East Europe problem is that savings in many parts of the region are not sufficient to underpin growing loan books, thus the banks in the region - which are largely foreign owned - have needed to draw on their parent companies to bolster their balance sheets. When many of the parent banks entered into their own refinancing problems last year as the global financial crisis spiralled out of control, this channel of funding was transformed from being a source of strength into being a source of weakness.

In addition, at the start of last summer the Polish currency soared to record highs against the euro, and many Polish companies took out hedging contracts, effectively betting on further zloty appreciation. Now, as the currency has weakened and weakened, many of these very same companies have found themselves with substantial losses.

The Polish financial watchdog estimated last month that local banks may need to take out as much as $284 million in provisions to cover for client losses on currency options, which currently amount to 155 million zlotys ($49.33 million) among Warsaw-listed companies. And that figure could obviously grow if the zloty continues to weaken.

The zloty is currently at its lowest level since the end of 2004 - around 4.306 to the euro. Furthermore, it seems the government’s promise of accelerating the process of euro-adoption - which helped calm the zloty’s decline back in October - is failing to reassure markets. In fact most analysts seem to think that at this point having a 2012 entry target is as good ashaving no target at all.

Euro/PLN Cross - Please Click On Image For Better Viewing

Izabella Kaminska quotes the view of RBC capital, who basically argue that there is no way that the assigned date was ever going to be achievable:

On top of all this, there is no guarantee that Poland will meet the five Maastricht convergence criteria. Holding the PLN stable within the ERM2 bands for two years may prove to be a tall order while the budget deficit, which has been squeezed lower purely as a result of recent strong economic growth, will widen sharply as the economy slows, breeching (SIC) the 3%/GDP limit and disqualifying Poland from Euro entry.

As Izabella says there is a sort of catch-22 at work here: the only way Polish zloty can be saved from further weakening is Eurozone membership, but Eurozone membership becomes ever more distant as the zloty weakens due to the Maastricht criteria. Yet if we look at what has been happening to competitiveness in Poland in recent years (see REER comparison chart with Germany below), it is clear that due to the combined effect of wage inflation and a rising currency, there is some correction still to be made (not comparable with the Baltics or Hungary, but still) if Poland is recover its lost export prowess.

And here's another chart from Citi Poland showing how unit labour costs have steadily risen, and productivity has steadily fallen. The critical crossover point seems to have been somewhere towards the start of 2007. This pattern has been repeated in one CEE country after another, and really lies at the heart of the current economic crisis in the region.

In an attempt to boost liquidity in short-term Swiss franc money markets the National Bank of Poland has set up a currency swap agreement with its Swiss counterpart and the European Central Bank. The agreement will now last until at least the end of April. But while this agreement is obviously providing some relief it is clearly far from solving the problem.

“Today, the SNB, the ECB and the NBP are jointly announcing that they will continue these one-week euro/Swiss franc foreign-exchange swap operations at least until the end of April to support further improvements in the short-term Swiss france money markets,” according to the Polish central bank statement earlier this week.

UniCredit Under Threat?

At the heart of the forex lending (and exposure) in the East lie a small number of major banks whose head offices are to be found in large cities in the core countries of the EU (Western) old guard. Among these, indeed in pride of place here, comes Italy's Unicredit . (See my longer post on Unicredit here). Now it is true to say that Unicredit's Polish subsidiary - Bank Pekao - is relatively immune to the forex lending problem, since it refused to offer mortgages in foreign currencies, and its loan-to-deposit ratio at about 90 percent (compared with an average of about 110 percent for Polish banks generally) is fairly healthy. These features and a capital adequacy ratio of around 11 percent should offer Pekao a reasonable buffer going into the slowdown, but this is not the same thing as an absence of risk, since any serious deterioration in operating conditions inside Poland will affect PLN loan default rates as well as Fx ones, although evidently the banks with fx loan exposure are much worse positioned.

Concern about the position of the entire Unicredit group has been mounting steadily of late, as witness be the latest research report from Moody’s Market Implied Ratings group, which highlighting nagging doubts many observers have over the degree of the bank’s exposure to Central and Eastern Europe. The note, written by analyst Lisa Hintz, suggests UniCredit’s CDS-implied rating of A1 may well be “an overly optimistic signal of the bank’s level of credit risk”.

UniCredit largely avoided the proprietary trading and structured product problems suffered by the other large European banks. However, the financial problems arising from the economic downturn, such as imbalances, could cause deterioration in UniCredit’s loan portfolio, and we do not believe this is reflected in the trading levels of its credit default swaps.

UniCredit’s CDS-implied rating is A1, down three notches from a recent high of Aa1 and one notch below its senior unsecured rating of Aa3. We still see this as an overly optimistic signal of the bank’s level of credit risk, in that it doesn’t capture UniCredit’s comparatively thin level of capitalization and heavy exposure to Central and Eastern Europe. This exposure came after a rapid expansion which has left the bank with an unseasoned loan portfolio.

Loans to Central and Eastern European clients made up 13% of UniCredit’s assets at the end of 2007. These made up an even greater portion of its revenue—21% in the third quarter, and at the top of the list in both cases - see charts below - comes Poland. Fortunately no one is suggesting that the level of loan defaults might be anything like the 60% anticipated in Ukraine (or Russia??, both of which fortunately make up a much smaller part of their portfolio). This CEE activity means UniCredit leads its rivals Austria's Erste Group Bank and Raiffeisen International, France's Societe Generale, Belgium's KBC and Hungary's OTP in terms of both emerging European assets and exposure.

Indeed, UniCredit fell again in Milan today, after the Italian central bank warned yesterday that bank lending is declining and interbank liquidity is insufficient. UniCredit dropped as much 6.5 percent to 1.26 euros, the lowest intraday price since May 13, 1997, and traded at 1.29 euros as of 9:55 a.m. local time. UniCredit shares have now fallen 77 percent since January 2008. The Bank of Italy said yesterday there has been a “significant deterioration” in the general economic scenario and that “lending growth continues to decelerate” because of the high cost of funding for banks. “The situation just seems to keep spiraling in a negative way and if confidence in and among banks doesn’t return there’s no easy way out,” said Giulio Baresani Varini, head of investments at Banca MB SpA in Milan.

Meanwhile UniCredit Bank Austria AG, Austria’s biggest bank, plans to decide whether it will ask for Austrian state aid as part of the national bank bailout programme by the end of March. “We plan to make a decision by the end of the first quarter,” Chief Executive Officer Erich Hampel told journalists in Vienna today. Hampel said in December that Unicredit Bank Austria would need “about 2 billion euros” to increase its Tier 1 ratio, a measure of financial strength, to 9 percent from 7.6 percent at the end of Sept. 30.

But of course it isn't only Unicredit and its subsidiaries who are affected. BRE Bank SA fell to a three-month low on the Warsaw stock exchange this morning, leading Polish banks lower, as loan provisions and losses on derivatives cut into fourth-quarter earnings. The bank - which is a subsidiary of Commerzbank AG - slumped as much as 16.3 zloty, or 10 percent, to hit 146.9 zloty before recovering to 147 zloty at 10:32 a.m. in Warsaw, the lowest level since Oct. 27. The benchmark WIG20 Index was down 3.2 percent and has fallen 8 percent so far this year. The index slumped 48 percent last year, posting its biggest annual decline since its creation in 1994.

Despite 2008 being the worst year in a relatively short history of Polish equity market, with WIG20 down 48% we are not looking for a turnaround in 2009. The performance of the Polish market should still be strongly influenced by global markets which are likely to take some time to recover given the scale of a global macro slowdown not seen since 1945. The illness appears to be very serious and you simply need time to properly recover. We expect the WIG20 index to be down this year by some -10% to -15% (driven largely by expected weak performance of the banking sector).
Polish Equity Market Monitor - Citi Poland - January 2009

So Just What Are The Chances Of A Polish GDP Contraction In 2009?

Well the chances of a contraction of some order in Poland in 2009 are non negligible in my opinion. We are evidently not talking here of something of the order of the Baltics, Romania and Ukraine, or even of the order of Hungary, but still the extent of the slowdown in Poland (or the Czech Republic) should not be underestimated. Average corporate wages rose at their slowest pace in since November 2006 last month, suggesting economic growth is slowing more sharply in the wake of the global financial crisis than many seem to think.

The latest central bank forecast suggested that Poland’s economic growth will slow to 3.7 percent this year from about 5 percent in 2008, but this is very optimistic, and far from everyone agrees. Citi Poland come in with a much lower forecast, and in my opinion a much more reasonable one.

The Polish economy is not immune from global disruptions and an incoming and unavoidable slowdown is already visible. The question is when we will see the recovery. The answer is not easy as so far we have not yet seen the weak GDP numbers which are just around the corner. Looking back at the most recent slowdown during 2000-2003 period we observed 10 consecutive quarters GDP numbers below 2.5% and within that 5 sequential quarters when GDP growth came below 1%. However, this time the most recent 3Q08 GDP number came in at 4.8% so we see a lot of bad macro news ahead of us.

In 2009 we expect GDP growth slowing to 1.4%, driven predominately by deterioration in investment growth as banks started to be very restrictive in lending while corporates are looking for savings and are rather rapidly scaling down investment programs.
Polish Equity Market Monitor - Citi Poland - January 2009

I would go somewhat further. I think it is perfectly possible to see a recession in Poland at some point in 2009, not necessarily a strong one, but a recession just the same.

Poland To Consider Interbank Guarantees As The Forex Lending Crisis Deepens

2008-10-27T12:37:00.000+01:00

Well, it's been a few weeks now since I posted on this blog, but I have a feeling that this situation may now be about to change. Pressure on Poland's economy is mounting as the clutches of the global credit crunch start to make their grasp and reach felt.

Stocks In Decline

Central European stocks declined for a fourth consecutive fourth day today, with indexes in Vienna and Budapest heading for record monthly drops, on mounting concern that the global financial crisis is going to have a severe impact on economic growth in the region and that the IMF sponsored rescue packages in Hungary and Ukraine won't avoid the worst of the damage. Concern is also mounting that the problem will affect the whole region, and hence the mounting pressure on Poland's rather stronger economy. If Poland falls, god help the rest of them.

Erste Group Bank AG slid to the lowest level in more than five years while Raiffeisen International Bank Holding AG, which operates in Russia and the Ukraine, plunged after mounting financial chaos forced Ukraine to seek help from the IMF.

Poland's WIG20 Index added 2.2 percent today following a 5.9% fall on Friday. The MSCI Barra Core Index (which is a measure of comparative equity values) is down 48% so far this month, and 61.24% over the last three months.

The Polish government has also announced today that Poland is considering guaranteeing interbank transactions, according to Deputy Prime Minister Waldemar Pawlak speaking on Polish public radio this (Monday) morning. Pawlak said that the government is examining the possibility of taking bank shares as collateral for the guarantees. Foreign investors in Polish banks have applied policies that are too strict in Poland, though credit problems have not affected Polish banks, Pawlak said .

According to the draft of a new law which is set to go before cabinet tomorrow (Tuesday) Poland's government will be empowered to guarantee commercial banks loans from the central bank and other lenders on the interbank markets. The government will also be able to lend cash and state securities to banks.

Poland's central bank injected 9.3 billion zlotys ($3.42 billion) of liquidity into the banking sector last week, in the form of 14-day repos. The decision was taken in order to try to ease strains on the Polish money market. The bank said it had accepted all bids worth 9.267 billion zlotys, at an average rate of 6.16 percent, 16 basis points above the main policy rate, with state bonds used as collateral. The minimum rate at which the central bank lent money to banks was 6.15 percent, while the maximum at 6.25 percent.

Poland's deputy prime minister also warned that local bank capital was at risk of capital being transferred to their financially-strapped foreign owners and urged the country's watchdog to stay vigilant.

"There is a risk that the capital will be transferred from Polish institutions to their parents," Waldemar Pawlak, who is also the economy minister and heads the governing coalition's junior party, was quoted as saying by PAP newswire.

The Financial Oversight Commission (KNF) has asked banks domiciled in Poland to report all transactions with their foreign owners daily. In a newspaper interview last week, the head of the KNF, Stanislaw Kluza, said the risk of capital transfers was very low, however, because Polish banks, with $284 billion in total assets, were too small to rescue large players in Europe and the United States. This is evidently true, but some of these bank are now under great pressure to avoid additional exposure in the east, and movement of funds can equally correspond to this strategy.

Foreign financial groups, among them Italy's UniCredit, the Dutch ING Groep, and KBC Group NV, Belgium's biggest bank and insurer by market value (all of whom are struggling with major problems at the present time), control two-thirds of the Polish banking sector after buying stakes in local lenders during the banking sector privatisation of the 1990s.

Polish lenders have been especially hurt in recent weeks by concerns over their ability to obtain foreign currency through interbank markets and worries about the fate of their foreign parents. Executives at some Polish banks have urged the government to consider introducing guarantees after the central bank's moves to boost liquidity on the interbank market, including foreign exchange swaps, failed to boost confidence between lenders. The financial watchdog KNF said on Saturday that Poland should think about measures to boost the Swiss franc positions of Polish banks, along with guarantees of interbank transactions or an eventual "institutionalisation" of the interbank market. But the regulator, the government and central bank insist Polish banks remain solvent and enjoy "over-liquidity."

Many of Poland's banks, like other lenders in the region, have been forced to introduce severe curbs on mortgages in Swiss francs due to pressure on their own liquidity and balance sheets. Such lending had become popular in Poland in recent months due to lower interest rates available from Switzerland and what was once favourable exchange rate.

Millennium BIGW.WA and PKO BP PKOB.WA, two of Poland's top home loan lenders, have gone so far as to announce that they were going to tighten rules for new mortgages due to the rising cost of money and fears that global financial nervousness may lead to much slower economic growth in Poland. Millennium Chief Executive Boguslaw Kott said last week that the group - which is Poland's third-biggest mortgage lender would ask for a 35 percent downpayment for popular Swiss francs-denominated home loans, a move which is likely to put a sharp brake on the growth of its mortgage portfolio.

PKO, Poland's largest mortgage lender, also confirmed it would ask new clients to put up 20 percent of the value of property when borrowing in francs. Millennium, which is controlled by Portugal's Millennium bcp, will now also require customers to cover 20 percent of investment when borrowing in Polish zlotys. Both banks had previously been offering mortgages equal to the entire value of the new home (100 LtV). Basically, what the hell these people thought they were doing by continuing to lend at 100% LtV after we have seen all that has happened in the US, and that is now happening in the UK and Spain is totally beyond "my ken", it really is.

Chief Executive Boguslaw Kott described the move as a precautionary one, and said it did not reflect any liquidity problems, adding that it was now more difficult to get Swiss francs on the interbank market. Marek Juras, head of research at BZ WBK brokerage is quoted as saying: "At times like these it is more important for banks to take care of their liquidity than drive their sales even higher." He estimated that for some lenders this would translate into a drop in new mortgages by between one-third and one-half.

The two market leaders join other smaller lenders, which in recent days moved to raise the bar for mortgage lending in foreign currencies as banks become more conservative and try to lure more cash on deposits by offering even higher yields. Mortgage adviser Expander said Getin's DomBank and Santander and GE Money had tightened their lending requirements. Many banks have also boosted margins on their mortgages in the past two weeks.

The Polish mortgage market has expanded rapidly since 2003, driven by economic growth and soaring wages, with annual growth exceeding 40 percent in the first half of this year. Large numbers of central and Eastern European housebuyers hold loans in foreign currencies, especially Swiss francs.

Most major Austrian banks, including UniCredit's Bank Austria, Erste Group Bank and cooperative Raiffeisen have now completely stopped lending to Polish domestic retail customers in foreign currencies.

After a meeting with economic advisers President Kaczynski advised Poles to keep faith in the zloty as the currency suffered further setbacks on the markets on Friday. Kaczynski recommended that loans should be taken in zlotys, not foreign currencies in order to avoid losing money on currency exchange.

"The depreciation of the zloty, which has its good sides for exports, boosts
mortgage loan installments for those who took them especially in the Swiss
franc. This may, however, be a lesson to us all to take loans in the Polish
currency. Considering low inflation, this gives the best results," Polish
President Lech Kaczynski told a press conference last Friday.

Seventy percent of the Polish banking sector is owned by foreign banks leading to concern that the impact of the general crisis in the banking sector will be felt in Poland. On Tuesday, Polish business Daily, Gazeta Prawna wrote, "The global financial crisis may cause large shifts in the Polish banking sector, AIG Bank Polska will soon be sold and there has been speculation that Fortis, Dominet, Citi Handlowy and even Bank Pekao may change hands."

Sell off speculation has surrounded the Italian owned Pekao bank over the last two weeks. It was subject to a 20 percent share price decrease in October prompting concerns that owner UniCredit may have been considering selling of all its Central and Eastern European assets. This has since failed to materialize but shows the current lack of faith surrounding the Polish banking sector.

Slawomir Skrzypek, president of The National Bank of Poland stated it had no intention of stepping in to help the zloty as it continues to weaken on the foreign currency market in a statement to reporters on Friday.

The sale of apartments in Poland has dropped by 70 percent in comparison to the same time last year, showing that the credit crunch is beginning to bite in Poland. The tightening of lending policies by banks has caused demand to fall and though prices are decreasing by 10 to 20 percent in some areas, buyers are looking for smaller flats, or withdrawing from the transaction altogether. The financial crisis has also influenced the situation of those clients who wanted to buy apartments without needing to get a mortgage, the number of which is declining due to losses on the stock market, says Gazeta Prawna.

Polish banks are to crack down on credit lending for housing loans after Poland’s financial regulator asked them to get tougher on lending practices. Millennium bank is one of the first high street banks to react and will now expect customers to cover 35% of the loan if they borrow in a foreign currency or 20% if borrowing in Polish zloty. The move is thought to be a precautionary one and not an indication of any liquidity problems, according to CEO Boguslaw Kott who told a news conference on Tuesday, “The decision practically blocks an increase of our mortgage portfolio.” He also told reporters that Swiss francs are harder to come by on the interbank market. Millennium Bank has been a dominant force in the Polish housing lending market with 80% of its mortgages being in Swiss Francs. This reflects a trend across Central and Eastern Europe where many house buyers have loans in either Swiss or other foreign currencies.

PKO BP, another major Polish mortgage lender, has joined Millennium in giving credits up to 80% of the value of the real estate. Fears that the Polish housing market could suffer similar repercussions to that of some western banks are as yet premature although the move does indicate a degree of uncertainty on behalf of the lending sector’s big hitters.

"We are extending between 35 and 60 million zlotys worth of mortgages each day, the vast majority of those in Swiss francs." Mariusz Grendowicz Head of BRE Bank BREP.WA "To fund our growth in mortgages, we were the only bank to the best of my knowledge that was using not swaps, which were the cheapest alternative, but actually taking a three- to four-year loan in Swiss francs to fund the book,"

The impact of the seize up in Swiss Franc housing loans is hard to guage at this point, although all the indications are that it will be serious. Foreign currency lending has not been such an important phenomenon in Poland as it has been in other CEE countries, but its weight has been growing in the last 18 months or so (see chart below).

The role of forex lending is clearly more important in housing loans than in general lending (see chart below).

One of the reasons for the recent uptick in Swiss Franc lending has been the monetary tightening cycle initiated by the central bank (see chart below), which made the cheaper interest rates available in CHF more attractive even though there was an evident currency risk involved.

If we look at the next chart the year on year rate of increase in the forex loans (the Polish central bank don't distinguish in their data between CHF and Euro, but all the anecdotal evidence cited above points to a significant role for the CHF, and especially given the role of Austrian banks were this type of lending has been commonplace.

The big problem is really that the CHF is a "carry trade" currency, and carry currencies have a strong tendency to shoot up in value as risk sentiment retreats, quite simply because people all try to liquidate their positions at the same time. Hence carry currencies have a kind of "pro-cyclical" role, adding to the boom during the good times, and making the bad times even worse. Which would be one very good reason why if you really do want an fx mortgage, using a currency other than a carry one would be a good idea. Obviously those who have euro denominated mortgages - while not being immune from the present problems (see the Baltics) - are less exposed, since the movements in the relative value of the euro tend to be in the opposite direction to those of the CHF and the Japanese yen.

Where Does All This Leave Us?

Well obviously Polish GDP growth is now set to slow quite dramatically. At this point just how dramatically is hard to see. Credit Suisse Group recently cut its forecast for Polish economic growth next year, predicting that the global financial crisis will hurt consumption and investment.

Credit Suisse said Poland's gross domestic product will rise by less than 4 percent in 2009, compared with the 4.4 percent rate it had previously forecast, according to a note to clients last week. The revision, amid rising aversion to risk in emerging markets, pushed the zloty to a two-year low against the euro. I think, basically, even Credit Suisse are being over optimistic at this point, although I think we need to see some real economy data before putting numbers on just how over-optimistic they may be.

Poland's `` private consumption and investment should fall further than we had anticipated due to our expectations of an increasingly restrictive credit environment in 2009,'' Jacqueline Madu, an emerging-markets research analyst at Credit Suisse in London, wrote in the note.

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One of the first areas where we should expect this crunch to be felt is in construction activity itself. There is no doubt that Poland has been "enjoying" the fruits of a construction boom since the second half of 2006. It seems to have come in two "waves" if we look at the chart below, with the first wave being much stronger than the second one.

If we actually look at the level of the seasonally adjusted index, then the steep increases in the levels of construction output become apparent. We should also notice how since about April the level has stopped rising, and this seems to suggest that the expansion in the industry had been slowing even before the latest credit shock. Be ready for this to be followed by a sharp slowdown in the months to come.

If we look at the chart for year on year industrial activity, then it is clear that the expansion in output has been fading for months now - not a good sign, not good at all, since it means that there is little underlying stability to resist the knock. The thing is running out of energy.

This becomes evn clearer when we look at the seasonally adjusted index, since it is pretty clear to see that industrial output went into decline at the end of last year, killed off in part by a high zloty, and in part by excess internal wage and cost push inflation.

Poland's Central Bank Leaves Rate Unchanged

2008-08-27T17:50:00.001+02:00

Poland's central bank left its benchmark interest rate unchanged for a second month as it assesses whether eight increases in the past 16 months have been enough to keep inflation within the limits it requires. The Narodowy Bank Polski kept its seven-day reference rate unchanged at 6 percent this week, although it did stress that further monetary tightening may be needed to bring inflation down to the target.

Slowing industrial output and retail sales indicate economic growth is itself slowing, and the bank takes the view that this, and the recent decline in global oil prices should reduce pressure on inflation after consumer prices rose at a rate of 4.8 percent in July, the highest level in eight years.

The bank said today that recent data showed the economy was gradually slowing while wage growth still remained strong. The central bank expect the inflation rate to stay above their 1.5-3.5 percent target range in the coming months, and indeed they have now been struggling for some 10 months get the rate down to their 2.5 percent target midpoint.

Polish Wages Continue To Rise Strongly In July

2008-08-18T16:28:00.000+02:00

Polish average corporate wages rose more than 10 percent for a seventh consecutive month in July, suggesting that interest rates will be raised in the future. Wages rose an annual 11.6 percent to 3,229 zloty ($1,425), compared with a 12 percent rate in June, according to the Central Statistical Office today. Wage growth has been the main gauge of inflationary pressure by the Narodowy Bank Polski, which has so sar boosted its benchmark rate eight times since April last year, to the current rate of 6 percent.

Employment was up 4.7 percent from a year in July, and rose 0.2 percent on the month. Unemployment is thought to have fallen to 9.4% in July, down from June's 9.6%. Poland's inflation rate rose in July close to a seven-year high as accelerating wage growth spurred consumer demand. The annual rate rose for a third consecutive month to 4.8 percent from 4.6 percent in June.

The inflation rate may rise in August to as high as 5.1 percent, according to the central bank forecast.

Where Now for CEE and Baltic Currencies?

2008-08-06T15:15:00.001+02:00

By Claus Vistesen: Copenhagen

Ever since the illusive credit turmoil began sentiment in the market place has been fickle and essentially, like the assets of which it consists, volatile. We started off with an adamant focus on downside risks to growth which then turned into a focus and fear of inflation. Now, as the cyclical data has turned for the worse in Europe and many places in Asia the focus seems to be reverting to growth. Now, I won't go into the whole decoupling v recoupling discussion at this point since I think that this dichotomy is a false one. It never was about de-coupling à la traditionelle but moreso about two interrelated points. The first would be the extent to which the world already has decoupled from the US in the sense that a key group of emerging economies are now set to ascend in economic prowess. The second would be the extent to which the de-coupling thesis always built on a fallacy. The main point would be that the main fault line of slowdown was observed across economies with external deficits; something which, I am sure most will agree, is sure to impact surplus economies too.

Now, that does not completely let the ECB off the hook since by maintaining a focus on inflation it also assumed the role, if only temporary, of the new anchor in a re-wamped version of Bretton Woods II as the Euro ascended to new highs. This bet on global re-balancing was always going to end in tears and in this light the Eurozone could not decouple from the US; that much, I think, is true.

The key issue here however, as I have argued time and time again is represented in two crucial interlocked questions which together form a key structural trend in the global economy. One is what happens when the surplus economies slow down and there is not sufficient demand to pull the economy back up? Demographics and a high median age are key variables to watch in this regard. The second question is the extent to which hitherto deficit nations can turn the boat around and increase savings (i.e. rely more on exports) and what it will mean for global capital flows when they begin this process?

In the context of the CEE economies the themes above are also present. In a recent note I detailed the change in sentiment from growth to inflation and what it might mean for Eastern Europe's economies and their respective currencies. The key situation as I sketched it was one of a dilemma.

On the one hand, the rampant inflation levels suggest that the exchange rate be loosened to allow appreciation and thus pour water on the roaring inflation bonfire. On the other hand however the Baltics, as well as many other CEE countries, are saddled with extensive external deficits financed by consumer and business credit denominated in Euros. It is not difficult to see that this represents a regular vice from which it will be very difficult to escape since as long as the peg remains deflation seems the only painful alternative as a mean of correcting.

(...)

Another point which is specifically tied to Eastern Europe is that if domestic nominal interest rate increase to keep up with inflation rates it will have a strong substitution effects towards Euro denominated loans. This can become a dangerous cocktail should the tide turn against the currencies.

Now that the focus seems to be changing back again it appears to be a good time to revisit the situation

Within this global nexus of what exactly to do with inflation relative to growth, many Eastern European economies has so far opted to go for inflation by raising interest rates. At an initial glance this seems quite reasonable and in many ways the CEE central banks merely latched on to market sentiment and expectations that many emerging economies would seek to use nominal appreciation as a tool to flush out inflation.

Consequently we have seen how both Ukraine and Hungary have chosen to loosen the peg to the Euro as well as other floating currencies in Eastern Europe have seen their yield advantage increase in an attempt to flush out inflation. This has not been without problems though or more specifically it is not clear that an appreciation of the currency is all for the good. Two points here would seem particularly important. One is the simple question of whether in fact an appreciation is deflationary in a world where capital flows, and in particular the hot kind, act strongly on yield. However, another point would be specifically tied to the situation in Eastern Europe. As such, nominal appreciation of the currency also increases the purchasing power which is not what many CEE economies need at the present time as they stand before the task of correcting a rather large external balance. Moreover, rising domestic interest rates will increase and exacerbate the credit channel by which loans denominated in Euros and Swiss francs become more attractive. I have shown this to be true, for example, in the context of Lithuania. The important thing to do note here would what would happen to the servicing of these liabilities should the domestic currencies depreciate.

What happens next then? Or more concretely, even though CEE currencies, in general, have enjoyed a rally on the back of market expectations of nominal appreciation fed by hawkish central banks what happens if and when central banks reverese course?

An initial warning shot across the bow was handed to us as the governor of the Czech central bank mused that he might lower rates come next meeting due to the strenght of the Koruna and the subsequent effect on exports. Also Poland recently opted to abandon the hawkish stance as rates were kept steady. In light of this event Macro Man managed, as ever, to hit the proverbial nail on the head.

There is little more bearish for a currency these days than abandoning the inflation fight in a pursuit of growth; this is particularly the case when the market is heavily positioned the other way.

This is exactly the issue which now confronts many Eastern European economies. What to do as growth visibly tanks at one at the same time as inflation stays high. One thing here would be for the central banks to hold their raising cycle which in itself should ease the pace of appreciation but what if they need to lower rates.

Now the numbers above do not, in themselves tell anything remotely interesting. For one, the difference between the economies are quite big. For example the Czech Republic has been able to gain, with a comparatively low interest rate, currency appreciation which has actually helped the external balance in so far as it has made imports cheaper. Obviously, at this point the benign effect on the trade balance is just as much down to decreasing domestic demand as the value shield of a dear currency. On the other hand, if we consider especially Ukraine, Romania, and Hungary the price has been dearer and the subsequent effect on inflation less pronounced. One could always argue that the situation would have been much worse, but one thing is certain; the ensuing loss of competitiveness has not been compensated for with a decrease in inflation. And one has to wonder whether pushing nominal interest rates ever higher would be a sound solution.

The key here is that these high interest rates carry with them a high lock-in premium which makes it difficult to reduce them without causing substantial pain to the currency. Add to this that as long as interest rates stay in this territory the incentive to borrow in foreign currency remains very appealing. In fact, the incentive structure here is quite disruptive as many of these economies have higher rates on domestic currency deposits and lower rates on foreign credit. This incites consumers and companies to place their deposits in local currency while funding themselves in foreign currency. Finally, there is of course the more standard economics 1-0-1 point that whatever nominal rate is ascribed to a currency and an economy the latter needs to be able to provide the structural demand for which to satisfy the yield. Otherwise you just pour more gasoline on an already raging bonfire.

Obviously, as long as the local currency remains strong and on an upwards march or the trading band is kept in place the show goes on. But the longer this structure lingers the more difficult it will be to break free; and break free they must since I am quite sure that Eurozone membership is off, for the immediate future at least.

Another more hard hitting point would simply be that whatever growth momentum these economies had going into 2008 it is now steadily levelling off. Now, these economies need to rebalance their external accounts at the same time as they labour under the yoke of slowing growth, high interest rates which are difficult to reduce and/or a quasi fixed exchange rate to the Euro. Can you feel the chilling cold of deflation blowing across the Urals? I can.

Basically, the past years' rapid process of nominal convergence will now need to be kicked into reverse, since it is quite obvious that many CEE economies have been riding a blade too tough.

Be Careful Indeed

Last time I massaged this specific topic I summarised by ominously stating that the CEE economies and their central banks should be careful what they wished for in terms of using higher interest rates and subsequent nominal appreciation of their currencies to flush out inflation. The key point was that the effect would likely be limited and only further worsen the imbalances in the economies. And thus, here we are.

Another more subtle point in the context of market reactions would be the boomerang effect which comes from the currency appreciation as interest rates are increased (and the peg/band abandoned) to the subsequent plunge when the economic tide turns. In line with the change in global sentiment towards growth and deflation (see e.g. here) and the fact that other hitherto strong yielders (e.g. the Kiwi and Aussie) are beginning to falter we may be at an inflection point in the whole discourse of upwards movement in CEE currencies. Stephen Jen's recent tour of global FX markets is a fine addition to this argument.

As ever, this is obviously still a dilemma for most of these economies since inflation continues to rage ahead. In Romania for example the PPI rose at its highest pace since 2004. However, as long as the credit tap stays open and as long as the purchasing power is increasing so will the the demands for higher wages stay strong. This is particularly true in the context of the CEE economies as these are in possession of structurally broken population pyramids after two decades worth of lowest low fertility and, in the cast of the latter decade, net outward migration.

The main point I would like to emphasise here is that correction is coming and that it will only become harder the higher the currencies move upwards. In a more general light this correction will not be a small one and it most certainly will not be felt exclusively in Eastern Europe. Basically, the big hidden data point in all of this is the dependence of Germany on CEE imports. So far, this has moved along just nicely but Germany is in for a rude awakening once the link breaks ... and break, I am afraid, it will.

Polands Central Bank Holds Interest Rate Steady In July

2008-07-30T19:08:00.000+02:00

Poland's central bank kept its benchmark interest rate unchanged today as the economy slows and it anticipates inflation falling back. The Narodowy Bank Polski left the seven-day reference rate unchanged at 6 percent, after previously raising it four times this year.

The Monetary Policy Council has been struggling for nine months to bring down the inflation rate, at a four-year high of 4.6 percent in June, to its 2.5 percent target. Slower-than expected employment growth, retail sales and industrial output in June indicate the economy is losing steam and the central bank said this may damp inflation. Annual wage growth in Poland's corporate sector accelerated to 12.0% in June, above forecasts and up from a 10.5% rise in May. On the month,average wages were up 4.8%, following a 2.2% monthly decline in May. Total employment at firms with more than nine employees was running at 5.39 million in June, up 4.8% on the year. That annual rise was below the February peak of 5.9%, and suggests job creation in Poland is now starting to slow.

The economy expanded an annual 6.1 percent in the first quarter, down from 7.3 percent at the beginning of last year and 6.4 percent in the fourth quarter.

The 10.8 percent rise of the zloty against the euro, which has converted the zloty into the world's second-best performing emerging market currency this year, has also helped keep inflation in check. The June inflation rate of 4.6 percent was driven mainly by a 3.3 percent monthly gain and an annual 7.5 percent advance in fuel prices, which policy makers cannot control.

Momentum In Polish Retail Sales Slightly Weaker In June

2008-07-25T13:03:00.000+02:00

Polish retail sales rose at their slowest rate this year in June, suggesting that the increase in consumer demand may now be slowing enough to allow monetary policy makers to pause before raising rates again. Retail sales rose at an annual 14.2 percent rate, compared with 14.9 percent in May. The monthly increase was 2.4 percent, after a 1.9 percent decline in May, the Warsaw-based Central Statistical Office reported today. The pace of retail sales growth has now halved since February in real terms.

Policy makers at the Polish central bank have lifted borrowing costs by 2 percentage points since April 2007 as wage growth and higher consumption have kept the inflation rate above the central bank's target of 2.5 percent for the last nine months.

Poland's June Industrial Output Rebound and Tame Producer Prices Lower Rate Rise Prospects

2008-07-19T17:14:00.000+02:00

Expectations the Polish central bank would increase rates in the coming months eased back slightly this week following better than expected producer price numbers, and a rebound in industrial output which was lower than analyst expectations. And this despite the fact that consumer price inflation continues stuck significantly above the banks target.

According to data released by the Polish statistical office Poland's industrial output rose 7.2 percent year-on-year in June (see chart above), while the rate of increase in producer prices held constant at 2.7 percent year-on-year (see chart below).

Folllowing publication of the data Monetary Policy Council member Andrzej Slawinski is quoted as saying that the level of interest rates would now largely depend on the zloty.

"What is going to happen with the interest rate level will largely depend on the changes in the zloty exchange rate," Slawinski, seen as a moderate on the 10-member MPC, speaking to TVN CNBC.

The zloty - which was little changed after the data - has gained almost 4 percent against the euro in July alone and is up more than 10 percent since the start of the year.

Poland's Monetary Policy Council has raised rates eight times since April 2007, bringing the key rate to the current 6.0 percent in response to the booming economy, growing inflation and a tight labour market.

June consumer inflation stood at 4.6 percent year-on-year, above the central bank's 2.5 target.

However, not everyone is convinced about the inflation outlook, and Halina Wasilewska-Trenkner, a hawk on the 10-strong policy panel, told daily Rzeczpospolita during last week that although the zloty was probably too strong it was difficult to determine the level of excess, and hence the bank should continue to tighten monetary policy.

"Maybe growth is not as dynamic as last year but it is still robust growth," she said.... "I think that in the second quarter it could have been at about 5 percent but there is still a chance that the result for the whole year will be slightly higher. I believe that we should tighten monetary policy more,"

Also monetary policy maker Dariusz Filar argued on Friday that the Polish central bank should immediately raise its main interest rate by at least a quarter of a percentage point to cap inflation. The new core inflation rate, introduced three months ago, and which strips out food and fuel prices (thus giving a better reading on the state of domestic demand) - was probably a "bit too high'' in June (at 2.2 percent) and thus Narodowy Bank Polska's 6 percent seven-day reference rate was not enough to adequately cap price growth.

``That's why an immediate reaction is needed,'' Filar said in an interview on Friday in Warsaw. ``Waiting too long with a change of interest rates may cost us in the future in the form of a higher inflation rate.''

Central bank policy maker Halina Wasilewska-Trenker has also added her voice to the debate. Wasilewska-Trenker stated in an interview with a Polish news agency this weekend that Poland's 6 percent interest rate should be raised as slower-than-expected industrial output data last month provided no proof of an economic slowdown. ``Eonomic growth is still robust,'' ....Poland is ``far from a rapid slowdown,'' she added.

Monetary Policy Council member Marian Noga also feels the Polish central bank should raise interest rates even as economic growth slows because accelerating inflation is only going to prompt demands for higher wages. Noga alos expects freeing energy prices as of next year will drive up inflation to almost 5 percent in January before slowing to below 3.5 percent in the middle of 2010.

``The faster-than-expected economic slowdown would have dismissed the need for interest rate increases if wages hadn't risen at such a quick pace,'' said Noga in a July 18 interview. ``Since second-round effects have emerged, policy tightening must be continued.''

``We realize that our decisions impact on the zloty but it can't be an obstacle for us,'' Noga said. ``It's not the zloty behind the slowdown, but the weakening global economy.''

Poland's Monetary Policy Council has ten members in total.

Polish Inflation Ticks Up In June 2008

2008-07-16T09:50:00.000+02:00

Poland's inflation rate accelerated in June and reached a four-year high as fuel, alcohol and tobacco prices all surged. In my opinion the chances the central bank will lift interest rates again sooner rather than later has just risen. Poland's annual inflation rate rose to 4.6 percent from 4.4 percent in May according to the latest data from the Warsaw-based statistics office.

Poland's Monetary Policy Council have raised borrowing costs eight times in the past 14 months as accelerating wages and falling unemployemnt have fuelled consumption and kept inflation above their 2.5-percent target since last October.

Polish Central Bank Raises Interest Rates (June)

2008-06-26T11:06:00.000+02:00

Poland's central bank raised its benchmark interest rate by a quarter of a percentage point yesterday. The rate now stands at 6 percent, the highest in three years, as record oil prices and rising consumer demand threaten to push up inflation. Polish policy makers have increased borrowing costs eight times since April last year while the inflation rate almost doubled.

The May inflation rate rose to 4.4 percent, the highest since December 2004, and has exceeded the central bank's 2.5 percent target for eight months. Annual consumer price growth may be as much as 4.7 percent in December, according to an updated central bank forecast.

Poland Retail Sales May 2008

2008-06-24T15:19:00.000+02:00

Polish retail sales rose more than many observers expected in May, adding to speculation that central bank policy makers will increase interest rates tomorrow as domestic demand continues to fuel inflation. Retail sales rose an annual 14.9 percent, compared with 17.6 percent in April, according to data from the Warsaw-based Central Statistical Office earlier today.

Demand for consumer goods, in part a by product of record high employment and the fastest wage growth in eight years, has been driving inflation in Poland, boosting the impact of the surge in oil and food prices. Inflation has remained above the central bank's target of 2.5 percent for eight months.

Poland's annual inflationrate rose to 4.4 percent in May, up from 4 percent in April. Consumer prices rose a monthly 0.8 percent, compared with a gain of 0.4 percent a month earlier.

Wages in Poland's corporate sector rose 12.6% on the year in April, above forecasts and up from 10.2% in March, according to data released Monday by the Central Statistical Office. On the month, April average wages fell 0.2%, following March's 3.7% monthly rise. The figures are preliminary and cover Polish companies with more than nine employees.

Total employment at firms with more than nine employees amounted to 5.39 million in April, up 5.6% on the year.

Poland's jobless rate declined to the lowest rate in almost a decade in April, falling for a third consecutive month as robust economic growth boosted hiring. Unemployment declined to 10.5 percent from 11.1 percent in March, according to the methodology used by the Central Statistical Office. About 1.61 million Poles were registered as unemployed at the end of April, the office said.

Using the EU harmonised methodology there were 1.313 million Poles unemployed in March (the latest month for which we have such data) and the seasonally adjusted unemployment rate was 7.7%.

Construction output was up by 22.8% in April.

Most observes feel that the central bank Monetary Policy Council will lift the benchmark seven-day reference rate by a quarter of a percentage point to 6 percent tomorrow. Policy makers have lifted the rate to 5.75 percent in seven increases since April last year, when the rate was at the record low of 4 percent.

The Polish central bank rejected a bid to raise the benchmark interest rate a quarter of a percentage point last month since policy makers said they wanted to see the bank's inflation projection which is due this month, according to the minutes of the rate-setting meeting.

``Most members of the Council decided that the full assessment of the risk of persisting inflation'' will be ``possible after the release of the central bank's June inflation projection,'' the bank said in minutes from the May 27-28 meeting. ``This argument justified, in their opinion, leaving interest rates changed.''

However there is one possible snag with the interest rate rising scenario. The question is, what impact will such a move have on the appetite among Poles to contract debt in euros rather than in zloty. There is a considerable market for non-zloty loans in Poland, although it is not at this point as extensive as the demand for forex loans in places like Hungary, the Baltics or Croatia, and the appetite for such loans this does not seem to have grown disproportionately vis a vis zloty loans (both have been growing very fast) in recent years.

And there has long been a healthy demand for non zloty mortgage finance.

But interestingly, if we come to look at the comparative year on year changes between the two possibilities in terms of mortgage finance, what we will see is that while the zloty loans were gaining ground when monetary policy in Poland was relatively loose, since the National Bank of Poland started tightening in a serious way last autumn, the situation has inverted, and the year on year rate of increase in forex loans has been accelerating, while the rate of increase in zloty mortgage lending has been slowing. If the Polish central bank needs to continue to tighten and the ECB (despite Trichet's most recent sabre rattling) starts to loosen later in the year, then it will be interesting to follow the comparative path here, since the position in Poland gives a pretty good birds eye view of the effectiveness of single country monetary policy (or its limits) in the context of today's globalised world.

Poland Inflation May 2008

2008-06-14T16:35:00.000+02:00

Poland's inflation rate rose in May to the highest since the end of 2004, increasing the possibility that the central bank will raise interest rates again as early as this month. The annual rate rose to 4.4 percent from 4 percent in April. Consumer prices rose a monthly 0.8 percent, compared with a gain of 0.4 percent a month earlier.

Poland's inflation rate has now been higher than the central bank's target for six consecutive months, a situation which has lead to seven increases in the key interest rate since April last year. The zloty rose to 3.3865 against the euro after the report before closing lower at 3.3900 in Warsaw. The prospect of rising interest rates is obviously liable to lead to zloty strengthening.

Polish Monetary Policy - A Hypothesis

2008-06-07T20:41:00.000+02:00

Poland's Monetary Policy Council left interest rates unchanged in May for a second consecutive month as it awaits more data on inflation and economic growth before making any further increases. Rate setters kept the seven-day reference rate at 5.75percent at their meeting this morning.

The central bank has raised rates seven times in the past year to curb inflation as rising salaries and record-high employment spur consumer demand.

The question is, what impact will this have on the appetite among Poles to contract debt in euros rather than zloty. There is a considerable market for non-zloty loans in Poland, although this does not seem to have grown disproportionately vis a vis zloty loans (both have been growing very fast) in recent years.

More specifically there has long been a healthy demand for non zloty mortgage finance.

But interestingly, if we come to look at the comparative year on year changes between the two possibilities in terms of mortgage finance, what we will see is that while the zloty loans were gaining ground while monetary policy in Poland was relatively loose, since the National Bank of Poland started tightening in a serious way last autumn, the situation has inverted, and the year on year rate of increase in forex loans has been accelerating, while the rate of increase in zloty mortgage lending has been slowing. If the Polish central bank needs to continue to tighten and the ECB (despite Trichet's most recent sabre rattling) starts to loosen, then it will be interesting to follow the comparative path here, since it gives a pretty good birds eye view of the effectiveness of single country monetary policy (or its limits) in the present globalised world.

Poland GDP Q1 2008

2008-05-30T22:34:00.001+02:00

Polish gross domestic product grew an annual 6.1 percent, compared with a revised 6.4percent in the previous three months, the Central Statistical Office in Warsaw said today. This rapid first-quarter growth may persuade policy makers to increase borrowing costs as a 10 percent gain in wages and record- high employment boost demand and inflation.

Domestic demand grew 6.3 percent, while consumer demand increased 5.6 percent. Investment rose 15.7 percent, construction gained 16.7 percent and production grew 6.9 percent, the statistics office said.

The Polish economy is expected to grow by "around 6 percent" in the current three-month period as domestic demand remains robust, Deputy Finance Minister Katarzyna Zajdel-Kurowska said.

The zloty strengthened to 3.3732 per euro as of 12:49 p.m. in Warsaw from 3.3790 yesterday. The yield on the benchmark five-year bond rose 2.9 basis points to 6.438 percent.

Polish Central Bank Leaves Interest Rates Unchanged in May

2008-05-28T14:36:00.000+02:00

Poland's Monetary Policy Council left interest rates unchanged in May for a second consecutive month as it awaits more data on inflation and economic growth before making any further increases. Rate setters kept the seven-day reference rate at 5.75percent at their meeting this morning.

The central bank has raised rates seven times in the past year to curb inflation as rising salaries and record-high employment spur consumer demand.

Poland's inflation rate unexpectedly fell back in April, a factor which has also evidently influenced today's decision. The rate slipped to 4 percent from 4.1 percent in March. Consumer prices gained 0.4 percent in the month.

Unemployment has been falling steadily, and using the EU harmonised methodology there were 1.313 million Poles unemployed in March (the latest month for which we have such data) and the seasonally adjusted unemployment rate was 7.7%.

Polish retail sales continued to grow at a healthy clip in April, if rather more slowly than in March, a factor which may well have influenced the central bank policy decision. Retail sales rose 17.6 percent from a year earlier and 2.9 percent from March.

On the other hand Polish industrial output growth accelerated in April, although this whole situation is clouded somewhat by the timing of easter this year, and the fact that April thus had more working days than March. Production rose an annual 14.9 percent, compared from 1 percent in March. Month on month, production was up 4 percent over March.

The zloty has gained 5.6 percent against the euro and 12.7 percent vis a vis the dollar this year, driven by strong economic growth, the prospect of euro adoption and rising yield differentials as the central bank has steadily raised rates.

The Polish government now forecasts that growth will slow to 5.5 percent this year from the decade-high 6.5 percent in 2007.

Central bankers are concerned that slowing growth won't prevent higher wages and employment from speeding up inflation. Average corporate wages rose an annual 12.6 percent in April, while employment increased 5.6 percent from a year ago. It remains to be seen whether the current policy rate will be sufficient to continue to hold back inflation given the vigour of the current expansion and the steadily dwindling pool of appropriately trained and educated workers.

Poland Retail Sales April 2008

2008-05-28T13:55:00.000+02:00

Polish retail sales grew more slowly than expected in April, a factor which may well influence the central bank policy decision later this morning. Retail sales rose 17.6 percent from a year earlier and 2.9 percent from March, the Warsaw-based Central Statistical Office said today.

Unemployment Poland April 2008

2008-05-27T14:27:00.000+02:00

Poland's jobless rate declined to the lowest rate in almost a decade in April, falling for a third consecutive month as robust economic growth boosted hiring. Unemployment declined to 10.5 percent from 11.1 percent in March, according to the methodology used by the Central Statistical Office. About 1.61 million Poles were registered as unemployed at the end of April, the office said.

Using the EU harmonised methodology there were 1.313 million Poles unemployed in March (the latest month for which we have such data) and the seasonally adjusted unemployment rate was 7.7%.

Poland Wages and Employment April 2008

2008-05-21T20:36:00.000+02:00

Wages in Poland's corporate sector rose 12.6% on the year in April, above forecasts and up from 10.2% in March, according to data released Monday by the Central Statistical Office, or GUS. On the month, April average wages fell 0.2%, following March's 3.7% monthly rise. The figures are preliminary and cover Polish companies with more than nine employees.

GUS said the average gross wage was 3,137.74 zlotys ($1,443.90) in April, down from PLN3,144.41 in March. The wage figures, despite slightly lower-than-expected April annual inflation of 4.0%, may support policy hawks on Poland's rate-setting Monetary Policy Council or RPP, pushing for a 25 basis points rate hike at the end of May.

April's industrial production data, out yesterday, will also be important in discussions on the next policy move.

Total employment at firms with more than nine employees amounted to 5.39 million in April, up 5.6% on the year. This slightly lower than expected employment rise may provide central bank "doves" with an argument for leaving the key rate at 5.75%.

Central Bank policy maker Halina Wasilewska-Trenkner will almost certainly not be one of these however, and she was out this week arguing interest rates should be raised immediately to help bring the inflation rate back toward the central bank's target.

Wasilewska-Trenkner said the inflation rate, which was 4 percent in April, will be around 3.5 percent and 4 percent at the end of this year, and won't fall below the 3.5 percent upper limit of the bank's target until 2010. She doesn't expect the central bank's June inflation outlook to change its tone from the previous forecast in February, which assumed slower growth of fuel prices and wages.

``There is still room for an interest rate increase'' and ``the sooner it happens, the better.....One or two hikes would be enough as the policy tightening cycle is about to end.......There is no point in waiting for the projection release to change rates as there are still forces in the economy driving inflation........ Dynamic wage growth, which won't be matched for another month by labor productivity, may denote that we have to deal with second-round effects and must intensively work to set up a barrier against further price growth.''

Fellow policy maker Andrzej Slawinski basically seems to agree with her:

``The worsening business climate due to weaker growth prospects and stronger zloty'' does not rule out ``further monetary tightening because of still double-digit rate of growth in wages,'' Slawinski said.

Fellow rate setter Marian Noga told TVN CNBC yesterday that he will vote in favor of a rate increase this month, while council member Andrzej Wojtyna said one boost can be made ``in the immediate future,'' the daily Rzeczpospolita reported yesterday.

The inflation rate, which has been hovering close to a four- year high, unexpectedly slipped to 4 percent in April from 4.1 percent in March as the advance of the zloty against the euro helped to curb import prices and growth in food prices slowed. The rate is still above the central bank's 2.5 percent target. The zloty has gained 5.7 percent against the euro this year and reached a more-than 6 1/2 year high of 3.3785 on May 14

The central bank has raised the key rate seven times in the past year to 5.75 percent in an attempt to damp inflation as a buoyant labor market, with salaries growing an average 10 percent, and record-high employment drive demand for consumer goods, but at some point the central bankers will begin to worry that raising interest rates and boosting the zloty may begin to undermine the competitiveness of Polish exports, and basically at that point the only real arm the Polish administration will have left is running a fiscal surplus to drain demand via that route out of what seems to be slowly becoming an "overheated" economy.

Poland Industrial Output April 2008

2008-05-21T15:32:00.001+02:00

Polish industrial output growth accelerated in April, which had more working days than the March, raising the prospect that the central bank may well raise interest rates to counter a pickup in growth. Production rose an annual 14.9 percent, compared from 1 percent in March, the Central Statistical Office said today. Month on month, production was up 4 percent over March.

Basically it is important to remember that Easter was in March this year, and this is playing havoc with non-working day adjusted data. But still y-o-y growth looks pretty robust at this point.

Poland Inflation April 2008

2008-05-14T23:02:00.000+02:00

Poland's inflation rate unexpectedly fell in April, raising the chances the central bank will hold interest rates steady in the coming months. The rate slipped to 4 percent from 4.1 percent in March, according to data from the Central Statistical Office in Warsaw. Consumer prices gained 0.4 percent in the month.

The April result was driven mainly by food price growth of 6.8 percent annually, regulated energy price gains of 7.2 percent and a fuel cost increase of 6 percent.

Slowing inflation adds another argument to keep interest rates unchanged after the Monetary Policy Council paused the tightening cycle last month following seven increases in the benchmark seven-day reference rate, as wages, industrial production and retail sales rose at a slower pace. The key rate now stands at 5.75 percent.

The 10-member Monetary Policy Council have lifted borrowing costs seven times in the past year to counter the effect of rising wages and strong consumption.

Poland's Central Bank Holds Rates

2008-04-30T15:46:00.000+02:00

Poland's central bank left its benchmark interest rate unchanged today, as policy makers seek signs the economy is slowing and argue that the zloty is strong enough to tame inflation for the time being. Rate setters held the seven-day reference rate at 5.75 percent.

The 10-member Monetary Policy Council have lifted borrowing costs seven times in the past year to counter the effect of rising wages and strong consumption. Policy makers' efforts to bring the inflation rate, at 4.1 percent in March, back to within its 2.5 percent goal may be aided by slowing retail sales and industrial output, but we need to wait and see I feel.

The zloty traded at 3.453 per euro after the decision, little changed from 3.449 in the morning and up from yesterday's close of 3.453. Yield on the government's two-year bond fell to 6.169 percent from 6.178 percent before the decision.

Average corporate wages rose an annual 10.2 percent in March, below the central bank's forecast, while the 15.7 percent annual advance in retail sales was the slowest in three months. These are still strong numbers however. Industrial output on the other hand rose an unexpectedly weak 0.9 percent. This may well be an impact of the rising zloty on the relative prices of home grown output.The zloty has gained 4.2 percent against the euro and 10.3 percent against the dollar this year so far, raising concerns that it may hurt exports and affect growth.

Poland Inflation March 2008

2008-04-15T15:11:00.001+02:00

Polish inflation unexpectedly slowed in March, raising expectations that the central bank may put interest rate increases on hold for the time being. The inflation rate declined to 4.1 percent from 4.2 percent, the Central Statistical Office reported today in Warsaw. Consumer prices gained a monthly 0.4 percent, the same as in February.

The inflation rate fell for the first time in seven months. The central bank-led Monetary Policy Council has increased the benchmark seven-day reference rate seven times in the past year to 5.75 percent, trying to bring the inflation rate down near its 2.5 percent target.

Poland Gross Wages March 2008

2008-04-15T14:54:00.000+02:00

Wages in Poland's corporate sector rose 10.2% on the year in March, below forecastsand down from 12.8% in February, data released Tuesday by the Central Statistical Office. On the month, March average wages rose 3.7%, following February's 2.1% monthly rise. The figures are preliminary and cover Polish companies with more than nine employees.

The wage figures, coupled with lower-than-expected March annual inflation of 4.1%, may delay the possibility of a quarter-point interest-rate hike by Poland's central bank at its meeting at the end of April.

The average gross wage was 3,144.41 zlotys ($1,458.65) in March, up from PLN3,032.70 in February. Total employment at firms with more than nine employees amounted to 5.38 million in March, up 5.8% on the year. That annual rise was slightly below the consensus analysts' average forecast of a 5.9% rise, but suggests Poland's economy is still adding jobs at a pretty fast pace.

Poland's Central Bank Raises Interest Rates to 5.75%

2008-03-26T17:19:00.000+01:00

Poland's central bank today raised its benchmark interest rate by a quarter of a percentage point to its highest level in three years in an attempt to stop inflation getting out of control. The Narodowy Bank Polski lifted the seven-day reference rate to 5.75 percent, the third consecutive increase and the seventh in the past 11 months.

The rate-setting Monetary Policy Council has so far failed in its bid to contain price growth after the inflation rate breached the upper end of its 1.5 percent to 3.5 percent target range in November and rose to a three-year high of 4.2 percent in February. Other statistics, including industrial output, retail sales and wages, have all boosted concern that inflation may well be set to accelerate further.

``The council sees inflation as more likely to remain above the target in the mid term and decided to raise key rates,'' the council said in a statement. ``The council will vigilantly observe wage growth and labor productivity. It will also monitor the exchange rate of the zloty and global economic trends.''

The zloty traded at 3.533 per euro at 3 p.m. in Warsaw, little changed from before the decision and down from 3.524 yesterday. Yield on the government's bond maturing in April 2012 was 6.139 percent, unchanged from just ahead of the announcement and up 3 basis points from yesterday.

The average corporate wage rose in February an annual 12.8 percent, the largest year on year monthly increase in almost eight years:

while industrial output growth, at 14.9 percent, was the highest in 14 months:

Todays retail sales data has also added to expectations that there may well now be further monetary policy tightening in the pipeline, since the statistics office reported that retail sales in February rose an annual 23.8 percent the highest in almost four years.

Poland's 625 billion euro economy expanded 6.5 percent last year, the fastest pace in a decade, and may have grown by about 6 percent in the first quarter of this year, according to recent estimates from Katarzyna Zajdel-Kurowska over at the Finance Ministry.

Polish Growth Forecast At 6 Percent in Q1 2008

2008-03-19T21:00:00.000+01:00

Poland's economy may have grown about 6 percent in the first quarter of 2008, according to Deputy Finance Minister Katarzyna Zajdel-Kurowska in Warsaw today..

``Economic statistics for the first months confirm that Poland is resilient to the global economic slowdown,'' Zajdel- Kurowska she told a press conference in Warsaw today. The Polish economy expanded 6.1 percent in the fourth quarter of 2007.

Wage and employment growth are likely to boost the inflation rate and budget revenue, while the ministry doesn't expect this year's spending plan to be fully implemented, she said.

Poland's Monetary Policy Council has raised interest rates six times in the past 11 months on concern that wage growth, outpacing production, will increase labor costs and force companies to lift retail prices. The average corporate wage rose 12.8 percent last month, the fastest pace in eight years.

Zajdel- Kurowska forecast the average inflation rate would rise to at least 3.5 percent, above the government's forecast of 2.3 percent. The main threat to the inflation outlook stems from energy and food prices, as well as rising unit labor costs and potential zloty depreciation if the central bank should ever need to reduce interest rates.

Poland Industrial Output and Producer Prices February 2008

2008-03-19T20:03:00.000+01:00

Poland's zloty rose against the euro again today following release of the industrial output data which seemed to suggest that economic growth quickened last month, giving the central bank more reason to raise interest rates. The zloty gained for a second day as producer prices jumped 3.2 percent, from 2.8 percent in January, and industrial output gained to an annual 14.9 percent, from 10.8 percent, the Warsaw- based Central Statistical Office said today. Month on month, output rose 1.6 percent, while the annual growth rate was the highest since January 2007.

Analysts now seem pretty convinced that Poland's central bank will raise its main rate a quarter-percentage point to 5.75 percent when it next meets on March 27. The central bank has raised its benchmark rate by 150 basis points since April to the current 5.5 percent rate. Poland's main interest rate is thus now 1.5 percentage points above the euro region's 4 percent benchmark and 325 basis points above the Federal Reserve's 2.25 percent target rate.

The zloty rose to 3.5375 per euro by 3:25 p.m. in Warsaw, from 3.5393 late yesterday. Poland's zloty climbed to a six-year high against the euro on February 28 after the central bank raised its main interest rate and said inflation may accelerate faster than its earlier forecast. Since then it has fallen back slightly.

But since August last year the zloty has rosen considerably, rising by 2.3 percent during February alone, making it the second-best performing emerging-market currency in Europe, after the Czech koruna.

The Future of Poland's Interest Rates

2008-03-18T13:15:00.000+01:00

The future of Polands benchmark interest rate is a matter of some controversy at the present time. Poland's central bank raised its benchmark interest rate by a quarter point to 5.25 percent at its last rate setting meeting at the end of February, and this was its fifth increase since April 2007. The central bank is fighting a strong rearguard action in an attempt to combat Poland's steadily rising inflation. So while the Federal Reserve has been busy cutting U.S. borrowing costs in an attempt to fight off and salvage battle scarred bank balance sheets, and the European Central Bank has kept its main refinancing rate at 4 percent since June, Poland's rate has been on the up and up, raising the yield differential and with it the value of the zloty as investors come in to gain the extra yield on offer in what is seen as being a relatively stable economy.

Poland's zloty climbed to a six-year high against the euro at the end of last month after the central bank raised its main interest rate and said inflation may accelerate faster than its earlier forecast. The zloty in fact rose 2.3 percent advance in February, the most since October, ranking it as the second-best performer among 11 emerging-market currencies in Europe, the Middle East and Africa, after the Czech koruna. Since that time the zloty has dropped back slightly, but talk of more interest rate rises is only going to fire it up yet again. Piotr Wiesiolek, the newly appointed deputy governor of Poland's central bank, is well aware of this issue, and has been actively out and about in recent days stressing that he sees no need to ``intervene'' to weaken the zloty. Indeed Wiesiolek emphasised he sees "further room" for rate increases in Poland in an interview with the television station TVN CNBC Biznes earlier this month.

``February inflation is lower than expected, but still not as low as we would like it to be,'' Wiesiolek said. The ``cycle'' of rate increases may end within one year.

With the Monetary Policy Council due to meet on March 25-26, and with analysts generally forecasting another increase in borrowing costs by 25 basis points to 5.75 percent, not everyone is so naunchalant about the situation, and Stanislaw Owsiak - who is a voting member of the Monetary Policy Council - is quoted this morning as saying he saw a need for a pause in interest-rate increases to allow time to better evaluate the outlook for inflation after the bank raised borrowing costs six times in the past year.

Owsiak, who is among a total of 10 members on the rate-setting Monetary Policy Council, said he expected inflation to return to the central bank's target range of 1.5 percent to 3.5 percent at the turn of next year after it accelerated to 4.2 percent in February.

The zloty weakened to 3.5433 against the euro following Owsiak's comments (perhaps this was his intention) and traded at 3.5403 at 10:27 a.m. from 3.5429 late yesterday. The yield of the zero-coupon bond was at 6.32 percent.

Owsiak said he saw a ``great need'' for a joint effort by the central bank and the Finance Ministry to combat inflation, which was fuelled mainly by rising energy prices and accelerating wage growth.

He also said the central bank must not ignore the rate disparity between Poland, the U.S. and the euro zone. Poland's borrowing costs are currently 1.5 percentage points above the European Central Bank's benchmark and 2.5 percentage points higher than the Federal Reserve's.

``There is a discussion on how rate disparity impacts the zloty,'' Owsiak said. ``Excessive appreciation of the Polish currency would be harmful for the economy.''

Traders saw a 78 percent likelihood the Fed will cut its target rate by a full percentage point at today's meeting, futures on the Chicago Board of Trade showed. There is a 22 percent chance the rate will be lowered 1.25 points.

The zloty has gained 7.6 percent against the euro since the beginning of last year, rising to near a six-year high on Feb. 28 in the midst of fast economic growth and expectations the central bank will raise interest rates further. Owsiak said the strength of the currency was already hurting some exporters.

Poland Wages and Salaries Januuary 2008

2008-03-17T15:57:00.000+01:00

Polish average corporate wages rose in February an annual rate 12.8 percent. This was the fastest rate of increase registered in almost eight years, adding to expectations the central bank will raise interest rates next week. Month on month wages rose 2.1 percent, according to data from the Central Statistical Office earlier today.

The quarterly average nominal hourly rate chart possibly gives a better idea of what is happening, as it irons out some of the monthly fluctuation.

Clearly a number of factors are at work here, but among them the fact that the labour market is steadily tightening, as employment rises:

and unemployment steadily falls:

Policy makers are considered to be likely to raise the interest rate by a quarter of a percentage point to 5.75 percent at the next meeting on March 25-26. If this expectation is fulfilled it will be the third rate increase this year as policy makers seek to slow inflation to the central bank's 2.5 percent target.

In February, the inflation rate rose to 4.2 percent and may start returning to the target at the end of next year, central bank Governor Slawomir Skrzypek said on March 11.

The Statistical Office also said employment in February grew 5.9 percent from February 2007 and increased 0.4 percent from January.

The zloty traded at 3.5474 per euro at 2:30 p.m. in Warsaw, little changed from earlier in the morning and down from 3.535 on Friday, but this change may have more to do with global conditions this morning than with domestic Polish data. Yield on the government's five-year bond rose 6 basis point to 6.316 percent.

Polish GDP Q4 2007

2008-03-01T20:40:00.001+01:00

The Polish economy grew at a slower annual pace in the fourth quarter after domestic demand eased, giving policy makers room to hold off on raising interest rates.

Gross domestic product expanded 6.1 percent in the final three months of 2007, the Central Statistical Office in Warsaw said today. Fourth-quarter growth was the slowest last year and down from 6.4 percent in the third quarter.

Poland's economy is growing at a slower rate than the 6.9 percent expansion in the neighboring Czech Republic or the the 14.1 percent growth rate in Slovakia, but this may be rather reassuring than being perceived as a problem.

There seems to have been a significant slowdown in private consumption, but these consumption dynamics may well have been a one-off effect and in the first quarter we may well see private consumption return to its old higher level.

Deputy Finance Minister Katarzyna Zajdel-Kurowska recognised that the fourth-quarter data indicated that the pace of growth in consumption was slowing, attributing the phenomenon to the impact of accelerating inflation. She also suggested that the dynamics of gross fixed capital formation, which was up 18.5 percent year on year, "remained high".

Total domestic demand grew by 6.2 percent, while consumer demand increased 3.8 percent. Construction was up 8.8 percent and production by 7.9 percent.

Full-year GDP growth is estimated to have reached 6.5 percent in 2007, the fastest pace in a decade. The government predicts 5.5 percent growth for 2008.

The central bank's quarterly forecast which was also released today showed the inflation rate may rise to 4.7 percent after reaching a three- year high of 4.3 percent in January.

Polish Central Bank Raises Interest Rates To 5.5%

2008-02-27T18:38:00.000+01:00

Poland's central bank raised its benchmark interest rate by a quarter of a percentage point today to 5.5 percent. The increase was the sixth in the past 10 months and the second this year.

The upward movement in Polish interest rates has so far failed to contain price growth after the inflation rate breached the top of the central bank 1.5 to 3.5 percent target range in November and rose to a three-year high of 4.3 percent in January. Recent rises in retail sales and wages have increased concerns that inflation may continue to rise and reach higher than previously expected levels, the council said in the statement which accompanied the decision.

Concerns are mouting that the Polish economy may now be overheating. The economy expanded 6.5 percent last year, the fastest pace in a decade. Retail sales where up at an annual 21 percent in January, while industrial output rose 10.8 percent. Employment grew last month at a record pace of 5.9 percent, while private sector wages have soared at a double digit rate in four of the previous six months.

According to the central bank forecast, the inflation rate this year may rise to 4.7 percent, up from the previous forecast of 3.5 percent, and may rise to 4.9 percent next year, even remaining as high as 4.8 percent in 2010. I would say that all of these numbers are subject to significant upside risk in the short term, since if the economy moves into overheating mode the possibility of a sharp rise in inflatio rates undoubtedly exists.

The central bank council also published their economic growth forecast, saying growth may be between 4.4 and 5.8 percent this year, while next year growth will be in the 3.5 to 6.1 percent range. Obviously the further forward we move the more the uncertainty over forecasts grows, and all we can realistically say at this point is that in the short term the risk on the growth forecast is an upside one, with the accompanying danger of overheating.

Council member Andrzej Slawinski is quoted as saying that any economic slowdown abroad should have only a "limited effect on Poland", and in the short term I am inclined to agree. Obviously, apart from what is happening in Germany, Poland may be most vulnerable to the turn of events in the UK and Ireland, where large numbers of migrant workers are employed and from where large quantities of remittances are sent home every month.

The zloty gained 0.2 percent to 3.5284 per euro by 5:43 p.m. in Warsaw on the decision, up from 3.5352 yesterday, when it traded at at one point at 3.5230, its highest level since January 2002.

Poland Retail Sales January 2008

2008-02-25T15:19:00.000+01:00

Polish retail sales rose an annual 20.9 percent in January, the highest in almost four years, raising expectations that central bank policy makers will raise borrowing costs when they meet later this week.

Sales growth, compared with the same month a year earlier, was the fastest since April 2004, the Central Statistical Office reported today, while compared with the year on year growth rate of 12.4% in December the rate of increase was up sharply.

Today's report may tip the balance for the central bank's rate-setting council, which meets to discuss interest rates on Feb. 27. Higher-than-expected industrial output last week increased speculation that the bank will raise the 5.25 percent benchmark interest rate for the sixth time in 10 months. The zloty traded at 3.563 per euro at 10:55 a.m. in Warsaw, little changed from earlier in the morning and Friday's close. The yield on the government's bond maturing in April 2012 rose 3 basis points to 6.138 percent from Friday.

Cars sales soared an annual 42 percent in January, leading retail sales of all products and followed by an almost 30 percent gain in sales of textiles and footwear. January sales of food rose 12.5 percent on the year after falling 0.3 percent in December.

The central bank-led Monetary Policy Council starts its two- day meeting tomorrow. The council lifted the key interest rate to 5.25 percent last month. The rate was record-low 4 percent in April last year when the council started to its series of rate increases.

Polish Central Bank Raises Rates

2008-01-31T15:22:00.000+01:00

Poland's central bank raised its benchmark interest rate by quarter point to 5.25 percent yesterday, its fifth increase since April, to combat rising inflation, while the Federal Reserve has cut U.S. borrowing costs by 1.25 percentage points this month to prevent a recession in the world's largest economy. The European Central Bank has kept its main refinancing rate at 4 percent since June.

Poland's central bank is likely to continue to raise rates in the coming months given the need to cap wage-related inflationary pressures.

The Polish zloty rose the most in a week against the euro after the central bank decision. Poland's currency climbed to its highest level since Jan. 24 after policy makers lifted the seven-day reference rate to 5.25 percent. The zloty was also buoyed as a report showed the $339 billion eastern European economy expanded by its fastest pace in a decade last year, supporting the case for more rate increases.

Inflation will remain above its target of 2.5 percent plus or minus 1 percentage point, boosted by food and oil costs, the central bank forecast. Policy makers next decide on interest rates on Feb. 27.

Poland GDP 2007

2008-01-30T11:29:00.000+01:00

Poland's economic growth accelerated at the fastest pace in a decade last year as rising employment and wages boosted profits and consumer spending. Gross domestic product expanded 6.5 percent last year, the central statistical office reported,The economy grew 6.2 percent in 2006.

Poland, which is the biggest European Union member in eastern Europe, is counting on accelerating economic growth to help living standards rise to western European levels. However there are conncerns that many years of below replacement fertility, heavy out migration of productive age workers and a rapidly ageing population may have placed a cap on the rate at which the economy can grow without seriously overheating, and despite rather high continuing levels of unemployment there are serious concerns about labour shortages.

The unemployment rate dropped to 11.4 percent in December from a record 20.7 percent in February 2003. Authorities now must grapple with allowing the expansion and keep inflation at bay. Investment rose 20.4 percent in 2007, while domestic demand gained 7.3 percent. Construction rose 15.6 percent and production increased 7.7 percent, the statistical office said in its preliminary estimate today.

At the same time, the proportion of Poles in legal employment increased by a record annual 5 percent in November, putting more money in people's pockets and boosting demand for housing. Construction ``remained one of the flywheels'' of Poland's economy, statistical office head Jozef Olenski said at a press conference today in Warsaw. We had better just hope that the wheel in question doesn't simply fly off its axis.

The Zloty and Polish Inflation 2007

2008-01-03T10:55:00.000+01:00

The Polish zloty continues to rise against the euro on speculation the Polish central bank will keep raising interest rates to stem accelerating inflation. Poland's zloty rose against the euro again today after central bank monetary policy council member Jan Czekaj said it's ``more likely'' interest rates will be raised further to curb an expected acceleration in inflation. Czekaj's comments, made in an interview broadcast by TVN CNBC Biznes today, came after the finance ministry said inflation probably accelerated in December to 4 percent. Against the euro, the zloty rose to 3.6048 by 5:02 p.m. in Warsaw, from 3.6153 late yesterday. Poland's currency gained 6.1 percent versus its European counterpart last year, its biggest advance since 2005, as policy makers lifted borrowing costs during the year by 2 percentage points to 5 percent.

The Polish central bank kept its key rate unchanged at its last meeting on Dec. 19 after lifting the benchmark seven-day reference rate by a quarter of a percentage point four times earlier in the year.

The cost of manufactured goods in Poland's $339 billion economy rose an annual 2.6 percent in November, compared with 2 percent the month before, a government report showed last week, while net core inflation accelerated to 1.5 percent from 1.4 percent.

Polish central bank monetary policy council member Dariusz Filar said recently that he expects inflation to accelerate in 2008, and that it won't come close to the bank's mid-range target of 2.5 percent until in the first half of 2009, fueling speculation that policy makers will raise interest rates as early as next month.

"I fear that we have a period of rising inflation before us" he said in an interview with the Gazeta Prawna daily. The inflation rate may "find itself in the region of 4 percent" in the first quarter of next year, he said.

The inflation rate rose to 3.6 percent in November, above the bank's target range of 1.5 percent to 3.5 percent.

According to Filar, the economy may expand at ``around 5 to 6 percent'' in 2008, slowing from a projected 6.5 percent this year. Turbulence on the world markets will have little effect on Polish economic growth as it is ``mainly driven by internal demand,'' he said. We will see, although one thing is for sure, internal demand in Poland, and in particular construction demand are the key.

Wages, a major driver of consumption, grew an annual 12 percent in November. Earnings have been bolstered by an economy that has grown at 6 percent or more for seven quarters, and unemployment at its lowest in nine years.

Merry Xmas and A Happy New Year

2007-12-25T00:05:00.001+01:00

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.

Credit crunch, did someone use the expression credit crunch?

The Polish Economy: An Unlimited Need For People?

2007-12-17T18:02:00.001+01:00

The gentleman in the photo is Konrad Jaskola, Chief Executive Officer of Polimex-Mostostal SA, Poland's biggest construction company, and according to this article in Bloomberg, he has just one message for us all: "I have an unlimited need for people".

The issue arising is that Joskola has plans to hire "several thousand" new workers next year to meet demand for new bridges and factories, but he has a problem, and the problem is that due to Poland's growing labour shortages he may have difficulty finding them. Poland's economy has been growing strongly in recent quarters, although not as strongly, it should be noted, in some of the more evidently "overheating" economies like the Baltics. Poland's economy expanded an annual 6.4 percent in the third quarter of 2007, following 6.7 percent growth in the second quarter and 6.8 percent in the first one, according to data released by the Warsaw-based Central Statistical Office at the end of November.

This strong growth rate is partly fueled by construction activity and partly by strong consumer demand for retail items like cars and washing machines. Construction in Poland rose 20 percent in the first nine months of 2007, and as can be seen in the chart below - which offers a breakdown of Polish GDP growth by components, construction has been playing a very important part in the process. The thing is, however, that construction activity is pretty labour intensive.

According to Joskola, Polimex needs to offer higher salaries across the board, to engineers and managers, and to on-the-ground site workers, as Poland's skilled workers steadily move abroad (like all that hedge fund money which is flowing in the opposite direction) in search of higher yield. As a result local competition for workers increases, and wages start strong upward climb. Polimex has raised wages by 11 percent over the last 12 months and plans to raise them them by a further 10 percent next year.

The company, which is a "recycled" formerly state-owned machinery supplier, established to drive Poland's post-World War II reconstruction effort, currently plans to spend as much as 200 million zloty on acquisitions next year, in order to add workers and production capacity. I imagine some, at least, of those acquisitions will have to be of workers coming from outside Poland.

Inflation On An Upward Path

Meantime Polish inflation accelerated to the upper end of central bank's target range in November on the back of higher food and oil prices, meaning policy makers at the central bank may be forced to raise interest rates again in the coming months, in so doing possibly pushing up the value of the zloty, and attracting even more funds in search of even more workers to put to work.

Polish inflation rate rose to 3.6 an annual percent in November from 3 percent in October, the Central Statistical Office reported today in Warsaw. Consumer prices gained a monthly 0.7 percent after rising 0.6 percent in the previous month. Food prices grew an annual 7.2 percent 1.3 percent from the previous month, while fuel prices soared 13.2 percent from November 2006 and 2.5 percent from last month

As Unemployment Continues To Fall

The unemployment rate fell for the ninth consecutive month in October to 11.3 percent from 11.6 percent in September, the office said in a separate report today. Earlier this month, the office said that average corporate wages advanced an annual 11 percent in October and employment grew a record 5 percent from the year before.

And Wages Continue To Rise

As I say, inflation in Poland is also being fed by a 10 percent average wage growth and record low unemployment this year. In fact Polish average corporate wages advanced in November at the fastest pace in more than seven years, suggesting that the very rapid economic growth and large scale out-migration of key age group workers may be squeezing the labour market more than people imagined, thus provoking the sharp rise in inflation. Wages rose at an annual 12 percent rate (and 4.8 percent from a month earlier) to 3,092.01 zloty, according to the Warsaw-based Central Statistical Office earlier this week.

While Remittances Continue to Flow in Strongly

Remittances from abroad, mostly by taking advantage of free movement of labor within the European Union, are currently estimated (by the Polish National Bank) to be worth almost 2.5% of the gross domestic product of 250 billion euros. Since the United Kingdom opened its labor market to Poles three years ago, at least half a million Poles have settled in Britain.

Marcin Korolec, under-secretary at Poland's ministry of economics is quoted as saying that "the statistics show that the transfer from Polish people working abroad is something like 6 billion euros a year....Obviously this is a huge amount of capital, a huge amount of flow. It has an impact on internal consumption and internal growth."

All of Which Produces A Rapid Rise in Sales

Polish October retail continued their rapid rate of annual increase adding to evidence that economic growth remains strong despite four interest rate increases from the Central Bank so far this year. Retail sales rose an inflation corrected 16.3% in October over October 2006, this was up from a 12.2% rise in September compared with 14.2 percent in September, according to the Warsaw-based statistics office today.

The growth which is driven by sales of vehicles (which rose 42% year on year) and sales furniture and household appliances (a 21.9% annual rate of increase) - confirms the impression that consumer demand is being bolstered by falling unemployment, which dipped to an 8 1/2-year low, higher wages, which last rose the most in seven years last month, and a steady and economically significant inward flow of remittances.

Monetary Policy in A Bind?

The central bank lifted the seven-day reference rate a quarter-point to 5 percent only last month, and this was the fourth increase since April, when the key rate was 4 percent. So as we can see, at this point of time , and against all traditional expectation, monetary tightening may actually be having the perverse effect of accelerating the economy.

At the same time the zloty continues its rise, trading at 3.58 to the euro after the release of this weeks wages data, holding near its highest in five and a half years.

So as the Monetary Council begins its 2 day meeting for December today, we can see that there are some difficult decisions to take. Members of the council have already made public some of their divergences, with policy maker Marian Noga having taken the view that "The sooner we have the hike, the better, as preventive action is cheaper than boosting rates to chase down inflation", while Council member Miroslaw Pietrewicz takes the view that Poland's central bank should delay raising the benchmark interest rate until policy makers have had time to assess whether the four increases already made so far this year have been sufficient to bring inflation into check in the mid term.

What this dispute is a reflection of are the serious issues which arise concerning the actual ability of conventional monetary policy to work in a situation like the one facing Poland, since raising interest rates may just as easily stoke up more inflation - as we have seen in Australia and New Zealand, and to some extent in China - by attracting more investment funds into the country. This issue became apparent when the zloty also gained after a central-bank policy maker Marian Noga said the interest rate may have to rise as much as three-quarters of a percentage point before the end of 2008 to ward off inflation. Normally, an impending rise in inflation and a monetary tightening process (which reduces growth) would be considered to weaken and not strengthen a currency. So what happens next? Well this is just what we don't know, since we have never been here before. Clearly these economies will continue accelerating till the day they can't. And after that, well we will have to wait till we get there to actually see. What is happening in Hungary may give us some clues, and what happens next in the Baltics will definitely provide another of the missing links. Meantime we are in "wait and see" mode I feel. And behind Poland, roaring down the track come Russia and Ukraine, remember.

Poland Wages November 2007

2007-12-17T17:48:00.000+01:00

Polish average corporate wages advanced in November at the fastest pace in more than seven years, suggesting very rapid economic growth and large scale out migration of key age group workers may be squeezing the labour market more than people imagined, and provoking a sharp rise in inflation. Wages rose at an annual 12 percent rate (and 4.8 percent from a month earlier) to 3,092.01 zloty, according to the Warsaw-based Central Statistical Office earlier today.

The central bank-led Monetary Policy Council last month raised its key seven-day reference rate for a fourth time this year in an attempt to contain inflation. The November inflation rate rose to 3.6 percent, above the upper end of the central bank's target range of 1.5-2.5 percent. The Monetary Policy Council will start its monthly two-day meeting tomorrow, but the bank is in something of a double bind here, since raising interest rates will only attract more capital inflows in the short term, and more capital is not what Poland needs, since it is this capital looking for people to employ that is provoking the overheating, in Poland and across the EU 10.

Employment in the private sectors also grew by 5 percent from November 2006, rising 0.3 percent on the month to a new total of 5.3 million. The zloty traded at 3.618 per euro at 2:40 p.m. today, unchanged from before the report and from Friday.

The Rise and Rise of the Zloty

2007-12-05T15:12:00.000+01:00

The Polish zloty gained again today, rising a 5 1/2-year high against the euro as risk appetite improved and investors bet the interest-rate difference with the U.S. will widen. The zloty, which has been the best performer in a group of 26 emerging-market currencies, has gained 6.2 percent since April, when the central bank began raising its reference rate in four quarter point stages to its current 5 percent level . Federal Reserve Vice Chairman Donald Kohn has recently acknowledged the threat to US consumer spending which could result from a reduced access to credit, stoking expectations that the Fed will lower interest rates for a third straight time on Dec. 11.

The zloty rose as much as 0.2 percent to 3.6036 per euro today, the highest since May 2002, and was at 3.6070 by 11:31 a.m. in Warsaw, from 3.6121 late yesterday. All of this raises important questions about the actual ability of conventional monetary policy to work in Poland, since raising rates may just as easily stoke up more inflation - as we have seen in Australia and New Zealand, and to some extent in China - by attracting more investment funds into the country. This issue became apparent when the zloty also gained after a central-bank policy maker Marian Noga said the interest rate may have to rise as much as three-quarters of a percentage point before the end of 2008 to ward off inflation. Normally, an impending rise in inflation and a monetary tightening process (which reduces growth) would be considered to weaken and not strengthen a currency.

``The sooner we have the hike, the better, as preventive action is
cheaper than boosting rates to chase down inflation,''
Marian Noga.

Faster-than-expected economic growth in the third quarter and a drop in unemployment have increased the chances inflation will breach the 3.5 percent upper limit of the central bank's target. The inflation rate, which rose to 3 percent in October, first exceeded the target's 2.5 percent midrange in June.

Noga said the repurchase rate may have to rise to between 5.5 percent and 5.75 percent in quarter-point moves to quell consumer- price growth. ``Moves by 25 basis points are reasoned and balanced,'' Noga was quoted as saying in an interview in Warsaw.

Growth continued at the strong annual rate of 6.4 percent in the third quarter of 2007, according to data released by the Warsaw-based National Statistics Institute earlier this week. Year on year retail sales rose in October by 10 percent, while sales of manufactured goods increased 14 percent on year in October.

Not everyone in the central bank agrees with Marian Noga, however. Monetary Policy Council member Miroslaw Pietrewicz has said that Poland's central bank should delay raising the benchmark interest rate until policy makers assess whether four increases this year have contained inflation.

The increases are ``a lot and the first results could be visible in the second half of next year,'' Pietrewicz, 66, said is quoted as saying in an interview earlier today in Warsaw. "Inflation is currently driven by factors that cannot be influenced by monetary policy", while any further increases "could boost inflationary expectations."

Pietrewicz's comments may signal a split in the council about the future direction of monetary policy and is an indication of the difficulties the central bank will have in controlling inflation in the years when Poland is trying to enter a euro adoption process.

Poland's inflation rate, which was at 3 percent in October, probably reached the 3.5 percent upper limit of the central bank's target in November because of rising food costs around Europe, the Finance Ministry said on Dec. 3. The Organization for Economic Cooperation and Development said today Polish consumer-price growth will accelerate to 3.6 percent next year.

Pietrewicz takes the view that such predictions don't necessarily "require a reaction from us, because first of all, we need to be sure that this acceleration is not a one-time jump generated by food prices, as it was in October"......."It's too early to figure this out in December".

The government also plans to reduce the budget deficit to 27 billion zloty ($11 billion) from the targeted 28.6 billion zloty.

Poland GDP Q3 2007

2007-11-30T15:17:00.000+01:00

Poland's economy expanded an annual 6.4 percent in the third quarter, a little faster than forecast, increasing concerns that the economy may be running above its long term capacity rate, and raising expectations that the central bank will raise interest rates further. Growth in gross domestic product in the period from July to September compared with 6.7 percent in the second quarter and 6.8 percent in the first quarter, according to the Warsaw-based Central Statistical Office.

The Polish central bank this week raised its benchmark interest rate to a more-than two-year high of 5 percent, the fourth increase this year, on concerns inflation may accelerate further above target. Booming demand for cars, furniture and household appliances has been triggered by an average 10 percent increase in wages this year and a record pace of job creation.

Domestic demand grew 7.4 percent and consumer demand increased 5.2 percent, while investments rose 18.8 in the third quarter, the office said. Production grew 6.6 percent and construction was up 12.6 percent, the office said.

Poland Central Bank Meeting

2007-11-27T10:00:00.000+01:00

Poland's central bank raised its benchmark interest rate for a fourth time this year today after higher food costs and strongly growing consumer demand is firing up inflation inflation. The bank's Monetary Policy Council lifted the seven-day reference rate by a quarter point to 5 percent.

Poland's $350 billion economy is expected to expand 6.5 percent this year, compared with last year's 6.6 percent, bolstered by domestic consumer demand. Poles are buying more cars, furniture and household appliances after wages soared 10 percent this year and new jobs were created at a record pace.

The zloty traded at 3.651 per euro after the decision, little changed from 3.651 before the decision and up from 3.672 yesterday. Yield on the government's five-year bonds was unchanged after the rate decision. It fell 2 basis points to 6.012 percent from yesterday.

The inflation rate rose in October to 3 percent, above the central bank's 2.5 percent target and in the upper part of the 1.5 percent to 3.5 percent range. Policy makers raised the benchmark rate by three-quarters of a point between April and August in three quarter-point increases.

The average corporate wage rose 11 percent in October, the fastest annual pace in seven years and the unemployment rate fell to an 8 1/2-year low of 11.3 percent. With more money in pockets, Poles moved to buy cars, furniture and household appliances, boosting retail sales in October an annual 19.4 percent, the highest in 3 1/2 years.

The consumer-optimism indicator WOK, compiled by Ipsos market researcher, rose in November by 5 points to 112.9, the highest since 1991.

The Lombard rate, which the central bank charges to commercial banks borrowing overnight with government securities as collateral, was also lifted by a quarter point to 6.5 percent. The discount rate, a reference rate for some bank loans, will rise to 5.25 percent, also by a quarter point.

Poland October 2007 Retail Sales

2007-11-26T14:02:00.000+01:00

Polish October retail continued their rapid rate of annual increase adding to evidence that economic growth remains strong despite four interest rate increases from the Central Bank so far this year. Retail sales rose an inflation corrected 16.3% in October over October 2006, this was up from a 12.2% rise in September compared with 14.2 percent in September, according to the Warsaw-based statistics office today.

The growth which is driven by sales of vehicles (which rose 42% year on year) and sales furniture and household appliances (a 21.9% annual rate of increase) - confirms the impression that consumer demand is being bolstered by falling unemployment, which dipped to an 8 1/2-year low, higher wages, which last rose the most in seven years last month, and a steady and economically significant inward flow of remittances.

The unemployment rate fell for the ninth consecutive month in October to 11.3 percent from 11.6 percent in September, the office said in a separate report today. Earlier this month, the office said that average corporate wages advanced an annual 11 percent in October and employment grew a record 5 percent from the year before.

Economic growth slowed to 6.4 percent in the second quarter from 7.2 percent in the first three months of the year. The report on third-quarter gross domestic product will be released on Nov. 30 at 10 a.m. The full-year growth will be in the region of 6.5 percent, Deputy Finance Minister Katarzyna Zajdel-Kurowska said at a seminar in Warsaw today, confirming the ministry's earlier forecast.

Catch Up Growth and Demographics - Evidence from Eastern Europe

2007-10-24T12:29:00.001+02:00

by Claus Vistesen: Copenhagen

Performing a simple series of adept Googling exercises around various sources on the internet you can easily discover that certain species of the lynx are able to travel at speeds of up to 50 kph (31 mph). Wikipedia informs us that the Eurasian lynx, on average, commands a hunting area of between 20-60 square kilometers in which the lynx is able to walk and run about 20 kilometers in one single night. All in all, a pretty rugged and constitutional little thing this lynx.

In this way, and perhaps because, at that particular point in time, the Eastern European Economies looked as if nothing could come in their way of economic prosperity and growth they were paired, by the Economist, with the region's sturdy feline coining the notion of 'Lynx Economies.' Thus, 'that particular point in time' was sometime back in the spring of 2006 where the Economist's (and my own) coverage of the CEE and Baltic economies came in hot on the heels of publications by the World Bank and and the Vienna Institute of Comparative Economic Studies speaking favorably of the future prospects of economic prosperity and thus 'catch-up' growth in the CEE and Baltic Economics.

Yet, merely 1 year and a tad later things seem to have changed quite significantly with respect to the discourse on the economic situation in Eastern Europe. Many of the contributors to this blog has been pitching on the change in discourse but also some of major institutional actors have been flagging the red banner. Not least the World Bank seems to have changed their attitude somewhat with most notably a recent report on the demographics of Eastern Europe entitled From Red to Gray - The Third Transition of Ageing Populations in Eastern Europe and the former Soviet Union as well as a recent writ with specific focus on the macroeconomic risks prevailing in the region. Yet, also the IMF in their latest World Economic Outlook devotes a chapter to the managing of large capital inflows where Eastern European economies also take center stage of the general tone of warning; in essence this note of warning concerning Eastern Europe seems to be the general talk of the day amongst economic analysts and journalists. As such, perhaps even the lynxes roaming the forests and planes of Eastern Europe are beginning to feel that the otherwise catchy notion conjured by journalists at the Economist is becoming something of a stretch according to the reality of the situation. Sure, things are moving fast now but it is what happens next which might finally serve to make the allegory rather unrealistic. In this entry I set out to explicitly investigate an issue which in fact has been treated several times on this blog and perhaps most often in the context of the CEE and Baltic Economies. Simply put and in the form of one simple question;

How do changing demographics and more specifically the final and ongoing stages of the demographic transition affect the notion and principle of economic catch up growth and thus economic convergence as it is stipulated by (neo-classical) economic growth theory?

As I have hinted above in the introduction my main subject of analysis on which the general theoretical argument is based is the current and ongoing situation in the CEE and Baltic economies. A lot has been written about this recently not least from the hands of the contributors to this blog (see also above). As a one-stop overview of the concrete issues at hand this recent note by Edward over at Global.Economy.Matters should provide you with suitable ammunition to get you started. In particular, the following three point overview of the current economic situation in Eastern Europe should always be in the back of your mind as we move forward from this point ...

Basically the principal outstanding issues confronting the EU10 countries are threefold:

Labour capacity constraints (which are normally a by product of long-term low fertility and large scale recent migration flows) are producing significant wage inflation and strong overheating.

A structural dependence on external financing - which is in part a by-product of the effect of low levels of internal saving, and which is another factor which separates the EU 10 from those like India or China who are benefiting from a typical demographic dividend driven catch up, is leading to large current account deficits, and potentially high levels of financial instability.

A loss of control over domestic monetary policy due to eurozone convergence processes which - with or without the presence of formal pegs - make gradual downward adjustment in currency values as a alternative to strong wage deflation virtually impossible. This issue is compounded by the likely private "balance sheet consequences" of any sustained downward movement in the domestic currency given the widespread use of mortgages which are not denominated in the local currency.

Traditionally a rigorous economic analysis in the light of the immediate events would focus a lot on point 2 and 3 but in this note we shall look specifically at number 1 and the issues of labour capacity, its constraints, and what it means of the economic growth of less to medium developed countries. Now, the most obvious caveat in this entry is that I really don't have the time at this point to really lay out the whole theoretical framework of economic growth theory and as such the precise slot in which my argument should be inserted within the wider theoretical framework. This will be the topic of a more rigorous article not suited for the blog format. However, I still need to attach some comments to set the scene where I should also immediately note that my previous note here at DM about catch up growth in Eastern Europe serves as a good state of the game post for what comes next.

Apart from my studies of selected pieces of the economic growth literature one of the best overviews of the concept of economic convergence as a function of the theoretical and practical assumptions vested in the growth models is to be found in an article by Norbert Fiess and Marco Fugazza on economic integration in Europe (PDF). As such it is important to note that convergence of GDP per capita levels is not a holy grail within the fields of economic growth theory. Rather, the process of convergence should be seen as an inbuilt consequence of the fact that as economies mature returns to production inputs decrease; that is to say that this discussion essentially revolves around the concept of increasing v. decreasing returns to scale in our economic model. If we think about decreasing returns to scale and introduce the concept of marginal productivity to production inputs we can then see that less developed countries are likely to exhibit higher rates of growth than their more mature counterparts in the sense that their marginal productivity is higher which then leads to a process of convergence. Now, this argument in its most strict sense is usually applied in the context of capital as a production input and coupled with the properties of an open economy and subsequent free flow of production factors this would lead to a rather rapid process of convergence or absolute convergence as the technical term. As regards to labour as a production input is has also been argued that the universal transition from an agricultural to manufacturing over to service (?) based economy produces a mechanism of convergence in the sense that this process implies a move up the value chain and thus that every unit of labour becomes more productive. Of course and even though we are talking about stylised facts here, this is also where the whole debacle begins in the context of my immediate argument because how certain is this process? Also, we need to take into account the distinction between stocks and flows (of labour) which is a crucial issue to consider when talking about ageing economies.

However and it does not take much of an economist to see that empirical facts do not support the idea of absolute convergence or at least it seems as if the process takes much longer to materialize than predicted by the theory. This has lead, among other factors, to a 'new' strand of economic growth models which allows for persistent growth divergence to exist between countries. The crucial aspect to understand here is the mechanism through which persistent divergences can occur. In this way, one of the widest contributions by economist to this thesis has dealt with the possibility that technological processes and thus accumulation of technological advances exhibits increasing returns to scale. The fundamental brilliancy of this notion is that it allows for a model where there is indeed decreasing returns to labour and capital but where different levels of technological effort leads to internal positive feedback mechanisms and thus explains persistent divergences in growth and 'prosperity' across countries.

Ok, I think that I have already said enough at this point and in order to get us back to track one crucial assumption and conceptual idea needs to be pinned down. As such and if we look at the rudimentary description of the economic growth process above it is not wholly unreasonable to argue that the growth process of an economy is somewhat directly related to the process of the demographic transition. Or as Robert Lucas puts it in a widely cited article ...

That is, the industrial revolution is invariably associated with the reduction in fertility known as the demographic transition.

As such, why don't we take a look at Eastern Europe where the economies have experienced, quite as expected by the conventional theory of economic growth, economic dynamics tantamount to catch-up or convergence. Especially the economic data since the expansion from EU15 to EU25/27 and, for some countries, the subsequent anchoring to the Euro has been very impressive indeed. Yet as Edward and I have been at pains (see link above) to explain again and again these countries are not your average emerging markets. This follows from the fact that their demographic structures have been fundamentally distorted due to a collapse of fertility in the beginning of the 1990s which has been aggravated by a persistent net outflow of migrants serving to further speed up the decline in the working and essentially also most productive cohorts. In order to capture this development and in order to frame the current situation the following point I made in a previous note is worthwhile to repeat.

In short, we are dealing with countries where the demographic transition by far, and indeed worryingly, has out paced the traditional economic process of economic convergence.

This is exactly what we are talking about here and apart from going to the heart of the imminent issues in Eastern Europe it also strikes right smack into the concept of economic growth theory and how to deal with the fact that the demographic transition does not occur the way it was originally anticipated. Most emphatically, we can see in the context of the Eastern European countries that the final stages of the transition have arrived far before and quicker than the twists and turns of history allowed for these economies to really get on with business. Yet, the general argument can just as easily be expanded into a discussion of the ageing part of OECD where it is painfully clear at this point that conventional economic theories are wholly incapable of explaining what is likely to happen next. In fact, we could stretch it so far as to say that modern economic growth theory is not able to explain what happens when fertility drops to a level below replacement level and stays there!

In Summary

Even though that a lot words have been written in this entry I am afraid that only superficial contributions have been made to the final answer of the proposed question. This entry principally had one main task, namely to initiate a line of reasoning which ultimately and hopefully can lead to a better understanding of modern economic growth processes in a context of the current demographic profile of many developed and developing economies. Specifically, this entry revolved around the concept of catch-up growth/convergence where the countries in Eastern Europe were suggested as an example to demonstrate how demographics can fundamentally alter the principles by which the economic growth process is likely to conform. In this way, the message is not that modern economic growth theory and growth accounting methods are rendered obsolete in the face of changing demographics but rather that considerable adjustment needs to be made; especially in the context of catch up growth/convergence but also crucially in the context of the notion of a steady state of economic growth. Returning briefly to the real world before we sign off it could seem as if the branding of the lynx economies never was more than a quick and essentially expensive make-up which is set to quickly wear off as we venture on. Specifically, recent signs coming out of the ECB and the European commission suggest that expectations are aligning towards an outlook where the process of convergence effectively risks grinding to a halt. My advice would then be not to exchange the carrot too swiftly into a stick since this would only serve to kick those who are already on the ground.

Poland's Trade Balance

2007-10-20T14:31:00.000+02:00

Employment in Poland

2007-10-19T08:36:00.000+02:00

This post is essentially a research note on the current state of the Polish labour market. It forms part of a series of posts being prepared by Global Economy Matters to accompany the up and coming Polish elections, which are due to be held this weekend. Alongside this post you can find a general review of the electoral situation by Manuel Alvarez, and I will be writing additional notes on the Polsih trade balance and on migration and remittances in the Polsih context, while Claus Vistesen will be taking a look at indebtedness, capital flows and the current account balance situation. All in all a rather full analysis, which given the key role which Poland may play in any Eastern European emerging markets disarray is probably only fitting.

Now, at the end of September the Polish Statistical Office published its unemployment report for the second quarter of 2007, and very interesting reading it is.

Before going into the details of the report, perhaps a bit of background information would be useful. First of all, economic growth. GDP has been growing at a pretty nifty clip in Poland in recent quarters, not as fast as in the Baltics, but pretty fast, as we can see in the chart below. Over the last twelve month the rate has been hovering in the 6% to 7% region.

Now the question is, is this growth sustainable? Stripped to its bare minimum, an economy needs three things for growth - labour, capital and raw materials - pretty much in the same way as a cement mixer needs sand, cement and water, all in the right proportions, of course. The analogy, in the present context, is not completely devoid of significance, since construction activity, and hence the production of cement, is an important part of the recent Polish story in its own right.

So as I say: is this sustainable? Well, capital is at present in pretty plentiful supply, although the danger does exist - since this capital is to a large extent not the product of domestic Polish savings - that this supply could dry up, and even be sucked backwards, as Claus will explain in his post. Raw material are available, but not always at the most favourable price, as we are currently seeing in relation to food and energy.

But what about labour? What is the position with the labour supply situation in Poland? Well this brings us directly to the tricky topic of Polish unemployment, which we will now proceed to explore.

Long Term Unemployment Decline

Historically unemployment in Poland has been pretty high. Most recently it peaked in 2003, and has now been dropping for a number of years, as can be seen from the annual unemployment chart below.

If we come to look at the monthly unemployment data for the last twelve months then we can see that this decrease in unemployment has been accelerating steadily in recent times.

The decrease in the numbers of unemployed is in part, of course, a reflection of an increase in employment, and the volume of employment in Poland has, as can be seen below, been increasing steadily since the end of the contraction which took place between 1999 and 2004.

Here is the annualy % change in the volume of employment:

And here are the numbers of employed on a quarterly basis since the begining of 2004:

The number of people registered with the Polish labour offices as unemployed at the end of June 2007 was 1,895,100 (of which 1,107,700 were women). This constituted a reduction of 337,400 on the number of unemployed in March (the end of Q1). Compared with June 2006 unemployment was down by 592,500 (or by 23.8%). Thus, viewed on a quarterly basis, the decline has been very dramatic, as can be seen below.

Perhaps also worthy of note is the fact that the decline in the numbers of unemployed has been more rapid among men - 322,800 (or 29.1% of the total unemployed) - than among women 269,800 (or 19.6%).

When compared to June 2006 unemployment decreased in all the Polsish voivods, and the declines have been quite dramatic. The most significant declines took place in in Dolnośląskie (30.2%), Wielkopolskie (29.8%), Pomorskie (27.5%), Opolskie and Śląskie (26.8%).

(Please click over image for better viewing)

The unemployment percentage rate at the end of June 2007 was 12.4% of the economically active civilian population, and was thus 2.0 points lower than in Q1 2007, and 3.5 % points lower than in June 2006.

There is still considerable territorial difference in the levels of unemployment in Poland. The highest unemployment rate is to be found in the voivods of Warmińsko-Mazurskie (19.6%), Zachodniopomorskie (17.9%), Kujawsko- Pomorskie (16.2%) and Lubuskie (by 15.8%), while the lowest unemployment rate exists in the voivods of Wielkopolskie (9.3%), Małopolskie (9.5%), and Mazowieckie (10.2%).

(Please click over image for better viewing)

Looking at the two maps taken together, it is very clear that the area where labour tightening is most dramatic at the present moment is Wielkopolskie, since the unemployment rate is already comparatively low, and the pace of reduction in the unemployment rate is also pretty rapid. Wielkopolska Province is second in area and third in population among the sixteen Polish voivods, with a land area of 29,826 km² and a population of 3.4 million. The province's principal cities are Poznań, Leszno, Kalisz and Gniezno. It also hosts part of the Kostrzyn-Slubice Special Economic Zone.

In general terms what we can see is that as the Polish economy has been expanding, it has been consuming labour, and rapidly so. One interesting calculation here is to make an estimate of how much labour is needed to produce 1% of GDP growth with the current proportions of sand, cement and water which are being shoveled into the economic mixer (ie at today's rate of productivity increase). A rough and ready, rule of thumb type, calculation would tell us that to get 6% annual growth the unemployment roll is coming down by about 600,000 peopple per annum, that is that each annual percentage point of economic growth reduces the numbers of available unemployed by 100,000. (This is a rough and ready calculation, but it is a more sophistocated one than first meets the eye, since it does, in approximate way, implicitly incorporate the ageing and withdrawal from the labour force dimension).

What this means quite simply is that, given the relatively low size of the younger cohorts about to enter the labour force, a 6% growth rate just is not sustainable for that much longer. If we imagine that unemployment could only with great difficulty fall below 500,000 without producing spiralling hyper-inflation, then we have an outer limit of 2 years at the present growth rate I think.

After that, what is the sustainable - capacity - growth rate? This is very hard to say without a much fuller econometric analysis, since it depends among other things on the direction and intensity of both migratory and capital flows. Many people, and especially those with a relatively poor understanding of how economic processses actually operate, tend to raise the objection at this point that such a calculation may not be accounting for productivity growth. This would be a mistake, and an elementary one, since the present rate of unemployment attrition already incorporates a certain level of productivity improvement.

So what such an argument normally wants to claim is that some sort of rapid improvment in the rate of productivity growth is on the horizon - rather like Alan Greenspan argued in the late 90s based on the arrival of the internet. A continuing increase in Polish productivity is, of course, to be expected, but it is not clear why people are expecting a dramatic acceleration in the rate of productivity growth. If this expectation is to become more than a simple vain hope it does need some sort of analytical justification. In the meantime we might do well to bear in mind that such improvements are a by product of stocks and flow movements in human capital formation, which is why the age structure of the existing population, and their education level, is such an important topic.

So, if we said that between 2010 - 2012 Polish capacity economic growth might be something in the region of 2 to 3%, then we probably would not be that far from the mark. Post 2012 it is much harder to estimate things, especially since, among other issues, the ageing population component will begin to have an ever greater impact.

Labour Quality

One of the main issues on which we are focusing in this analysis is the rate of reduction of the unemployment level in Poland and the evolution of the future labour supply. It is important to be aware that this future evolution is in great part conditioned by two factors:

1) The very low numbers of live births (in historical terms) which there have been in Poland since the late 1980's and;

2) The relatively high levels of out migration which Poland has expecienced in the last three or four years, which mean certain key groups of workers in the main productive age ranges will not be available to Poland to fuel growth as we move forward.

I have a much fuller (examination of the Polish fertility vackground in this post , but the following graph should make the underlying position pretty clear:

Basically live births dropped from a level of around 700,000 per year in the mid 1980's to around 400,000 per annum in the mid 1990s. That is a net loss of 300,000 potential labour market entrants per year (or a reduction of around 40% in the labour flow, I can hear that cement mixer starting to crunch as I write), a loss which will increasingly make its presence felt between now and 2015.

With these points in mind it is interesting to note that in Q2 2007 the number of people who left the unemployment rolls was 873,000. The largest group who went off the unemployment rolls in Q2 2007 did so as a result of finding a job. In fact 364,000 people left the rolls to take up work in Q2 2007 (or 41.7% of the total leaving) as compared with 425,300 (or 46.8%) in Q2 2006.

It is also inetersting to note that during Q2 2007 264,900 people who were previously registered as unemployed did not confirm their readiness to take a job. This seems to suggest that the Polish authorities are busily cleaning up their unemployment registers - the reduction for "non-availability" constituted some 30.3% of the total reduction in the number of people on the unemployment rolls during the quarter (in Q2 2006 the figures were respectively 259,500 and 28.6%) - and many of the people removed were more than likely already working, whether the work in question was inside or outside of Poland.

So one part of the apparent Polish "reserve army" may in reality simply not exist. Another part may - speaking in plain English terms - be far from serviceable for modern economic growth purposes.

In this context it is interesting to note that the long-term unemployed constituted 65.7% of the Q2 2007 total (1,245,000), and many of these people may turn out to be very hard to "recycle" into the modern world. In terms of the relative age structure of the remaining unemployed, under 25 year olds constituted 18.9% of the total (358,600), while persons aged over 50 were 21.0% (398,1oo thous).

At the end of Q2 2007, 1,639,300 people on the rolls did not possess the right to unemployment benefit, and this group represented 86.5% of the total number of registered unemployed, (in the previous quarter it was respectively 1,930,700 and 86.5%). Among this group 43.4% were people living in rural areas.

There were also more female than male unemployed. At the end of Q2 2007 58.5% of the total unemployed were female, and this was up by 3.1 % points on Q2 2006. The highest percentage share of women in the total number of the unemployed is to be found in the Wielkopolskie (65.6%), Pomorskie (64.0%), Kujawsko-pomorskie (62.3%) and Małopolskie (61.5%)vovoids.

One of the key difficulties in evaluating the remaining unemployed labour force in Poland is getting a precise reading on the quality of the labour which remains available. It is hard to get a clear picture here, but one indication which is not without importance can be found in the fact that the majority of the unemployed registered in the labour offices were persons with relatively low levels of education. The share of registered unemployed who did not have any occupational qualification whatsoever was 30.7% of the total registered unemployed (582,000).

In addition the two largest groups among the unemployed were persons having only basic vocational orlower secondary education (30.1% of the total), or persons with only primary or even incomplete-primary education (32.5% of the total number of the unemployed registered at the end of June 2007). Combined these groups constitute 62.6% of the total number of the unemployed.

On the other hand some 22.3% of the total had the certificate of completion of post-secondary and vocational secondary schools, while 9% had completed secondary education and 6.1% were graduates from tertiary schools.

So, in conclusion, and to reiterate. Poland is facing a potentially very acute and imminent trade off between economic growth and inflationary cost push. Some indication of this can already be found in the producer price index, which has been coming under increasing pressure since early 2006:

The earlier interest rate tightening from the central bank seems to have had some sort of short term impact during the March to July period, but, as we can see, the thing now seems to be taking off again. This position is only even more strongly confirmed if we look at the construction producer cost index.

It is also very clear that the steady tightening of labour market conditions is having an impact of Polish wages and salaries.

The annual rates of increase have been steadily picking up speed, and while they are still below those to be found elswhere in Eastern Europe (like the Baltics, Romania, Ukraine) the early warning signs of the "Baltic Syndrome" are there, which is hardly surprising since the underlying causes are essentially the same.

Information for this report comes, by and large from the Polish Statistical Office and Eurostat. In particular the recently publishedunemployment report for the second quarter of 2007 was evry useful, while additional information was taken from the Q2 2007 Labour Report (archive).

Poland House Price Index September 2007

2007-10-18T22:43:00.000+02:00

Here's the relevant part of the monthly annual rate of change on the house price index that goes accompanies the EU monthly harmonised CPI. The rate of increase is brisk, but it is hardly inordinately high.

Polish Construction Output 2007

2007-10-18T22:08:00.001+02:00

Well, I think this graph pretty much speaks for itself. Polish construction has seen some pretty large increases in output during 2007.

Since there are some silght differences between the two, here is the version of the index which is published by Eurostat. Since the time series I am using is also slightly longer, we can see that construction activity really seems to have taken off last autumn, reached a peak - in terms of monthly rates of increase - this spring, and is now slowin slightly, although, as I say, the rates of increase are still pretty substantial.

Inflation in Poland September 2007

2007-10-15T14:46:00.000+02:00

Well with all that inflation going on all round the EU 10, I guess Poland wouldn't want to be left out, now would it? So just to prove a point, Polish inflation accelerated in September for the first time in three months. As elsewhere the increases were led by food costs, but there was also a sneaky little detail of housing maintenance costs. We wouldn't be short of a Polish plummer here and there would we?

In fact the inflation rate rose to 2.3 percent, after falling to 1.5 percent in August. Consumer prices gained a monthly 0.8 percent after dropping 0.4 percent in August.

Anyway, here is the chart for monthly inflation this year.

Actually, compared with what is happening eslewhere this rate of inflation almost seems saintly. Nonetheless it looks very probable that the central bank will raise interest rates again. In fact the Polish central bank has been very successful in bringing down inflation in recent years, as can be seen in the following chart for annual inflation.

The Polish central bank is more likely to raise its benchmark 4.75 percent repurchase rate This would be the fourth time this year that the bank has raised the rate - which is currently at 4.75% - to try to keep price growth under control as inflation threatens to breach the bank's inflation target for a second time.

The Monetary Policy Council of the Polish central bank lifted borrowing costs in March for the first time since May 2005 after the annual inflation rate reached the bank's target of 2.5 percent. The inflation rate fell to 1.5 percent in August from 2.6 percent in June.

Food prices rose 2.4 percent in September from August and 5.1 percent from September 2006. House maintenance costs gained 0.3 percent from August and were up 3.5 percent from a year ago.

The zloty also advanced following a pattern we are seeing in other countries as people react to the idea that interest rates might rise by finding the currency more attractive without reflecting on the long term dimension of where all this is leading.

Typical of the sort of response we are seeing is this one quoted in Bloomberg:

``The data should show the need for further monetary tightening in Poland and is likely to push the euro/zloty to new five-year lows below 3.72 today and toward 3.70 this week,'' a team of analysts led by Gavin Friend at Commerzbank AG in London wrote in a research note.

But the real underlying problem is not food prices by growing labour shortages and wages, as was made clear in separate report which showed that average annual wages climbed by 9.5% in September, down very slightly from the from 10.5 percent a year rate regsitered in August. Again, we are not yet at Baltic levels, or even at Bulgarian or Romanian ones by the curve is ascending and the clock on all those labour shortgaes is ticking away inexorably.

Of course, with delicate situations developing all over the EU10 the last thing Poland needs right now is an election, but that is what we are having this Friday. The latest news on this front is that support for the Citizens' Platform - the largest opposition party - rose to a record 46 percent according to a poll carried out by TNS OBOP and published by the Dziennik daily., This would be enough to create a majority government, but matters are far from clearcut, and rolling survey by PBS DGA published in Gazeta Wyborcza daily showed backing for the Platform at 38 percent and for Law & Justice at 37 percent.

World Bank Report on Labour Shortages in the EU10

2007-09-27T16:08:00.001+02:00

The European Union's 10 eastern members must take concerted action to increase employment participation levels to avoid a serious short-term slowdown in economic growth and important supply-side structural problems in the longer term according to a report published today by the World Bank.

"Addressing the emerging skills shortages is particularly important, because failure to do so will constrain job creation and future economic growth"

You can find the report summarized here, or you can download direct here.

Claus and I will prepare a full summary and review over the weekend, but for now here are some revealing extracts.

The report in fact says the following:

In this atmosphere of short term turbulence it is important not to lose sight of the longer term trends and the fundamental challenges the EU8+2 continue to face. With the exception of Hungary, growth remains high throughout the EU8+2 and in the case of Latvia represents serious overheating. This growth is sustained largely by consumption and investment. With tightening labor markets, large increases in real wages and employment and very rapid credit expansion, a moderate slowdown in growth may in fact be desirable in the countries showing signs of overheating.

They also have this to say, which is IMHO very important, and to the point:

Unemployment has fallen substantially in virtually all EU8+2 countries since 2004 due to strong growth in labor demand. This has given rise to skill shortages and associated wage pressures, often amplified by out-migration of EU8+2 workers. However, employment/working age population ratios remain relatively low.

Really this is the very point that Claus and I have been making. They then continue:

In contrast to the earlier period of weak labor demand it is now the supply side of the labor market that constrains new job creation. Many persons of working age are economically inactive in EU8+2 either because they lack skills demanded by employers, or because of labor supply disincentives, such as early retirement benefits, generous disability schemes, high payroll taxes, and limited opportunities for flexible work arrangements. These effects are concentrated among the younger and older workers, while the participation rates for middle aged workers are similar to those of the EU15. Hence the main challenge facing now EU8+2 is to mobilize labor supply to meet the demand. Addressing the emerging skills shortages is particularly important, because failure to do so will constrain job creation and future economic growth. To increase the effective labor supply EU8+2 countries need to: (a) improve labor supply incentives through reforming the social security systems, (b) improve worker skills through reforming the educational systems and improving domestic mobility; and (c) import labor with skills that are in short supply by opening labor markets to foreign workers. The weights assigned to each policy depend on the nature of the most binding constraint to labor supply, which vary across countries.

also this is very important, even if I am nowhere near as optimistic as the World Bank is about the possibilities of Eastern Europe staying out of the firing line, especially as the eurozone itself is slowing fast.

The effects of deepening financial turbulence would potentially be more serious for the EU8+2, but are more difficult to predict. The greatest risk is that the countries that have large current account deficits – the Baltics, Romania and Bulgaria – are suddenly less able to finance them through capital inflows and are forced into an economic contraction. This is particularly true for countries like Hungary that are highly dependent on more volatile portfolio inflows than on FDI. Banking sector foreign borrowing which is the main financing source in the Baltics is generally less volatile than portfolio flows, but the extreme surge in the Latvian CAD (to 30% of GDP in the 12 months to end July ) clearly cannot be financed in this way in a sustained manner. There are other potential risks as well. A general retreat from mortgage lending provoked by US experience would lead to broad based credit tightening and weaken the booming construction sector in the EU8+2. Moreover, the increased risk sensitivity may cause the unwinding of carry trades making external finance more difficult for higher interest, carry trade destination countries.

Finally:

In the latest quarters unemployment rates have either continued to fall or have remained fairly stable despite upward seasonal pressures. In several countries unemployment rates declined to historical minima (the Baltic States, the Czech Republic, and Poland). Employment rates in Latvia, and also in Estonia reached the highest levels since the start of transition and are around 68% for people aged between 15 and 64 years, which is close to the Lisbon strategy target of 70%. Nevertheless, further employment increases may be limited because of structural nature of joblessness due to skills mismatches and unwillingness to relocate or retrain, which is particularly relevant for those who stayed out of the labor market longer.

The recent trends have undoubtedly strengthened the power of employees in the wage bargaining process. Real wages have begun to grow rapidly in Poland where their expansion had been moderate so far. The highest growth is occurring in sectors which suffer most from shortages of workers (for example, construction). Rising employment and strong dynamics of real wages are pushing the growth of the wage bill into double digits. Nevertheless, demands of higher wages for public sector employees come into sight in most countries in the region. In Bulgaria and Poland, trade unions are prepared to resort to strikes or the threat of strikes in wage setting negotiations.

In all countries apart from Slovakia and Slovenia, wages are growing faster than labor productivity. Rising unit labor costs provoke central bankers in the region to tighten monetary policies (Poland and the Czech Republic). Apart from inflationary pressures, excessive ULC growth may undermine competitiveness and prospects for sustained long-term output growth and further labor market improvement.

Polish Central Bank Leaves Interest Rates Unchanged

2007-09-26T14:14:00.001+02:00

The Polish central bank kept its benchmark interest rate unchanged, following three increases this year, stating that it is awaiting more evidence on whether or not inflation is under adequate control.

The Warsaw-based Monetary Policy Council left the seven-day reference rate at 4.75 percent today, following a quarter-point increase last month.

The central bank raised borrowing costs after inflation reached its medium-term target of 2.5 percent in March and exceeded it in June. The annual rate fell to 1.5 percent in August and the zloty has gained 1.3 percent as compared to the euro during September.

Poland's economy expanded an annual 7.4 percent in the first three months of the year and 6.7 percent in the second quarter.

The Polish unemployment rate fell in August to an eight-year low of 12 percent, while average corporate wages rose 10.5 percent in August from a year ago, the fastest pace in almost eight years.

The zloty traded at 3.779 per euro at 1:10 p.m., unchanged after the rate decision and from yesterday. The yield on the government's five-year bond was also unchanged at 5.582 percent.

Polish August 2007 Retail Sales

2007-09-25T15:18:00.000+02:00

Polish retail sales rose at an annual 17.4 percent rate in August, this was the fastest annual pace in five months, as rising wages and increasing employment are encouraging spending. Retail sales rose 2 percent from July, according to data out today from the Polish statistics office.

The accelerating rate of economic growth has encouraged companies to increase hiring and wages have started to increase rapidly. This has raised central bankers' concerns that inflation is poised to pick up. The Monetary Policy Council raised its benchmark interest rate three times this year to keep inflation from exceeding its 2.5 percent target.

Polish GDP Q2 2007

2007-08-30T17:04:00.000+02:00

Here is the latest preliminary release from the Polish Statistical Office for Q2 GDP:

Poland's economy expanded an annual 6.7 percent in the second quarter, faster than expected, suggesting interest rates may be raised a fourth time this year. Growth in gross domestic product compared with 7.4 percent in the first quarter, the Central Statistical Office reported in Warsaw, and exceeded the 6.1 percent median forecast of 21 economists surveyed by Bloomberg. The economy grew 6 percent in the second quarter of 2006.
Bloomberg

In fact the rate of GDP growth in Q2 - which according to my calculations was 0.34% - seems to have slowed from Q1, when it was a fierce 1.6%. This slowdown can be seen in the following chart.

Domestic demand increased year on year by 9.3% in the second quarter, up from 8.6% in the first quarter, and from 5.4 percent in the same period last year. Consumer demand increased 5.1 percent, up from 4.8 percent a year ago, while production grew 6.3 percent, slower than the 9.2 percent growth rate achieved in the second quarter of last year.

The prime contributors to second quarter growth seem to have been fixed investments and a large increase in inventories, which combined boosted annual growth in gross capital formation to 34.2% in the second quarter, up from 26.8% in the first quarter.

Construction, of course, increased considerably - by 17.7 percent - up from 12.1 percent in Q2 2006, but down from the first quarter's 40.1% rate, an output level which had been aided by unusually warm winter weather.Investments rose 22.3 in the second quarter, up from 14.5 percent last year and down from 29.6 percent in the first quarter.

Basically it is very hard to determine anything very clearly at this stage from the provisional data we have. A lot depends on what is happening with the inventories, and where construction is going. As we can see from the following chart, the annual increase in Q2 has slowed somewhat, but this doesn't really mean that the economy is slowing to any significant extent, we need to see more data going forward to decide on this.

What the data does seem to show is that fixed investment has replaced private consumption as the main contributor to growth, and this seems strange. Fixed investment contributed a net 3.8 percentage points to second quarter GDP growth, up from 3.6 percentage points in the first quarter. Private consumption contributed 3.2 percentage points, down from 4.6 in the first quarter.

A negative contribution was made by foreign trade, at -2.6 percentage points, a deeper dent than the -1.1 percentage points registered in the first quarter. Exports increased 7.8% on the year in the second quarter, while imports grew 14.2%. So obviously there are big trade balance issues to think about.

Industrial output growth slowed to 6.3% on the year in the second quarter, from 9.1% in the previous three months. While the services sector expanded 6.0% on the year, down from a 7.4% increase in the first quarter.

Polish Central Bank Raises Interest Rates

2007-08-29T15:17:00.000+02:00

The Polish central bank raised their benchmark interest rate a third time this year today, as wage growth and household spending coupled with growing labour shortages threaten to push up inflation. The Monetary Policy Council lifted the seven-day reference rate by a quarter of a percentage point to 4.75 percent.

The Polish economy expanded 7.4 percent in the first quarter, which was the fastest pace in a decade. With wages rising at a record pace in the second quarter, policy makers have said inflation may exceed the central bank's 2.5 percent target by the end of the year unless interest rates are lifted again.

In fact average corporate wages grew at an annual rate of 9.3 percent in July, and at a record rate of 8.9 percent in the second quarter. Employment rose 4.7 percent from a year ago in July, while unemployment fell to 12.2 percent and retail sales rose at an astonishing annual 17.1 percent. The inflation rate fell to 2.3 percent in July from 2.6 percent in June. The central bank expects it to rise to 3.3 percent by December if borrowing costs are left unchanged.

The interesting thing to note here, as can be seen from the piece below from Bloomberg, is that the Zloty kept falling despite the rate increase. The weather is changing, and quickly.

Poland's zloty fell for a second day versus the euro as declines in global equity markets prompted investors to shun riskier emerging-market assets.

The zloty dropped along with Turkey's lira and the Slovak koruna as the NTX Index of stocks in central and eastern Europe's 30 biggest companies lost the most in almost two weeks. The Polish currency was the second-worst performer against the euro in Europe after the Romanian leu.

``Investors are growing increasingly nervous and the declines in equity prices are taking their toll on emerging market currencies,'' said Michal Dybula, central European economist at BNP Paribas SA in Warsaw. ``We may see more losses if U.S. stocks open lower today.''

Against the euro, the zloty fell to a one-week low of 3.8495 and was at 3.8454 by 11:36 a.m. in Warsaw from 3.8302 yesterday. It may extend its drop to 3.9 by the end of 2007, Dybula said.

Katarzyna Zajdel-Kurowska and the Euro

2007-08-27T14:53:00.000+02:00

Poland's Deputy Finance Minister Katarzyna Zajdel-Kurowska is widely quoted this morning as saying:

``Poland is definitely on the way to the euro.''

She made this statement after revealing that Poland's 2007 budget deficit will be narrower than the government's original forecast. I have no idea when or whether Poland will enter the euro, but I would say that, as in the case of the Baltics, the potential labour shortage issue, and the problem of wage and cost push inflation that this will generate is a much more important medium term obstacle to Poland's euro membership than the budget deficit issue is.

Poland, Retail Sales July 2007

2007-08-24T11:29:00.000+02:00

Retail sales in Poland rose in July by 17.1 percent from July 2006 and 1.7 percent from June, according to the Warsaw-based statistics office this morning. This was the fastest annual pace in four months, and has raised expectations that interest rates will be increased for a third time this year, maybe as early as next week.

Variations in the monthly index can be seen in the chart below.

And the rapid rate of increase can be observed in the next chart which shows annual change each month.

Consumer demand, which is being driven by the fastest growth of wages in six years and a record increase in the number of new jobs, is putting considerable pressure on inflation, and this has already produced a half percentage-point increase in the benchmark interest rate earlier this year. Today's data may lead monetary policy makers to raise the interest rate again as early as at their next meeting on Aug. 28-29.

In a separate report, the office said the rate of unemployment in July dropped to 12.2 percent from 12.4 percent in June. The number of unemployed totaled 1.86 million people, or 39,000 fewer then in June and 587,000 below July last year, when the rate was 15.7 percent. The unemployment data confirmed estimates of the Labor Ministry published on Aug. 8.

The zloty was trading at 3.8389 per euro at 10:05 a.m. in Warsaw, up from 3.847 yesterday. The yield on the government's five-year bonds was unchanged for a second day at 5.69 percent.

Polish Migrants More Choosy About Their Jobs in the UK

2007-08-23T14:26:00.000+02:00

Signs are growing that the tide of Poles going to work in Britain may have peaked.

According to the UK Home Office, the number of workers applying to work in the UK from the A8 countries – the eight eastern and central European nations of the As analysed by Latvian Abroad here, almost two-thirds of the 683,000 workers who have applied to work in the UK from A8 countries have come from Poland.

The latest UK figures appear to show that eastern and central European migrants had started to move up the jobs chain and are occupying more professional positions.

Some 41 per cent of registered workers applied to work in administration, business or management posts during the latest quarter. This compared with 25 per cent three years ago when Britain opened its job market to A8 workers.

On the other hand, UK fruit and vegetable growers have warned this week that they are facing a struggle to attract sufficient eastern and central Europeans to harvest their crops because A8 workers had become more choosy about the work they undertook.

According to the Home Office the hospitality industry has accounted for 19 per cent of jobs filled by A8 workers, and agriculture 11 per cent, since 2004.

Running out of Capacity in Central and Eastern Europe

2007-08-22T15:59:00.000+02:00

By Claus Vistesen

Cross Posted From Alpha Sources

Well, it is pretty much official now I think that some countries in Eastern Europe might be heading for an economic crash. As such, both the FT and the Economist recently ran articles on this topic in which warnings were duly handed out. On the record, I am pretty convinced myself that some countries might crash very soon among those the most notable candidates being Latvia and Lithuania. Behind this doom and gloom call is a very simple hypothesis that demographics matter for economic growth and that this fact is now hitting home big time in the CEE countries proxied by dwindling capacity to match expectations of economic growth and prosperity. Of course I am sad to say, the mainstream coverage cited above did not have the faintest squeak about demographics and the unique population regime in which the CEE countries are situated. For that reason I recommend you to read Edward Hugh's recent post at AFOE in which he pins the Economist, his note on Latvia as well as my own analysis on Lithuania. In this entry I am looking at Poland in much the same way that I have been looking recently at Lithuania. Clearly, Poland are Lithuania are different not only because of the differences in size but also because Poland seems to be equipped with much more spare capacity than is presently the case in Lithuania and the other Baltic countries for that matter. I have marked 'seems' in italic since whereas Poland's unemployment rate is still in double digit territory accounts of substantial labour shortages are mounting which suggests that high growth regions in Poland are fast running out of qualified labour. In this way, the trend in the labour force is very similar to Lithuania but where Lithuania represents a small single deck frigate which is set to quickly succumb to any water intake Poland perhaps resembles more the Titanic. However, as I will demonstrate below, through graphs, the tendency is the same which only further substantiates the claim that when it comes to the CEE economies it is in fact, at this point, all about demographics and even though I realize that I am biased in my view here from the offset I just cannot see how any reasonable economist would be able to argue otherwise.

Let us look at the data then and more specifically the short term indicators on economic growth which show how growth and wage costs have been picking up the pace lately which also shows itself in a widening current account deficit. The first graph plots (in % y-o-y) growth in GDP, wage costs and industrial production, the second plots retail sales and the third plots the evolution of the current account deficit. Note that while the graphs for GDP(etc) and the current account share time perspective in the form of quarterly indicators the graph for retail sales plots monthly y-o-y % growth rates.

As can readily be seen, growth in Poland had been indeed picking up the pace in the past year. This has naturally pushed up the demand for labour with an ensuing rather dramatic tightening of the labour market to follow. Also wage costs are beginning to rise rapidly and as the Economist Intelligence Unit reports (sorry, no link available) labour productivity is not able to follow the speeds of wage increases which of course questions the sustainability of this brisk growth spurt. This is accentuated in the following quote which cites the view of JPMorgan ...

In Poland, JPMorgan expects the dataflow over the next two weeks to confirm that “the labour market continues to tighten fast and that the labor productivity-wage relationship is deteriorating."

Curiously, wage costs are yet to show up in core inflation and producer price inflation where growth is still very moderate relative to the overall economic growth rate. It serves to remember here that the Polish unemployment rate is still in double digit territory which indicates that capacity needs to be a bit more strained for pressures in CPI and PPI indices to take hold.

Like I argued with Lithuania I believe it is important to take a long hard look at the Polish labour market and population dynamics in order to see what is really going on. Regarding the latter, Poland is inhabited by about 39 million people and as almost all other CEE countries Poland is set to age very rapid as a result of a severe stagnation in fertility from 1990 and onwards still lingering today. This is a very important point to remember as we move through the graphs below. Let us begin with a long term indicator of migration flows which demonstrate that Poland has suffered from a net-outflow since 2001. The numbers might seem puny in relation to the general population size but remember two things. Firstly, Poland's demographic profile is already damaged as a result of the fertility decline and secondly that all evidence suggests the skill component of the net outflow results in a loss of net value added from the point of view of the Polish economy. In short, even if the numbers are small Poland can hardly afford to lose these people if catch-up growth is to be sustained.

This brings us to the general labour market dynamics which are presented below in terms of short-term indicators which share the time perspective as the economic data above. Essentially, two identical time series for unemployment are presented with the first being in real numbers and the second in percentage of the workforce.

Clearly, the situation in Poland is very different from Lithuania and as such unemployment in Poland still linger in double digit territory. However, this will not go on for much longer if the current growth rates are sustained and this is where the problems begin to emerge. As such, you could choose to flag optimism in Poland on the basis of what is after all very impressive economic momentum which at this point is even welcomely deviating from nudging up core inflation rates. However, this is also at the core of the problem with almost all CEE countries in the midst of what is currently an unprecedented spurt of global growth. These economies are thus growing briskly, quite naturally, as emerging economies but with the important qualifier that they have extremely mature and essentially loop sided demographic profiles. This means that given the underlying capacity constraints these economies are faced with they are quite simply growing much faster than is sustainable in any meaningful sense of the word. This has then, at this point, obviously caught up with market participants and financial commentators but my guess is that it is moving way faster than many seem to think. Clearly, Poland is not Lithuania where the time span is already under one year but it still raises the question of just how much further this can go given the underlying structural capacity issues. Also remember here that while structural remedies such as raising labour force participation rates as well to address the skill mismatch on the domestic labour market should be strongly advised this is just moving so fast in some countries that this really does not seem to be a viable solution to address what is clearly becoming a short term issue with long term and structural drivers. In the end, what we have now regarding the CEE economies is evidence that a demographic profile wholly out of sync with the economic stage of development effectively can halt the process of catch-up growth. In order to ram this point home here at the end we need to look at productivity and how brisk productivity needs to grow in order follow suit. And this is just the point; catch-up growth and productivity increase as an economy moves up the value chain takes time and time is exactly what the CEE countries do not have at this point with the current growth rates.

Appendix

This was really the end of this entry but if you want to catch a glimpse of how fast this might be moving I invite you to read on. However, beware ... dodgy empirical methods and math will follow! Let us try then to do a thought experiment and ask the question, how far will it take for the Polish economy to reach a 'critical' level of unemployment rate where 'critical' here is defined as either a 3% or 5% unemployment rate?

Well, before we move I need to attach some important qualifiers.

Firstly, the following thought experiment does very little to represent sound empirical economics but the general approach is still worth while I think. As such, we know that rapidly ageing societies, especially those growing rapidly as is the case here, will tend to face a structural decline in the unemployment rate and/or the labour force as more people leave the labour force compared to entrants. Add to this, in the Polish case, the trend of net outward migration as well as the high economic growth rates and suddenly an unemployment rate of 10% becomes a rather small buffer. Secondly, be aware since math will now follow. I rarely do this at Alpha.Sources and I promise you that it will not turn into a habit but I think that it is important in this case.

Regarding the method I have already hedged my bets above and please do note that the underlying assumption of trend perpetuity in the following experiment makes the predictive power virtually useless, at least at the time horizon we will be looking at. So, what are we in fact looking at?

Well, based on rough and ready calculations the average monthly decline in the unemployment rate in Poland between July-06 and May-07 stood at a monthly decline of 2.4% (i.e. in absolute terms). Based on an all things equal approach, assuming trend perpetuity, how far would it take for Poland to reach an unemployment rate of 3% and 5% respectively? To answer this we use the common expression for time value of money as an imperfect yet useful approximation:

FV = PV(1+r)n (in our case -n but that is of little matter)

where FV denotes future value at time n, PV the present value at time 0, r is the compound rate at each period, and finally n denotes the periods. In our little experiment we approximate the expression to our need by assigning the values as follows;

FV: 3% and 5%

PV 10,5% (unemployment in May 07)

r: 2.4% (average monthly decline)

n: ? (i.e. this is what we want to find out)

Calculating for 3% ...

3 = 10,5(1.024)n

solving for n ... (a bit complicated but Excel delivers in a heartbeat)

In(3/10,5)/In(1.024) = -52.8

Which translates into about 53 months to reach an unemployment rate of 3% or 53/12 = 4.4 years assuming trend perpetuity.

Calculating for 5% ...

5 = 10,5(1.024)n

solving for n ...

In(5/10,5)/In(1.024) = -31.2

Which translates into about 31 months to reach an unemployment rate of 5% or 31/12 = 2.6 years assuming trend perpetuity.

So, was this useful at all? Well, perhaps not but do note that the assumption of 'perpetuity' as regards to a structural decline in the labour force/unemployment rate is not entirely voodoo magic when we think about the CEE societies. Clearly however, the process will be subject to notable nonlinearities as we approach ever lower levels and furthermore it is not certain that the current cyclical economic boost will continue. But the point is that, at the pace with which this is moving it is difficult to see how structural mechanisms such as improving labour market institutions, raising participation rates, and addressing the skill mismatch can keep up with the structural and cyclical run on the level of capacity if it continues much longer. Especially, the fact that these countries are now targets for a substantial part of new global credit suggests that the pressure is very high indeed. Note also that many central banks in the region would be effectively unable to act as a lot credit is denominated in foreign currency. As such, an aggressive turn of monetary policy to the loose side would entail severe balance sheet issues as the countries' domestic currencies most likely would plummet. Effectively this would mean strong appreciation of the liability side (denominated in e.g. Euro) relative to the asset side (denominated in the domestic currency).

In the end, whatever rate of decline we assign in our little pet model here we are looking at a horizon in most CEE countries where labour markets are set to tighten significantly in the next 2 years and in some countries it will move much faster than this.

Poland: Lower inflation, but worrying credit growth

2007-08-20T14:47:00.000+02:00

From Danske Bank:

Poland: Lower inflation, but worrying credit growth Polish inflation eased to 2.3% y/y in July from 2.6% y/y - in line with our forecast, but a bit below the consensus expectation (from Reuters) of 2.4% y/y. The inflation numbers do not give us any reason to change our expectation for the Polish markets and monetary policy. The drop in inflation is mostly due to a fairly strong base effect. That said, there are clearly inflationary pressures in the Polish economy and we would expect inflation to inch upward towards 3% by the end of the year. The inflationary pressure in Poland stems from the supply as well as the demand side of the economy. We are mostly concerned that the tighter labour market situation will increase wage pressure, but the risk of zloty weakness and higher food prices poses some inflationary risk. However, we expect the Polish central bank (NBP) to especially focus on wage development as an indicator for future inflationary pressure. We continue to expect the NBP to hike rates twice more this year (two times 25bp), but the NBP is likely to keep rates on hold at this months monetary policy meeting. Today we also got money supply and credit growth numbers. The money supply (M3) grew 19.3% y/y a bit on the high side, but more importantly, the credit growth to households continues to accelerate. Hence, credit growth to households was 40.1% y/y in July up from 37.6% in June. Until now we have not been overly concerned about lending growth in Poland at least not compared to other countries in the region but this kind of credit growth is clearly not sustainable in the longer run.

Polish Industrial Output July 2007

2007-08-20T14:43:00.000+02:00

Polish industrial output rose at a 10.4 percent on the year in July 2007, and declined 2 percent from June, according to the Warsaw-based Central Statistical Office today.

The annual pace of growth almost doubled from last month and for the first time in three months has outpaced wage growth.

Polish Fertility

2007-08-14T16:09:00.000+02:00

This post is a brief "state of the game" one to accompany our recent material on capacity problems in the Polish labour market. First off, it is interesting to note that there is a debate inside Poland which is begining to wake up to this problem, as the following link from the External service of Polish Radio shows. In fact they make the claim that in 2005 Poland had the lowest fertility in the EU, at 1.24:

The declining birth rate observed for years has prompted the government to come up with a long-term pro-family program, which is expected to encourage women to have more kids. Poland’s fertility rate - that is the number of children per one woman – is the lowest in Europe. In 2005 it was 1.24, whereas the EU average is 1.5, according to a report just published by the statistical office of the European Union – Eurostat.

Actually, it isn't clear that Poland still has the lowest fertility in the EU, since according to the 2006 CIA factbook, by 2006 Polish fertility had sneaked back up to 1.26 Tfr, whilst the Czech Republic was down at the 1.24 level. However - as can be seen from the graph below - whichever way you look at it, Poland has a serious fertility problem, and one which is set to only make those labour shortages currently being experienced worse with time.

Poland's population has been in natural decline since the early years of this century:

“Since 1984 the number of children born in Poland has been decreasing. In 1999, for the first time, the number of deaths exceeded the number of births. We have a truly difficult demographic situation”. A number of factors are at play causing women to postpone childbirth and to have less children. Aneta Seibert from the Gender Equality Coalition explains.

As suggested in the article, one for the reasons for the strength of the decline in Poland has been - as elsewhere - birth postponement:

Since the median age at first birth of Polish women is still in the mid twenties, and thus some way below the current Western European norm of 29-30, it would appear that this postponement process still has some way to run.

But in addition to the general postponement process, there are number of other factors at work, which stem from the traditional nature of Polish society:

“One is very evident discrimination of women on the labor market associated with the fact that that they are mothers or that they may become mothers. There is a very wrong assumption among Polish employers that once you become a mother somehow your qualifications disappear along with your commitment to work.”

and

Another important factor is lack of institutionalized good quality and affordable child care, especially for children under 3. “In Poland only 2 percent of children under 3 attend organized child care while in other countries it’s over 50 percent, similarly with kindergartens.”

Now the response to all of this has been an attempt by the Polish government to give more support to would be parents, the problem is that this costs money, and money is what the Polish government is not exactly flush with given the need to control the deficit and reduce the tax wedge (as mentioned in the last post). So there seems to be a kind of self-reinforcing double-bind at work here.

The government is preparing a comprehensive program of support for the family. Some 5.9 billion US dollars may be spent until 2014 on pro-family measures such as extended maternity benefits, tax breaks for families with several children.

As some of the skeptics claim, all of this may be far short of what is needed, but the question still remains, where is the money going to come from?

The BBC also had an article on the new initiative as well as this more general article on the decline of childbirth in Poland. Essentially the BBC also highlight the missmatch between a rapidly evolving society - and in particular a changing labour market - and the presence of traditional values:

If you asked many people which countries are the most Catholic and traditional in Europe, they would probably answer either Ireland or Poland. And in many respects they would be right. Anna Jurczak, who has six-month-old twin boys. Women's expectations of men are changing, says Anna Jurczak According to surveys, around two-thirds of Poles go to church every Sunday and 70% say that family and children are the most important things in their lives....

So why are family-oriented Poles having fewer babies? It is partly because there is a difference between what people say and what they do. And it is also because Polish society has been undergoing profound changes in recent decades.

First, more and more young people, especially women, are going to college and university.

"Women are becoming more and more demanding. They want to get a job and career first so they're not dependent on their husband later," says 34-year-old Anna Jurczak, who has six-month-old twin boys. "Twenty years ago you had to get married young but in our generation, my friends and I, first of all we want to find a good job and then we can find someone we can love." And women are getting more choosy when it comes to picking a suitable husband, she says.

Another dramatic change came with the transition from communism to a market-based economy. Under communism unemployment officially didn't exist. Now, at 18%, it's the highest in the European Union.

As well as concerns about job security, there is a chronic housing shortage and many young people live with their parents because they cannot afford a flat. The cost of raising a family is also increasing.Another reason why women are reluctant to break their career to start a family is because they fear they won't be able to get their jobs back after taking maternity leave.

Finally, I think one think needs to be borne clearly in mind here. Any success in nudging fertility back up again using the kinds of measures which are presently discussed will only have any kind of impact on the labour market in over 20 years time, and in the meantime the brunt of the labour shortages problem I spoke about in the last post is really going to lock in between now and 2020.

Which isn't to say that you don't need to address the low-fertility issue, but simply that this alone isn't going to be enough.