Polish markets experienced only a brief setback after the tragic plane crash that claimed the lives of many of its leaders. Why? asks, Patrick Bradley of Legg Mason affiliate Brandywine
In April a plane crash tragically took the life of Poland’s president, his wife, and a Polish Central Bank governor. A number of other members of Poland’s political and military establishments perished as well. Such a blow at the heart of a country’s leadership should produce uncertainty that would be reflected in Poland’s currency and sovereign government bond market.
While the markets experienced a brief negative reaction, they quickly settled back into patterns reflective of their underlying fundamentals.
Why? Because Poland’s institutional framework remains on sound footing. What this tragic event demonstrates is Poland has created a political and economic foundation that will support its continued movement toward economic liberalisation. Poland started down this path two decades ago and the success of that journey allowed its economy to experience strong economic growth and to weather the recent economic storm better than many countries, developed and developing alike.
What might be driving investors to Poland?
1. Poland escaped the recession because of its greater reliance on domestic demand, rather than trade.
The Polish economy is more exposed to domestic demand and compared to many economies it has less exposure to trade. It has benefited from a period of rising real income and falling unemployment. As a result, when 70% of its economy continued to grow, Poland avoided the pitfalls of a global contraction in trade that plagued economies more dependent on trade. In fact, its current account deficit actually improved to 1.7% of gross domestic product (GDP) in 2009, from a deficit of 5% of GDP in 2008. As a result forecasters now think Poland could grow close to 3% in 2010 and over 3% in 2011.
2. Poland did not enter the global downturn exhibiting economic excesses that might have blunted its countercyclical policy tools.
Poland’s current account deficit remains relatively low, and back in 2007, its budget deficit at 2% of GDP, was lower than the Maastricht criteria. However, slower economic growth has put some pressure on that public deficit, as automatic fiscal stabilisers kicked in and the country enacted policies to combat the downturn, totaling some 0.7% of GDP.
3. The march down the path of economic liberalisation was aided by a central bank set on reining in inflation and doggedly pursuing (and hitting) its inflation target, helping to anchor the economy’s inflation expectations.
This focus on inflation targeting gained the central bank immense credibility and the support of market participants. As a result during the credit crisis, the central bank engineered a reduction in interest rates from 6% to 3.5% currently.
4. Poland’s currency, the zloty, is free floating – its value determined by the market.
As a result the zloty can adjust helping to ameliorate a negative economic environment and improve its global competitiveness. A freely flexible currency was an important factor for Poland during this crisis, in sharp contrast to its euro-bound neighbours.
From its peak in July 2008 to its February 2009 trough the zloty tumbled 48%, while the euro fell around 21%. Other things being equal such an exchange rate adjustment can potentially produce a sizeable pricing adjustment to Polish firms that export. The zloty is no longer very cheap as measured by purchasing power parity (PPP), but it is substantially cheaper compared to early 2008 levels. The independence of the central bank has also provided some support for the currency.
5. Poland had access to other external sources of funding that could take some pressure off its fiscal policy.
Not only did Poland’s banks remain well-capitalised (partly a by-product of foreign ownership) they continued to obtain access to the credit markets. Poland has access to external sources of funding that take some pressure off fiscal policy.
Poland has been the recipient of funds under the EU’s so-called Cohesion Policy. Such funding is provided to help countries alleviate regional growth disparities and to help countries improve their transportation infrastructure. It also includes support under the common agricultural policy (CAP). Under this programme the EU directs funds to countries like Poland.
The OECD estimates in 2009 these cohesion funds will total 3.3% of GDP. Additionally, Poland was the second participant, following Mexico, in the IMF’s Flexible Line of Credit (FLC) programme. That line of credit totalled $20.5bn. The line of credit recognises the policies enacted earlier by the Polish government and provides Poland with a stop gap in the event, for example, that access to the capital markets becomes encumbered. It is purely precautionary in nature, acting as a backstop if needed.
Challenges ahead
The aftermath of the plane crash has reaffirmed our view Poland has a healthy, stable economy. Its infrastructure can respond to a potential crisis, political or economic. Its policies have created an economy ready to compete in the 21st century and beyond. That is not lost on investors. Its recent economic performance owes much to the pursuit of economic liberalisation begun 20 years ago. Challenges lie ahead for Poland. Like other countries, Poland’s next challenge will be a gradual withdrawal of fiscal and monetary stimulus necessitated by the downturn. Further the OECD notes Poland will also have to pursue structural reforms in its fiscal policies. Among the suggestions cited: reforming the pension system and broadening the tax base. Nevertheless if the past is a prologue, Poland will build on those past economic successes.
Patrick Bradley, Legg Mason affiliate Brandywine
