160th mBank – CASE Seminar Financing for the Polish economy: prospects and threats
The 160th mBank-CASE seminar was devoted to the financing of the Polish economy, its prospects and threats. Access to funds and the way they are used are key for the growth of investment in an economy, in both the private and the public sector, and as a result for a country’s economic development. A specific role in this process is played by financial intermediary institutions, and they were the main subject analyzed by the four experts invited to the panel, and of the audience discussion.
In the first part of the seminar, the main speaker, Andrzej Halesiak (an expert on financial markets and a member of the Association of Polish Economists) presented the basic sources of financing for the Polish economy in the past 14 years (2003-2017), meaning during Poland’s membership in the European Union, and discussed their changing structure. The financial system, which includes intermediary banks and the capital market, supports investment processes in the real sector: the sector of non-financial enterprises and consumption (meaning households). The mission of the financial sector is to transform capital over time, and to transmit funds from entities with financial surpluses to those with shortages. The data presented by Mr. Halesiak demonstrate that the earlier process taking place of the deepening of the Polish financial market was halted in 2014 (the measure of the depth of the financial market is the relation between total obligations, i.e. capital and debt, to GDP, and in 2014-2017 obligations to GDP stabilized at a level slightly below 300%. In other words, in the last few years the size of financial obligations has been growing in Poland at a rate close to the GDP growth rate.
This statement was accompanied by an in-depth analysis of external financing over the past 14 years, performed separately for the enterprise sector and for households. The fastest growth (15% a year) came in financial obligations of households, but their share in total obligations was and remains the smallest. The reason for the strong growth of household obligations turned out to be a change in the model of consumption. The speaker defined this transformation as a transition from the principle of “save to buy” to that of “buy to pay off.” The high growth in households’ debt is happening alongside a very strong drop in their savings rate. Shifting to a discussion of the financing of the enterprise sector, Mr. Halesiak stressed the unique influence of banks on investment processes in the real sector: It is banks that to a large degree select projects and decide which of them are executed at a given moment in the economy and which are not. The enterprise sector accounted for and still accounts for the highest share of financial obligations, but over 14 years of EU membership the rate of growth in such obligations averaged just 9% a year, which should set off a yellow warning light: The accumulation of assets is shifting in the direction of other sectors, which may lead to a shift in the structure of assets to less productive ones. Next Mr. Halesiak noted that since the global financial crisis, the significance of external financing in the enterprise sector (in particular from organized capital markets) has declined, and the role of self-financing has grown.
The significance of foreign capital has not changed in terms of volume, but its forms and recipients have changed. After Poland’s entry to the European Union, the foreign share of companies’ obligations grew, as a result of a very strong wave of direct investments: They reached as much as 7% of GDP. In recent years foreign capital constituted a serious source of financing for the Polish public finance deficit. An analysis of data for the entire period leads to an interesting conclusion: foreign financing to a great degree simply suited the needs of the Polish market.
And finally, the role of the stock market: After 2004 its significance as a source of financing for companies grew, but this process halted during the global financial crisis, and in recent years we have been facing a slight declining trend.
The author of the presentation pointed to an important phenomenon taking place in the enterprise sector: the growing surplus of savings over investment, which today reaches 6-7% of GDP. What’s happening with these savings? They’re being transferred to other sectors of the economy. The enterprise sector today is financing the needs of the public sector (high public finance deficits) and of the household sector. The question must arise of whether this is efficient in the long run, and whether at a certain moment it won’t begin to have a negative impact on our economic growth.
Next, Mr. Halesiak discussed the trends related to investment by enterprises during the period of Polish EU membership, and pointed to two significant characteristics: Since 2009 investment in proportion to nominal GDP has been declining, while its structure is gradually departing from that observed in emerging economies, and evolving in the direction of that observed on developed markets. The greatest challenge is the low level of companies’ outlays. Although enterprises in Poland are aware that they should invest more, the circumstances in which they operate do not support investment.
The first commentary on Mr. Halesiak’s presentation was delivered by Dr. Ernest Pytlarczyk, chief economist of mBank. He began by expressing the caveat that he had seen his task as finding points he could disagree with, in order to create a space for discussion. First of all, he said, we must ask where the problem really lies. It certainly isn’t a shortage of funds to finance enterprises’ investment projects, since we have 16% growth in loans to enterprises and can’t see any symptoms of underinvestment in the economy. We have high productivity growth, moderate real wage growth and low inflation. If the economy were suffering from underinvestment, tensions would have to appear somewhere, and there’s no sign of them. The lack of a problem with competitiveness is also indicated by good figures for Polish exports in the first quarter of 2019, despite the signs of a slowdown in Germany. The second debatable question is the financing of debt by foreign capital. Of course, foreign capital finances our fiscal deficit, but it does so at quite low interest rates. Foreign investors aren’t looking for the highest rate of return (meaning risky investments), but they choosing Polish government bonds as a way to diversify their portfolios. Addressing the changed model of financing of Polish enterprises, Dr. Pytlarczyk noted that it has approached the model observed in the mid-sized enterprise sector in Germany. As in Germany, we have a departure from credit as the basic source of funding for development, in favor of internal financing. This choice has the advantage that having one’s own “financial cushion” makes enterprises independent of unfavorable economic conditions, and guarantees greater financial security. Simultaneously, Dr. Pytlarczyk argued that very fast growth of lending in several developed countries before the global financial crisis of 2007-2009 shouldn’t be the goal of developing the financial system in Poland. He also pointed out that in the past two years the role of the banking sector in financing the Polish economy has grown, and this is no surprise in light of several well-publicized scandals on the capital market, which have quite effectively drained funds away (banks benefited, taking up the resources freed up from stock market investments).
In the final part of his commentary, Dr. Pytlarczyk questioned the correctness not only of the method of measuring investment in the economy, but also the relationship between the investment rate and the level of GDP. He stated that the current low level of investment (as traditionally measured) may have other causes. He believed these were not problems with financing, as in general there is plenty of capital and it’s cheap. The reason is most likely uncertainty: After the global financial crisis we have a new fiscal and regulatory regime, and are also experiencing a shortage of workers, and the price formation processes on the global market (on which Polish companies have no influence) and their volatility translate into uncertain returns on investment. Additional significant factors shaping the domestic economic reality, according to Dr. Pytlarczyk, are the insufficient level of competition, the inability to achieve benefits from economies of scale and the reduction of inflows to Poland of grants from the European Union.
Stefan Kawalec, president of Capital Strategy, focused his comments on the banking sector. He began by stating that the financial sector is a good subject for quantitative analysis because of the supply of a broad spectrum of data. At the same time, he noted that drawing conclusions from this analysis is risky: De facto, economics has not yet created a mature theory combining the functioning of the financial sector with the real sector of the economy; macroeconomic analyses, describing economic models, have completely passed it by. Mr. Kawalec noted in this context that the ideas concerning the optimal size of the financial sector went through a significant evolution during the period before and after the financial crisis – and are likely to continue changing. Against this backdrop, as Mr. Kawalec stated, in general it seems that the Polish banking sector is the right size, and the scale of bank financing does not pose a problem for the economy. But a real threat may come from regulatory costs that burden this industry and reduce its profitability below that of the non-financial sector, and below its cost of capital. This situation, according to the panelist, will over the longer term create economic imbalances that contribute to the emergence of a crisis.
Mr. Kawalec also briefly discussed changes in the ownership structure of the banking sector consisting in the growing share of state-controlled lenders. He pointed out that a few years ago he had called for the “domestication” of some of Poland’s banks, meaning a process of foreign lenders’ subsidiaries being taken over by domestic private capital, placing their decision-making centers in Poland. But at the time he clearly said that the point was for these banks to be privately owned, and that it was necessary to avoid the easiest path, which would be taking these banks under state control. This process of bank nationalization may occur if the sector’s profitability is very low and the policy continues of placing more and more fiscal burdens on the banks. We can expect that in that case, foreign banks will withdraw from Poland. Over the longer term, this path is very dangerous for the economy, as historical experience teaches.
Areto’s Managing Partner Mariusz Więckowski began his comments with the statement that he shared the opinion of the remaining panelists that Poland’s capital market could be stronger and that there is room for this market to finance Polish companies’ investments to a greater degree. He pointed out that the capital market plays a specific role in making financing possible for young companies. Early-stage companies with high business risk are an important catalyst of the so-called Fourth Industrial Revolution, so their financing is significant, and possibly of increasing significance, for the modernization and efficiency improvement of the entire real sector.
A great portion of Mr. Więckowski’s comments addressed the question of barriers to the development of the capital market. He pointed out the growth in market regulation in recent years, which has translated into growth in companies’ costs of entering and functioning on the market. Additionally, the capital market is limited by inefficiencies in its infrastructure and institutions. Also notable is a lack of leadership necessary to coordinate reforms essential for the capital market to start playing its role well. Another problem is the low level of financial education in society.
The answer to these problems should be the introduction of the solutions contained in the Capital Markets Development Strategy, a document commissioned by the government which had been made available for public consultations a month earlier. The overriding goal of the Strategy is first of all to increase the scale of capital acquisition directly from the capital market by the enterprise sector, and second, to eliminate the most significant barriers to the development of the domestic capital market. Proposals include appointing courts specializing in capital markets to increase the degree of investor protection, and the introduction of corporate governance principles in relation to minority investors. The Strategy sees the introduction of tax incentives both for issuers and for investors as essential for animating the market.
The Strategy is divided into stages. The first, in principle, is to be executed in 2019-2023, but it also calls for certain long-term actions. In concluding his comments, Mr. Więckowski expressed his hope that the implementation of the Strategy will contribute to the liquidation of inefficiencies in the capital market, which contributes to better development for Poland.
After the panelists’ comments, an interesting discussion with the audience began, which focused on the following questions:
- macroeconomic aspects, in particular those that are significant for the financing of structural changes and economic development in the following years;
- the role of the banking sector as a basic source of financing for the Polish economy – taking into particular consideration in these processes changing risk appetites and ownership changes in the sector;
- the role of the capital market as a particular source of financing for economic processes in Poland: In this area it was important to indicate the reasons for the weakening of this market, to identify potential solutions and to describe the chances for carrying out the needed systemic reforms.