Polish Economic Outlook 1/2007: Special Topic – Poland, the Euro and the Maastricht criteria

The latest edition of PEO rates 2006 as a year in which economic growth exceeded expectations, reaching the highest yearly rate since 1997. The outlook for the Polish economy looks positive in the short and medium terms. Forecasts show GDP growth will remain high (above 6%) in 2007, largely due to strong domestic demand, though is expected to slow by 2008.

Inflation remained among the EU’s lowest in 2006, yet upward pressures were already visible in the first quarter of 2007. The authors of the report also comment on rapidly rising levels of employment and wages, the improvement in the fiscal balance and the continued surge in exports.

The report includes a special section devoted to Poland’s “Euro Readiness” in comparison to other new member states, which shows that the Polish economy seems capable of fulfilling the Maastricht criteria, with 2012 looking like the the most likely target date. Click here to download the latest Polish Economic Outlook.

Executive Summary

Growth in the Polish economy in the fourth quarter of 2006 and in the whole of 2006 exceeded expectations reaching the highest yearly rate since 1997. The economy expanded at 6.6% yoy in the fourth quarter and at an annual average of 6.1%.  The growth was driven by a surge in investment, private consumption and exports. Strong demand was met by an acceleration of industrial production growth and contributed to a reduction of registered unemployment to the lowest levels since the late 1990s.

The outlook is positive both in the short and medium term. Forecasts show continued high GDP growth in the coming quarters and business sentiment indexes, as well as consumer confidence indexes are at or close to historically high levels. The rapid growth of fixed capital investment adds to the picture of prevailing optimism. The 2006 HICP inflation rate, at an annual average of 1.3%, remained among the EU lowest, while higher GDP growth and tax revenues have led to a smaller-than-expected fiscal deficit in terms of GDP.

Despite the positive perspective there are, however, a number of risks to the downside emerging.  First of all, rising demand and credit figures lead to the emergence of some inflationary pressures. On the supply side, despite still high registered unemployment rates, labor supply in some markets seems especially squeezed, in part due to migration. March 2007 inflation exceeded expectations reaching 2.5% and is projected to rise further by the end of 2007.

Government spending needs to be cut back given the growth phase of the economic cycle and unprecedented optimism levels. However, plans for consolidation do not seem ambitious and the postponement of tax reforms constitutes a foregone occasion to reorganize the state budget before a slowdown kicks in. For now, there seems little possibility of meeting the 3% of GDP limit on fiscal deficit and having the EU’s excessive deficit procedure lifted in the coming years.
The housing market in the main cities is booming, fueled largely by increased access to mortgage loans. Supply in the entire construction sector is rising, though is curbed in part by problems of tightening labor supply. Poor credit access in the past leads to the expectation that this fast growth is part of a catch-up effect rather than a bubble. If rising inflation pressures are not contained in time and will ultimately require large(r) interest rate hikes, the housing market may be vulnerable to a rapid cooling.

Some additional sources of uncertainty in the fourth quarter of 2006 included issues of energy security and rather ambiguous attempts to find a replacement for the outgoing central bank governor.

Finally, mainly due to high demand for exports in the EU, the current account deficit remains moderate; however the most recent figures exceeded expectations because of a larger-than-expected trade deficit.

Therefore, although the economy is certainly doing well, some fears of overheating are emerging, and there is room for both central bank and government action in order to contain the uncertainties and sustain the high growth.

In the new edition of the Polish Economic Outlook we summarize the main macroeconomic developments in the last quarter of 2006 and the first quarter of 2007. We present CASE forecasts for the main variables and introduce a Special Topic section in order to focus on broader economic issues. To start we propose Poland, the Euro and the Maastricht Criteria.