Polish reforms are moving in the right direction, concluded International Monetary Fund experts in a report on the Polish economy published last December. With a production level higher by 20 percent than 10 years ago when reforms began, and with a private sector employing two-thirds of professionally active people, Poland is a model for other countries transforming their economies.
In recent years Poland has also made significant progress in reducing its budget deficit. The government and the central bank are implementing a firm anti-inflationary policy, which has allowed for a major cut in interest rates in the second half of 1998. The success in the next years depends on the consistent restructuring of state-owned companies and their fast privatization.
Macro-success
The fundamentals of the Polish economy—all the basic macroeconomic indicators—seem solid, and world financial markets are increasingly giving Poland special attention among other emerging markets. Last year's crisis in Russia proved they're right, as the Polish economy remained almost unaffected, though some banks and companies with operations in the East did suffer losses.
The government assumes the gross domestic product will rise by 5.1 percent this year, while independent Polish experts regard this forecast as too promising. The IMF experts' estimations hover around 4.75-4.8 percent. The cautious approach is the effect of last year's GDP rise of 4.8 percent, much lower than the government's prediction of 5.5 percent. The slower rate of economic growth, clearly visible in the second half of 1998, resulted from the government and the National Bank of Poland's policy of cooling down the economy. This tendency may remain through the first half of this year, with all the consequences, including lower demand, production, exports and wages.
Last year Poland beat the inflation barrier of 10 percent, coming in at 8.6 percent, the lowest in 10 years. That was possible thanks to a very low increase in food prices (2.8 percent). Low inflation was also possible because of world prices of fuel and raw materials, as well as deflationary tendencies in other countries.
This year's inflation is difficult to predict. The government expects the December 1998-to-December 1999 rate will drop to 8.1 percent, and the average annual rate to 8.5 percent. Experts, however, are in general of the opinion that the inflation rate will be lower, below 8 percent, and perhaps as low as 7 percent. The Finance Ministry stresses that this year most of the deflationary impulses are no longer present: there will be no further drop in the world prices of raw materials, and the situation after the Russian crisis is stabilizing. The ministry also notes that if the prices increase slower than expected, theoretically revenue should also be lower, which might make it more difficult to finance budget spending. On the other hand, a lower inflation rate may mean higher real incomes for individuals and companies—so their expenditures may be bigger, too, bringing about higher budget revenue from VAT.
Last year's cooler economic cycle was reflected by the unemployment rate's rising from 9.5 percent in August to 10.4 percent in December, and employment in companies grew more slowly. Investment outlays, however, were growing steadily, increasing by about 20 percent in 1998.
The industry, agriculture and construction sectors were also affected. In most companies in those sectors, profitability decreased, while their deteriorating financial situation combined with expensive loans put a limit on modernization and reconstruction of machinery—preventing an increase in the economy's competitiveness. Such was the case in many processing sectors, including furniture, machines, pharmaceuticals, chemicals, and rubber and plastic products. The growing barrier to sales resulted in a visible increase in the supply of unsold coal and lignite, oil, wood and wood products. As a result, industrial production went up by only 4.8 percent, compared to 11.2 percent in 1997.
1998 was another poor year for agricultural producers. Farmers had problems selling their products after exports to Russia collapsed. The prices of many products dropped, bringing farmers' incomes to the lowest level in five years. Poland's problems with agriculture are caused by an undeveloped infrastructure, low labor efficiency and outdated technology. Most Polish farms are small, less than 20 hectares, and about 11 percent of Poles live off farming. Both Polish government and European Union experts agree that outmoded agriculture will be one of the biggest obstacles Poland will have to overcome to join the EU in the next four years.
Foreign Trade Targets Reoriented
The trade balance and the balance of payments should not change much this year. In the budget, the government expects the foreign trade deficit will be $14.3 billion (last year it was $13.6 billion, or more than 4 percent of GDP), and the current balance of payments deficit $7.8 billion. Last year exports grew slower than imports, as they have for three years running, thus deepening the trade deficit. Trade with Russia collapsed, dropping by 30 percent, and Polish exporters of agricultural and food products, as well as fabric and clothing, can still feel the effects. Cross-border trade also plunged; previously, it had generated around $6 billion a year.
Poland is strongly dependent on economic conditions in the EU countries, which are the destination of more than two-thirds of Polish exports and the source of three-fourths of imports to Poland. For years Poland has recorded a trade deficit with all the EU countries, as well as with the former East Bloc countries.
So far the trade deficit has been compensated for by the inflow of foreign direct investment. In 1998 FDI reached a record of $8.5 billion, according to the Polish Agency for Foreign Investment. The total value of direct investment by the end of last year exceeded $29 billion, which makes Poland a leader in Central and Eastern Europe in terms of foreign capital invested.
Four reforms
"The budget will be dramatically difficult in part because it will have to bear the accumulated cost of the state's four fundamental reforms," says Leszek Balcerowicz, deputy prime minister and finance minister. The government estimates the cost of reforms at zl.8.2 billion: zl.4 billion for the new pension system, zl.2 billion for reforming the health-care system, zl.600 million for administrative reform and zl.1.6 billion for mining sector restructuring. The cost of education reform, starting this year, will reach zl.300 million, but will be borne mainly by provinces, counties and communes.
When these reforms are completed, the budget will in the long run get rid of expenditures that have nothing to do with development. The budget's decentralization, connected with the administrative reform, should result in more efficient management of funds. On the other hand, the health-care system and local budgets tend to break financial discipline, so in these areas the central government should increase control.
The pension reform introduced this year should gradually lead to decreased budget spending on subsidies for old-age and disability pensions—today, they make up 21.5 percent of state expenditures. Lower budget outlays mean less tax burden on society. According to the IMF report, "In the years to come this will be very important, because lower taxes will help leave more money in the taxpayers' pockets. That, in turn, will make them more active on capital markets, which will play an important role in stimulating economic growth."
Tax reform
The Finance Ministry is preparing a proposal for fundamental reform of the tax system, which would affect both individuals and companies. It will be presented to the Sejm in the spring. The reform is to simplify the tax system, reduce the number of tax brackets and increase the level of income that is free of tax. The government plans to create better conditions for investment by companies, through lowering the corporate income tax and simplifying the tax exemption system. In the opinion of the IMF experts, these proposals are an expression of a modern approach and will contribute to creating a more efficient tax system in Poland which will also be more attractive for foreign investors.
Privatization to speed up
The Polish economy is 70-percent privatized in terms of employment. The private sector already dominates trade, industry, services and transport. Private companies make up three-fourths of foreign trade. The state still owns most heavy and defense industries. The municipal sector is also large.
1999 plans call for beginning privatization in mining, metallurgy, oil, power and gas, sugar and alcohol production. The Treasury Ministry expects that 70 large state-owned companies will be privatized. Privatization in the banking sector will continue, as the state plans to sell its shares in banks listed on the Warsaw Stock Exchange, and launch the transformation of the largest Polish retail bank, PKO BP, and Bank Gospodarki Żywnoiściowej SA, which serves the agricultural sector.
The government has adopted an ambitious plan to raise zl.15 billion from privatization of state-owned companies this year. Success will depend on world economic conditions, and on the appearance of investors interested in Polish refineries, steel mills and power plants.

Dariusz Styczek

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