Macroeconomic Imbalances, Macroeconomic Policies and the Economic and Financial Crisis the monetary and fiscal policies followed during 2008 and 2009 in the context of and in relation to the economic crisis.
The Economic and Financial Crisis
The recent economic and financial crisis originated in the US where monetary excesses, partly caused by FED easy monetary policy in the period 2001-2007, prompted the housing boom, which in turn led first to financial markets turmoil, and then to the real economy crisis that spread worldwide between 2007 and 2008.
The first symptoms of financial crisis were observed on the USA mortgage market already in the first half of 2007, but only with the collapse of Lehman Brothers in September 2008, the crisis extended from the financial sector to American real economy, and from there it broadened globally.
For more than a year since the eruption of the financial market turmoil, the persisting inflation risks, the substantial stresses in the financial systems and risks to its stability led to a passive monetary policy. However, with the worsening of the crisis in September 2008, risk aversion rose dramatically and confidence plummeted, stresses in the banking system increased, the money market became dysfunctional credit tightened), world economic activity weakened substantially, a sharp drop in world trade and a marked decline in commodity prices were observed. This sudden and substantial deterioration brought a significant decrease in inflation risks and a steep increase of the risks to financial instability. Banks became more and more reluctant to lend to each other as a result of a sharp increase in the perceived risks of counterparty default and a continued lack of transparency about the health of banks' balance sheets.
In response, major central banks took steps of unprecedented magnitude to ease monetary policy and inject large amounts of liquidity, also by relying on non-standard measures.
Economic consequences of the crisis: how the global crisis hit Poland
The financial turmoil hit Poland swiftly in late 2008. Following the inception of the crisis, Poland experienced a rapid capital outflow, a significant depreciation of the zloty, and a freezing of the interbank market.
The subsequent decline in credit growth, combined with lower exports, contributed to a marked decline in GDP growth. Nonetheless, in consideration of the fact that the climax of the crisis took place in the last quarter of 2008, this was one of the best results in the EU member states. Specifically, Poland, together with the Czech Republic, has been the most robust economy among the EU10 and was the only European economy not to contract.
Impact on actual and potential growth
Following Poland's accession to the EU, from 2004 until the middle of 2008, all the main sectors (i.e. services, industry, and construction) showed strong economic growth, hence pulling GDP growth. This upward trend, which got to its highest point in 2007 with a 6.8% increase in GDP, was interrupted in 2008, when GDP increased only by 4.9%. Specifically, after the first three quarters of the year displaying economic growth at 5.7%, a clear slowdown was observed in the last quarter of 2008 when growth rate dropped to 2.9%.
On the basis of the analysis of current conditions and the cycle of economic development, the growth rate is expected to drop in the next quarters of 2009 (in the first quarter of 2009 the growth rate was 0.8%).
Specifically, IMF projects a mild recession in 2009 (decline in GDP by about 0.5%) and a slow recovery in 2010(about 1% recovery in 2010).
Domestic demand (Consumption+ Investments)
Domestic demand was the main growth factor of GDP in 2008 and in the last few years. However in 2008 the growth rate of domestic demand experienced gradual decrease in successive quarters, from 7.3% in the first quarter to 3.5% in the fourth quarter. The overall annual growth rate was 5.4%.
Individual consumption, the main factor stabilizing the growth rate of domestic demand in 2008, increased at 5.6% rate during the first half of the year and fell to 5.2% in the second.
In particular, in 2008 the total consumption increased by 5.6%, which led to a significant increase in individual consumption (5.4%). The consumption growth rate was highest in 10 years. The factors that determined the scale of this increase are a 3.7 % rise in employment and 6 % rise in real salary. The social benefit fund has increased by 9.2%. The increase in the income of households, which prompted individual consumption, resulted also from subsidies under Common Agricultural Policy.
The high acceleration of investment recorded in 2006 continued through the first half of 2008.
The increase in investment in 2008 resulted from continuing investment processes from previous years.
The investment dynamics was maintained, due to a favourable, though deteriorating financial situation of enterprises resulting from the advancement of the crisis, and an increase in the exploitation of EU funds. The accumulation rate remained high.
However, the growth rate of investment capital has been decreasing since the first quarter of 2007, reaching 15.2% in the first two quarters of 2008. The annual increase of investment capital in 2008 was 8.2%.The main factors contributing to the investment slowdown is the current economic recession and negative assessment of the prospects for economic development.
Impact on budgetary positions
Further to the comprehensive reforms and restructuring activities pursued in 1990s, which required substantial funds and placed a heavy burden on the public finance sector, in recent years the situation in terms of public debt and deficit has significantly improved. Unfortunately, as a consequence of economic slowdown and world crisis, the situation of public finance in 2008 and the first half of 2009 deteriorated.
State Budget receipts
As a result of the deteriorating economic growth of Poland in 2008, the actual state budget receipts were lower than planned. They amounted to PLN 253.5 billion. As compared to 2007, the state budget receipts grew by 7.3% in nominal terms, and by 2.9% in real terms. The ratio of budgetary revenue to GDP in 2008 was 19.9%.
The state budget tax receipts amounted to PLN 219.5 billion and were 3.8% lower than the amount planned in the Budget Act. They accounted for 86.6% of total receipts.
The main factor behind the lower than planned tax receipts was the receipts on indirect tax, which were lower by PLN 11.2 billion (6.8%) than the figure expected in the budget.
The non-tax receipts amounted to PLN 19.3 billion, which accounted for 7.6% of total state budget receipts.
The planned non-tax receipts were exceeded by PLN 0.9 billion (4.9%). Non-tax receipts were higher due to, among other things, higher income of budgetary units (by 12.7%).
State Budget expenditure
The total state budget expenditure in 2008 amounted to PLN 277.9 billion. Compared to 2007, the expenditure was higher by PLN 25.6 billion, i.e. by 10.1% in nominal terms and by 5.7% in real terms. The share of executed state budget expenditure in the estimated GDP accounted for 21.9% in 2008. At the time of planning the budget, it was estimated that its share in the budget would amount to 24.8%.
The current structure of budgetary expenditure, marked by a high, multi-annual dominance of fixed expenditure, limits the possibilities of the government to model the level of budgetary deficit.
As in the previous years, most of the budgetary expenditure was fixed expenditure, i.e. expenditure required under statutory provisions or legally binding commitments entered into previously. Its share in total expenditure in 2008 amounted to 72.7% and was by 0.4 p.p. lower than in 2007. In 2008, the share of expenditure determined by law in total budget expenditure decreased, while its nominal value once again increased.
The most essential fixed expenditure included:
− Subsidies to local government units (20,1%),
− Public debt servicing (12,4%),
− Subsidies to the Social Insurance Fund (16,4%),
− Expenditure on national defence (6,8%),
− Subsidies to the Agricultural Social Insurance Fund (7,4%),
− Contributions to the EU budget and expenses reimbursed from the EU budget (12,5%).
In 2008, 27.3% of overall state budget expenditure was allocated to flexible expenditure. Compared to 2007, the expenditure was higher by 11.8% in nominal terms.
Primary (budget) deficit
The state budget deficit in 2008 amounted to PLN 24.3 billion, which represents 89.9% of the amount planned under the Budget Act and 1.9% of the GDP. Domestic financing of the budget deficit amounted to PLN 20.8 billion, which accounted for 103.5% of the amount planned under the Budget Act. Foreign financing reached PLN 3.5 billion, i.e. 50.6% of the planned amount.
As at the end of June 2009, the state budget receipts amounted to PLN 134.3 billion (44.3% of the annual receipts planned in the Budget Act for 2009). The advancement of expenditure is higher than the receipts and accounts for 47% (PLN 151.0 billion). The budget deficit after six months amounted to PLN 16.7 billion (91.6% of the amount planned in the Budget Act for 2009.
The general government deficit in Poland reached 3.9% of GDP in 2008, above and not close to the 3% reference value set by the Stability and Growth Pact. The breach of the threshold mainly reflects the fact that good times were only to a certain extent used as an opportunity to consolidate public finances and undertake deep reforms on the expenditure side. Poland's general government deficit over the past five years averaged 4.3% of GDP, at the same time as GDP growth on average exceeded 5%.
At the end of 2008, the debt amounted to PLN 597.8 billion, which accounted for 47% of GDP, and the rise in debt, as against the previous year, amounted to 13.3%. At the end of May 2009, the State Treasury debt amounted to PLN 602.5 billion - 5.7% more than at the end of 2008.
Impact on labour market and employment
Despite a noticeable improvement on the labour market since 2004, the Polish economy still faces the problems of low employment rate and significant mismatch between labour demand and supply, in particular compared to the EU Member States. In fact, Poland experiences a surplus of low-qualified and a shortage of highly-qualified workers. Structural mismatch results mainly from a relatively low flexibility of the Polish education and salary systems. The former is inadequately developed to provide adults with professional mobility; whereas the latter, in the government sector in particular, is little sensitive to changes in the relation between the labour demand and supply on the market. Spatial concentration of unemployment, caused by a relatively low mobility of labour force, also leads to structural mismatch. Underdeveloped regions, where labour demand is lower, have highest unemployment rates in the country. At the same time, there are shortages of workers in dynamically developing regions, in large urban agglomerations in particular.
In 2008, the average unemployment level in Poland was 1 211 thousand persons, i.e., 7.1% of economically active people, with the unemployment rate of 8.0% for women and of 6.4% for men. Compared to 2007, the number of the unemployed dropped by 25.0%.
According to the registered unemployment statistics, 1 473.8 thousand persons remained out of work at the end of 2008. The registered unemployment rate was 9.5%, i.e., 1.7 p.p. lower than in 2007. The most significant economic factors, which determine the labour market, include, among other things, the rate of economic growth and investment. The dynamic growth trends observed since 2004 also continued throughout 2008 despite an economic slowdown in the last quarter.
Impact on global imbalances
Export of products and services has been another important factor of economic growth in the years 2007-2008. The stable impact of export on the economic growth was maintained until the third quarter of 2008.
In the last quarter of 2008, its impact on the economic growth was slightly negative. Indeed, as a consequence of the recession on markets of Poland's trade partner (mainly Germany and the rest of Eurozone), the external imbalance of Polish economy increased, with the net exports negatively affecting GDP growth. However, as a result of the dramatic decrease in domestic demand in the first quarter of 2009, imports dropped significantly and hence net export recorded a positive effect on GDP.
Since the beginning of the decade, Polish exports had been prompted up by the increasing competitiveness of products, mainly resulting from real unit labour cost reduction. In 2008, the downward trend of unit labour costs reversed and it is estimated that the costs increased by 3.5%.
In addition, the breakdown in domestic demand on major EU markets, which took place in the fourth quarter of 2008, negatively affected Polish commodity exchange in the last 2 months of 2008, as well as in the subsequent months of 2009. While in the 1st - 3rd quarter of 2008 Polish exports (in EUR) rose by 19.8%, i.e. by 4 p.p. faster than in 2007 and by 3 p.p. faster than the average rate in 2001-2007, in the 4th quarter of 2008 it fell by 1.2%, which resulted from exports breakdown in November and December 2008. Consequently, the average yearly exports growth rate in 2008 slowed down to 14.1%, i.e. it was by 1.7 p.p. lower than in 2007.
Further to the severe fall in exports of the first two months of 2009, the next months of 2009 saw some stabilisation, and even a slowdown in the exports fall rate.
The fall in exports was followed by a fall in imports, sharper with every subsequent month. After a relatively dynamic growth in the first three quarters of 2008 (growth in EUR reached nearly 23.8%, and was faster by 4 p.p. than in exports), a slowdown to 3.7% was recorded in the 4th quarter. As a result, the average imports growth rate in 2008 decreased to 18.3%, i.e. remained 4 p.p. higher than in exports. However, as predicted by the Ministry of Economy, from the beginning of 2009, the imports fall rate started to outdistance that of exports. When the trend to higher imports growth rate, which lasted for three years, was reversed, the fall of imports in the 1st quarter of 2009 (by 26.8%) was almost 7 p.p. deeper than of exports. The disproportion became even bigger in April and May 2009.
The import slowdown is of relatively long-lasting character, and it is strongly connected with the crisis, e.g. through the fall in world prices of raw materials (especially energy resources), the decrease in FDI and cost shock in imports caused by deep zloty depreciation, especially in the situation of more difficult access to bank loans.
Apart from the different negative implications for Polish economy and foreign trade conditions, the crisis brought about a significant reduction of an exceptionally high and dynamically growing commodity trade deficit of the last few years.
The commodity trade deficit, which, after 3 years of dynamic growth, reached an unprecedentedly high level of EUR 26.2 billion at the end of 2008, was reduced during 5 months of 2009 to almost EUR 3.3 billion. It means that the average monthly level of deficit was reduced from EUR 2.2 billion in 2008 to EUR 0.7 billion in 5 months of 2009, i.e. 3.1 times.
Apart from the unit labour costs, foreign currency prices and currency exchange rate also determine the competitiveness on foreign markets by affecting transaction prices in exports and imports.
Since the beginning of 2007 until the summer of 2008, PLN appreciated against EUR, which had a negative effect in the competitiveness of Polish products on foreign markets. In the second half of 2008, PLN depreciated by ca. 30%, with further depreciation in the first months of 2009.
The decrease in foreign currency prices in exports by 12.4% in the first quarter of 2009, as compared to the third quarter of 2008, was more than compensated to exporters by a relatively sudden and deep depreciation of PLN, which occurred after the crisis reached Poland. Transaction prices for exports increased in the first quarter of 2009 by 21.4% as compared to the third quarter of 2008, i.e. the period before the crisis. Such a significant rise in transaction prices, despite a quite significant fall in foreign currency prices, caused by the crisis, was possible due to a deep depreciation of PLN in relation to the main foreign currencies - also as a direct consequence of the crisis.
Consequently, the fall of PLN was a very favourable buffer, which mitigated negative effects of the bad economic situation and of the fall in foreign currency prices on the financial situation of many exporters, in particular SMEs.
At the same time, a significant and rapid depreciation of PLN resulted in a serious price shock in imports, in particular in imports for the domestic market and in supply imports meant for production for exports with a relatively long production cycle. Despite the fall in currency prices in imports (by over 9% in the 4th quarter of 2008 and by 7.9% in the 1st quarter of 2009), transaction prices in imports in the 4th quarter of 2008 and in the 1st quarter of 2009 rose by 6% and 9.3% respectively.
This reduced the effect of global economic slowdown on export, and significantly limited the growth rate of import.
To sum up
The dynamics of economic growth recorded in 2008 was lower than in the previous year. The GDP increased by 4.9% compared to 6.8% in 2007. The GDP growth rate recorded in subsequent quarters was lower with each quarter. Until the 4th quarter, some growth of activity was observed in the conditions of growing inflation, expectations related to inflation, wage pressure, and gradually improving situation on the labour market. The situation of State Budget was better than assumed in the Budget Act, while the situation in balance of payments deteriorated. The relation of current account deficit to GDP increased from 4.7% in 2007 to 5.5% in 2008. 2008 was also a subsequent year in a row when the deficit in Polish foreign trade increased.
While analyzing the demand factors of the economic growth, it should be noted that the economic growth in the first half a year of 2008 was balanced. It was based on private consumption, investment capital, as well as on exports (despite the unfavourable PLN appreciation). In the second half of the year, the two latter factors decreased, with the consumer demand remaining the primary economic driver. The decrease in investment demand and PLN depreciation contributed to the reduction of the growth rate of import
IMF projects a mild recession in 2009 and a slow recovery in 2010. Domestic demand is likely to contract further, as private investment retrenches, consumption wakens, unemployment rises, and credit and wage growth recede. Consequently, the mission projects GDP to decline by about ½ percent in 2009 and to only recover modestly by about 1 percent in 2010. With imports declining faster than exports, we expect a significant decline in the current account deficit. Inflation is expected to continue to ease.