Poland Economic Insights: Pandemic continues to drag GDP growth and lift CPI

Polish economy entered the pandemic in a relatively strong condition with the cyclical slowdown only beginning. The current account surplus has been recorded already in 2019 and during the pandemic the foreign trade channel once again proved to be a growth stabilizer (similarly to the slowdown after the financial crisis). Not only exports dropped by less than imports which boosted foreign trade, but also exports recovered faster after the Q2 lockdown owing to demand from Germany. This was also the result of the rising share of exports of electric batteries which is set to become even more important with new plants opening in Poland. Moreover, the trade surplus widening was to large extent also driven by the rising balance of trade in durable consumer goods which were in demand during the pandemic.

Once again consumption proved to be a key strength of the Polish economy as observed in the rapid recovery following the Q2 lockdown and large increase in online sales which helped to smooth sales during the periods of increased restrictions. At the same time, the demand has shifted from consumption of (restricted) services to purchases of home equipment and furniture — sales of which have recorded double-digit growth for six straight months after restrictions were partially lifted in April 2020.

Finally, the part of the economy which has fared very poorly through the pandemic are investments which despite the lighter 2^nd wave of the pandemic were still lower by 10.1% yoy in Q4 20 (vs +6.2% yoy in Q4 19). A decline in investment outlays of over 10% yoy has been recorded in 2020 in over half of sectors with only selected ones reporting growth in outlays. These include real estate, coke, and refined petroleum, chemicals as well as electrical equipment (which may again be related to the rising exports of electric batteries). The value of investments as a percentage of GDP decreased further to 17.1% (from 18.5% in 2019) and was the third-lowest in the EU (after Greece and Luxemburg) vs 25.1% in Czechia and 27.5% in Hungary.

Since February Poland has been going through the 3rd, most severe pandemic wave with not only record number of new cases and deaths reached but also with seriously strained health sector. Around Easter first signs of stabilization have been observed. Still, it is yet to be seen how the celebrating of Easter impacts the development of the pandemic. In view of this uncertainty, the government announced on April 7 that it will prolong recently tightened restrictions for another week, at least until mid-April.

It is important to stress however, that there have still been no movement restrictions across regions or curfew which have been observed in many other European countries. Most importantly, the restrictions remain far from the lockdown imposed in the first wave in Q2 2020. This results in relatively smooth operations of firms, especially in the industrial sector, while the services, recreation and accommodation sector remain under high pressure. However, there may of course be disruptions stemming from labor shortages due to many people being infected or on quarantine and therefore unable to work or those taking care of younger children. This is already visible in surveys like the Manufacturing PMI where firms have pointed at labour shortages as one of the constraints in operating.

Finally, the outlook remains brightened by ongoing vaccinations. Poland is faring relatively well in terms of the pace of vaccinations across Europe. While Q1 disruptions in the supply of vaccines slowed the process and Poland has not reached yet beyond the EU-wide deployment scheme (which has been done by Hungary or Slovakia), the awaited supply increase in Q2 has already happened. Moreover, the government recently announced changes allowing more facilities to vaccinate which should also accelerate the process. It announced plans for all people who wish to be vaccinated to be able to do so by the end of August.

With our 2021 GDP growth forecast of 3.7% yoy, following a decline of 2.7% in 2020, we are more cautious compared to the consensus (4.0% according to Bloomberg). The reasons for that include pandemic-related issues: slower than expected vaccine rollout in Q1, ongoing 3^rd wave of the pandemic and risk of new variants which may slow “the return to normal”. Our assumptions also include that the ongoing (although declining) uncertainty will hamper the rapid recovery of investment outlays among private firms. While especially on the public side an important support factor will be the inflow of the NGEU funds, these will start making a significant impact only in 2022 in our opinion. We expect the strongest effect to be visible in 2023, which will allow smoothening the transition between the previous and new EU budget (which in 2016 resulted in a drop of investments by 8.2% yoy). For 2021 however, this component of GDP growth may still be on the lower side, hence our forecast of a rise by only 1% yoy this year (vs -8.4% in 2020).

With that in mind, consumer demand will remain key, and in view of the limited negative impact of the pandemic on the labor market, we expect this GDP component to increase by 4% yoy following a drop of 3% in 2020. However, we also see here downside risks in case of a delayed negative impact on the labor market once the government support measures no longer require firms to freeze employment.

Similarly to 2020, the net foreign trade should again add to GDP growth this year although less than in 2020 as imports continue to recover and are additionally boosted by the rebound in oil prices.

The hit to the economy in 2020 due to pandemic and the resulting restrictions was significantly limited by the fast and sizable government support. Measures announced in 2020 were planned to reach over PLN 300bn (still not all have been disbursed), which is more than 14% of GDP. The support was largest after the 1^st wave in Q2 2020 which brought the strictest measures on the whole economy while at the end of 2020 new packages were directed to selected, most hit sectors. The support was relatively large in terms of direct help compared to other EU countries with the highest share spent on aid for SME firms (over PLN 40bn, non-refundable), wage subsidies (over 15bn) and exemptions from paying contributions (around 15bn).

The antipandemic support resulted in a general government deficit increase from 0.7% in 2019 to 6.9% of GDP in 2020. While historically high, this is significantly less than initially expected (government forecast assumed -11.8%, RBI: -9.1%). After the expenditure rule (limiting their increase) has been suspended and modified due to pandemic, the return to the previous spending path may (legally) last 2 to 4 years. With the pandemic still ongoing, the assumed deficit this year is thus expected to remain sizable compared to previous years but likely to decrease to around 4% of GDP. With that our forecast is more optimistic compared to the estimate in the 2021 budget bill (-6.3% of GDP) and close to the European Commission's forecast of -4.2%. While above the 3% threshold the fiscal policy does not raise concerns as underlined by IMF's assessment which recommended a gradual reduction in deficit while at the same time approved the extension of the antipandemic fiscal support.

The government is also working on medium-term plan for the economy named as National Recovery Plan. It includes details on how the EU funds shall be invested but also plans of domestic reforms. The details have not been released yet but changes may include important reforms in income taxes or creating a separate fund for financing public investments. The reforms and details of the plan will be important not only for medium-term economic outlook but also for the political future of the governing party as it has been recently losing advantage in polls and continues to struggle with conflicts with its coalition partners.

2020 was expected to bring higher inflation in Poland the forecasts were broadly met. The peak of CPI has been reached in Q1 at 4.7% — well above the NBP target band of 1.5-3.5% yoy, and a gradual decline has been observed throughout the rest of the year.

With high base effects from 2020 decreasing core inflation, as well as likely lower food prices following good season in 2020, this year should bring a decline in inflation compared to 2020, especially the core indicator.

There are however several upward factors that will likely keep CPI near or above the mid-target of NBP. These are: again higher fuel prices, another large increase in electricity prices from January as well as other regulatory price hikes introduced this year (waste, sugar tax). While the pandemic-related price hikes should abate later in the year, starting from late 2021 demand-driven factors may intensify slightly. This may result in higher core inflation than we currently anticipate (below 2% in late 2021).

We recently revised our CPI forecast to 3.2% yoy from 2.7% yoy in response to the rise in fuel prices in Q1 but also addressing some of our concerns about upward risks. Despite that, we see more risks to our forecasts to the upside rather than downside, mainly stemming from our still relatively low core inflation forecast and from food prices (due to uncertain weather conditions and the African swine fever disease).

Still, despite those risks, we do not expect this to lead to hawkish reactions from the Polish MPC, especially as some assumed upward effects are in our view temporary. The MPC itself also points at the fact that many of the factors driving CPI higher lie beyond the influence of monetary policy. As a result, we still expect interest rates in Poland to remain at the current level throughout this year, and possibly also for most of 2022.