Gomulka: The worst is over
The bullish 5-6% gross domestic product (GDP) growth of previous years is tapering off and is expected to drop to anywhere from 1.5-3% this year. While the government is still positive, projecting 5.1% growth, the economy in the first quarter of 1999 has not shown signs of supporting those estimates. Industrial output has weakened, the current account and budget deficits have deepened, and the unemployment rate has remained stubbornly high at around 12%. Government spending is also way up, with the budget having to support costly pension and health care reforms implemented at the beginning of the year. But Economist Stanislaw Gomulka, a professor at the London School of Economics and also an adviser to the Finance Ministry, said he believes the bad news is about to come to an end. In a recent interview, he talked with the WBJ's Bohdan Barylko about how he expects the economy to recover in the near term, but also about the problem areas that stand in the way of that comeback.
Q: The economy right now seems to be at a turning point. Has the hangover from the Russian crisis ended, or are we on the brink of even greater problems?
A: It seems to me that indeed the worst is over; that this significant external shock that took place last year and pushed down the level of industrial output is fading. Domestic demand is increasing, and in March a significant increase in manufacturing activity was seen. A combination of stronger exports and much stronger domestic demand should lift the level of output in the remaining months of the year. The present Russian crisis is unlikely to have a major impact, mainly because Poland has disengaged almost completely from trade with Russia, and also because the crisis was more political than economic.
Q: What signs of recovery from the crisis have you seen, and where are the weaknesses that could hurt the economy in the next few months?
A: I see expanding growth of retail sales, increasing nominal and real wages, which do not lead to inflationary pressure since manufacturing output is still significantly below the maximum level achieved in the middle of last year. Investment growth is also strong, 15% a year, so at the moment the GDP level is several percentage points below its potential. And industrial output is also about 15% below potential output. Also foreign-direct investment is continuing at a high rate, so it seems to me that this rapid investment activity will continue this year. On the supply side, I see traditionally strong sources of growth being active again. So if we have some improvement in the external environment, then I see no significant obstacle to renewed fast growth.
Q: When you say external, do you mean Russia?
A: I mean mainly Western Europe. The new projections for the world economy from the IMF (International Monetary Fund) are a little more optimistic. We have seen the beginning of the end of the financial crisis in the Far East, and the U.S. economy in the first quarter was again very strong. In Germany and other countries of Western Europe, we have not seen a very strong recovery yet, but certainly there has been no deterioration.
Q: What are your projections for GDP growth this year and in the next few years?
A: My projection is that the quarterly growth rate, year-on-year, would follow more or less the sequence of 1, 3, 5, 7%. The first quarter is likely to still be very depressing in terms of growth performance, maybe even worse than the last quarter of last year. But one should also remember that the first quarter of last year was very strong and therefore year-to-year comparisons lead to rather poor formal performance in the first quarter. But somewhat depressed output growth in the first half of the year would mean that this year I would expect average growth of about 4%. But next year should be somewhere around 5.5%, and that is a likely assumption for next year's budget.
Q: How well do you think Finance Minister Leszek Balcerowicz and central bank President Hanna Gronkiewicz-Waltz have responded to the economic pressures? Is there anything that has been done wrong?
A: One can always improve. On the whole, both fiscal and monetary authorities performed an excellent job. As far as monetary policy is concerned, it was essential to bring interest rates down rapidly during the second half of last year, which they did. Also in January they decided to reduce interest rates sharply.
Q: So why do people say, for example, that Balcerowicz has made Poland poorer and poorer?
A: Balcerowicz resisted a huge pressure to increase the allocation of funds to the health sector last year. If he gave in and allowed the original proposal to go through, with something like 10-11% of taxes going to those health funds rather than 7.5%, then the fiscal situation this year would be much poorer and we would see a significant weakening of the zloty with the RPP (Monetary Policy Council) possibly increasing interest rates and the situation continuing. But because the fiscal measures were tough, it was possible for the monetary authorities to reduce interest rates more sharply and that led to a moderate weakening of the zloty. This combination of lower interest rates and a weaker zloty was needed in that particular period of weaker external demand to preserve and stimulate domestic demand.
Q: What indicators have been the most important? Wasn't too much attention given to reducing inflation?
A: When? At the beginning of 1998 there was a bit of tension between the Finance Ministry and the central bank because the government decided to increase excise taxes and that led to a temporary increase in inflation. But these measures were understood to help the budget situation in the course of the year and to lower interest-rate expectations. Nevertheless, the central bank took this temporary increase at the beginning of last year very seriously. It decided to increase the so-called basic interest rate to 24% and to keep it at this high level for about half a year. At that time the Finance Ministry was pressing the central bank to reduce interest rates earlier than was done. They (the central bank) only started the reduction in July; we thought that there was perhaps a three-to-four-month delay in this process. The immediate response by markets to the high interest rates was to invest in Polish debt instruments, so there was a large inflow of foreign speculative capital that led to a significant strengthening of the zloty.
Q: What macroeconomic indicator currently gives you nightmares, and which indicator makes you sleep soundly?
A: Until recently, I was very concerned with the possibility that the budget deficit would actually be much bigger than would be prudent. Because of weaker economic activity there was grounds to think that revenue would also be much weaker. On the other hand, the reforms that were implemented at the beginning of this year, the health reform in particular, and pension reform, might lead to larger expenditures. Indeed, there was some pressure in January and February on the expenditure side. A larger transfer of resources was needed for pension funds. Nevertheless, during the last four months on the revenue side, the situation has been much better than one would expect on the basis of mere output indicators. That is the situation and so it seems to me that we are unlikely to have fiscal cuts. I was expecting that 100% of the budget deficit envisaged for this year would be reached during the second quarter .
Q: After the first three months the budget deficit amounted to more than 70% of that planned for the year. By April it had reached 80%.
A: Actually it is less than 80%: It stood at zl. 9.3 billion ($2.38 billion) after April. The outcome in March and April was much better than February and the data we have for May continues to be fairly good. We are now projecting a shortfall of maybe zl. 2 billion ($512 million).
Q: What about inflation? What are your estimates for the year? How do you expect the zloty to perform?
A: Concerning inflation, there were unusual circumstances that worked to lower it. One had to do with food prices. A very good harvest plus the collapse of exports produced a surplus on the domestic market, and that depressed food prices. Secondly, the strong zloty helped to reduce the price of imported goods. That combination helped to bring the inflation rate down in February to the extraordinary level of 5.6%. It was clear that for the remainder of the year, though, the rate of inflation might well be higher. Not much, but somewhat higher. The weaker zloty is also contributing to this increased rate of inflation. I assume that in December the inflation rate will be 7.4%, December-to-December, and fall in the course of next year, to something like 5.4%. In any case, the average inflation rate this year is expected to be 6.8%, and then fall about one percentage point next year. We have a particular inflation target for joining the European Union (EU) - 3-4% by the year 2003. When Poland wants to join the monetary union, about three years after joining the EU, the inflation rate should be 1-2%.
Q: Is this achievable?
A: If we have 5.5% in 2000, a rate of 3-4% by the year 2003 is perfectly achievable.
Q: What are you concerned with?
A: In the medium term, which has been adopted recently by the government, the "Poland 2010 Strategy," there are a number of difficult objectives to be met. We have specific aims to achieve: restructuring key sectors, accelerating privatization, eliminating the budget deficit, reducing inflation. Restructuring may be seen as socially and politically costly. Restructuring has already started in the coal and steel industries, but restructuring of agriculture is a long-term affair. Economic policy has to address the problem of unemployment. The government has to be concerned with it in the next 10-20 years. In the next five to six years, a large inflow of new labor will happen because of the baby boom, which started 20 years ago. The labor force will increase by 200,000 a year, which means an increase of 1.1 million by 2001. That's why in a 10-year strategy we have the task of creating 3 million-4 million jobs. That is the key social and economic policy objective for the next decade.
Q: The economy right now seems to be at a turning point. Has the hangover from the Russian crisis ended, or are we on the brink of even greater problems?
A: It seems to me that indeed the worst is over; that this significant external shock that took place last year and pushed down the level of industrial output is fading. Domestic demand is increasing, and in March a significant increase in manufacturing activity was seen. A combination of stronger exports and much stronger domestic demand should lift the level of output in the remaining months of the year. The present Russian crisis is unlikely to have a major impact, mainly because Poland has disengaged almost completely from trade with Russia, and also because the crisis was more political than economic.
Q: What signs of recovery from the crisis have you seen, and where are the weaknesses that could hurt the economy in the next few months?
A: I see expanding growth of retail sales, increasing nominal and real wages, which do not lead to inflationary pressure since manufacturing output is still significantly below the maximum level achieved in the middle of last year. Investment growth is also strong, 15% a year, so at the moment the GDP level is several percentage points below its potential. And industrial output is also about 15% below potential output. Also foreign-direct investment is continuing at a high rate, so it seems to me that this rapid investment activity will continue this year. On the supply side, I see traditionally strong sources of growth being active again. So if we have some improvement in the external environment, then I see no significant obstacle to renewed fast growth.
Q: When you say external, do you mean Russia?
A: I mean mainly Western Europe. The new projections for the world economy from the IMF (International Monetary Fund) are a little more optimistic. We have seen the beginning of the end of the financial crisis in the Far East, and the U.S. economy in the first quarter was again very strong. In Germany and other countries of Western Europe, we have not seen a very strong recovery yet, but certainly there has been no deterioration.
Q: What are your projections for GDP growth this year and in the next few years?
A: My projection is that the quarterly growth rate, year-on-year, would follow more or less the sequence of 1, 3, 5, 7%. The first quarter is likely to still be very depressing in terms of growth performance, maybe even worse than the last quarter of last year. But one should also remember that the first quarter of last year was very strong and therefore year-to-year comparisons lead to rather poor formal performance in the first quarter. But somewhat depressed output growth in the first half of the year would mean that this year I would expect average growth of about 4%. But next year should be somewhere around 5.5%, and that is a likely assumption for next year's budget.
Q: How well do you think Finance Minister Leszek Balcerowicz and central bank President Hanna Gronkiewicz-Waltz have responded to the economic pressures? Is there anything that has been done wrong?
A: One can always improve. On the whole, both fiscal and monetary authorities performed an excellent job. As far as monetary policy is concerned, it was essential to bring interest rates down rapidly during the second half of last year, which they did. Also in January they decided to reduce interest rates sharply.
Q: So why do people say, for example, that Balcerowicz has made Poland poorer and poorer?
A: Balcerowicz resisted a huge pressure to increase the allocation of funds to the health sector last year. If he gave in and allowed the original proposal to go through, with something like 10-11% of taxes going to those health funds rather than 7.5%, then the fiscal situation this year would be much poorer and we would see a significant weakening of the zloty with the RPP (Monetary Policy Council) possibly increasing interest rates and the situation continuing. But because the fiscal measures were tough, it was possible for the monetary authorities to reduce interest rates more sharply and that led to a moderate weakening of the zloty. This combination of lower interest rates and a weaker zloty was needed in that particular period of weaker external demand to preserve and stimulate domestic demand.
Q: What indicators have been the most important? Wasn't too much attention given to reducing inflation?
A: When? At the beginning of 1998 there was a bit of tension between the Finance Ministry and the central bank because the government decided to increase excise taxes and that led to a temporary increase in inflation. But these measures were understood to help the budget situation in the course of the year and to lower interest-rate expectations. Nevertheless, the central bank took this temporary increase at the beginning of last year very seriously. It decided to increase the so-called basic interest rate to 24% and to keep it at this high level for about half a year. At that time the Finance Ministry was pressing the central bank to reduce interest rates earlier than was done. They (the central bank) only started the reduction in July; we thought that there was perhaps a three-to-four-month delay in this process. The immediate response by markets to the high interest rates was to invest in Polish debt instruments, so there was a large inflow of foreign speculative capital that led to a significant strengthening of the zloty.
Q: What macroeconomic indicator currently gives you nightmares, and which indicator makes you sleep soundly?
A: Until recently, I was very concerned with the possibility that the budget deficit would actually be much bigger than would be prudent. Because of weaker economic activity there was grounds to think that revenue would also be much weaker. On the other hand, the reforms that were implemented at the beginning of this year, the health reform in particular, and pension reform, might lead to larger expenditures. Indeed, there was some pressure in January and February on the expenditure side. A larger transfer of resources was needed for pension funds. Nevertheless, during the last four months on the revenue side, the situation has been much better than one would expect on the basis of mere output indicators. That is the situation and so it seems to me that we are unlikely to have fiscal cuts. I was expecting that 100% of the budget deficit envisaged for this year would be reached during the second quarter .
Q: After the first three months the budget deficit amounted to more than 70% of that planned for the year. By April it had reached 80%.
A: Actually it is less than 80%: It stood at zl. 9.3 billion ($2.38 billion) after April. The outcome in March and April was much better than February and the data we have for May continues to be fairly good. We are now projecting a shortfall of maybe zl. 2 billion ($512 million).
Q: What about inflation? What are your estimates for the year? How do you expect the zloty to perform?
A: Concerning inflation, there were unusual circumstances that worked to lower it. One had to do with food prices. A very good harvest plus the collapse of exports produced a surplus on the domestic market, and that depressed food prices. Secondly, the strong zloty helped to reduce the price of imported goods. That combination helped to bring the inflation rate down in February to the extraordinary level of 5.6%. It was clear that for the remainder of the year, though, the rate of inflation might well be higher. Not much, but somewhat higher. The weaker zloty is also contributing to this increased rate of inflation. I assume that in December the inflation rate will be 7.4%, December-to-December, and fall in the course of next year, to something like 5.4%. In any case, the average inflation rate this year is expected to be 6.8%, and then fall about one percentage point next year. We have a particular inflation target for joining the European Union (EU) - 3-4% by the year 2003. When Poland wants to join the monetary union, about three years after joining the EU, the inflation rate should be 1-2%.
Q: Is this achievable?
A: If we have 5.5% in 2000, a rate of 3-4% by the year 2003 is perfectly achievable.
Q: What are you concerned with?
A: In the medium term, which has been adopted recently by the government, the "Poland 2010 Strategy," there are a number of difficult objectives to be met. We have specific aims to achieve: restructuring key sectors, accelerating privatization, eliminating the budget deficit, reducing inflation. Restructuring may be seen as socially and politically costly. Restructuring has already started in the coal and steel industries, but restructuring of agriculture is a long-term affair. Economic policy has to address the problem of unemployment. The government has to be concerned with it in the next 10-20 years. In the next five to six years, a large inflow of new labor will happen because of the baby boom, which started 20 years ago. The labor force will increase by 200,000 a year, which means an increase of 1.1 million by 2001. That's why in a 10-year strategy we have the task of creating 3 million-4 million jobs. That is the key social and economic policy objective for the next decade.
