Year Zero

Public debt, according to the previous government’s own estimates, is poised to approach 60 per cent of GDP by 2026. And today, it is not hard to identify the fastest-growing component – state debt servicing costs. In the beginning of the fourth quarter, these costs grew at an impressive rate of 87.5 per cent and were PLN 21 billion higher than the previous year, reaching PLN 45.1 billion in October. In 2023, Poland is set to repay creditors even more than the projected PLN 62 billion in the revised budget. Meanwhile, the forecast for full-year corporate tax revenue is PLN 77.6 billion. As corporate income tax continues to decline as profits shrink, only about PLN 5 billion will be left in 2023 from the entire corporate tax collected by the state, after deducting debt servicing costs.

This means that taxation from companies in Poland will struggle to cover the growing costs of state debt servicing. These proportions are far from healthy given the pressing and immense financing needs of other expenditures.

And I earnestly request not to draw the conclusion that companies should pay higher taxes. I recommend taking a moment to reflect, for example, on the often-repeated, reflexively stated slogans such as “we have low debt relative to GDP” or “our public finances are in excellent condition”.

The deficit of the public finance sector, according to EU methodology, is currently around 6 per cent of GDP, and it will still be over 5 per cent of GDP in 2024. In recent years, the anticyclical Stabilising Expenditure Rule [SER] has lost its efficacy. Without prompt repair, it will cease to have any impact.

According to the latest edition of the IMF’s Fiscal Monitor, the structural deficit (adjusted for cyclical effects), currently at 5 per cent of GDP, is expected to decrease to 4 per cent of GDP by 2028 – a figure four times higher than the recommended level by the European Commission, allowing for an assessment of the state of public finances as stable.

In 2024, Poland may be subject to the Excessive Deficit Procedure (EDP) by the European Commission, from which there is no way out without significant effort on the side of adjustments in fiscal policy. The acceptance – heralded, among others, by Mateusz Morawiecki – by the EC to exclude defence expenditures from consideration when applying the EDP to Poland, cannot be found at the moment either in the modification of the COFOG code or in the tables of Government Finance and EDP Notification Tables. Moreover, in the 4 per cent of GDP spent on defence in Poland, material expenses account for less than half. Why would the EC agree to exclude 2 per cent of GDP in defence expenditures from the EDP, which include military personnel salaries?

In the new financial perspective for 2021-2027, access to cohesion funds now depends on fulfilling recommendations from semi-annual reviews of national policies by the EC. Neglecting these recommendations and implementing government promises at the expense of slowing fiscal consolidation are now becoming historical facts.

Bitten by Inflation

When assessing the state of the Polish economy, it is hard to ignore the historically lowest investment rate, already below 17 per cent of GDP.

The unemployment rate is low because the labour market has changed significantly in the last decade, mainly due to demographics and shifts in supply and demand towards services. This is the case worldwide.

The lack of investment and the dwindling labour force are causing a systematic decline in the economy’s potential, currently to around 2.5 per cent, which, with the observed cyclical acceleration of GDP, will lead to an escalation of inflationary tensions in the future when potential is exceeded.

Unresolved issues persist with post-pandemic inflation. CPI inflation fell rapidly in the second half of 2023 due to base effects, fiscal interventions in price processes, and price manipulation by the national fuel market monopolist.

According to my estimates, base effects, supported by Orlen, removed approximately 1.3 percentage points from the annual CPI rate in October. However, the wonders came to an end. In February 2024, the most substantial base effect will occur, contributing to a decline in CPI inflation. The strength of these declines depends on fiscal interventions in price processes and changes in the weightings in the Statistics Poland inflation basket.

In my opinion, the new government should promptly restore the 5 per cent VAT rate on basic food items. It should refrain from freezing energy and gas prices at this year’s levels, allowing them to gradually approach market prices. However, it would be prudent to control margins, as the unlimited margins of energy companies in the current situation will determine the growth of energy prices. The inflation path in Poland still depends too much on fiscal interventions in price processes, and that urgently needs to change.

A decline in CPI inflation from around 6-7 per cent in the first half of 2024 will only be possible if fiscal interventions continue on the same principles. This burdens the budget, distorts relative prices, leads to suboptimal resource allocation, and distorts the inflation path throughout the economy (including PPI). However, even then, the decline in CPI will be increasingly slow.

In the second half of 2024, base effects will be less significant for inflation declines, and in the base index, already higher than CPI, increases in real wages (also in the public sector) and growing GDP dynamics will begin to accumulate.

Achieving sustained inflation declines towards the 2.5 per cent target, without distorting fiscal interventions and without changing interest rates, currently moves beyond the horizon of the central bank’s monetary policy. The problem of inflation in Poland has not disappeared; it is real and still poorly addressed.

Opening Balance

The economy has been deprived of much-needed access to funds from the National Reconstruction Plan (pol. Krajowy Plan Odbudowy, KPO). Pre-financing from the Polish Development Fund (pol. Polski Fundusz Rozwoju, PFR) will not exceed PLN 5-8 billion, a meagre result compared to almost EUR 23 billion of funds available under the grants alone (without loans) from the KPO. Not all funds can be recovered now, translating into tangible losses for the economy.

The tax system inherited after 8 years of PiS rule is in a state of deep chaos following the so-called Polish Deal and requires urgent reorganisation.

By the end of 2023, the risk balance in the Polish economy could be summarised as follows: on the economic growth side, the average annual GDP dynamics hovered around zero+, with the prospect of growth to around 3 per cent in 2024; on the inflation side, the risk was slightly below the consensus forecast, but with significant uncertainty related to the course of the inflation path due to fiscal interventions in price processes.

My simulation of removing current administrative and fiscal regulations in one step shows that the CPI index, after the release of energy prices (without limiting margins) and gas, would jump by about 2.4 percentage points. The return of VAT on food would increase CPI inflation by nearly 1 percentage point. Price shocks would fade, but the average annual inflation in 2024 would approach 10 per cent, following an increase of 11.6 per cent in 2023. In 2025, CPI inflation would average around 4.8 per cent, already without fiscal interventions in price processes. The CPI index would regain its value in assessing inflationary pressure – a quality it currently lacks.

The other side of the equation is the additional budget income from the increase in VAT and CIT taxes after removing administrative interventions. I estimate this to be around PLN 25 billion in 2024, excluding any contribution to the price equalisation fund by Orlen.

Naturally, these are only computational simulations. We are already aware that energy and gas prices will remain frozen, at least until the first half of the year. The new government is unlikely to revoke the regulation extending the zero VAT rate on food for 1Q 24, hastily signed by Morawiecki’s two-week government. Therefore, fiscal interventions in price processes will persist in 2024, temporarily suppressing the inflation path but also leading to a reduction in budget income and necessitating government financing through debt.

The ball is still in the government’s court when it comes to the level of current inflation (a dominant fiscal element). However, the trajectory of the inflation path in the medium term still hinges on the central bank, more precisely on the reaction role of the majority of the Monetary Policy Council, assuming no basis other than substantive for the decisions made.

As early as the third quarter, it became evident that the economy was gradually gaining momentum. However, the breakdown of this growth left much to be desired. The increasing share of consumption and declining investment (projected to be below 2023 levels in 2024) portend numerous challenges. With observed GDP dynamics surpassing potential, growing aggregate demand, and fiscal interventions persisting in price processes, inflation is poised to remain at elevated levels for an extended period.

Overstated Enthusiasm

The exaggerated improvement in overall sentiment, particularly the enthusiastic response of the financial market to the outcome of parliamentary elections, where the government team swapped places with the opposition, was undoubtedly overstated. The degree of objective difficulties, including institutional challenges, that the new government must grapple with warrants considerable restraint in expecting quick results – both in the real sphere (growth and improvement of GDP decomposition) and in the nominal sphere (inflation, interest rates).

In my opinion, 2024 should be regarded as a “zero year”. The goal is to, in a relatively short time, mitigate well-identified factors negatively impacting macroeconomic balance: prevent fiscal destabilisation, ensure transparency of public finances, expedite the achievement of the inflation target, rebuild institutional credibility, enhance Poland’s international standing, provide breathing space to entrepreneurs, and foster stability to encourage increased private investment.

We must patiently await the unveiling of the medium-term economic strategy. Currently, no one in this new team is focused on it, and no one with that focus is even visible on the horizon yet. ©Ⓟ