Poland’s economy has had a great start to the year, but as the conflict in neighboring Ukraine enters its second month, fears are growing that its growth may be harmed on numerous fronts.
Since Russia invaded Ukraine on February 24, triggering a slew of harsh international sanctions, Eastern European economies, in particular, have been endangered by the expected blow to exports, supply chain disruptions, and rising inflation.
Poland has the sixth-largest nominal GDP in Europe (not adjusted for inflation) and is a major manufacturer of machinery, automobiles, and electronics, as well as a variety of minerals such as coal, copper, zinc, and rock salt.
The country’s economic performance in February was strong, despite the fact that it does not reflect the entire impact of the fighting. After a 4.2 percent monthly increase in January, industrial output in the country increased by 17.6% year on year and 2.1 percent month on month seasonally adjusted terms in February. Production is presently 24% higher than it was at the end of 2019.
Last week, Liam Peach, an emerging markets economist at Capital Economics, remarked that the country’s export-oriented industries are performing well, with manufacturing, electricity, and gas output also improving.
Peach, on the other hand, claimed the Ukraine conflict was putting a “black cloud” over the country.
“Poland’s economy continued to grow briskly at the start of this year,” he added, “but the crisis in Ukraine is expected to stymie the rebound by reducing exports, disrupting supply chains, and raising inflation.”
“Poland’s products exports to Russia account for roughly 3% of GDP (which will largely be lost), while imports from Russia (mainly raw materials) will be badly interrupted, affecting Polish industry.”
As the crisis in Ukraine shows no signs of ending, Capital Economics has lowered its GDP growth prediction for Poland from 4.5 percent to 3.5 percent for 2022, which is lower below economists’ expectations.
‘Anti-inflationary shields’
Inflation is one of the looming clouds on Poland’s horizon. Even before the conflict, Poland, like most of Europe and beyond, was dealing with continually rising prices.
In January, the government temporarily reduced the value added tax on gas, food, and fuel in an effort to rein in rising consumer costs, and as a result, headline inflation fell to 8.5 percent in February from 9.4 percent in January.
However, recent geopolitical instability and commodity market volatility have muddied inflation estimates even more. JPMorgan warned in a note last week that estimates should be taken with a grain of salt because high underlying inflation pressures are projected to prevail in Poland over the next few months.
Higher commodity prices, in particular, will drive up food and energy inflation, restricting real earnings and household expenditure, according to Capital Economics’ Peach.
“When the government’s tax breaks expire in the middle of the year, energy prices are likely to rise, driving inflation back toward 12%,” warned JPMorgan’s emerging Europe team.
“However, we believe there is a strong likelihood that the government would prolong the ‘anti-inflation shields,’ implying a lower CPI.”
According to economists, there is another upside risk to inflation in the country: the European gas market. Gas prices in Europe reached an all-time high earlier this month.
Poland’s energy authority approved a 54 percent increase in gas prices in December, and JPMorgan experts believe that more price hikes may be required.
Thousands of Ukrainian refugees have also arrived in the nation. More than 3.6 million people have fled the conflict so far, with more than half of them crossing the Polish border.
Goldman Sachs predicted that the flood of migrants into the CEE-4 (Poland, Hungary, Slovakia, and the Czech Republic) would deliver a “substantial boost to GDP” that would outweigh the conflict’s short-term effects on businesses and households in a note published in early March.
As refugees began to contribute to both domestic demand and the labor force, experts reduced their GDP projections for the region by 0.25-0.5 percentage points in 2022, while rising them by a comparable amount in 2023.
The central bank’s conundrum
Given persistent inflation pressures and additional food and energy price shocks, the National Bank of Poland now has a difficult task, which threatens to keep consumer prices high beyond the end of the year.
This, paired with a shaky growth outlook, means the central bank won’t be able to tighten policy as aggressively as it might otherwise.
“Normally, the NBP could look past supply shocks and focus on demand-pull forces,” JPMorgan economists wrote, “but that leeway has been lost in the previous 24 months.”
“At this point, being hawkish has no downside: it helps the currency and can be reversed without losing credibility if the situation improves later.”
As a result, economists predict the NBP will likely remain hawkish, supporting higher interest rates to keep inflation under control, albeit the timing and amount of future policy tightening actions will be determined by risk appetite in the foreign currency market as well as demand dynamics.
“The zloty [Poland’s national currency] has recovered from its lows, giving the NBP some breathing room.” If demand data continues to deteriorate from March, the NBP’s ability to argue for a dovish stance will be strengthened, according to JPMorgan.
“Once that is taken into account, and assuming no large zloty selloffs, we believe the NBP will aim for a peak policy rate of 5%, which we project to be attained in 2Q22.”
On March 8, the Polish central bank raised its key interest rate by 75 basis points to 3.5 percent, the highest level in nine years. The main policy rate was raised for the sixth time in a row.
