TRANSITION REPORT 2014 Innovation in Transition

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Highlights

  • Unexpectedly high growth in early 2014 may have been transient. The current slow-down is largely due to the weakening eurozone performance and regional tensions around Ukraine. At present, the rate of expansion is projected at 3 per cent for 2014 and slightly above that for 2015, though the external environment may hamper this growth.
  • The pension reform has diminished the role of institutional investors as a source of long-term capital. While this step has benefited public finances in the short term, the pension system overhaul may have undermined the public’s trust in the retirement savings mechanism.
  • Poland has secured significant EU structural and cohesion funds. Under the European Union (EU) Cohesion Policy, Poland will receive funds equivalent to about 21 per cent of annual GDP cumulated over the next seven years. The operational programme for innovation and a greater reliance on private co-financing for EU funds suggests an orientation towards sustainable growth.

Key priorities for 2015

  • Mounting tensions between the EU and Russia present a risk to some sectors of the economy, such as agribusiness, and to overall investment sentiment. Reorienting exports to other markets will require upgrading quality standards and further increasing value added.
  • The shortage of long-term funds remains a major constraint on private capital formation. With the curtailment and likely consolidation of private pension funds, the government should press on with reforms designed to develop alternative household savings products, including through appropriate tax incentives.
  • Poland has tabled comprehensive proposals for a more integrated EU energy policy, and for a stronger pan-EU investment. In energy, Poland will need to press on with the development of renewable energy sources and take other steps to reduce the country’s excessive reliance on carbon-based fuels, alongside initiatives to increase the interconnectedness of energy markets.

UNEXPECTEDLY HIGH GROWTH IN EARLY 2014 MAY HAVE BEEN TRANSIENT

THE PENSION REFORM HAS DIMINISHED THE ROLE OF INSTITUTIONAL INVESTORS AS A SOURCE OF LONG-TERM CAPITAL

POLAND HAS SECURED SIGNIFICANT EU STRUCTURAL AND COHESION FUNDS

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth 3.9 4.5 2.0 1.6 3.0
Inflation (average) 2.7 3.9 3.7 0.8 0.4
Government balance/GDP -7.9 -5.0 -3.9 -4.3 -3.2
Current account balance/GDP -5.1 -5.0 -3.7 -1.4 -1.5
Net FDI/GDP 1.5 2.4 1.1 -0.1 1.2
External debt/GDP 67.1 62.2 74.2 73.3 n.a.
Gross reserves/GDP 19.9 19.0 22.2 20.5 n.a.
Credit to private sector/GDP 47.4 49.8 48.2 48.4 n.a.

Macroeconomic performance

The Polish economy should continue to expand after the slow-down that was registered in 2013, though the external environment may weigh on the pace of recovery. After relatively slow growth of 1.6 per cent in 2013, real GDP growth accelerated to 3.4 per cent in annual terms in the first half of this year. Still, the beginning of the third quarter brought some signs of deceleration, as evident in industrial production and retail sales, both of which started to lose momentum. Domestic demand is gradually becoming a more prominent driver of economic growth. Gross fixed capital investments picked up substantially in the first half of the year and should strengthen further as the government moves into the new 2014-20 phase of EU structural funds. An additional contribution may come from long-term investment projects. Low inflation rates and improved labour market conditions should increase private consumption. Real GDP growth is forecast to average 3 per cent and 3.3 per cent in 2014 and 2015, respectively.

A key downside risk for the economy lies in Russia’s food import ban. Poland’s export volumes to non-EU countries in emerging Europe have already shrunk in the first half of 2014. This trend is expected to be amplified by Russia’s ban on food imports from the West, which came into effect in August 2014. Polish exports to Ukraine have declined by more than 25 per cent, while sales to Russia dropped by 11 per cent over the first half of 2014. These two countries represent about 8.3 per cent of Poland’s overall exports and foodstuffs banned by Russia account for only 0.5 per cent of total exports. However, the agribusiness sector is highly exposed (20 per cent of fruit and vegetable exports are destined for Russia), and confidence indicators have already deteriorated.

Stronger-than-expected growth, the transfer of certain pension assets and reduced contributions to private pension funds should benefit public finances. With the transfer of pension assets into the state-run social security system in February 2014, public debt was reduced by an estimated 8.6 per cent of GDP. As the government has, in the process, taken on additional pension liabilities, the overall effect on long-term public finances is unclear. Despite the positive windfall in the short term, Poland remains under the EU Excessive Deficit Procedure (EDP). However, an expected reduction in the deficit below 3 per cent of GDP next year may allow Poland to exit the EDP.


Major structural reform developments

The reform of Poland’s pension system, which was first announced in September 2013, has been carried through. While this is of considerable benefit to the still-stretched public finances, the role of local institutional investors in providing long-term capital has been curtailed. Poland’s 13 privately managed pension funds (OFEs) transferred 51.5 per cent of their assets, consisting mainly of treasury bonds and treasury-guaranteed bonds, to the state-run Social Insurance Institution (ZUS) in early February 2014. OFEs have been banned from investing in domestic or foreign government bonds. Nevertheless, they face fewer restrictions on their share of equity holdings. To continue diverting their social security contributions to the privately managed pension funds, some 16 million OFE members had to re-enrol in the system. However, by the end of July 2014, when this option came to an end, only about 15.4 per cent of members had done so. In addition, those approaching retirement within 10 years will gradually shift accumulated assets into the state-run system. The diminished contribution and gradual redemption therefore imply that in the coming years, the OFEs will be a net drain on Polish capital markets.

Research and development (R&D) expenditures remain very low and are primarily funded by the public sector. Most firms in Poland suffer from weak innovation performance, which is evident from the relatively low expenditures (0.9 per cent of GDP) in R&D, compared with the EU average of more than 2 per cent. In the EU’s Innovation Union Scoreboard 2014, Poland ranked 25th (out of 28 EU member states) in terms of overall innovation performance. In Poland the state funds the major part of research expenditures and just over one-third comes from enterprises, compared with the EU average, where more than 63 per cent of total R&D expenditures comes from enterprises. Consequently, innovation may be poorly matched to the demands of businesses. Against this background the government recently adopted an operational programme under the new phase of the EU structural and cohesion funds, roughly €10 billion of which is allocated to innovation over the coming seven years, and aims to support national and regional innovation programmes.

Infrastructure investments are still expected to pick up. The government initiative of 2012 to stimulate investment through two state-backed entities has had a slow start, though it appears to be taking off as the number of signed projects has grown since May 2013. The programme aims to provide funding to viable infrastructure projects, and in the process, catalyse long-term private capital without impairing public finances. The two pillars are Polskie Inwestycje Rozwojowe (PIR), which is responsible for preparing and implementing infrastructure projects, and the state development bank (BGK), which will enable an increase in the volume of new loans and guarantees up to Zl 40 billion (approximately €10 billion). PIR and BGK will both be gradually capitalised by shares of up to Zl 10 billion (about €2.5 billion). At the same time, PIR, which operates on commercial terms, signed its first public-private partnership for oil exploration in the Baltic Sea in August 2014. Over 60 projects have been analysed, of which five are at an advanced stage. Recently, government officials have voiced scepticism over the efficacy of PIR in stimulating investment and may consider further institutional changes.

The second package on professional deregulation was approved in May 2014. The package, which lowers barriers for 82 technical professionals (such as architects and building engineers) and financial market professionals (accountants, tax advisers, insurance agents, brokers and actuaries), will affect some 200,000 professionals. This deregulation forms part of the government’s drive to accelerate structural reforms through cutting red tape and reducing legal barriers that grant monopolistic privileges to incumbents. Poland has the highest number of regulated professions in Europe.

New shale gas regulations were adopted based on expectations that exploration will speed up. The main aim of the new regulations is to attract investment in exploration in order to assess the potential shale gas production in Poland in the long term (subject to environmental concerns and economic viability). The regulation is designed to encourage investors by cutting red tape and reducing regulatory hurdles. Therefore, the so-called special taxes in this sector (totalling up to 40 per cent of gross profits) will not be charged until 2020 and only a single type of concession for exploration and production was created, simplifying the three different forms previously available. The pace of shale gas exploration in Poland has slowed recently with only half as many wells drilled in 2013 compared with the previous year. This was mostly due to concerns over poor exploration results and regulations that have prompted some international companies to leave (ExxonMobil, Marathon Oil and Talisman). Poland is also striving to cut back its energy sector’s reliance on Russia through a new liquefied natural gas terminal in Swinoujscie, currently scheduled for completion by mid-2015. This terminal will have a capacity of 5 billion cubic metres per year (one-third of Poland’s annual consumption of natural gas).

A first nuclear power plant is expected to become operational by 2024. The government has adopted a national nuclear power programme that involves the construction of two nuclear power plants, each capable of producing 3 GW of electricity. The first block is expected to be finished in 10 years and the whole project should be completed by 2030. The investment will cost an estimated total of €12 billion and is expected to be pursued by a consortium of Polish energy companies led by the state-controlled Polish energy group, PGE. At present, coal still accounts for more than 80 per cent of Poland’s primary energy supply, and a nuclear power plant may be one of the cheapest ways to cope with ambitious EU energy and climate goals.