Economic Analysis - Weak Investment And Politics Cloud Otherwise Strong Outlook - MAR 2018

BMI View: Polish real GDP growth will slow but remain robust over the coming years on the back of strong private consumption and a rebound in fixed investment. That said, the tight labour market will be a double- edged sword as inflation pressures build and labour shortages weigh on potential GDP growth. Subdued private capital spending remains a concern, and risks to long-term growth are rising due to political developments.

Polish real GDP growth reached an estimated 4.5% in 2017, a five-year high. While we still expect a slowdown in 2018, we have revised up our forecast from 3.6% to 3.8%. Our projection for 2019 remains steady at 3.1%. The outlook for private consumption remains robust on the back of a very tight labour market, although this is a double edged sword as inflation pressures will build and severe labour shortages will begin to weigh on potential output growth. Fixed investment will recover in 2018 from a multi-year lull as firms seek to address rising capacity constraints and EU structural funding inflows pick up pace. However, against a backdrop of strong domestic demand, net exports will begin to make a negative contribution to real GDP growth in 2018 as eurozone and global growth cool somewhat.

Labour Market A Double Edged Sword

Poland's tight labour market will be positive for private consumption, which we forecast to expand by 4.1% on average in 2018-2019 and be the main contributor to headline GDP growth. The economy is near or at full employment, with both employment and activity rates at all-time highs and a rapidly rising proportion of firms citing labour shortages as a factor limiting production capabilities ( see ' Full Employment A Headwind To Growth ' , September 14). Poland is in the midst of its strongest run of job growth since prior to the global financial crisis, but we expect the pace to slow in 2018 as the pool of available labour continues to shrink.

Labour Shortages Rising
Poland - Wages & Business Survey - Firms Citing Labour As Factor Limiting Production
Source: Eurostat, Bloomberg, BMI

The tightness of the labour market will support wage growth, which ended 2017 in a firm uptrend and will likely accelerate further in 2018. Growth will be somewhat less impressive in real terms, however, as we forecast inflation to rise towards 3.0% y-o-y by end-2018. This forecast underpins our expectation for the National Bank of Poland (NBP) to follow in the footsteps of the Czech and Romanian national banks - both of which hiked rates in 2017 - and commence a rate hiking cycle by the end of the year. That said, borrowing costs will remain low by historic standards and supportive of consumer credit conditions, particularly in light of improved employment prospects.

Real Wage Growth Less Impressive Than Nominal
Poland - Nominal Wages, Real Wages & Consumer Price Index, % chg y-o-y
Source: Bloomberg, BMI

Weak Investment A Puzzle

After contracting by 5.7% in 2016, real fixed investment excluding construction shrank by -0.1% y-o-y on average in the first three quarters of 2017. Our core view is that there will be a pick-up in 2018, which alongside strong construction activity, will see total fixed investment growth accelerate to 5.5% from an estimated 2.0% in 2017. That said, the subdued non-construction investment rebound so far is puzzling, given that domestic conditions have been ripe for capital spending. Demand and business confidence have been particularly strong, borrowing costs low, and capacity constraints rising (at 80.7% the capacity utilisation rate is just shy of the 2008 peak of 81.1%). We have previously highlighted Poland's relatively low rates of fixed investment relative to peers, particularly in the private sector, and how this hinders growth potential ( see 'Lack of Investment To Constrain Growth ' , October 18). The country's current political climate may be exacerbating difficulties, given the populist Law & Justice Party (PiS)'s tightening grip on the state apparatus and the economy.

Sluggish Investment Rebound So Far
Poland - Real GDP & Gross Fixed Capital Formation
Source: Eurostat, BMI

While construction investment also contracted sharply over 2016, a rebound is underway with Q317 data showing 7.3% y-o-y growth. The outlook for the construction sector is positive over the coming years, due to the strong domestic backdrop but also due to an expected ramp up in spending on projects co-financed by EU structural funding. Poland is among the EU's main net beneficiaries of such funding, and government-led investment has in recent years been crucial in propping up total investment amidst subdued private sector capital spending.

EU Funding A Major Growth Driver
2014-2020 EU Structural Funding Allocation, % of 2017 GDP
Source: European Commission, Eurostat, BMI

However, as the current 2014-2020 budget expires Poland's continued access to funding in the next cycle is at risk given ongoing disputes with the EU over controversial judicial reforms being pushed through by PiS ( see 'Support For PiS Unchallenged Despite Controversial Reforms', October 25). With the European Commission's scope for punitive action limited by Hungary's promise to veto any potential sanctions, and with the total pool of funding in the EU budget already poised to shrink due to Brexit, a much less generous allocation of resources to Poland in 2021-2027 could be the EU's preferred course of action if the current dispute over judicial reform is not resolved amicably. This would weigh heavily on Poland's long-term growth outlook and act as an immediate drag on investor sentiment once announced, and represents a primary risk facing the economy.

Drag From Net Exports

The expected rebound in fixed investment implies stronger domestic demand growth in 2018 relative to 2017. However, alongside accelerating domestic demand will come strong import growth, and a drag on headline GDP growth from net exports in 2018-2019 of -0.5 percentage points (pp) on average, according to our forecasts. This follows an estimated positive contribution of 0.4pp in 2017. While the outlook for Polish exporters remains quite strong on the back of a healthy global backdrop, economic growth in Poland's main developed state trading partners (including Germany, UK, Italy and the Netherlands) will ease from multi-year highs in 2017.