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by Piotr Arak | 30th November, 2022
Poland has one of the highest inflation rates in Europe. Part of it is exogenous, increased by the pandemic, part due to the external shock of rising energy prices. But before talking about the two shocks one needs to remember that, because of the lower gross domestic product (GDP) per capita, the price level in Central and Eastern Europe is proportionally lower than in France, Germany, the United Kingdom or the United States.
At the same time, with economic convergence, prices are gradually levelling out between the western and eastern parts of the EU. This does not have to mean higher inflation in itself, as the convergence of the price level can also take place as a result of the exchange rate strengthening (of a country’s currency) against the euro. But in most cases it means that the consumer price index (CPI) is higher in catching up economies.
Prior to the pandemic Poland had a sound inflation rate. One could argue that fiscal policy was too loose and interest rates were too low, making 2020 the year of potential monetary tightening. Slower growth of the Polish economy expected that year looked set to push inflation lower.[i] Then the pandemic hit and the central bank did what everybody expected it to do, namely, it decreased interest rates[ii] almost to zero and took part in a kind of quantitative easing scheme for the first time ever.
The first repurchasing operation took place on 16 March 2020 and lasted through 2020 and 2021. Through 2021, the National Bank of Poland (NBP) purchased PLN 135.8 billion (Zloty), in Treasury and government-guaranteed securities on the secondary market, that is 5.8 per cent of 2020 GDP. During the first wave of the Covid-19 pandemic, the scale of quantitative easing in Poland was substantial compared with the other non-euro-zone EU countries.
One common concern raised by commentators is that the central banks’ asset purchase programmes would lead to a significant rise in inflation. Indeed, such programmes can lead to higher inflation – that is, in fact, their intended purpose. However, fears of uncontrolled price increases seemed unsubstantiated at that time. The Polish economy experienced a very strong shock, which led to a sharp decline in GDP. The risk of deflation and economic output falling below potential was the main threat to the economy and society. But during the pandemic inflation in Poland started to rise. In 2020, the CPI stood at 2.3 per cent, but the following year it increased to 5.1 per cent and now looks set to be 13 to 14 per cent in 2022.
In late 2021 inflation reached its highest level in 20 to 40 years across the globe. This is because of two factors in particular: the rapid unfreezing of the economy in the course of the pandemic, and higher energy prices. The economy was reopening quickly as more and more Covid restrictions were lifted. People started to travel and eat in restaurants again. They were buying more and spending some of the money they could not use during the lockdowns. When the economy picked up, companies could raise prices without losing customers.
However, Companies were finding it difficult to keep up with rapidly growing demand as they were still rebuilding supply chains that had been hard hit by the pandemic. Transporting goods was more difficult and expensive because of a range of various problems, such as a shortage of shipping containers. Since these problems lasted for some time, the resulting costs were passed on to customers in the form of higher prices.
The pandemic has also changed our way of life and work, and thus our needs. We started to buy more of certain products, including electronics, than retailers anticipated. Suddenly it was difficult to obtain important parts or materials, such as semiconductors. When companies could not keep up with demand for goods, prices went up.
Another important shock for prices was the energy market. Oil, gas and electricity have become more expensive around the world. In Europe, Russia rationed the supply of gas to its partners, causing prices to increase. In addition, because the winter of 2020 was cold, oil and gas stocks were lower. All this, combined with rising demand, has caused prices to rise rapidly. Because energy costs account for a significant portion of corporate and household costs, oil, gas and electricity prices have a major impact on overall inflation.
Everyone expected inflation to decline over the course of 2022. Supply was expected gradually to catch up with demand. Energy prices, according to market expectations, should have fallen. This is the time when both the US central bank Federal Reserve (Fed) and the European Central Bank (ECB) expected inflation to be transitionary. In mid-2021 with higher inflation rates the central banks in Central Europe started to hike interest rates. The NBP waited until September 2021 to make its first move.
The Monetary Council raised interest rates for the first time in October 2021, including the policy interest rate to 0.5 from 0.1 per cent. In November, it raised the interest rate to 1.25 per cent, in December to 1.75 per cent, in January 2022 to 2.25 per cent, followed by 2.75 per cent in February and 3.5 per cent in March. For the next few months up to June 2022 it was raised by 0.75 basis points per month, finally reaching 6 per cent. In August 2022 interest rates went up by 0.50 basis points and in September by 0.25 bps, signalling that this might not be the end of this cycle of hiking in accordance with similar communiques from the ECB and the Fed.
Poland has long pursued a strategy of diversifying its energy supply and decoupling from Russia as a supplier of gas and oil. In 2021 Poland imported 15 per cent of its coal, 43 per cent of its natural gas, and 73 per cent of its crude oil, plus considerable amounts of diesel from Russia.[iii]
Today, according to the government, Poland has various possibilities to substitute the missing gas supplies from Russia, via European pipeline systems, the liquefied gas terminal in Swinoujscie, a modest amount of its own gas production, and finally, from autumn onwards, the Baltic Pipe pipeline, which will provide Poland with a stable supply of Norwegian natural gas. The now interrupted supplies through the Yamal pipeline would have ended at the end of 2022 anyway.
It’s likely that coal will be the most difficult resource to substitute, as the import or transit of hard coal from Russia or the Dombas has been banned. An increase in domestic production and imports is supposed to make up for the gap. An increase in domestic production, however, can only be in the order of 1 to 1.5 million tonnes per year, compared with the 8.3 million tonnes that Poland imported from Russia last year. More crucially, the coal imported from that direction was used in housing because of its different caloric values. The Polish government has also signed an agreement to obtain coal from war-torn Ukraine.
In the oil sector, imports from Russia are to be offset primarily by purchases from Saudi Arabia. For some time, the government has been pursuing a policy of replacing Russian oil supplies. The state-owned oil company Orlen has only short-term supply contracts with Russia, which will expire in January 2023 and December 2024. The changes in import sources do not shield Polish society and businesses from the rapidly increasing energy costs on the global market, however.
Long before the West began to impose sanctions on Putin's Russia, the latter was already in an economic war with it. In autumn 2021 it turned off the gas taps, compounding cost pressures in Europe. Putin’s actions are responsible for more than a third of the current inflation in Poland. Putin's attempt at gas blackmail shows up in CPI inflation almost everywhere: directly in the prices of energy carriers and indirectly in electricity prices; and in core inflation, driving up the prices of goods with a large share of gas and electricity in their total costs. Gas costs account for 60 to 80 per cent of fertiliser production costs; fertilisers, in turn, account for 25 to 40 per cent of grain and feed production costs. Gas costs are responsible for 50 to 80 per cent of the increase in food prices in recent months, partly via the expectations channel.
Pandemic inflationary pressures were strong at the beginning of 2022 (9.4 per cent CPI in January), but economic experts expected them to go down subsequently. In March CPI shot up to 11 per cent and gradually rose each month up to August, when it topped 16 per cent. The cause was Russia’s invasion of Ukraine. As a result, liquid fuels, gas and food became more expensive. Some economists coined the term ‘putinflation’ for this rapid increase in the CPI, which up to autumn 2021 was expected to be lower.
The Polish government and even the central bank have had limited influence over the factors causing the current price level. They could neither end the war nor suppress energy prices in global markets. Nor could they rebuild supply chains. Also, policies to raise interest rates have little effect on energy prices. The only thing left to do, in all probability, is simply to wait, because all the factors causing today's high prices are temporary (which does not mean »short-lived«). But this is not what many EU governments have decided to do, including the Polish government.
The trade unions in particular were in favour of increasing the minimum wage for the second time in 2022 (with further increases in 2023), a second valorisation (revaluation of the monetary value) of pensions, amendment of the state budget for 2022, including a guarantee of additional funds for wage increases in the budget, the elimination of the WIBOR[iv] rate, etc.
EU Member States have adopted various measures to mitigate the effects of higher energy prices for their citizens, implementing discretionary measures adopted by late April 2022 amounting to about 0.6 per cent of EU GDP. Actions taken so far (September 2022) by the Polish government include three measures at a total cost of around 2.1 per cent of GDP.[v] The so-called government Anti-Inflation Shield consisted of:
The Polish government’s declared solutions to mitigate the effects of higher energy prices on households and small and medium-sized enterprises (SMEs) include curbing price increases for electricity and gas. According to the estimates of the Polish Economic Institute, electricity bills will increase by 25 per cent, and gas bills by a similar or lower amount (the minimum is about 10 per cent). The planned cost to the budget will not exceed PLN 62 billion (approximately 2.4 per cent of GDP, 13.2 billion euros), of which freezing gas prices for individuals will cost PLN 23 billion (4.9 billion euros), for electricity PLN 13 billion (2.8 billion euros), and for small and medium-sized enterprises, an additional PLN 36 billion (7.7 billion euros).
In the context of electricity tariffs, the Polish government is also considering the solution of linking preferential tariffs to consumption volumes. This would encourage energy saving and consequently reduce costs for the budget. The proposal is that a lower tariff could apply to consumption of no more than 90 per cent of the previous year. Once this value is exceeded, the consumer would be subject to the standard tariff. Limiting tariff price increases affects inflation, while energy allowances do not. However, limiting energy price increases does not provide an incentive to reduce consumption. If countries competing for raw materials intervene to reduce bills, this will result in energy shortages. Preferred tariffs based on consumption, on the other hand, will encourage reductions and put less strain on the budget. However, this solution would need to take into account the structure of energy consumption and its changes from the base year to which the tariff relates. This will be particularly important for those heating their homes with electricity directly or with heat pumps.
Because of the hikes in interest rates credit costs for borrowers have become a crucial political issue. Most mortgages in Poland are at a variable rate, linked to the central bank interest rate. The government has approved a law that allows borrowers temporarily to suspend mortgage repayments without cost for four months in 2022 and another four months next year. Approximately 2 million borrowers could use this scheme, and it is almost universal, though only holders of mortgages in zloty (rather than in foreign currencies) for owner-occupied housing will be able to benefit from the new regulation. According to an opinion issued by the Poland’s central bank, the cost to the banking sector of the so-called ‘credit holidays’ granted this year and in 2023 could reach 20 billion zloty (4.18 billion euros) if all those eligible were to participate. The government has also announced plans to change the WIBOR in line with what social partners have been advocating.
Listening to the trade unions the government plans to increase the minimum wage twice in 2023. The minimum wage will rise to a gross PLN 3,490 a month in January (740 euros), and PLN 3,600 in July (760 euros). It currently stands at PLN 3,010 (640 euros). The government did not valorise pensions twice, but this year it has provided additional pension benefits, known as the thirteenth and fourteenth pensions. On top of everything, in 2022 a tax reform came into force that increased the tax-free amount and decreased the basic personal income tax (PIT) rate from 17 to 12 per cent.
Analysts have warned that the welfarist solutions imposed by the government are at odds with the monetary tightening being carried out by the central bank, which has repeatedly raised interest rates in response to soaring inflation. But the central bank has been criticised as well. The Supreme Audit Office (NIK) assessed that in 2021 the manner in which the Monetary Council communicated with the markets on monetary policy had a negative impact on the perceptions of inflationary processes.
Where will this policy mix take us? The European Commission raised its forecast for Poland's GDP growth in 2022 to 5.2 per cent and lowered its estimate for 2023 to 1.5 per cent. It also raised its estimates for HICP inflation (harmonised index of consumer prices; different from the internal CPI) in Poland for 2022–2023 to 12.2 per cent and 9.0 per cent, respectively. Next year, prices in Poland are expected to grow at the fastest rate in the EU.
The European Commission stresses that Poland's economic growth will slow down in the second half of 2022 because of Russia's aggression against Ukraine, monetary tightening, deteriorating sentiment and a weaker external environment. Private consumption will continue to be supported by refugee demand from Ukraine and the ongoing fiscal expansion (the Anti-inflation shield). Nevertheless, consumption growth will come under pressure from heightened uncertainty and monetary policy tightening, which could spur savings and weigh on household disposable income, especially given the volume of variable-rate mortgages in Poland.
Nonetheless, weakening economic growth and the gradual easing of pressures in global supply chains and declining energy prices are likely to result in lower inflation toward the end of the forecast horizon. A very similar interpretation, albeit with different numbers is expressed in the projection by the Polish Economic Institute. It envisages deteriorating growth prospects at the end of 2022, which leads us to believe that growth will average 4.5 per cent. There are many risks ahead but the current scenario does not envision a recession in Poland. The economy has a chance to grow at a pace of 2 to 2.5 per cent in 2023, with very low growth at the beginning of the year. The CPI should start to go down in autumn and winter 2022. The government will still use its tools to keep energy prices at a lower level, which would translate into an average inflation rate of 9 to 10 per cent in 2023, with a rather unlikely scenario of reaching the Monetary Council’s target at the end of 2024.
[i] The inflation rate should be in the range of 1.5 to 3.5 per cent; the target of the Polish central bank (NBP) is 2.5 per cent, with possible deviations of 1 percentage point up or down. If inflation remains at a higher level the Monetary Council would increase rates.
[ii] The National Bank of Poland (NBP) reduced its policy interest rate by 140 basis points to 10 basis points, with rate cuts on 17 March 2020 (50 basis points), 8 April (50 basis points), and 28 May (40 basis points). From March the NBP provided liquidity to banks, reduced the required reserve ratio from 3.5 to 0.5 per cent, and adjusted the interest rate on required reserves to the level equal to the policy interest rate.
[iii] Poland’s electricity sector relies heavily on coal, which accounts for 67.5 per cent of total electricity generation (data for July 2022). Power generation from renewables and natural gas accounted for 22.6 per cent and 3.5 per cent, respectively.
[iv] WIBOR means the Warsaw Interbank Offered Rate benchmark, administered by GPW Benchmark S.A. or another entity that may assume this role in the future, for the period determined in the Agreement on the Variable Base Interest Rate.
[v] It should be noted that no new taxes have been introduced to finance these measures, which entails an increase in the deficit, even with the high nominal growth rate of GDP.
Piotr Arak is a Polish economist and director of the Polish Economic Institute.
