Investment Research General Market Conditions Trip report ... · sharply rising wages and...

Important disclosures and certif ications are contained f rom page 7 of this report. www.dans keresearc h.c om

Investment Research — General Market Conditions

This note summarises the key findings of my trip to Warsaw last Thursday and

Friday, where I met corporates, private banks and policy makers.

Apart from a red-hot labour market and fast economic growth, the Polish

economy does not show signs of imminent overheating.

However, the above-potential growth, coupled with expansionary macroeconomic

policies, increases the risks over the next year.

We think a strengthening of the Zloty would help constrain the economy and we

lower our current EUR/PLN forecast path to 4.15 in 1M (4.17 previously), 4.13 in

3M (4.15 previously), 4.12 in 6M (4.14 previously) and 4.08 in 12M (4.12 prev.).

The Polish government is in cruise control ahead of next year’s election and may

be able to find a compromise with the EU on the Rule of Law issues.

Is the Polish economy on the brink of overheating?

• I visited Warsaw Thursday and Friday last week, seeing large companies, private banks

and policy makers. My visit focused on two key issues: 1) to what extent the Polish

economy is showing signs of overheating and 2) the political situation and the outlook

for a resolution of the conflict between the EU and Poland on the Rule of Law.

A key concern among private companies and banks was whether the Polish economy

is overheating. An overheating economy is normally characterised by fast economic

growth, accommodative fiscal and monetary policies leading to large credit expansion,

sharply rising wages and deteriorating domestic and external macroeconomic balances.

In such an environment, inflation is typically rising, which prompts the central bank to

step in and the currency strengthens in the case of a floating exchange rate regime. In

case of no adjustment, the real effective exchange rate would appreciate given higher

inflation aggravating the external imbalances further through lower net exports. The

risk is that without adjustment, an overheating economy would eventually fall into a

recession and/or experience a financial crisis.

• Parts of the Polish economy are indeed showing signs of overheating, notably in the

labour market:

o The Polish labour market is red-hot. About nine out of ten Polish companies are

reporting a shortage of skilled labour; this was confirmed in our meetings with

private companies. In response to these constraints, companies are either

considering cutting back on production or launching new projects. Profit margins

will also be under pressure. In the latest reading in November, gross wages rose by

almost 7% and most private companies and banks saw the wage growth increasing

to double-digit figures. However, the central bank cautioned that companies were

more likely to cut back on production, public sector wage growth remained subdued

and minimum wage growth was only 5%.

24 January 2018

Chief Analyst and Head of International Macro and Emerging Market Research Jakob Ekholdt Christensen +45 4512 8530

[email protected]

The Polish economy is hitting capacity

constraints

Source: Polish Statistical Office (GUS), Macrobond

Financial

As increasing # of companies cannot

find skilled workers

Source: Institute for Economic Research (Ifo),

Polish Ministry of Family, Labour & Social Policy

Prompting a surge in wages

Source: OECD, Poland Central Statistical Office,

Macrobond Financial

Trip report from Warsaw

Is the Polish economy on the brink of overheating?

2 | 24 January 2018 www.dans keresearc h.c om


o The Polish economy is growing above potential . Last year, the economy grew by

about 4.6% while this year we and market consensus believe that the economy will

grow about 4%. We estimate the potential growth of the polish economy to be

somewhere between 2-3%. The above-potential growth means the capacity

constraints in the economy would increase further in 2018. As private consumption

growth is likely to level off somewhat in H2 this year, investment would

increasingly need to take over. While public investment is boosted by increasing

absorption of EU funds, private investment is still relatively weak owing to

uncertainty among companies about the tax regime and other regulatory factors.

The lack of workers was also mentioned as a reason for lack of investment in the

construction sector.

However, other indicators do not point to imminent problems of overheating for

the Polish economy:

o Still muted inflation pressures: While headline inflation briefly reached the

central bank’s 2.5% inflation target in November, it dropped to 2.0% in December.

Despite the rapid wage growth, core inflation has remained fairly modest , hovering

around 1% since April last year. This conundrum (normally the two are fairly

correlated, see chart) is explained by two factors: firstly, imported inflation is still

modest on items such as clothing, shoes, and appliances, partly as global inflation

is low (and the Zloty has appreciated quite substantially over the past year).

Secondly, there are signs that companies are reluctant to pass on higher costs to

consumers due to fears of losing market share, dating back to the financial crisis.

However, this may only last for a certain period and once companies start raising

prices, others may follow suit, creating a “ketchup” effect on CPI inflation. We

expect inflation to increase over the coming months and reach the 2.5% target

earlier than the Q3 2018 expected by the NBP.

o No real macroeconomic imbalances (yet): So far, both fiscal and current account

balances are holding up pretty well. In fact, the budget deficit is likely to be much

lower than expected around 2% of GDP in 2017 owing partly to the strong growth

in the economy and significant tax compliance gains (amounting to almost 1% of

GDP in 2017) reaped earlier than anticipated. The budget for 2018 foresees a deficit

of 2.7% (assuming a GDP growth of 3.8%), but may be lower due to a positive carry

over from the strong fiscal performance in 2017. Furthermore, the budget assumes

full implementation of spending targets, which are typically not the case. On the

external side, the current account balance is in surplus, aided by strong global

demand and remaining Polish cost competiveness (the central bank sees a

competiveness edge of about 10%), with company surveys pointing to an

equilibrium EUR/PLN rate below 4. However, the current wage differential relative

to Germany, a key trading partner, of about 4-5% would erode Poland’s competitive

edge over time.

Core inflation hasn’t picked up despite

rapid wage growth

Source: Polish Central Statistical Office (GUS),

National Bank of Poland, Macrobond Financial

But rise in inflation is so far modest.

Source: NBP, Macrobond Financial

No significant macro imbalances

Source: IMF WEO October 2017

No real credit boom taking place

Source: National Bank of Poland, Macrobond

Financial



o Absence of a credit and housing boom. A key characteristic of many financial

crises is a significant credit and housing boom in the run-up to the crises. Currently,

neither credit to the economy nor house prices are growing strongly. In fact, house

prices have been almost flat since the financial crisis and the money and credit

growth are only a fraction of the pre-financial crisis levels.

All in all, the Polish economy is not showing signs of imminent overheating.

However, the combination of above potential economic growth amid a very tight labour

market situation, together with an accommodative macroeconomic policy mix, would

pose dangers for the Polish economy unless adjustments in macroeconomic policies

stem the demand pressures in the economy, in our view.

We believe that the first best solution to steer the economy away from overheating

would be tighter macroeconomic policies (notably fiscal and structural policies),

but this appears unlikely over the next year or so:

o Fiscal policy would actually be neutral to slightly expansionary in 2018 according

to our estimation and is unlikely to be tightened over the next year ahead of the

2019 election.

o NBP seems in no hurry to tighten monetary policy, with Governor Glapinsky

signalling unchanged rates this year. With real rates in negative territory, monetary

policy would become increasingly expansionary. Many see the MPC as overly

focused on growth, risking a significant overshooting of the inflation target. Our

base case however is that MPC will be forced to tighten its monetary policy in 2018

as inflation picks up, but there is a risk that it may react too late.

o Structural policies such as the 500+ programme and lowering of retirement ages ,

while effectively having a smaller impact on the labour supply than believed, still

promote consumption over investment and hence do not help raise potential growth,

which could have helped alleviate some of the capacity constraints.

What about the Zloty? In our base case of a tighter monetary policy in 2018, the Zloty

is likely to strengthen over the next year. We think a strengthening of the Zloty would

help constrain the economy and we lower our current EUR/PLN forecast path to

4.15 in 1M (4.17 previously), 4.13 in 3M (4.15 previously), 4.12 in 6M (4.14

previously) and 4.08 in 12M (4.12 previously). The stronger Zloty would reduce net

exports and help contain inflation pressures, but would also lead to a weakening of the

current account balance. There is a risk that the NBP stays put for too long and inflation

overshoots which would lead to a real appreciation (and worsening external balance

over time) through higher inflation. In such a scenario, the Zloty would weaken

eventually.

House prices fairly stable

Source: Polish Central Statistical Office (GUS),

National Bank of Poland, Macrobond Financial

After recent strength, the Zloty is

closer to its long-term fundamentals

Source: BIS, NBP, Macrobond Financial



The PIS government in cruise control toward the next election

The PIS government is enjoying very strong support in the polls, both due to the

strong economy and also a relatively weak and disorganised opposition. The spat

with the EU had not weakened the support for the government, in fact it seemed to have

strengthened its support. Some noted that it was not so much a question of the PIS

government winning a second term in next year’s election but more about whether it

could get a third term. However, some observers cautioned that the tide could turn for

the government, but it would probably take a major scandal to change the fortunes of

the government given the strong Polish economy.

While the recent government reshuffling could open the door for a compromise

with the EU, some observers noted that Polish policies are likely to remain

unchanged. The government reshuffle has replaced older ministers with a younger

generation of politicians who may have less nationalistic views, which could help

improve the perception of Poland in EU circles. In the same vein, the three-hour

meeting between the new Polish Prime Minister Morawiecki and European

Commission President Jean-Claude Juncker was seen as a step toward a more

constructive relationship between Poland and the EU and closing the Rule of Law

(ROL) procedure (see Annex 1 on the evolution of the ROL procedure for Poland).

However, Jarosław Aleksander Kaczyński is in control of the government’s policies,

increasing the chances for presentation of new controversial policies.

• On the Rule of Law procedure, the base case is still that the EU fails to find

unanimous agreement among all other EU member states to determine the

existence of a breach (the second step of the preventive mechanism) given the

opposition of Hungary. With the government reshuffling in Poland, the chances of a

resolution have increased. Without a resolution in the near term, Poland would be

without important political capital in the upcoming EU budget discussions in late

spring/early summer this year, which would be particularly contentious in view of the

UK contribution falling out.

PIS enjoying very strong support in the

polls

Source: Wikipedia



Annex 1: The Rule of Law Procedure

against Poland

The evolution of the Rule of Law Procedure against Poland

Source: EU Commission, Danske Bank

13 january 2016

4 recommendations!27 July 201621 December 201626 July 201720 December 2017

1 June 2016

20 December 2017, triggered by 1/3 of EU member states

This where we are now



Different stages under the Preventive mechanism

Source: EU Commission, Danske Bank

Preventive mechanism of ROL procedure

To determine that there is a clear risk of serious breach of ROL

To determine the existence of seriousbreach of ROL

Sanctions against member states:Suspension of certain rights, incl. Rights of

the country in the EU council

This is where we are now:Requires 4/5 of member states i.e. at least 22 membersMight happen

EU council acting by unanimity i.e. all member states needto support the resolution: Poland counting on the support of Hungary here

Although risk of sanctions is small, Poland is wasting political capital:• EU budget negotiations• Future size of EU investments• Strategic partnerships in NATO, UN



Disclosures This research report has been prepared by Danske Bank A/S (‘Danske Bank’ ). The author of this research report is

Jakob Ekholdt Christensen, Chief Analyst and Head of International Macro and Emerging Market Research .

Analyst certification

Each research analyst responsible for the content of this research report certifies that the views expressed in the

research report accurately reflect the research analyst’ s personal view about the financial instruments and issuers

covered by the research report. Each responsible research analyst further certifies that no part of the compensation

of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed

in the research report.

Regulation

Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject

to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske

Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority

(UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation

Authority are available from Danske Bank on request.

Danske Bank’s research reports are prepared in accordance with the recommendations of the Danish Securities

Dealers Association.

Conflicts of interest

Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high -quality

research based on research objectivity and independence. These procedures are documented in Danske Bank’s

research policies. Employees within Danske Bank’s Research Departments have been instructed that any request

that might impair the objectivity and independence of research shall be referred to Research Management and the

Compliance Department. Danske Bank’s Research Departments are organised independently from, and do not

report to, other business areas within Danske Bank.

Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes

investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance

or debt capital transactions.

Financial models and/or methodology used in this research report

Calculations and presentations in this research report are based on standard econometric tools and methodology as

well as publicly available statistics for each individual security, issuer and/or country. Documentation can be

obtained from the authors on request.

Risk warning

Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis

of relevant assumptions, are stated throughout the text.

Expected updates

None.

Date of first publication

See the front page of this research report for the date of first publication.

General disclaimer This research report has been prepared by Danske Bank (a division of Danske Bank A/S). It is provided for

informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered

as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial

instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options,

warrants, rights or other interests with respect to any such financial instruments) (‘Relevant Financial Instruments’).

The research report has been prepared independently and solely on the basis of publicly available information that

Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue

or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and

subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any

loss of profits, arising from reliance on this research report.

The opinions expressed herein are the opinions of the research analysts resp onsible for the research report and

reflect their judgement as of the date hereof. These opinions are subject to change and Danske Bank does not

undertake to notify any recipient of this research report of any such change nor of any other changes related t o the

information provided herein.

This research report is not intended for, and may not be redistributed to, retail customers in the United Kingdom or

the United States.

This research report is protected by copyright and is intended solely for the designated addressee. It may not be

reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank’s prior written

consent.



Disclaimer related to distribution in the United States This research report was created by Danske Bank A/S and is distributed in the United States by Danske Markets

Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank A/A, pursuant to SEC Rule 15a-6 and related

interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for

distribution in the United States solely to ‘U.S. institutional investors’ as defined in SEC Rule 15a -6. Danske

Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely

to ‘U.S. institutional investors’ .

Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of

research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not

registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a

non-U.S. jurisdiction.

Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument

may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non -U.S. financial

instruments may entail certain risks. Financial instruments of non -U.S. issuers may not be registered with the U.S.

Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S.

Securities and Exchange Commission.

Report completed: 24 January 2018, 17:35 CET

Report first disseminated: 24 January 2018, 20:35 CET

Investment Research General Market Conditions Trip report ... · sharply rising wages and...

Documents

Transcript of Investment Research General Market Conditions Trip report ... · sharply rising wages and...