Poland Faces Economic Headwinds before the 2023 Elections

Inflation was below the central bank’s 2.5 percent target, GDP growth was solid at 4–5 percent, and unemployment was falling as a result, among other things, of an aging society. The government could thus simultaneously decrease the fiscal deficit and increase spending, especially on new social benefits like a child-support scheme.

Even the coronavirus pandemic had only short-lived negative effects on the economy—in 2020 GDP decreased by 2.5 percent, nominal disposable income per capita increased by 2.3 percent, and employment fell by just 0.3 percent. In 2021, the majority of indicators returned to pre-pandemic levels and only in some sectors of the economy, like tourism or passenger transport, did the pandemic have a longer-lasting effect. Such a quick rebound could be attributed partly to a very flexible economy, including in terms of the adoption of digital solutions, and partly to a very generous fiscal stimulus package (around 10 percent of GDP) that was financed by the central bank through a program of buying state-guaranteed bonds issued by a public development bank.

However, this success came at price. The menace of high inflation started to loom at the beginning of 2021 and rapid price increases kicked in after the summer holidays. In December, inflation stood at 8.6 percent. The government introduced several anti-inflationary measures at the beginning of this year: a temporary reduction in the excise tax on fuels and electricity as well as a reduction in VAT on energy, food, and fertilizers.

But then Russia invaded Ukraine. Almost immediately, Polish consumers experienced an unprecedented rise in fuel prices of 40 percent over two weeks as well as increasing food prices while the zloty depreciated rapidly, temporarily hitting an all-time low of 5 zloty against the euro. As a result, inflation rose to 11 percent in March and 12.4 percent in April. It is predicted to peak at around 13 percent in May and to remain in double-digits till the end of the year, driven by price increases in almost all categories as the price-wage spiral is beginning to spin out of control.

Inflation is expected to slow down only slightly to 8.2 per cent in 2023, which would place Poland in the top-three EU countries. It will be fed by the pass-through of energy-price and wage increases into the prices of products and services as well as by the increased demand driven by refugees from Ukraine and the increase in income related to the reduction in personal income tax. Only the increase in fuel prices will slow down, slightly, but they will still be 17.5 per cent higher on average than in 2022.

Inflation is expected to slow down only slightly to 8.2 per cent in 2023, which would place Poland in the top-three EU countries.

This and the fact that 2023 will be an elections year will make it extremely difficult for the government to wind down its anti-inflationary measures. In fact, it is planning to introduce additional policies aimed at soothing the pain of higher prices, such as cutting the rate of personal income tax from 17 percent to 12 percent and a 14th monthly pension payment per year. This loose fiscal policy aims to delay the problems caused by high inflation until after the elections. But higher public spending will eventually strengthen the wage-price spiral and lead to high inflation also in 2024.

In October 2021, the Monetary Policy Council started a tightening. Many economists had called for doing this earlier but the politically minded president of the central bank, Adam Glapinski, had stated that inflation was temporary and no action was needed. As it was late in counteracting the rapid increase in inflation, the Monetary Policy Council had to speed up the pace of interest rates increases until in May the reference rate was at 5.25 percent (up from 0.1 percent in the third quarter of 2021). Further hikes that will bring the rate to 6–7 percent are expected this year.

The fast monetary tightening has brought demand for credit to a halt, especially in the case of mortgages where the fall in credit affordability was additionally propelled by restricting macroprudential regulations. Together with increasing construction costs, this will translate into falling demand in the housing market after a five-year boom. Many households are currently unable to buy a decent property to live in, which—in addition to the lack of social housing and an unstable, expensive, and fragmented private rental market—has sparked social unrest across the country.

The rise in interest rates has also translated in a rise in mortgage repayments as almost all mortgages in Poland are on a variable interest rate. Many of those who took out loans during the housing boom have experienced an increase of 75 to 100 percent in their monthly repayments. On top of rising utility costs, this has decreased consumer spending, especially for durable goods, as well as threatened a spike in non-performing loans and, eventually, foreclosures. Therefore, the government introduced credit moratoria for the second half of 2022 and for 2023. This will bring some comfort to borrowers, but in the medium term it will result in higher inflation and in the long-term it will not solve the actual problem as interest rates will still be high after 2023 when the credit moratoria end.

The fast tightening of monetary conditions, not only in the country but globally too, poses a threat to the soundness of Poland’s fiscal situation.

The fast tightening of monetary conditions, not only in the country but globally too, poses a threat to the soundness of Poland’s fiscal situation. Currently, the government is using the windfall of higher tax revenues caused by higher inflation to finance its anti-inflationary measures and its expansionary fiscal policy. But in the coming years public spending will automatically be driven up by higher prices while debt-servicing costs will rise exponentially due to rising interest rates. The Ministry of Finance is trying to reassure the public that everything is under control but credit default swaps for Poland’s sovereign bonds have increased to the levels of those of peripheral eurozone countries, indicating that private investors see fiscal troubles ahead.

Summing up, Poland’s economy is in rough seas with a perfect storm brewing. Most likely the government will try to kick the can down the road until after the 2023 elections, keeping consumers, mortgage borrowers, and fixed-income investors pacified. Its temporary measures will bring some comfort but will eventually result in even bigger problems after 2023.

It will also be very difficult for PiS to roll out a generous political program aimed at boosting its electoral appeal through direct transfers. Its options will be limited and the opposition will exploit this situation during the elections campaign. This does not bode well for PiS. But regardless of the result of the elections, serious economic challenges lay ahead that will have yet to be solve by those at the helm afterward.

Adam Czerniak is chief economist and director for research of Polityka Insight.