Wednesday, July 13, 2011

IMF's annual assessment of the Polish economy

The IMF has just published its annual report on the Polish economy (the so-called Article IV). It is a useful read, replete with the usual high-quality analysis, but somewhat marred by an arcane language, which makes it hard to read for anyone outside the narrow economists’ circles.

(A digression: as IMF desk economist for Moldova, I was writing staff reports myself – I needed to quickly learn how to use the same undecipherable language to relay the right message without disturbing the audience and the markets. To my great surprise, chiseling the text was taking more time for everyone than the underlying economic analysis!).

There are plenty of things I would broadly agree with:

- maintaining fiscal discipline (in my view Poland should aim for a balanced central budget by 2016, reduce publid debt to closer to 40 percent of GDP and establish a Fiscal Council to increase credibility and transparency of public finances),
- increasing labor participation (more than 1.5 million Poles more should be working when compared with Western Europe, there is another million working in low-productivity farming, which should be moved to industry and services, there is a substantial scope for increasing immigration, especially the high-skilled type)
- streamlining bureaucracy (there is nevery enough of it)
- stimulating further business climate reforms (some of it is happening and Poland is likely to improve its position in this year's Doing Business rankings)
- and continuing privatization (although it is somewhat irritating to read the banalities about the permanent advantage of private vs. public ownership. This is simply not always true; vide the fact that many Polish partially state-owned firms, PKO BP, KGHM, Orlen, Lotos etc, have recently performed better/equally well as their private sector competitors and—above purely private returns—have also provided substantial social returns by maintaining operations and profits in Poland and—as in the case of PKO BP—increasing lending were needed. The usefulness of maintaining some sort of public control over the most important enterprises is even higher during uncertain times: for instance, in a scenario of further worsening of the euro zone crisis, we might need to use PKO BP again to support lending and/or buy out foreign banks, if needed) The key is not ownership per se, but the existence of competitive pressures and commercial orientation).

However, I disagree with IMF’s view that foreign exchange reserves are too low and that they should be increased. This is for three reasons:

- First, FX reserves may be lower than the total value of short-term debt, but a large part of this debt is short-term only by name, as it includes inter-company financing from foreign banks and companies for their Polish subsidiaries. This type of funding has proven to be extremely stable in the past. Even during 2008-2009, at the bottom of the first wave of the global crisis, foreign banks, for instance, have actually increased, not decreased their financing for Polish subsidiaries. This is likely to be the case in the future too, implying that the FX reserves do not have to inordinately high.

- Second, Poland maintains access to the $30 billion Flexible Credit Line from the IMF (for which it is paying about $50 million dollars a year in commitment fees), which could be used at any time to bolster reserves. Maintaining the same $30 billion on NBP’s balance sheet would cost us $1.2 billion a year in opportunity costs (see below). So, it is better to further increase the FCL than to build up reserves.

- Third, and above all, FX reserves are one of the most inefficient ways of investing public money: while NBP invests $100 billion worth of dollars and Euros in US and euro bonds yielding 1-2% a year, at the same tiem the Ministry of Finance borrows the same dollars and Euros from the global financial markets at 6% a year. As a result, the poor Poles are subsidizing rich Americans and Western Europeans to the tune of some $4 billion a year! Does that make any sense?

In an ideal world, NBP should not have to accumulate any FX reserves and rely instead on the ECB and/or IMF-like insurance policies guaranteeing payment in case of a crisis. The accumulated reserves should be used to pay back the burgeoning public debt (reducing the total outstanding public debt by one third). Poland will come close to this ideal situation when it enters the euro zone around 2020: as part of the euro zone, there will be no need any more to maintain FX reserves (except for our contribution to ECB and small reserves for technical reasons). One more reason to enter the euro zone at some opportune moment and at a competitive exchange rate.

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