We expect a slowdown in the Polish economy in 2019-2020, along with a lower growth in the Euro zone – the main target market for exported Polish goods – and a slowdown in global trade. Such perspectives of Polish exports are supported by some advanced leading indicators. The PMI index for the industry in Poland is below the level of 50.0 from November 2018, largely reduced by new export orders.

Chart: PMI for the Polish industry

Source: National statistics, IMF, IHS Markit

The increase in exports to the Euro zone (in particular to Germany) decelerated sharply and fell below the rate of export growth in non-Euro zone economies in the first quarter of 2019.

Chart: Polish Export to selected regions (denominated in Euro,% y / y)

Source: National statistics, IMF, IHS Markit
It is noteworthy that the upward trend of Polish shipments to countries outside the Eurozone since 2018 has been driven by exports to Great Britain (thanks to the British stocks accumulating before the expected Brexit) and the US (thanks to the positive effects of the US fiscal stimulus in 2017/2018 in global trade).

We expect, however, that the impact of these factors will decrease in 2019-2020, because Brexit will be consumed at some point, and the US economy, which is very likely, will clearly slow down. As a result, it is anticipated that general external demand for Polish goods will continue to slow down in the coming quarters. It is expected that throughout 2019, domestic demand will remain wide-ranging and will be the main driver of growth, while reduced external demand will act as a brake. Consumer spending will be supported by still solid wage growth, low unemployment and perhaps moderate inflation (we have doubts about this year’s and next year’s inflation target). Investments will benefit from continued loose monetary policy and current EU fund flows, although the impact of the latter should gradually decrease. In addition, public spending is expected to grow thanks to a stimulus package before parliamentary elections at the end of 2019. This package is expected to increase annual growth by around 0.3 percentage points over the next two years, and thus (perhaps unintentionally) to alleviate the negative impact of tensions in global trade on the Polish economy. Overall, real GDP is projected to grow by + 3.9% this year and then fall to around + 3.2% in 2020.

Days Sales Outstanding (DSO) better than the global average

The average DSO in Poland fell significantly in the years 2015-2016 and since then it was well below the global average. In Poland, slightly less than one in five companies are repaid only after three months, while this applies to one out of four companies at the global level. Between 2017 and 2018, with particularly strong economic growth, the average DSO of listed companies in Poland increased by +1 day to 59 days, which is a sign of greater confidence of companies in the period of accelerated growth. However, the expected decreasing growth rate in the Polish economy over the next two years, updates the need for payment discipline. Therefore, we expect the Polish DSO to fall by -1 day to 58 in 2019.

Chart: Debt turnover cycle (average) against the background of the global cycle – days

Source: National statistics, IMF, IHS Markit

We expect a rise in risk in the enterprise sector.

Despite the fact that the Days Sales Outstanding (DSO) of listed companies indicates that large companies enjoy relatively good payment discipline, the general risk of non-payment has steadily increased over the last three years. This is reflected in the ongoing upward trend in insolvency of enterprises (on average by 10% per annum in 2016-2018). We expect that the number of companies’ insolvencies will increase by another + 10% in 2019, creating a special risk for large suppliers of Polish enterprises.

The upward trend in corporate insolvencies continues

Despite the economic boom and relatively favorable DSO in the last few years, the risk of payment congestion in Poland has been steadily increasing since 2016, reflecting the ongoing upward trend in the bankruptcy of enterprises. In annual terms, the insolvency rate increased for the third consecutive year in 2018 by + 10%. In quarterly terms, strong growth was recorded in the fourth quarter of 2018 (+ 25% q / qi + 17% y / y) and I q 2019 (+ 8% q / q and + 10% y / y) after a temporary decline in previous two quarters.

Chart: Insolvency rate of Polish enterprises on a quarterly basis

Source: National statistics, IMF, IHS Markit

At the beginning of 2016, the Restructuring Act of 2015 became applicable. Together with the amended version of the Bankruptcy Act of 2003, the Restructuring Act aims to facilitate a greater number of recovery proceedings instead of ordinary bankruptcies (liquidation). It succeeded because the number of liquidations slightly decreased since 2016, when the number of corrective actions (which are also included in the insolvency, because the creditors are not repaid) increased significantly.

Secondly, the abovementioned rapid increase in nominal wages, which exceeded the increase in productivity. This is reflected in the strong increase in unit labor costs by an average of + 2.4% in 2016-2018, which was much higher than the average in the euro area, though lower than in other V4 countries.

Chart: Annual increase in labor costs compared to the Visegrad Group countries and the Euro zone

Source: National statistics, IMF, IHS Markit

Polish companies have absorbed higher wage costs, accepting lower profit margins without raising prices (CPI inflation remained low). As a result, profit margins dropped from a record high of 51.4% in the fourth quarter of 2015 to a 10-year minimum of 47% at the end of 2018, despite an improvement in operating profits in 2017-2018 (data includes 4 quarters in cumulative terms):

Chart: operating profit (% y / y), value added (% y / y) and profit margin (%, law scale) – 4 quarters in cumulative terms

Source: National statistics, IMF, IHS Markit

Thirdly, obsolete business models in some sectors are an obstacle to productivity growth, resulting in low productivity levels. Eurostat data show that labor productivity in Poland amounted to only 75% of the EU average in 2017, which puts the Polish economy behind Slovenia, the Czech Republic and Slovakia among the EU Member States in Central Europe.

Chart: Labor productivity of an employed person against the background of the EU and other countries

Source: National statistics, IMF, IHS Markit

A look at insolvency data in the six major sub-sectors of the Polish economy provides further information. It shows that services (280) and production (257) recorded the most cases of insolvency in the 12 months to April 2019, followed by wholesale trade (172) and construction (156). Over the past three years, production has become unstable and has seen increasing energy costs, while rapid wage growth has had the greatest impact on services and construction, sectors in which labor is the largest contributor to the cost structure of enterprises. Meanwhile, retail (92) and transport (53) recorded the least cases of insolvency and recorded the highest growth rates (21% and 77% respectively). Traditional sellers are facing the typical pressure from the competition. Meanwhile, Polish transport companies, which have dominated international road transport in the EU for over ten years, are facing a number of challenges: (i) higher energy prices; (ii) increasing (price) competition from Romania, Lithuania, Hungary and Bulgaria; (iii) obsolete business models (many small family businesses that do not want to consolidate); and (iv) lack of capital (despite the rapid growth in the past, small capital was accumulated). Based on data from the first four months of this year, we expect that the total number of bankruptcies of enterprises will increase by another + 10% in 2019 as a whole. This creates a particular risk for suppliers of Polish companies who face a decline in turnover and profits in the face of a slowing global economy.

Chart: Insolvency of enterprises in key sectors of the economy (12 months, y / y change)

Source: National statistics, IMF, IHS Markit
A look back, which is what we have been dealing with in the economic context for the past five years.

Over the past five years, Poland has experienced rapid economic growth with an average annual rate of + 4%, caused by strong foreign demand, an investment boom and a clearly strengthening labor market. While the last two should stay in 2019, foreign demand (especially from the euro zone) is decreasing. As a result, in the face of the increasingly difficult economic environment in the world, we expect a slowdown in Poland’s growth from + 5.1% in 2018 to + 3.9% in 2019 and + 3.2% in 2020.

Strong foreign demand

In real terms, Polish exports in real terms grew by 7.8% annually in 2014-2018, thanks to the revival in the Euro zone. Deliveries to the Member States of the monetary union, especially Germany, have increased significantly more than to the rest of the world (see figure). The share of the Euro zone in Polish export of goods increased from 51.6% in 2013 to 57.7% in 2018 (Germany’s share increased from 25.1% to 28.2% in the same period). Polish companies have benefited from the supply chain structures that have emerged over the past two decades.

Investment boom

Effective use of EU funds for eligible projects has contributed to investment growth. As the previous EU program for financing research and innovation for the years 2007-2013 has come to an end, Poland was able to obtain a number of approved projects, with payments made in 2014-2015. In addition, this funding attracted significant private investments. In 2017/2018, Poland was able to increase the use of EU funds again, which accelerated the growth of fixed investments (+ 4% in 2017 and + 8.7% in 2018) and the construction of inventories. The increase in inventories contributed to the average annual + 0.6 pp GDP growth in two years.

Good situation on the labor market

Both the export cycle and the investment boom have had a positive impact on the Polish labor market since 2014. The total number of employees in the national economy increased on average by 2.1% annually in 2014-2018. In the private sector, the average increase was even 2.8%. As a result, the unemployment rate (national definition) dropped sharply from 13.5% in 2013 to 6.1% in 2018. In addition, with the tightening of the labor market, the increase in nominal wages accelerated from + 3% in 2014 to + 6.9% in 2018. Since consumer price inflation was very low in 2014-2018 (annual average + 0.4%), real wage growth and household disposable income also increased, increasing consumer spending. In real terms, the latter increased from just + 0.2% in 2013 to + 4.5% in 2018. There are signs that the economic recovery in Poland will soon decrease.

Challenges facing the Polish economy

Political activities that could improve product quality and exports in the country, as well as its overall attractiveness, and thus increase medium-term growth prospects are:

Improving the business environment.
Regardless of the outcome of the elections in autumn 2019, the government should have room for maneuver to cope with the deterioration of the business and investment climate in recent years. In addition, it should implement measures to reduce the length of legal procedures, improving investor protection and ownership rights, and facilitating business registration and the availability of credit for SMEs.

Increased innovation to reduce dependence on the supply chain.

In order to climb the ladder of added value, we need to increase investments in research and development (R & D) – it is only 1% of GDP in Poland, well below 1.8% in the Czech Republic and 1.9% in Slovenia, not to mention the average OECD of 2.4% or 3% in Germany. Another example of Poland’s position in terms of innovation is the share of people carrying out development research in the total workforce (5.9 people per 1000 people in total working compared to 9.3 in Germany or 9.2 in Slovenia and 8.3 in OECD countries).

Supporting the reconstruction of the inflow of FDI.

The inflow of foreign direct investments to Poland has significantly decreased over the last two years. They amounted to around 2% of GDP in 2017-2018, which is a decrease from the average of 3.6% in the previous three years. The more interventionist attitude of economic policy since 2015, as well as the gradual deterioration of the business environment, discourages some foreign investors from sending money to Poland. Improving the investment climate for foreign capital in order to regain the inflow of FDI would be beneficial for long-term economic growth.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all RCieSolution management teams. Are subject to revision over time.