The Coming Polish Recession Must Be Blamed on the Political Corruption of the Incumbent Kleptocracy By Matthew Tyrmand
http://m.wprost.pl/tylko-u-nas/id,479456/Matthew-Tyrmand-Polskie-twarde-ladowanie.html
Matthew Tyrmand, the son of 20th century writer and anti-communist Leopold Tyrmand, is an investor and economist based in New York City. He co-runs a Chicago-based NGO focused on bringing transparency to government spending (www.openthebooks.com) which he hopes to introduce to Poland now that he has obtained Polish citizenship.
I was recently asked by a Polish venture capitalist what my thoughts were on a recession occurring in the Polish economy and if so what the timing and depth of it would be. What follows is my response.
The short answer on the timing of the recession that I am predicting is right after the national elections in 2015, though I do believe the cracks in the economy are starting to show and with the recent 50 basis point interest rate cut, I think the nomenklatura see it too and are trying to put a “bandage on a gunshot wound” ahead of next year’s elections. Hopefully this coming recession lasts two to three years at most and is accompanied by a changing of the political guard. If Polish politics follows the trend of most of Europe- that of Brussels led socialism- then it will look more like a lost generation in the manner that Japan has had and the likes of which the US and parts of the EU are embarking upon. In this case the coming recession will last closer to ten years than two or three. Politics matters.
My reasoning behind this recession and its depth primarily hinges upon the preponderance of political corruption that has undermined Poland’s free market. To understand why there is an economic reversal occurring or about to occur (but not yet having commenced if you believe the statistics out of the government) one has to understand the previous positive trends. Poland’s strong tailwinds, and strong they have been, will not guarantee perpetual growth. Poland has had over two decades of uninterrupted sequential quarterly GDP growth with nary a recessionary contraction. Growth rarely occurs in this straight a line and Poland has amazed the world for how long this straight line has been (thanks to Balcerowicz and his eponymous economic liberalization plan). This is similar to the China of the last 20 years in the sense that after 1989 in Poland there were huge amounts of pent up animal spirits ready to be unleashed on a free market (one need only look at the entrepreneurship that followed passage of Wilczek’s Law in 1988) . Poland weathered the recent crisis well because it decoupled from the Eurozone in large part due to the potency of this massive 20 year tailwind. In essence, 40mm people from a closer-to-third-world post- Soviet regime saw economic development that moved the nation toward the first world Western European middle class quality of life and with it much stronger consumption trends and a more potent rule of law when it comes to private property protection. This was more prevalent in Poland than other Soviet satellites due to a stronger education system and a civic minded population. There has always been, even throughout the dark years of communist oppression and now to this day still, a stronger moral center in this society (politicians not withstanding) rooted in the Catholic Church. In addition political engagement has gravitated toward being more liberty minded for centuries. The health of the societal balance sheet has been aided by cultural thrift that has led to a relatively smaller scale social welfare state. The continent’s overextended welfare states have catalyzed much of the Eurozone’s trend toward insolvency and have also encouraged a foreign immigrant incentive program that has furthered this economic drain. Although Poland had been ripe to correct for the years following the continental European and global crisis, German growth did rebound enough to help support German consumption of Polish output. This is largely thanks to “helpful” ECB liquidity in the form of the bond purchases and the lending facilities of the LTRO (Long Term Refinancing Operations…congruent to the Quantitative Easing- QE- that has done little for Japan or the US) that financed EU-wide consumption of German goods and services. The countries of Europe have had crippling amounts of debt on their balance sheets so the solution to this quandary for the Keynesian economics ministers of Europe has been to layer on more debt. (Brilliant, is it not?) The continued relative strength of the German economy further catalyzed global capital Polish inflows after 2009 given the relative attractiveness to foreign investors mired in zero growth, stagnant, over levered, mature economies. This delayed the reckoning.
The signal to me that the party would/will soon be over in Poland and that we are going to see continual capital outflows and eventually a downward revaluation of assets due to diminished growth prospects has been catalyzed by the politicians. All the self-described reformers of four and five years ago encouraged investors with their rhetoric. The Western Press still refers to PO as a center right party thanks to this rhetoric (this in spite of their actions- Tusk’s immediate VAT hike in 2010 comes to mind despite promises to the contrary). In my view, the only thing center right about PO is the side of the road their chauffeurs drive them on. Their actions belied their promises and they took a slowing and precariously now lower growth economy and hurt it in so many more ways. For example, despite their promises to the contrary: more bureaucracy was introduced, more regulations and laws passed, new oversight agencies, higher taxes, bigger government in all its obnoxiousness, more hostility to those who would create jobs, a still corrupt, inefficient, and arbitrary judicial system, etc. Capital markets also became
tighter which is extremely unhealthy for a developing economy’s fundamentals when banks are not loaning to the would-be job creators at affordable rates.
The bough broke for me when the mobsters of the current national government did the unthinkable and nationalized the private sector OFE pension funds to help finance a buying/stealing of the upcoming 2015 national elections. As I wrote in Onet in late November 2013, global investors do not go where assets get nationalized. This is especially true of financial assets- as that is always the harbinger of more bad behavior due to the ease in which it exists to steal capital from free people these days: one touch of a computer key and done….no due process.
Argentina, Hungary, Venezuela, and others have all taken these actions in the last 20 years and they were never economies you wanted to be invested in thereafter. I do concede that there is still some hope for Poland that this recession may be shallow if a political pivot away from the socialist party PO does takes place. But first the inevitable recession needs to occur as it will be necessary to catalyze this political pivot. As I allude to earlier, I actually believe the economy may already be in a recession and the numbers being reported are materially overstating growth. This is not something one can put past this government after the OFE nationalization and the Belka affair came to light in June, especially given the upcoming elections in which they are fighting to maintain power. They are of course aided by a complicit mainstream media that actively deflects criticism, makes apologies for, and engages in a campaign of pro-government propaganda (remember, Belka was the victim!). Is it any wonder that this government infused taxpayer capital into Agora and now owns 17,5% of the company and is responsible for about a third of Gazeta Wyborcza advertising and subscription revenues? Yet another criminal act of cronyism by the criminal class at the expense of the hapless taxpayer.
A primary outcome of the OFE nationalization has been that it has woken up smart, large scale global capital investors and multinational corporations to the risk of doing business in this country. These participants in the Polish marketplace have been among the best transitional job creators in the migration from this developing world economy to the Western European standard. One of the other outcomes of the OFE nationalization is that it is leading to reduced liquidity available to mid-size companies that would be ready to grow aggressively into large companies if they could go public. International investors will be less likely to invest in WSE issuances, for several years a beacon marketplace for Central and Eastern European concerns, and even domestic investors (money managers) will have less capital to invest in public markets as OFE provisions equity investment down in the later years before the retirements of soon-to-be pensioners. It is also likely that the current government officials, if they can hold on to power through another election cycle, will nationalize the equity portions of the pension plans as well in coming years. This is sad as the WSE was a huge reason for Polish growth. Equity capital is the healthier way to infuse capital into an economy rather than debt. It is called “risk” capital and stocks are a “risk asset” for good reason. When investors are willing to risk their capital by investing in an economy it is a signal of confidence in future growth. That confidence is now waning if not altogether gone. The government has decided, against every practical case of empirical economics, to reduce the equity/debt ratio of the societal balance sheet. This is another warning sign to “smart” money (like the global hedge funds I have worked for in the past).
Concurrent to the above financial shenanigans, international integrated energy concerns have shown they are not interested in doing business in Poland due to the obvious risks the politicians have introduced. The political shortsightedness, greed, and venality have scared them away. Shale gas exploration could have created tens of thousands of new jobs in the next few years directly (drilling, equipment manufacture and distribution, etc.) and indirectly (goods and service providers doing business in the regions where there was exploration). ExxonMobil, Marathon, Eni S.p.A. and others have said goodbye after being asked for too many bribes and to put up all the capital in upfront investment while giving up the vast majority of upside in revenues they may create with 75% royalties to the state. They were also asked for expensive short term licenses with no guarantees that should they discover deep reserves they would be able to exploit their discovery. Without provisions that the multinationals would be able to recoup these large capital outlays if the development investments panned out, their rationale for investment was materially reduced. The way in which politicians looked to extort the energy companies would make any large scale exploration investment less compelling to an operator. For these types of entities it is never an emotional decision but merely a rational one that is probability adjusted and economically prudent. All of these factors combined with the optics of seeing the pensions nationalized (given that many of these multinationals have had assets nationalized before in Africa and Latin America) led them to leave before breaking ground and creating jobs.
To compound matters further the situation in Poland recently has shown even more venality. In June Marek Belka (the head of the constitutionally mandated INDEPENDENT central bank- the National Bank of Poland) was caught on tape telling Interior Minister Sienkiewicz that he would engage in the aggressive lowering of interest rates (this plan still seems to be on as evidenced by the recent 50 basis point cut) and engage in a round of money printing to help his pals make the economy look healthier than it is. By creating this excess short term liquidity, to be borrowed and spent where the most votes can be purchased, the appearance of an economic stimulus could be created. Of course this strategy has yet to work in Japan (over decades) and is certainly not helping in the USA or EU today. Belka and Sienkiewicz were clear in their motives to buy the upcoming national election with these printed funds. The OFE nationalization gave them this “wiggle room” as debt to GDP ratios had reached their constitutionally mandated ceiling (55%). To solve this they turned the liability, money owed pensioners in the form of government bonds, into an asset by nationalizing these bond funds. This had the effect of reducing the debt to GDP ratio to 48% (optically reducing net debt) and allowing the government to begin borrowing and increasing debt yet again. This additional borrowing causes further dilution (lowering purchasing power) of the zloty. This act is tantamount to straight up stealing from 40mm Poles and any investor who invested in building property/plant/equipment and has invested in fixed zloty denominated assets in Poland. This is another reason investors are leaving.
What makes this recession truly inextricable (even with a potential political shift Poland will still be guaranteed to see at least some reckoning for its bad decision making and hostile business climate) is that Germany is now in recession. For those who don’t believe that, as the German government downplays the bearish macro picture and does not suggest that things are trending like southern Europe, I encourage the examination of the most recent quarterly reports out of Siemens and BASF. These two bell-weathers are showing slowing revenue and earnings growth and may even show declines in both the top and bottom line in the coming quarter. Both firms are cutting jobs. I predict that German banks and large cap financial firms like Allianz and Munich RE will be the next negative indicator of the massive risks to the German economy.
Most Polish economists have said Poland will avoid recession because it is a nation of shopkeepers that create 70% of GDP. As true as that GDP figure breakdown may be it is that other 30% of GDP that worries me. Those shopkeepers have not been responsible for the ~40% in GDP growth since 2000. Global efficiencies have helped them a little incrementally but like Polish wages, which have remained largely stagnant for the last generation, the trickle-down effect never materially took hold. The reason for this is that the government essentially stole this growth from the Polish laborer (shop keeper or wage earner) by growing itself and by raising taxes to feed itself at the expense of ordinary Poles. There now exists, both in aggregate and on a per capita basis, more government employees and contractors than there were under PRL. The growth in GDP has been predominantly driven by international investment and large scale evolution in the marketplace for goods and services across multiple sectors of the economy from the retail, consumer discretionary, and staples sectors (Tesco/Zara/H&M/Biedronka/etc.) to the industrial, commercial, and business services segments (IBM/Accenture/etc.). Poland is unfortunately levered to Germany and in a smaller part the rest of Europe, which is in horrible shape. France, the number two Eurozone economy, is in a depression that is set to accelerate and is well deserved, resulting from socialism, employment practices that are hostile to entrepreneurs, higher and higher taxes (Hollande’s proposed 75% income tax on high earners and job creators has gotten much coverage for scuttling the productive class), as well as the social breakdown in the rule of law in no small part thanks to a 21st century Islamic crusade. Poland is emulating France in all those ways (except the last one thankfully) even as France is trying (unsuccessfully) to reverse these generationally embedded policies.
Add to this the new geopolitical instability driven by Russian aggression and saber rattling. War, risk of war, and danger on a nation’s borders are all GDP killers. Who wants to invest in the eastern regions now with long term potential for continued instability in Ukraine now introduced and a commensurate potential risk to Poland?
Moreover Russia is already looking to engage in GDP destruction as a policy to manipulate European politics. There is little doubt in my mind whether or not Putin uses continental energy dependence on Russian fossil fuels to lash out at her ideological enemies, even with consequent Russian economic damage induced. What is currently taking place in Ukraine (energy agreement falling apart ahead of winter) is just the start in my view and much damage will be done to the EU economy writ large. This is obviously another headwind for Poland’s economy as well. This also further proves the damage that political shortsightedness has wrought on Poland’s future economic prospects thanks to the destruction of the shale gas industry and the potential energy independence it may have led to as well as the potential aggregate export impact.
Poland was going to see a correction eventually. A basic economic theorem holds that something that cannot go up forever…won’t. Could Poland have escaped a hard landing and made it a soft one? Probably so. Actions like lowering taxes, continuing to encourage new investors (like the energy multinationals), deregulating and getting out of the way of innovators (who now all look to reincorporate in the UK or US if their ideas get past proof of concept), not siphoning off money from every business transaction with a culture of bribery and corruption, and by not having cronies like Rostowski and Belka be willing to destroy the currency (OFE, June tapes) and steal from every zloty holder in order to do what is in their own and their friends short term best interests at the expense of all citizens and investors would have all lessened the coming recession and made it shorter and more shallow.
I can tell you from my view watching global capital flows that unfortunately I am near term very bearish on the Polish economy. Long term I am bullish and I will look to deploy capital to take advantage of the market disruptions to accumulate stakes in intermediate sized companies and stable cash flow producing assets at low valuations. I believe the USD/PLN cross is going to 4 in the near term and that does upset me as I am starting to be invested in operating entities (and job creators) doing business in zlotys. The closer I get to Poland the more I would like to keep Polish capital within Polish borders and not repatriate this capital to the United States (the reasoning for this would necessitate a whole other essay well longer than this one). A weak currency is a reflection of a weak and compromised economy and I have always believed in a strong currency (which many economists, like Belka, do not). Devastatingly the zloty and, by extension, the Polish economy is compromised because the investing world has lost its faith in the integrity of the Polish marketplace, its central bank, and its rule of law. This is very sad.
The one bright spot is that a recession will not change who Poles are as people and with that the strong Polish cultural values that have allowed Poland to survive many eras of hardship. I maintain a strong belief in Poles who are naturally inclined toward freedom, free markets, and entrepreneurial activity despite having been co-opted and coerced by the statist and socialist forces of the Polish political class. Poles will eventually demand a change in the status quo and like all things in life this too will be cyclical. The way Poles respond to the recession in their choice of political leadership and economic philosophy going forward will determine how deep this recession will be. I maintain my hope that the Polish nation will eventually make the right choices and banish those who continue to damage the Polish marketplace to serve their own corrupt and venal self-interest.
© MATTHEW TYRMAND LLC. ALL RIGHTS RESERVED. 2014.
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