Poland: An Eastern Star Looks Dimmer

But it may be tough enough to weather the slowdown

Polish doctors, paid just $260 a month, picket hospitals in white lab coats, while nurses protest at the Parliament over their meager wages. Both groups had hoped sweeping health-care reform would address their low pay. Farmers, angry at collapsing food prices, block roads into Western Europe, forcing the government to slap tariffs on imported grain, pork, and dairy products. Teachers wave banners demanding better retirement benefits.

Eastern Europe's brightest star, which joined NATO just in mid-March, is looking dimmer. After five years of 5% to 7% economic growth, Poland has hit an obstacle in its road to full-fledged capitalism. Squeezed between the slowdown in Western Europe and Russia's collapse, the country faces declining exports, rising unemployment, and sluggish profit increases. The economy may grow as little as 3% in 1999.

Yet this is no Asia-style meltdown. Because Poland took much of its free-market medicine bravely 10 years ago, it may be in a better position than most emerging markets to weather a downturn. Indeed, a tough economic cycle could galvanize the coalition government to plow ahead with stalled reforms, from critical privatizations to welfare spending cuts. Poland's success in taking these next steps could tell how soon it may be ready to join the European Union. "Poland's performance in 1999 will be the sustainability test," says Krzysztof Rybinski, chief economist at ING Barings in Warsaw.

Already, policymakers have signaled they won't back off from tough measures. Finance Minister Leszek Balcerowicz is keeping a tight rein on spending. He plans to slash Poland's budget deficit from 2.4% of gross domestic product last year to zero in the next few years, largely by trimming spending on pensions and health care. Monetary policy under central bank chief Hanna Gronkiewicz-Waltz has cut inflation. And privatization czar Alicja Kornasiewicz has battled political opposition to take more companies off the state's books. Thanks to her initiative, telecom giant TPSA listed 15% of its shares on the Warsaw stock exchange last year and will sell as much as 35% to a foreign strategic investor in 1999.

BOARDROOM COUPS. Bank privatization, crucial to the efficient flow of investment money, is poised for completion. By summer, the government will choose a strategic investor for its 55% stake in Pekao, a huge retail bank, from two finalists: Citigroup, and a partnership between Milan-based UniCredito Italiano and German insurer Allianz. The 100% state-owned Bank Zachodni, in western Poland, is also on the block.

Currency policy, meanwhile, is positioning Poland to fit smoothly into the European economy. Over the past year, the government has gradually been widening the zloty's trading band to plus or minus 15% of the euro and dollar basket to which it's pegged. That range is wide enough to allow Poland to qualify for Europe's Exchange Rate Mechanism--a first step toward monetary union. The zloty is "as good as floating," says Gronkiewicz-Waltz.

Meanwhile, the economic downturn has had a plus side for the private sector. Nominal short-term interest rates plunged during 1998, from 25% to about 13%, cutting the cost of financing for businesses. Companies that once invested in high-yielding Treasury bonds must find more productive uses for their cash. And as profits come under more pressure, shareholders are putting the screws to inefficient management.

The most striking example is $828 million industry conglomerate Elektrim. Foreign shareholders ousted top management last November when the previous CEO arranged an asset sale without disclosing its details. In February, the board installed an American venture capitalist who has already sold off 80 noncore businesses and refocused Elektrim on energy and telecoms. Similar boardroom coups have taken place at other big, privatized companies.

POLITICAL MALAISE. Much of Poland's economic health, of course, depends on external factors. A long downturn in Western Europe, which buys two-thirds of Polish exports, would further punish manufacturers, which are already scaling back capital spending and hiring. And including black- and gray-market activity, Russia accounted for about 15% of Poland's trade before last August's crisis. That business is unlikely to recover quickly.

The country also suffers from political malaise. As it prepares to join the EU, Poland must stick to the strict fiscal discipline laid out by Balcerowicz. But the party he leads, the center-right Freedom Union, is constantly battling its coalition partner, the union-backed Election Action Solidarity, which opposes reform. The current government has the lowest popularity rating of any Polish government in the past decade.

Yet compared with most other emerging economies, Poland has an edge. Tight and consistent monetary policy has brought inflation below 6%, from 14% a year ago. Banks are not weighed down with bad corporate debt, as they are in the Czech Republic and in Asia. Nor is Poland at risk of sudden capital flight. ING's Rybinski notes that Poland's short-term borrowing is only 18% of foreign exchange reserves, compared with 60% in the Czech Republic and 120% in Brazil.

Such advantages suggest that Poland is far from facing the big setback that Asian economies have suffered. Whether the country retains its status as Europe's next hot spot depends on the government's commitment to stay on track. If reforms keep coming despite slower growth, this could be the year when Poland proves its mettle for good.

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