Crunch Time For Warsaw's Number Cruncher

A rookie finance czar must push through a tough budget

Jaroslaw Bauc admits he's exhausted. Since joining the minority Solidarity Electoral Action (AWS) government on June 12, Poland's new, 42-year-old finance minister has worked night and day to prepare a draft budget for 2001. Now he faces an even harder task: selling his deficit-cutting budget to Cabinet colleagues, members of Parliament, and the financial markets. "We're at the start of a long process," Bauc says. "I'm sure that the document will be approved by the government. As regards Parliament, we'll have to wait and see."

No one will be awaiting the outcome more anxiously than foreign investors. Poland has long been one of the star performers of the former Soviet bloc--investors have poured more than $24 billion into the country over the last five years. But in this uncertain season, they aren't sure what to do next. The reason has much to do with the huge challenge facing Bauc. If the fledgling Finance Minister fails to push a tight budget through Parliament this fall, investors could withdraw billions of dollars of short-term loans and portfolio investment, plunging Poland into crisis.

MOBILE CAPITAL. Poland's current predicament stems from its huge current-account deficit, which topped 8% of gross domestic product in March. Analysts expect the deficit to ease to 7.5% for the year as a whole, but that's still way above the 6% that economists say is sustainable. According to Bauc, the deficit is primarily a private-sector phenomenon--the result of heavy corporate borrowing abroad and a big imbalance between imports and exports. Those factors may stall growth, which has been a stellar 6% so far this year. "That would be devastating for the transformation process," warns Bauc. If this scenario starts to unfold, outside investors will pull short-term debt and equity capital out of the country. Analysts calculate that the amount of highly mobile capital invested in Poland is around $13 billion, more than half of foreign-exchange reserves. Capital flight of that magnitude could trigger a wrenching depreciation of the zloty--up to 15% by some estimates--leading to higher inflation and interest rates.

The political consequences would be dire, too. A failure to forestall a crisis could force early elections--which the socialist Democratic Left Alliance (SLD) looks set to win. And the SLD probably won't have the stomach to force through a tough budget. But it's only by squeezing the budget deficit that Poland has a real chance of tackling its current-account problem. That would curb demand, including the Polish appetite for foreign goods that's creating the current-account deficit.

Bauc, a highly regarded economist who graduated from the University of Lodz in central Poland in 1982 and studied at the University of Windsor in Canada, has crafted a budget that looks good on paper. By reining in government spending and raising taxes, he plans to cut the fiscal deficit by a third, to 1.7% of GDP. But analysts say he will have a hard time achieving that goal. This year's budget assumes an annual average inflation rate of 5.7%, while the real figure is likely to be closer to 9%. As a result, the government will have to increase pensions and other social payouts next year more than it had originally hoped.

To make matters worse, Bauc counts some proceeds from next year's sale of third-generation mobile- phone licenses as revenue. Critics says he shouldn't include this windfall: Without it, the fiscal deficit would be 2.6% of GDP. "So fiscal policy isn't really as tight as it looks," says Marcin Olecki, an analyst at Raiffeisen Capital & Investment Polska in Warsaw. "A lot of market people have lost confidence in Bauc as a result."

COLD FEET. Whatever wizardry Bauc uses, he's unlikely to get his budget through Parliament. His party lost a key ally last month when the fiscally conservative Freedom Union quit the coalition over the budget issue. Many MPs in Bauc's party favor a more populist budget that hikes spending, since they fear losing their seats in the next election.

Meanwhile, the SLD is trying to muster the two-thirds majority in Parliament needed to force an immediate election. But when SLD leader Leszek Miller spoke to analysts in London recently, he told them he wanted "higher growth whatever the budget deficit." That's precisely what they didn't want to hear. They want assurances that Poland is maturing into a stable, well-run economy, not turning into another benighted spot in central Europe.

Before it's here, it's on the Bloomberg Terminal.