Mission Impossible for Poland's New Finance Chief?

He must rev up the economy--but meet tough EU standards

It was clearly the wrong thing to say. "Go off on your summer holidays and leave me to work!" Grzegorz W. Kolodko blithely advised his compatriots after he was sworn in as Poland's new Finance Minister on July 6.

Immediately, traders started dumping the Polish zloty, interpreting Kolodko's comment as a signal that he planned to devalue the currency to boost exports and rekindle growth. "Some people thought he was hinting that they should go abroad now while the currency is still strong," explains Maciej Reluga, chief economist at BZ WBK, a bank in Warsaw. By July 10, the zloty had lost 4% of its value and was trading at its lowest level against the euro in almost two years.

Kolodko's shaky start just complicates one of the toughest jobs in the former East bloc. Poland is trying to rev up its sluggish economy while engaging in tough talks about joining the European Union by 2004. Kolodko's predecessor, Marek Belka, quit in frustration on July 2, claiming exhaustion. Now it's up to Kolodko to boost growth and slash an 18% unemployment rate, all the while keeping Poland's budget deficit in line with requirements for EU membership. And he must do all that without rattling already jittery financial markets.

Investors have good reason to be nervous. Just two months ago, Kolodko called for a 10% to 15% zloty devaluation. That's anathema to foreign institutional investors who have poured billions into Polish equities and bonds in recent years--and don't want to see the value of their investments plummet. Kolodko is also known as a big government spender from his previous stint as Poland's Finance Minister from 1994 to 1997. That's when the economy expanded 6% to 7% a year, but public finances began to spin out of control.

To make matters worse, the political atmosphere in Poland this summer is the tensest it has been in years. The country's political parties are gearing up for September local elections, which will be seen as a referendum on Prime Minister Leszek Miller's 10-month-old center-left coalition. Opinion polls show that disgruntled voters are deserting the government for nationalist Andrzej Lepper's Self Defense party, which is hostile to Poland's accession to the EU. Self Defense is now the second most popular party in the country with 18% support, vs. 34% for the Democratic Left Alliance, the coalition's leading party.

Faced with this panoply of pressures, what is Kolodko likely to do? For now, the 53-year-old economist is keeping his cards close to his vest. "We have to boost growth while working to stabilize public finances," he declared after his appointment, stating the obvious. Although Kolodko's instinct would be to promote growth by ratcheting up government spending, as he did in the mid-1990s, his hands are tied by requirements from Brussels. This year's budget deficit will come in at about 5.3% of gross domestic product. But it needs to be brought down to 3% once Brussels lets the country join the EU.

Members of the Polish Peasants' Party, the junior party in the government coalition, want to raise more revenues by slapping a tax on imports. But that would horrify the EU, which could see the ploy as a measure to protect local manufacturers and farmers. The last thing Kolodko and Miller want is to jeopardize Poland's chance of joining their rich neighbors' club by infuriating the bureaucracy in Brussels.

That's why Kolodko is pressuring the National Bank of Poland, the central bank, to reduce interest rates, which are currently 8.5%, well above the 2% inflation rate. That would spur investment, growth, and job creation, he says. But central bank President Leszek Balcerowicz, a monetary hawk, isn't one to be pushed around. Balcerowicz says the government should create the conditions for bigger rate cuts by squeezing the budget deficit and reforming public finances. "He's just as combative and forceful as Kolodko," says an economist who has worked with them both.

Economists generally agree with Balcerowicz that Kolodko needs to bite the bullet by cutting taxes and slashing state spending. "That would lay the foundations for solid growth," says BZ WBK banker Reluga. A recent report by the Organization for Economic Cooperation & Development calls for payroll tax cuts, faster privatization, and lower interest rates to speed growth.

With elections looming, Kolodko is unlikely to take tough measures now. Even after the September vote, most analysts think Kolodko would prefer to steamroll the central bank rather than make politically unpopular moves. He may try to push through legislation that would increase the size of the central bank's monetary council, which he would then pack with officials who agree with his interest rate policy. But such a move could mean full-scale war between the government and central bank, and more strain on the markets. Foreign investors, as well as ordinary Poles, may be in for an exciting time.

By David Fairlamb, with Bogdan Turek, in Warsaw

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