Inside S&P’s ratings calculator

Frank Gill, Senior Director at S&P Global Ratings, opens the bonnet to S&P’s ratings machine to reveal Poland’s sovereign risk outlook.

S&P rated Poland at A- in 2007. That rating was maintained until early 2016 when it was downgraded to BBB+. Last October, S&P brought Poland back up to A-. You maintain that this doesn’t mean Poland is back to where it was before the downgrade, but rather the decision reflects a major structural change in the Polish economy. Can you elaborate on this?

For starters Poland´s surplus in net services exports skyrocketed from 1.5%/GDP in 2012 to just under 4%/GDP last year, reflecting rapid expansion of the business, transport, and financial service export sectors. That is an unusually high services surplus for a large country that is not a major tourist destination (and we have seen similar surging of services surpluses across Central Europe). Also, the overall size of the export sector during that same period (2012 to 2018) increased by 10 percentage points of GDP to 55%/GDP last year. Poland, particularly for its size, is a very open economy, as well as a very diversified economy. Now a lot of those exports are sales of components and other machinery primarily to Germany, given Poland´s integration into the Germany capital machinery supply chain (which includes autos). If, due to an escalation of global protectionism, German exports suffer, that will also weigh on the Polish economy.

Economically, Poland is now the healthiest it has been over the last 30 years. The country has high and balanced growth, decreasing public debt in relation to GDP, a very low unemployment rate, wages rising faster than ever, etc. What should the country do to move beyond A-?

There is no question that Poland´s economy is booming. However, in our view, potential growth is lower than recent GDP growth. This means that the underlying fiscal position is weaker than the low headline deficits suggest. If, however, Poland were running outright budgetary surpluses – that is, using the current good times to pay down public debt – then that would very likely push up the rating further. In our view, the good times will not last forever. Risks on the horizon include the possibility that the US government slaps tariffs on European auto exports. We are already seeing a marked slowdown in GDP growth in large European economies, including Germany.

According to some sources, Poland is still a developing market. To others, it is already a developed market. How would you explain this disparity in assessment?

There is no magic number that transforms an economy from a developing to a developed one, but here are a few benchmarks. Does a country issue all of its public debt in its own currency, and do global central banks allocate a portion of their reserve holdings into assets denominated in that currency? Is there an actively traded equity market, which also serves as a source of capital to startup companies? Is the economy competitive because it is cheaper on a relative basis compared to other economies, or is the economy competitive because the goods and services it produces are of higher quality, and therefore command greater pricing power? What is the quality of public outputs, in particular of health and education?

In that context, how do you see the potential adoption of the euro currency playing out for Poland? In such a scenario, most of Poland’s debt, if not all, would be issued in euros, yet the country would no longer have control over its monetary policy. That brings in mind the fate of Greece. Do you think the adoption of the euro would bring Poland closer to a developed market?

In our view, there is not a strong impetus among decision makers in Poland to join the common currency area, certainly not over the next decade. Whether or not Poland joins the single currency area does not, by itself, imply more or less economic development. One benefit would be access to deeper capital markets. But Poland could improve the depth of its own local currency markets, if it moves ahead with current pension reform plans, and finds other ways to stimulate domestic savings.

Interview by Bartosz Stefaniak, Poland Today’s co-founder and creative director.

Frank Gill is a Senior Director in the European Sovereign Ratings Group. He is currently responsible for analytical coverage for Poland, South Africa, Turkey, Greece as well as other EMEA sovereigns. Before working for S&P Global Ratings, Gill was a macroeconomic analyst focusing on European markets for Fortress, a New York-based hedge fund. His earlier professional experience included over eight years as an analyst focused on Russia, Eastern Europe and Turkey for Ideaglobal in London. Frank holds a Post-Graduate Diploma in Economics from the London School of Economics and a M.I.M. from the American Graduate School of International Management.

As shown in the accompanying chart, since the global downturn of 2008, Poland’s currency has weakened inversely proportional to economic growth. Despite being Europe’s growth champion, Polish GDP counted in dollars at current prices is now roughly in the same place as it was in 2008 – that is, for the last decade, it has been floating around the same level as it was in 2008. What’s going on with the Polish currency?

First of all, according to our estimates, Poland´s dollar-denominated GDP, which remained fairly close to $525bn (+/-) between 2011 and 2015, increased by over 10% in 2018 to (our estimate) $585bn. That jump reflects a combination of factors: a) a step up in EU transfers and b) rising real wages, and rising employment, as Poland´s economy shifts away from the production of goods towards the production of services. As a rule, services are both more labour intensive, and higher wage sectors. So purchasing power in foreign currency may have turned a corner. However, the bad news is that labour productivity growth – that is, output per worker – remains underwhelming. So most of the growth over the last few years was a function of more jobs, rather than more productive jobs. Ultimately, weak productivity growth will tend to mean a weaker currency. How to fix the productivity challenge? Provide more education and training to workers. And give Poland´s dynamic private sector the opportunity to compete with public sector companies.

But isn’t productivity by definition the share of GDP per hour worked? When you measure GDP by purchasing power parity (PPP), you see growing productivity, but when you measure GDP by its current value in USD, you see stagnation. Same goes with wages: the purchasing power of Polish wages grows steadily in the domestic market but is lower in USD compared to 2008. Yet Poland’s current workforce is neither less skilled nor puts in fewer hours than in 2008. Does this long-term currency depreciation provide proof that Poland is stuck in the mid-income trap?

Look, Poland is getting richer, but so is the rest of the world. You look at productivity growth to determine relative competitiveness gains of Poland versus its trading partners. Here, as I said, the news is a bit more disappointing since most of the strong GDP growth over the last 3 years has been about putting more people (including mostly Ukrainian immigrants) to work, rather than increasing individual output. But it is important to stress that productivity per person is becoming tougher and tougher to measure, as economies become more services oriented. I remain an optimist about Poland, not least because of a strong legacy of education, and hence a skilled labour force. Going forward, educational policies will determine whether Poland´s skills edge can be maintained.

Click for full image. Data source: International Monetary Fund (World Economic Outlook - Oct. 2018)
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