III. Economic Trends and Outlook A. Major Trends and Outlook Five years after starting the transition to a free market economy, a period marked initially by contractions in production and employment and by high inflation, the Polish economy has begun to show signs of growth and increased stability. The rate of inflation has continued to decline, although high unemployment remains a major social and political problem. The leftist government elected in September 1993 so far has continued the process of free market economic reform and won support from the international community in recognition of its commitment to disciplined financial policies. Poland's gross domestic product (GDP) grew by 3.8 percent in 1993 and the government projects GDP growth of 4.5 percent for 1994. While overall unemployment remains high (about 2.8 million jobless), the unemployment rate began to edge down in early 1994. After peaking at just over 16 percent in February, the rate fell to 15.5 percent in May. The rate of inflation in Poland, which was almost 600 percent in 1990, continues to decline and the annual inflation rate for 1993 was 35 percent. The government forecasts an annual inflation rate of 27 percent for 1994. Declining inflation is also reflected in recent government decisions, effective next year, to redenominate the local currency (deleting four zeroes to a rate of about two zlotys to one U.S dollar) and to index pensions to consumer prices rather than wages. Poland's central bank currently devalues the zloty on a crawling peg system of 1.6 percent per month on a market basket of western currencies. The last major exchange rate adjustment was an 8 percent devaluation in August 1993. B. Principal Growth Sectors The higher rate of GDP growth in 1993 resulted from increased activity in most key sectors of the economy, except transportation. Compared to 1992, 1993 output posted gains in manufacturing, commercial construction, communications, and retail trade. Despite an apparent pickup in privately financed home building early this year, residential construction remains mired in recession (unit output down by 35 percent in 1993 compared to 1992). The volume of transportation services shrank in 1993, primarily owing to reduced passenger traffic. While manufacturing still dominates the Polish economy, other sectors are emerging. The communications sector has experienced the fastest growth rate. Sales of communications services were up by 11.8 percent in 1993 over 1992, and by over 18 percent in the first quarter of 1994 compared to the same period last year. However, communications at present accounts for only a fraction of GDP (1.2 percent in 1993). Agriculture contributed significantly to Poland's economic upturn in 1993 by posting an output gain of 1.2 percent after a drought-induced decline of nearly 12 percent in 1992. Inefficient and undercapitalized, this sector still accounts for only 7 percent of GDP, while employing almost one quarter of the Polish labor force. Manufacturing contributed most to economic growth in 1993, accounting for 40 percent of GDP. Industrial sales last year grew by 7.4 percent, but still lag behind 1989. Industries showing the highest real growth rates included electrical engineering, transportation, apparel, food, chemicals, paper and wood. C. Government Role in the Economy In the September 1993 parliamentary elections, the Social Democratic Alliance (SLD - successor to the communist party) and the Polish Peasant Party (PSL - a "coalition" partner of the communist-era regime) won a majority of parliamentary seats. The two parties formed a coalition, with PSL head Waldemar Pawlak as Poland's new prime minister. Despite initial western concerns over the economic policies of this new government, the Pawlak government has remained largely faithful to the principles of market economic reform. The new government has kept Poland's economic policies within International Monetary Fund (IMF) guidelines and successfully completed a one-year IMF standby arrangement in March 1994. In March, the Polish parliament adopted a 1994 budget projecting a deficit equivalent to 4.1 percent of GDP and reached a favorable debt rescheduling accord with the London Club of commercial bank creditors that ultimately will reduce Poland's $13 billion in commercial debt by almost half. In June, the government approved a new long-term economic policy -- "Strategy for Poland." Over the next three years, the "strategy" proposes policies that seek high growth rates, increased foreign and domestic investment, shrinking inflation, and reduced unemployment in an environment of fiscal discipline and continued economic restructuring. The Polish government also is moving ahead with the privatization of state-owned industries. In 1993, fifty-five (55) companies were sold to private investors, and 199 were leased, usually to company managers and workers. In 1993, proceeds from privatizations totaled around $225 million. Nevertheless over 5,000 state-owned enterprises await privatization. Expectations run high for the mass privatization program, which is scheduled to begin in late 1994. Under this plan, private management firms will take management control of 460 medium-sized companies grouped in 15 national investment funds, shares in which will be sold to the public for a nominal fee. The reorganization of Poland's banking sector also continues, with a third major state commercial bank scheduled for privatization by the end of 1994. D. Balance of Payments Situation While still in deficit, the Polish balance of payments shows signs of improvement. The current account deficit jumped from $270 million at the end of 1992 to $2.3 billion by the end of 1993, but this deficit is structured in ways that affords positive interpretation. The merchandise trade deficit is the main factor, while trade in services and investment flows tend to show a surplus. While exports grew over 7 percent in 1993, import growth exceeded 18 percent, and in the first quarter of 1994, imports are running about 10 percent ahead of exports. However, the sharp rise in imports may be attributable to a resurgence of capital spending in industry. The government expects exports to rebound as a share of GDP from a recent low of 14 percent in 1993 (compared to 23 percent in 1990) to over 16 percent this year. Net capital inflows are also healthy, showing surpluses of over $3 billion. These factors moderate the balance of payments deficit and suggest potential for future growth. The developed West now dominates Poland's merchandise trade. Poland conducts over 50 percent of its total trade with the European Union (EU), of which Germany alone accounts for half. Approximately 38 percent (about $1.8 billion) of the Polish trade deficit in 1993 was attributable to EU trade. Other OECD countries contributed to most of the remaining imbalance. The country's trade imbalance with the EU is somewhat offset by private purchases made by EU visitors (mostly Germans) which may amount to between $1 billion to $4 billion per year. Poland's balance of payments pattern remained relatively constant into the first quarter of 1994. At the end of April, the current account was $393 million in the red. The current account deficit stems mainly from merchandise trade losses and foreign debt payments, while other current account components such as services, net investment, and other capital inflows showed surpluses. E. Trade and Investment Barriers Following several years of pressure from Western countries, the Polish government in 1994 passed a law on copyrights to combat wide-spread piracy in Poland, especially of video and sound recordings. The lack of such a law was a major barrier to Western investment in Poland. The passage of this law was also instrumental in allowing a 1990 treaty on trade and economic relations between Poland and the United States to take effect. This treaty provides investment guarantees for U.S. investors in Poland, protects intellectual property rights, and allows free transfer of profits from Poland. The Pawlak government is also moving ahead on a law to compensate property owners whose property was seized by the communist government. The government law would guarantee the rights of current investors by guaranteeing that any property sold by the government to a third party will not be returned to the original owner. F. Labor Force In 1993, the number of people employed in Poland stopped shrinking for the first time since 1989. Today some 15 million are employed in the national economy. Employment has grown in the sectors of clothing, fuels, power, timber and food, as well as in finance and insurance. At the same time, there are declines in employment in the non-ferrous metals industry, construction, precision engineering, leather manufacturing and road transport. Employment also declined in public sector agriculture, housing management and health care. Overall employment in the public sector continues to shrink as the private sector in Poland grows. Despite this stabilization in employment, unemployment in Poland continued to rise in 1993, although in 1994 it slowed and even declined slightly. At the end of 1993, some 2.9 million Poles (including 1.5 million women) were unemployed, reflecting a rate of approximately 15.7 percent. In January 1994, unemployment in Poland rose to just over 16 percent but declined to 15.5 percent in May. The impact of unemployment varies dramatically depending upon the region of the country. Unemployment remains worst in the northeast and in some northwestern areas (where unemployment exceeds 25 percent), while the cities of Warsaw, Poznan and Katowice have unemployment rates of 8-10 percent. In 1993, Poland spent 27 trillion zlotys (over $1 billion) on unemployment benefits. Most of these funds go to income replacement rather than to "active" programs to combat unemployment, such as retraining or small-business start-up loans. Real wages in Poland fell for four consecutive years, but began rising slowly during the first half of 1994. A new wage control law will limit future public sector (including state owned industries) wage increases. At the end of the first quarter of 1994, the average wage in Poland was approximately $225 per month. G. Major Local and Third Country Competition There is tremendous unrealized demand for Western goods in Poland which creates ample opportunity for a broad range of exports by large, medium, and small American producers. Local production in most best prospect export categories is generally low, though more firms start-up new manufacturing operations each year. However, U.S. exporters across-the- board face strong competition from European producers. In certain sectors, such as computers and consumer electronics, competition from companies in Asia and Southeast Asia is also present. Geography is one natural reason there are currently more EU products on the Polish market than American. Locating, purchasing and importing European products is quicker and easier for Polish firms. European companies also travel more and spend more time, at less cost, promoting their products in Poland than U.S. firms. European satellite broadcasts in Poland breed familiarity with European products. However, this situation is made worse by a tariff structure that makes imports of U.S. products into Poland immediately more expensive than similar European products. This is a result of the March 1992 implementation of trade provisions within an association agreement between Poland and the European Union (signed in December 1991), where many rates on EU imports were lowered or eliminated. In 1993, Poland's trade with the EU represented 63 percent of its exports and 57 percent of its overall imports, with Germany the leading trade partner. H. Infrastructure Situation: Goods/Services Distribution U.S. businesses currently have to deal with communications, banking, accounting, and distribution systems that are still developing in Poland. Companies establishing branch offices find office space and housing in short supply and very expensive. Businesses in Poland suffer from a lack of personnel with western management training and experience. Former centrally controlled and managed enterprises have been slow to adapt to modern business thinking and technique. Skilled labor is abundantly available, however. Poland's banking system is being restructured, and banks now set their own lending and deposit rates. In general, however, banking and accounting services are still inefficient by world standards. Interest rates on loans to Polish businesses are relatively high, but are becoming competitive. The U.S. banks and accounting firms that currently operate in Warsaw have greatly helped to alleviate these problems. The zloty, though internally convertible, is not expected to be internationally convertible until 1996. Redenomination of the zloty eliminating four zeros will take place in January 1995. The road and rail networks in Poland are relatively extensive, and Poland's air and sea ports are structurally adequate for receiving and shipping cargo. However, all are in need of expansion and modernization to facilitate the growth of Poland's economy. Airport cargo modernization is underway, and a restructuring of the rail system is under examination. Rural road travel is difficult and particularly dangerous at night in Poland. There is a lack of adequate (four-lane) highways between major cities capable of carrying the increased volume of trucks necessary to the growth of Poland's distribution systems. An extensive road network upgrade is planned over the next 10-15 years. The slow rate of modernization of Poland's infrastructure, the lack of available management personnel knowledgeable in foreign languages and skilled in Western commercial and management techniques, contradictory decisions on the part of governmental agencies and a lack of follow- through on decisions that are made, bank credit restrictions, unreliable and arbitrary interpretations of customs regulations, limitations on the purchase of real estate by foreigners and limitations on tax breaks, the prohibition of foreign currency bank accounts by companies with foreign capital, unattractive amortization rates, and double taxing of group insurance premiums are issues of concern for the U.S. business community in Poland. I. Major Infrastructure Projects Underway Roads top the list of Polish infra-structural priorities in the coming decade. Major institutional lenders are already involved in motorway, road, toll road, and bridge development projects. Poland has received a $150 million loan from the World Bank to finance a program for the modernization of Poland's main network of roads and bridges. The European Bank for Reconstruction and Development (EBRD) has approved a loan of $35 million for upgrades and improvements of specific sections of roads and toll roads. Poland has developed a program for the construction and financing of new motorways, at a total cost of about $6 billion, that extends through the year 2007 and includes major north-south and east-west highways. Railways are also being modernized and refurbished across Poland. This includes track maintenance equipment, telecommunication and power supplies, and platform and bridge repairs. Poland's current airport network consists of eight major airports. Development plans through the year 2000 include: installation of navigation lighting systems and meteorological equipment at almost all of the airports; modernization or repavement of runways and aprons for many of the airports; and modernization of emergency equipment and winter maintenance equipment throughout the airport system. All of these projects offer excellent opportunities for U.S. companies. Increasing environmental awareness and the introduction of significant changes in environmental legislation in Poland have resulted in increased demand for capital equipment to reduce pollution across all sectors of heavy industry in Poland. Air pollution, water, and waste-water treatment are the major areas of focus. Privatization of Poland's oil and gas sector and the heat and electric power industry in Poland offer new opportunities for major project involvement. Other infra-structural areas going through restructuring and/or privatization that offer good opportunities for U.S. manufacturers or service firms include telecommunications, banks, tourism, housing and hotel development.