Abstract

Since the outset of the reform effort in 1990, ital Poland has made great strides in expanding its trade in goods with the rest of the world.1 Poland has at the same time experienced a remarkable reorientation of its trade from countries of the former Council of Mutual Economic Assistance (CMEA) to those of western Europe, especially Germany. A measure of this success is the doubling of the convertible currency trade (the sum of exports and imports) between 1989 and 1993 (Appendix Tables Al4 and A15); this is equivalent to an increase of over 20.2 percentage points of GDP, from 16.9 percent to 37.1 percent of GDP (purchasing power parity basis with 1991 as base). The corresponding data for total trade (including transferable ruble trade and trade under bilateral agreements) indicates an increase of 13.1 percentage points of GDP, indicating not only a reorientation, but an expansion, of trade.2

Since the outset of the reform effort in 1990, ital Poland has made great strides in expanding its trade in goods with the rest of the world.1 Poland has at the same time experienced a remarkable reorientation of its trade from countries of the former Council of Mutual Economic Assistance (CMEA) to those of western Europe, especially Germany. A measure of this success is the doubling of the convertible currency trade (the sum of exports and imports) between 1989 and 1993 (Appendix Tables Al4 and A15); this is equivalent to an increase of over 20.2 percentage points of GDP, from 16.9 percent to 37.1 percent of GDP (purchasing power parity basis with 1991 as base). The corresponding data for total trade (including transferable ruble trade and trade under bilateral agreements) indicates an increase of 13.1 percentage points of GDP, indicating not only a reorientation, but an expansion, of trade.2

In contrast to the impressive opening of its economy to trade in goods, Poland has, to date, been relatively unsuccessful in attracting foreign capital. Foreign capital has been deterred, among other things, by the heavy debt burden remaining from the prereform period, the delays in normalizing relations with commercial bank creditors, and the slower than anticipated progress in implementing structural reforms, including privatization. Despite the restructuring of the largest component of the debt, these circumstances have required Poland to run current account surpluses (adjusted for unrecorded trade and on a cash basis, i.e., excluding interest arrears) during a period of development when the use of external savings could typically have been expected to benefit the financing of the reform process; the exception to this pattern occurred in 1991, when the temporary suspension of import tariffs led to an import boom.3 Over the past four years, the current account surpluses have been of sufficient magnitude to compensate for capital account deficits (or small surpluses) and to build up international reserves in anticipation of the heavy debt-service schedule forthcoming in the next decade (Table 6-1). In fact, gross reserves increased from $7.8 billion at end-1991 to $10.2 billion at end-1993, equivalent to about 21 percent of the total external debt. At end-1993, gross official reserves were the equivalent of 3.0 months of imports of goods and nonfactor services.

Table 6-1.

Summary Balance of Payments in Convertible Currencies1

(In millions of U.S. dollars)

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Adjusted for unrecorded trade and on a cash basis.

Poland’s ability to regain access to the international capital markets will be tested only after the normalization of relations with creditors, especially its international bank creditors. As Poland reached an agreement in principle with the Bank Advisory Committee (BAC) representing its bank creditors on March 10, 1994, this constraint should be eliminated before end–1994. Nevertheless, modest examples of spontaneous access to capital emerged in 1993; specifically, sham increases, albeit from a low base, in medium–term suppliers’ credits and foreign direct investments—the traditional leading indicators of international investor interest.

Poland’s successful trade expansion has resulted in a balance of payments dominated by developments in the trade accounts: gross annual trade flows of about $30 billion exceed the sum of all other gross above-the-line flows by a factor of 2.5. This asymmetry elevates the importance of trade policy in Poland and at the same time raises concerns about policies to attract foreign capital to Poland. A critical component of Poland’s continued growth and transformation to a market economy will be sustaining its export growth, especially in its main export market, the European Union (EU). On the capital account, policies must restore foreign investors’ confidence in the Polish economy to facilitate the financing of the reform process. This section examines the recent developments in Poland’s policies regarding trade and foreign capital and their effects on the structure and growth of trade and capital flows, respectively. It concludes that the recent export growth is sustainable, especially in the short run. However, import growth may be finance constrained. Regarding the capital account, along with the envisaged normalization of relations with banks, the first indications of spontaneous capital flows can be seen, suggesting that these constraints may be easing.

Developments in Trade Policy and the Trade Accounts

Trade Policy

As recounted elsewhere in this paper, Poland has undertaken an ambitious and comprehensive reform program with the objective of transforming itself into a market-oriented economy. The reform program has resulted in a relatively quick stabilization of the macroeconomy that has included progress with structural reform and a recent return to positive growth. These factors have created a more stable environment for the expansion of trade. Within the overall strategy, the reform of the exchange and trade systems at the outset of the transformation program played the major role by importing foreign prices to provide efficiency guideposts to the transforming economy, and thereafter to provide competition to domestic producers.

The reform process began in 1990 when Poland abolished the state monopoly and administrative management of foreign trade; the trade system was largely liberalized and made transparent, with customs duties becoming the main trade policy instrument. Initially, Poland used trade policy as an instrument to combat near hyperinflation in 1990–91. Thus, most nontariff restrictions were eliminated (January 1990) and customs duties were suspended on 4,500 import items (June 1990)—with the average applied tariff being only 5.5 percent—so as to use import prices as transmitters of world market prices (Appendix Table A16; see also A17). Thereafter, to support the budget and the balance of payments, the tariff suspension was withdrawn (August 1991)—and the average unweighted most favored nation (MFN) tariff rose to 18.4 percent (13 percent on a 1991 trade-weighted basis)—and was followed by the implementation of an across-the-board 6 percent import surcharge (December 1992), from which only alcoholic beverages, tobacco products, fuels, and automobiles were exempted.

To assist the transformation process, the EU (then the EC) improved access to its markets, initially through a bilateral trade and cooperation agreement (September 1989) that provided for the phasing out of all selective quantitative restrictions (QRs) over a ten-year period and granted MFN status, including the more favorable Generalized System of Preferences (GSP) treatment for some goods (January 1990). In December 1991, the EC opened further its markets to Poland, when Association Agreements with Poland, Hungary, and Czechoslovakia were signed. These agreements aimed at the progressive economic integration with the EU through a wide range of economic and financial reforms (e.g., regarding the movement of capital and labor, the rules of competition, and the harmonization of economic and financial laws to community legislation).

The agreement contains provisions for immediate and progressive trade liberalization that are asymmetric in nature; the agreed trade liberalization would be introduced over five years by the EC and over seven years by Poland. At the time the agreement entered into force (on an interim basis for the trade-related aspects from March 1992 and formally—in its totality—from February 1994), most tariff and all quantitative restrictions imposed by the EU on industrial goods (except cars) were eliminated (chemicals, fertilizers, glass, leather, and automobiles face nonbinding ceilings that if exceeded could lead to increased duties upon request of the domestic producer).4 However, trade in textiles, coal and steel, and agricultural products is covered by special protocols that are in general more restrictive.5 In addition, the Association Agreement contains safeguard provisions, which permit the implementation of protectionist measures in several cases—for example, infant industries, industries undergoing restructuring, and industries facing important social problems and requiring compensation for anticompetitive practices or subsidies. Furthermore, antidumping actions are permitted in accordance with the GATT articles.

The main Polish exports facing barriers following the implementation of the agreement, according to the authorities, are agricultural products—the fruit sector, vegetables, and meat products—with the main constraints taking the form of minimum prices, variable levies, and transportation conditions for live animals. Quotas have been considered a problem only in some categories of the textile industry. Of the 89 overall ceilings faced by Polish goods in 1992, 42 were breached, but levies were only imposed in 5 cases. Of the 13 quotas facing Poland in 1992, only 6 were used. Finally, the alleged frequent resort to, and the future potential reliance on, the safeguard clauses and antidumping action were also cited as barriers to trade expansion as well as a deterrent to foreign direct investment (Appendix Table A18). (The Association Agreement also impedes foreign direct investment through its “rules of origin” clause. It requires that at least 60 percent of the value of a product be created in Poland for it to be eligible for the favorable treatment permitted under the agreement.)

Similar agreements were concluded between Poland and European Free Trade Association (EFTA, signed December 1992 and entered into force on an interim basis from November 1993) and with Czechoslovakia and Hungary (signed December 1992 and entered into force on an interim basis from March 1993). The agreement with EFTA parallels from the initial (often low) base over five years, in many ways the EC Association Agreement; there is an asymmetric implementation of liberalization and the agreement contains safeguard clauses similar to those in the EU agreement. It could, however, be considered more liberal overall than the EC Agreement. Tariffs and QRs are eliminated for all industrial goods (except textiles and metallurgical products, mainly steel). There is completely free trade in fish products. Processed agricultural products receive the same treatment granted to EC goods before the introduction of the European Economic Area (EEA); other agricultural products are not covered by the agreement.

The Central European Free Trade Agreement (CEFTA) involves symmetric trade liberalization, with the liberalization of trade in “sensitive” products (textiles, steel, and agriculture) undertaken over eight years and in “normal” goods over three to four years. As in the other agreements, exceptions remain; for example, duties on agricultural products will be eliminated over five years, but QRs will remain in force indefinitely.6

For the renegotiation of their accession protocol, the Poles have presented to the GATT a tariff schedule that they would be prepared to bind, that is, set its upper limits. The major remaining stumbling block to the conclusion of the negotiations apparently is the bilateral negotiations with a major industrial country. It is hoped that the Polish proposal will be accepted before the end of 1994.

In June 1993, in response to criticism of the remaining restrictive aspects of its association agreements with the Czech Republic, Hungary, Poland, and Slovakia—especially the reproach that under the agreement the EU is opening access most slowly to markets in which CEFTA countries have the highest export potential—the European Council at its Copenhagen meeting decided unilaterally to improve market access even further and to speed up the reduction of import duties. Specifically, the Copenhagen amendment to the association agreement brought forward by two years the proposed lowering of the weighted average Community tariff on imports from 4 percent to 2 percent, increased the annual expansion in the remaining ceilings for industrial products (except textiles and clothing) by 10 percentage points, eliminated duties on steel and textiles and clothing a year earlier than envisaged (in 1996), and advanced the existing schedule for the liberalization of agricultural products by six months. The most important remaining restrictions would appear to be the quotas on textiles, the nontariff barriers (NTBs) on agricultural products, and the threat of resorting to the safeguard provisions or antidumping actions (see below for an analysis of their effectiveness).

In contrast to the move by the EU to open further access to their markets, Poland introduced a somewhat more protective trade regime, especially as concerns agriculture. In July 1993, the tariff structure was revised with the objective of charging lower duties on imported raw materials and semifinished products and increasing it on finished products and those products produced in Poland, thus raising the effective rate of protection, though no precise estimates are available. While the average trade-weighted tariff including tariff quotas and tariff suspensions (weighted by eight months of 1993 trade) fell by about 1 percent, to 11.6 percent, the average rate for agricultural products rose by about 1 percent, to 18.2 percent, and the average rate for industrial products fell by about 1 percent, to 10.7 percent. (This was the first major change to the tariff schedule since 1991, though in 1992 duties had been raised on several goods, including motor vehicles, cigarettes, consumer electronics, and sugar.) Effective protection was likely further increased in July 1993 owing to increased recourse to preferential (low or duty-free) tariff quotas for inputs: such tariff quotas cover 14 groups of goods, with the major category being electronic goods (up to $800 million). Furthermore, a tax on sugar content was introduced, equal to 0.0017 ECUs per 10 grams of sugar per kilogram of product, and licensing requirements on the imports of chicken meat, milk products, and wine were introduced (Appendix Table Al9). Also of concern is the introduction of variable import levies on several agricultural products, which the Government introduced in June 1994.

The Government has also adopted an export promotion program that they expect to implement in 1994. This program includes tax and financial incentives, and the provision of guarantees and insurance. Tax incentives consist of VAT refunds for export products, income tax relief for investors involved in export promotion, and property tax relief for companies investing in exports. Financial relief will be provided by the National Bank of Poland (NBP) through attractive refinance credits to institutions financing exports. Finally, the Export Credit Insurance Corporation (KUKE) will be recapitalized ($15 million) and an additional fund will be established for the provision of export insurance against noncommercial risk.

Exchange System

The exchange system was liberalized and the exchange rate set to a competitive level at the outset of the reform program (see Section IV for a detailed discussion of exchange rate policy). The multiple exchange rates were unified (January 1990), and many restrictions on the availability of foreign exchange were eliminated (1990–91). To maintain competitiveness, the official exchange rate was devalued and pegged to the U.S. dollar (January 1990 to May 1991) and subsequently followed a crawling peg to a basket of currencies (October 1991). Most importantly, the parallel market was legalized (March 1989), with residents allowed to transact freely in this so-called kantor (small foreign exchange dealer) market where the exchange rate is determined flexibly by market conditions, de facto resulting in full currency convertibility for this segment of the market.

Trade Accounts

The major external impetus to the change in the structure of Poland’s economy was the collapse of CMEA trade, resulting from its conversion to world market prices and settlement in hard currencies (January 1, 1991). Moreover, parallel reform efforts in Poland’s CMEA partners—due in great part to the collapse in CMEA trade—magnified the collapse in trade. The price shock resulted in a deterioration in Poland’s interregional terms of trade of about 30 percent in 1991, with the price of critical petroleum imports from the countries of the former Soviet Union estimated to have increased by 118 percent. Though Poland was fortunate to have been the CMEA country with the smallest concentration of trade to the CMEA—accounting for about a third of its total trade in 1989—trade with the CMEA countries (convertible and transferable ruble exports plus imports) fell precipitously, from around $9 billion in 1989 to $4.0 billion in 1991 and further to $2.3 billion in 1993, and accounted for only 7.8 percent of total trade in 1993, with Russia accounting for over half of this remainder. The decline in volume terms—to be treated cautiously owing to the non-market character of CMEA prices—was even more pronounced; exports declined by two-thirds and imports by over 70 percent during 1990–91 and an additional 10 percent and 32 percent, respectively, during 1992–93 (Table 6–2).

This radical change in trading practices led to a dramatic increase in trade with non-CMEA countries; non-CMEA exports increased by 61 percent and imports by 53 percent in 1990–91 and a further 13 percent and 40 percent, respectively, in 1992–93. As a result, the EU has become Poland’s largest trading partner, with $8.0 billion of exports (58.7 percent of total exports) and $9.2 billion of imports (58.2 percent of total imports), with the share to Germany in 1993 accounting for 32.2 percent of total exports and 29.0 percent of total imports (excluding unrecorded trade for which the bulk is cross-border trade with Germany; see AppendixTable A20). Trade with industrial countries excluding those with which Poland has signed regional trade agreements (United States, Japan, and Canada) does not appear to have been affected by the creation of this regional trading block, as both exports and imports to these countries have increased at a faster pace than to the regional partners during 1991–93. (Trade with EFTA countries–Poland’s second-largest trading group–accounted for 13.8 percent of total exports and 15.3 percent of total imports, while trade with CEFTA countries accounted for 3.2 percent of exports and 2.7 percent of imports.)

Table 6-2.

Changes in the Value, Price, and Volume of Exports and Imports1

(In percent)

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Sources: Polish authorities; and IMF staff estimates.

Based on payments basis data: unit prices for 1991 based on invoice data, for 1992 and 1993 from the IMF. World Economic Outlook, various issues.

up to 1990, Council of Mutual Economic Assistance (CMEA) trade covers ruble trade only. Thereafter, trade with CMEA partners under all arrangements have been taken into account, and changes in value and price relate to magnitudes expressed in U.S. dollars, with transferable ruble transactions converted at the commercial cross rates.

Includes transactions under bilateral payments agreements.

A critical question for the success of the reform process is the sustainability of Poland’s recent export performance. In addition to the requisite structural reform, the answer also hinges on (i) the extent to which the recent export developments reflect trade diversion—which by definition should be of limited duration—or trade creation, (ii) the sensitivity of exports to exogenous factors, especially partner country growth and foreign protectionism, and (iii) the competitiveness of exports.

Both the overall growth of exports and the transformation of their composition provide evidence supporting the hypotheses that the recent export growth has been due to trade creation as well as the obvious above-described trade redirection. Based on the broadest of indicators, Poland would appear to have expanded its exports over the first four years of the transition despite the reorientation of export markets from east to west. The value of exports (convertible and nonconvertible currency) increased by 14 percent in the face of a cumulative deterioration of export unit values and output; the ratio of exports to GDP (1991 PPP basis) has expanded from 12 percent in 1989 to 17 percent in 1993.

Moreover, though the current structure of exports, for the main, still reflects the inheritance from the old CMEA trade regime, it also contains evidence that the structure of trade is shifting toward new products. In a somewhat simplified version of developments under the previous trade structure, energy and raw materials were imported from the CMEA countries to produce low value added and capital-intensive manufactured goods for export back to the CMEA countries, with most trade occurring bilaterally with the former Soviet Union; other CMEA countries produced goods that were close substitutes for Polish exports.

A comparison of the composition of exports in 1988 to that in 1992 reveals a relatively unchanged structure; approximately 50 percent manufactured goods, some 10–15 percent agriculture products, 10 percent mineral fuels (mostly coal), and close to 10 percent plastics (Appendix Table A21). However, within the large category of manufacturing, one can ascertain a shift away from machinery and transportation equipment toward miscellaneous and lighter manufactured products. This shift has moved the structure of exports to parallel the one that existed between Poland and developed (industrial) countries prior to 1989. Though the analysis is hampered by the aggregation of the data, it could be interpreted as a change in the composition away from low-quality products shipped to the captive market of the east toward products that are competitive in western markets (see Kaminski (1993)), Interestingly, trade with the former socialist countries (for the most part consisting of the CMEA countries, most importantly Russia) has shifted toward agricultural products from industrial products.

The top exports through the first nine months of 1993 contain further encouraging signs; besides traditional exports such as coal (10 percent), iron and steel (7 percent), refined copper products (4 percent, mostly cables), wood products (4 percent), and ships (5 percent), many nontraditional products were also high on the list, such as cars (5 percent, mostly the Cinquecento automobiles produced by a joint venture with Fiat), garments (5 percent), and furniture (3 percent).

There are other, indirect indications of trade creation. First, the private sector has increased its share of both exports and imports, from 21.9 percent and 49.9 percent in 1991 to 40.8 percent and 57.6 percent, respectively, in the first half of 1993.7 Second, Germany’s customs data indicate a surge of new types of products from Poland, 3,500 in 1993 versus 1,500 in 1992, with the most common new items consisting of such high-quality products as instruments, measuring equipment, and chemical and wood products. Third, customs figures fail to capture much of the booming border trade; that is, day-trippers moving in both directions. Border surveys have indicated that gross unrecorded exports to Germany were at least DM 3 billion in 1993, consisting mostly of fuel, food items, and clothing. However, such trade could be substantially larger than the amount indicated by the survey (potentially more than double). This is supported by the fact that net purchases of foreign exchange by Polish commercial banks from kantors amounted to DM 3 billion in 1993 and that these kantors are concentrated near the German border. (Estimates of unrecorded trade are understandably inexact. The use of net purchases from the kantor market as a proxy obviously underestimates the gross flows.) If one adds net purchases and sales from the kantor market to exports—as a proxy for unrecorded trade—export volume growth to non-CMEA countries increased to 15.4 percent from 5.5 percent in 1992 and to 11.7 percent from 7.3 percent in 1993.

However, the structure of trade also reveals potential limitations to sustained growth. An admittedly rudimentary classification of exports by their factor intensity reveals that during 1991–93, the share of unskilled-labor-intensive products (for example, textiles) increased by almost 10 percentage points (Appendix Table A22).8 If the relative expansion of such exports has been motivated by the recent decline of real wages, future growth prospects could be hampered by the unlikely continuation of wage compression. In addition, natural-resource-intensive exports continue to represent the largest share of exports, an estimated 50 percent in 1991 and 1992. Such exports are traditionally low-value goods that are sensitive to the business cycle in partner countries, a premise supported by the close to 10 percentage point drop in the export share of such goods in 1993 (most likely in the first half of the year) in response to the economic slowdown in Europe, and especially Germany (Chart 6-1).9 On a positive note, the analysis by factor intensity also indicates that capital-intensive, technologically advanced, and high-skilled-labor exports increased their share by 3.3 percent.

Chart 6-1.

Export and Import Volumes

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Sources: Polish authorities; and IMF, International Financial Statistics and staff computations.

Of some concern for future export growth is the extent to which Poland’s main export items are those which have not been fully liberalized by the EU; in fact, some 40–50 percent of Poland’s exports still face some form of trade barriers. Though Poland has recently had continuous trade deficits with the EU—peaking at $1.3 billion in 1993—the recent trade statistics have not indicated that exports in sensitive areas—especially for industrial products—have grown significantly less rapidly than the non-sensitive exports (Table 6–3).10 The trade deficit appears to correspond to a geographically broad-based import expansion. The main exceptions appear to be the coal, chemical, and agricultural sectors—where the slower growth may also be explained by excess supply in the EU. The decrease in the share of chemicals is partly based on the decline of such exports to Russia.

Table 6-3.

Growth of Exports of Products Classified as Sensitive Under the Polish-EU Association Agreement

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Source: Polish authorities.

For 1993, data for first nine months only.

In view of the use of the exchange rate as a nominal anchor, the potential loss in competitiveness could also jeopardize future export growth. The ultimate proof regarding a change in competitiveness should be commensurate changes in market share. Under this interpretation of competitiveness, Poland would not appear to have suffered any loss, as exports have managed to penetrate non-CMEA trading partners’ markets by 8 percent during 1993, the year export growth is least affected by the reorientation-of-trade effect; including unrecorded exports, market penetration would increase to over 12 percent.

Contrary to the mostly reassuring analysis regarding the short-term prospects for export growth, especially as import demand in Poland’s major trading partners seems to be recovering, the outlook for imports is difficult to forecast based on recent, erratic performance. Poland’s non-CMEA imports have exhibited large swings. Both in 1991 and 1993, import growth was explosive, increasing in volume terms by 34 percent and 32 percent respectively, following periods of lower growth in 1990 (11 percent) and 1992 (6 percent). The 1991 performance was related to the tariff suspension during June 1990–August 1991, when import volumes increased by some 200 percent. The 1993 episode coincided with the rebound of real GDP growth, starting from the second half of 1992 and continuing through the end of 1993. The elasticity of imports relative to real income during this period has also been erratic; a negative number in 1989–91, followed by an outcome of 2 in 1992, and jumping to over 5 in 1993, with the in-year and non-CMEA volatility being even higher. Though the 1993 outcome can be partly explained by the balance between demand and supply and uncertainties in policies, especially exchange rate and taxation policies (that is, the introduction of the VAT), the fact that the import growth has been spread relatively evenly across products and across expenditure categories indicates that demand was not simply consumption based (Appendix Table A23).11

A medium-term analysis based on realistic export growth rates, increasing access to international capital markets, and continued implementation of macroeconomic and structural policies, as outlined elsewhere in this paper, suggests that if the underlying elasticity of imports relative to income continues to exceed values of the order of 1.1 and growth continues at the recently observed pace, then the equilibrium real exchange rate could be threatened, since import growth would push Poland against a balance of payments constraint. Unfortunately, the past unpredictability of imports does not permit much insight into the underlying behavioral relationships driving import demand.

Developments in the Capital Account

Poland’s medium-term growth prospects depend on its ability to access the international capital markets to finance the requisite investments. Although the capital account (cash basis, adjusted for unrecorded trade) was in deficit during 1991–92 and in a small surplus in 1993, implying that the policies to attract foreign capital are not yet fully effective, recently there have been indications of renewed foreign investor interest, reflecting a long-gestating confidence in the Polish economy. This finding is supported by developments in the secondary market price for Poland’s nonperforming medium- and long-term debt to commercial banks (DDRA) that, among other things, reflects foreign investor sentiments. It has been on a relatively steady upward trend since the critical 1992 budget was passed (Chart 6-2). (The major exception to the upward trend is a recent market correction for the overshooting that resulted from Bulgaria reaching an agreement in principle with its Bank Advisory Committee on a restructuring agreement, which was initially interpreted as an upper bound for the amount of debt reduction that Poland could achieve.) This subsection describes the recent developments in the capital account, emphasizing the specific areas where there has been evidence of spontaneous access to international capital, and concludes with a discussion of the major constraints to more substantial capital inflows.

The major source of capital flows into Poland has been international financial institutions, especially the World Bank.’12 Beginning in 1991, they had disbursed over $1.2 billion by end-1993, with the World Bank accounting for over 90 percent of the total and the European Investment Bank the bulk of the remainder. The resources have been used mostly to finance public sector projects, but the World Bank has also disbursed close to $0.5 billion in balance of payments support. The institutions’ natural lead role in providing resources to Poland have resulted in Poland’s liabilities to them—including the International Monetary Fund—accounting for 4 percent of the total debt stock and close to 90 percent of the new (post-1990) debt stock; the resulting debt–service payments account for 7.4 percent of the debt service (Table 6-4 and Appendix Tables A24, A25). However, as the reform process continues, the exposure of the international financial institutions should begin to stabilize and eventually decline, relinquishing external financing to other creditors.

Chart 6-2.

Poland’s Nonperforming Medium- and Long-Term Debt to Commercial Banks

ch06ct02
Source: Salomon Brothers.1 January 1994 only.

The other major source of medium-term capital inflows has been suppliers of commercial credits of a relative short maturity (2-3 years) and very high spreads over LIBOR, for the most part linked to trade. During the three-year period 1991–93, such inflows have increased from $0.4 billion to $0.6 billion per year, almost all unguaranteed. 13 They may increase further in the near future as most foreign export credit rating agencies placed Poland back on medium-term cover in early 1993 and subsequently relaxed their annual ceilings in the face of strong demand. However, the relatively shorter-term maturity of these flows has begun to diminish the net impact of these flows, as amortization payments increased strikingly in 1993 to $0.9 million, compared with $0.3 billion in 1991.

Table 6–4.

External Debt

(In millions of U.S. dollars)

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Sources: Polish authorities: and IMF staff compilations.

Additional evidence of a return in foreign investor confidence in Poland is the reported extension of short-term trade credit (e.g., three months’ duration) to Polish companies. Market participants report that as Polish companies build up a proven payments record, an increasing number of western companies, which previously only exported to Poland on a prepayment basis, are extending open terms to local clients. Typical arrangements for the lowest-risk customers have switched to cash against documents or payment of a portion (such as 30 percent of the contract in advance and the remainder at the time of delivery). The spreads over LIBOR on these transactions’ yields have been exceptionally high, reportedly averaging some 200 basis points. (Polish enterprises reportedly prefer zloty to foreign currency credits, as interest costs are tax deductible, while foreign exchange losses are not. However, Polish banks’ ability to finance large quantities of imports is constrained, as total capitalization is estimated at about $2 billion and regulations limit a bank’s exposure to a single customer to 10 percent of its capital.)

Following the pattern in other developing countries, interest in foreign direct investment (FDI) has preceded inflows of most other spontaneous private capital flows. FDI, particularly as regards commitments, has risen rapidly over the past year, raising hopes for the future of more such capital inflows and the concomitant transfer of technology. Through January 1994, foreign investors had reportedly invested $3.0 billion and made commitments for an additional $4.6 billion, amounts that approach investments completed in Hungary.14 To date, the bulk of FDI has been linked to joint ventures, since they are extended favorable treatment in the relevant legislation. One of the largest, and most successful, cases of a joint venture operation is the $2 billion commitment by Fiat to produce the Cinquecento model, though only $250 million was disbursed as of end-1993. Future prospects for FDI would be greatly enhanced by a strengthening of the recent privatization process (see Section V, “The Supply Response”); for example, the sale of 25.9 percent of Bank Slaski to ING Bank raised $57 million.

A survey commissioned by PAIZ (Warsaw) and completed in August 1993 indicated that foreign investors have been attracted to Poland by two main factors, the low-cost labor and the large domestic market, including Poland’s proximity to the potentially large markets of the countries of the former Soviet Union. It also revealed that over 50 percent of the enterprises that include foreign participation are involved in export activities and that 20 percent are mainly export oriented. The most common exports are clothing and metal products, and the main destinations are the countries from which the investment capital originated. A commodity breakdown of FDI by sector supports the survey’s results; they indicate investor preferences are concentrated mainly in industrial goods, including several top exports, for example, electrical machinery, cars, and chemicals (Appendix Table A26).

Foreign investors listed the major constraints to FDI to be the uncertainty regarding the implementation of regulations and practices limiting competition. Importantly, they did not attribute major responsibility to central government policy, which liberalized foreign direct investment in July 1991. Under the new legislation, registration of such investment was abolished (with the exception of some priority sectors) and repatriation profit taxation simplified. The limits on the transfer of profits were lifted, and it was established that invested capital could be repatriated freely for joint ventures and investments in shares of Polish companies. In addition, investors were granted tax benefits for new joint ventures depending on the size of their investment (larger than ECU 2 million per year) and the geographical region (those facing acute structural unemployment).

Other nascent indications that Poland may be receiving access to some new forms of spontaneous capital flows are the foreign portfolio investments in the Warsaw Stock Exchange and the government securities market though the amounts are small. These inflows have been encouraged by regulations permitting the full repatriation of such investments, which were approved in July 1991 and July 1993, respectively. Market participants have estimated foreign participation in the WSE at around 20 percent of market capitalization, which would represent approximately $0.6 billion.15 Most foreign investment has occurred through country funds and has been spurred by the general trend in emerging markets, Poland’s well-publicized economic performance in 1993, the postponement of a capital gains tax until 1995, and the lack of a withholding tax.

Foreign participation in the government T-bill market has been reportedly placed at $250,000$500,000 per weekly auction; as foreign interest has focused on the more liquid 8-week and 13-week bills, annual foreign investment could be of the order of $3 million to $4 million. Foreign participation in government bonds has been practically nil owing to the lack of liquidity in the market and the lack of a forward market to cover the exchange rate risk.

Poland’s difficulty in attracting spontaneous private market capital flows reflects in part its large debt burden, which may act as a disincentive if investors fear taxation will need to increase in order to service the debt. Poland’s total external debt stood at $48 billion at end-1993, approximately 57 percent of GDP and 313 percent of exports of goods and nonfactor services. Debt to Paris Club and commercial bank creditors accounted for about 61 percent and 26 percent of the total external debt. The resulting debt-service ratio stood at 21.5 percent on an accrual basis and 12.1 percent on a cash basis in 1993, with the main component of the difference accounted for by the accumulation of arrears to commercial bank creditors. Poland is also accumulating arrears to Russia and to the former CMEA banks—the International Bank for Economic Cooperation (IBEC) and the International Investment Bank (IIB). A “zero” debt option, which would eliminate all mutual debts, is being negotiated with Russia, and negotiations with IBEC on the normalization of relations have progressed significantly, with similar negotiations expected with IIB.

In March 1991, the Paris Club granted Poland debt and debt-service reduction on exceptional terms for a middle-income country. This agreement reduced interest due to 20 percent of the original contractual interest until March 1994 and pushed amortization past 1994. Thereafter, it provided debt reduction equivalent to 50 percent in present value terms (taking into account the reduced interest payments in the first three years), through either debt or debt-service reduction. Since over 70 of the creditors opted for debt-service reduction, the agreement would reduce the debt service and not noticeably reduce the debt stock. In 1991–93 annual interest payments to the Paris Club were reduced on average by over $2 billion, about 13 percent of the 1991–93 average of exports of goods and nonfactor services. It should be noted, however, that the Paris Club agreement contains a backloaded amortization schedule, which will lead to heavy amortization payments—averaging $3.4 billion annually—in 2004–2008.

Poland stopped servicing its debt to commercial bank creditors in the last quarter of 1989. Since then, $7.1 billion of arrears have accumulated, of which $3.4 billion are arrears on interest payments. After a long hiatus, Poland recommenced negotiations with its commercial bank creditors on a “Brady” style debt and debt-service reduction (DDSR) operation in early 1993. At that time, Poland commenced making partial payments equivalent to 10 percent of interest due on the medium- and long-term debt (increased to 15 percent in January 1994) and reduced full service payments on the revolving trade facility to 20 percent of interest due, leaving partial payments basically unchanged.

On March 10, 1994, an agreement in principle was finally reached on a restructuring operation that is precedent-setting in several respects, especially as it grants debt reduction on interest arrears. (Previous DDSR operations had achieved debt reduction on interest arrears related only to debt allocated to the buy-back options, never on the totality of interest arrears.) The overall debt reduction will depend on the allocation among the various options, as well as interest rate movements.16 The agreement should greatly increase Poland’s access to international capital markets, since the banks had managed a relatively successful boycott of new bank credits to Poland. If the experience of other countries that have concluded Brady operations is a guide, this agreement should open the door for Poland to place securities directly in the international securities markets. In this regard its initial credit rating by the credit rating agencies such as Moody’s and Standard Poor’s will play a major role.

In view of the low amortization payments in the current debt-service schedule and the below-market interest rates on a large component of the debt, the key indicator in the short term of the debt burden is the ratio of interest to exports of goods and nonfactor services. On an accrual basis, this ratio is high: 11 percent in 1993. However, since only partial payments are being made to banks, this ratio falls to 5.5 percent on a cash basis. After a debt restructuring with commercial banks, this indicator of the debt burden would fall to somewhere in the range of 8–9 percent—implying a future interest schedule that would still be on the high side; similar ratios for the most severely indebted middle-income countries were projected to average 11.7 percent in 1992, while for middle-income countries as a whole the ratio was projected to average 7.7 percent in 1992 (World Bank, 1992, 1993). In the medium term, as amortization payments to the Paris Club fall due, the debt-service ratio remains unchanged despite assumed annual export volume growth on the order of 6.5 percent. The implication for medium-term viability is that it will depend critically on attracting sufficient foreign financing.

Conclusion

In summary, Poland’s export growth would appear to be sustainable in the short run: (i) export volumes to non-CMEA countries have exhibited a high dependence on trading partner country growth rates, which are projected to continue their recovery; (ii) the commodity composition of growth does not indicate, prima facia, any major constraint arising from EU protectionism and, in fact, points to the existence of some dynamic, new, private-sector-led exports; and (iii) there does not appear to be any loss of competitiveness, since Poland has continuously increased its market share in partner country imports. In the longer term, however, the importance of the reform effort to further growth may increase as exports hit capacity constraints and the lack of capital impedes further investments. Moreover, the potentially dynamic import growth in combination with the still high debt burden necessitate Poland’s regaining access to international capital markets as a condition for sustaining growth. In this regard, the conclusion of negotiations with banks, and the current indications of increased foreign investor interest, are positive signs.

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1

There are two main sources for trade statistics in Poland: the Central Statistical Office (GUS), which obtains data from customs declarations, and the National Bank of Poland, which obtains payments basis data from commercial banks. Differences in coverage and definitions, as well as timing leads and lags, do not permit direct comparison. This section uses payments basis data to describe the value and direction of trade and refers to GUS data for the composition of trade, since the composition of payments basis data is dominated by the category “other.” However, the GUS pre-1993 data should be treated with caution; delays in processing data in 1991 and the difficult transformation to the EU’s single administrative document system (SAD) in 1992 impaired the GUS data for 1991–92, raising questions about the validity of a comparison between 1993 GUS data and data from previous years. In addition, the shift in 1991 from categorizing trade based on the Harmonized Commodity Description and Coding System to the EU’s Customs Nomenclature (CN) complicates an analysis of the evolution of the structure of trade.

2

Caution must be exercised in interpreting the value of trade in transferable rubles, as export and import unit prices were not market determined. In this paper, transactions in transferable rubles are converted into U.S. dollars using the transferable ruble–zloty cross commercial rates.

3

Net unrecorded trade is estimated from the value of net purchases/sales from the kantor (small foreign exchange dealer) market, an item included in the capital account of the balance of payments. On this basis the balance of unrecorded trade was in deficit in 1991 ($620 million) and in surplus in 1992 ($1.182 million) and in 1993 ($1.750 million).

4

Similar commitments by Poland are to be implemented over a longer period. Poland, however, will open access to its market in vehicles more quickly. The Association Agreement included a large duty–free import quota for cars and trucks into Poland: 31,750 vehicles in 1993 and about 35,000 vehicles in 1994, which translates into imports of some $300 million–$500 million annually and accounts for about one-half of automobile imports in 1992 and an estimated one-third in 1993.

5

For textiles and clothing, duties will be phased out over six years and quotas dismantled before 1998. For steel and coal, duties are eliminated over five years and QRs immediately and after one year, respectively. For agriculture, the liberalization process is more opaque. Some products are excluded from the agreement altogether (e.g., cereals). For others, levy reductions of 30–100 percent will be phased over five years, and QRs will be progressively increased by 10–20 percent per year from the initial (often low) base over five years.

6

Trade agreements also exist with Finland and Russia. Under the KEVSOS Agreement, effective since 1976, trade between Poland and Finland is based on a zero customs rate, with the exception of most agricultural products and the recent introduction by Poland of duty-free tariff quotas on paper (up to $8 million are duty free, after which a duty is applied) and fuel (455,000 tons). Poland’s trade with Russia is on the basis of an intergovernmental foundation treaty with annual agreements to determine indicative lists. However, no annual agreement has been signed recently, with the last annual agreement becoming inoperative in early 1992 as Russia reduced its gas exports and introduced new legislation requiring mandatory surrender requirements for a portion of the exports receipts.

7

The lower share of the private sector in exports relative to imports most likely reflects the large unrecorded net export growth, the large share of industrial goods in exports—which are produced by state-owned enterprises—and the existence of state-owned trading companies, which still intermediate for small private firms unfamiliar with export markets.

8

The classification by factor intensity is based on the export’s EU Customs Nomenclature (CN) chapter; sections 1-5, 8, 10, 14, and 15 are considered to be natural resource intensive; sections 9, 11, 12, 13, 20, and 21 are considered to be unskilled labor intensive; and sections 6, 7, and 16-19 are considered to be capital/technology and highly skilled labor intensive.

9

Because of the high share of low-value-added exports and the direction of trade, the external terms of trade have become relatively stable. However, movements in unit export and import prices, and thus export and import values, are dominated by the movements in the exchange rates of their largest trading partners, especially Germany. This is reflected in the decline in export values in 1993, when the U.S. dollar strengthened against the deutsche mark.

10

Kaminski (1994) in a detailed analysis on data through 1991 draws a similar conclusion.

11

The customs data indicate that the composition of trade between the major expenditure categories remained unchanged between 1992 and 1993—raw materials (61 percent), investment goods (17 percent) and consumption goods (22 percent).

12

Official bilateral creditors have provided net financing through a debt-restructuring agreement in 1991 an exceptional terms and have henceforth refrained from providing new money (see below). This agreement was a major reason that Poland remained outside the G24 process for Eastern European countries.

13

The increase in unguaranteed flows may be underestimated, as the activity of the private sector has understandably become harder to monitor. The source of most of payments basis data is Bank Handlowy, whose role as the major player in the trade finance market has been greatly reduced since the beginning of the reform process.

14

Based on data provided by the State Foreign Investment Agency (PAIZ), under the Ministry of Privatization. The data is considered to be tentative, as foreign investors are not obligated to publish data. The balance of payments is on a payments basis and records only foreign direct investment that passes through the banking system, overlooking foreign direct investment in kind and reinvested earnings. On a payments basis, foreign direct investment has increased from $117 million in 1991, to $280 million in 1992, and $580 million in 1993.

15

Of course the initial inflow would have been much less. Assuming that most of the inflows occurred in the latter half of the year, they would have amounted to $50 million-$100 million.

16

The operation contains four options: a buy-back and three bond exchanges with different structures including an exchange at par with a below-market and fixed interest rate and an exchange at a discount with a floating-market rate, and a new-money option under which banks provide 35 cents of new money for every dollar of old claims that are effectively rescheduled. The par and discount bonds are fully collateralized as to principal. The buy-back option offers the most debt reduction but at the highest upfront cost. The exchanges of existing claims for bonds result in debt reduction for lower upfront costs (the cost of the collateral). The terms of the bonds are structured so as to provide broadly equivalent debt reduction per dollar of upfront cost. Banks allocate among the various options depending on their long-term outlook for Poland (a decision to exit through a buy-back or maintain exposure through a bond exchange) as well as their projections for interest rates.

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