Poland: Market volatility materializes amid ongoing judicial crisis
August 1, 2017
Rising political tensions over the Polish government’s controversial judicial overhauls were checked, at least temporarily, on 24 July when President Andrzej Duda unexpectedly vetoed two of the three reform bills that had reached his desk. The recent escalation follows a nearly two-year battle between Poland and the European Union over the state of the country’s democracy and the government’s respect for the rule of law. Although Duda defused the immediate political crisis by vetoing measures that would have given politicians more control over the country’s courts, it appears that Poland is still set for a period of heightened uncertainty as both the EU and the ruling Law and Justice (PiC) debate their next moves. Markets were initially rattled by the perceived jump in political risk, although the greater threat to the economy now lies in the possibility of increased volatility in both foreign exchange and bond markets as investor confidence is tested. Should the stand-off with the bloc worsen, the level of investment in the country could be on the line in the near term as the crisis throws into question the country’s hard-earned reputation for relative stability in the region.
The impact of rising uncertainty is being seen in financial and foreign exchange market volatility. In the days following the announcement, bond yields climbed as markets grew increasingly concerned over how the diplomatic showdown between the right-wing majority government and Brussels would unfold. Further fueling anxieties was Duda’s later suggestion that the vetoed bills required only minor tweaks to eventually obtain his signature—a strong possibility that could keep pressure on the country’s financials in the near term. Jittery markets initially rewarded the zloty and bond prices on the announcement of the vetoes, although the currency recouped only a fraction of the steep losses incurred in the run-up to the decision, days which were marked by protests across the country. Critics of the PiC argued that the party’s latest push to overhaul the court system would move Poland toward more autocratic rule and would drive a wedge between the country and its democratic neighbors.
Downside risks to the economy have almost certainly intensified in the wake of the controversy. The EU has triggered legal action against Poland and it remains to be seen how recent events will affect Polish investment. Spooked by the increasing vulnerability of Polish institutions, along with the likelihood of a protracted legal battle with the EU, investor confidence could be at risk and any deterioration could threaten the attractiveness of investment in the country. Moreover, EU officials have threatened that Poland’s voting rights within the bloc would be at risk should any lower court judges be dismissed by the justice minister in what was a warning to the PiC not to follow up on the lone new law that had not been vetoed by the president. Even less clear is the new, non-negligible prospect of curtailed EU investment into the economy via the bloc’s future budgets, although at this juncture this route seems unlikely.
With the economy performing laudably so far this year, it appears likely that strong fundamentals could shield economic momentum from the growing threat of uncertainty—at least for now. Currently, it seems unlikely that the fallout from the political crisis will topple, or even dent, the fast-growing economy. Having notched 4.0% GDP growth in Q1 on the back of improved household spending, the country’s fundamentals appear to be strong. Moreover, our FocusEconomics Consensus Forecast panelists this month expect solid 3.7% GDP growth this year and 3.4% the next. Reflecting analysts’ broadly held view that the economy should emerge largely unscathed from the ongoing political crisis, our 2017 GDP growth projection is unchanged from a month ago. That said, it remains to be seen whether credit downgrades are on the table. Although Duda’s vetoes have likely put off an immediate downgrade, the possibility of a drawn out political saga with the EU and the prospect of greater autocracy could leave the door open for adjustments by the credit rating agencies over the coming quarters.
Author: Christopher Thomas, Economist