When I first traveled to Warsaw over 20 years ago, it was a grey and forbidding place with drab shop windows, a holdover from the Communist era. Now it is a bustling, prosperous place with wonderful restaurants, new, tall office buildings and hotels, and beautifully restored old buildings and monuments. The changes in Warsaw and elsewhere in Poland over the past two decades have been truly remarkable.
Situated in the heart of Europe between Russia and Western Europe, Poland is strategically well-positioned. With a population of 38 million,1 the country has a large consumer market and a strong workforce. Poland was the only country in the European Union (EU) that was able to avoid recession during the global financial crises years of 2008 – 2009.2 Its border with Germany is an advantage, in our view, since Germany is a major importer and is Poland’s largest trading partner, accounting for more than a quarter of Poland’s exports and imports.3 With a well-educated workforce, Poland now successfully competes in outsourcing of services with countries like India. Moreover, the country is poised to potentially benefit from the relocation of factories from Western Europe to Eastern Europe.
Poland’s economy has been doing quite well recently; forecasts call for gross domestic product (GDP) growth above 3% in 2014, which would be one of the highest growth rates in Europe.4 However, over the last 10 years, the general trend has been for the country’s economic growth to slow as it continues to mature. In 2006, growth was just over 6% and in 2007, it reached almost 7%, but since then there has been a decelerating trend.5 Poland’s economic growth is broad-based, however, driven by both domestic and external demand. As a result, although Ukraine shares a border with Poland, we think the impact of the ongoing Ukraine-Russia crisis on Poland should be minor.
The Solidarity Movement
During the era of harsh Soviet Communist rule of Poland, its citizens rebuilt the country’s war-devastated industries but living standards remained poor. By 1980, strikes and riots broke out. At the Lenin Shipyard in Gdansk, workers developed into a strong non-violent “Solidarity” movement despite the Communist government’s repression. Poland began the process of unshackling its economy from communism earlier than other countries in Eastern Europe, engaging in sweeping reforms dubbed “shock therapy” that included ending price controls, opening borders and privatizing state-owned enterprises. The fall of the Berlin Wall in 1989 signaled a new mood in Europe, and in 1990, Lech Walesa, head of the Solidarity movement, was elected president in a free and democratic election. The Soviet Union formally ended in 1991, and by 1997, Poland’s National Assembly adopted a new Constitution. Integration into Western Europe continued to gather steam and in 2004 Poland joined the EU. Poland’s entry into the EU in 2004 has had a big impact on the economic life of people in Poland and more importantly it’s had a big impact on the legal and political life because Poland had to meet the legal and societal requirements set by the EU. There are an incredible number of companies in Poland that are exporting products to Germany and other countries in Europe; EU membership offers free access to all European markets and it goes in both directions.
We think a big surge in consumer spending has been very important in boosting Poland’s economy in recent years, as consumer spending accounts for a much larger part of the country’s GDP than it does in Hungary or the Czech Republic, for example. A number of post-Communist-era reforms, particularly the privatization of state-owned companies, resulted in the development of a vibrant capital market, chiefly important for equity investors like us interested in an active stock market.
In our view, the privatization of Polish state-owned enterprises was the most revolutionary action taken after the fall of Communism in Russia and Eastern Europe. In 1989, the Polish government controlled most of the country’s nonagricultural assets and there were few private enterprises. The natural next step was developing a market for the privatized company shares, and in April 1991, the Warsaw Stock Exchange was opened. Subsequently, in mid-1991, the government announced a shock privatization program with its Act on the Privatization of State-owned Enterprises calling for 50% of state-owned assets to be privatized within three years. The laws to make such a program possible were not enacted until April 1993. Then the “mass privatization” program was launched based on the free distribution of shares, with Polish citizens over 18 able to buy shares at a discounted price. Unfortunately, most citizens were not aware of the value of such shares and those who realized the value bought up as many shares as possible. Many became quite rich.
Pension Reform in Poland
As a result of high unemployment and lower incomes after the fall of Communism, fertility rates fell in Poland. Therefore, fewer workers were available to fund the pension of the growing group of retirees. Thus, the government started a compulsory private pension system. There were critics who said that the private pension funds were expensive and inefficient. The pension funds said that too-tight government regulations hampered their ability to take risks and drive good performance, since they had to keep more than half of their portfolios in domestic bonds, mostly government bonds. A great deal of money was spent by the pension funds on mass media and an army of salespeople to attract clients.
We believe the most significant recent event in Poland’s capital market history was probably the takeover of private pension fund bond holdings by the Polish government. At the beginning of 2014, the government seized 153 billion zloty (US$50.4 billion) in Polish Treasury bonds from 13 private pension funds. Those bonds represented about half of the funds’ investment portfolios. Of course, the action boosted public finance for the short term but it threatened to undermine the key goals of pension reform, which were to boost national savings and reduce the long-term burden of retirement costs on the state budget. To make matters worse, the government introduced rules, such as requiring all 16 million Polish pension fund contributors to choose whether to remain in private funds or to transfer to the state social security system by the end of July 2014, which would likely make it difficult for the private pension funds to survive. Since the government prohibited private funds from advertising during the selection period, we think there is a good chance that many will opt to transfer into the government’s social security system.
This change is crucial, since after the collapse of Communism, private pension funds were established throughout Central and Eastern Europe to share the rising costs of retirement with the state social security systems. Funds deposited in private pension funds were invested in stocks and bonds to help finance private companies and public infrastructure projects. They became the foundation for the stock and bond markets in those countries, including Poland. Critics say that the move by the government is simply an expropriation of private assets. The Organisation for Economic Cooperation and Development (OECD) warned that the government measures “might well damage social trust in the pension system and harm the credibility of future structural reforms more broadly.” The OECD also said that the rapidly aging population required a pay-as-you-go system.
The main reason for the government action appears to be to cover growing public debts. After it seized the bonds, the government cancelled them, thus turning the budget deficit into a surplus and reducing the public debt, but placing the long-term liability of pension payments on the government budget in the future. The motivation appears to us to have been political since the centrist Civic Platform party was facing challenges from the Law and Justice Party in parliamentary elections scheduled for 2015. This move was a way for the government to avoid austerity measures, as well as to have the freedom to spend money to attract voters. In our view, the move by Poland is symptomatic of moves by other governments in Central and Eastern Europe that have been trying to avoid deeper economic reforms in the interest of short-term political objectives.
The worry is that by scaling back private pension systems, in the future, an aging population will require and demand larger and larger government support. By stunting the growth of capital markets, which drive investment and economic growth, the economy could suffer, leading to recessions in times of global economic crisis. I think Poland, as one of the largest countries in Central/Eastern Europe, has not set a good example in this regard. Although I have criticized the bond seizure plan, I have kept my faith in the Polish market—and still do. I think as retirement payments grow and become an increasing burden on the government budget, the pressure will grow to return to private pension schemes.
Spotting Potential Investment Opportunities
My trips to a country are incomplete without visiting companies that are or could be potential investments in our portfolios. While visiting an electric utility company in Poland, we were informed by its management that electric utilities there have had a difficult time in recent years. There is keen competition between the power generators, but now a new government scheme called the “operating reserve mechanism,” introduced at the beginning of 2014, has resulted in increased prices for energy. The mechanism involves payments to power companies to reduce their production during peak hours, but to keep the capacity available for the system. Since the forecast demand growth is only about 1%, new power plants do not make economic sense.
My team and I also visited a retail footwear chain with stores throughout Poland. It relies on imports from China, India and Taiwan for the bulk of its products, so a weak Polish zloty could therefore be a potential problem. The company’s management has already noticed higher prices for Asian imports, as Chinese and other labor costs are rising. Cost competitiveness is important since the sale of shoes over the Internet is becoming more and more significant and Internet suppliers are engaging in fierce price competition. The management of the company believes customers will not bother looking for bargain shoes over the Internet if they have a quality product at good prices available in convenient locations at nearby shopping malls. Nevertheless, the company is also engaging in Internet sales.We also wanted to get insight into distribution businesses in Poland and visited a major distributor of technology equipment, radio and TV products, home appliances, mobile devices, and office equipment. In addition to its operations in Poland, one third of the company’s sales are in a large number of other countries. Profit margins, however, have been declining as shipment costs have risen. The firm has become active in e-commerce as well.
Another firm we visited is a provider of pay satellite television broadcasting services, and it has also entered the telecommunication services market with the launch of wireless broadband in a multi-play service. We believe growth in the pay-TV segment, however, is limited as the market has become saturated. So, growth may come only from advertisers willing to place more advertisements on their TV channels, but this depends on the quality of the programming produced. With the Internet, the barriers to entry decreased significantly so everybody who has the right content can attract viewers—in other words, life for traditional content producers has become much more challenging.
Poland’s Strong Culture
Poland has suffered partition and wars in its history, so it is a testament to its strong culture that the Polish sense of nationhood has survived. In 1941, Hitler attacked the Soviet Union and Germany took control of all of Poland, committing many atrocities and murdering an estimated three million Polish Jews in concentration camps all over the country.
On 1 August of every year, sirens, bells and horns ring out all over Warsaw. Everyone in the bustling city stops what they are doing and stands at attention in a massive show of respect for the Warsaw Uprising when, in 1944, the Polish Resistance fought the Nazi occupation of the city. Unbeknownst to the freedom fighters, the year before in Tehran, Roosevelt, Churchill and Stalin secretly agreed that the Russians would take control of postwar Poland. After the loss of 180,000 lives and the heroic resistance of the entire population, Poles were forced to surrender and then began the arrest and deportation to concentration camps of thousands of Warsaw residents.
In 1944, at the time of the Uprising, there were only about 900,000 people living in Warsaw since so many Jews and others were arrested and deported. After the Uprising, Hitler ordered the complete the destruction of the city so that by 1945, less than 1,000 people remained in the totally flattened city. This time is immortalized in Roman Polanski’s film “The Pianist.” I visited the Warsaw Rising Museum, an impressive and heartrending multimedia interactive display that documents the Uprising with artifacts and documents including eye witness accounts.
When the Germans were defeated, the Russian Communists marched into the city. In order to establish a Communist dictatorship, they started arresting and persecuting members of the Uprising, calling them “bandits” and “reactionaries.” Throughout this period, there were countless acts of heroism and sacrifice, a demonstration of the strength of the Polish national spirit.
The country’s history of art and music is outstanding. Let’s not forget Frederic Chopin or Jan Paderewski! During a recent trip there, I visited the National Museum in Warsaw to see a special exhibition of Aleksander Gierymski (1850 to 1901), an outstanding artist. The exhibition brought together 120 paintings and oil sketches, 110 woodcuts and 70 drawings of the artist. It was the first exhibition of the painter’s work on such a scale in 76 years and quite an accomplishment considering the kind of destruction that Poland suffered during two World Wars. Part of the exhibition showed a video of how some of the artist’s paintings that had been heavily damaged were painstakingly and beautifully restored by Polish restorers using the latest scientific techniques. Many of the paintings portrayed Poland’s past as well as poignant portraits.
Overall I found Poland to be a country with good potential for further economic progress and with diverse business interests. My team and I will continue to monitor businesses in Poland for attractive potential investment opportunities.
See me and my team in action in Poland in this brief video: http://youtu.be/AOB3fVulBPY
Dr. Mobius’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
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