PL

From golden goose to black swan

Investment & finance
At the beginning of the year, hardly anyone thought that a meltdown was lurking around the corner. At the 6th Invested Interest – Investment Market Conference, held by Eurobuild Conferences on February 27th, we spoke to Prof. Witold Orłowski, the chief economic advisor at PwC, about the potential risks for the economy. The coronavirus was by then only just rearing its ugly head in Europe, but even then he warned us of the possible devastating consequences for the market it could trigger

Tomasz Szpyt-Grzegórski, ‘Eurobuild CEE’: What’s the main factor that the health of the global economy currently hinges upon?

Witold Orłowski, chief economic advisor, PwC: That’s easy right now – it’s how serious the coronavirus epidemic will turn out to be. However, a more comprehensive answer would be slightly different. If the world economy was in an excellent state, if there were no concerns about the various risks of it bubbling up on the horizon, then there also wouldn’t be as much reason to worry about the coronavirus. However, it could turn out to be the fuse that ignites all these problems that have been building up. First of all, the global economy we now have is unbalanced. China, the country that was first impacted by the epidemic, is one great, financial – an optimist would say – ‘enigma’, but a pessimist might describe it as a ‘ticking time-bomb’. Chinese finances are the weak point of its economy and we don’t know how devastating the consequences of a sharp slowdown of the country’s growth could be. Already there has been talk of its GDP shrinking from 6 to 4 pct and I think that, if worse scenarios unfold, zero growth also cannot be ruled out. This could cause financial turmoil in an economy such as China, which is dependent on rapid economic growth. Of course, China has the resources to take defensive action, but there is a serious risk that these will not be enough. The greater risk, however, could be the fact that China is not a democracy and a financial collapse there could just be the prelude to even worse problems. We are still only talking about potential scenarios... but it is possible that the ‘black swan’ that everyone has been afraid of [an unexpected phenomenon with serious and unpredictable economic consequences – editor’s note] has actually arrived. The pessimistic scenario is that China and the economies of developing countries are in a potentially very grave situation. If there were a serious financial crisis, then apart from a recession we would have to contend with a ‘flight to safety’ as people rushed to buy the bonds of such countries as the US or Germany. Capital will then flood out of developing markets – Poland and the rest of the CEE region included. We should expect a rapid weakening in these countries’ currencies and many other negative consequences. None of this is destined to happen, but the black swan scenario is still entirely conceivable. We should also take into account the fact that Poland is still regarded as a developing market and the publication of the odd index that says otherwise will do little to change this general perception. In good times, we may look rather like a developed market, but we will only be treated as a developing country if problems arise. In good times, investors expect much higher rates of return from such markets due to the higher risk. However, if the global economy is stricken by anything adverse – and not necessary on our market – then investors flee to safer havens. We have to live with this – investors simply behave this way. All of this overlaps with the fact that the European economy has been on the verge of recession for about a year, especially in Germany, which is already undergoing an economic slowdown. This country is the main market for Polish exports, so if a recession occurs there, Poland will also go in the same direction, no matter what the people in power say or do. However, there is another crucial fact that needs to be remembered – the world is not a safe place in a financial sense. And I mean, global debt. For the last ten years we have been seeing an increase in public debt in developed countries together with a decrease in the level of private debt, as well as a huge increase in private business debt in developing countries, mainly in China. Furthermore, this latter debt is highly suspect, since it is not supervised. It is not debt from ordinary loans but from rather opaque operations involving the direct purchase of companies’ bonds by banks. Loans are assessed for risk even in China. But a bank buying company bonds, for example, for USD 1 bln does not require anyone’s consent. So is China a ticking financial time-bomb? Yes, it is. Will coronavirus cause a massive collapse in Chinese finances? I don’t know, but the risk certainly exists.

Given this background, what are the prospects for the Polish real estate market and other countries in the CEE region ?

In Poland as well as in neighbouring countries we have had several years of robust economic health, which was always going to come to an end sooner or later. So the questions are now being asked: when will this happen and what could trigger it? It’s very likely that this will be the coronavirus and related events. A few issues have been building up in the global, European and Polish economies for several years now – and this is typical during a period of economic growth: soon or later there has to be a bigger or smaller adjustment. When there’s a glut of optimism it’s tempting to build up a stockpile of fireworks for the next expected celebration. But when there are a lot of fireworks lying around, a single spark could cause a catastrophic explosion. Everyone is wondering now if the coronavirus might be that spark. I’m no epidemiologist so I can’t judge whether it has this potential, but there’s no doubt that the economic and financial consequences of the virus are already being felt. The questions are, will this continue and will the scale of the pandemic grow? However, there’s also good news – there is not so much explosive material lying around in Poland. Fortunately, unlike in the Czech Republic or Hungary, for example, the real estate boom in Poland has not been so rapid, at least to date. If there’s going to be a correction, my hope is that it won’t be of such a catastrophic scale in Poland – if you fly lower, the fall to earth is less painful. However, we have to be careful. The situation on this market is maturing to the point where a correction is going to happen. And each cycle has to come to an end one day.

When could this happen?

Until around early 2019 – when many had been saying that a downturn was just around the corner – I was convinced that the Polish real estate market would continue growing, without any major threat of this going into reverse. However, I did start to raise the alarm about a year ago. I’ve not seen anything yet that could directly lead to an imminent collapse, but the situation has now matured to the extent that we have to take on board the possibility that things will get worse.

What prompted you to change your tune?

An accumulation of factors: Polish finances had weakened slightly, growth had slowed and a number of global issues had arisen. However, I still thought that 2020 would be another period of relatively moderate growth, even though the first few clouds had already appeared on the horizon. However, the coronavirus has revised my predictions downwards.

Should we then prepare for the worst?

If there is to be an actual collapse of the real estate market around the world, I would prefer it to happen sooner than later – before the Polish market heats up enough to become a full casualty of it. Whenever I see ads urging you buy houses or apartments quickly because their prices will rocket over the next few years, that’s when I start to worry that we are approaching the end of the boom. What’s likely to lie ahead of us if this happens? The economy will slow down in Poland. If the pandemic worsens, there could also be recession. At the same time, inflation is already high and if the złoty weakens significantly it will continue to rise. This would be a disaster for the economy and such a situation would certainly have a huge impact on the real estate market. I think we’re in a very similar situation today as in 2008.

Polish capital is still virtually non- existent on the institutional real estate investment market. Is there anything that could change that?

We need more savings. In Poland, we currently have a government that urges people to spend money rather than to save it. And investment capital comes from savings. Pension funds are typical real estate players. In Poland, however, the notion that Poles have little reason to save up for the pensions is rather widespread and encouraged by the government. If this doesn’t change, there won’t be any long-term capital, either.

Economic career growth

Witold M. Orłowski is an economics professor, a lecturer at the Warsaw University of Technology Business School and the Vistula University in Warsaw, and the chief economic advisor at PwC Poland. He is a member of the Polish National Development Council and the former head and member (respectively) of the economic advisory teams of former presidents Aleksander Kwasniewski and Lech Kaczyński. He was also a member of the Government Economic Council of former prime minister Donald Tusk. Witold graduated from the University of Łódź and Harvard University. He advised Poland’s chief negotiator over the accession to the EU, and later the European Commission. He is currently a member of the economic council of the Polish minister of finance.

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