Stabilisation, Privatisation, and the Development of Capital Markets in Poland.

Neil MacDermott

The path from the command economy to free-market system has been a difficult one for the countries of central and eastern Europe. The initial euphoria of freedom has been replaced by a distrust of all things western. Neil MacDermott in this essay examines the case of Poland and analyses its success in making the transition.

'There is nothing more difficult to carry out, nor more doubtful of success, nor more dangerous to handle, than to initiate a new order of things. For the reformer has enemies in all who profit by the old order , and only lukewarm defenders in all those who would profit from the new order. The lukewarmness arises partly from fear of their adversaries who have law in their favor; and partly from the incredulity of mankind, who do not truly believe in anything new until they have had actual experience of it.'

Niccolo Machiavelli, The Prince (1513)


In the emerging transitional economies of Central and Eastern Europe political and economic reform are interdependent. If 'adjustment fatigue' sets in at the present early stage of the process the political consequences will spillover to the detriment of economic reform. This investigation into the progress of these new democracies will focus on the stabilisation of the Polish economy, the development of their privatisation programme and the advance of capital markets. Poland has distinguished itself as a leader in economic reform. It was the first Soviet satellite to reject communism with semi-free elections in June 1989, followed in August by the removal of the old Communist establishment. However this path has not been without difficulties, the Poles still suffer high inflation and unemployment and have recently voted the old ruling communist party back in to power, the effects of which have yet to be gauged.

The importance of a well functioning capital market for an emerging economy, the enterprising actions of the Polish government with respect to stabilisation and the uncertainty inherent in investing in these countries forms the rationale for this piece. The second section will outline the macroeconomic stabilisation process and privatisation policy undertaken by the authorities. Progress in the crucial area of banking reform and the development of an efficient capital market in Poland will be highlighted in the third section. Finally, the conclusion deals concisely with the achievements of the Polish authorities struggling down the road to economic reform.

The Stabilisation Process


An unprecedented challenge confronts the centrally planned economies of Central and Eastern Europe in their attempts to reform and stabilise their respective economies. Most commentators argue that the development of a market-oriented structure and institutional framework through a 'simultaneous assault on macroeconomic stabilization, prices and property rights is necessary from the start'.

Price liberalisation is the first step. Prices act as indicators to enterprises of demand conditions for their products. When prices are market-determined they equate supply and demand. 'Big Bang' price liberalisation as occurred on the first of January, 1990 in Poland causes an immediate price explosion for both supply and demand reasons. It was thought that the monetary overhang particularly would encourage inflation as goods became available, but some studies have shown that in the longer run, consumers refrained from price bidding because of the overall aura of uncertainty at the time. Liberalisation also brought about a significant decline in output. Real incomes fell as did consumption levels. The CMEA collapse depressed export demand in conjunction with the increase in cheaper and superior imports from foreign competition in the West.

Poland attempted to curtail its rampant inflation and maintain internal convertibility by using four stabilising anchors:

1. a fixed exchange rate,

2. incomes policy,

3. real money supply,and

4. real interest rates.

The authorities hoped to restrain inflation and reduce an escalating budget deficit. The achievement of these goals was expected through 'monetary policy means alone(no fiscal intervention), while long term structural changes were to be enterprise-driven....[the development of an efficient financial intermediation system]....They were to take place in the absence of any industrial policy, with weak trade policy and with an underdeveloped financial sector' . The idea that the necessary restructuring could be achieved without recourse to fiscal activism was a throwback to the liberalism most associated with the first post communist solidarity-led coalition government.

Some Economic Statistics

                             1989     1990    1991     1992     1993    1994e   
Real GDP Growth %        0.2     (11.6)   (7.6)    2.6      4.0      4.5    
CPI%             258.1    558.3    75.9     45.3     36.8     30.0   
                            (2.3)     1.1     (1.7)   (0.3)    (2.7)    (2.7)   
Current a/c Bal % GDP                                                         

This policy changed quickly when the authorities realised that the economy needed some continuity: markets were simply not developed enough to carry out an effective allocative role. The deflationary measures introduced in 1990 included a 35% cut in the wage bill, a reduction in state sector subsidies from 11% to 7% of GDP and a scaling-down of the state investment programme. Despite these efforts, inflation almost doubled in 1990 while the country experienced severe negative real GDP growth. Private sector growth, although affected by the slump in the state sector, still recorded positive growth. However, these poor figures were worse than most had predicted. Unemployment, which theoretically had been nonexistent, grew to 11% in 1991. Poznanski (1993) informs us that state owned-enterprises have, on the whole, maintained employment. Growth in unemployment is therefore mainly among new entrants to the labour market. As a result Poland's transition programme came under attack from certain commentators. Inflation was curbed significantly and the zloty, the polish currency strengthened against the dollar but the drop in output 'wasn't just a temporary structural adjustment but a deep recession if not depression' in all sectors of the economy. I, however, believe this attack is flawed [Poznanski, R. 1993]. Bruno (1992) suggests that external shocks exacerbated an already depressed situation. The collapse of the CMEA , the recession experienced in most European and North American markets, the slower than expected rate of structural adjustment and privatisation were all contributory factors. GDP growth did resume in 1992-1993 (1.5% and 4% respectively), but the GDP remains 13% smaller than in 1989 all the same.

The drop in output notwithstanding, Poland has sizeble economic potential. Production assets in industry and construction alone are estimated at about US$70 billion. In addition, it has almost 39 million consumers, a skilled labour force and a well-developed transport infrastructure.



Privatisation has proved to be the basic means of dismantling Poland's command economy while raising revenue, improving tax collection and boosting capital markets. Apart from the need for economic efficiency, widespread privatisation is important because the concept of private ownership is consistent with a democratic state. The literature outlines the various routes towards privatisation:

(a) public share issues,

(b) mass privatisation through a voucher scheme, and

(c) employee buy-outs.

However, it is difficult to grasp the sheer scale of the transformation programme that these countries face. Poland had over 8,000 state-owned enterprises that were in line for restructuring, representing more than 80% of GDP9 . Western experience is often alluded to in policy descriptions, yet in Thatcherite Britain the government sold off enterprises representing only 5% of GDP. Therefore no realistic precedent exists. Experiences in Poland will form a testing ground for many of the other ex-Soviet satellites policy options.

The issue of corporate governance must also be considered when choosing a method of privatisation. To achieve the desired dispersal of ownership the Polish government decided upon a multitrack approach. State-owned enterprises had three options: Liquidation, commercialisation, or remaining in the public sector.

The authorities decided to include 'insiders'(workers' councils and managers) in the decision process, granting them an effective veto over privatisation.

State Enterprises Transformed as of 30/06/9411

     Commercialised                  579                      7.0%            
       Liquidated                   2,132                     25.9%           
          Other                     5,117                     67.1%           
          Total                     8,228                     100%            

The privatisation process has been particularly successful in the small retail and service oriented industries. In those sectors restructuring is less complex, not only because organisational size is small, but more importantly because their impressive performance is 'linked with the de facto resolution of ownership rights'. The lack of such clarity with respect to large state-owned enterprises, coupled with the insiders' veto, and the large scale restructuring that is necessary, has stymied the process. In response, the government has established a voucher-based mass privatisation programme for medium and large enterprises, Those participating will be turned over to fifteen-to-seventeen National Investment Funds(in an attempt to overcome the corporate governance issue), which in turn will be managed by supervisory boards elected by the Treasury. Delays have dogged the programme, but assuming the problems can be overcome, the Polish Ministry of Privatisation has ambitious plans. The ministry is seeking approval for a 1995 plan to commercialise 1,500 state-owned enterprises and a further 3,800 by 1998.

A need for a set ofre-privatisation rules has been identified by the Ministry. The lack of such rules has slowed down the process, especially in rural areas. A new owner is never sure whether the property he has purchased, be it enterprise or farmland, is burdened with any undisclosed reprivatisation claims. Up to mid-1994 over 100,000 reprivatisation claims had been registered, the majority coming from inhabitants of Polish territories conceded to the USSR who resettled after the second world war. As of right these people should be compensated for the lost property. However, this figure represents only a fraction of potential claimants, if the laws concerning the recovery of lost property are simplified, is planned in the Sejm(the lower legislative chamber). Originally the legislation provided material compensation, albeit incomplete, or compensation in terms of government securities hwere this wasn't feasible. Substitute property could be chosen from the so called undesirable property of enterprises earmarked by the state. However, because of the strain on the state finances, the new Government announced its own version, which stated that the state could only afford symbolic re-privatisation.(From a statement by Wieslaw Kaczmarek, the Minister of Privatisation). The Ministry reported 1993 revenue from privatisation at $225m for the state budget and Minister Kaczmarek expected the 1994 figure to reach $275m.(From a statement by Wieslaw Kaczmarek, the Minister of Privatisation).

Banking Reform and the Capital Markets

Pescetto (1992) suggests the following three reasons for developing an efficient banking system.

(a) Firstly, the banking system facilitates the efficient allocation of capital. Through credit risk analysis it ensures that only the most effective firms receive the necessary finance while imposing a strict budget constraint. Thus banking reform and privatisation are interdependent.

(b) Secondly, the control of money supply and all its aggregates is a crucial function for a central bank. For the government to effect stabilising policy, control must be placed on money supply.

(c) Thirdly, the supervision of the commercial banking system by the central bank is also of great importance, as is the continuing effort to bring informal markets into the legitimate economy.

It is with these in mind that I continue, firstly with a brief discussion of the banking system in Poland and the reform process, and secondly with an outline of the development of capital markets in Poland.

Banking Reform

Until 1988, the shape of the Polish banking system was typical of any centrally planned economy.The National Bank of Poland combined the duties of a central bank (although it had little autonomy with regard to monetary and credit policies) and of a commercial one (handling accounts of state enterprises and natural persons) as outlined in the monobank model. The Banking Act and the National Bank of Poland(NBP) Act were passed on January 31, 1989. The NBP is the current bank of issue, a lending institution for other banks and the central foreign exchange banking institution. Nine commercial banks were separated from the NBP structure. This legislation made it possible to create a two-tier system modelled on that of Germany.

Banks are free to set rates,both deposit and lending, and to use the NBP refinancing rate as a common reference. The NBP has a policy of maintaining a positive differential over the rate of inflation. Most banks have a significant portfolio of non-performing creditors. Chopra (1994) believes that banks will resort to 'charging burden sharing premiums on performing loans and widening of interest rate spreads i.e. imposing a tax on financial intermediation to recapitalise.' As an alternative the state could encourage banks to use debt-equity swaps, turning banks from creditors into owners of the company. Any other alternative involves placing the burden of debt on the state budget.

Finally, it is expected that a new banking act and an act pertaining to the central bank , conforming to the European Communities standards, will be passed in 1994.

Polish Capital Markets

Developing capital markets is crucial to the advancement of a market economy. Stiglitz (1992) places great emphasis on their importance 'if capital is at the heart of capitalism, then well functioning capital markets are at the heart of a well functioning capitalist economy'17 . Chopra (1994) suggests in the recent IMF paper on Poland that the success of transformation programmes is dependent on the development of an efficient financial intermediation system as well as credit and capital markets. Capital markets facilitate the reconciliation of saving and investment flows and therefore play an important role in the real sector of the economy.

The regulated capital market has been in existence in Poland since 1991, operating under the Trading in Securities and Trust Funds Act of March 1991, which was amended in January 1994. It includes provisions governing the public issue of securities, and secondary trading in securities on the stock exchange and the over-the-counter markets. The Warsaw Stock Exchange(WSE) is the principal institution of Poland's capital market. It is run as a joint-stock company with US$4 million in share capital. Only brokerage firms and banks may acquire interest in the Stock Exchange. The Polish system is fashioned after the order-driven market model and all transactions are settled at the fixed price of the day. The Securities Commission has been established to regulate and supervise the public capital market. In addition, this institution monitors the issue of new securities and also licences brokerage houses and brokers. Banks' brokerage divisions and private brokerage houses act as agency brokers(until now 40 permits have been issued so far). Brokerage houses also launch new issues, manage investment portfolios and render the services of investment advisers.

Shares of 23 companies were listed on the Stock Exchange in early 1994, up from 16 at the end of 1992. ' No restrictions are placed on foreign participation in the WSE and non-residents are free to repatriate all profits earned in Poland. Non-resident investors are subject to the same levels of taxation as Polish residents. Between 1992 and 1995 all capital gains are exempt from tax, with dividend income charged at a flat rate of 20%'.18 Following a period of sluggish development in 1991-92, the Stock Exchange grew dynamically in 1993. The WSE Index(WIG) increased during this period by over 1,100% and its turnover expanded over 100 times. In early 1994, trading exceeded US$500 million a week. Trading is dominated by private investors although the activity of institutional investors - both national and foreign - is on the rise. As of yet, however, the stock market has not been an important source of raising new capital. Low price/earnings ratios have discouraged firms, although they improved dramatically improved in 1994. Chopra (1994) suggests that the cost of capital now secured in the equity market is around 3% of net earnings, in contrast to bank lending rates of closer to 40%. This would lead us to conclude that the boom experienced in Poland will continue as the stock exchange sees greater issuance and greater use of the market is made by newly commercialised firms.


The success of Poland's transformation continues to depend on the rate of structural adjustment, the growth performance of its major trading partners, and the confidence of Western companies and the major financial markets in Poland. Progress has been made to stabilise inflation, minimise the drop in output and encourage private ownership. In addition, a new framework for the banking system has been developed and capital markets are beginning to emerge both of which will prove crucially important to the financing of newly privatised companies and in acting as an important source of capital to the Polish government. They will also promote investment in the economy through their provision of credit analysis. Recent experiences in Mexico have highlighted the fickle nature of market investment. Such experiences only strengthen the notion of the interdependence of all emerging economies in achieving a successful transition.


Bruno, M., (December 1992) 'Stabilization and reform inEastern Europe', IMF Staff Papers.

Chopra, A., (1994) Poland: Path to a Market Economy IMF Occasional Paper No 113.

Pescetto, G., (1992) 'Eastern Europe and financial m', Ch5 of G. Bird(ed), Economic Reform in Eastern Europe .

Poznanski, R., (1993) 'Poland's Transition to Capitalism:Shock and Therapy' in Stabilisation and Privatisation in Poland

Stiglitz, J. E., (1992) 'The design of financial systems for the newly emerging democracies of Eastern Europe' Ch 9 of C Clague and G Rausser (eds), The Emergence of Market Economies in Eastern Europe.