By Brian Daigle

Poland, the 6th largest economy in the European Union and by far the largest in Eastern Europe, has been able to withstand the recent financial crisis in ways that are enviable to most OECD countries. But recent developments with two of Poland’s trading partners – Russia and Germany – could slow Poland’s remarkable growth.

Since the fall of the Soviet Union, Poland has become a standard bearer of trade and market liberalization, privatization, and the establishment of strong internal regulatory infrastructures. These factors all help to explain Poland’s significant growth, as nearby economies make anemic progress or slip into recession.

Unlike the larger economies of the UK, France, Italy, or neighboring Germany, during the financial crisis Poland’s economy never officially went into recession. In 2009, when France’s economy contracted 3.1%, Germany 5.1% and the UK 5.2%, Polish GDP grew at a rate of 1.8% (although it is true that Poland started from a lower floor of development and has significant growth potential). As the EU struggles to return to its pre-crisis levels, Poland’s GDP has expanded 16% since the onset of the recession.

However, certain indicators currently suggest that outside forces may disrupt Poland’s economy, creating potential problems both for Eastern Europe’s development and the larger recovery of the EU economy. While the World Bank currently projects Polish growth next year to be 3.5% and 3.8% in 2016, these desirable estimations have not adjusted for the tensions and economic consequences of the EU economic sanctions against Russia, nor Russia’s retaliatory sanctions against EU agricultural goods.

Russia’s sanctions against EU agricultural goods have hit Poland especially hard. Polish agricultural exports represent the largest EU member state contribution to Russian food imports (approximately $1.1 billion in lost revenue for Poland). As a result, Poland’s particularly sensitive agricultural market has been hit hard.

Agriculture is a tricky subject in Poland. Despite liberalization of many markets, agriculture remains a protected industry in the country, with significantly low taxes on farmers contributing to an oversupply of labor and a particularly sensitive market to external shocks (despite contributing to only 3.5% of overall GDP, approximately 13% of Poland’s labor force is devoted to farming).

These sanctions have led to increased EU support for Poland’s agricultural workers, though this is criticized as insufficient to cover even the farmers’ costs of production. In addition, Russia recently passed a law disallowing the re-export of EU goods from Belarus to Russia, further hampering Poland’s agricultural efforts. Even a brief proposal by the Polish economy minister to change advertising laws to make it easier for Poles to buy cider in an attempt to boost domestic apple consumption failed to pass (approximately half of Poland’s apples are shipped to Russia).

Coupled with agricultural concerns, the security element of the Russia-Ukraine dispute has led to a shift in Polish spending towards meeting self-defense needs. The Defense Ministry has announced that it is planning on boosting the 100,000-strong Polish military to include a new 20,000-strong territorial force. Poland also announced the $490 million purchase of 40 air-launched missiles from the United States (the first with the capacity to hit Russia from Polish territory), as well as 48 F-16 jets.

With low growth in Germany (Poland’s largest trading partner), and the freeze in trade from Russia (Poland’s 2nd largest import partner, and 5th largest export partner), Poland’s successes in achieving sustainable growth and chipping away at its notoriously high unemployment levels (especially among the youth) could be wiped away.

In a surprise move, last week Poland’s central bank announced a 50 basis point reduction in interest rates to 2% following 15 months of unchanged rates. The fall in consumer prices from a backstop of agricultural produce was explained as the chief source of the change, with possible further easing in the months ahead.

Ewa Kopacz’s inauguration as Poland’s prime minister on October 1 may also sow market discord. Her predecessor, Donald Tusk, was the central leader of Civic Platform, and his departure to become President of the European Council has left a hole in Poland’s center-right party infrastructure.

Whether Kopacz will be able to fill Tusk’s shoes remains to be seen, but Poland’s parliamentary elections next October could see a shift in power that could throw off Poland’s historic political stability without Tusk at the helm.

The fundamentals of Poland’s economy are strong. It has a significant service-based industry, with a strong regulatory framework and a prominent devotion to open markets and open access to investment.

But Poland’s weak points – an oversized and non-diversified agricultural sector, persistently high unemployment, and the flight of Poland’s educated young people to better opportunities elsewhere – are all being tested by Russia’s sanctions.

Aside from the clear economic implications, the military and defense component of the Russia-Ukraine conflict will likely lead to further strain in Poland’s budgetary framework, and could harken a downturn in Europe’s largest consistently growing economy.

First published in Global Risk Insights.