On March 9, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Poland.1
In the past two years, Poland’s outstanding economic performance has come under strain. Output growth has dropped to about 4 percent in 1999–2000 from an average of 514 percent during 1993–98. Total employment has fallen by some 6 percent since mid-1998, largely reversing the trend increase since 1994. Longstanding downward trends in unemployment and inflation have been broken: unemployment has risen back to 15 percent; headline inflation, which dropped to 6½ percent in early 1999, rose back to 10–11 percent in mid 2000; and the external current account deficit rose to 7½ percent of GDP in 1999.
Several factors combined to produce this outcome in 1999 and 2000. Adverse external shocks, starting with the Poland’s loss of eastern export markets and most recently oil price rises weakened the current account balance, output growth and employment. Partly spurred by these shocks a new round of labor shedding ensued, raising unemployment.
Shifts in the policy mix made matters worse, and combined with the shocks have weakened domestic demand. Both in 1999 and 2000 significant fiscal tightening was planned to lower the external deficit and inflation, while setting the stage for an easing of monetary conditions. But slippages in both years undermined this strategy. Overall, the fiscal stance was little changed in 1999 and, according to staff estimates, was tightened by 0.2 percentage points of GDP last year on a commitments basis—less than a third of the targeted adjustment. Prompted by concerns about these developments, rising inflation and the external current account deficit, the Monetary Policy Council raised the central intervention rate by 600 basis points between September 1999 and August 2000. Banking interest rates followed suit. These factors have combined to weaken domestic demand from early 2000.
Poland has, however, weathered these shocks well. Growth of 4 percent is low only by recent Polish standards, and would be satisfactory by almost any other. Inflation is again trending downwards. The current account has also strengthened. While to some extent this reflects weakening activity, new export capacity coming on stream has also contributed significantly. Financing, moreover, has never been in doubt with the still sizable deficit in 2000 (6.1 percent) being entirely financed by FDI. There was no disturbance to capital flows ahead of or following the abolition of the crawling exchange rate band in April 2000 and the shift to a pure floating exchange rate regime. The banking system had also weathered recent increases in interest rates without sizeable decreases in portfolio quality or profitability.
On the structural front, progress continues but some new challenges are also evident. The most pressing among the new challenges is unemployment, which has risen considerably. The roots of the problem remain somewhat obscure, though there is some evidence that wage flexibility may be hampered by a binding national minimum wage. Privatization continues at a rapid pace, and is conservatively expected to generate 3 percent of GDP in receipts for the budget in 2001. The restructuring of the coal sector also continues, as is evident in the reduction of losses and arrears to social security contributions.
Executive Board Assessment
Executive Directors commended the authorities for the progress made in reducing the external current account deficit and inflation in the past year in the face of a difficult external environment. They considered that the authorities’ commitment to pursue these goals further, alongside deepening structural reforms, will strengthen medium-term economic performance and place Poland in a strong position to secure accession to the EU.
Directors noted that Poland’s economic performance in the past two years has been robust in the face of external shocks. In particular, growth was a creditable 4 percent, and while the fall in underlying inflation has been interrupted, it has not reversed. Further, the bulk of the external deficit has been funded by foreign direct investment and Poland has retained access to international capital markets on keen terms. Nevertheless, strains have emerged: notably, output growth has fallen below most estimates of potential, unemployment rates have risen to worrisome levels, and fiscal and inflation targets have been overshot. In addition, fiscal slippages have placed an undue burden on monetary policy. Thus, while the immediate outlook is for continued reductions in inflation and in the current account deficit, output growth is likely to remain modest.
In this context, Directors noted that fiscal and monetary policies for 2001 would have to strike a difficult balance between securing progress toward medium-term targets and avoiding an unduly tight policy stance in the short term when growth is below potential. In this light, they welcomed the authorities’ decision early this year to lower their fiscal revenue target in response to a reduction in projected growth and to offset only part of this adjustment through lowering spending. This represented an appropriate use of fiscal stabilizers given that inflation and the external current account balance are on a downward track. Even accepting the authorities’ revised growth projections, Directors noted that there were uncertainties in the budget estimates—notably with respect to the impact of spending carried forward from 2000, VAT receipts (assuming improved collection), and the anticipated auction of arrears of social security contributions. Should these expected sources of revenue not materialize, Directors agreed that contingency measures should be taken to secure the integrity of the budget.
In the event that GDP growth is weaker than the authorities projected, several Directors argued that the fiscal deficit should be allowed to exceed the target, on condition that inflation and the current account deficit remain on track, that existing nominal spending allocations are strictly observed, and that data on the fiscal deficit outturn are published in a timely manner. By responding in this way, Directors believed that the authorities would be maintaining the momentum towards the goal of fiscal balance in 2003, while also supporting activity in the short term. A number of Directors suggested that the authorities should monitor carefully vulnerability indicators before allowing automatic stabilizers to operate, cautioning that the room for maneuver was limited by the medium-term fiscal targets. In addition, it was noted that should the slowdown in growth remain protracted, then monetary policy action might be more appropriate. A few Directors also expressed understanding of the authorities’ view that changing the officially adopted state deficit target would be difficult in Poland’s current legal and political environment.
Directors welcomed the authorities’ objective of achieving fiscal balance in the medium term as it would provide essential room for further private investment, especially if growth of domestic demand picks up and output growth returns to potential. Directors underscored the need to strengthen initiatives to restructure public expenditure in the medium term in order to secure the balanced budget target. They emphasized that further reform of welfare and of the public wage bill warrants a high priority. Such initiatives would be crucial, especially if consolidation is to be secured alongside the reduction in the burden of taxation on the economy that is needed to spur private sector activity and employment.
Directors welcomed the preparation of the fiscal transparency module of the ROSC, progress made in many areas covered by the IMF code on Fiscal Transparency, and the authorities’ commitment to secure greater adherence to the code. They identified as priority areas the timely publication of the components of the economic deficit, the authorities’ plans for improved data reporting by ail parts of general government (including extra budgetary funds), and the reporting of expenditure arrears. Given the uncertainties in the decision-making process, a few Directors suggested that the authorities should adopt multi-annual ceilings for expenditure.
Directors welcomed the recent reduction in official interest rates. With inflation now back on a downward track towards the 2001 and medium-term targets, Directors generally agreed that there appears to be room for further interest rate reductions. However, they acknowledged that these steps would have to strike a balance between the uncertainties about the determinants of inflation in Poland, the risks of supply shocks and structural fiscal slippages, on the one hand, and concerns about the weakness of output, on the other. Directors also noted that real interest rates remain high, even after the recent reduction in nominal rates, as reflected in the strong upward pressure on the zloty in recent months. In this context, they were concerned that undue delays in lowering interest rates could jeopardize short-term output prospects and may slow the much needed strengthening of the current account. Some Directors felt that it would be appropriate to consider further adjustments to the inflation targeting framework once the 2001 inflation target has been secured.
Directors commended the authorities for the strengths of the Polish financial system as reported in the Financial Sector Stability Assessment. Its strength has been a key factor sustaining capital inflows to Poland in recent years, despite external shocks. Areas of concern have been highlighted, however, including the exposure of the non-financial sector to foreign currency risk and in bank credit risk, especially if activity decelerates further. Regarding the latter, a few Directors pointed out that in light of the falling bank profitability indicators, close monitoring of credit risk is warranted.
Directors supported the authorities’ intention to continue to abstain from intervention in the foreign exchange market, a policy which has served Poland well. The volatility of the exchange rate has been manageable and has promoted responsible hedging. Several Directors welcomed the authorities’ intention to deepen the process of capital account liberalization by abolishing the remaining controls on short-term capital flows.
Directors noted with concern the sharp increase in unemployment in the past two years. While part of this appears to be the result of the slowing of growth and much-needed restructuring of industry, certain labor market institutions may also be playing a role in impeding job creation, notably the minimum wage. Given high unemployment and the prospect of a large inflow of new entrants to the labor force, Directors urged early and active consideration of reform of the minimum wage structures, continued reform of the labor code without imposing rigidities on employers, and efforts to encourage internal labor migration and worker retraining. Directors praised the authorities’ commitment to rapid completion of industrial restructuring and privatization. These reforms would ultimately spur employment and would contribute to the preparation for EU accession.
While noting that Poland has subscribed to the Special Data Dissemination Standard and its statistical base is adequate for surveillance, Directors urged the authorities to continue to improve the quality of macroeconomic data, in particular, by reporting quarterly national accounts in current and constant prices, and strengthening monthly fiscal and balance of payments data.
|Real economy (change in percent)|
|Real domestic demand||9.6||9.4||6.5||5.0||2.3|
|Unemployment rate (in percent)||14.3||11.5||10.1||12.0||13.9|
|Gross national saving (percent of GDP)||20.9||21.6||21.9||18.9||20.1|
|Gross domestic investment (percent of GDP)||21.9||24.6||26.2||26.4||26.3|
|Public finance (in percent of GDP)|
|General government balance 1/||-3.3||-3.1||-3.3||-3.1||-2.6|
|Public debt 2/||47.9||46.9||42.9||44.5||42.5|
|Money and credit (end of period, percent change)|
|Domestic credit (12-month change)||31.1||26.5||22.1||20.5||6.9|
|Broad money (12-month change)||29.5||27.3||25.2||19.3||11.8|
|Money market rate (end. of period, in percent)||21.6||24.8||15.9||16.4||18.9|
|Balance of payments in convertible currencies|
|Trade balance (in percent of GDP)||-5.7||-7.9||-8.7||-9.3||-8.2|
|Current account (in percent of GDP)||-1.0||-3.0||-43||-7.5||-6.1|
|Official reserves (in billions of U.S. dollars)||18.2||21.4||28.3||27.3||27.5|
|Reserve cover (months of merchandise imports)||6.7||6.7||7.7||8.0||8.0|
|External debt (end of period, percent of GDP)||33.1||34.5||37.3||41.5||40.3|
|Fund position (in millions of SDRs)|
|Fund holdings of currency (end-December 2000)||1,196.7|
|Holdings of SDRs (end-December 2000)||13.6|
|Exchange rate regime||Floating Rate|
|Present rate||ZI 3.9837 per US$1 (March 8, 2001)|
|Zloty per U.S. dollar|
|(period average, in percent)||2.7||3.3||3.5||4.0||4.3|
|Appreciation (+) of real effective exchange rate|
|(relative CPIs, in percent)||13.0||1.7||4.8||-4.0||7.3|
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. This PIN summarizes the views of the Executive Board as expressed during the March 9, 2001 Executive Board discussion based on the staff report.