Journal Issue

Republic of Poland: Selected Issues

International Monetary Fund
Published Date:
August 2005
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IV. What Should be the Level of Public Debt in Poland?36

A. Introduction

64. The paper looks into the issue of how to determine the level below which public debt should kept during normal times (when output is close to its potential) in the medium- and long-term. The standard analytical framework for debt sustainability (IMF, 2003) cannot be directly applied to countries during income convergence because this period is often characterized by an average real growth rate that is higher than the average real interest rate. Real growth is faster than in mature market economies because of income convergence and the real interest rate can be lower because of higher average inflation (the Balassa-Samuelson effect) and gradually declining risk premia. In trying to establish a target level for public debt for Poland, therefore, the paper relies on other considerations related to fiscal risks and intergenerational fairness. The latter takes into account the fact that with income convergence over, real growth and the real interest rate should settle at levels observed in mature market economies. This will change the key parameters in the standard debt sustainability equation substantially, requiring a significantly stronger primary position than during income convergence to maintain any given level of public debt. Poland has two debt ceilings already in place, a constitutional debt limit and the Maastricht debt limits, both 60 percent of GDP (though for different definitions of debt). These levels, however, reflect prudential considerations: they do not imply that debt should be kept at or close to 60 percent of GDP during normal times.

B. Recent Trends

65. Public debt has increased sharply since 2001 and, after a temporary decline in 2004, it is projected to increase further in the medium term.37 Reflecting a strong real appreciation of the zloty and high privatization receipts, public debt relative to GDP declined slightly in 2004 despite a further widening of the structural deficit (Figure 1). It will, however, continue to increase rapidly in the medium term if no additional fiscal reforms are undertaken.

Figure 1.Poland: Public Debt: Baseline Scenario

(In percent of GDP)

Sources: IMF Staff calculations; Polish authorities.

66. Relative to other emerging market countries, Poland’s debt ratio fell in the decade to 2000, but since then it has risen. Benefiting from a debt restructuring, rapid growth, and high privatization receipts, Poland moved from being a relatively highly indebted emerging market economy to a relatively low one by 2000—when its public debt (excluding guarantees) relative to GDP was some 20 percentage points below the group median. Since then, however, public debt relative to GDP has increased rapidly in Poland, while it remained largely stable for emerging market economies as a whole.38

Figure 2.General Govenrment Debt in Emerging Market Economies

(In percent of GDP)

Note: For Poland, public debt excluding

Sources: IMF WEO; IMF Staff calculations; Polish authorities.

67. Continuously widening structural primary deficits were the most important factor explaining the upward trend in public debt. In the 1990s, rapid growth kept the headline primary position close to balance, while the structural primary position was gradually eroded, to a deficit of about 1 percent of GDP by 1997 (Figure 3). The fiscal expansion in 2001 pushed the structural primary deficit, to above 2 percent of GDP, and the subsequent consolidation efforts in 2002–03 brought it down somewhat. Reflecting a widening output gap, however, the headline primary deficit increased to about 3 percent of GDP by 2002. The next wave of fiscal expansion in 2004 pushed the structural primary deficit to close to 3 percent of GDP, while planned consolidation efforts in 2005 are expected to reduce it again somewhat, to below 3 percent of GDP.

Figure 3.Poland: Structural and Headline Primary Balance, 1995-2005

(In percent of GDP)

Sources: IMF Staff calculations; Polish authorities.

68. The continuous deterioration of the primary position in Poland since 2000 is in sharp contrast with the overall trend in emerging market economies. On average, emerging market economies maintained a largely stable primary surplus of between 1 and 2 percent of GDP in the new millennium (Figure 4). More specifically, empirical studies of fiscal response functions in the RAM-8 and EU candidate countries (IMF, 2005) have found a significant positive relationship between the level of the general government debt and the primary balance—suggesting that governments in the region react to increasing debt by improving the primary position. This relationship, however, does not seem to hold in Poland for 2000–04: the higher the debt stabilizing primary position the higher the primary deficit (Figure 5). Similarly, the higher the debt level in the previous year, the higher the primary deficit in the current year (Figure 6). Both findings, though based on data for a short period, does not seem to suggest a fiscal response function for this period oriented towards stabilizing the public debt.

Figure 4.Primary Balance in Emerging Market Economies

(In percent of GDP)

Sources: IMF WEO; IMF Staff calculations; Polish authrities.

Figure 5.Poland: Fiscal Response Function, 2000-04 Debt stabilizing and actual primary balance1/

1/ Data points in the figure are pairwise observations for these variables.

Sources: IMF Staff calculations; Polish authorities.

Figure 6.Poland: Fiscal policy response function, 2000-04 Debt ratio and primary balance1/

1/ Data points in the figure are pairwise observations for these variables.

Sources: IMF Staff calculations; Polish authorities.

C. Fiscal Risks

69. Relatively high exposure to risk stemming from output volatility and rollover risk argue for keeping public debt considerably below the constitutional debt limit. With public debt close to the constitutional limit a relatively large shock would push up public debt quickly. This would render the required corrective actions unrealistic and would trigger strong market reaction. If, however, public debt were lower, a similar shock would have no such effect. Exposure to rollover (liquidity) risk is another factor that should limit public debt. New theoretical frameworks (e.g., Besancenot et al., 2003) that incorporate this factor and the attitude of debt holders towards countries exposed to such risk show that public debt should be kept at a level that is lower than standard debt sustainability models would suggest.

70. Output in Poland during the past decade has been volatile by regional standards. The standard deviation of GDP growth in the period following the early transition shock (1994–2004) was around 1.9 percentage points in Poland, compared to 2.1 percentage points on average in the RAM-8 excluding Poland, 1.5 percentage points on average in the RAM-8 excluding the Baltics, and 1.4 percentage points on average in the EU-15 (Figure 7).39

Figure 7.Growth and Volatility in the EU economies, 1994-2004

Notes: EU-15: the EU member states prior to the 2004 enlargement;

RAM-8: the Central and Eats European new EU members; CEE-5: the Central European new EU members.

Source: IMF WEO data base.

71. Given the sensitivity of debt dynamics to real shocks, public debt should be kept considerably below the 60 percent of GDP constitutional debt limit during normal times to avoid a rapid increase during shocks. As the 2001–03 experience suggests, even a slowdown lasting for 2 years can result in a rapid increase in public debt. Simulation results show (Figure 8) that a real shock to staff’s baseline scenario, similar in size to the one in 2001–03 (a decline of 2.75 percent in growth for 2 years) hitting the economy at a public debt-to-GDP level of close to 60 percent would result in an escalating public debt. The same shock would have a much milder impact if the structural fiscal position was stronger and the debt ratio was significantly lower (Figure 9).

Figure 8.Poland: The Impact of a Large Real Shock on Public Debt: Baseline Scenario

(In percent of GDP)

Sources: IMF Staff calculations; Polish authorities.

Figure 9.Poland: The Impact of a Large Real Shock on Public Debt: Alternative Scenario

(In percent of GDP)

Sources: IMF Staff calculations; Polish authorities.

72. Confirming theoretical arguments, industrial countries on average seem to keep their debt at levels that take into account the variability of their output. A simple equation for OECD countries, relating the average debt-to-GDP ratio (in 2000–04) to the longer-term standard deviation of growth, explains over 60 percent of the variation in the debt-to-GDP ratio across these countries (Figure 10). The values for both the old and new EU members as groups are along the fitted line in Figure 10, which for Poland suggests a public debt (excluding guarantees) of about 37 percent of GDP.40

Figure 10.General Government Debt and Output Variability in OECD Countries

Note: * EU15 excluding Belgium, Greece, and Italy

73. Using a framework which incorporates the impact of shocks to the planned future primary surplus, related to shocks to the output (tax base), leads to a similar result. In this model (Besancenot et al., 2003), the largest amount of debt rational investors will hold is lowered (relative to a model with no shocks) by the size of the shock to the primary surplus and is given by the formula

where R is the upper bound for future primary surpluses, A is the parameter of the uniform distribution [-A, A] from which the random shock to the primary surplus is drawn, and i is the risk free interest rate. Making R the highest observed primary surplus in Poland since 1994, 1.8 percent of GDP; A the impact of one standard deviation of growth during the same period (1.9 percent) on the primary balance using available estimates of the marginal sensitivity of the budget balance to the cycle for Poland (0.36, given by Coricelli and Ercolani, 2002); and the risk free interest rate equal to the 10-year euro yield (3.15 percent), leads to a public debt (excluding guarantees) limit of 35½ percent of GDP (or 37–37½ percent of GDP for public debt including guarantees).

74. The relatively short average maturity of domestically-issued public debt argues for a debt level that is lower than the norm in more mature economies. Though it has increased significantly since EU accession the average maturity of domestically-issued marketable State Treasury debt, at 3.2 years in January 2005, is still relatively low in Poland (Figure 11), about half of the average in the EU-15 (Figure 12). This, together with a high deficit, creates strong exposure to roll-over risk. Poland’s annual gross public financing requirement (maturing debt plus deficit) is about 60 percent higher than the average in the EU-15, even though Poland has a significantly lower debt ratio than the EU-15 average. Poland’s annual gross public financing requirement is similar to that of Italy, where general government debt is over 100 percent of GDP.

Figure 11.Poland: Average Maturity of Domestically-Issued Marketable State Treasury Debt

(in years)

Source: Polish authorities.

Figure 12.Selected EU Countries: The Average Maturity of Marketable Central Government Debt

(in years)

Poland in January 2005, other countries in 2002

Sources: OECD Central Government Statistical Yearbook, 2004; Polish authorities.

D. Intergenerational Considerations

75. Intergenerational fairness also influences the appropriate level of debt during income convergence. As Poland approaches convergence of its income relative to the EU, a slowdown in income growth will require stronger primary position the higher the level of debt at the time. It is therefore important to complete the process of income convergence with a level of public debt that does not put an unfairly high burden on future generations after convergence is achieved. Simple, illustrative long-term simulations (see Box 1) show that, under certain assumptions, the adjustment in the primary position future generations will have to achieve may be twice as large if debt at the end of convergence reaches 60 percent of GDP instead of 40 percent (Figures 13and 14). This exercise is based on a narrow concept of intergenerational fairness and the model does not incorporate the optimal distribution of the costs of higher public investment during income convergence across generations. Moreover, there are several other possible scenarios for income convergence in Poland (and the region, see Hughes Hallett and Lewis, 2004). Nonetheless, these results suggest that a careful consideration should be given to intergeneration fairness.

Figure 13.Poland: Convergence with Debt at 40 Percent of GDP

(In percent of GDP)

Source: IMF Staff calculations.

Note: For the assumptions underlying this scenario, see Box 1.

Box 1.Long-Term Debt Sustainability Simulations

The results presented in Figures 13 and 14 are from simulations based on the following assumptions:

Figure 14.Poland: Convergence with Debt at 60 Percent of GDP

(In percent of GDP)

Source: IMF Staff calculations.

Note: For the assumptions underlying this scenario, see Box 1.

  • The rate of real growth during income convergence is assumed at 4.6 percent, which produces full income convergence in 35 years. The rate of growth gradually declines toward the end of the convergence process, to 3¾ percent in 2040, and to 2 percent by 2045. It is assumed to stay at 2 percent in the rest of the simulation period.

  • The real interest rate is assumed to be 2½ percent during convergence, gradually increasing to 3 percent afterwards (by 2045).

  • In the first scenario (Convergence with Debt at 40 percent of GDP), the primary deficit is reduced to ½ percent of GDP by 2010 and kept at that level until the end of convergence (2040). The primary balance then moves to a surplus of 1 percent of GDP.

  • In the second scenario (Convergence with Debt at 40 percent of GDP), the primary deficit is reduced to about 1.4 percent of GDP by 2010 and kept at that level until the end of convergence (2040). It is then moves to a surplus of 1 percent of GDP.

  • All other assumptions (e.g., the rate of inflation) are identical in the two scenarios.

E. Implications for Fiscal Consolidation in the Short Run

76. Standard debt dynamics analysis indicates that the present deficit, if sustained, would produce an extremely high level of debt before stabilization occurred. The basic relationship driving debt dynamics is

where σ is the required primary position (relative to GDP) to maintain the existing debt ratio,r is the real rate of interest, and n is the rate of real growth, and b is the existing level of public debt (relative to GDP). Taking Poland’s average growth rate of 4½ percent in the past decade or about 3½ percent for the past five years, a forward looking real interest rate (between about 2 percent in the euro area and 3 at present in Poland), and the current level of public debt (about 50 percent of GDP), Poland would have to maintain a primary deficit of less than ⅓–1¼ percent of GDP to keep the debt ratio stable. This compares to a structural primary deficit of close to 3 percent in 2004. If the target level for public debt was 60 percent of GDP, it would allow a primary deficit relative to GDP by some ¼ percentage point higher, while a 40 percent of GDP target would require a ¼ percentage point lower level. That is, depending on the assumptions, the structural primary position relative to GDP needs to be reduced by some 1½–2½ percentage points (Table 1). The current structural primary deficit of about 3 percent of GDP would lead to debt levels ranging from 200 to over 400 percent of GDP under any set of assumptions.

Table 1.The Basic Debt Sustainability Equation
Target level for debt40.
Growth rate3.
Real interest rate2.
Required primary position-0.6-0.2-1.0-0.6-0.8-0.3-1.3-0.8-0.9-0.3-1.5-0.9
Source: IMF Staff calculations.

F. Conclusions

77. Several considerations related to fiscal risks and generation fairness suggest that a prudent level of public debt in Poland during income convergence would be 40 percent of GDP or less. This level would make it possible to absorb the impact of large real shocks without triggering abrupt corrective actions; would limit the roll-over risk; and would position Poland well for the post-convergence period.


    Besancenot, Damien, KimHuynh, and RaduVranceanu, 2003, Default on Sustainable Public Debt: Illiquidity Suspect Convicted, Economics Letters 82 (2004), pp. 20511.

    Coricelli, Fabrizio and ValeroErcolani, 2002, Cyclical and Structural Deficits on the Road to Accession: Fiscal Rules for an Enlarged European Union, CEPR Discussion Papers No. 3672, CEPR, London.

    HughesHallett and Lewis, 2004, Hansa vs Hasburg: Debt, deficit and the entry of accession countries into the euro, CEPR Discussion Paper Series No. 4500, July2004.

    IMF, 2003, World Economic Outlook, Chapter III: Public Debt in Emerging Markets: Is it too high? (Washington: International Monetary Fund).

    IMF, 2005, Hungary: Selected Issues, Chapter II Fiscal Commitment: The Role of Budget Institutions, International Monetary Fund, May2005, IMF Country Report No. 05/215.

Prepared by István P. Székely.

This paper uses the Polish definition of public debt (in the Public Finance Act), which includes the risk-weighted stock of government guarantees and is based on a broad definition of the general government. To ensure comparability, public debt excluding guarantees is used in international comparisons.

Emerging market economies include Argentina, Brazil, Bulgaria, Chile, China, Colombia, Costa Rica, Cote d Ivoire, Croatia, Ecuador, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Lebanon, Malaysia, Mexico, Morocco, Nigeria, Pakistan, Panama, Peru, Philippines, Poland, Russia, South Africa, Thailand, Turkey, Ukraine, Uruguay, and Venezuela.

The EU15 countries are the EU member states prior to the 2004 EU enlargement.

For public debt including guarantees, this would be slightly below 40 percent of GDP.

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