Republic of Poland: Staff Report for the 2003 Article IV Consultation
Author: International Monetary Fund
Publication Date:
25 Jun 2003
eISBN:
9781451831856
ISBN:
9781451831856
Language:
English
Keywords:
ISCR; CR; headline CPI inflation; government; estimate; monetary policy; exchange rate; foreign currency; broad money; current account; Inflation
Download PDF (1.8 MB)

This 2003 Article IV Consultation highlights that the economy of the Republic of Poland began to recover during 2002 from the sharp weakening of growth in 2000–01, but the recovery is fragile. Private consumption picked up gradually, fueled by rising real fiscal transfers, easing monetary policy, and a drop in the savings ratio. Exports outpaced rather weak market growth as competitiveness improved. The recovery also reflected a lessening of negative influences: a sharp drop in inventories ended, and the contraction of fixed investment lessened.

Abstract

This 2003 Article IV Consultation highlights that the economy of the Republic of Poland began to recover during 2002 from the sharp weakening of growth in 2000–01, but the recovery is fragile. Private consumption picked up gradually, fueled by rising real fiscal transfers, easing monetary policy, and a drop in the savings ratio. Exports outpaced rather weak market growth as competitiveness improved. The recovery also reflected a lessening of negative influences: a sharp drop in inventories ended, and the contraction of fixed investment lessened.

I. background

1. In 2002, the economy began to recover from the sharp weakening of growth during 2000–01, but the recovery was fragile (Figure 1 and Table 1). Private consumption picked up gradually, fueled by the jump in fiscal transfers in 2001, easing monetary policy and a drop in the savings ratio. Exports outpaced rather weak market growth as competitiveness improved, domestic market growth disappointed, and exporters moved aggressively into rising CIS markets. In other respects, the recovery reflected more a lessening of negative influences than the emergence of sources of strength: a sharp drop in inventories ended, and the contraction of fixed investment lessened. Without signs of a leading force behind the recovery, its robustness remains in doubt. Investment appears to be weighed down by an overhang from the late-1990s, rising unemployment and moderating wage increases threaten consumption growth, and weak European markets constrain the scope for exports. Recent retail sales, construction activity and confidence surveys reinforce these doubts.

Figure 1.
Figure 1.

Poland: Activity and Demand, 1998-2003

(Year-on-year real growth, in percent)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Sources: Polish authorities and staff calculations.
Table 1.

Poland: Selected Economic Indicators, 1998-2003 1/

(In percent, except where indicated)

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Sources: Polish authorities and staff estimates.

GDP series for 2000-2002 are based on the authorities’ new methodology introduced in late 2002. GDP series prior to 2000 are staff estimates of the new methodology, using growth rates from the old methodology. This applies to all tables and figures of the staff report

Derived as a difference between total savings and current account

With second pillar pension funds part of general government

With second pillar pension funds outside general government

Data for 1996-98 covers central government debt only.

Including risk weighted stock of outstanding guarantees.

2. The slack in the economy remained evident (Figure 2). Consumer price inflation fell below 1 percent. Falling food prices played a role, but more important were moderating cost, especially wage, increases. Employment continued to drop, and, even with falling labor force participation, the unemployment rate rose to almost 19 percent. The external current account deficit remained moderate by transition country standards (Table 2).

Figure 2.
Figure 2.

Poland: Indicators of Economic Slack, 1998-2003

(In percent)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Sources: Polish authorities, Labor Force Survey, and staff calculations.1/ The quarterly Labor Force Survey was not undertaken in Q2 and Q3 of 1999.2/ The Mazowieckie region encompasses Warsaw.
Table 2.

Poland: Balance of Payments, 1998-2007

(In millions of US dollars)

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Sources: NBP and staff estimates.

Based on WEO calculations.

Net oil related imports are defined as net imports of mineral fuels, lubricants, and related materials (SITC section 3), using customs data.

Defined as external liabilities minus external assets, both exclusive of equity portfolio and direct investment.

Excluding debt buyback.

3. Macroeconomic policies were eased. Since early 2001, monetary policy in particular was deliberately and substantially relaxed, and by April 2003, the main policy interest rate had fallen cumulatively by 1,325 basis points to 5.75 percent (Figure 3). With inflation falling, real interest rates dropped more gradually—but still by a substantial 6 percentage points. Also, lower interest rates (together with political uncertainties and the need to attract sharply higher portfolio and other capital inflows as FDI slowed to a trickle) contributed to a welcome 15 percent depreciation of the real effective value of the zloty since early 2002. Nevertheless, credit growth to enterprises was low reflecting banks’ caution in the face of rising non-performing loans and weak demand as enterprises delayed investments (Table 3).

Figure 3.
Figure 3.

Poland: Indicators of Monetary Policy, 1998-2003

(In percent, except where indicated)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Sources: Polish and other country authorities, International Finance Statistics, and staff estimates.1/ The real interest rate and the REER have weights of 50 percent; Jan 1998–Oct 2002 = 100.2/ Since end-March 2002, rates reflect revisions of monetary accounts.3/ 28-day intervention rate through end-2002; 14-day intervention rate thereafter.4/ Policy rates deflated by the percentage change in CPI over the previous 12 months.5/ ECB fixed rate until July 2000; minimum bid rate thereafter.
Table 3.

Poland: Monetary Survey, 1998-2002

(In millions of zloty, end-of-period)

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Sources: National Bank of Poland and staff estimates.

As of September 2002.

4. After a large injection of fiscal stimulus in 2001, the fiscal stance in 2002 was neutral (Table 4). Financial plans of the general government for 2002 aimed for a withdrawal of stimulus of around 2/3 percent of GDP. In the event, lower-than-expected economy-wide wage increases cut into the tax and contribution base while expenditures—most significantly, transfers to households and public sector wages—could not be reduced commensurately with lower-than-expected inflation. Thus, the structural fiscal deficit rose slightly to 4.9 percent of GDP, the actual deficit widened from 5½ to over 6½ percent of GDP, and public debt rose sharply.

Table 4.

Poland. General Government Revenues and Expenditures, 1998-2003

(In percent of GDP)

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Sources: Polish authorities and staff estimates and projections.

General government overall balance on a cash basis including payments in compensation for insufficient indexation in the 1990s.

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Sources: Polish authorities; and staff calculations.

General government overall balance on a cash basis including payments in compensation for insufficient indexation in the 1990s.

5. The origins of the weakness in economic activity in 2000–01 were complex, and a robust recovery will await corrections on several fronts. Global cyclical influences do not tell the whole story. That the slowdown was substantially more severe than in Poland’s relatively more open transition neighbors points to the importance of other influences.

uA01fig01

GDP Growth

(year-on-year, in percent)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Source: Authorities.

  • At the heart of the slowdown was a long slide in investment growth as the torrid pace of early-transition investment cooled. Combined with restructuring after the Russia crisis, this slide contributed to a radical shift from employment creation to employment destruction. External cyclical influences and the severe tightening of monetary policy in 2000 played a role, but with an investment overhang also likely to have been a factor, the recovery could be slow.

  • The fiscal-monetary policy mix remains a problem. Efforts since the mid-1990s to address excessive spending, especially on social transfers, have met strong political resistance. Moreover, revenue reductions largely absorbed the limited success in curtailing and better targeting spending (Figure 4). As the structural deficit and public debt climbed, monetary policy was left to curb current account and inflation pressures, producing a policy mix that put pressure on interest rates and the exchange rate. More recently, even as monetary policy has eased, the risk of a tightening if fiscal adjustment is delayed creates market uncertainty.

  • Privatization largely ground to a halt in 2002, and progress was slow in redressing the problems of state enterprises where privatization prospects are remote. Subsidies continue to burden the budget, and low productivity in public enterprises weighs on growth. The share of GDP produced by the public sector remains above that in other advanced transition economies.

  • The banking system, which is well supervised and largely foreign-owned, was strained by the slowdown. Bank profits dropped as nonperforming loans rose, the value of banks’ equity holdings fell, and lending decelerated. While the drop in profitability is probably largely cyclical, at least the early stages of the recovery will be affected by banks’ reluctance to lend, particularly to small and medium-sized enterprises.

Figure 4.
Figure 4.

Poland: Fiscal Indicators, 1995-2002

(In percent of GDP, except where indicated)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Sources: Polish authorities and staff calculations.
uA01fig02

Share of GDP Produced in the Public Sector, 2001

(Percent)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Source; EBRD’s Transition Report, 2002.
uA01fig03

Banking Sector: Non-performing Loans

(as a percent of Gross Claims) Source: Polish authorities.

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Source: Polish authorities.

6. Political uncertainties also cloud the situation. Falling popularity of the government and the recent breakup of the coalition have created a difficult environment for structural reform and legislative changes needed for EU entry. The President and Prime Minister have called for a general election, originally scheduled for late-2005, in June 2004; speculation about an earlier date is rife. Relations between the NBP and the government remained strained, owing to a new conflict about use of the revaluation reserve of the NBP. The need to reconstitute the MPC in early 2004, when the terms of all current members (excluding the President) expire, adds to the uncertainty.

7. Notwithstanding these weaknesses, the economy enters this upturn with distinct strengths. EU accession opens an era of policy coordination with Europe through potentially powerful channels for speeding income convergence. This, and modest external indebtedness, prompted declining spreads and an upgrade in Moody’s ratings of external debt to A2 in November 2002 (Table 6). The structural revamping of private industry after the Russia crisis, when firms had to cut costs and turn to Western markets, left it leaner and more competitive. Slowing domestic demand reinforced these tendencies. Wages proved responsive to developments in the labor market (although continuing high unemployment may require an even stronger response), while the zloty depreciation in 2002 further bolstered export profitability (Figure 5). Reforms to the labor code introduced since mid-2002 should stimulate labor demand once the recovery takes hold. And inflation expectations have been tamed. With a moderate current account deficit and a floating exchange rate, these developments have diminished important sources of vulnerability.

Table 5.

Poland: Savings and Investment Balance, 2002-2007

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Sources: Polish authorities and staff estimates.

BOP basis.

Table 6.

Poland: Indicators of External Vulnerability, 1999-2003

(In percent of GDP, unless otherwise indicated)

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Sources: Bloomberg, Polish authorities, and staff estimates.

Data for 1999 and beyond covers general government debt; data for earlier years includes central government debt only.

End-of-period.

Backward-looking with actual CPI.

By original maturity.

CPI based, using 1999 trade weights.

In Standard & Poor’s rating system BBB- is investment grade whereas BB+ is below.

In Moody’s rating system Baa is investment grade whereas Ba is below.

Spread on Polish bond expiring 03/2010 with a 6 percent coupon and German bond expiring 07/2010 with a 5 1/4 percent coupon.

Figure 5.
Figure 5.

Poland: Indicators of Wage Costs, Profits and Competitiveness, 1997-2003

(January 1997=100, unless otherwise indicated)

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Sources: Polish authorities. Information Notice System, OECD Analytical database, and staff calculations.1/ Trade weights for 1999 for Austria, Belgium, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, Norway, Spain, Sweden, Switzerland, United Kingdom, and United States.2/ US dollar ULC in Poland relative to US dollar ULC in Hungary, Czech Republic, and Slovakia, weighted by share of average exports of goods and services in 1995 and 1996.3/ Wage bill per employee in the manufacturing sector as ratio to value added per employee, relative to the same ratio in France. A higher ratio implies less favorable profitability, other things being equal.4/ Using IMF staff estimates for total employment.5/ NEER and REER data for February and March 2003 are approximated by a basket of euro (60 percent) and dollar (40 percent) against the zloty.
uA01fig04

Wages Have Been Responsive to Unemployment Sources: Polish authorities and staff calculations.

Citation: IMF Staff Country Reports 2003, 187; 10.5089/9781451831856.002.A001

Sources: Polish authorities and staff calculations.

II. Report on the Discussions

8. Discussions focused on policies to build on the nascent recovery and return to a path of high growth. Fiscal and structural reforms, policies to prevent an undue increase in inflation, and plans for euro adoption were the main issues.

9. The authorities were optimistic about growth prospects and reaffirmed their commitment to fiscal adjustment and structural reform. They noted, however, that after several failed attempts to introduce substantive fiscal reforms and with the recent split in the majority coalition, the political challenges were daunting. Renewed efforts would be based on a cooperative approach drawing all segments of the government into the process. They were concerned about falling investment and rising unemployment, but believed that the cyclical recovery, structural reforms, and positive effects of EU accession would improve the situation. They were confident about the soundness of the banking system, despite the weakening of banks’ performance during the past two years.

10. The authorities intend to enter ERM2 and adopt the euro on the most compressed schedule possible. They concurred with ongoing staff analysis indicating that Poland meets optimum currency area criteria (synchronization of business cycles and economic integration) by the standards of many existing euro-area members. The Ministry of Finance (MoF) and NBP agreed that adopting the euro would bring substantial benefits and plans for early adoption would help mobilize support for needed fiscal adjustment—the most challenging Maastricht criterion for Poland. They therefore aimed to meet the Maastricht criteria by 2006 so as to be able to adopt the euro in 2007. Dissent, even within the government, would make the timetable a challenge. The authorities were eager for clarification of some aspects of ERM2 and the Maastricht criteria: most importantly, whether the exchange rate would need to remain within wide or narrow bands for two years prior to euro adoption and the definition of the deficit against which the fiscal criterion would be measured.

A. Economic Outlook

11. Near-term, the recovery is likely to remain gradual and fragile. Strengthening corporate profits, diminishing excess capacity, and a recovery in Western Europe will boost investment, but with no signs yet of a decisive turnaround, timing is highly uncertain. Staff expected that private consumption would decelerate slightly in 2003 as the effects of the 2001 fiscal stimulus wore off, unemployment rose, wage growth remained slow and the terms of trade weakened (Tables 1 and 4). Export growth was likely to fuel the recovery, although external factors—German growth in particular—would be critical. Thus, staff saw growth rising to 2.6 percent in 2003 (in line with consensus) and to 4 percent in 2004. The authorities broadly agreed with this assessment, although, expecting an earlier rebound in investment, felt the budget forecasts for GDP growth of 3½ percent in 2003 and 4.9 percent in 2004 were still feasible.

12. Pressures on inflation and the current account should remain subdued. The output gap, which staff estimates at 2.6 percent of potential output in 2002, will widen through 2004. Even with some drop in unemployment in 2004, labor market conditions should constrain wage growth. Staff therefore concurred with the authorities that inflation would be below 2 percent in 2003 and, even with some easing of interest rates, remain well within the target range of 1.5–3.5 percent in 2004. Although imports will rise when investment recovers, strong export growth should keep the current account deficit at about 4 percent of GDP through 2004.

13. For the medium term, assuming the initiation of structural fiscal reforms and some further easing of interest rates, prospects for growth are good. Estimates of the capital stock and trend productivity suggest that with a cyclical increase in employment, output growth should rebound to 5–5½ percent as the output gap closes during 2005–08, before falling to potential of 4¼ percent (Table 5). The scenario underlying the new medium-term fiscal program of the MoF was more optimistic. Envisaging stronger investment growth than in the staff scenario, it sees growth rising to 5½–6 percent by 2005–06. Taking into account the large fiscal adjustments needed, staff saw this as feasible only with decisive structural reform through privatization, improving the functioning of labor markets and incentives to work, and strengthening fiscal expenditure and tax frameworks. Moreover, staff emphasized that without improvements to the policy mix, growth prospects could be significantly worse than envisaged in its own scenario. Staff and the authorities agreed that increases in public savings were essential for containing current account pressures and crowding in private investment, including FDI. External and public debt dynamics remain manageable under most stress tests, but in some public debt would exceed the constitutional limit of 60 percent of GDP (Tables 7 and 8).

Table 7.

Poland: External Debt Sustainability Framework, 1997-2007

(In percent of GDP, unless otherwise indicated)

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Sources: Polish authorities and staff calculations.

Derived as [r - g - ρ(l+g) + επ(l+r)1/(l+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(l+g) + ∑a(l+r)]1/(l+g+ρ+gρ) times previous period debt, stock, ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

Table 8.

Poland Public Sector Debt Sustainability Framework, 1997-2007

(in percent of GDP, unless otherwise indicated)

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Sources. Polish authorities and staff calculations

Indicate coverage of public sector e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(l+g) - g + ag(l+r)l/(l+g+πgπ)) times previous period debt ratio, with r = interest rate π = growth rate of GDP deflator; g = real GDP growth rate, α=share of foreing-currency denominated debt, and ∑ = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(l+r)

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).