Republic of Poland
2009 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Poland

This 2009 Article IV Consultation highlights that Poland’s rapid growth had begun to lose steam even before the global crisis hit. Following robust and relatively well-balanced expansion, driven by an EU accession-related investment boom and rapid credit and wage growth, economic activity began to slow down in the face of capacity constraints. Executive Directors have noted that a significant deceleration in economic activity is under way, reflecting adverse spillovers through real and financial channels. They have also commended the authorities for the timely, well-focused, and measured policy response.


This 2009 Article IV Consultation highlights that Poland’s rapid growth had begun to lose steam even before the global crisis hit. Following robust and relatively well-balanced expansion, driven by an EU accession-related investment boom and rapid credit and wage growth, economic activity began to slow down in the face of capacity constraints. Executive Directors have noted that a significant deceleration in economic activity is under way, reflecting adverse spillovers through real and financial channels. They have also commended the authorities for the timely, well-focused, and measured policy response.

I. Context1

1. Poland’s rapid growth had begun to lose steam even before the global crisis hit. Following a robust and relatively well-balanced expansion, driven by an EU accession-related investment boom and rapid credit and wage growth, economic activity began to slow in the face of gradually emerging capacity constraints. By mid-2008, inflationary pressures peaked and the unemployment rate was at record lows. Still, despite a somewhat pro-cyclical fiscal policy, external and internal imbalances were relatively limited going into the crisis.


Poland: Real GDP Growth

(Annualized q-o-q percent change, sa)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Source: Polish Statistical Office.

2. A sharp deceleration in activity is underway, reflecting spillovers from the global crisis through real and financial channels.

  • Real sector channel. With Poland’s key export markets in recession, exports contracted by 30 percent (year-on-year) in the first quarter of 2009. While the share of exports in GDP of about 40 percent is relatively low compared to regional peers—reflecting the larger size of the Polish economy—the significant compression in exports is having a considerable direct impact on domestic activity (Figure 1).

  • Financial sector channel. As in other countries in the region, local asset markets succumbed to sharp price declines and capital outflows led to rapid zloty depreciation in the wake of Lehman Brothers (Figure 2). In addition, the interbank market froze in late October 2008, reflecting increased uncertainty, and a number of banks had difficulty obtaining foreign exchange liquidity to fund their growing foreign-currency-denominated (largely Swiss franc) mortgage portfolio.

Figure 1.
Figure 1.

Poland: Recent Economic Developments, 2001-09

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: European Commission; Bloomberg; and Haver.
Figure 2.
Figure 2.

Poland: Recent Financial Markets Developments June 2008 - July 2009

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: Bloomberg; and Polish Ministry of Finance.

3. As a result, output growth has decreased sharply, albeit less so than in regional peers. While consumption held up relatively well through the first quarter of 2009, partly supported by tax cuts that came into effect in 2008-09, investment declined significantly, and domestic demand slowed sharply as uncertainty about the economy emerged. Still, while other economies in the region contracted in the last two quarters, Poland managed to maintain slight positive growth.


Poland: Contributions to GDP Growth

(Annualized q-o-q percent change, sa)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Source: Polish Statistical Office.

GDP Growth, 2009Q1

(Q-o-q, s.a.)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

4. As exports fell sharply, the current account balance worsened before reversing course in recent months. Notwithstanding gains in export market share, the current account deficit widened to 5.5 percent of GDP in 2008 from 4.7 percent of GDP a year earlier. However, the deficit declined to 4 percent of GDP in the first quarter, as domestic demand weakened, and the compression in imports more than offset the contraction in exports in early 2009. Following sustained inflows in recent years, FDI slowed sharply by about 50 percent in the first quarter of 2009 compared to a year earlier.2


Poland: Current Account Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: NBP; IMF Direction of Trade.

5. Against this background, markets have welcomed Poland’s FCL. The zloty reached a four-month high against the euro immediately following Poland’s FCL announcement, but has subsequently lost some ground, in line with developments in the region (Figure 3). CDS spreads narrowed by about 100 basis points over this period, although this also reflected, in part, regional trends. Shortly after the FCL was approved, the authorities tapped the euro bond market with a spread that was 20 basis points lower than in January. In early July, the authorities issued a $2 billion ten-year bond, their largest ever issuance on the U.S. market. Both papers were significantly over subscribed.

Figure 3.
Figure 3.

CE-3: Reaction to Mexico and Poland FCL Announcements

(March 2, 2009-June 29, 2009)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Source: Bloomberg; and DataStream.

6. A sharp slowdown in credit growth is underway. While foreign bank exposure to the Polish banking sector has remained stable since the third quarter of 2008, surveys suggest that banks have tightened credit criteria dramatically both for corporate and individual borrowers since the fourth quarter of 2008. Such changes in lending policies have been influenced by uncertainties related to the economic outlook, growing industry-specific risks (real estate and export industries), and the expected deterioration in the capital position of the banks. Loan demand has also weakened with declining investment activity. Reflecting growing uncertainties and the continuing difficulties faced by global banking groups, Polish banks—mostly foreign subsidiaries—have a strong liquidity preference and have not been willing to lend to other banks in the interbank market beyond one-week maturities.

7. The banking system, nonetheless, has weathered the crisis well so far. Poland’s banking system entered the crisis from a relatively strong position. Although it has experienced a rapid credit expansion as in other countries in the CEE region, Poland’s credit boom started later and has been shorter (Figure 4). Still, credit risk has risen with the slowdown of the economy. NPLs started to pick up in 2009, especially in the non-financial corporate sector (Figure 5). Lower asset returns and higher funding costs have already begun to squeeze profitability—banking sector profits have fallen by about 50 percent in the first quarter of 2009 from a year earlier. But the banking system remains well capitalized with a capital adequacy ratio (CAR) of 11.7 percent at the end-April 2009, a high ratio of tier 1 capital, and record profits in 2008.

Figure 4.
Figure 4.

CE-3: Key Lending Indicators, 2005-08

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: IMF, International Financial Statistics database; Haver; and EMED.
Figure 5.
Figure 5.

Poland: Recent Credit Developments, 2005-09

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: National Bank of Poland, and IMF staff estimates.

II. Policy Response to the Crisis

8. Monetary policy has been accommodative. Inflation rose through the third quarter of 2008, overshooting the NBP’s tolerance range of 1½ to 3½ percent. Since then, the global commodity price boom reversed course, slower output growth set in, and wage and price pressures receded. In this regard, the size of the exchange rate pass-through to inflation has diminished, which has alleviated inflationary pressures from building up during the recent zloty depreciation episode (Annex 1). The decline in inflation, together with the room provided by euro interest rate cuts, has prompted the NBP to embark on a loosening cycle: since November, policy rates have been lowered by 250 basis points to 3.5 percent. Besides renewed price pressures in commodities, recent policy rate cuts have been tempered by concerns about zloty depreciation. The reserve requirement was recently lowered by 50 basis points to 3.0 percent.

9. Measures have also been taken to assist bank funding and safeguard financial stability. Specifically, to address foreign-currency funding risks and broader liquidity shortfalls, the authorities introduced dollar, Swiss franc, and euro swaps; widened the list of collateral that can be used at its discount window; and extended the maturity of repo transactions (Text Table). They have also proactively addressed a potential fall in capital buffers by stepping up the frequency of top-down stress testing and on-site inspections and have successfully convinced most banks to retain their profits from 2008. Finally, to ease the credit crunch, the authorities have introduced a credit-guarantee program offered by the state-owned bank BGK, albeit, so far, no bank has applied for it likely because of potential adverse signaling effects.

Text Table.

Measures to Safeguard Financial Sector Stability

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10. A fiscal stimulus enacted before the crisis came into effect as the slowdown set in. The 2008 general government deficit exceeded the budget target by 1½ percent of GDP, reaching almost 4 percent of GDP and prompting the EC to invoke the Excessive Deficit Procedure against Poland.3 Revenue shortfalls due to the economic slowdown in the second half of 2008 contributed to this outcome. But the deterioration of the fiscal stance was also the result of a significant discretionary relaxation enacted in 2007—comprising mainly cuts in the tax wedge, but also one-off spending increases. This provided some stimulus as the economy slowed, with the cyclically-adjusted balance deteriorating by about 2 percentage points. Late in 2008, in response to the crisis, the authorities proposed limited employment subsidies and mortgage support for the unemployed; given their small size—less than 0.1 percent of GDP—these were not expected to affect the 2009 deficit.

III. Outlook and Risks

11. The economy is set to contract in 2009 and recover slowly in 2010. The central scenario envisages a small contraction of about ¾ percent this year, primarily reflecting a deep recession in Poland’s main European trading partners and the likelihood of a credit crunch. Domestic demand is poised to continue to decline, as business confidence remains weak, unemployment rises, and credit and wage growth decline. Modest growth of about 1½ percent in 2010 is predicated on improving global conditions and moderate consumption growth, consistent with a gradual strengthening of financial conditions and a slowly improving labor market. Risks to the central scenario, stemming from a slower-than expected global recovery and uncertainty regarding domestic demand, are on the downside.

Poland: Real GDP Growth Projections, 2009-10


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Sources: IMF staff projections.

12. Inflation is projected to remain subdued. As world commodity prices are expected to be in check and wage developments are likely to track real activity, price pressures should be subdued. With growth well below potential, headline inflation is projected to stay within the tolerance range of 1½ to 3½ percent for the foreseeable future. The impact on headline inflation of recent increases in food, fuel, and administered prices pose is likely to be temporary, in part because of favorable base effects..


Headline Inflation

(Y-o-y percent change, end-of-period)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: Polish Statistical Office; and IMF staff projections.

13. Poland is expected to meet its financing needs for 2009–10 with no undue pressures on the zloty. Despite gross external financing requirements of around $100 billion (25 percent of GDP) in 2009–10, financing gaps are not expected to emerge under the baseline scenario. Specifically, the public sector has already secured a large part of its rollover needs for 2009;4 the decline in private sector rollover rates is expected to continue, being largely demand driven (trade credit accounts for over 80 percent of non-bank short-term debt). Moreover, declining import volumes and favorable terms of trade developments should more than offset a projected decline in exports and gradually narrow the current account deficit to about 3¼ percent of GDP in 2009–10. Given these considerations and staff’s assessment that the real exchange rate is broadly aligned with fundamentals, pressures on the zloty are not expected to emerge (Box 1).

14. In the case of unexpected external shocks, including an intensification of regional spillovers, the FCL would provide a considerable cushion. A worsening of the crisis in Western Europe with an attendant delay in economic recovery could further slow export growth and result in additional retrenchment of foreign assets from Poland. Moreover, the risk of contagion from adverse developments in the region, not least the Baltics, can not be excluded. In turn, reduced rollover rates by parent banks and corporates could exacerbate downward pressures on the zloty. In this scenario, a more severe contraction of the Polish economy would emerge and result in mounting NPLs, heightening the pressure on private-sector balance sheets. Limited public sector access to capital markets would become a binding fiscal constraint in the presence of significant revenue shortfalls and potential bank recapitalization needs. However, the possibility to draw on the recently approved FCL would provide a considerable cushion to limit the economic impact of such an extreme scenario.5

15. While sharing concerns about the downside risks, the authorities were more sanguine on growth prospects in 2009, but somewhat less optimistic about 2010. The authorities foresee growth of about ½ percent in 2009, supported by resilient consumption. For 2010, their forecasts range from about ½ percent to 1½ percent, reflecting differences in the outlook for the external sector.

Poland: Real Exchange Rate Assessment

Staff estimates do not point to significant misalignment in the real exchange rate. CGER assessments for the latest reference period suggest that the sizable depreciation of the zloty since August 2008 has more than offset the real appreciation that had been registered in the first half of 2008 for an overall assessment of a 10 percent undervaluation. However, nominal exchange rate appreciation since the reference period would bring the assessment closer to equilibrium. Specifically,

  • ■ The equilibrium real exchange rate (ERER) methodology suggests a moderate undervaluation of around - 12 percent; this estimate reflects a strengthened equilibrium level driven by improvements in relative productivity and a CPI-based real exchange rate that is now in line with its historical average.

  • ■ The macroeconomic balance (MB) and external sustainability (ES) approaches also suggest a moderate undervaluation of 5 and 13 percent respectively, given the medium-term current account projections that are above the current account norm and NFA-stabilizing deficit.

CGER Results, 2008-09

(Percent deviation from estimated equilibrium)

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Poland: Real Effective Exchange Rate

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001


Poland: Alternative REER Measures

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Source: National authorities; European Commission; GDS.As regards other indicators of price and cost competitiveness, increases in ULC-based measures of the REER have also started to reverse course in late-2008 as weakening cyclical conditions help dampen wage pressures.

IV. The Policy Agenda

A. Setting the Stage for a Credible Medium-Term Fiscal Consolidation

16. The revised 2009 budget entails a limited increase in the fiscal deficit. Given staff’s macroeconomic scenario, the recent state budget amendment expected to be approved by Parliament in mid-July implies that the general government deficit will rise to about 5½ percent of GDP compared to 2½ percent planned in 2009. Underlying this outcome is a shortfall in tax revenues of about 2¼ percent of GDP and higher expenditures of more than 2 percent of GDP, partially compensated by higher expected dividend receipts from state-owned companies of about ½ percent of GDP and across-the-board expenditure cuts estimated at close to 1 percent of GDP. Nevertheless, as a result of the 2008 personal income tax cuts enacted in 2007 but becoming effective in 2009, the cyclically-adjusted fiscal balance is expected to deteriorate by about 1 percentage point in 2009—following the 2 percentage points deterioration of 2008—providing a small stimulus during the downturn. So far, markets have reacted positively to the revised budget, and government bond auctions have seen high bid-to-cover ratios—averaging about 3 in recent months—and yields have remained stable despite the increase in the public sector’s borrowing requirement.

17. Staff supports the proposed increase in the deficit limit, but believes that it should be accompanied by measures to strengthen confidence in medium-term consolidation targets. Fiscal policy should balance short-term cyclical considerations and medium-term consolidation efforts. On the one hand, taking stronger pro-cyclical measures to curb the deficit now would exacerbate the economic slowdown. On the other hand, allowing automatic stabilizers to fully operate through a higher short-run deficit would imply the need for a deeper fiscal adjustment in the coming years. Thus, even with the 2009 measures, staff expects the deficit to increase to 6 percent of GDP in 2010 and remain above the Maastricht limit in the medium term, with debt hovering close to the 60 percent-of-GDP threshold. Against this background, staff believes that the decision to increase the deficit limit should be supported by measures to strengthen the medium-term framework. In this regard, a revamped fiscal framework consistent with international best practice—including binding multi-year expenditure limits—could bolster confidence and underpin a durable consolidation (Box 2). This will help to anchor market expectations despite higher short-run financing needs and reassure European partners that Poland is committed to achieving its medium-term targets.

18. The 2010 budget should set the stage for a sustained medium-term consolidation. On the assumption that the recovery will begin next year, permanent measures amounting to about 1 percent of GDP starting in 2010 would be needed for a three-year period, in order to meet the 1 percent of GDP medium-term deficit target agreed with EU partners, albeit with a one-year delay. This adjustment will help stabilize debt comfortably below 60 percent of GDP. However, to prevent a strongly pro-cyclical stance, the authorities should be prepared to delay this adjustment if the economy does not begin to recover as projected.


General Governemnt Deficit

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Source: Poland Ministry of Finance; and IMF staff projections.

Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

19. Spending reforms will be required to achieve a durable medium-term adjustment. Owing to the early implementation of pension reforms in the 1990s, aging costs do not pose a significant problem to the medium-term fiscal outlook. But statutory expenditures constitute a large proportion of the budget. Hence, reforms are needed to reduce the deficit in the medium run, including in the area of social spending, where recent increases have led to additional fiscal costs. Possible options include better targeting child deductions in the personal income tax, disability contributions, and pension indexation.

20. The authorities agree with the need to embark on a fiscal consolidation, but do not see the need for forward-looking binding expenditure rules. They are still working on the details for the 2010 budget but remain committed to starting an expenditure-based fiscal adjustment then. They are also open to introducing a performance-budgeting system to improve the effectiveness of policies. However, they do not see a need for introducing binding expenditure ceilings in their multi-year fiscal plan, noting that these would be difficult to implement, given their dependence on uncertain projections, and could run the risk of being interpreted as entitlements. They believe that strict yearly deficit limits and the existing Public Finance Act—which triggers fiscal actions once the debt reaches certain thresholds—are sufficient to ensure the credibility of fiscal policy.

Poland’s Fiscal Framework: Proposed Changes and Options for Strengthening

The authorities have recently proposed to update their budgetary framework, which focuses on annual budgets, by introducing a multi-year financial plan for the state (MFPS). The plan would include a rolling four-year horizon—current and three years ahead—detailing a nonbinding direction for fiscal policy. The one-year ahead budget deficit would, nonetheless, be expected to be adopted the following year baring exceptional circumstances. In addition, the new framework would introduce medium-term plans at other levels of government and elements of performance-based budgeting, while maintaining Poland’s national debt ceilings.1

The proposal introduces elements of a medium-term fiscal framework but, by focusing on nominal deficits, the pro-cyclical bias in fiscal policy remains. Moreover, the lack of binding commitments beyond a year limits its role as an effective tool to prioritize and rationalize public expenditure and articulate a high-quality medium-term consolidation.

While international best practice varies, establishing binding multi-year expenditure ceilings would strengthen Poland’s fiscal framework and would be facilitated by:

  • Establishing rolling forward estimates derived from the path of fiscal deficits consistent with the authorities’ medium-term targets and fiscal sustainability, coupled with revenue projections in line with the economic outlook.

  • Developing of an effective top-down/bottom-up reconciliation process as part of the annual budget preparation. This would compare the expenditure and revenue trends indicated by the forward estimates with the government’s targets, in order to identify any necessary changes to expenditure, revenue, or fiscal policy.

  • Enhancing the expenditure prioritization process, including systematic expenditure review.

  • Continuing to develop performance budgeting, which will support forward estimates and the expenditure prioritization process.

Greater transparency and accountability can help to further safeguard fiscal discipline. In this regard, strengthening of fiscal institutions could enhance the objective analysis of current fiscal developments, long-term fiscal sustainability, and costing of budgetary initiatives. In addition to safeguarding the independence of projections, this could also provide a broader context for normative assessments of fiscal policy.

1 The constitution establishes a cap of 60 percent of GDP for public debt. Currently, the government must take increasingly tough corrective actions if debt breaches triggers established at 50 percent of GDP and 55 percent of GDP.

B. Cautiously Easing Monetary Policy

21. Further policy rates cuts are warranted. With inflation set to remain within the tolerance range for the foreseeable future, staff considers that the loosening bias in monetary policy should continue. Moreover, should increases in the government’s borrowing requirements—associated with the operation of automatic stabilizers—exert pressure on domestic interest rates, monetary policy should stand ready to accommodate fiscal policy.

22. A measured relaxation was not expected to weaken the zloty. Staff noted that the scope for interest rate cuts and their pace will be tempered by external financing constraints. However, while still volatile, the zloty appears to have stabilized, and lower interest rates are not expected to weaken it further. Pressures on the exchange rate are likely to continue to moderate as Poland’s cyclical position and monetary policy stance relative to those of the euro area and the US strengthen. Moreover, the weakening of the zloty that has already taken place has served to align the real exchange rate with fundamentals, and the current account is set to continue to improve. Still, monetary relaxation should proceed with caution.

23. On balance, the authorities thought that a further small interest rate cut now followed by a pause would be appropriate.6 While cautioning that world oil price increases may result in rising inflation, they believe that continued weak demand will contain inflationary pressures. The authorities considered that the interest rate cuts so far, together with the reduction in reserve requirements, will support the economy’s return to potential growth. While further interest rate cuts cannot be ruled out, these would depend on the evolution of inflation and the economy, including financial markets and the zloty.

C. Safeguarding Financial Sector Health

24. While the banking system is well buffered, risks remain. The authorities’ top-down stress tests suggest that the system is resilient to adverse scenarios, and only a prolonged recession would lead to general recapitalization needs (Box 3). Moreover, post Lehman Brothers, parent banks have maintained stable exposures to their Polish subsidiaries and continued to provide them with funding and capital injections, when needed.

  • Credit quality represents the most immediate risk to the Polish banking system. NPL ratios have increased from historic lows to reach 5.7 percent at end-April 2009 and are expected to rise further with slower economic activity and higher unemployment. While the corporate sector is not highly leveraged, and strong profits through the third quarter of 2008 (Figures 6 and 7) have kept it liquid, pressures are rising as profits are falling and funding is becoming more expensive. Net corporate profits over the fourth quarter of 2008 and the first quarter of 2009 were about half the average quarterly profits in the first three quarters of 2008, partly due to financial losses from zloty depreciation, with more vulnerable sectors such as manufacturing exports and construction experiencing large earnings declines. The household sector has been relatively healthy so far, and the portfolios of foreign-currency denominated mortgages have continued to perform well, as lower foreign interest rates have been compensating for the depreciating zloty. In addition, lending standards for foreign-currency denominated loans have been tightened since 2006, as recommended by supervisors. The main risk to the sector remains rising unemployment, should the recession last longer than expected, and a reversal of monetary policy easing abroad.

  • Direct foreign exchange risks could emerge. Banks maintain their ability to hedge against foreign exchange (FX) and interest rate risk through their parents in light of illiquid financial markets. While direct FX risks are now under control, banks are finding it more expensive to close their open positions. The NBP’s sensitivity analysis shows that only in an extreme case in which banks are unable to rollover the entire value of maturing hedging transactions, eight of them (representing 15 percent of system assets) would not meet the regulatory capital requirement.

  • Risks related to exposures to structured credit products and derivatives appear contained. Polish banks have negligible direct exposure to U.S. subprime mortgage assets. But they have been affected by corporate losses on derivative contracts that were made as the zloty was appreciating, and subsequently back-fired once the currency trends reversed. These risks, however, are now diminishing. Exposures have been declining to about 0.4 percent of GDP in April, compared to 1.2 percent of GDP in January 2009, due to favorable exchange rate movements, but also to individual negotiations and restructuring of claims with banks. Of the remaining exposure, about 80-85 percent is naturally hedged, as it was incurred by the tradable sector. Under existing contracts, around 80 percent of options should be settled by end-2009.

  • Funding risks could arise in some banks, but measures taken by the NBP have helped. The overall loan-to-deposit ratio stands at around 110 percent. At the aggregate level, total exposure to foreign funding has remained stable since September 2008. Funding risks, however, are not evenly distributed among banks and are particularly acute for a number of small- and medium-sized banks, which had relied on market funding. To close their funding gaps when interbank market access remains restricted, these banks resort to parent banks’ assistance and aggressive offers on the deposit market. The NBP measures have mitigated some pressures, but a number of these banks had to stop expanding their balance sheets, especially in new foreign currency mortgage lending. Costly new deposits and foreign funding—due to higher risk premiums following rating agency’s downgrades of Polish and their parent banks—will limit profitability and the banks’ capacity to internally accumulate capital.

Figure 6.
Figure 6.

Poland: Nonfinancial Corporate Sector Indicators, 2003-08 1/

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: Worldscope; and IMF staff estimates.1/ Mean values for listed companies available in Worldscope database.
Figure 7.
Figure 7.

Poland: Recent Developments in the Corporate Sector, 2007Q4-2009Q1

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: NBP, Poland Central Statistics Office (GUS), Worldscope, and IMF staff estimates.1/ Altman z score is a one-year-ahead probability of survival developed in Altman (1968). Higher score means lower default probability. Companies with z scores above 3 are generally categorized to be in “safe zone.”2/ Using non-financial corporate data according to GUS which covers 17,440 firms employing over 50 workers.

Poland’s Financial Sector: Stress Tests

Staff’s credit risk stress tests suggest that Poland’s systemically important banks are resilient to a sharp increase of non-performing loans. Specifically, only one of the eight systematically important banks would see its capital adequacy ratio fall below the regulatory minimum if the NPLs were to more than triple from their end-2008 level to 15 percent. Assuming, however, that 2008 profits are retained, the CAR should remain above the minimum threshold for all banks. These results are based on stress tests of eight systemically important banks—accounting for 54 percent of total banking sector assets—using balance sheets for which end-2008 data are available from Bankscope.

The NBP’s top-down stress tests show that the banking system is robust to adverse scenarios. The most important risk identified by these tests are credit risks associated with a slowing economy and rising unemployment. In an adverse scenario where GDP contracts in two consecutive years, losses are expected to be about 3 percent of total assets, more than twice the losses experienced during the 2001-03 slowdown. In this case, recapitalization needs to keep the CAR at 8 percent would amount to 0.3 percent of GDP over 2009-10.

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Source: NBP.

Value of capital increase necessary to ensure that all banks have CAR above 8 percent. Assuming a fall in pre-impairment income of 10 percent in relation to 2008.

These tests are based on a consistent set of macro assumptions and panel estimation of loan loss reserve. The NBP derives its macro scenarios from a medium scale structural macroeconometric model. These scenarios are translated into aggregate loss provisioning by a bank-level panel model. Interest rate levels follow a Taylor’s rule while movements in the exchange rates are not captured in the main panel estimation model. The tests also assume constant assets and exogenously imposed operating profits of the banks. The macro stress tests are complemented by two simulations for households’ ability to service debt, employing micro-level data from household budget surveys and credit registry. Due to limited data availability, the NBP does not have a model specifically for corporate sector default.

25. The revival of credit activity to support growth in 2010, including through restoring the normal functioning of the interbank market, is likely to depend mainly on external factors. Underlying credit demand exists: mortgage loans stand at only 15 percent of GDP, and half of firms do not rely on bank credit. But the supply of credit is likely to remain constrained, given the above risks and the reliance of many banks on funding and liquidity from international parent banks which are still in the process of deleveraging. Measures to unfreeze the interbank market have not yet succeeded in restoring transactions at longer maturities. To a large degree, the reluctance of foreign-owned subsidiaries to lend to each other in the Polish interbank market mirrors the reluctance of their parents to do so. This suggest that normalizing financial markets in Poland will, to a large degree, hinge on normalizing such markets globally.

26. Vigilance and pre-emptive measures by the authorities remain key in the current situation. In this regard, encouraging banks to boost capital buffers, mainly by retaining the record-high 2008 profits, was appropriate. Moreover, postponing the recommendation to tighten lending standards for foreign-currency denominated loans has rightly avoided a pro-cyclical action. In staff’s view, as a complement to the top-down stress test performed by the NBP, a case can be made for the KNF’s conducting systematic, bottom-up, bank-by-bank stress tests based on a consistent set of macroeconomic projections. This would help identify emerging weaknesses and potential bank recapitalization needs, as well as alleviate uncertainty in the financial system. A national effort in this regard would complement the EU’s approach of stress-testing major banking groups, and such an exercise could be coordinated with neighboring countries.

27. Staff supports the KNF’s effort to strengthen supervision of credit unions (SKOKs). While staff is not aware of problems in these institutions, it is a concern that they have no direct access to a lender of last resort facility, are not supervised by the KNF, and are not covered under the bank guarantee fund, but only by their internal insurance fund. While SKOKs are small (as a share of total banking assets) and, on their own, are unlikely to pose a systemic risk, any problems could spillover to the rest of the system.

28. There has been progress in improving the framework for financial sector surveillance and crisis management. The Financial Stability Committee was formalized by law, and the Ministry of Finance introduced a law on state treasury assistance to financial institutions and a law on recapitalization of distressed financial institutions. The former—entered into force in March 2009—allows the State Treasury to assist financial institutions with guarantees, loans, and sale of securities. The latter—still under discussion in Parliament—allows the Minister of Finance to issue a guarantee to a financial institution to increase regulatory capital or increase its capital by taking up shares, bonds or bank securities. Moreover, the governing structure of the Bank Guarantee Fund (BGF) has been modified to include the KNF—beside the NBP and the MOF—in its governing council. The BGF is no longer partly funded by the NBP, although it retains the ability to borrow through the NBP and the state budget. In addition, the time period for deposit insurance payments in case of bank suspension—currently at around 3 months—is expected to be lowered to comply with the new EU Directive by end-2010.

29. With the prospect of reduced intermediation through banks, it should be a matter of priority to foster the development of domestic capital markets. The equity market has been growing in terms of market capitalization with an increasing number of IPOs, aided by active measures such as the introduction of new corporate governance rules and a new trading platform for start-ups and new companies. The privatization of the Warsaw Stock Exchange—expected in 2009—will bring further international linkages to Polish capital markets. The non-government bond market, however, remains small and illiquid. Consistent with the 2006 FSAP Update recommendations, measures to facilitate corporate debt issuance, such as enhancements in market infrastructure in the areas of custody and depository services and streamlining issuance procedures, could support the development of the market. Moreover, to diversify the funding of banks’ mortgage credit portfolio, universal banks should be allowed to issue covered bonds to mobilize longer-term funds and reduce maturity mismatch.

30. The authorities agreed with the thrust of staff’s recommendations. They continue to monitor the situation in individual banks closely and to analyze system-wide issues, such as exposures to foreign-exchange options. While they are, in principle, open to undertaking a bottom-up stress-testing exercise, they are inclined to resist doing so within broader regional context unless carried out under the EU umbrella. In addition, the authorities welcomed the prospect of an FSAP update in 2010.

D. Bolstering Growth and Adopting the Euro

31. Removing labor-supply bottlenecks will be vital to boosting long-term growth. Before the crisis hit, resource constraints were emerging particularly in the labor market, reflecting Poland’s low labor participation rate, especially among those above 50 years old. To address this bottleneck, the authorities reformed the early-retirement provisions by substantially tightening the eligibility requirements slashing the number of eligible citizens from over one million to about 250,000 in 2008. Staff strongly welcomed this and suggested that future priorities should include gradually increasing the effective retirement age and equalizing the statutory retirement age of men and women (Annex 2). Moreover, special pension schemes should also be reformed and merged into the general pension scheme. Besides helping to promote fiscal sustainability, labor-market reforms would complement continued efforts to improve the regulatory interface with business and reinvigorate privatization plans to enhance the economy’s flexibility and bolster its long-run potential.

Figure 8.
Figure 8.

Poland: Banking Sector’s Market Indicators, 2007-09

Citation: IMF Staff Country Reports 2009, 266; 10.5089/9781451832068.002.A001

Sources: DataStream; Moody’s KMV; Bloomberg; and IMF staff calculations.1/ Estimated EDF by Moody’s KMV constructed with market-based data.

32. A more flexible economy would allow Poland to adopt the euro successfully in the medium term. On balance, staff felt that euro adoption remains beneficial for Poland. But the increased uncertainty in global markets and the current cyclical conditions have tilted the short-term balance in favor maintaining monetary policy independence and a flexible exchange rate for now. Delaying euro adoption would also allow the economy to adjust to possible changes in long-run financing prospects prompted by global deleveraging. Besides allowing for addition time to achieve the needed fiscal consolidation, it would provide time for exchange rate volatility to subside and for political support to be marshaled to ensure smooth passage of the constitutional amendment needed for euro adoption.

33. The authorities are determined to adopt the euro as soon as possible and continue implementing structural reforms. They recognized, however, that adopting the euro in 2012 may not be feasible and a short delay would be necessary. Still, the authorities considered that an early adoption target would help galvanize support for fiscal consolidation and structural reforms. In this connection, they will continue to give priority to reforms that would alleviate supply constraints, particularly in the labor market. This would be in line with the objectives established in their Solidarity 50+ and Poland 2030 plans.

V. Staff Appraisal

34. Poland is weathering the global crisis relatively well. The economy has continued to expand even as all neighboring countries and most CEE peers have been mired in deep recession. While the global financial crisis engulfed Poland’s financial markets last fall—paralyzing the interbank market, causing a credit crunch, and weakening the zloty—a significant measure of stability has returned since then. This has been helped, in part, by Poland’s availing itself of the FCL on a precautionary basis. As a result, the zloty has stabilized, CDS spread have declined, and the government—which throughout the crisis has preserved access to international capital markets—has seen a notable decline in interest rates on its zloty bonds.

35. This strong performance owes much to relatively sound economic policies. Entering the crisis without serious internal or external imbalances, policy makers were afforded some room to undertake counter-cyclical measures. Their responses have generally been timely, well-focused, and properly measured. Given the authorities’ continued commitment to adjust policies appropriately as circumstances evolve, staff expects Poland to experience only a mild recession before a recovery slowly gets underway.

36. Monetary policy should continue to maintain a loosening bias. The lowering of policy rates since last November has been appropriate, and staff believes that further relaxation is justified by the outlook for inflation, not least by the notable easing of pressures on wages. Should the increase in the government’s financing need result in an increase in interest rates—which staff considers unlikely—then the MPC should stand ready to accommodate. In recommending a continued loosening bias, staff is taking into account that the MPC has built considerable confidence in its anti-inflation credentials over the past decade.

37. Staff does not expect a measured, further monetary easing to cause the zloty to depreciate. Poland’s cyclical position and its monetary stance relative to the euro area and the US appear to be strengthening, suggesting that the zloty could, if anything, be subject to upward pressure. In any case, the weakening of the zloty since the onset of the crisis has facilitated adjustment, and some further depreciation—in the event of unforeseen shocks—should not pose a problem. While a flare-up in what is still an unsettled regional situation could potentially cause negative spill-over to Poland, recent experience suggests that the impact will be transitory. In this regard, the potential access to the FCL remains an important safeguard.

38. The challenges facing fiscal policy are more complex. On the one hand, the significant structural relaxation that has taken place recently—in part reflecting important reforms enacted before the onset of the crisis—means that the deficit is set to remain well above the Maastricht target even as the economy recovers. On the other hand, taking drastic corrective actions now would impart an unwelcome pro-cyclical impulse in the midst of the global crisis, risking to turn a mild recession into a more serious one. In staff’s view, the authorities’ recent decision to increase the deficit limit for 2009 to partly accommodate the inevitable revenue shortfall as the economy slows is appropriate and should unsettle neither Poland’s European partners nor markets, which indeed appear already to have discounted it. A sustained fiscal consolidation should start in 2010, unless there are signs that the recovery will not materialize as expected. To help anchor confidence in the authorities’ medium-term consolidation targets, the authorities should consider revamping the fiscal framework by introducing rolling and binding three-year expenditure limits.

39. Aging costs do not pose a significant problem. Too often overlooked, Poland’s early implementation of comprehensive pension reforms means that the issue of an aging population weights much less on the medium-term fiscal outlook than in many other countries. This is another example of how good economic policies in the past are now affording policy makers room for maneuver.

40. Even as the financial sector has been well buffered, continued vigilance is warranted. Rising NPLs and funding cost are squeezing profits and capital adequacy ratios, but staff takes note of top-down stress tests suggesting that only very severe shocks would pose systemic risks. In this regard, vigilance and pre-emptive actions on part of the regulatory authorities—such as the welcome decision to encourage banks to retain the record-high 2008 profits—have helped to ensure that the banking system is well-buffered.

41. Staff feels that the KNF should go further, by conducting bottom-up, comprehensive stress tests of banks. Such an exercise should be coordinated with neighboring countries to take into account the regional dimension of the problem. This could help alleviate uncertainty and thereby facilitate the unfreezing of the interbank market, although staff acknowledges that the current reluctance to engage in interbank transactions mainly reflects concerns about the financial health of foreign parents rather than of their Polish subsidiaries. Nevertheless, credit supply is set to become increasingly constrained by scarcity of capital, posing a risk to the recovery once confidence and the demand for credit begin to return. A more comprehensive forward-looking analysis of capital adequacy would help the KNF ensure that banks move pre-emptively to shore-up capital.

42. Looking to the medium term, the key challenge facing policy makers is to boost Poland’s exceptionally low labor participation rate. The evidence that growth had begun to falter even before the onset of the global crisis because of emerging labor shortages should serve as an important reminder of the urgency of this task. In this regard, last year’s radical reforms of the system for early retirement are very encouraging. However, much more needs to be done, including by increasing and equalizing retirement rates and merging special pension schemes with the general scheme.

43. It is recommended that the Article IV consultation remain on a 12-month cycle.

Table 1.

Poland: Selected Economic Indicators, 2005-10

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Sources: Polish authorities; and IMF staff estimates.

Derived as total savings minus the current account minus capital transfers.

IMF definition (including pension reform costs).

NBP Reference Rate. For 2009, latest.

Annual average.

For 2009, exchange rate as of July 13.

Annual average (1995=100).

Table 2.

Poland: Balance of Payments on Transaction Basis, 2005-14

(In millions of US$)

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Sources: National Bank of Poland; and IMF staff estimates.

By remaining maturity.

Exports of goods and services.

Excluding repurchase of debt.

Table 3.

Poland: External Debt Sustainability Framework, 2004-14

(In percent of GDP, unless otherwise indicated)

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Derived as [r − g − ρ(1+g) + αε(1 +r)]/(1 +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, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

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

For projection, line includes the impact of price and exchange rate changes.

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

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Table 4.

Poland: Financial Soundness Indicators, 2002-09

(In percent)

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Source: National Bank of Poland.

Data for 2009 are Q1.

Data for domestic banking sector.

Table 5.

Poland: General Government Revenues and Expenditures, 2005-10

(In percent of GDP)

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Sources: Polish authorities; and IMF staff estimates and projections.

IMF definition (including pension reform costs).

ESA 95 definition

National definition

Table 6.

Poland: Public Sector Debt Sustainability Framework, 2004-14

(In percent of GDP, unless otherwise indicated)

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General government.

Derived as [(r − π(1+g) − g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = 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(1+r).

For projections, this line includes exchange rate changes.

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

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

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

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Table 7.

Poland: External Financing Requirements and Sources, 2008-11

(In million of U.S. dollars)

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Sources: National authorities and staff estimates and projections.