Republic of Poland
2010 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Poland.

The Republic of Poland’s 2010 Article IV Consultation shows that Poland is the only European Union country to have escaped a recession in 2009 owing to its limited reliance on exports and well-capitalized and profitable banking system. Like its regional peers, it experienced spillovers from the crisis through both real and financial channels, in particular the latter, as an abrupt slowdown in capital inflows caused a credit crunch and a sharp decline in investment. The banking sector is well buffered, but risks related to foreign-exchange lending should be curbed.


The Republic of Poland’s 2010 Article IV Consultation shows that Poland is the only European Union country to have escaped a recession in 2009 owing to its limited reliance on exports and well-capitalized and profitable banking system. Like its regional peers, it experienced spillovers from the crisis through both real and financial channels, in particular the latter, as an abrupt slowdown in capital inflows caused a credit crunch and a sharp decline in investment. The banking sector is well buffered, but risks related to foreign-exchange lending should be curbed.

I. Context and Recent Economic Developments1

1. Poland is the only EU economy to have escaped a recession in 2009. Like its regional peers, it experienced spill-overs from the crisis through both real and financial channels, in particular the latter, as an abrupt slowdown in capital inflows caused a credit crunch and a sharp decline in investment. However, consumption held up relatively well, and the foreign balance began to contribute positively to growth from the onset of the crisis. This reflected the large domestic market and attendant modest reliance on exports; a flexible exchange rate policy (the zloty depreciated by 30 percent in real effective terms during the initial phase of the crisis); and, not least, significant fiscal stimulus and monetary easing, as policymakers took full advantage of the room for maneuver afforded by Poland’s contained external and internal imbalances on the eve of the crisis. GDP growth amounted to 1.7 percent in 2009, and a negative output gap of only some 1 percent of GDP had opened up by end-2009 (Box 1).


EU27: GDP Growth, 2009


Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Source: Eurostat.

Poland: Contributions to GDP Growth

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

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

2. Inflation has fallen close to the National Bank of Poland’s (NBP) target of 2½ percent. Headline inflation declined from close to 5 percent in mid-2008 to 2.9 percent in February 2010, helped by a renewed strengthening of the zloty. Core inflation followed a similar path, declining to 2.2 percent in February.

3. The zloty is recovering. The rapid contraction in the trade balance led to a decline in the current account deficit from 5 to about 1½ percent of GDP in 2009. In the financial account, FDI has fallen notably, although higher retained earnings have cushioned the fall. After an initial sharp contraction, trade credits are again increasing. Portfolio inflows have performed particularly well, especially since the middle of last year, driven by renewed external appetite for zloty-denominated government debt.2 As a result, after its initial sharp fall, the zloty has been recovering steadily, although it remains some 18 percent below its pre-crisis peak level in real effective terms.3

Estimating Poland’s Potential Output

In the run-up to the global financial crisis, Poland was growing above its potential. In view of the weakness of statistical methods, such as the HP filter, in identifying boom-bust turning points, a recent IMF working paper provides new estimates of Poland’s potential output using a standard production-function approach.1 The methodology concentrates on obtaining a robust estimate of the labor input by deriving Poland’s natural rate of unemployment and the corresponding unemployment gap. The paper finds that, prior to the recent global financial crisis, Poland’s output and employment were both growing above their respective potential levels. This finding is consistent with the upward trend in inflation and the emergence of capacity constraints seen in Poland during the pre-crisis period.

Indeed, the rapid investment-led output growth in 2006-07 was unsustainable. By disaggregating the contributions to potential growth, the paper finds that the contribution of TFP growth was steadily rising through the first half of the decade, remaining positive until 2007, when it turned negative—largely coinciding with the trend-reversal in potential output growth. At the same time, the contribution of capital was steadily increasing, as investment growth stayed robust, but it was insufficient to prevent the growth in potential output from declining throughout 2008.


Poland: Contributions to potential Growth 1/

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

1/ Contributions are computed as year-on-year percentage changes.

In the aftermath of the current downturn, Poland is not expected to experience a sizable and persistent negative output gap. While Poland avoided an outright recession, economic growth slowed down sharply, resulting in a small negative output gap in 2009. According to the production function methodology, the gap is projected to bottom out at around minus 1 percent this year, and gradually close by 2011-12. This contrasts somewhat with the experience of other European countries, many of which currently have negative output gaps that are large and expected to persist for a number of years.


Poland: Output Gap, 2004-10


Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

1 See Epstein N. and Corrado Macchiarelli (2010), IMF Working Paper No. 10/15 “Estimating Poland’s Potential Output: A Production Function Approach”
Figure 1.
Figure 1.

New Member States: The Boom Years

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: IMF, World Economic Outlook; IMF, International Financial Statistics; and IMF staff estimates.
Figure 2.
Figure 2.

Poland: Recent Economic Developments, 2008-10

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: European Commission; and Polish Statistical Office.
Figure 3.
Figure 3.

Poland: Balance of Payments Developments, 2007-09

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Source: National Bank of Poland.

4. The banking system has withstood the crisis relatively well. Capital adequacy ratios (CARs) have risen to over 13 percent at end-2009, from 11 percent a year ago. Moreover, profits remained robust in 2009, reaching about two thirds of the record-high level of the preceding year. While nonperforming loans (NPLs) rose from around 4½ percent in 2008 to about 7½ percent in 2009 as economic activity declined, their growth appears to be slowing. Banks’ balance-sheet restructuring is coming to an end. They have recently started to ease lending policies for housing loans and short-term corporate credits and resumed foreign-currency lending, especially for Euro-denominated mortgages (Box 2).

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

Recent Developments in the Banking Sector

The banking system entered the crisis from a position of relative strength. Polish banks were not exposed to toxic products and relied on international funding sources to a lesser extent than regional peers. Moreover, foreign subsidiaries—representing about 70 percent of the Polish banking system—continued to receive significant liquidity and capital support from their parent institutions.

Credit quality has deteriorated as the economy slowed. The increase in NPLs to 7.6 percent at end-2009 was mainly due to worsening corporate credits. More recently, household consumer loans have started to deteriorate at a faster rate, though mortgages (both in domestic and foreign currencies) have remained relatively stable. With unemployment on a rising trend, non-performing consumer loans are expected to increase further and then stabilize. The quality of corporate credits is expected to gradually improve, as non-performing loans linked to foreign-exchange (fx) derivative contracts have been declining as contracts have expired and the zloty has appreciated. Overall, the system remains resilient to adverse macroeconomic shocks, as shown by recent stress tests by the NBP.

Capital adequacy ratios have risen, and profits remained robust. Capital adequacy ratios have reached over 13 percent at end-2009. Some of the increase, however, is due to banks’ holding significant amounts of government paper, which reduces risk-weighted assets. Moreover, the zloty appreciation has also led to a decline in risk-weighted assets associated with fx-denominated mortgages. Profits remained strong in 2009, reaching about two thirds of the record-high 2008 levels.

Banking-system liquidity is gradually improving. As elsewhere, the interbank market froze in late 2008. While the market resumed functioning in 2009, it has not fully normalized. The spread between the 3-month WIBOR and the policy rate declined and remained stable in the last quarter of 2009. But it still remains above its pre-crisis level and higher than comparable euro area spreads, with transactions at maturities longer than one week still rare. However, swap markets are normalizing, and demand for the NBP’s facilities in Swiss franc, euro and dollar has been negligible since November last year. In addition, inflows of EU funds are increasing banking-system liquidity, pushing overnight interbank rates close to the floor of the NBP’s corridor and prompting the NBP to absorb liquidity through the issuance of bills. Finally, deposit growth has held up well, underpinned by rising corporate deposits. Though still high, rates on retail deposits appear to be softening.

The decline in credit growth has stopped. Annual credit growth declined to 10 percent in 2009 from 36 percent in 2008. This was due mainly to slowing corporate credit, as enterprises ran down inventories and reduced demand for loans to finance fixed capital formation. In contrast, the growth of household credit remained robust, especially in the mortgage segment. The latest senior loan-officer survey suggests that in Q4 2009 banks stopped tightening overall lending policies and lowered spreads, based on a more positive economic outlook for 2010. While banks eased policies for housing loans and short-term corporate credits, they still tightened them somewhat for consumer and long-term corporate lending. Looking forward, the survey reports an expected increase in demand, a slight softening of the lending criteria on short-term credit, and a slight tightening of long-term credits.

Banks have started to increase foreign-currency lending. The introduction of Recommendation S in 2006, imposing tight lending standards on mortgages, including those denominated in foreign currency, was helpful—together with favorable developments in interest rates—in limiting credit risks during the downturn. Nevertheless, this measure was not able to prevent a sizable build-up of fx-denominated mortgages. The stock of fx-denominated mortgages now stands at 65 per cent of total mortgage assets, most of which is denominated in Swiss francs. Since Q3 2008, the share of new fx-denominated loans has fallen, as banks faced difficulties in hedging the associated foreign-exchange risk in wholesale swap markets. But, more recently, there has been an uptick in fx-denominated mortgages, especially in euros.

Figure 4.
Figure 4.

Poland: Banking Sector Developments, 2007-10

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: National Bank of Poland: and IMF staff estimates.
Figure 5.
Figure 5.

Poland: Credit Developments, 2007-10

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: National Bank of Poland; Bloomberg; and IMF staff estimates.
Figure 6.
Figure 6.

Poland: Banking Sector Market Indicators, 2007-10

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: Data Stream; Moody’s KMV; and Bloomberg.1/ Estimated EDF by Moody’s KMV constructed with market-based data.

II. Recent Policy Responses

5. Fiscal policy is providing significant counter-cyclical stimulus. There was a discretionary fiscal relaxation estimated at 1¾ percent of GDP in 2008 and 2½ percent of GDP in 2009, mainly due to tax cuts enacted in 2007 but coming into effect with a delay. While the government initially intended to offset revenue shortfalls to the extent needed to maintain the state budget deficit below the limit of Zloty 18 billion in 2009—through what would have been highly pro-cyclical expenditure cuts—it appropriately changed such plans at mid-year, when it raised the limit to Zloty 27 billion. As a result, the general government deficit increased from under 2 percent of GDP in 2007 to over 7 percent of GDP in 2009. The strong counter-cyclical stimulus provided by fiscal policy—through a combination of discretionary relaxation and the work of automatic stabilizers—was a major reason for Poland’s not falling into recession during the global crisis.

6. Market reaction to the wider deficits remained positive, helped by the authorities’ decision to avail themselves of the FCL. While the impact of the Flexible Credit Line (FCL) is difficult to disentangle from a broader improvement in sentiment, senior officials and market participants indicated that access to the FCL was helpful to allow the authorities to acknowledge considerably larger fiscal deficits without unsettling markets. Thus, the FCL has been credited, in part, for the increase in demand in the domestic bond market—which saw a return of foreign investors especially after April 2009—and the subsequent decline in yields. Moreover, after the approval of the FCL, the government was able to tap successfully international markets with long-term bond offerings that were significantly oversubscribed. This allowed the authorities in late 2009 to start pre-financing needs for 2010. The positive trend continued this year, with two large issuances of Eurobonds at spreads that were half of those paid a year ago.

7. The monetary policy easing cycle has ended. The Monetary Policy Council (MPC) continued to cut rates through the first half of 2009, to 3.5 percent. It maintained a loosening stance until October 2009, when it changed its informal bias to neutral, reflecting an improved outlook and renewed concern about inflation. The new MPC that took office in February confirmed the neutral bias in its first meeting.

8. Facilities for exceptional liquidity support are being phased out. In early 2009, the NBP lowered reserve requirements, extended the maturity of repo operations, broadened the range of accepted collateral, and engaged in foreign-exchange repos with the ECB and the Swiss National Bank (SNB). Given the improved market conditions, the NBP has limited the use of the three and 6 month repos and allowed the repo agreement with the SNB to expire in early 2010. Finally, the authorities have offered a credit-guarantee scheme through the state-owned BGK bank aimed at boosting corporate lending, but demand for such guarantees has been limited so far.

9. Further measures have been taken to safeguard financial stability. The recommendation by the Financial Supervision Commission (KNF) last year that all banks retain 2008 profits was instrumental in quickly restoring CARs to pre-crisis levels. With CARs now considered to be at comfortable levels despite the continued increase in NPLs, the KNF has decided not to repeat this general recommendation in 2010, although it intends to encourage weaker banks to retain a large share of their earnings to create buffers above the recommended CAR of 10 percent. While the quality of capital is generally high, the KNF recently allowed banks to count certain convertible and long-term bonds in their own funds for a set period of two years. However, this measure is subject to approval on a case-by-case basis and aimed primarily at the cooperative sector. The KNF has also recently introduced Recommendation T, which tightens credit assessments on household lending, as it considered standards in this segment of the market to be of uneven quality.

Figure 7.
Figure 7.

Poland: The FCL’s Impact on Financial Markets, 2009-10

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: Bloomberg; Polish Ministry of Finance; Dealogic; and IMF staff estimates.

III. Outlook and Risks

10. The recovery is set to continue to gain strength. The global environment is improving; the balance-sheet adjustment in the Polish banking system appears to have run its course, with renewed risk appetite suggesting that banks are ready to cautiously expand credit; and, not least, transfers from the EU are expected to almost triple in the next few years. Against this background, staff projects a continued recovery in domestic demand, in particular public investment; a gradual increase in real GDP growth to around 2¾ percent in 2010 and 3¼ in 2011; and closure of the negative output gap by 2011-12. The projection assumes a small negative contribution of the foreign balance to GDP growth, with the current account rising to around 3 percent of GDP in 2010-11.4 Despite the zloty’s sustained appreciation since early 2009, staff assesses the real exchange rate to be broadly in line with fundamentals (Box 3).

Poland: Real GDP Growth Projections, 2010-11


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Sources: IMF staff projections.

Poland: Headline Inflation (Y-o-y percent change, end-of-period) Projections in March 2010

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: Polish Statistical Office; and IMF staff projections.

11. Inflation is expected to remain contained. In view of the negative output gap, and with no evidence of pressures on wages and commodity prices, staff projects inflation to continue to fall during the first half of 2010, stabilizing at or below the NBP’s target, under the assumption of unchanged policies.

12. Risks to the outlook are balanced, but external uncertainty looms large. On the upside, developments during 2009 point to the possibility of a stronger-than-expected rebound. Risks in this regard arise mainly from the possibility of larger capital inflows, if ample liquidity and low interest rates in advanced countries, coupled with an accelerated recovery in global risk appetite, were to cause an even stronger demand for assets of well-performing emerging market countries like Poland. An alternative upside risk is a confidence-driven improvement in domestic demand, not least coming from a faster-than-expected expansion of banks’ balance sheets. On the downside, the still fragile economic outlook in Europe, including tail risks associated with vulnerabilities of a number of countries with high fiscal deficits within the Euro Area, point to the possibility that global investors might yet decide to retreat.

Real Exchange Rate Assessment

Staff estimates suggest that the real exchange rate is broadly in equilibrium. Preliminary estimates based on the CGER methodology for the latest reference period suggest that the recent appreciation of the zloty has partly offset the real depreciation that had been registered in the earlier part of 2009. Specifically:

  • The equilibrium real exchange rate (ERER) methodology suggests a balanced assessment. This estimate reflects a strengthened equilibrium level, driven by improvements in relative productivity.

  • The projected medium-term current account deficit (including capital transfers) is below the net foreign asset-stabilizing deficit and close to the current account norm, implying a moderately undervalued estimate according to the external-stability (ES) approach and a balanced estimate based on the macro-balance (MB) approach.

  • The CPI-based real exchange rate is now slightly above its historical average. However, Poland’s real exchange rate is still considerably below that of regional peers, in cumulative terms, as Poland underwent a sharper real depreciation in the earlier part of 2009. Consequently, there is no evidence yet of Poland having become uncompetitive as a result of last year’s appreciation.

  • As regards other indicators of price and cost competitiveness, ULC-based measures of the REER improved in the course of 2009, as weakening cyclical conditions helped to dampen wage pressures.

CGER Results, 2009-10

(Percent deviation from estimated equilibrium)

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Poland: Real Effective Exchange Rate

(Index, 2000=100)

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001


Poland: Alternative REER Measures

(Index, 1999=100)

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: National authorities; European Commission; and GDS.

IV. The Policy Agenda

A. Embarking on a Credible Medium-Term Fiscal Consolidation Strategy

13. The general government deficit is likely to increase further. The recently approved 2010 budget will, in staffs view, entail an increase in the state deficit to about 4½ percent of GDP, taking into account an expected revenue over-performance. With continued high deficits in the National Road Fund, social security system, and local governments, the general government deficit is set to increase to about 7½ percent of GDP in 2010, or about 7 percent of GDP in cyclically-adjusted terms. Uncertainty around these projections remains high, especially with regard to the deficits of sub-national governments, whose 2009 outturn has not yet been finalized, and whose plans for 2010 can change during the year, as they are not directly under the control of the central authorities.

14. The authorities have yet to fully specify a plan for how to reduce the fiscal deficit. Their target is ambitious: a deficit of 3 percent of GDP by 2012, as required under the Excessive Deficit Procedure and outlined in their revised Convergence Programme. However, the recently announced package of fiscal reform proposals, which remains to be implemented, will in the view of staff only bring down the deficit modestly, to just under 7 percent of GDP in 2011 and about 5¾ percent of GDP in 2012 (Box 4). As a result, the general government debt-to-GDP ratio on an ESA95 basis is set to continue to increase, peaking at about 62 percent of GDP by 2014 (including debts of the National Road Fund that are excluded from the national definition of debt).

15. A consolidation strategy should balance short-term cyclical and medium-term consolidation objectives. In light of the still incipient and uncertain recovery, staff believes that aiming at a deficit of 3 percent already by 2012 is too ambitious and that a more gradual reduction in the deficit is warranted. Staff suggests additional structural fiscal measures—over and above those announced already—of ½ to 1 percent of GDP annually during the next 4-5 years. With such measures, the deficit would fall below 3 percent of GDP by 2013-14 and the debt-to-GDP ratio would begin to decline from then onward.


Poland: General Government Balance

(ESA95, percent of GDP)

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

Sources: Eurostat and IMF staff estimates.

Poland: General Government Debt

(ESA95, percent of GDP)

Citation: IMF Staff Country Reports 2010, 118; 10.5089/9781455202546.002.A001

16. The substantial fiscal adjustment needed over the medium term will require changes in entitlement programs. Given that statutory spending represents about ¾ of total expenditures, a durable expenditure reduction is unlikely to be achieved merely by the proposal to introduce a rule limiting the real growth of discretionary spending to one percent per year. Staff agrees, however, that such rules, reinforced by comprehensive expenditure reviews, could prove helpful in controlling discretionary spending. Regarding statutory spending reforms, possible options include tightening pension indexation, rationalizing other benefits (sickness, disability, etc.), and increasing the flexibility of limits on defense spending. These could be complemented with further revenue-enhancing measures, such as better linking contributions to income for the self-employed, extending coverage of the PIT to include farmers, unifying VAT rates at a higher level, improving the targeting of child benefits, and revamping the property tax system.

17. The medium-term fiscal framework needs to be further strengthened. The four-year rolling fiscal plans that were introduced as part of the revamped Public Finance Act in late 2009 are useful in providing guidance on medium-term policy goals. However, they are non-binding and remain focused on nominal deficits, retaining the potential pro-cyclical bias in fiscal policy. Hence, there is a need to adopt a permanent, binding expenditure rule with a deficit or debt anchor that is consistent with the authorities’ medium-term targets. The framework could be further strengthened by the implementation of the ongoing multi-year performance budgeting reforms at all levels of government.

18. Poland has been ahead in implementing reforms to ensure the long-term sustainability of its pension system. This is evident from cross-country comparisons using more comprehensive, intertemporal measures of Poland’s net worth.5 Paradoxically, traditional deficit and debt indicators are worse as a result of these reforms. With the deficit now above the Maastricht limit and debt running against the ceilings imposed under Polish legislation, the authorities have been considering, among other options, lowering transfers to private pension funds (which currently add around 1.5-2 percent of GDP per year to the deficit and debt).6 Staff is concerned that this could be seen as a more fundamental reversal of pension reforms at a time when the credibility of Poland’s commitment to medium-term fiscal consolidation hinges on reforms of entitlement programs. As regards alternative proposals, including redefining the national debt definition and corresponding debt thresholds in the Public Finance Act, this should be done in such a way as not to undermine confidence in the fiscal framework and not to encourage spending pressures.

19. The transparency of fiscal accounts could be increased. The authorities should consider moving public entities (such as the national Road Fund) within the budget and publishing the intertemporal net worth of the public sector on a regular basis.

20. The authorities believed that their fiscal consolidation plans were sufficient to achieve a significant reduction in the deficit. Even under an alternative scenario—with macroeconomic assumptions closer to staffs—they saw the deficit reaching 3 percent of GDP by 2013 under the measures announced so far. Compared to staff, the authorities project higher tax buoyancy and the same growth rate for other expenditure categories as for discretionary expenditures that are covered by the CPI+1 rule. They agreed that strengthening the medium-term fiscal framework is key to anchoring expectations in the sustainability of public finances for the medium and long run. In this regard, they noted that they were working on the details of a permanent fiscal rule and intended to provide a road-map for its implementation later this year.7 The authorities also noted that a final decision had not been taken regarding the proposal to lower transfers to the private pension funds and acknowledged that any action to this effect would need to be carefully designed and communicated so as not to undermine policy credibility.

The New Fiscal Consolidation Package

The authorities have unveiled a package of fiscal consolidation and development priorities. While the plan is important, it is not fully specified and is, in staffs view, expected to yield only modest savings, of about 0.1-0.3 percent of GDP per year in the medium-run. It is yet to be approved.

The plan contains concrete measures to broaden the tax base and improve tax collection:

  • Rules on VAT reimbursements for company cars and fuel will be tightened.

  • Fiscal registers for lawyers and doctors will be introduced.

  • E-taxes will be introduced.

It also aims to improve the fiscal framework, including through new fiscal rules:

  • A temporary nominal spending limit on discretionary spending, the “CPI+1 rule”—capping its real growth to 1 percent—will be in effect until the medium-term objective (1 percent structural deficit) is attained.

  • A permanent fiscal rule will replace the nominal limit. It would apply to a broader scope of public expenditures and rely on a real growth rate in a reference period and an inflation target. The details, including coverage, target, and timing, are yet to be specified.

  • An additional measure of public debt will be defined, based on an idea of the public sector’s intertemporal net debt.

  • Performance budgeting will be helped by the implementation of multi-year budget planning.

  • Liquidity management of public resources will be strengthened through a monitoring system of all budgetary funds and obligatory placement of all deposits of selected public-finance sector organizations on Ministry of Finance accounts.

It advances reforms of pensions and disability benefits:

  • Disability pensions will be aligned with social security contributions paid.

  • Pensions of uniformed personnel will be merged into the general system starting in 2012. With grandfathering, savings will be obtained only after 2030.

  • A debate about changing the farmer pension scheme (KRUS) will be restarted.

  • The investment efficiency of the private pension system (OFE) will be improved by modifying investment limits, lowering fees, and prohibiting advertisement of pension funds.

It accelerates the privatization agenda:

  • Privatization of public enterprises in 2010 will be accelerated, to generate 25 bn zloty. Additionally, arable land would be sold.

But it also includes measures to improve state administration that will require additional spending:

  • These measures include improving the judiciary system, increasing teacher salaries, advancing R&D, etc.

Announced Fiscal Measures

(in percent of GDP)

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B. Maintaining a Flexible Monetary and Exchange-Rate Policy

21. Staff believes that a rise in policy rates would not be warranted any time soon. This is in line with its view that inflation, under current policies, is set to stay around the NBP’s inflation target of 2½ percent for the foreseeable future. It contrasts with the projection in the NBP’s February Inflation Report that inflation is likely to exceed the upper end of the tolerance band in 2012 and with the market’s consensus view that policy rate hikes are in the offing before the end of 2010.

22. If upward pressures on the zloty persist, and inflation remains contained, the policy rate should be cut. The recovery in global risk appetite, not least in the demand for assets of countries that have weathered the crisis well, suggest that foreign demand for Polish assets could continue to build, resulting in further zloty appreciation. In that case, staff believes that the MPC should revert to an easing bias and cut the policy rate.

23. In this case, the NBP could also respond by undertaking limited pre-announced foreign-exchange intervention. The intervention policy should be transparent and well-communicated so as not to compromise the integrity of the inflation-targeting framework. The experience of other countries has shown that such a policy can be successful at a time when the economic cycle permits a looser monetary policy.8 With subdued inflation and a negative output gap, Poland appears well poised to successfully implement such a policy on a temporary basis if upward pressures on the zloty continue during 2010. Intervention would also boost international reserves, which are still low relative to standard metrics. The limitations on foreign-currency lending for prudential reasons discussed below could have the auxiliary benefit of slowing capital inflows. However, if capital inflows persist and cause overheating, there would be no alternative but to tighten fiscal policy and allow appreciation.

24. The authorities had mixed views on the monetary policy stance. While most of the mission’s interlocutors believed that the neutral bias remained appropriate, the discussions showed different views regarding the balance of risks going forward: some MPC members stressed the need to signal a possible near-term increase, reflecting the view that risks were dominated by the possibility of a faster absorption of the remaining slack in the economy and attendant increase in inflationary pressures; others, however, agreed with staff that the more likely risk is that the zloty continues to appreciate, driven by capital inflows, while the economy continues to operate below potential, which would call for a renewed loosening bias. In this regard, while policy makers generally saw some scope for further appreciation without jeopardizing competitiveness, there was a growing concern that a rapid zloty appreciation could jeopardize the recovery.

C. Ensuring Financial System Resilience and Enhancing Prudential Regulations

25. Efforts to strengthen financial system resilience are continuing. The recent introduction by the KNF of Recommendation T is expected to strengthen what are considered to be uneven lending standards as far as household credits are concerned. Moreover, in view of international efforts to tighten liquidity and capital standards, the KNF continues to closely monitor and enforce quantitative liquidity requirements, and it plans to ensure that the weaker tier of banks rebuild their capital buffers. It is also working on bottom-up stress tests of banks, complementing the NBP’s top-down tests. In response to what is widely perceived to be a potentially serious financial sector vulnerability, a law has recently been approved that subordinates cooperative credit unions (SKOKs) to supervision by the KNF and makes them eligible for lender-of-last resort support from the NBP, although the law is currently subject to a review by the Constitutional Tribunal. Finally, the authorities are advancing legislation allowing the government to recapitalize financial institutions in emergency situations.

26. Risks stemming from un-hedged foreign-exchange exposures should be curbed. With liquidity problems having eased and domestic risk appetite returning, regulators and market participants expect banks to increase foreign-exchange lending, not least euro-denominated mortgages. In view of this, staff believes that the KNF should take forceful steps to limit such lending. The KNF should ensure that foreign-exchange lending is funded and hedged on a longer-term basis, and capital requirements on foreign exchange-denominated mortgages should be raised decisively to reflect the higher credit and valuation risks in the event of a sudden depreciation. These measures could be calibrated so as to reduce the attractiveness of such mortgages. If prudential measures were ineffective in slowing the growth of these mortgages, the government should consider legislating constraints.

27. The authorities agreed with the thrust of staff’s recommendations. The KNF has been recently using moral suasion to stop banks from offering yen-denominated mortgages. Moreover, it indicated that it was now working on a formal recommendation that would require long-term funding and hedging for all currencies. The KNF stressed, however, that the effectiveness of higher capital requirements would hinge on the cooperation of the home regulatory authorities of parent banks, to prevent these banks from providing foreign currency-denominated mortgages directly to local borrowers. An alternative was to place constraints at the product level, which could then be enforced locally, using the KNF’s existing consumer-protection powers or new legislation. Finally, the authorities indicated that discussions are underway on how to permanently improve crisis management and resolution processes, building on the strong resolution powers on the part of the KNF. They welcomed the prospect of an FSAP update.

D. Adopting the Euro and Increasing Structural Flexibility

28. Delaying euro adoption is appropriate at the current juncture. The authorities have played down prospects for early euro adoption. In staffs view, the large adjustment needs in the next few years and the continued uncertainty in the external outlook suggest that early ERM-II entry would be risky. More important, in determining when to adopt the euro, the authorities should be mindful of the fact that exchange-rate flexibility has served Poland well, providing a shock absorber that significantly facilitated adjustment to the global crisis; such flexibility was an important reason for Poland’s having avoided a recession in 2009. Staff believes that a higher degree of synchronization between Poland and the Euro area as far as external shocks are concerned should be achieved before giving up an independent exchange-rate policy. The credibility of Poland’s monetary policy framework, not least what has proven to be a well-functioning inflation-targeting framework, also suggests that there is no urgency to Euro adoption. Nevertheless, Euro adoption should remain an important goal.

29. There is considerable scope for boosting potential growth through structural reforms. Priority should be given to increasing Poland’s exceptionally low labor participation, especially among those above 50 years of age. With significant population aging expected in the coming decades, this bottleneck will likely hamper competitiveness and weigh heavily on its long-run growth. The authorities have taken important steps to address this concern, including by strengthening active labor market policies, reducing the tax wedge, and tightening eligibility criteria for early retirement. But more should be done, especially on reforms with a complementary long-term fiscal impact, such as pension reforms aimed at gradually increasing and equalizing the retirement age between men and women and unifying special pension schemes within the general system. Such efforts should be complemented by actions to enhance product-market flexibility, including vigorously pursuing the ambitious privatization agenda and further reducing administrative barriers to business activity.

30. The authorities confirmed that increasing labor participation remained an over-arching priority. In this regard, they noted that work was underway on advancing labor supply-enhancing reforms, including on unifying special pension schemes within the general system and reforming the tax system for farmers. These efforts are in line with their objectives established in their Solidarity 50+ and Poland 2030 plans. The authorities also pointed out that privatization efforts were on track, with more than one fifth of the total planned receipts for 2010 already achieved by end-March, and more revenues expected later in the year from the privatization of several key public energy companies.

V. Staff Appraisal

31. Poland has adjusted its economic policies in a timely and effective manner in response to the global crisis. It weathered the crisis well, being the only EU country not to have fallen into recession in 2009. This is due, in part, to Poland’s large domestic market and attendant limited reliance on exports, which—coupled with a well-capitalized and profitable banking system—limited the negative spill-over from the crisis through both the real and financial channels. But it also reflects sound economic policies prior to the crisis, which contained macroeconomic imbalances and allowed considerable room for maneuver when the crisis struck. Policy-makers took full advantage of this room to provide significant monetary and fiscal stimulus. Looking forward, with the relative cyclical position continuing to advance, but the recovery still feeble and uncertainty high, the challenge facing policy-makers now is when and how to begin withdrawing fiscal and monetary stimuli, i.e. how to adjust the policy mix as circumstances evolve.

32. With inflation falling steadily and the economy operating below potential, staff sees no case for an increase in policy interest rates at this juncture. Indeed, in view of the steady recovery in capital inflows and attendant upward pressures on the zloty, staff believes that the decision last October to end the loosening cycle and adopt a neutral bias might have been premature. If such inflows persist, and if inflation remains contained, the MPC should reduce policy rates further. Staff also sees a case for transparent interventions in the foreign-exchange market at the current juncture, without fuelling inflation expectations or undermining confidence in the inflation-targeting framework.

33. The highly counter-cyclical fiscal policy has been a main reason for Poland’s having avoided a recession. The large discretionary relaxation was fortuitous in as much as it reflected the delayed coming-into-effect of measures adopted well before the crisis. Be that as it may, the government’s decision in mid-2009 to abandon plans to offset the revenue shortfall—through what would have been severe pro-cyclical spending cuts—was a much welcomed change of heart. In this regard, the availability of the FCL enhanced the policy space at this sensitive juncture, as it allowed policy-makers to recognize significantly higher deficits going forward without unsettling markets. Indeed, spreads fell notably even as announced deficits widened.

34. The government now needs to be clearer about its fiscal exit strategy. With the economy continuing to recover, the fiscal stimulus should be gradually withdrawn. The government’s official objective—meeting the SGP target of 3 percent of GDP by 2012—is ambitious, yet its plan for achieving it is unclear. In staffs view, the measures announced by the authorities so far will only slowly and modestly lower the deficit in the next few years to slightly below 6 percent of GDP by 2012. This is too slow, and staff suggests taking additional measures of about ½ to 1 percent of GDP annually. This would reduce the deficit to 3 percent by 2013-14. Staff believes that its proposal strikes a more appropriate balance between short-term cyclical and medium-term consolidation objectives: going faster—as envisaged under the SGP—is too risky in view of the still feeble recovery in Poland and abroad, but going as slow as implied by the government’s announced measures would limit the ability to react to unforeseen changes.

35. Thus, a reduction in the deficit is important for the authorities’ ability to adjust the policy mix in a timely manner as circumstances change. In the near team, there appears to be little risk that the slow withdrawal of the stimulus implied by the government’s announced measures might be a source of inflationary pressures in the event of a stronger-than-expected recovery in private sector demand. However, this risk increases as the time horizon is extended and the output gap closes. In this regard, considering that it could prove difficult for the authorities to tighten fiscal policy in a timely manner during what will be a prolonged cycle of presidential, parliamentary, and local elections in 2010-11, staff is concerned that the slow fiscal adjustment implied by current plans could force the authorities to adopt an inappropriate policy mix, with excessive reliance on monetary policy to contain inflationary pressures, and attendant upward pressures on the zloty. For now, the MPC has room to respond to the upward pressures on the zloty associated with the large public sector borrowing need by lowering policy rates, but as inflationary pressures gradually reemerge, such room will disappear, and continued large public sector borrowing could be a source of excessive zloty appreciation.

36. The KNF has responded effectively during the crisis. Its proactive move to encourage banks to retain the record-high 2008 profits and its recent recommendations aimed at strengthening lending standards for household loans speak to the effectiveness of its supervision. Looking forward, the KNF should take forceful steps to counter what appears to be a renewed appetite for foreign-exchange lending, not least the extension of foreign currency-denominated mortgages. In this regard, the authorities should be mindful of the experience of regional peers during the 2008-09 crisis that large un-hedged foreign-exchange liabilities significantly curtailed policy options, in effect exacerbating the recession through pro-cyclical policies. Foreign-exchange lending should be funded and hedged on a longer-term basis, and capital requirements on foreign exchange-denominated mortgages should be raised decisively to reflect higher credit and valuation risks. If such prudential measures were ineffective in slowing foreign currency-denominated mortgages, the government should consider legislation imposing explicit constraints.

37. Staff does not support early euro adoption. While this should remain an important goal, entering ERM2 any time soon would not be advisable in view of the uncertain global outlook and the rigidities in the macroeconomic policy mix discussed above. More importantly, the crisis has underscored the importance of being able to use the exchange rate to facilitate adjustment to external shocks. In staffs view, the swift change in the real exchange rate was one of the key reasons for Poland’s not falling into recession in 2009.

38. Overall, staff believes that Poland’s enviable performance during the global crisis owes much to good and timely economic policies—before and during the crisis—including a sound institutional framework. This augurs well for the authorities’ ability to meet the challenges ahead.

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

Table 1.

Poland: Selected Economic Indicators, 2007-11

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Sources: Polish authorities; and IMF staff estimates.

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

According to ESA95 (includhg pension reform costs). Including the authorities’ recent fiscal consolidation package.

Excluding debts of the National Road Fund.

NBP Reference Rate (sop). For 2010, latest.

For 2010, exchange rate as of April 5.

Annual average (1995=100).

Table 2.

Poland: Balance of Payments on Transaction Basis, 2007-15

(In milions of US$)

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

Perminary estimate based on quarterly national accounts data for 2009Q.1-Q3 and monthly Perminary data for 2009Q4

Reserve level at end of previous year over short-term debt by remaining maturity.

Exports of goods and services.

Excluding repurchase of debt and Including deposits.

Table 3.

Poland: General Government Revenues and Expenditures, 2008-15

(In percent of GDP, ESA95 basis)

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Sources: Eurostat; and IMF staff estimates.Notes: The projections include consolidation measures that have beeen announced but not yet implemented. They do not include additional measures that would be triggered under the Public Finance Act if debt (national definition) exceeds the 55 percent-of-GDP threshold.
Table 4.

Poland: Financial Soundness Indicators, 2005-09

(In percent)

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Sources: National Bank of Poland; and KNF.

Data for domestic banking sector.

Data are from KNF and for 2009Q3.

Table 5.

Poland: External Financing Requirements and Sources, 2008-13

(In million of U.S. dollars)

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Sources: National authorities; and IMF staff estimates.
Table 6.

Poland: Medium-Term Scenario, 2008-15

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Sources: Polish authorities; and IMF staff estimates.

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

The projections include consolidation measures that have been announced but not yet implemented. They do not include additional measures that would be triggered under the Public Finance Act if debt (national definition) exceeds the 55 percent-of-GDP threshold.

Table 7.

Poland: Monetary Accounts, 2004-09

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Sources: IMF, International Financial Statistics and IMF staff estimates.