Republic of Poland
Staff Report for the 2011 Article IV Consultation
Author: International Monetary Fund
Publication Date:
08 Jul 2011
eISBN:
9781455295708
ISBN:
9781455295708
Language:
English
Keywords:
ISCR; CR; GDP; headline CPI inflation; NBP; inflation rate; liquidity position; core CPI; fcl arrangement; short-term debt; debt ratio; debt stock; Current account deficits; Inflation; Global; debt-service-to-income ratio
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In this study, the economic development of Poland after the recession is discussed. The importance of maintaining macroeconomic policies and advancing growth-enhancing structural reforms are explained. Increase in labor participation and a reduction in product market rigidities are key to increase potential growth. Improvements of the balance of payments compilation system has been encouraged by the authorities. To strengthen the financial sector, increase the independence of financial supervision authority, develop a framework for coordinating policy responses to systemic risks, and strengthen the bank resolution framework are also encouraged.

Abstract

In this study, the economic development of Poland after the recession is discussed. The importance of maintaining macroeconomic policies and advancing growth-enhancing structural reforms are explained. Increase in labor participation and a reduction in product market rigidities are key to increase potential growth. Improvements of the balance of payments compilation system has been encouraged by the authorities. To strengthen the financial sector, increase the independence of financial supervision authority, develop a framework for coordinating policy responses to systemic risks, and strengthen the bank resolution framework are also encouraged.

I. Context

1. A solid recovery is underway, driven by domestic demand. As capacity constraints tighten, inflationary pressures and the current account deficit are expected to rise. The fiscal deficit in 2010 was large and the government debt-to-GDP ratio rose. Indicators of banking system soundness are generally stable, though some challenges remain. The FCL arrangement continues to play an important role in providing insurance against tail risks.

2. Against this background, the mission focused on the following key policy issues:1

  • How would an upward revision to the current account deficit affect external vulnerability?

  • How quickly should fiscal policy tighten, given the need to ensure counter-cyclicality and fiscal sustainability?

  • What considerations should determine the pace of monetary policy tightening?

  • What can be done to further strengthen financial sector policies?

  • How should policies respond if capital inflows were to increase sharply?

  • How can structural reforms boost potential growth?

3. Parliamentary elections are expected in October 2011. The center-right Civic Platform (PO) has governed in a coalition with the agrarian Polish People’s Party (PSL) since 2007. Poland will take up the rotating presidency of the EU Council in July 2011.

II. Recent Economic Developments

4. The economic recovery gained momentum in 2010 (Figure 1 and Table 1). Real GDP growth picked up to 3.8 percent, driven primarily by private consumption—in turn helped by a rebound in employment and wage growth during the second half of the year—and strong inventory accumulation. Fixed investment contracted, as robust EU-financed public investment was more than offset by weak private investment, as firms remained cautious about the outlook. Strengthening domestic demand reduced the contribution to growth from net exports. High-frequency indicators point to continued momentum in the early months of 2011, with strong retail sales and industrial production.

Figure 1.
Figure 1.

Poland: Recent Economic Developments, 2008-11

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: European Commission; and Polish Statistical Office.
Table 1.

Poland: Selected Economic Indicators, 2009-13

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Sources: Polish authorities; and IMF staff estimates.

Real GDP is calculated at constant avergae prices of previous year.

According to ESA95 (inc. pension reform costs). Including the 2011 budget and all announced measure as of March 2011.

Excluding debts of the National Road Fund.

NBP Reference Rate (avg). For 2011, as of June, 2011.

For 2011, exchange rate as of June 14.

Annual average (2000=100); for 2010, January-October average.

5. Labor market conditions have strengthened (Figure 2). Private-sector employment growth increased, largely driven by the service sector. The labor force participation rate also rose, reflecting both improved employment prospects and tighter eligibility requirements for early retirement. The LFS-based unemployment rate declined to 9.3 percent at end-2010.

Figure 2.
Figure 2.

Poland: Labor Market developments, 2007-10

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Source: Poland’s Statistical Office

6. Inflation rose, mostly reflecting higher commodity prices, a VAT hike, but also some increase in core inflation (Figure 3). CPI inflation increased to 4.5 percent in April 2011, mostly driven by food and energy prices as well as the one-off effects of the recent hike in VAT rates. At the same time, rising capacity utilization, a closing output gap, and increasing private sector nonfarm wage growth put some upward pressure on core inflation.

Figure 3.
Figure 3.

Poland: Capacity Utilization, Output, and Inflation, 2007-11

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: European Commission; Polish Statistical Office; and IMF staff estimates.

7. The current account deficit widened in 2010, reflecting stronger domestic demand (Figure 4, Table 2). The current account deficit increased to 3.4 percent of GDP, as a rebound in export growth due to improving conditions in Poland’s main trading partners was more than offset by an acceleration of imports. The current account deficit was almost fully financed by capital transfers from the EU and net FDI inflows. The decline in FDI reflected a specific foreign disinvestment in the insurance sector. Financial market turbulence in Europe in May and November 2010 temporarily increased Poland’s CDS and government bond spreads (Figure 5). The real exchange rate is broadly in line with fundamentals (Box 1).

Figure 4.
Figure 4.

Poland: Balance of Payments Developments, 2007-11

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Source: National Bank of Poland.1/ Excludes NBP.
Figure 5.
Figure 5.

Poland: Recent Financial Markets Developments January 2009 - May 2011

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: Bloomberg; and Polish Ministry of Finance.
Table 2.

Poland: Balance of Payments on Transaction Basis, 2009-16

(Millions of US dollars)

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

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.

8. The banking sector remained profitable and well capitalized in 2010, but credit quality deteriorated (Figure 6, Table 5). Improving net interest margins boosted profitability and the average capital adequacy ratio rose to around 14 percent, with Tier 1 capital representing 90 percent of total capital. The nonperforming loan ratio increased to about 9 percent, but now appears to have stabilized. Stress tests by the central bank, reported in the December 2010 Financial Stability Report, show that most banks are resilient to adverse shocks. Preliminary analysis by the authorities indicates that banks generally meet the new Basel III requirements. Private sector credit grew by about 9 percent, with mortgage lending remaining strong, consumer lending falling, and corporate lending picking up (Figures 7 and 8).

Figure 6.
Figure 6.

Poland: Banking Sector Developments, 2007-11

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: National Bank of Poland; and IMF staff estimates.
Figure 7.
Figure 7.

Poland: Credit Developments 2007-11

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: National Bank of Poland; Country Central Banks; and IMF staff estimates.
Figure 8.
Figure 8.

Poland: Residential Real Estate Lending, 2007-11

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: National Bank of Poland; Bloomberg; KNF; and IMF staff estimates.
Table 3.

Poland: General Government Revenues and Expenditures, 2009-16

(In percent of GDP, ESA95 basis)

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Sources: Eurostat; and IMF staff estimates.Notes: The projections include measures announced to date.
Table 4.

Poland: Medium-Term Scenario, 2008-16

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

Table 5.

Poland: Financial Soundness Indicators, 2005-11

(In percent)

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Sources: National Bank of Poland; KNF; and IMF staff

Data for domestic banking sector.

III. Outlook and Risks

9. Real GDP growth is expected to remain at about 3¾–4 percent in 2011–12, underpinned by domestic demand (text table, Table 4). Private consumption is projected to continue to grow steadily, supported by stronger labor market conditions that more than offset headwinds from the VAT rate hike and higher energy prices. EU-funded public investment is set to peak in 2011 and then slow in 2012. Private fixed investment should accelerate, given higher profitability and increasing capacity utilization. Inventory accumulation is projected to slow down from a year ago. Employment growth should remain solid, leading to a further fall in the unemployment rate. The full relaxation of German labor market restrictions on Polish workers is not expected to have a major impact on the Polish labor market. CPI inflation is expected to rise through mid-2011 and then gradually decline toward its 2½ target by end-2012.

10. Based on existing data, the current account deficit is projected to widen to 4.1 percent of GDP in 2012. While foreign demand should support exports, strengthening domestic demand and high commodity prices will boost imports. Following the temporary slowdown in 2010, net FDI flows are expected to increase in 2011 and then remain stable. Portfolio inflows should decline gradually in line with lower government financing needs. Reserve accumulation is expected to continue, although at a slower pace than in recent years.

Poland: Real Exchange Rate Assessment

On balance, the evidence suggests that the real exchange rate of the zloty, which is classified as a free float, is broadly in line with fundamentals. Specifically:

  • The actual real exchange rate is less strong than the estimated equilibrium real exchange rate, which has been boosted by improvements in relative productivity. The sum of the current account balance and capital transfers in the medium term is slightly more negative than the current account norm used in the macro-balance approach, but slightly more positive than NFA-stabilizing current account balance used in the external sustainability approach.

  • The CPI-based real exchange rate is slightly above its historical average, but Poland’s cumulative real exchange rate appreciation since 2000 remains below that of regional peers. ULC-based measures of the REER have picked up over the last year as improving cyclical conditions have contributed to a pick-up in wage pressures.

CGER Results, 2010-11

(Percent deviation from estimated equilibrium)

article image
uA01bx01fig01

Poland: Real Effective Exchange Rate

(Index, 2000=100)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

uA01bx01fig02

Poland: Alternative REER Measures

(Index, 1999=100)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: National authorities; European Commission; and GDS.

Poland: Real GDP Growth and Inflation Projections, 2011-14

(Percent change)

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Sources: Polish authorities; and IMF staff estimates.

11. Improvements to the BOP compilation system may lower large errors and omissions, but increase the reported current account deficit and external vulnerability. The authorities are scrutinizing the nonfinancial private sector’s external assets, banks’ off-balance sheet operations, and various current account items (especially trade in goods and services, and private transfers). The authorities have indicated that imports of used cars may have been under-recorded, and net private sector transfers over-stated. As a result, the forthcoming BOP data release may revise up the 2010 current account deficit by 1–2 percentage points of GDP to 4½–5½ percent of GDP. Revisions to E&O may change the structure of GDP, but are unlikely to change overall growth as any upward revisions to imports are expected to be offset by higher consumption and investment. A higher current account deficit would indicate that net national saving is lower and that vulnerability to external financing shocks is higher than previously thought. Furthermore, it would affect the assessment of the exchange rate and could imply a higher projected path for external debt (Appendix I).

12. Risks to the growth outlook are balanced, with external risks mainly on the downside and domestic risks mainly on the upside. While direct exposure to Europe’s periphery via trade and financial channels is limited, sovereign financing concerns in the region could spill over to funding pressures in core Europe and in turn increase financing costs for Poland. In addition, Poland is closely integrated into Europe’s banking system, making it potentially vulnerable to contagion from financial strains. Poland’s FCL arrangement provides insurance against these risks. A sustained rise in global oil prices would represent a risk to GDP growth. On the upside, increased investor appetite for Polish assets could lead to a surge in capital flows. Also, given improved corporate profitability and tightening capacity constraints, private fixed investment could recover more rapidly than currently envisaged.

Authorities’ views

13. The authorities broadly shared staff’s views on the outlook and risks. The central bank’s GDP growth projections for 2012–13 are slightly lower than staff’s, reflecting the view that fiscal consolidation will have a more negative impact on domestic demand.

14. The authorities were more sanguine than staff about the implications of a higher current account deficit for external vulnerability, emphasizing that the past widening of the current account deficit was gradual and fully financed.

IV. The Policy Agenda

A. Narrowing the Fiscal Deficit

15. The fiscal deficit widened in 2010 (Figure 9, Table 3). Given initial uncertainty about the strength of the recovery, the 2010 budget envisaged a roughly neutral policy stance. In the event, the fiscal deficit widened to 7.9 percent of GDP, mainly reflecting the lagged effects of the 2009 economic slowdown on corporate income tax revenues, as firms continued to deduct earlier losses. Financing needs were comfortably met in financial markets (with nonresident purchases of government bonds reaching an all-time high) and through privatization receipts. With government debt not far from an important threshold under the Public Finance Act, the authorities specified additional corrective actions triggered by the debt threshold.2

Figure 9.
Figure 9.

Poland: Recent Fiscal Developments

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

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

16. Substantial fiscal consolidation is under way (text table). Consolidation measures amounting to 1½–1¾ percent of GDP each year are being implemented in 2011–12, notably tightened eligibility for early retirement, a ceiling of CPI+1 on the growth of discretionary expenditure (which includes a wage bill freeze in 2011), a VAT increase of 1 percentage point, and increases in excise taxes. In addition, some pension contributions are being shifted from the private to the public system and the government intends to further restrain local government deficits. Based on announced policies and tax buoyancy, staff expects the fiscal deficit to fall to 5.6 percent of GDP in 2011 and 3.6 percent of GDP in 2012.

17. To put government debt firmly on a downward path, additional fiscal consolidation will be needed (text figures). On staff’s baseline projections, the fiscal deficit would fall over the medium term to 2 percent of GDP and government debt would decline slowly to 53 percent of GDP (ESA95 basis). To reduce debt firmly over time, the fiscal deficit should be cut to no more than 1 percent of GDP over the medium term, which is also Poland’s medium-term objective (MTO). The MTO ensures long-term sustainability taking into account projected increases in age-related spending. This would require additional permanent measures of a little more than 1 percent of GDP. With such measures, the debt-to-GDP ratio would fall to about 40 percent of GDP by 2021. Given that statutory spending represents about ¾ of total expenditures, the authorities could continue their reforms of entitlement programs to attain a durable expenditure reduction. Specific measures that could be considered include tightening pension indexation, aligning disability benefits with the pension formula, improving the targeting of other benefits, increasing the flexibility of the floor on defense spending, streamlining public administration employment, limiting tax reliefs and exemptions, and enhancing VAT yields. Staff suggested that, given the tightening of capacity constraints and increased vulnerabilities associated with an upward revision to the current account deficit, it would be good to front-load this additional adjustment.

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Sources: MoF and IMF staff estimates and projections.

Due to EU regulations.

uA01fig01

Poland: General Government Balance

(ESA95, percent of GDP)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Notes: The baseline includes identified measures announced to date.Sources: Eurostat; MoF; and IMF staff estimates.
uA01fig02

Poland: General Government Debt

(ESA95, percent of GDP)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Notes: The baseline includes identified measures announced to date.A 1 percent interest-growth differential is assumed in the long run. Sources: Eurostat; Mof; EC; and IMF staff estimates.

18. The authorities are planning to adopt a permanent fiscal rule. They are aiming for a fiscal rule that would allow for countercyclical policy responses, be expenditure-based to help constrain the size of government, and be simple to design, implement, and present to the public. Specifically, they are considering a ceiling on nominal expenditure growth equal to historical nominal GDP growth minus 1 percent. Given the importance ensuring fiscal sustainability, staff suggested that the spending rule be anchored by Poland’s MTO, so that spending growth would be reduced if the deficit consistently exceeds the MTO (a “debt brake”). Such a rule would be effective in restraining debt while allowing for some counter-cyclicality. Staff also highlighted that the rule should be complemented by strengthening the implementation of the ongoing multi-year budgeting reforms, including through annual spending reviews, moving toward top-down budgeting, and preparing multi-year fiscal forecasts at the general government level.

19. The shift of some pension contributions from the private to the public system will improve government debt dynamics, but should not be allowed to facilitate higher spending or tax reductions that could weaken fiscal sustainability. The comprehensive pension reform of the late 1990s improved long-run fiscal sustainability (Appendix II). However, the funding of future pension liabilities in the private second pillar led to higher fiscal deficits and debt than would have otherwise been the case. The recently-implemented shift of some pension contributions from the private to the public pension will reduce the fiscal deficit and projected debt. However, if the shift contributes to delays in structural fiscal reforms, then it could weaken fiscal sustainability. Moreover, given the projected long-term decline in replacement ratios, staff suggested raising national saving once fiscal space allows (i.e. once the MTO is achieved), either by strengthening the fiscal balance target or increasing contributions to the second pillar. Also, a funded second pillar is potentially beneficial from international risk-diversification and capital-market development perspectives. At the same time, the regulation of private pension funds should be improved.

Authorities’ views

20. The authorities agreed that additional fiscal measures will be needed over the medium term, but differed on timing. The authorities are confident that the outlined measures will be sufficient to meet the 2012 target. Nevertheless, they stand ready to adopt additional measures, if necessary.

21. The authorities saw scope for anchoring the envisaged permanent fiscal rule in the MTO. They added that the rule would be accompanied by a strengthening of budgetary processes and be governed by either a new Fiscal Responsibility Law or an amendment to the Public Finance Act.

22. The authorities agreed on the need to increase retirement saving over the long term, but preferred to improve incentives for voluntary private saving (third pillar). While they did not exclude a more ambitious fiscal target to create additional fiscal space, they opposed using this space to enhance mandatory private saving under the second pillar.

B. Tightening Monetary Policy

23. After keeping the policy interest rate unchanged during 2010, the central bank began to raise the rate in January 2011. As financial conditions normalized, exceptional liquidity facilities were gradually withdrawn during 2010. The central bank has hiked the policy rate since January by a cumulative 1 percentage point to 4½ percent. This puts the policy rate broadly in the neutral range (based on an estimated equilibrium real rate of 2¼ percent plus the 2½ percent inflation target).

uA01fig03

Policy Rate

(Percent)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

24. Looking forward, core CPI inflation is projected to continue to rise. Improving labor market conditions and tightening capacity constraints are expected to boost core inflation. Headline inflation should peak at around 4¾ percent in 2011Q3 before starting to fall, as commodity price increases moderate.

25. Given inflationary pressures, some further increases in the policy rate will be needed. The appropriate magnitude and pace of tightening will depend on the evidence on capacity constraints, as well as developments in inflation expectations, labor markets, the exchange rate, and possible second-round effects from higher food and fuel prices. In staff’s model-based forecast, which incorporates an endogenous interest rate path, further gradual hikes in the policy rate by about a cumulative ½ percentage point over the next 12 months would bring inflation back to the 2½ percent target over the policy horizon (Appendix III). Financial markets are pricing in a similar pace of policy tightening.

26. Monetary policy communication has been strengthened. In particular, recent post-MPC meeting communiqués have contained more discussion of the MPC’s view of the inflation outlook. There is scope for further elaboration, for example regarding the MPC’s views of the balance of risks or the short- versus medium-term dynamics.

27. The recent decision to convert some EU funds on the foreign exchange market (FX) will lower reserve accumulation. Hitherto, most EU funds have been exchanged at the central bank; the authorities now plan to convert some EU funds on the foreign exchange market, which—in their view—would limit excess liquidity in the banking system. Market conversion implies a slower buildup of foreign exchange reserves by the central bank, which will contain sterilization costs. Reserves exceed several measures of reserve adequacy, but fall short of short-term debt at remaining maturity plus the current account deficit, suggesting that some additional reserve accumulation would be desirable (Appendix IV). Staff suggested that official sales of foreign exchange ought to be done in a transparent and non-discretionary way, so as to minimize potential exchange rate volatility.

Authorities’ views

28. There was agreement on the need for some further gradual rate hikes, but the authorities took slightly different views on reserve accumulation and FX sales. The central bank noted that reserves are more than adequate on most measures and thus saw little need for further reserve accumulation. On FX sales, the authorities noted that market reactions are difficult to anticipate, but emphasized that the policy intention is not to influence the exchange rate.

C. Strengthening Financial System Resilience

29. Financial sector policies have been effective, but there is room to further strengthen resilience. In early 2010, the Financial Supervision Authority (KNF) introduced Recommendation T, imposing tighter standards on lending to households, including by capping the debt-service-to-income ratio under stressed scenarios at 50 percent (65 percent for above-average earners). More recently, the KNF reinforced the previously-issued Recommendation S—which strengthened standards on mortgage lending to households—by capping the debt-service-to-income ratio for FX loans at 42 percent, with banks having until end-2011 to adjust. KNF recommendations appear to have helped reduce the share of FX mortgages in new mortgage lending since mid-2010, but FX mortgage loans still account for over 60 percent of the stock of total mortgage loans. Depending on the impact of these recommendations, further tightening of the existing prudential requirements or the introduction of other supervisory measures (e.g., increasing capital requirements under a Pillar II approach) could be considered. Staff pointed to the desirability of funding mortgage lending on a longer-term basis and further developing the market for covered bonds (presently issued by a limited number of specialized mortgage banks). Staff noted the importance of remaining alert to the risk of increased lending by non-regulated or less regulated entities, following the recent tightening of banks’ lending standards.

30. Financial supervision should be strengthened further. Regarding micro-prudential supervision, the preliminary conclusions of the recent Basel Core Principles assessment suggest that more frequent on-site inspections and better coordination between on- and off-site supervision are essential for monitoring compliance with prudential requirements and for a timely identification and containment of risks. Also, to support the enforcement of financial oversight policies, the KNF’s independence could be increased, including by enhancing governance arrangements and the legal protection of staff (Appendix V). Regarding macro-prudential supervision, it would be helpful to develop a framework for coordinating policy responses to systemic risks, building on the central bank’s analytical framework for identifying systemic risks, the KNF’s experience with designing and implementing prudential requirements, and the effective forum for discussion provided by the Financial Stability Committee (which consists of the central bank, the KNF, and the Ministry of Finance). In addition, the bank resolution framework could be strengthened by adopting a broader range of instruments and by increasing the role of the Bank Guarantee Fund.

31. The introduction of a financial stability contribution is being considered. The contribution would build a fund that could facilitate the resolution of weak credit institutions. The base for the contribution would be bank liabilities excluding Tier 1 capital and insured deposits. Operational modalities (notably the tax treatment and the relationship of the new fund with the existing Bank Guarantee Fund) are still being clarified. Over time, the contribution could be refined to reflect the riskiness of different institutions.

Authorities’ views

32. The authorities generally agreed with staff’s recommendations, but expressed reservations regarding the need to increase the KNF’s independence. The authorities are committed to closely monitor the implementation of recent prudential requirements and to tighten prudential requirements in the area of liquidity management to ensure that banks build adequate long term funding. The authorities expressed concern about the often-limited powers of host supervisors in the context of the EU supervisory architecture, especially with regard to the oversight of branches. The authorities also agreed on the need to improve the coordination of policy responses to systemic risks and to enhance the resolution framework. However, the authorities considered that the independence of KNF is adequate. Finally, the authorities indicated that they would request an FSAP Update in 2012.

D. Policy Options if Capital Inflows were to Surge

33. Poland was one of the main recipients of capital flows among emerging economies in 2010. The primary destination for inflows was government securities, reflecting in part the government’s increased financing need. Despite these inflows, the appreciation of the exchange rate was limited. Going forward, gross FDI inflows are projected to rise gradually in line with the upturn in investment, other investment inflows should remain steady, while portfolio inflows are expected to fall gradually given the government’s declining financing need. There is a risk that increased investor appetite for Polish assets could lead to a surge in capital flows.

34. If capital inflows were to increase sharply, monetary policy could be tightened more gradually and fiscal consolidation could be accelerated. As the exchange rate is not overvalued, some appreciation would be acceptable. This would dampen inflationary pressures, thus reducing the need for increases in the policy interest rate. However, if a surge in capital inflows were to put excessive pressure on the exchange rate, then the pace of reserve accumulation could increase, within the NBP’s prevailing monetary policy guidelines, and the already-envisaged fiscal adjustment could be accelerated, which would also reduce the need for interest rate hikes. In addition, targeted macro-prudential measures, such as measures to tighten bank lending standards, could complement the macroeconomic policy response.

Authorities’ views

35. The authorities broadly agreed with staff’s recommendations, but did not see a need for additional reserve accumulation. The authorities concurred that some gradual exchange rate appreciation would be acceptable and that the already-envisaged fiscal adjustment could be accelerated.

E. Enhancing Growth and Flexibility

36. Despite recent reforms, structural rigidities continue to hamper potential growth. Poland’s labor force participation rate has increased since 2007, due in part to measures that lowered the tax wedge and tightened early retirement entitlements (Figures 10). However, the participation rate is still low compared to the EU average. The government has also tackled administrative and product market rigidities by introducing computerized land registers, one-stop-shop regulations, and e-invoicing of VAT; streamlining documentation and licensing requirements; and stepping up the privatization agenda in 2010–11. Poland’s score on the World Economic Forum’s Global Competitiveness Index is relatively high, but it lags its peers on the World Bank’s ease of doing business index, and a recent OECD study notes weak product market regulations and large state involvement in network sectors such as transport, energy, and communication (Figure 11).

Figure 10.
Figure 10.

Poland: Labor Market Indicators

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: Eurostat; EU Commission; and OECD.
Figure 11.
Figure 11.

Poland: Product Market Indicators

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: World Bank Doing Business; and OECD.

37. Possible further structural reforms include the following (Appendix V):

  • Labor market: Labor force participation could be increased by adopting labor-supply enhancing measures with a complementary long-term fiscal effect, such equalizing and increasing the retirement age and merging special pension schemes, including the farmer’s scheme, within the general system. With limited resources for spending on active labor market policies, the efficiency and targeting of existing measures could be reviewed. Finally, existing (but temporary) flexible employment provisions could be extended beyond 2011.

  • Product markets: Administrative barriers to business could be further reduced, including by simplifying building permit requirements, improving one-stop-shop regulations, eliminating tax reliefs and exemptions, and further streamlining documentation and licensing. Efforts could continue to deregulate network sectors such as energy and transportation and decrease the share of state ownership in the economy through privatization.

Authorities’ views

38. The authorities recognize the importance of structural reforms and remain committed to proceed with the reform agenda. Improving labor participation remains the authorities’ main priority: the goal is to raise the employment rate from 65 percent in 2010 to 71 percent by 2020. To this end, discussions on reforming police pensions are under way, while changes to other special pension schemes, increasing statutory retirement age, or equalizing the age for men and women are under consideration. The authorities are determined to pursue the privatization agenda, with the ultimate goal of reducing state companies’ contribution to GDP from 20 percent to 10 percent, implying that only strategic firms, mainly in key infrastructure like power grid or railroads, would remain state-owned.

F. Euro Adoption

39. Euro adoption remains an important long-term objective. The authorities are pursuing an appropriate strategy, aiming to achieve sufficient progress toward convergence and fulfilling the entry criteria, especially on the fiscal deficit, before announcing a specific target date. In the meantime, they are working on required changes to the Constitution to permit entry into the euro area.

V. Staff Appraisal

40. Poland returned to solid growth in 2010, building on timely and forceful countercyclical policy responses to the global crisis. These responses were permitted by limited macroeconomic imbalances prior to the crisis and access to an FCL arrangement with the Fund, both of which reflected a track record of very strong policies.

41. With the economy gaining momentum, capacity constraints are tightening, inflationary pressures are rising, and the current account deficit is widening. Risks to the short-term growth outlook are balanced, with external risks mainly on the downside and domestic risks mainly on the upside. The FCL arrangement provides insurance against external financial risks.

42. Revisions to BOP data are expected to increase the current account deficit. A higher current account deficit would indicate that net national saving is lower and that vulnerability to external financing shocks is higher than previously thought, though the impact on the projected path of external debt and the assessment of the exchange rate (which is currently seen as broadly in line with fundamentals) would likely be modest. Given that errors and omissions were not at an acceptable level, the authorities’ much-needed efforts to improve BOP data are welcome and should continue.

43. Given the large fiscal deficit in 2010, the substantial fiscal consolidation already under way is welcome, but additional fiscal consolidation will be needed. To reduce debt firmly over time, additional permanent measures of a little more than 1 percent of GDP will be needed over the medium term. Given the tightening of capacity constraints and increased external vulnerabilities associated with an upward revision to the current account deficit, it would be good for this additional adjustment to begin sooner rather than later, with significant front-loading.

44. The recent increases in the policy interest rate are welcome and some further gradual hikes in the policy rate will be needed to bring inflation back to target. The appropriate magnitude and pace of monetary tightening will depend on developments in aggregate demand pressures and inflation expectations. The increased discussion of the inflation outlook in the post-MPC meeting communiqué is welcome and further elaboration would be desirable. While international reserves are more than adequate on several measures, on balance some additional reserve accumulation would be desirable.

45. Financial sector surveillance policies in Poland have been effective, but efforts to further strengthen financial sector resilience need to continue. Depending on the impact of recent prudential recommendations, further steps could be considered. While financial supervision is already strong, there are areas where it could be further improved, including through more frequent on-site inspections. The independence of the Financial Supervision Authority (KNF) could be increased and it could be given broader authority to issue binding regulations. Regarding macro-prudential issues, a framework for coordinating policy responses to systemic risks, in line with evolving international thinking, could be developed. Finally, to strengthen the bank resolution framework, a broader range of tools is needed.

46. Further raising labor participation would boost potential growth. Labor-supply enhancing measures with a complementary long-term fiscal effect, such as raising the retirement age and equalizing it between men and women, and merging special pension schemes within the general system, would be desirable.

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

Figure 12.
Figure 12.

Poland: External Debt Sustainability: Bound Tests, 2005-16 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percent occurs in 2010.
Figure 13.
Figure 13.

Poland: Public Debt Sustainability: Bound Tests, 2005-16 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2011, 166; 10.5089/9781455295708.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2010, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Table 6.

Poland: External Debt Sustainability Framework, 2005-16

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - ρ(1+g) + εα(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 7.

Poland: Public Sector Debt Sustainability Framework, 2005-16

(In percent of GDP, unless otherwise indicated)

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General government gross debt, ESA95 definition.

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.