Economic Outlook

After robust economic growth in 2011, private consumption and investments are slowing. Fiscal consolidation and shrinking availability of EU structural funds weigh adversely on public demand. In addition, developments in Europe weaken external demand and add to uncertainty. As a result, the Polish economy is expected to grow by 2.5 percent in 2012 as opposed to 4.3 percent in 2011.

Over the medium term, the economic outlook should improve, driven by a rebound in domestic demand. But given strong trade and financial linkages with the EU, risks are on the downside. The unemployment rate will likely remain relatively high, at around 12.5 percent on average, before the economy gains momentum and the expected benefits of labor market reforms materialize.

Poland continues to benefit from the Flexible Credit Line arrangement with the Fund which provides an additional reserve buffer and helps strengthen investor confidence.

Fiscal Policy

The Polish authorities are determined to further reduce the fiscal imbalance in order to ensure long-term fiscal sustainability. The measures undertaken—both on the expenditure and revenue sides—aim at bringing the general government deficit in line with the Excessive Deficit Procedure (EDP) in 2012 and narrowing the structural deficit to meet the medium term objective, i.e., 1 percent of GDP, by 2015. Mindful of fragile growth, the authorities carefully design measures to reduce expenditure and boost expenditure effectiveness. They also continue to improve the efficiency of the tax system. A detailed description of the fiscal measures was presented by the authorities in the 2012 update of the Convergence Programme. In addition, the 2013 budget assumptions approved by the Council of Ministers in June 2012 are in line with the fiscal consolidation path.

The 2011–12 consolidation package has already resulted in a strong reduction of the general government deficit—from 7.8 percent of GDP in 2010 to 5.1 percent in 2011. The share of general government expenditure in GDP (after excluding budget co-financing of projects financed with the EU structural funds) has been put on a downward path, and in 2012 it is expected to reach its lowest level in the last two decades. Moreover, the austerity effort is expected to reverse the growth of the general government debt-to-GDP ratio in 2012. Simultaneously, the authorities continue to strengthen the fiscal framework and increase fiscal discipline on all levels of the general government. A temporary expenditure rule on the central level and deficit-reducing rules on the local level are already in place. In addition, the authorities continue to work on the fiscal responsibility law and a permanent fiscal rule, which are expected to be enacted in 2013. An expenditure review is also in the pipeline.

Monetary Policy

In 2011 despite tightened monetary conditions—a 100 basis point increase in the policy rate in the first half of the year—CPI inflation exceeded the upper limit for deviations from the 2.5 percent target. Inflationary pressures mainly originated from factors beyond the control of the monetary authorities. Since December 2011 inflation has been slowly put on a downward path but small fluctuations have persisted. In May 2012 the headline CPI dropped to 3.6 percent, while core inflation reached 2.3 percent, i.e., the lowest level since April 2011. Slowing economic growth and relatively high unemployment limit the risks of second-round effects.

In May 2012, the Monetary Policy Council increased the policy rate by 0.25 percentage points to anchor inflation expectations and to ensure positive real interest rates. While the current level of interest rates appears to be adequate to maintain price stability in the medium term, the Council remains vigilant to the developments in the economy and stands ready to act accordingly.

The National Bank of Poland ensures that the level of official reserves is adequate. The current account deficit narrowed and was mostly financed by EU funds and FDI inflows. Despite last year’s volatility of the exchange rate, an outflow of short term capital was not recorded.

Financial Sector

Despite a large presence of foreign investors, the Polish financial sector remains resilient to the sovereign debt crisis. The banking sector is much less leveraged than EU and global banks and remains liquid, well-capitalized and highly profitable. In 2011, net profit increased by 37.5 percent, reaching a record high level for the Polish banking sector. The capital adequacy ratio remains high (over 13.8 percent in the IQ2012), with Tier 1 capital representing 90 percent of total capital.

There has been limited evidence of bank deleveraging so far. Credit growth rebounded strongly in 2011, rising 11 percent y/y (after exchange rate adjustment), mainly due to strong corporate sector demand. Total corporate lending rose by 19 percent y/y in 2011 with 60 percent of this increase generated by small and medium sized companies (SME). At the same time, credit to households slowed significantly as a result of more restricted lending policies caused by new legal regulations imposed by the Financial Supervisory Authority (KNF) in 2010 (Recommendation T) and 2011 (Recommendation S II).

The stock of FX mortgage loans remains elevated, but the share of FX loans in new mortgage lending has been significantly reduced. Despite a steep depreciation of the zloty in the second half of 2011, FX mortgage loans are still the best performing type of asset with a NPL ratio at 1.7 percent in March 2012, versus 3.6 percent for zloty mortgage loans. The overall loan performance (overall NPLs) has slightly improved during the course of 2011; however, the picture is diverse across the different types of assets: with 10.9 percent in corporate lending and 17.7 percent in consumer lending.

Structural Reforms

Mindful of the importance of structural reforms for long-term growth, the authorities continue to implement labor and product market reforms. They also remain focused on moving forward with privatization—when market condition allow—and on enhancing the management of public assets.

In order to increase the labor force participation rate—which is still relatively low compared to the EU average—the authorities are implementing pension system reforms. From 2013 onwards, the retirement age for men and women will be gradually raised to reach 67 for both groups—by 2020 for men and by 2040 for women. The length of work required for pension eligibility has also been extended for uniformed services which are regulated by a special law.

Improving conditions for business activity and innovations remains one of the authorities’ priorities. The measures undertaken include streamlining the requirements for setting up new businesses by a further reduction of administrative and disclosure requirements and enhancing the effectiveness of legal court proceedings. In addition, the deregulation of the 380 licensed professions is in the pipeline. The process is expected to be implemented in three stages with the first one aiming at improving access to 49 professions