Abstract
This staff report for the Republic of Poland’s 2013 Article IV Consultation highlights economic development and policies. The current account in 2012 was primarily financed by EU transfers and foreign direct investment (FDI), notwithstanding a reduction in net FDI inflows. Moderate outflows from the domestic banking system were more than offset by strong portfolio inflows into the government bond market. The current account deficit and real effective exchange rate are broadly in line with medium-term fundamentals and desirable policies according to the External Balance Assessment models. The largely foreign-owned banking system has remained well-capitalized, profitable, and liquid.
On behalf of our Polish authorities, we would like to thank staff for the constructive consultations held in Warsaw and the comprehensive set of papers. The authorities broadly concur with the staff assessment and policy recommendations.
Economic Outlook
While the Polish economy continued its upward trend in 2012, it entered a phase of cyclical GDP slowdown. Economic growth moderated last year to slightly less than 2 percent. This year, it is expected to reach 1.1percent, the lowest figure since 1991. Key factors behind the weak GDP growth in 2013 include unfavourable economic situation in the euro area, falling household consumption dynamics (driven by a difficult situation in the labor market and a gradual recovery in household savings), as well as fiscal tightening, and falling public investment financed with EU structural funds. Still, Poland remains one of the fastest growing EU economies.
Over the medium term, however, the economic outlook should improve, due to a rebound in domestic and external demand. Given strong trade, financial and confidence channels between Poland and its external environment, risks are on the downside. The unemployment rate remains high at 10.7 percent (reflecting, among other factors, an increase in participation rate). Until domestic consumption improves, net exports are expected to remain a positive contributor to growth on the account of higher dynamics of exports than imports. In the first four months of 2013 Polish exports grew by more than 7 percent, notably due to a partial reorientation toward less-traditional—i.e., non-EU—markets. In April the current account recorded an all-time high monthly surplus, while narrowing to 2.5 percent in 12-month terms of GDP.
Similarly to recent developments observed elsewhere, June witnessed an outflow of portfolio investments from the sovereign debt market. The dynamics for July, however, are more balanced, showing a positive perception of the country’s risk by foreign investors. The authorities decided to abstain from holding bond sales in July and August after they managed to pre-fund almost 90 percent of the yearly borrowing needs by end-June owing to highly favorable financing conditions.
Poland continues to benefit from the precautionary Flexible Credit Line arrangement with the Fund which provides an additional reserve buffer against external shocks and helps strengthen investor confidence.
Fiscal Policy
The Polish authorities remain fully committed to reducing the remaining fiscal imbalance and ensuring long-term fiscal sustainability. Mindful of the fragile economic outlook, they carefully design the range of measures in a way that would not pose a threat to the country’s medium-term growth perspectives. The 2010-12 sizeable consolidation package, combining both revenue and expenditure measures, helped to cut the nominal deficit from 7.9 percent of GDP in 2010 to 3.9 percent in 2012. In structural terms, the reduction took place at a pace even exceeding the one recommended by the EU Council (in 2012 alone, the structural balance was improved by 1.7 percentage points of GDP). As expected, in 2012 the share of general government expenditure in GDP (after excluding budget co-financing of projects financed with the EU structural funds) reached its lowest level in the last two decades. In the same year the authorities managed to put the public debt ratio on the downward path to 55.6 percent of GDP (ESA95 definition).
Nonetheless, the adverse economic circumstances had a major negative impact on the government finances and led to deterioration of its cyclical component. In effect, the decrease of the nominal deficit-to-GDP ratio reached in 2012 turned out to be too small to enable abrogation of the Excessive Deficit Procedure (EDP). However, in recognition of Poland’s significant structural effort, the EU Council granted a two-year extension of the deadline for correction of the excessive deficit situation, from 2012 to 2014. The authorities are committed to further improving the structural balance in the coming years in line with the recommendation and with the aim to reach the medium-term budgetary objective (MTO) of 1 percent of GDP in 2016.
Simultaneously, our Polish authorities continued efforts to strengthen the fiscal framework. Work on the design of a stabilizing permanent fiscal rule reached the final stage. The overarching aim of the prospective rule is to reduce and—subsequently—stabilize the deficit and public debt. To this end, the rule will set an expenditure limit based on the medium-term GDP growth and be equipped with an appropriate correction mechanism. The latter will take into account business cycle developments and thereby will ensure avoiding a risk of fiscal procyclicality. Our authorities appreciate the collaborative work with staff on the analysis of alternative variants of fiscal rules.
Monetary Policy
After persistently exceeding the upper limit for deviations from the NBP’s target of 2.5 percent in the recent years, in the fourth quarter of 2012 the inflation rate began to decrease rapidly. In early 2013, headline CPI reached levels below the lower limit of the permissible fluctuation band. Also, PPI continued its downward trend and fell into negative territory. Low inflation rate stems from a negative output gap and weak demand pressure related to the weak labor market.
In response, the Monetary Policy Council (MPC) commenced a monetary policy easing cycle. Cumulative interest rate cuts of 225 bps—including the July MPC’s decision which is supposed to end the cycle—resulted in an all-time low reference rate of 2.50 percent. This significant reduction of rates, implemented since November 2012, should support economic recovery and limit the risk of inflation running below the NBP target in the medium term. Moreover, the level of official reserves remains largely adequate, covering about 5.6 months of imports.
Financial Sector
The ongoing slowdown in GDP growth and the sovereign debt crisis in the euro area did not adversely affect resilience of the Polish financial sector. Polish banks maintain low leverage ratios, remain liquid, well-capitalized and highly profitable.
Despite weaker macroeconomic conditions and falling interest rates, the net profits of Polish banks have been stable since they reached record high levels in 2011. In line with recommendations issued by the Financial Supervisory Authority (KNF), banks increased their capital buffers with the capital adequacy ratio reaching 15.4 percent at the end of the first quarter of 2013 and Tier 1 capital representing around 90 percent of total capital. At the same time, the liability structure of Polish banks improved as the parent-based funding was, to some extent, substituted with deposits from non-financial residents. In spite of the impact of the financial crisis on some of the foreign parent institutions, there was no evidence of disorderly deleveraging in the Polish banking sector.
After a strong credit growth over the last two years, the expansion slowed this year. Although the overall credit to non-financial sector grew by 2.2 percent y/y (after exchange rate adjustment) as of the first quarter of 2013, further tightening of banks’ lending policies is expected—particularly for SMEs. With a view to mitigating credit constraints they face, a new government-sponsored initiative was launched. The “De Minimis” program is aimed at providing government guarantees for loans for SMEs, enabling them to raise funding for their working capital needs and taking some of the risk burden away from the commercial banks.
Simultaneously, the authorities take further measures to strengthen the financial sector and improve supervision, including new macroprudential and bank resolution frameworks. Regulatory and supervisory actions to reduce the share of FX loans in new mortgage lending proved successful. Although the overall NPLs level slightly increased on the account of economic slowdown and rise in unemployment—with most pronounced deterioration in the corporate loan portfolio, it remains well provisioned.
Structural Reforms
Mindful of the importance of structural reforms for long-term growth, the authorities are further advancing the structural reforms agenda. They maintain efforts to implement labor and product market reforms, with focus on further increasing the labor participation rate and reducing youth unemployment. Important steps were taken to ease access to regulated professions, with the first deregulation act (easing access to 51 professions) expected to soon enter into force, the second deregulation (91 professions) recently approved by the Council of Ministers and the third tranche (104 professions) currently under consultations. In addition, the authorities remain committed to further improving the business environment and moving forward with privatization of state-owned enterprises.
To provide a stimulus for greater activation of private capital in the Polish economy, the authorities have launched the “Polish Investments” Program. It aims to support long term and commercially-viable infrastructure projects. Importantly, the program’s design ensures that public debt will not be increased.