Abstract
This paper discusses Poland’s Review Under the Flexible Credit Line (FCL) Arrangement. Economic growth is expected to recover gradually on the back of improving domestic demand and higher growth in core euro countries. But the economy is still subject to substantial external risks as Poland is highly integrated with Europe through trade and financial channels, as well as with global financial markets. In IMF Staff’s view, Poland continues to meet the qualification criteria for access to FCL resources specified under the Board decision on FCL arrangements, and therefore IMF Staff recommends completion of the review under this FCL arrangement.
On behalf of our Polish authorities, we thank staff for fruitful discussions held in Warsaw and for a candid report recommending the completion of the review under the Flexible Credit Line (FCL) Arrangement. The current FCL and its predecessors have served the Polish economy very well, effectively complementing the country’s strong macroeconomic fundamentals and sound policies. During the last few years of heightened risks in Poland’s external environment, the FCL has provided continued insurance against adverse exogenous shocks and helped support investors’ confidence. Our authorities reaffirm their intention to treat the instrument as precautionary. Furthermore, the ongoing accumulation of policy buffers supported by the FCL will help taking steps towards an exit from the arrangement as soon as external conditions allow.
Economic Outlook
Recent economic data surprised on the upside. Following four consecutive quarters of subdued growth, real GDP growth rebounded to 0.5 and 0.6 percent quarter-on-quarter (seasonally adjusted; q-o-q, sa) in the second and third quarter of 2013, respectively. In the second half of the year, private consumption and fixed investment turned out to be higher than expected. Real year-on-year (y-o-y) GDP growth reached 1.9 percent in Q3 2013. For 2013 as a whole, real GDP growth should be close to 1.5 percent—as officially forecast by the Ministry of Finance—primarily driven by net exports. Looking ahead, growth is expected to accelerate further this year, to close to 3 percent, on the back of the expected improvement in external demand as well as more optimistic business and consumer sentiment. Given strong trade, financial and confidence linkages with Europe and global financial markets, we see risks to the outlook dominated by external factors.
While the Polish labor market remains relatively weak, a small but noticeable improvement has also been recorded in the second half of 2013. The seasonally adjusted jobless rate decreased to 10.2 percent and recent high-frequency data point to a stabilization of labor demand.
Monetary Policy
Despite the recent increase in the CPI (from the record low of 0.2 percent in June to 0.8 and 0.6 percent y-o-y in October and November respectively), inflation remains much below the official target. The negative output gap and continued lack of wage pressure have translated into overall low inflation pressure. Inflation expectations are also very subdued. The PPI has remained in negative territory since end-2012.
After completion of the monetary easing cycle in July 2013, which resulted in cuts in policy rates of 225 basis points, the Monetary Policy Council (MPC) has kept the reference rate at an all-time low of 2.5 percent. Furthermore, in November the MPC provided forward guidance about its intention to keep policy rates on hold until at least mid-2014.
External Sector
The current account (CA) deficit remains sustainable, and stabilized at 2 percent of 12-month GDP in September. The capital account surplus (mainly due to EU structural funds inflows) and net FDI inflows covered almost 150 percent of the CA deficit. September also brought an end to the three-month period of moderate outflow of portfolio investments from the sovereign debt market. Notably, this emerging market sell-off affected Poland less than many other peer economies. The level of official reserves remains broadly adequate, more than covering short-term external debt.
Fiscal Policy
The authorities aimed at striking a balance between necessary consolidation measures and avoiding fiscal policy to become a drag on economic growth. In response to the cyclical slowdown in 2013, automatic stabilizers were thus allowed to operate. However, lower economic growth resulting in a decline in government revenues hindered the realization of the fiscal adjustment path foreseen in the Convergence Programme update 2013. While Poland presented a set of measures aimed at deficit reduction, the actions taken were assessed as insufficient and, in response, the Ecofin Council issued a new recommendation, extending the deadline for correction of Poland’s deficit by one year, to 2015. To this end, Poland should reach a headline deficit target of 3.9 percent of GDP in 2014 and 2.8 percent of GDP in 2015 (excluding the impact of the changes in the pension system).
Last year, the authorities concluded a comprehensive review of the pension system and decided to introduce changes to its second pillar in order to eliminate existing inefficiencies. In result, part of the pension fund assets (sovereign treasuries) will be transferred from the second (privately managed) to the first (public) pillar. This one-off operation will lead to a significant reduction of the public debt. Changes to the pension system were subject to extensive discussions with all stakeholders. The authorities also placed high importance on ensuring that they clearly communicate the changes to the markets. Reactions of the markets have been positive.
Simultaneously, the Polish authorities continued efforts to strengthen the fiscal framework. A new stabilizing permanent fiscal rule has been adopted. It covers about 90 percent of the general government sector and sets a limit on the growth of expenditures in order to reduce and stabilize the deficit and consequently the public debt. Importantly, by taking into account business cycle developments, it will help avoid the risk of fiscal procyclicality. In addition, taking into account the 7 percentage point reduction of the debt-to-GDP ratio resulting from the changes in the pension system, two new lower public debt thresholds are to be introduced, replacing the previous one of 50 percent.
Financial Sector
The Polish financial sector remains stable and resilient. Banks are well capitalized, liquid and profitable. The capital adequacy ratio in the banking sector reached 15.6 percent at the end of Q3 2013. Nevertheless, given the high share of foreign ownership and the level of parent funding, any structural changes to funding models of euro area banks might have negative implications for credit supply in Poland and, consequently, economic growth.
The Polish financial sector plays an important role in the CEE region. Given Poland’s relatively deep and liquid financial markets, investors often use the zloty as a proxy for exposure to, or hedge against, risks in the region. Its significance has been recently confirmed by the inclusion in the Fund’s list of systemically important financial centers.
Meanwhile, the government-sponsored “De Minimis” initiative launched in March 2013 and aimed at mitigating credit constraints for SMEs proved to be a success. So far, 31,000 SMEs have benefitted from the program, and they were altogether granted with credit of more than PLN 10 billion (around USD 3.3 billion). This was supported by almost PLN 6 billion (around USD 2 billion) of government guarantees. The scope of the guarantees has recently been widened to cover also long-term credits.
Structural Reforms
The authorities continue with the implementation of the structural reform agenda. In particular, their focus on further improving the business environment and limiting red tape has borne fruits, which is reflected in the World Bank’s Doing Business reports. Poland has achieved a remarkable improvement of 29 places over the last two years