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 agree with staff’s assessments and policy recommendations.

Economic Outlook

Between late 2011 and early 2013, the Polish economy was experiencing a cyclical slowdown with growth moderating to below 2 percent due to unfavorable economic conditions in the euro area (Poland’s main trading partner), lower household consumption, fiscal tightening, and falling public investments financed with EU structural funds. Last year, however, the economy started to recover. Since the last quarter of 2013, economic growth has been driven mainly by a rebound in domestic demand, which was supported by a rise in private consumption and investment growth. The acceleration in private consumption resulted from an improvement on the labor market. In the coming quarters, consumption growth should be further spurred on by an increase in households’ real disposable income, prompted by low inflation. Private investment activity will be supported by rising exports thanks to higher growth among Poland’s trading partners, low financing costs and the government’s “Polish Investments” program. According to official projections, economic growth is expected to reach levels well above 3.0 percent in 2014.

Poland remains one of the top EU performers in terms of economic growth. Over the recent years, Poland has been the fastest catching-up-economy in the EU. In contrast to other countries, Poland avoided recession and its cumulative real GDP growth since 2008 reached 20 percent—almost twice as much as for Slovakia, the second top performer.

Labor market conditions are also slowly improving. The unemployment rate, although still high, has decreased to 9.7 percent in April—the lowest level over the past three years. While productivity has been steadily rising, limited wage pressure keeps unit labor costs in check and translates into improving labor cost competitiveness.

External Sector

The current account (CA) deficit in 2013, at 1.3 percent of GDP, reached its lowest level in over a decade. A favorable competitive position and weak domestic demand, translating into lower imports, fuelled a sharp improvement in the balance on goods and services. Export dynamics were sustained by gains in the market share and an expansion toward Central and Eastern European as well as other developing markets.

In April 2014, according to preliminary data, the current account recorded the highest surplus in the recent history. This contributed to a reduction of the overall CA deficit in terms of 12-month GDP to only 0.8 percent. It was accompanied by a substantial capital account surplus, primarily a factor of a strong inflow of the EU structural funds. External debt is relatively stable—approximately 70 percent of GDP. At the same time, around two-thirds of corporate external debt is either intercompany or trade credit, which substantially reduces roll-over risk. The level of official reserves slightly decreased over the last few months, but remains broadly adequate, fully covering short-term external debt. Moreover, 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

In 2013, the Polish authorities faced challenging conditions for fiscal consolidation. An unfavorable external environment, cyclical slowdown and the widened output gap translated into a significant decline in tax revenues. This hindered the realization of the previously foreseen fiscal adjustment path. In December 2013, the Ecofin Council issued a new recommendation extending the deadline for correction of Poland’s deficit by one year, to 2015. Poland’s general government deficit, in 2013, widened to 4.3 percent of GDP, which was lower, however, than the 4.8 recommended by the Council. At the same time, in response to the Council’s recommendation, the Polish authorities took further consolidation measures. In result, in the recent European Commission’s assessment, Poland has met the recommended change in the structural balance foreseen for 2014 and is expected to stay within the ceiling of the headline deficit recommended by the Council.

Looking ahead, the government is committed to reducing the excessive imbalance in public finances in a manner which would not pose a threat to medium-term growth prospects. In line with the Council recommendation, the authorities are aiming at bringing down the deficit in a sustainable manner below 3 percent of GDP in 2015. In addition, fiscal policy in the coming years will be oriented towards achieving the medium-term budgetary objective (MTO) of 1 percent of GDP. This will be fostered by compliance with the new stabilizing expenditure rule introduced last year.

This year, the general government sector is projected to record a one-off surplus of 5.8 percent of GDP due to the effect of the recent reform of the pension system. This follows a review concluded by the authorities last year and their decision to introduce changes to the second pension pillar in order to eliminate inefficiencies inherent in its original design. The creation of the second pension pillar in 1999 led to a significant financing gap in the first pillar, operating on the PAYGO basis. This gap had to be financed with transfers from the state budget, which necessitated additional debt issuance. In the years 1999–2012 the accumulated amount of that debt reached 17.5 percent of GDP.

As a result of the reform, part of the pension fund assets (Treasury securities and Treasury-guaranteed bonds) were transferred from the second (privately managed) to the first (public) pillar. Cancellation of the acquired Treasury securities (after their equivalent was registered on the individual social security sub-accounts) led to a significant reduction in the general government debt (from 57.1 percent of GDP in 2013 to, projected, 49.5 in 2014). Changes to the pension system had been subject to extensive discussions with all stakeholders. The authorities also placed high importance on ensuring that they clearly communicate the changes to the markets. Rating agencies assessed the changes as rating neutral. In the long term, the effects are expected to be positive—thanks to lower debt, servicing costs, and borrowing requirements. Furthermore, given the significant reduction in the debt-to-GDP ratio, two new lower public debt thresholds triggering downward corrections in the expenditure growth limits were introduced in the public finance law—together with the new stabilizing expenditure rule. They are equal to, respectively, 43 and 48 percent of GDP, and they replaced the previous 50 percent threshold.

Monetary Policy

In 2013, inflation pressure in Poland was very weak and the headline CPI remained significantly below the inflation target. The low inflation rate resulted from low demand pressures, and favorable dynamics of electricity and food prices. The Monetary Policy Council (MPC) continued the cycle of interest rate cuts initiated in late 2012. Over the entire cycle, NBP reference rate was reduced by 225 bps, from 4.75 percent in November 2012 to the all-time low 2.50 percent in July 2013. The MPC has kept the interest rates unchanged ever since, and on several occasions signaled that the rates should further remain unchanged in subsequent quarters. The Council currently assesses that NBP interest rates ought to be kept unchanged until the end of the third quarter of 2014. The MPC does not exclude interest rate adjustments if the incoming information supports such a decision.

Financial Sector

Amid the GDP slowdown in 2012–13 and the sovereign debt crisis in the euro area, the Polish financial sector has remained stable and resilient. In spite of the impact of the financial crisis on some of the foreign parent institutions, there has been no evidence of disorderly deleveraging in the Polish banking sector. Banks maintain low leverage ratios, remain liquid, well-capitalized, and highly profitable. The banking sector has ample capital resources to meet credit demand as growth picks up, while improving economic fundamentals should in turn further strengthen its position.

Despite an unfavorable environment, the net profits of Polish banks have been stable since reaching a record high in 2011. In line with recommendations issued by the Financial Supervisory Authority, banks maintained their capital buffers with the capital adequacy ratio reaching 15.6 percent at the end of Q1 2014 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 reduced in an orderly fashion and, to some extent, substituted with deposits from non-financial residents.

After a slower credit growth in 2013, the expansion picked up this year. As of Q1:2014, overall credit to the non-financial sector grew by 4.4 percent y-o-y (after exchange rate adjustment). The growth in loans to enterprises continues to be supported by the successful government guarantees program “De Minimis”, now covering both—working capital and investment loans.

Simultaneously, work is progressing on further measures to strengthen the financial sector and improve supervision, including macroprudential and bank resolution frameworks. Regulatory and supervisory actions to reduce the share of FX loans in new mortgage lending proved successful as the FX mortgage portfolio has been in runoff mode since mid-2012. Loan-to-value limits for housing and commercial real estate loans, which came into force in early 2014 and will be gradually tightened until 2017, should contribute to strong loan quality going forward. While still high, the share of NPLs in non-financial sector decreased slightly over the past year, on the account of improving economic conditions and sales of NPLs by some banks. The coverage of NPLs by provisions remains at a comfortable level.

Structural Reforms

The Polish authorities continue to implement their structural reforms agenda. Starting this year, they plan to undertake new measures to improve tax compliance and strengthen the efficiency of tax administration. They maintain efforts to further advance labor and product market reforms, with a focus on increasing the labor participation rate, especially among women, limiting labor market segmentation, and reducing youth unemployment. Important steps have been taken to facilitate access to regulated professions, with subsequent tranches of de-regulations gradually entering into force. In addition, the authorities remain committed to further improving the business environment and reducing red-tape.