Republic of Poland: Staff Report for the 2015 Article IV Consultation
Author: International Monetary Fund. European Dept.
Publication Date:
14 Jul 2015
eISBN:
9781513502434
ISBN:
9781513502434
Language:
English
Keywords:
ISCR; CR; deficit; inflation expectation; Poland; EU regulation 680/2014; financial market; government bond; statistics Poland; broad money; short-term debt; Inflation; Europe
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The economy has recovered from the 2012–13 slowdown, supported by sound policies and improving external conditions. The outlook is for robust growth and subdued inflation but risks, although moderating, are tilted to the downside. Further structural reforms and stronger policy buffers will mitigate risks and ensure that the recovery is durable and balanced. Interconnectedness. Poland’s strong interconnectedness with Europe through both trade and financial linkages has facilitated growth and income convergence and reduced inequality. However, it also exposes Poland to external shocks that can propagate through substantial foreign participation in the government bond market and in the banking system. Monetary policy. The recent policy interest rate cuts should help gradually return inflation to the target. However, the Monetary Policy Council (MPC) should stand ready to further ease monetary policy if inflation expectations were to disappoint. Financial sector policy. The financial sector remains profitable, well-capitalized, and liquid. Credit growth is picking up in tandem with activity. Addressing legacy vulnerabilities and completing financial sector reforms would further buttress financial stability and support continued healthy credit expansion. Fiscal policy. Gradual fiscal consolidation should continue to build policy buffers and address long-term aging-related contingent liabilities. The authorities should identify measures to underpin their fiscal plans. Structural reforms. Over the past two decades, Poland succeeded in closing a quarter of its per capita income gap with the European Union (EU) average. Further boosting income levels and living standards requires structural reforms to move up the value- added chain and facilitate labor mobility to higher productivity sectors.

Abstract

The economy has recovered from the 2012–13 slowdown, supported by sound policies and improving external conditions. The outlook is for robust growth and subdued inflation but risks, although moderating, are tilted to the downside. Further structural reforms and stronger policy buffers will mitigate risks and ensure that the recovery is durable and balanced. Interconnectedness. Poland’s strong interconnectedness with Europe through both trade and financial linkages has facilitated growth and income convergence and reduced inequality. However, it also exposes Poland to external shocks that can propagate through substantial foreign participation in the government bond market and in the banking system. Monetary policy. The recent policy interest rate cuts should help gradually return inflation to the target. However, the Monetary Policy Council (MPC) should stand ready to further ease monetary policy if inflation expectations were to disappoint. Financial sector policy. The financial sector remains profitable, well-capitalized, and liquid. Credit growth is picking up in tandem with activity. Addressing legacy vulnerabilities and completing financial sector reforms would further buttress financial stability and support continued healthy credit expansion. Fiscal policy. Gradual fiscal consolidation should continue to build policy buffers and address long-term aging-related contingent liabilities. The authorities should identify measures to underpin their fiscal plans. Structural reforms. Over the past two decades, Poland succeeded in closing a quarter of its per capita income gap with the European Union (EU) average. Further boosting income levels and living standards requires structural reforms to move up the value- added chain and facilitate labor mobility to higher productivity sectors.

Context

1. The economy has recovered from the 2012–13 slowdown. Growth strengthened to 3.4 percent in 2014 on the back of buoyant domestic demand. Private consumption and investment continue to benefit from higher disposable income, eased financial conditions, and robust credit growth. Nonetheless, inflation has been negative since July 2014.

2. Poland’s integration with global markets has facilitated growth and income convergence. Poland has developed strong trade and financial linkages with the euro area and has become an integral part of the German supply chain (Figure 1). This has led to substantial technological transfers and increased sophistication of domestic value added, with positive implications for productivity, competitiveness, and growth. Foreign investment in the manufacturing sector, stable inflows of intercompany lending, and EU structural funds helped expand the capital stock, further supporting growth. As a result, during the past two decades, Poland gradually closed a quarter of its per capita income gap with the EU average, while income inequality has declined to the EU average (see Appendix I).

Figure 1.
Figure 1.

Republic of Poland: Integration with the Global Economy

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Polish authorities, IMF World Economic Outlook, Bank for International Settlements Triennial Central Bank Survey, and IMF staff calculations.
A01ufig1

Convergence Toward EU Average Income

(Purchasing power parity (PPP) income per capita as a percent of EU-28 average)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Eurostat and IMF staff calculations.
A01ufig2

Income Inequality, 2005–13

(Gini coefficient of equivalized disposable income)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Source: Eurostat.

3. However, the high degree of trade and financial integration also exposes Poland to external shocks. Demand shocks in the euro area can propagate through substantial trade linkages. Exports to the EU represent 75 percent of Poland’s exports and 65 percent of Poland’s domestic value added embodied in exports is finally consumed in Europe. Global financial shocks can affect Poland through the substantial foreign investor presence in the government bond market (40 percent of domestic treasury securities are held by nonresidents) and in the banking system (about 60 percent of banking sector assets are held by foreign banks).

A01ufig3

Poland: Trade and Financial Linkages

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

4. So far, the economy has weathered well several bouts of market turbulence. Poland’s very strong fundamentals and policies helped preserve investor confidence in the face of continuing geopolitical tensions in the region and episodes of emerging market volatility (Figure 2). The large share of the relatively stable intercompany loans in corporate debt, reduced reliance on parent bank funding, and a stable and diversified investor base in the domestic government bond market have helped mitigate the risks of capital flow reversals and dampened financial volatility. The Flexible Credit Line (FCL) arrangement with the IMF has provided additional insurance against external shocks.

Figure 2.
Figure 2.

Republic of Poland: Financial Market Developments

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Bloomberg, Haver Analytics, Polish Ministry of Finance, and IMF staff calculations.

5. Going forward, it will be important to continue building policy buffers to enhance resilience to shocks and implement structural reforms to complete convergence.

  • Policy buffers. Much has been achieved in strengthening policy buffers. However, further effort is needed to create additional policy space to better cope with shocks. The fiscal deficit and public debt have declined, and Poland has exited the Excessive Deficit Procedure (EDP) one year earlier than expected. Nonetheless, public debt is still elevated. Continued gradual fiscal consolidation is needed to put it on a robust downward path. International reserves have increased and are broadly adequate on the IMF’s modified metric for assessing reserve adequacy (ARA). Nonetheless, reserves continue to fall short on some metrics, including as a share of short-term debt. Effective financial sector oversight promoted strong capitalization in banks but work to adopt the bank resolution and macroprudential frameworks needs to be finalized.

  • Completing convergence. Accelerating economic convergence will require structural reforms to close productivity gaps, move up the value-added chain, and complete structural transformation of the economy.

6. The near-term reform momentum is being dampened by political uncertainty. The presidential elections in May were closely contested and ended with a decisive victory of the opposition, Law and Justice (PiS) party candidate. Parliamentary elections are scheduled to take place in the fall. In the meantime, and given the uncertainty and the ruling coalition’s slim parliamentary majority, a slowdown of reform momentum is a risk.

Recent Economic Developments

7. Growth continues to strengthen. Real GDP growth reached 3.4 percent in 2014, up from 1.7 percent in 2013, supported by strong domestic demand. Higher disposable income—boosted by accelerating wages, falling unemployment, and declining prices—has buoyed private consumption. Investment has benefited from robust credit growth on the back of eased financial conditions. These trends have continued into the first quarter of 2015, with growth accelerating to 3.6 percent. High frequency indicators, including strong Purchasing Managers Index (PMI) readings, point to continued healthy economic expansion (Figure 3, Table 1).

Figure 3.
Figure 3.

Republic of Poland: Recent Economic and Labor Market Developments

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Haver Analytics, Poland Central Statistical Office, and IMF staff calculations.
Table 1.

Republic of Poland: Selected Economic Indicators, 2012–20

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Sources: Polish authorities and IMF staff calculations.

Real GDP is calculated at constant 2010 prices.

According to ESA2010.

Excluding debts of the National Road Fund.

NBP Reference Rate (avg). For 2015, as of June 4.

For 2015, exchange rate as of June 4.

Annual average (2000=100).

A01ufig4

Poland: Changes in Economic Indicators, 2012–15

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Polish authorities, Eurostat, and IMF staff calculations.

8. Financial conditions have eased. A cumulative 100 basis points (bps) cut in the main policy interest rate between October and March and low yields on local-currency government bonds reduced borrowing costs. In April, Poland became the first emerging market to issue foreign-currency denominated bonds at a negative yield helped by ample market liquidity following the launch of the European Central Bank’s quantitative easing (ECB QE) program. Credit expansion has been supported by recent easing of lending standards (except for housing loans, which saw tightening credit terms as loan-to-value (LTV) ratios were lowered), though these remain stricter than in the run-up to the global financial crisis. Equity prices have risen, benefiting from improved economic outlook and stronger equity fund flows. Volatility in international financial markets has recently increased, partly reflecting a correction of stretched bond valuations. Spreads of Polish and CE3 (Czech Republic, Hungary, and Slovakia) long-term government bond yields to German bunds have increased slightly while equity valuations have mainly followed the improved economic conditions.

A01ufig5

Contributions to Financial Conditions Index

(Percentage points of annualized q-on-q growth)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Datastream, Haver Analytics, JP Morgan, NBP, Reuters, Statistics Poland, and IMF staff calculations.
A01ufig6

Credit Standards on Loans

(Cumulative change in percent balance in quarterly lending survey; 2011Q1 = 0)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Haver Analytics, NBP, and IMF staff calculations.

9. Labor market conditions have improved markedly. The seasonally-adjusted harmonized unemployment rate has fallen by about 3 percentage points from its early-2013 peak to 7.9 percent in April on the back of rising employment. Nominal wages accelerated to 4.1 percent in the first quarter along with rising job vacancies. Wage growth outpaced labor productivity growth, pushing up real unit labor costs.

A01ufig7

Republic of Poland: Labor Market Developments

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

10. Inflation remains subdued. Low commodity prices and weak imported inflation, including from the euro area, have kept headline inflation in negative territory. Nonetheless, the rate of deflation slowed from a historic low of -1.6 percent in February to -1.1 percent in April. Core inflation has remained weak and stood at 0.4 percent in April year-on-year, suggesting that negative external price shocks have fed into core inflation despite the rapidly closing output gap (text chart and Cross-Country Selected Issues Paper on Low Inflation in European Inflation Targeters).

A01ufig8

Republic of Poland: Inflation Decomposition

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

11. Poland’s external position is consistent with medium-term fundamentals and appropriate policies. The current account deficit declined from 3.5 percent in 2012 to 1.4 percent in 2014, benefiting from strong exports to the euro area and increasing export shares outside Europe (Box 1). While lower oil prices provided a boost to the current account, this was more than offset by higher non-oil imports (Figure 4, Table 2). External debt and gross financing needs are high but vulnerabilities are mitigated by the high share of the relatively stable intercompany debt (Annex I).

Figure 4.
Figure 4.

Republic of Poland: Balance of Payments

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Narodowy Bank Polski (NBP) and IMF staff calculations.1/ Excludes NBP.
Table 2.

Republic of Poland: Balance of Payments on Transaction Basis, 2012–20

(Millions of U.S. dollars, unless otherwise indicated)

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Short-term debt is on remaining maturity.

Sources: National Bank of Poland and IMF staff calculations.

External Sector Assessment

The external position in 2014 is broadly in line with medium-term fundamentals and appropriate policies, though vulnerabilities exist. As of March 2015, it appears that the positive impact of lower oil prices on the trade balance is being more than offset by strong domestic demand growth and rising import demand, leaving the overall assessment of the external position unaffected.

Current account. The current account deficit declined from around 5 percent of GDP in 2010–11 to 1.4 percent of GDP in 2014. In 2015, the current account is projected to improve only marginally, despite the improvement in the oil trade deficit (3.4 percent of GDP in 2013) which is more than offset by higher non-oil imports due to strong domestic demand. The cyclically-adjusted current account balance is consistent with fundamentals and desirable policies.

Real exchange rate. The real exchange rate is assessed to be broadly in line with fundamentals and desirable policy settings. Alternative approaches suggest a modest undervaluation of between 2 and 11 percent (2 percent using the current account norm; the estimated undervaluation using the external sustainability estimate of the real effective exchange rate (REER) gap is 6 percent; and the estimated undervaluation using the REER index regression approach is 2 percent and 11 percent using the levels approach). Capital inflows following ECB QE action could result in appreciation of the zloty, though the 50 bps policy interest rate cut in March could mitigate the impact.

Capital and financial account. Portfolio inflows into domestic bond and equity markets have weakened in 2014. There has also been a decrease in foreign direct investment (FDI) flows, primarily reflecting high income repatriation, while EU funds—which finance the bulk of the current account—are stable. Although part of the decline in net FDI inflows was associated with one-off factors, going forward, financing of the widening current account could prove challenging should FDI inflows fall significantly below current projections.

Foreign assets and liabilities. Substantial net international investment position (IIP) liabilities have stabilized and stood at 60 percent of GDP in 2014. Associated vulnerabilities are mitigated by the large and diversified share of FDI liabilities and related intercompany lending (over 40 percent of foreign liabilities are FDI investments).

Reserve adequacy. Reserves are broadly adequate at about 114 percent of the IMF’s modified composite reserve adequacy metric at end-2014.

Outlook and Risks

12. The outlook is for continued robust growth and subdued inflation. Healthy domestic demand is expected to maintain growth at around 3½ percent in 2015. Private consumption and investment will continue driving growth over the medium term, supported by falling unemployment, robust wage growth, and a moderate pick-up in credit growth. On the supply side, given adverse demographic trends, increasing labor participation (including of women), and boosting investment and productivity will be key to sustaining strong growth (see also Section D). Poland should continue to benefit from improved economic conditions in the euro area and higher EU structural funds. The output gap is projected to close in 2016. Nonetheless, continued low commodity prices and still-low imported inflation, combined with subdued inflation expectations, will contain inflation below the target band (1.5 to 3.5 percent) until late-2016 (Chapter I of Selected Issues).

A01ufig9

Republic of Poland: Economic Outlook and Macro-Financial Linkages

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

13. Risks have somewhat receded but remain tilted to the downside (Table 3 with the Risk Assessment Matrix (RAM)).

Table 3.

Republic of Poland: Risk Assessment Matrix1/

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The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

External downside risks

  • Volatile global financial conditions. Asynchronous monetary policies among major central banks could increase financial market volatility. Both push and pull factors could affect capital flows. On the one hand, ample liquidity in the context of the ongoing ECB QE, combined with strong economic fundamentals in Poland, could attract large capital inflows, potentially fueling asset price bubbles and sharp zloty appreciation, which could weigh on inflation. On the other hand, monetary policy tightening in the United States (U.S.) could result in capital outflows, zloty depreciation, and liquidity shortages. Staff analysis (text chart) suggests that the co-movement between Polish and U.S. yields increases sharply during episodes of market stress. However, risks of outflows are mitigated by a stable and diversified investor base, Poland’s strong economic fundamentals, flexible exchange rate, and foreign exchange (FX) reserve buffers.

  • Sovereign stress (particularly in Greece) or a protracted slowdown in the euro area. While direct linkages with Greece are limited, market pressure on the euro area from a protracted turmoil in Greece could spillover into Poland. Nonetheless, contagion to the rest of Europe and Poland could be reduced by strong policy action at the euro area level, including through liquidity support and deployment of existing firewalls. Moreover, correlation of Polish government bond yields with Greece during periods of stress has historically been limited. A protracted growth slowdown in the euro area could adversely affect Poland via strong trade and financial linkages.

  • Conflict in Russia and Ukraine. An intensification of tensions could disrupt imported gas supplies to Poland’s heavy industry. While direct financial links are limited, spillovers could materialize through confidence channels, precipitating capital outflows.

A01ufig10

Poland’s Yield Correlations with Germany and U.S.

(Correlations of changes in 10-year gov. yields; Daily data 2013–15)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Note: Normal times defined as absolute values of daily changes in yields below 2 standard deviations in DEU and U.S. Shock represents observations greater than 2 standard deviations in each of these countries.Sources: IMF staff calculations.
A01ufig11

Correlations with Poland Yields during Stress Times, 2013–15

(Regression-based correlations)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Correlations are based on estimates from regressions of daily changes in Polish yields on changes in other countries’ yields while controlling for DEU yields. Global and country-specific financial shocks represent periods of changes in yields greater than 2 standard deviations in the U.S. and each respective country.Sources: Haver analytics and IMF staff calculations.
A01ufig12

Poland: Synchronization of Growth Rates

(Correlation coefficients of quarterly growth rates)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Haver analytics and IMF staff calculations.

External upside risks

  • Stronger trading partner growth. A faster-than-expected recovery in the euro area on the back of ECB QE and low oil prices would help lift growth in Poland, given high synchronization of Poland’s business cycle with Germany and the euro area.

A01ufig13

Republic of Poland: The Transmission of Global Shocks to Growth

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Domestic risks

  • Prolonged low inflation in Poland. Inflation could fail to pick up owing to external factors or if low inflation expectations become entrenched. Prolonged low inflation could ultimately have adverse balance sheet implications by reducing household debt tolerance, putting a dent in corporate and bank profits, and increasing government deficit and debt. In a tail risk scenario, this could result in an adverse loop of lower demand, higher nonperforming loans (NPLs), lower bank lending, and lower growth (Box 2 and Chapter II of Selected Issues).

  • Weaker impetus for structural reform. Elections this year could delay some structural and financial sector reforms. Protracted reform delays could undermine potential output growth going forward.

Republic of Poland: Balance Sheet Effects from Lowflation

Low inflation has so far had only limited economic impact in Poland. Strong economic activity on the back of healthy domestic demand and robust credit growth suggests that lowflation has so far not fed into the real economy. Private and public sector balance sheets are generally healthy and have weathered well two years of below-target inflation. Household debt has increased, but remains below debt tolerance thresholds. Public sector debt is on a declining path. Nonfinancial corporations and banks remain profitable.

However, prolonged low inflation could have negative economic repercussions. It could exacerbate existing pockets of vulnerability, including the rising household debt burden. In a tail risk adverse scenario, protracted lowflation could reduce household debt tolerance, put a dent in corporate and bank profits, and increase government deficit and debt. Such a scenario could result in an adverse loop of lower household consumption, weaker bank and corporate profits, declining investment, and lower domestic demand pulling inflation down further (Box Figure).

  • Households. In the near term, low inflation combined with continued healthy wage growth increases disposable income, supporting private consumption. However, protracted lowflation could eventually feed into wages and reduce households’ debt servicing capacity, ultimately resulting in lower consumption and higher NPLs.

  • Nonfinancial corporations. In the short run, low inflation alongside still-sticky wages could reduce corporate profits. In an adverse scenario of prolonged inflation and sluggish disposable income, lower profits would induce firms to postpone investment, further reducing domestic demand.

  • Banks. In the near term, lower interest rates could squeeze bank interest-rate margins. In an adverse scenario, lower demand for credit and rising NPLs would prompt banks to reduce credit supply.

  • Public sector. While so far deflation has had limited impact on fiscal revenue, prolonged lowflation could reduce fiscal space and make it more difficult to achieve fiscal targets, potentially triggering procyclical fiscal consolidation. In turn, this could further harm growth.

A01ufig14

Republic of Poland: Low Inflation and Risks to Balance Sheets

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Eurostat, Haver Analytics, KNF, NBP, Statistics Poland, and IMF staff calculations. See Chapter II of Selected Issues.

14. Appropriate policy response will depend on the nature of the risks:

  • In the event of severe external pressure, policies should focus on preserving financial stability. The exchange rate should be allowed to play its cushioning role, while being mindful of the impact on FX denominated debt. Fiscal policy should allow automatic stabilizers to fully operate around the consolidation measures. In the event of significant capital outflows, Narodowy Bank Polski (NBP) should stand ready to provide liquidity, including in FX, to the banking sector as needed. In the event of excessive capital inflows and zloty appreciation, monetary policy should be eased and macroprudential policy should be tightened to manage risks to the financial system, arising from asset price bubbles and excessive credit growth.

  • While prolonged lowflation is still a relatively low risk, its potential impact nonetheless underscores the importance of closely monitoring developments. If inflation fails to pick up, the NBP has ample policy space to cut rates further to avoid low inflation becoming entrenched in expectations. That said, the potential impact of lowflation on bank profits should be internalized in the authorities’ routine stress tests. Fiscal risks from lowflation should be addressed by using conservative inflation projections in budget forecasts and identifying contingency measures to respond to potential inflation surprises.

Authorities’ views

15. The authorities broadly shared staff’s views on economic outlook and risks. They agreed that domestic demand will remain the primary driver of growth and that inflation will gradually converge to target over the medium term, although the Ministry of Finance (MoF) thought that inflation would pick up somewhat faster than in staff’s baseline forecast. On risks, the authorities noted that Poland is well-positioned to manage excessive capital inflows or outflows given its flexible exchange rate, stable and diversified investor base, and strong fundamentals. Risks are further mitigated by a prudent debt management strategy, proactive pre-financing of this year’s government external financing needs, and broadly adequate reserves. Contingency plans are in place to ensure timely response to external shocks, including through the use of reserves to curb excessive exchange-rate volatility and via emergency liquidity provision in zloty and FX to the banking system as needed.

Policy Discussions: Advancing Reforms to Promote Stability and Income Convergence

16. Maintaining reform momentum is key to ensuring a durable economic recovery. Policies should focus on safeguarding economic stability and advancing structural reforms to encourage continued economic convergence (Table 4).

Table 4.

Implementation of Past Fund Advice

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A. Maintaining Accommodative Monetary Stance to Guide Inflation to Target

17. Monetary policy was eased in March. Monetary policy has been complicated by Poland’s tight integration with European and global markets. Inflation has been below the lower bound of the target band for more than two years and in deflation for ten months, largely reflecting declining commodity prices and low imported inflation. This has gradually pushed up real interest rates. The robust domestic demand has yet to lift core inflation and inflation expectations have declined (Figure 5). Against this backdrop, the MPC cut the policy interest rate in March by 50 bps to a historic low of 1.5 percent, bringing the cumulative reduction in the main policy interest rate since October to 100 bps (Figure 6). A draft law on changes to the NBP law, including staggered terms for MPC members, is progressing.

Figure 5.
Figure 5.

Republic of Poland: Recent Inflation Developments

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Bloomberg, Datastream, Haver Analytics, JP Morgan, NBP, Reuters, Statistics Poland, and IMF staff calculations.
Figure 6.
Figure 6.

Republic of Poland: Monetary Policy Developments

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Bloomberg, Consensus Economics, Datastream, Haver Analytics, JP Morgan, NBP, Reuters, Statistics Poland, and IMF staff calculations.
A01ufig15

Inflation Projections

(Year-on-year inflation in percent)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Concensus Economics, Haver Analytics, NBP, Statistics Poland, and IMF staff calculations.

18. The policy interest rate cut is welcome, but the announcement of the end of the easing cycle was premature. The October and March policy interest rate cuts, alongside continued strong domestic demand and wage growth and ECB QE, should help boost domestic and imported inflation. Taking into account monetary transmission lags (6 to 8 quarters), staff projects inflation to gradually return to the target band by end-2016. Nonetheless, weak inflation expectations point to downside risks to this forecast (Chapter I of Selected Issues).

A01ufig16

Republic of Poland: Inflation Forecast and Second-Round Effects

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

19. An easing bias should be maintained. The need for further monetary easing should be guided by a data-driven approach, including by monitoring inflation expectations, wage growth, exchange-rate developments, and the outlook for economic activity. Additional policy action would be necessary to return inflation to target if inflation expectations were to disappoint, or if widening interest-rate differentials result in unwarranted upward pressure on the exchange rate, undermining the inflation objective and ultimately competitiveness and growth. Risks related to monetary policy easing appear limited, with no indication of asset price bubbles or excessive credit growth. Nonetheless, close monitoring of bank risk-taking should continue in light of potential search for yield in the low-interest-rate environment.

A01ufig17

Republic of Poland: Credit and Asset Price Indicators

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

20. Moderate reserve accumulation would be prudent. Reserves increased by 7 percent in euro terms1 in 2014 and are broadly adequate at about 114 percent of the IMF’s modified ARA metric. In light of downside external risks, continued moderate reserve accumulation would help safeguard against external shocks.

Authorities’ views

21. The authorities broadly agreed with staff’s assessment. The authorities recognized the downside risks to the inflation forecast. However, they stressed that, so far, low inflation had supported domestic demand and growth and did not appear to have had negative effects on the real economy. Some members of the MPC noted that the March announcement of the end to the easing cycle would not preclude further adjustment should growth significantly underperform. At the same time, the announcement would help maintain financial market stability by limiting uncertainty about monetary policy.

B. Financial Sector Policies and Reforms to Buttress Stability

22. The banking sector is well capitalized and resilient to external shocks. Capital buffers are high and the banking system is liquid, with capital adequacy at 14.7 percent in the fourth quarter, a declining loan-to-deposit ratio, and liquidity above the regulatory minimum (Figure 7, Table 5). The reliance on foreign funding has declined (Figure 8) and the recent Asset Quality Review (AQR) and stress tests by the Financial Supervision Authority (KNF), performed alongside the ECB’s Comprehensive Assessment, confirmed the sector’s resilience to shocks, including substantial exchange-rate depreciation.

Figure 7.
Figure 7.

Republic of Poland: Banking Sector Capital and Asset Quality

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: KNF, NBP, and IMF staff calculations.1/ 12-month profits in percent of 12-month assets.
Figure 8.
Figure 8.

Republic of Poland: Credit Growth and Banking Sector Funding

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: Haver Analytics, International Financial Statistics, NBP, KNF, and IMF staff calculations.
Table 5.

Republic of Poland: Financial Soundness Indicators, 2007–15

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Sources: NBP and KNF.Note: Data according to Financial Soundness Indicators (FSI), except for asset composition and quality (indicators not part of FSI reporting template).

Data for domestic banking sector (since 2014: Bank Gospodarstwa Krajowego excluded). Since 2014: data on capital in accordance with CRDIV/CRR (not yet available for 2015Q1 as of May 5, 2015).

A01ufig18

AQR and Stress Tests: Impact on CET1 Changes in Polish Banks

(Common Equity Tier 1 (CET1) in percent)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: NBP Financial Stability Report and IMF staff calculations.
A01ufig19

Nonfinancial Sector Loans to Deposits

(Percent)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Sources: KNF and IMF staff calculations.
A01ufig20

Supervisory M2 Liquidity Standard at Commercial Banks

(Ratio)

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

Source: NBP Financial Stability Report, January 2015.

23. However, some legacy vulnerabilities remain:

  • Foreign-currency mortgages. While tighter prudential regulation has halted new FX lending, a substantial legacy stock of these loans remains. Close to half of mortgages are denominated in FX (mostly Swiss franc), exposing households and banks to sudden zloty depreciation—as was the case in January when the zloty depreciated around 20 percent against the Swiss franc. As such, the January episode had little macroeconomic impact and high capital buffers in banks mitigated financial stability risks. In addition, the availability of emergency liquidity assistance from the NBP, supported by the swap line with the Swiss National Bank, further mitigated risks (Appendix II).

  • Nonperforming loans. While NPLs have gradually declined during the past two years, they remain elevated at above 8 percent of total loans and are particularly high in the consumer loans and small- and medium-sized enterprise (SME) segments.

  • Credit unions. Credit unions account for a small segment of the financial sector, with assets corresponding to about 1 percent of banking sector assets. However, the segment is weak and KNF is actively working on its restructuring, including through takeovers and bankruptcy. The restructuring cost the budget about 0.1 percent of GDP in 2014, putting a dent in Bank Guarantee Fund (BFG) resources. Nonetheless, doubled financial sector contributions in 2015 should help replenish BFG funds.

A01ufig21

Republic of Poland: Credit Union Capital and Deposits

Citation: IMF Staff Country Reports 2015, 182; 10.5089/9781513502434.002.A001

24. Work to strengthen the financial safety net and supervision has continued, albeit with delays. Progress has been made in implementing the 2013 Financial Sector Assessment Program (FSAP) recommendations (Table 6). A draft law empowering the Financial Stability Committee to carry out macroprudential oversight—allowing early detection and prevention of systemic risk—is moving forward. However, preparation of legislation on the bank resolution framework that would also cover credit unions has been delayed by legal challenges related to the role of the judiciary in the resolution process. Elections this year risk delaying the adoption of final legislation.

Table 6.

Republic of Poland: 2013 FSAP Recommendations and Current Status1/

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See “Republic of Poland: Financial System Stability Assessment,” IMF Country Report No. 13/221, 2013.

25. Addressing legacy vulnerabilities will buttress financial stability and promote continued healthy credit expansion.

  • Foreign-currency mortgages. Given limited macroeconomic or financial stability concerns, staff supported the authorities’ approach of case-by-case restructuring of distressed Swiss franc denominated mortgages following the recent Swiss franc appreciation. Implementing the Financial Stability Committee’s recommendation for banks to pass on the negative Swiss franc LIBOR rates to customers and not require additional collateral would allow burden sharing between banks and mortgage holders.

  • Nonperforming loans. Changes in the consumer bankruptcy law have shortened the maximum period to repay debt. A new bankruptcy and insolvency law, which eases restructuring and insolvency procedures to encourage restructuring (instead of liquidation) of viable firms has been finalized and is expected to take effect on January 1, 2016. These measures should help lower the level of NPLs.

  • Credit unions. Staff supported the authorities’ ongoing work to restructure the credit union segment.

26. Implementation of key financial sector reforms should be expedited. Finalizing the macroprudential framework would help manage systemic risks to the financial system, for example related to asset price bubbles or excessive credit expansion, not least associated with accommodative monetary policy. In addition, continued strengthening of macroprudential policies to reduce risks of rapid household debt accumulation would reduce macro-financial risks (Chapter II of Selected Issues). Implementing the bank resolution framework would enhance the effectiveness of crisis response.

Authorities’ views

27. The authorities agreed on the importance of finalizing key financial sector reforms. They noted that vulnerabilities associated with Swiss franc mortgages and credit unions do not pose financial stability risks. In the context of ongoing healthy credit expansion, the authorities were not especially concerned about the level of NPLs, which they highlighted were already on a downward trajectory. They concurred that swift completion of the bank resolution framework and implementation of the macroprudential framework would be important to ensure a strong financial safety net and help prevent systemic risks.

C. Continuing Fiscal Consolidation to Reinforce Policy Buffers

28. Fiscal consolidation has advanced further, allowing Poland to exit the EDP one year early. The general government deficit declined to 3.2 percent of GDP last year from 4.0 percent of GDP in 2013 owing to the wage bill freeze, reduced debt servicing costs following changes to the pension system, and a cyclical rebound in tax revenues. When adjusted for the costs of the 1999 pension reform, the deficit declined to 2.8 percent of GDP, allowing Poland to exit the EDP one year ahead of schedule. Public debt also declined by about 5.5 percentage points of GDP to 50.1 percent of GDP, largely on account of changes to the 2013 pension reform (Tables 8 and 9; Annex II). By end-April, about 70 percent of the 2015 gross borrowing needs had been pre-financed.

Table 7.

Republic of Poland: Monetary Accounts, 2008–15

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Sources: Haver, IFS, NBP, and IMF staff calculations.

The difference between deposit money bank claims on the central bank and central bank claims on banks relates to banks’ reserves and currency in vault.

Table 8.

Republic of Poland: General Government Statement of Operations, 2012–20

(Percent of GDP, unless otherwise indicated)

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Sources: Eurostat and IMF staff calculations.

According to ESA2010.

Includes grants.