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.
The Polish economy has recovered from the temporary slowdown in 2012–13 and has continued the progress in rebuilding policy buffers. Economic growth last year slightly exceeded expectations, while continued fiscal consolidation efforts resulted in Poland’s exit from the EU’s Excessive Deficit Procedure (EDP) one year ahead of schedule. External position is consistent with fundamentals and appropriate policies. Financial sector remains sound and resilient. Similarly to the developments in the rest of Europe, inflationary pressures had subsided and in the second half of last year inflation turned negative. Implementation of structural reforms has continued. Overall, the outlook is for robust growth and gradual return of inflation towards the target over the medium term. At the same time, risks remain tilted to the downside and dominated by external factors.
On behalf of our Polish authorities, we would like to thank staff for the constructive consultations held in Warsaw and the timely and policy-relevant set of papers. The authorities broadly agree with staff’s assessment and policy recommendations.
Economic Outlook
Last year, real GDP growth was solid and amounted to 3.4 percent—twice as much as in 2013. The key factor behind this acceleration was domestic demand, which effectively replaced net exports as the main growth engine (the latter was characteristic for periods of weaker domestic demand, as in 2009 and 2012–13). Domestic demand was driven by higher growth rate of private consumption and a boost in investment. Consumption was spurred by rising employment, higher wages and low inflation, which translated into higher disposable income. Investment benefitted from robust recovery in the credit growth on the back of eased financial conditions. Relatively high competitiveness of Polish companies along with high capacity utilization drove up investment demand.
Poland continues to rank among top EU growth performers. In the first quarter of 2015, real GDP growth surprised on the upside by accelerating to 1.0 percent (q-o-q, sa) and its level was 3.5 percent higher than a year ago. Domestic demand is expected to remain the main growth driver this year, with overall economic growth performance in 2015 forecast to reach at least 3.4 percent, before gradually rising to 4 percent in 2018. Looking ahead, economic growth will be supported, among others, by increased inflow of the EU structural funds. Poland is set to be the biggest beneficiary of the European multi-annual financial framework for the years 2014–2020.
Along with economic growth, the labor market conditions have also been gradually improving since mid-2013. Employment and activity rates have been increasing, while unemployment has continued its downward trend, reaching 7.8 percent in May—well below the EU average. This has been accompanied by steady growth in labor productivity.
External Sector
The current account (CA) deficit has been narrowing over the recent years. After reaching its lowest level in over a decade at 1.3 percent of GDP in 2013, it remained unchanged last year. In April, according to preliminary data, the CA deficit decreased to 0.6 percent of 12-month GDP. Generally, since Q2 2013 exports have been supported by the rebound in the euro area activity. The negative impact on the Polish trade from Russia/Ukraine crisis has been to a large extent counterbalanced by redirection of exports towards other, more dynamic markets as well as gains in price competitiveness. At the same time, imports have recently strengthened due to the rapid acceleration of domestic demand. This has only partially been mitigated by the positive effect of lower oil prices. The CA deficit continues to be comfortably covered by the capital account surplus, driven mainly by stable inflow of the EU funds.
External debt remains relatively stable at around 70 percent of GDP. Around two-thirds of corporate external debt is either intercompany or trade credit, which substantially reduces the roll-over risk. The official foreign reserves remain broadly adequate at about 114 percent of the IMF’ s modified composite reserve adequacy metric, as of end-2014. Their level has slightly increased since the beginning of the year, in both EUR and USD-terms, to around 94 and 103 billion, respectively. In addition, Poland continues to benefit from the precautionary Flexible Credit Line (FCL) arrangement with the Fund, since January this year with a substantially lowered level of access—in line with the authorities’ request and their exit strategy. The FCL provides an additional reserve buffer against external shocks and helps strengthen investor confidence.
Fiscal Policy
The general government deficit last year was reduced to 3.2 percent of GDP—significantly below the 3.9 percent level recommended for that year by the EU Council under the EDP rules. In addition, taking into account the costs of the 1999 pension reform (still incurred in the first half of 2014, despite the last year’s systemic changes), amounting to 0.4 percent of GDP, the deficit was effectively reduced below the 3.0 percent of GDP reference value. Consequently, it reached a level that enabled exit from the EDP—one year ahead of the deadline set by the EU Council, and six years after the procedure for Poland had been launched. General government debt also declined last year, to 50.1 percent of GDP, mainly on account of the earlier changes in the pension system.1
The correction of the excessive deficit creates some room for fiscal policy reflecting better current economic situation. However, the authorities are committed to further reducing the remaining imbalance in public finances, in a manner which would not pose a threat to Poland’s medium-term growth prospects. Going forward, fiscal policy will be guided by progressing towards the medium-term objective (MTO) of a structural deficit of 1 percent of GDP. Achieving the MTO and keeping the government debt significantly below the Maastricht reference value of 60 percent of GDP will, in particular, be ensured by full compliance with the new stabilizing expenditure rule.2 Among structural fiscal measures, an action plan aimed at improving tax compliance and effectiveness of tax administration has been implemented since last year, which should help foster budget revenues already in the near term.
Monetary Policy
Monetary policy in 2014 and early 2015 was conducted in an environment of low growth in Poland’s main trading partners and falling commodity prices globally. Core inflation was continuously low on the back of still negative output gap and moderate wage pressures. All these factors have led to deflationary developments in the Polish economy. Average CPI inflation for 2014 remained constant (0.0 percent).
Amid challenging external conditions, the Narodowy Bank Polski (NBP) strived to maintain price stability, in line with its mandate, while at the same time supporting balanced economic growth. Thus, the NBP cut the reference rate by 50 bps in 2014 and by another 50 bps in 2015, bringing its main policy rate to a new all-time low of 1.50 percent in March 2015. In result, the policy rate has come down by a cumulative 325 bps since the onset of the easing cycle in late 2012. Monetary policy easing has facilitated the gradual pick-up in economic growth and continued improvement in labor market conditions.
Although CPI inflation has been negative since July 2014, deflation has eased somewhat over the past few months. The Monetary Policy Council (MPC) expects that the gradual acceleration of economic growth and good situation in the domestic labor market should bring inflation back to the NBP’s target in the medium term. The MPC considers the current level of NBP interest rates as consistent with ensuring price stability, while discouraging a build-up of macroeconomic imbalances.
Financial Sector
The Polish financial sector has remained stable and resilient, supported by the economic recovery. Banks maintain low leverage ratios, remain liquid, well-capitalized and highly profitable. Despite record-low interest rates, the net profits of Polish banks have been stable at the record high level since 2011. In line with recommendations issued by the Financial Supervisory Authority, banks maintained their capital buffers with the capital adequacy ratio reaching 14.9 percent at the end of Q1 2015 and Tier 1 capital representing around 90 percent of total capital. At the same time, the liability structure of Polish banks has improved as deposits have been growing faster than loans, reducing banks’ use of other sources of funding. The reliance on parent bank funding has declined alongside the reduction in the outstanding FX loans.
Credit flow to the economy has been growing at a steady pace, close to the nominal GDP growth rate. As of May 2015, overall credit to the non-financial sector grew by 3.5 percent (y-o-y, after exchange rate adjustment). This pace of credit growth does not create imbalances in the economy, but also does not unnecessarily restrain economic growth.
Work is further progressing on 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 with the FX mortgage portfolio in runoff mode since mid-2012. The effects of the recent Swiss franc appreciation have been counterbalanced by lower Swiss interest rates, thereby limiting the impact on debt service costs for borrowers. The authorities do not see the remaining FX mortgage portfolio as a systemic problem, as both the banks and borrowers have strong capital and income buffers to absorb shocks.
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 have slightly decreased over the past three years, on 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 authorities have continued to implement their structural reforms agenda. Based on a number of integrated strategies, measures have been implemented to enhance growth potential of the economy. These measures are aimed, among others, at improving the access of companies to capital, stimulating entrepreneurship, strengthening business climate as well as counteracting the adverse effects of progressing demographic changes on the labor market and public finances. Among labor and product market policies: (i) the process of deregulation of professions has continued; (ii) measures have been taken to reduce labor market segmentation, including by better aligning civil law and temporary contracts with regular contracts as well as limiting excessive use of fixed-term contracts; (iii) efforts have continued to reduce the youth unemployment; (iv) a new housing rental program is in the pipeline to help develop the rental market and facilitate regional labor mobility. Also, a pro-family package—combining different benefits for families with children—is being carried out, along measures to increase female labor force participation. This is expected to increase the fertility rate and growth of labor supply in the long term. In addition, measures have also been undertaken to further improve business environment and promote R&D and innovation.