Republic of Poland: Review Under the Flexible Credit Line Arrangement
Author: International Monetary Fund. European Dept.
Publication Date:
13 Jan 2016
eISBN:
9781513568379
ISBN:
9781513568379
Language:
English
Keywords:
ISCR; CR; FCL arrangement; FCL resource; IMF's Executive Board; CA deficit; economy; IMF staff calculation; short-term debt; banking sector; current account; broad money; Global; interest rate
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This paper discusses Poland's performance under the Flexible Credit Line Arrangement. In recent years, Poland's macroeconomic policies have focused on further strengthening fundamentals and institutional frameworks. Fiscal consolidation has led to an exit from the Excessive Deficit Procedure. Monetary policy has been eased to help lift inflation. Financial sector supervision has been strengthened with a new macroprudential framework. Reserves are broadly adequate against standard metrics. The new government has pledged to maintain prudent policies, including gradual fiscal consolidation over the medium term, and to ensure the continued stability of the banking system. In the period ahead, it will be important to identify specific growth-friendly measures to underpin the fiscal adjustment and reduce implementation risk.

Abstract

This paper discusses Poland's performance under the Flexible Credit Line Arrangement. In recent years, Poland's macroeconomic policies have focused on further strengthening fundamentals and institutional frameworks. Fiscal consolidation has led to an exit from the Excessive Deficit Procedure. Monetary policy has been eased to help lift inflation. Financial sector supervision has been strengthened with a new macroprudential framework. Reserves are broadly adequate against standard metrics. The new government has pledged to maintain prudent policies, including gradual fiscal consolidation over the medium term, and to ensure the continued stability of the banking system. In the period ahead, it will be important to identify specific growth-friendly measures to underpin the fiscal adjustment and reduce implementation risk.

Context

1. Poland’s economy has remained resilient amid increased global financial volatility. Able macroeconomic management has helped support growth despite weakness in some export markets. While concern about slowing growth in China and other emerging markets (EMs) led to widespread EM sell-off and financial market volatility in late summer of 2015, bond fund outflows from Poland were less severe than in several other countries and government bond yields remained broadly stable (Figure 1). The zloty depreciated against the U.S. dollar alongside other EM currencies, but remained broadly stable vis-à-vis the euro. The Swiss franc appreciation in early 2015 resulted in a more than 10 percent depreciation of the zloty vis-à-vis the Swiss franc, but did not jeopardize financial stability. Steady growth continued, supported by robust domestic demand amid falling unemployment and rising disposable income. At the conclusion of the 2015 Article IV Consultation, Executive Directors welcomed Poland’s recovery from the 2012–13 slowdown, supported by its very strong economic fundamentals and policies.

Figure 1.
Figure 1.

Republic of Poland: Financial Market Developments, 2010–15

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

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

2. The FCL arrangement continued to provide valuable insurance against external shocks. Poland’s integration with global trade and financial markets facilitated valuable technological transfers and helped bolster productivity, competitiveness, and economic convergence. Nonetheless, the high degree of trade and financial integration also exposes Poland to international spillovers. While reliance on parent bank funding has declined, more than 60 percent of banking sector assets are foreign-owned, about 40 percent of domestic treasury securities are held by foreigners, and about 45 percent of mortgages are denominated in foreign currency—primarily in Swiss franc. Significant gross external liabilities combined with an open capital account, make Poland vulnerable to shifts in investor sentiment. Against this backdrop, Poland’s successive FCL arrangements have provided a reassuring signal to markets on the strength of Poland’s policies and a welcome buffer against tail risks.

3. The authorities have built additional policy space and further strengthened policy frameworks.

  • Gradual deficit reduction continued to strengthen fiscal buffers. In 2014, the pension-adjusted1 general government deficit declined to below 3 percent of GDP, allowing Poland to exit the EDP one year early. General government debt declined to about 50 percent of GDP at end-2014.

  • Reserves are broadly adequate. International reserves have increased from EUR 55 billion (USD 80 billion) at end-2009 to EUR 93 billion (USD 98 billion) at end-November 2015 and are broadly adequate against standard metrics. Reserves are relatively comfortable compared to those in the median emerging market (Figure 2). Poland’s flexible exchange rate has continued to serve as a cushion against external shocks. The swap line with the Swiss National Bank remains available in case of severe Swiss franc funding pressures.

  • The financial sector framework has been strengthened. A macroprudential framework to allow for early detection and prevention of systemic risk has been finalized, and a law on covered bonds has been approved, helping to support stable funding. A new corporate insolvency law to encourage restructuring (instead of liquidation) of viable firms was also completed. The new bank resolution framework is being finalized.

Figure 2.
Figure 2.

Republic of Poland: Reserve Coverage in International Perspective, 2014

(Percent)

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Sources: World Economic Outlook, and IMF staff estimates.1/ Reserves at the end of 2014 in percent of short-term debt at remaining maturity and estimated current account deficit in 2015. The current account is set to zero if it is in surplus.
Figure 2.
Figure 2.

Republic of Poland: Reserve Coverage in International Perspective, 2014 (concl’d)

(Percent)

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Sources: World Economic Outlook, Balance of Payments Statistics Database, and IMF staff estimates.1/ The ARA metric was developed by IMF staff to assess reserve adequacy and is the sum of 30 percent short-term debt at remaining maturities, 10 percent of other liabilities, 5 percent of broad money, and 10 percent of exports for countries with floating rate currencies. For the stock of porfolio liabilities, data for 2014, 2013, or 2012 are used depending on data availability.

4. The new government has stated its commitment to maintaining very strong policies and institutional frameworks. The Law and Justice (PiS) party won an outright majority in the October 25, 2015 parliamentary election. The new government’s priorities are focused on advancing inclusive growth, while maintaining fiscal discipline and financial stability (see authorities’ letter in the Appendix).

A01ufig1

Republic of Poland: Trade and Financial Linkages

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Recent Developments

5. Growth has held up well, labor market conditions have improved, and deflation appears to have bottomed out. Robust increases in private consumption, combined with healthy credit expansion, continued to support growth—at a better-than-expected 3.7 percent (2010 prices, yoy, sa) in the third quarter (Figure 3, Table 1). The seasonally-adjusted, harmonized unemployment rate has continued its downward trend, declining to 7.0 percent in October 2015—the lowest since end-2008. Moderate wage growth continued. Deflation moderated during spring and summer, and while it temporarily deepened again in early fall on the back of external factors, inflation picked up to -0.6 percent in November.

Figure 3.
Figure 3.

Republic of Poland: Recent Economic Developments, 2009–15

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

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

Republic of Poland: Selected Economic Indicators, 2012–20

article image
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 December 15.

For 2015, exchange rate as of December 15.

Annual average (2000=100).

A01ufig2

International Growth and Inflation Co-Movement

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

6. The current account deficit has declined. The deficit is expected to have narrowed to around 0.5 percent of GDP in 2015 from 2 percent of GDP in 2014, owing to lower cost of energy imports (Figure 4, Table 2). Nonetheless, geopolitical tensions have led to lower exports to the Commonwealth of Independent States (CIS), in particular to Belarus, Russia, and Ukraine. The current account continues to be largely financed by EU structural funds. While foreign direct investment (FDI) has traditionally served as a relatively stable source of financing, one-off factors contributed to its decline in the first half of 2015. Net external liabilities, including substantial cross-border intercompany loans, remained stable at around 65 percent of GDP. The real effective exchange rate remains broadly consistent with fundamentals and desired policies.

Figure 4.
Figure 4.

Republic of Poland: Balance of Payments

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.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)

article image

Short-term debt is on remaining maturity.

Sources: National Bank of Poland and IMF staff calculations.
A01ufig3

Poland: Trade-Weighted Exchange Rate Index

(2009=100)

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Sources: Haver Analytics, JP Morgan, and IMF staff calculations.

7. The financial sector remains liquid and well-capitalized. Banking sector liquidity has remained healthy with a liquid asset ratio above 20 percent in the third quarter of 2015 and the loans-to-deposits ratio steadily declining. The capital adequacy ratio stood at around 15½ percent in the third quarter, and nonperforming loans are gradually declining. While the banking sector continues to be profitable, profitability has declined in the low-interest-rate environment, which has resulted in narrowing interest-rate margins (Figures 5 and 6, Table 3).

Figure 5.
Figure 5.

Republic of Poland: Banking Sector Capital and Asset Quality

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Sources: KNF, NBP, and IMF staff calculations.1/ 12-month sum of profits in percent of 12-month average assets.
Figure 6.
Figure 6.

Republic of Poland: Bank Credit Growth and Funding

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Sources: Haver Analytics, International Financial Statistics, NBP, KNF, and IMF staff calculations.
Table 3.

Republic of Poland: Financial Soundness Indicators, 2008–15

(Percent)

article image
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 2015Q3 are preliminary.

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).

A01ufig4

Republic of Poland: Banking Sector Lending Conditions and Liquidity

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

8. Fiscal policy remained broadly neutral. The general government deficit is expected at around 3 percent of GDP in 2015 (Tables 4 and 5). While indirect tax revenue collections in 2015 have disappointed, under-spending is expected to have helped contain the negative impact on the deficit. Public debt at 50.4 percent of GDP at end-2014 is assessed as sustainable under a number of shock scenarios (Annex I) and, while yields have picked up moderately recently, financing conditions have remained favorable with 10-year bond yields at around 3 percent at mid-December.

Table 4.

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

(Percent of GDP, unless otherwise indicated)

article image
Sources: Eurostat and IMF staff calculations.Note: According to ESA2010. As of 2016, projections assume implementation of the announced measures of bank asset tax and retail tax (about 0.3 and 0.1 percent of GDP) and child benefit allowances (about 1 percent of GDP). 2016 includes one-off revenue receipts of 0.5 percent of GDP from LTE auction (negative expenditure as per ESA 2010). Assumes no reduction in the VAT rate in 2017 or equivalent permanent revenue measures; does not assume any unfunded new spending measures. Over the medium term, assumes targeted expenditure rationalization of 0.1 to 0.3 percent of GDP per year to achieve 0.25 percent of GDP annual structural deficit reduction envisaged by the authorities.

Includes grants.

Table 5.

Republic of Poland: General Government Financial Balance Sheet, 2013–20

(Millions of zloty, unless otherwise indicated)

article image
Sources: National authorities and IMF staff calculations.

Outlook, Risks, and Policies

9. Under current policies, the outlook is for continued robust growth and a gradual pickup in inflation. Growth in 2015 and over the medium term is expected to remain broadly unchanged at 3½ percent, supported by domestic demand. Robust growth will help the output gap to close in 2016. Inflation is projected to enter the target band (1.5–3.5 percent) at end-2016 amid negative external factors. The current account deficit is expected to narrow in 2015, reflecting continued low oil prices, and gradually converge to around -3 percent of GDP over the medium term alongside growing import demand and a gradual recovery of oil prices.

10. Downside risks have somewhat receded, but remain elevated. Previously identified risks have somewhat diminished—including those associated with a protracted slowdown in the euro area and the normalization of U.S. monetary policy—while new risks have emerged.

  • External. External risks have to some extent receded relative to the time of approval of the current FCL arrangement, but remain elevated. Risks related to structurally low growth in the euro area have moderately diminished on the back of ECB QE. At the same time, while volatility in the immediate aftermath of the U.S. Fed’s rate hike has been muted, uncertainties remain about the Fed policy path. These uncertainties could still result in increases—albeit of a smaller magnitude than had been envisaged earlier—in Poland’s risk premium (October 2015 Global Financial Stability Report). In addition, new downside risks have emerged, including from a potential significant slowdown in China and other large EMs (October 2015 World Economic Outlook). The External Economic Stress Index for Poland indicates that external conditions are broadly unchanged relative to one year ago, while downside risks related to euro area growth and U.S. monetary policy have subsided to some extent (Box 1). Poland’s very strong fundamentals, reserve buffers, and a stable and diversified foreign investor base are mitigating factors.

A01ufig5

The Global Outlook

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

  • Domestic. Domestic risks relate to continued low inflation and fiscal slippages. Inflation could fail to pick up, owing to ongoing spillovers from low oil prices and low euro area inflation. Alongside, the fiscal deficit could widen if inflation or growth were to disappoint, or if gains from revenue measures to finance new spending do not materialize as planned. Fiscal slippages or broader weakening of policies could weigh on market sentiment and increase financing costs going forward (see below).

A01ufig6

Republic of Poland: Exposure to Risk

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Republic of Poland: External Economic Stress Index

The external economic stress index was introduced in Poland’s staff report on the arrangement under the Flexible Credit Line, January 2015, based on the methodology in “The Review of Flexible Credit Line, the Precautionary and Liquidity Line, and the Rapid Financing Instrument,” IMF Policy Paper, May 2014. This box updates the index and compares it to the version published at the time of approval of the FCL arrangement.

The external economic stress index shows that external conditions are broadly unchanged, while risks have somewhat receded, but remain elevated. The baseline index shows the evolution of external conditions as they pertain to Poland. Weights are unchanged relative to the time of approval of the FCL arrangement. Risks capture both real and financial shocks identified at the time of the request: namely, those pertaining to a negative shock to euro area growth and adverse market reaction to the normalization of U.S. monetary policy. These risks have been updated to reflect changes in the external environment.

External conditions indicate above-average stress. The baseline reflects WEO projections for euro area growth and the U.S. 10-year bond yield. The euro area bank equity return and VXEEM are assumed to remain unchanged at their end-September 2015 levels. While euro area-related concerns have lessened somewhat as the region’s growth and bank profitability are slowly recovering, U.S. longterm bond yields have increased in expectation of continued interest rate hikes and emerging market financial volatility has risen. Going forward, it is assumed that the gradual recovery of euro area growth continues, U.S. interest rates are gradually increased, and emerging market volatility persists. Under these assumptions, external economic conditions are expected to remain broadly unchanged relative to the time of approval of the current FCL arrangement.

A01ufig7

Poland: External Economic Stress Index

(Negative values indicate above-average stress)

Citation: IMF Staff Country Reports 2016, 012; 10.5089/9781513568379.002.A001

Source: IMF staff calculations.

The two adverse scenarios point to somewhat lower risks than at the time of the request of the FCL arrangement. In particular, risks arising from a negative growth shock in the euro area and an unexpected increase in U.S. bond yields have subsided on the back of ECB QE and the recent U.S. Federal Reserve policy interest rate increase.

  • The first scenario includes a 75 basis point increase in the 10-year U.S. bond yield above the baseline—compared to a 100 basis point increase in the last FCL report, reflecting that U.S. monetary policy normalization has recently begun. As in the FCL request, this is combined with a 2 standard deviation increase in the VXEEM.

  • The second scenario includes a reduction in euro area growth by 0.4 percentage points relative to the 2016 baseline—compared to a 0.5 percentage point shock in the last FCL report to capture a corresponding relative decline in the probability of euro area recession during the past year (based on October 2014 and October 2015 World Economic Outlook assessments)—combined with a 1 standard deviation reduction in euro area bank equity valuation, compared to 2 standard deviations assumed at the time of the FCL request.

11. The new government aims to promote strong and inclusive growth, while maintaining prudent policies.

  • The 2016 budget, approved by the government, targets a general government deficit of 2.8 percent of GDP. The budget is largely based on the draft submitted by the previous government, but was amended to increase social spending on child benefits (around 1 percent of GDP annually), financed by retail and financial sector taxation, and one-off receipts from a mobile frequencies auction. For the coming years, the authorities have stated their commitment to maintain the budget deficit below 3 percent of GDP in 2017 and resume fiscal consolidation in 2018 at a pace of at least ¼ percent of GDP per year. This commitment to fiscal discipline is welcome and the proposed path will reduce the structural fiscal deficit to below 2¼ percent of GDP by 2020, keeping the general government debt firmly on a sustainable path. However, some recent decisions will dent somewhat the currently strong policy framework. The 2016 budget will be met partly with one-off fiscal measures, and the expenditure rule was modified to accommodate this. Also, some of the revenue-raising measures, including the planned sectoral taxes, could ultimately discourage trade and credit expansion, and should be replaced with higher-quality measures. Finally, while the authorities remain committed to a sound pension system, they have announced their intention to reconsider the statutory retirement age and possibly lower it, although the details of the proposal are still being worked out. In staff’s view, it is important to maintain fiscal discipline with a robust policy framework, including a financially sustainable pension system. In this context, specific growth-friendly measures should be identified in the context of the Convergence Program update (due in the spring) to underpin the fiscal adjustment path in the coming years and increase resilience to shocks.

  • Accommodative monetary policy has helped lift inflation. Despite strong domestic demand, external shocks have been a drag on inflation. In response, the Monetary Policy Council (MPC) appropriately lowered the main policy interest rate a cumulative 100 basis points between October 2014 and March 2015 (Table 6). Following the interest rate cuts, monetary policy has appropriately remained on hold with the Narodowy Bank Polski’s (NBP’s) November projection indicating that NBP inflation expectations for end-2017 are now mildly above those expected prior to the March interest rate cut. Nonetheless, additional interest rate cuts could be needed should inflation expectations become unanchored.

  • Financial sector supervision has focused on mitigating vulnerabilities. While earlier tightening of prudential regulation has halted new FX lending, the Polish Financial Supervision Authority (KNF) has recently acted to limit risks associated with the still-high outstanding stock of foreign-currency mortgages. Banks with significant foreign-currency exposure have been requested to retain dividends and further boost capital. In staff’s view, these measures, along with case-by-case restructuring of distressed FX-denominated mortgages, should be sufficient to address vulnerabilities in this loan segment. Any wholesale measures, such as a system-wide conversion of FX mortgages into zloty, should thus be avoided. Alongside, the authorities have continued to address vulnerabilities in the small, but weak credit union segment.

Table 6.

Republic of Poland: Monetary Accounts, 2010–15

(End of period)

article image
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.