Economic Outlook

Poland’s real GDP grew by 3.6 percent in 2015. Domestic demand remained the key source of that growth, with private consumption supported by higher disposable income (declining prices coupled with growing wages) and decreasing unemployment. Also, a healthy credit expansion, accommodative financial conditions and a relatively high competitiveness of Polish companies helped support private investment. Poland continues to rank favorably in terms of economic growth among the EU countries.

The economic growth is expected to remain strong. It is forecast to accelerate to 3.8 percent in 2016, and to increase gradually thereafter to 4.1 percent in 2019. Growth will be supported, among others, by an 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 the stronger economic growth, unemployment has been steadily declining and it reached a historically low level of 6.3 percent in March/April 2016. Notably, this is well below the EU average and it constitutes the lowest level since the beginning of economic transition in Poland in the early 1990s.

External Sector

In 2015, the current account (CA) deficit—at 0.2 percent of GDP—reached its lowest level in two decades. This was mainly due to a record high trade surplus, reflecting lower oil prices and improved terms-of-trade. In the recent quarters, exports have been supported by an increase in the economic activity in other EU countries. At the same time, imports have recently strengthened due to an improvement of dynamics of domestic demand. This has only been partially mitigated by the positive effect of lower oil prices. The overall external position in 2015 was consistent with fundamentals and desirable policies. The CA deficit continues to be comfortably covered by the capital account surplus, driven mainly by the inflow of the EU funds.

The official foreign reserves remain broadly adequate at about 107 percent of the IMF’s modified composite reserve adequacy metric, as of end-2015. Their level has further slightly increased since the beginning of the year, in both EUR and USD-terms, to around 97 and 108 billion, respectively, at end-May. In addition, Poland continues to benefit from the precautionary Flexible Credit Line (FCL) arrangement with the Fund, since January this year with a further lowered level of access—in line with the authorities’ request and their exit strategy. The FCL provides a valuable added insurance against adverse external shocks.

Fiscal Policy

The new government’s priority objective is to promote strong and inclusive economic growth while pursuing fiscal policy within the constraints of the domestic and the EU fiscal rules. The general government deficit is expected to remain at 2.6 percent of GDP this year (unchanged from 2015), to increase to 2.9 in 2017, and to decrease gradually thereafter to 1.3 percent of GDP in 2019. The authorities reiterate their commitment to keeping the deficit below 3 percent of GDP in line with EU framework, and obeying the domestic expenditure rule. The latter should also ensure keeping the general government debt significantly below the 60 percent of GDP threshold—at end-2015 it amounted to 51.3 percent of GDP.

The government’s flagship social scheme is the new family support program Family 500 plus, implemented from April 2016 onwards. The program is intended to facilitate an increase in the fertility rate and support disposable incomes of families with children. This should help counter unfavorable demographic trends, improve future labor supply and strengthen growth potential over the longer term. The program would also help reduce poverty and inequality.

New expenditures related to the implementation of the authorities’ priority social and economic goals require strengthening of the revenue side of the state budget. To this effect, a wide set of measures are being taken, including, inter alia, a new tax on the financial institutions’ assets (already implemented) and a comprehensive strategy to improve tax administration and fight tax evasion. The strategy includes (i) an introduction of a General Anti-Avoidance rule against tax avoidance; (ii) a reduction of the limit on cash transactions between companies from EUR 15,000 to PLN 15,000; (iii) a reorganization of tax and customs administration and establishment of the National Fiscal Administration—drawing on the Fund’s TA recommendation¹ to establish a single and unified, national tax administration; (iv) an introduction of an integrated IT system to track VAT invoices; among others.

Importantly, the above measures should be looked at in the context of the government’s recognition that the so called “VAT gap” in Poland remains one of the highest in the EU. Thus, the authorities consider that a significant improvement in the effectiveness of the tax collection is crucial. It may also create additional fiscal space for the implementation of the government’s priority social and economic measures. Two other proposals in this regard are currently in the sphere of public debate, namely (i) a revision of the 2013 retirement age increases and (ii) an increase in the personal income tax (PIT) tax-free allowance, as mandated by a constitutional court’s ruling.

Both proposals are at the stage of conceptual work with the intention to present a draft legislation by the end of the year. However, as indicated recently by government officials, implementation before 2018 is rather unlikely. The authorities are of the view that potential adverse impact of the considered changes to the retirement age can be mitigated by adjusting parametric conditions for entitlement to retirement. Regarding the increase in the PIT tax-free allowance, the authorities consider that it could be introduced as a part of a more comprehensive income tax reform, with lost revenues from higher new allowance offset by a more progressive tax regime.

Monetary Policy

Amid depressed global commodity prices, inflation in Poland remained very low, at -0.9 percent on average in 2015. While the CPI deflation had bottomed out since early-2015, it remains at -0.9 percent, as of May. Recently, also the core inflation has turned negative and it currently stands at -0.4 percent, as of May. These weak price dynamics are related to the pass-through from low commodity prices to other CPI components and a still slightly negative output gap. Nevertheless, so far, the low inflation has not materially affected neither households nor corporates. Firms continue to report good financial and liquidity conditions, with the share of profitable companies close to all-time-highs; and consumer demand is growing steadily.

Against this backdrop, the Narodowy Bank Polski (NBP) took advantage of its flexible approach to inflation targeting, striving to maintain price stability in the medium term, while supporting balanced economic growth. Since March 2015 the Monetary Policy Council (MPC) has kept the policy rate at the all-time low of 1.50 percent (completing the easing cycle of 325 bps initiated in late-2012). The MPC recognizes the external nature of the price shocks and points to the stable domestic economic growth accompanied by marked improvement in the labor market conditions. At this juncture, the MPC considers the current level of interest rates as conducive to keeping the Polish economy on the sustainable growth path and maintaining macroeconomic balance.

Financial Sector

The Polish financial sector has remained stable and resilient, supported by the solid economic growth. Banks remain liquid, well-capitalized and maintain low leverage, which result both from the high value of regulatory capital and the conservative level of risk weights used to calculate capital adequacy. In line with recommendations issued by the Financial Supervisory Authority, banks maintained their capital buffers with the capital adequacy ratio reaching 16.7 percent at the end of Q1 2016 and Tier 1 capital representing around 90 percent of total capital. At the same time, the funding structure of Polish banks remains favorable, as evidenced by a low funding gap, a large share of household deposits in liabilities and low reliance on the potentially less stable market funding.

Although in Q4 2015 and Q1 2016 the earnings and profitability ratios of the banking sector decreased, they remain at comfortable levels. The decrease in profitability was mainly the result of less favorable environment (i.e. low interest rates) as well as higher costs of banking activity (due to a one-off contribution to the Bank Guarantee Fund due to deposit payouts as well as initial contributions to the Borrower Support Fund established to provide a temporary support to housing loan borrowers in difficult financial situation). In Q1 2016, for the first time, banks had to pay the new asset tax introduced in February. Contrary to market expectations, however, the additional tax has not significantly influenced the profitability in the first months after its introduction. Also, credit flow to the economy has been growing at a steady pace. Nonetheless, more time is needed to more thoroughly assess its overall impact. The authorities intend to evaluate the performance of the new tax and adjust it if deemed necessary.

Work has further progressed on measures to strengthen the financial sector and improve supervision. The new macroprudential authority (Financial Stability Committee) became fully operational in November 2015. The bank resolution framework—in line with the European Bank Recovery and Resolution Directive (BRRD)—has just been completed and finally approved by the Parliament. Loan-to-value limits for housing and commercial real estate loans, which came into force in early 2014, are gradually being tightened to help further enhance loan quality. Since January 2016, the borrowers’ contribution should constitute at least 15 percent of the real estate’s value. The share of non-performing loans (NPLs) is slowly, yet steadily decreasing. The coverage of NPLs by provisions remains at a comfortable level.

While virtually no new foreign-currency (FX) lending is taking place following the introduction of stronger macroprudential measures, the outstanding stock of FX mortgages accounts for around 9 percent of GDP, as of April, and the portfolio is runoff mode. The government expressed its commitment to help FX mortgage holders in difficult situations, recognizing their concerns that some of these loans had been extended without adequate consumer information. Several alternative options for addressing this issue are being discussed with multiple stakeholders, however, no specific proposal has been subject to official consideration yet. The government is cognizant of the importance of ensuring that any future proposal safeguards financial stability. To this aim, the government considers that potential costs for banks would likely have to be extended over a longer time horizon.

Structural Reforms

The authorities have continued to implement structural reforms, as indicated in the staff report. Directions of Poland’s economic development in the years to come have been indicated in the new government’s Plan for Responsible Development². It provides for increasing the potential of the Polish economy through mobilizing domestic human and financial capital, fostering innovations through increased R&D spending and developing highly specialized industries, capable of building globally recognizable brands and products as well as creating highly paid jobs. The aim of the Plan is to substantially increase the level of investment over the next decade. Necessary actions to achieve that target include development of financial instruments offered by the Polish Development Fund—newly established entity integrating currently existing development institutions with the goal to increase their effectiveness. An important element of the strategy is creating a favorable institutional and legal environment increasing Poland’s investment attractiveness for foreign capital. The Plan also focuses on social (in particular in the areas of demography and education) and regional development promoting inclusion of small cities and rural areas. Specific measures underpinning the Plan’s objectives will be reflected in the Strategy for Responsible Development expected to follow by the end of the year.