Outlook and risks

Since the last consultation, Poland has significantly improved its macroeconomic position. Economic growth has been strong, driven mostly by private consumption and investment. The harmonized unemployment rate stands around a record-low level of 3.8 percent and the labor market continues to tighten. Nevertheless, inflation remains low at 1.6 percent on average in 2018 and consistent with the NBP inflation target. Consequently, NBP has maintained the interest rates, including the reference rate, unchanged at 1.5 percent. The external position remains broadly in line with fundamentals, and the level of reserves is adequate. Poland’s increased resilience to external shocks allowed for a termination of the Fund’s Flexible Credit Line in November 2017.

The authorities remain committed to prudent fiscal policy, while implementing the key objectives of Poland’s economic development strategy. Public debt has been put on a downward path, and the headline deficit is expected to reach a record-low level of 0.5 percent of GDP in 2018. The structural balance has improved on account of targeted policies aimed at enhancing VAT compliance and strengthening tax administration. Concurrently, the authorities have kept public spending in line with the stabilizing expenditure rule. In conjuncture with fiscal adjustments, the authorities successfully executed the “Strategy for Responsible Development”, which serves as a primary instrument for a flexible management of development in Poland.

The Polish financial sector remains stable, resilient, and liquid. Banks are profitable and well-capitalized, and the macroprudential framework remains sound. Risks associated with mortgages denominated in foreign currency are abating, as the loan portfolio gradually decreases. Recent changes in the governance of the Polish Financial Supervisory Authority intend to improve coordination across government agencies in order to respond to potential financial risks in a timely and efficient way.

Our authorities concur with staff’s views on the near-term outlook and risks. As the current economic cycle is maturing, growth is expected to moderate over the medium-term, reflecting the tight labor market and the projected slowdown in the euro area. Risks to the outlook are primarily associated with external factors, including the escalation of trade tensions, uncertainties on global financial markets, a hard Brexit, and the potential move of foreign labor force participants to other EU countries.

Fiscal Policies

The economic upswing and prudent fiscal policy continued to support public finances. Together with higher tax revenues on account of improved revenue administration and the elimination of loopholes, this contributed to substantial reductions in the headline and structural deficits in 2018. Poland’s fiscal policy is supported by a strong framework, including the constitutional debt ceiling of 60 percent of GDP, the “safety threshold” of 55 percent of GDP, and the expenditure rule that puts a nominal limit on the growth of public spending. The set of fiscal rules ensures stability and credibility of public finances and responsibility in fiscal policy implementation. In addition, Poland’s commitment to the EU’s Stability and Growth Pact helped rein in the fiscal deficit and limit government debt.

In 2018, Poland’s budget deficit is expected to be at record-low, and public debt remains on a firm downward path on the back of robust growth, further improvements in tax compliance, and favorable domestic conditions. Beyond 2018, the debt trajectory is expected to continue its declining path to 43.4 percent of GDP by 2022. Reaching the medium-term objective—a structural deficit of one percent of GDP—appears feasible. The Polish authorities also remain committed to rebuild fiscal buffers. In this regard, the revenue administration aims at further increasing tax compliance and tax collection efficiency. On the expenditure side, social spending as a share of GDP is on a declining path, as pension benefits are indexed well below nominal GDP, and some other social benefits are fixed in nominal terms. This welfare system is fiscally sustainable in the context of demographic headwinds. In the near term, no major risks to fiscal stability are foreseen.

Measures are needed to maintain the long-term sustainability of public finances in light of the increasing pension-age population. In response to this challenge, the Polish authorities adopted a new long-term savings scheme in October 2018, the “Employee Capital Plan” (PPK). Under the PPK, the accumulated assets will be managed by investment funds, pension funds, or insurance companies within a well-defined framework. The goal of the PPK is to increase savings and support productive investment that, in turn, will deliver higher returns in retirement and support continued income convergence.

The Polish authorities agree that more work is warranted to address deficiencies in the process of budgetary planning and procedures. In this context, Poland continues its work to reform the budgetary framework with a view to increasing the effectiveness and efficiency of spending. The completion of the first stage of these efforts is expected by the end-2019.

Monetary Policy

In 2018, notwithstanding relatively high economic growth and wages rising faster than in previous years, inflation remained moderate. It reached 1.6 percent on average, and thus was below the midpoint of the NBP’s inflation target (2.5 percent +/- 1 percentage point), yet within the target range. This indicates that the monetary policy stance in recent years was appropriate. Price growth was driven mostly by rising energy and food prices, while core inflation remained low at 0.7 percent. Looking ahead, CPI inflation is likely to remain close to the level observed last year. In the medium term, inflationary pressures should be limited due to the projected slowdown of economic activity, both at home and abroad. Furthermore, inflation in Poland in the quarters to come will not be lifted by higher energy prices, since a recently passed law has frozen electricity prices for all economic sectors.

Against this background, while we share the staff’s view that high uncertainty about both global economic conditions and future domestic price developments warrants a data-dependent approach for monetary policy, we disagree with the assessment that interest rates might be raised in the near term. In the context of persistently low inflation expected going forward, and amid a looming economic slowdown, the monetary authorities anticipate that interest rates are likely to stay at their current level in the coming quarters. Yet, the central bank stands ready to adjust monetary policy if macroeconomic developments materially deviate from the current forecasts.

External Sector

In recent years, favourable macroeconomic conditions have narrowed Poland’s external imbalances. In 2017, Poland recorded a current account surplus of 0.2 percent of GDP, compared with a deficit of 0.5 percent in 2016. This was, among other things, due to the nominal surplus in trade of goods and services that reached 4.1 percent of GDP. Polish exports benefited from economic revival in the euro area, especially in Germany, Poland’s main trade partner. Looking ahead, the current account balance is projected to deteriorate to -0.6 percent of GDP in 2018, mainly due to stronger dynamics for imports rather than exports. Nevertheless, the Polish external position is in staff’s assessment consistent with medium-term policies and fundamentals.

Financial Sector

Poland’s financial system remains broadly robust, with a sustainable rate of lending growth. Polish banks remain well capitalized and have a relatively low leverage. Banks are the main source of financing for the economy and they have continued to increase their regulatory capital, maintaining its high quality. The average capital adequacy ratio remains at 18.4 percent (16.4 percent for Tier 1), and the average applied risk weight is higher than in most EU countries. This results in a relatively high resilience of banks to shocks. The systemic risk associated with non-credit financial institutions is limited due to their size and business models.

In parallel, the risk associated with foreign currency mortgage loans is abating. The value of portfolio of mortgage loans is decreasing steadily, its quality remains very high, as does the financial situation of most borrowers. Political discussions on certain proposed legal solutions providing for the mandatory conversion of the loans at an exchange rate that differs significantly from the current market rate have calmed down.

Given the predominantly domestic orientation of the Polish banking sector and the well-balanced situation of the Polish economy, the risks to the stability of the domestic financial system are mainly external. They relate to the shocks to the global economy and financial system. The Polish banking system’s direct foreign asset exposures is limited, although the foreign funding of the banking sector, the government, and corporations remains important. Nevertheless, the results of the stress tests indicate that banks in Poland—thanks to consistent capital accumulation—remain resilient to adverse shocks, and the banking system would be able to provide continued financing to the economy.

Our authorities’ view differs from staff’s assessment regarding the increased risks associated with greater participation of the state-controlled institutions in the financial market. Until recently, the share of foreign banks amounted to three-quarters of total assets, creating a risk of potential withdrawal of funding in case of external financial shocks, and thus generating negative spillovers to the economy. The increased state footprint reflects the withdrawal of foreign participants from the market, whose shares were taken over by domestic institutions through their corporate decisions. This has contributed to a better balance between domestic and external ownership of the sector.

Recent changes in the governance structure of the PFSA are aimed at increasing cross-governmental coordination and a better-targeted response in case of financial shocks, while achieving greater institutional effectiveness through enhanced resource allocation. A legislative amendment improved funding of the PFSA by granting greater budgetary independence. Moreover, in our authorities’ view the PFSA board remains sufficiently independent as only four out of nine voting members are designated by the government.

Structural Policies

Poland has made a significant progress in reaching the objectives of the “Strategy for Responsible Development” (SRD), the government’s main policy document, which identifies and specifies key priorities for the country’s development until 2030. Strong institutions, efficient administration, and effective processes lay the foundation for the SRD’s successful implementation. The overarching goal of these concerted efforts is the continued convergence to higher living standards of the Polish people, along with poverty reduction and social inclusion.

Guided by the SRD, Poland launched various initiatives aimed at strengthening potential growth and ensuring responsible development. One of these initiatives is the higher education reform, adopted by the authorities as “Constitution for Science” in November 2018. It increases the quality of education and ensures sustainable development of Polish universities. The education reform, along with further investments in human capital, will increase the job market participation rate in the long term. In view of tight labor market, staff rightly point out that more work is warranted.

A further comprehensive legislative package adopted last year is the “Constitution for Business”, which enhances the business climate, especially for SMEs and startups. The new law aims at improving relations between business and public administration, as well as simplifying bureaucratic procedures. Clear and simplified regulation is designed to attract foreign capital, increase FDI, and raise productivity.

Furthermore, additional progress has been made towards incentivizing R&D spending through, inter alia, R&D tax incentives for innovative startups and the government’s emphasis on innovative areas, such as electromobility. EU-funded public R&D and infrastructure projects increased sharply in 2018, while private sector innovation spending is yet to accelerate.

The comprehensive and well-balanced SRD is compatible with the European Commission recommendations, detailed under the Europe 2020 strategy. It is assumed that by 2020 the average gross disposable income of households (per capita, in PPP terms) will increase to 76–80 percent of the EU average and will by 2030 reach the EU level. The authorities are cognizant that more work is needed to improve energy efficiency to improve air quality and make growth sustainable.