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At the conclusion of annual Article IV bilateral discussions with the authorities, and prior to the preparation of the staff's report to the Executive Board, the IMF mission often provides the authorities with a statement of its preliminary findings.
 

Poland -- Preliminary Conclusions of the 1999 Article IV Consultation December 14, 1999

1.  Economic performance in Poland has been outstanding. In the decade since Poland embarked on transition, inflation has been dramatically lowered, economic growth has been strong, and the structure of the economy--including the financial sector, company ownership, international trade, and capital account arrangements--has been transformed.

2.  The agenda for policy nevertheless remains challenging. External shocks slowed output growth in 1998-99. These shocks have largely passed, and growth should reach 4 percent this year and exceed 5 percent in 2000. But a current account deficit of 7 percent of GDP and the increase in inflation back to over 9 percent during 1999 require an immediate, decisive policy response. The problems posed by high unemployment rates and low employment growth require a similarly determined effort to remove impediments to job creation.

3.  Accession to the EU is the overarching policy aim within which these challenges will be addressed. The following observations are framed within this policy aim. They include a number of recommendations that pose technical, political, and social challenges. But the steps advocated will, in our view, help make best use of the opportunities that accession opens for economic growth. Particular care in the formulation of policies is all the more important because even the prospect of accession may well bring about unusually high rates of investment. Policies must do all that is possible to avoid the pitfalls often associated with high investment and ensure that investment is productive.

Priorities for macroeconomic policies in 2000

4.  The first priority is to halt the trend increase in the current account deficit. Further increases in that deficit would make Poland unduly vulnerable to a reversal of capital flows. Putting inflation back on a downward track is a close second in policy priorities. Inflation has recently plateaued at rates that are significantly higher than those of partner countries and renewed progress towards the goal of inflation below 4 percent in 2003 is important.

5.  The only way to attain both goals is to increase public savings. While the prospect of strengthened export market growth in 2000 helps to diminish the risk of a further deterioration in the current account balance, its impact will be muted by the corresponding increase in activity and imports. For this reason, a fiscal consolidation remains necessary to curb domestic demand, import growth and inflation. An improvement in the current account position would also lessen the external constraint that is now hindering effective implementation of the inflation targeting regime.

Fiscal policy

6.  Thus, fiscal consolidation in 2000 is essential. The amended budget implies a reduction in the underlying deficit of general government relative to GDP of about 1 percentage points. This should ensure the stabilization of the current account balance and buttress downward pressures on inflation.

7.  There are risks of fiscal slippage outside the state budget. While some of the difficulties that plagued ZUS in 1999 will not recur, the loss of payment discipline by taxpayers is likely to carry over into 2000, even with the enhanced efforts to combat it. In addition, the compression of local government investment spending that followed fiscal devolution seems unlikely to be fully sustained, and overruns in the health sector could prove extremely difficult to contain. In the event of significant slippages, the general government deficit target should be defended by mid-year fiscal adjustments, particularly if the current account balance does not strengthen.

8.  The commitment to transparency in fiscal data is commendable. Several actions are necessary, however, to give full expression to that commitment. In particular, official commentary on the fiscal stance should be refocused away from the state budget to the balance of general government, and the process of collection and dissemination of data on the local governments should be accelerated. The IMF fiscal transparency assessment requested by the Ministry of Finance would provide an appropriate context in which to consider further steps.

Inflation targeting

9.  The large external current account deficit qualifies the extent to which monetary policy can focus solely on inflation. The vulnerabilities associated with high deficits imply that monetary policymakers should not ignore the consequences of their actions for the external balance. This means that in the near term, when inflation is likely to remain at current levels or even rise, any consideration of a further increase in interest rates would have to be weighed carefully against the likely effect on the current account. This constraint on the use of monetary policy to pursue the inflation goal places an even greater burden on fiscal policy.

10.  The 2000 inflation target is nevertheless achievable. The substantial drop in inflation will require a deceleration of nominal wages. Even if international energy prices decline and the 2000 general government deficit target is met, nominal wage increases in the public sector will need to strictly adhere to the guidelines set in the 2000 budget. In addition, a concerted effort should be made to head off the risk that the current increase in inflation feed into private sector wage negotiations. The recent marked increases in official interest rates will help in this effort, and further initiatives should focus on persuasion. The difficulty of meeting the 2000 target also counsels strongly against any further increase in import tariffs.

Medium-term fiscal policy

11.  The authorities are committed to balance the general government position in 2003: this goal is appropriate and provides an anchor for fiscal policy. The prospect that private savings will increase in line with investment seems remote. In part, this is because of households' perception that entry to the EU will bring a marked permanent increase in income, reducing the need to save now. Thus, higher public savings are essential if external vulnerabilities are not to be aggravated.

12.  It is important that the government's commitment is widely perceived. The more firmly rooted is the appreciation of these fiscal goals, the larger the role they will play in buttressing investors' confidence in Poland's policies and outlook. We encourage you to give wide and consistent publicity to the medium-term fiscal framework and the goal of budget balance.

13.  Recent and pending reforms to the structure of taxation are welcome. Simplifications in the taxation of business through the CIT and the PIT should strengthen the tax bases, increase efficiency, and facilitate administration. The CIT reform--the structural changes, the rate reduction in 2000, and the commitment to lower the rate further--will boost Poland's attractiveness as a destination for investments, both for domestic and foreign investors. The prospective abolition of housing allowances in the PIT would also be a major advance and the proposed reduction in PIT rates would strengthen work incentives. But the goals of the proposals on joint filing and child allowances would be better pursued through targeted benefits.

14.  Public spending restraint will be essential to secure the fiscal balance targets and boost productivity. Tough choices will need to be made on spending on wages, pensions, subsidies. This challenge cannot be avoided without putting the goal of stability at significant risk. EU accession related expenditures will also have to be accommodated within the fiscal framework.

15.  Hard budget constraints on local governments will also be needed. For example, if local governments appeal for financial support from the central government to cover excess spending in the health sector, such requests will need to be firmly and publicly denied. Looking further ahead, the scope for local governments to borrow within current ceilings is substantial. Credit constraints and cautious attitudes that currently limit this risk are unlikely to last for long, and well before they ease additional instruments to contain borrowing should be put in place. As the new law on local governments is being drafted, consideration should be given to phasing in the current limits by imposing stricter limits in the short term: borrowing above such short-term limits might require approval by central government. There may also be a case for adjusting the formulae for central government transfers to local governments to reduce transfers to entities that borrow in excess of guidelines (even if that borrowing is within the current borrowing limits) and to raising the capital asset requirement on banks for lending to local governments.

Medium term monetary and financial sector policies

16.  The goal of inflation below 4 percent by 2003 is appropriate and attainable. Nevertheless, three changes to buttress efforts to secure that goal should be considered. First, the present one-year ahead band for the inflation target may give insufficient guidance as regards the path to the 2003 inflation goal. We would suggest instead that each year, target ranges be announced for all the years leading up to the three-year target date. This would provide markets with a clearer view of the MPC's policy intentions. Second, the terms of the members of the MPC run concurrently and no member may be reappointed. This means that the MPC will be completely reconstituted in 2004. These arrangements should be changed so as to avoid the step reconstitution of the MPC. Third, the transmission of official to banking interest rates has been impeded by the inadequacy of competitive pressures in key parts of the banking system. Though this problem is easing as competitive pressures increase, the planned completion of the privatization process in banking will be necessary to ensure full effectiveness of the monetary transmission mechanism.

17.  The case for abolishing or retaining the exchange rate band is finely balanced. Strictly speaking the band and inflation targeting are not consistent, although the band is currently so wide that risks of conflict with the inflation targets seem minimal. On the other hand, the crawling parity may play a residual role in guiding markets' perception of fair value for the zloty and a temporary role in capping possible appreciation of the zloty: but these roles are secondary. Decisions on the band should also recognize the implications for eventual entry to ERM. We do not see a strong case for either side, but we would strongly advocate choosing a time when exchange markets are calm and after Y2K problems are past to effect any change.

18.  On balance capital account liberalization would be beneficial. Current controls on short term asset positions may be slowing down financial flows by limiting the liquidity of zloty instruments. But such effects should not be having a substantial influence on the value of the zloty given the flexibility with which controls are currently applied and the size of the on- and off-shore zloty derivative markets. Furthermore, removing the remaining controls may promote the development of domestic financial markets, improve monitoring, and facilitate improved hedging. It may be advisable, however, to delay liberalization until the Y2K problem has passed and the current account has firmed.

19.  Banking sector supervision is satisfactory. But the pressures to which it is subject could become severe, especially if the prospect of EU accession engenders moral hazard in capital flows into Poland. In addition, the dramatic evolution of the pension industry spawned by the recent pension reforms underscores the need to ensure that any vulnerabilities in the non-bank financial sector are also quickly identified and addressed. To this end, a Financial Sector Stability Assessment, conducted by the IMF and the World Bank, is strongly recommended for 2000.

Medium term labor market and trade policies

20.  Job creation is paramount. Industrial restructuring has begun in earnest in the coal and steel industries, and similarly fundamental reform is required in the agricultural sector if Poland is to achieve its growth potential. But these initiatives will cost jobs in the restructuring sectors, in a context where official and hidden unemployment is already high. This places a premium on stimulating job creation in higher productivity activities elsewhere in the economy.

21.  To this end, reform of the minimum wage is essential. It is currently excessive. At some 40 percent of average wages, it is well above that in other countries in the region. It has particularly harmful effects on the young and unskilled and on incentives for companies to provide retraining. The proposal to reduce the ratio of the minimum wage to average wages progressively is a step in the right direction, but may not go far enough or take effect soon enough. In addition, reform of labor taxes and social benefits may also be necessary so as to ensure that their interaction with the minimum wage does as little harm as possible to job creation.

22.  Direct interventions--including reducing the work week, public works, import protection and export subsidies--are not appropriate to meet the challenge of job creation. These interventions introduce distortions, have limited beneficial impact even in the short term, and are often costly to the budget. Policy needs to focus at a more fundamental level, given the scale of the challenge, and should concentrate on removing impediments to employment and investment. Continued prosecution of trade liberalization, increasing flexibility in labor market structures, including the work week, and continued simplification of tax structures should all feature prominently in the overall jobs strategy.

23.  Finally, we welcome the decision to participate in the pilot project for the release of the Article IV staff report.

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We would like to thank you for the cordiality extended to us during our stay in Warsaw, and for the generosity of the assistance provided to us.