Poland 2000 IMF Article IV Consultation Discussions Preliminary Conclusions
December 13, 2000
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
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Poland—2000 Article IV Consultation Discussions
December 13, 2000
1. Poland's record of economic transition remains strong. Through the 1990s, sweeping changes in the macroeconomic landscape—disinflation, the entrenchment of market mechanisms, and a major expansion of the private sector—laid the foundations for job creation and high output growth rates. Reflecting these successes, Poland is in the vanguard for early EU accession. The decade, however, was not without its macroeconomic setbacks. In particular, fiscal deficits remained excessive even at peak rates of economic growth, leading to rising current account deficits as private investment grew. Also, given the inevitable dislocations of labor during transition, insufficient emphasis may have been given to ensuring that labor market institutions were flexible enough. The decade ended, therefore, with a clear agenda for policies: eliminate the fiscal deficit, strengthen market mechanisms in the labor market, and complete the task of privatization.
2. This agenda requires a clear and determined medium term program. Nowhere is the government's role more critical than in budgetary policies. These will need to play three key roles in ensuring that growth potential is achieved and sustained. First, they will need to boost domestic savings to stem excessive external imbalances and secure macroeconomic stability. For this reason, the economic balance should move into surplus in 2003. Second, they will need to provide for the public investment necessary to support private investment and meet EU requirements. Third, they will need to encourage enterprise by lowering the burden of taxation, notably on labor. These tasks cannot all be secured by a sequence of ad hoc annual adjustments to revenue and spending. They will require comprehensive structural reform of spending programs, in particular the public wage bill and transfers to households and companies. We urge early efforts to prepare these reforms.
3. Structural reforms, building on progress so far, are also essential to achieve Poland's medium-term goals. Trade liberalization for non-agricultural products, guided by commitments to the WTO and the EU, has been largely completed. The recent "double zero" agreement with the EU anticipates a reduction in protection for agricultural commodities and presages further liberalization in this area. Public sector restructuring continues apace—including in the mining and railway sectors, and in regard to privatization. But fundamental structural challenges still lie ahead, including restructuring of the agricultural, steel and defense sectors. If the job losses that are inherent in past and prospective structural adjustments are not to translate into permanent increases in unemployment, it is essential that labor market conditions that encourage job creation are established. In particular, the ratio of the minimum wage to average wages needs to be lowered, particularly in high unemployment regions and for labor market entrants. In addition, impediments to job creation that operate through labor market regulations should be removed, and measures that could inhibit job creation, such as shortening of the work week, should be avoided. A more efficient labor market will combat unemployment and greatly improve the environment in which macroeconomic policies operate.
4. These fiscal and structural policies would support an increase in annual economic growth of 5-6 percent even while reducing the current account deficit to below 5 percent over the medium term. In addition, they would create conditions for a reduction in nominal and real interest rates, inflation approaching Western European levels, and continued rapid productivity and associated real wage growth.
5. Alongside the medium-term agenda, policies for 2001 will have to grapple with issues arising in the aftermath of the external shocks of the last three years—beginning with the Russia shock and extending to a slowdown of demand in Western Europe, food price volatility, and a large terms of trade loss in 2000. In a weak economic setting, large fiscal adjustments planned for 1999 and 2000 did not materialize; and the burden of adjustment fell disproportionately on monetary policy. In many respects the economy has weathered this period reasonably well. Economic growth has remained above 4 percent, the inflation rate leveled off at about 10 percent, and while the current account deficit rose to an alarming 8 percent of GDP in early 2000, it has since fallen back to about 7 percent. Also, Poland has proven resilient to episodes of negative investor sentiment towards emerging markets. Nevertheless, these shocks and the difficulties with policies have left a challenging legacy: a still excessive current account deficit; inflation above its target range; and unemployment rising above 14 percent in the context of uncertainty about the current and prospective strength of domestic demand and activity.
6. After the moderation of quarter-on-previous quarter GDP growth rates in 2000, annual GDP growth is likely to weaken in 2001. Through 2001, demand will be boosted by the projected gains in the terms of trade as international oil prices fall, as well as some household spending out of one-off transfers, including the compensation for the unanticipated decline in real pensions in 2000. But demand growth will likely be dampened by the effect of unemployment on wage settlements and precautionary savings, further falls in employment, as well as the high level of interest rates and the anticipated fiscal consolidation. With export growth projected to slow compared to 2000 owing to the lagged effects of the strong zloty and some deceleration in export markets, the contribution to economic growth from net exports will weaken moderately. We project economic growth in 2001 of about 4½ percent and the external current account deficit to fall below 6 percent of GDP.
7. Recent evidence suggests that inflation is already on a downward track. The rapid response of the monetary authorities to emergent inflationary pressures from end-1999 has yielded fruit: the 12-month headline rate has fallen from its recent peak of 11½ percent in July to a little under 10 percent; and between July and October, seasonally adjusted consumer prices rose at an annualized rate of 7½ percent. Even if the monthly rate falls no further through end-2001, headline inflation would fall towards the bottom of the target range. But high real interest rates and a reduction in the economic deficit are likely to slow price growth further so that inflation could well fall below the target range. Unanticipated supply shocks could, of course, disturb this outlook—though such surprises could go either way—and additional steps need to be taken to eliminate fiscal risks. The key unknown factor in the benign inflation trend in the near term is prospects for nominal wage growth.
8. This outlook presents considerable difficulties for the formulation of fiscal policy. The proposed budget targets an economic deficit of 1.6 percent of GDP in 2001, from an estimated outturn of 2.5 percent in 1999. This target is predicated on GDP growth of 5 percent in 2001. In this context, it would constitute a commendable step towards the needed medium term fiscal consolidation goal. The total tax and social security contribution estimates are consistent with this projection and the strengthening of ZUS' management information system should much reduce the risk of a further overshoot of its deficit target. The budget incorporates several welcome tax changes; it will be important that the supporting legislation making these changes is enacted promptly, and that the administration of taxes is strengthened as anticipated. On the spending side, a sizeable anticipated increase in the wage bill implies a considerable squeeze in non-wage spending. Nevertheless, strict execution of the budget would require the identification of savings to compensate for a likely shortfall from sale of ZUS arrears in 2001 and to absorb any forward shift in spending from 2000. It will be critical that expenditure estimates are not exceeded and that arrears are not accumulated. The state budget deficit ceiling should be lowered to the extent of UMTS proceeds.
9. Revenues would, however, be significantly weaker if, as we expect, GDP growth is well below the 5 percent assumed. Careful monitoring of revenues should give an early indication of the extent of any shortfall. A decision on how to respond—whether to make transparent and meaningful offsetting adjustments or to allow some scope for fiscal stabilizers to work—should be made and announced as early as possible. But two principles should be inviolate. First, spending estimates in the draft state budget should not be exceeded. And second, the state budget deficit ceiling should not be preserved by non-transparent shifting of spending to entities outside of the state budget. While we appreciate that the state deficit cap has useful disciplining effects, these become perverse if they foist borrowing onto other levels of government in an apparently arbitrary or non-transparent manner.
10. In view of the considerable uncertainties about the assumptions and policies underlying the budget, close monitoring of its execution will be critical. We strongly recommend that currently available information on the economic deficit be made public as they become available: in particular, monthly data on ZUS' deficit and its transfer of funds to the second pension pillar; quarterly data on the revenue and spending of local governments; and data for 2000 at the same frequencies on all these entities to facilitate comparison. And gaps in the data available, notably for the health funds, should be addressed urgently. Provision of these data would substantially contribute to fiscal transparency and improve the co-ordination of fiscal with monetary policy. These steps should be implemented in parallel with the measures suggested in the IMF Fiscal Transparency Report for Poland.
11. Given the inflationary outlook, a case is emerging to lower currently high nominal and real interest rates. Decisions on the scope and timing of these adjustments should be made with care. Two types of decisions will be needed. First, for the immediate future, given weak growth, nominal rates should be lowered along with reasonable estimates of inflation expectations. Second, as 2001 progresses, assuming that annualized rates of core inflation remain in the 6-7 percent range, the Monetary Policy Council will need to decide when some reduction in real interest rates should occur. We see the need to strike a careful balance between two important considerations: minimizing the risk that inflation exceeds the lower end of the band; and avoiding unnecessary costs—including those associated with a further appreciation of the zloty—of real interest rates held at high levels largely for precautionary purposes. We support the Monetary Policy Council's plan to base its decisions on interest rate policy on inflation prospects, developments and outlook for money and credit, wage outcomes, the strength of the zloty, and the credibility of fiscal adjustment.
12. The Direct Inflation Targeting framework for monetary policy remains appropriate for Poland. Its effectiveness requires an unqualified commitment to the independence of the Monetary Policy Council as the heart of the framework. We support the widening of the inflation band to two percentage points for 2001 and the goal of inflation below 4 percent by 2003. We recommend that consideration be given to eventual adoption of a multi-year target range, and encourage ongoing efforts to model inflation and the transmission mechanism. The current monetary policy process and procedures exhibit a high degree of compliance with the IMF Code of Good Practices on Transparency in Monetary Policies.
13. Alongside moderate levels of external debt and a declining current account deficit, Poland's flexible exchange rate provides a significant degree of protection against sudden and large exchange rate changes. The fact that the NBP has made it a practice not to intervene in the foreign exchange market has helped secure clear market expectations and encourages an appropriate awareness of exchange rate risks. In view of the openness of Poland's financial markets to most capital flows and liquid offshore markets for the zloty, we remain of the view that the removal of remaining restrictions on short-term flows should not pose problems and could carry significant benefits for domestic financial market development. Currently, reserves are at a comfortable level relative to imports and short-term debt, but these ratios will fall in the absence of intervention. To the extent that markets take comfort from these ratios, the NBP may wish at some stage to prevent a sustained decline by setting a neutral rule to intervene to maintain these ratios. Such neutrality should also be reflected in the operation of the special government account with the NBP for privatization proceeds. This would be effected by the adoption of clear ex ante commitments on the sums to be placed in the account alongside a commitment to restrict use of the funds to settlement of foreign debt obligations and continued frequent publication of the balances held in the account.
14. Stability in the financial sector will also be critical to the effectiveness of monetary policy and sustaining growth. The Financial Sector Stability Assessment that was initiated in September 2000 concluded that there were no immediate threats to systemic stability of the financial sector and supported the official view that the banking system needs further consolidation. The assessment acknowledged that great progress has been made in establishing a stable financial system, underpinned by a supervisory framework that is approaching international standards at a fast pace. We encourage further efforts to strengthen the regulatory framework, in particular, the early passage of the amended banking law which would allow the supervisory authorities to better address risks before they become a threat.
15. Continued effective restructuring of public enterprises and privatization in 2001 and beyond will play a key role in financing government and reconfirm the authorities' commitment to these processes. We welcome the plan to restructure the railways, the improved performance of the coal sector, and encourage efforts to privatize power plants, coal mines and steel mills, and PKO-BP.
16. The assessment of economic developments and the design of appropriate macroeconomic policies would be much facilitated by the preparation of quarterly constant price national accounts data. We urge early steps to construct and publish such data regularly and on a timely basis.
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Finally, we would like to thank all our counterparts for the generosity of the welcome and assistance afforded us during our stay.