Poland -- Concluding Statement of the IMF Mission
September 11, 2002
1. Poland is approaching accession to the European Union with strong institutions and a stable macroeconomic environment. Price stability has been achieved, the current account deficit has been brought under control, and corporate restructuring has strengthened Polish business. The task for economic policy now is to safeguard these gains and create conditions for sustained growth and job creation. Already in the past year important progress has occurred: the reduction in the structural fiscal imbalance together with the easing of monetary policy have improved the policy mix and labor market reform has been started. But a firm footing for growth requires more. Most urgently, the increase in public debt needs to be reversed and reforms—in labor markets, the structure of fiscal spending, and ownership of public enterprises—should be geared toward unleashing Poland's economic potential.
The economic outlook
2. Recent economic indicators suggest that a recovery is under way, but will likely be muted until a pick-up in Western Europe takes hold. GDP growth is set to rise gradually, helped by lower interest rates and the depreciation of the zloty against the euro. Improving profitability and accelerating exports are boosting business confidence and should revive private investment growth. Private consumption, which has remained fairly robust through the cycle, should also increase with income. Our central projection is for GDP to grow by about 1 percent this year and about 2 ¾ percent in 2003, with downside risks from uncertainties about the recovery in Western Europe. On present expectations of a further improvement in the fiscal-monetary policy mix, neither inflation nor the external current account are likely to come under pressure. Considerable excess capacity and high unemployment should keep inflation below 3 percent and limit the cyclical rise in the trade deficit. Unfortunately, however, moderate growth would only stem the recent rise in unemployment. Aiming for higher growth over the coming years will thus be crucial.
3. Beyond 2003, stronger growth—even up to 5 percent during 2004-2006—should be possible. The restructuring of private business in recent years and stable macroeconomic conditions put Poland in a strong position to benefit from a recovery abroad, EU accession, and increased opportunities for foreign direct investment. With steady progress in improving the macroeconomic policy mix, excess capacity should be eliminated over these years before growth settles down to its potential, which we estimate at about 4 percent. Such growth coupled with reforms to make job creation more attractive will be essential for absorbing the rising labor force. The current account deficit would certainly rise with higher investment, but containing it to a manageable 6 percent of GDP should be possible.
4. In difficult economic circumstances, fiscal policy in 2002 has succeeded in reducing the structural deficit. At the state level, expenditures have been under control so far and in spite of lower-than-projected inflation, revenue performance is on target. The state budget deficit is therefore likely to be on target. Indications are that the general government deficit is also as envisaged: the deterioration in the deficit of the social security funds due to a drop in employment will most likely be counterbalanced by a lower-than-budgeted deficit at the local government level. As a result, the structurally adjusted economic deficit is likely to be reduced by 0.3 percent of GDP. Nevertheless, because of the unexpectedly rapid fall in inflation, public expenditure in real terms will grow considerably faster than planned. Although unintended, this is clearly the wrong direction for public finances and, together with the still-rising debt ratio, adds to the urgency of fiscal adjustment in 2003 and beyond.
5. The 2003 budget should take a decisive step toward fiscal consolidation. We welcome the intention to limit the growth of state spending to the projected rate of increase in the CPI plus 1 percent. This rule is key not only to addressing Poland's central fiscal problem—excessive spending—but also to establishing the credibility of the needed medium-term fiscal adjustment. Our expectation is that strict adherence to this rule at the state level together with reasonable estimates for state revenue and for balances in other parts of the general government would substantially reduce the general government deficit. This would imply a considerable tightening of fiscal policy on a cyclically adjusted basis, although the public debt ratio would likely still increase. To enhance the credibility of the fiscal targets, the state budget should be based on conservative macroeconomic assumptions and should allow for adequate transfers to the social security funds and local governments.
6. An explicit commitment to fiscal adjustment in the medium term is needed, and it should be centered on a spending rule. This approach not only focuses attention on an outcome that is controlled by policy, but also reassures markets that fiscal adjustment will continue throughout an economic upswing. Structural expenditure reforms must underpin such a spending commitment. In particular, better targeting of social benefits and containing the wage bill will be critical to making room for increased spending on infrastructure within the overall rule. Committing state expenditure to the CPI plus 1 percent rule for the next 3-4 years together with clear guidelines for restricting local government and social security spending would be consistent with reversing the rise in the public debt ratio and strengthening the cyclically-adjusted position of the general government to near balance.
Maintaining price stability
7. Price stability has been achieved in Poland, and monetary policy must be geared toward maintaining it. Core inflation is below 3 percent and with the expected fiscal tightening we envisage no significant upward pressure on inflation in 2003-04. In these circumstances, further easing of monetary policy in line with market expectations would be appropriate. However, with effects of the 1100 basis points cuts in the policy rate still in the pipeline, a cautious approach involving small cuts should be retained.
8. We continue to see inflation targeting and no direct intervention in foreign exchange markets as well-suited to Poland's circumstances. However, the inflation targeting framework should be adapted to a low inflation environment. In particular, a continuous medium-term inflation target needs to be established. The recently announced target of 3±1 percent for 2003 seems appropriate and should be extended to the medium term. This is broadly consistent with the eventual adoption of the euro and could accommodate Balassa-Samuelson effects with, at most, a moderate nominal appreciation.
9. One of the most important policy decisions of the coming years will be when and under what conditions to adopt the euro. Entering ERM II and later adopting the euro will undoubtedly promote price stability and lower interest rates. What is important at this stage is to identify the conditions under which it is beneficial to take these steps and to formulate the policies and structural reforms required to meet the Maastricht criteria in a credible and sustainable manner. The authorities should determine the costs and benefits of the different options in this regard and build a national consensus on a euro strategy. The establishment of a joint committee of the National Bank and the Ministry of Finance is an important step in promoting collaboration and progressing with needed technical work in this area.
Financial system stability
10. Notwithstanding strains caused by an increase in irregular loans, Poland's banking system remains sound. The cyclical downturn has taken a toll on banks' balance sheet, but we understand that full provisioning has been made and steady efforts to improve bank's risk assessment are in train. Consideration should be given to establishing guidelines for banks to write-off loss loans after a reasonable period. We welcome the recent steps taken by the GINB to promote better risk assessment of foreign currency-denominated loans to unhedged borrowers. These steps demonstrate the supervisory authorities' commitment to maintaining the soundness of the banking system and to reacting to new developments promptly.
11. The recent amendments to the Labor Code were an important step to increase labor market flexibility. Benefits from lower wage costs and less restrictive regulations on employers should be an impetus to employment growth in the recovery. However, as unemployment has reached alarmingly high levels, in particular among young people, every avenue should be explored to increase labor demand, to create a better functioning labor market, and to raise the qualifications of potential workers. We remain of the view that differentiating the minimum wage could help high-unemployment regions and young and unskilled workers. Also, raising educational standards, while clearly a long-term goal, is likely to increase the productivity of Polish workers and the attraction of Poland as an investment platform.
12. The government's new anti-crisis package aims at promoting growth and employment. It includes initiatives ranging from reforming the bankruptcy law to providing guarantees to restructuring industries and supporting SMEs. As public funds will be extremely scarce in the coming years, public expenditures involved in these schemes, including through government guarantees and tax expenditure, must be efficient and transparent and reflect the priorities of the budget. Moreover, these programs should not distract attention from the critical task of reinvigorating the privatization program.
13. Poland will have an historic opportunity to speed up economic and social development in the coming years. The prospect of EU membership and the results of a decade of economic transformation have made Poland potentially a prime location for FDI. Moreover, the preparation for EU membership and the eventual accession will provide the country with substantial new resources to promote growth and development. Maintaining macroeconomic stability and creating institutional capacities to absorb these resources will be crucial.
We would like to express our thanks for the close cooperation that we have received in Warsaw.