Poland -- Concluding Statement of the IMF Staff Mission
November 20, 2003
Poland is at an important juncture. A strong economic rebound is in train supported by a number of welcome developments—a sharp fall in interest rates, a depreciation that has created a stronger competitive position vis-à-vis Europe than seen in years, and steady progress toward EU accession next year. Building on these developments to sustain growth will be essential to the job creation and economic restructuring Poland needs. The key challenge here is public sector reform: the recovery cannot survive under the continuing burden of a government sector bloated by large and poorly targeted social transfers, inefficient public enterprises, and high and rising public debt. All the more so as Poland faces increasing competition of neighboring countries driven by the goal of joining the euro area rapidly. Rising to the challenge of redirecting public sector policies will make the difference between a future of durable growth and investment and one of continuing cycles of sluggish activity and high unemployment.
The export-led recovery in 2003 is gaining strength. Even though investment figures in the first half disappointed, exports have turned out far stronger than expected earlier in the year, and consumption growth has remained robust. We expect a recovery in investment in the second half due mainly to construction spending, and GDP growth for the year of 3 ¼ percent. The current account deficit, which we project at 2 ½ percent of GDP, remains low. Inflation is picking up as expected: we project it to be just over 1 ½ percent by end-year.
These positive underlying trends should continue into 2004. In this setting, we expect the large fiscal stimulus—about 1 ½ percent of GDP—to add little to growth. Diminishing excess capacity, strong corporate profits, and the corporate tax rate cut will be incentives for investment, although their full effect will be contained by firms' uncertainty about the fiscal outlook. Consumption growth should be boosted by large fiscal transfers and employment creation in the most productive parts of the economy. Although these developments will add up to a sizable increase in domestic demand, we expect much of it to leak out through the current account. In all, we expect GDP to grow by 4 ¼ percent, and, despite continuing high export growth, the current account deficit to rise to around 4 percent of GDP. By end-year, consumer price inflation should be just below 3 percent.
The durability of the recovery will depend on whether the government can seize the initiative to address the fiscal imbalance. Cyclical conditions are as propitious as they will ever be for undertaking bold actions. The long-discussed and unavoidable reform of pensions, social transfers and subsidies—bound to be politically contentious whenever done—will be most easily borne in a growing economy. Indeed acting now should push this recovery into a virtuous circle of growth, investment and stronger public finances; delay will only pile up a larger adjustment burden and worsen the conditions in which it will ultimately have to be addressed. We have focused in this regular mid-term visit between Article IV consultations on the immediate issues for fiscal and monetary policy.
With the recovery on a sound footing, the large increase in the 2004 fiscal deficit, which will feed further growth in the public debt ratio, is unfortunate. Broadly speaking, the increase in the deficit reflects about equally higher outlays related to EU accession, the corporate tax rate cut and higher current expenditures. Moreover, not included in the general government deficit, but weighing on the increase in debt, will be the growing arrears of the health care providers. We regard the corporate tax cut (to a rate competitive with other countries in the region) and the increase in EU-related investment spending as positive developments. But these growth-promoting measures need to be matched by reductions in unproductive spending to contain the growth in the deficit and debt. It is critical that every effort be made to find savings during 2004 and rein in the deficit.
The Hausner plan, fully implemented, would be a decisive step in reforming government finances. Its social expenditure component focuses on the crux of the fiscal problem—a poorly targeted and overly generous social transfer system that is not only the source of rising debt but also a potent disincentive to job search and employment creation. Building the political consensus for the reforms will be difficult, and we applaud the current outreach to gain the support of diverse interest groups. Time is of the essence, however. We are encouraged by plans for a condensed timetable for passing parts of the legislation critical for generating savings in 2004 and urge speedy consideration of all other parts of the program. Early progress will not only position the government to realize substantial savings in 2005, but will send immediate signals to financial markets of its commitment to the reform program. Moreover, some of the measures proposed—in particular, the restructuring of state-owned enterprises and health care providers, and improvements in tax administration—while likely to have significant benefits for the economy from the outset, typically produce budgetary savings with a long delay. Any slippages in or watering down of the program would pose challenges for the budget.
As the groundwork for implementing this program is prepared, attention to other aspects of fiscal management must be meticulous. Two areas stand out. First, given the increasing public borrowing requirement, steady implementation of the debt management strategy and close communication with financial markets will remain essential to securing budget financing on the best possible terms. Second, strong efforts are needed at all levels of public administration to create the institutional infrastructure for absorbing EU funds. These transfers offer a historic opportunity to modernize infrastructure and agriculture, and the highest priority must be accorded to using them fully and efficiently.
The timing of euro adoption will become an increasingly active concern after EU accession. Poland, like the other accession countries, will need to consider carefully the benefits of euro adoption—potentially large gains in trade and reductions in market risks—against the costs of losing monetary policy independence. Whatever the outcome of this calculation for the immediate future, Poland should move decisively to position itself to meet the Maastricht fiscal criteria over the next few years—a prudent objective regardless of the date of euro adoption. Alongside fiscal policy, monetary policy will need to safeguard low inflation.
The outgoing MPC leaves two major legacies—low inflation and non-intervention in the foreign exchange market. Preserving these assets should be the highest priority for the new MPC. Low inflation was achieved at some cost, but, if now maintained, will redound to the benefit of growth and investment in Poland. The new MPC therefore will need to gear interest rate decisions to the objective of meeting the existing inflation target of 2 ½ percent. In the current setting—where a recovery is in progress, a large fiscal stimulus is looming, and the yield curve is steepening—the scope in the coming months for any further easing of monetary policy has largely disappeared. More generally, the new MPC will need to consider carefully how best to establish its credibility from the outset.
The tradition—verging on an implicit commitment—of abstaining from intervention in the foreign exchange market has served Poland well. Clearly understood in markets, this tradition is a key element of the strategy for dealing with volatile market expectations: the range of fluctuations of asset prices when given free play instills an element of caution in market participants and prevents the NBP from getting caught on one side of speculative pressures.
Even as the economy recovers, developments in the banking system continue to reflect the two-year slump in activity. Credit growth remains slow, classified loans (after adjusting for valuation effects from the zloty depreciation) are still high, and bank profits are low. Nevertheless, it appears that capital adequacy ratios for most banks are high, and the growth of problem loans has fallen. The prospective change in the system of loan classification—done with the objective of bringing the system more in line with those of other accession countries—represents an easing of existing standards. It will be important for regulators to consider carefully the effects on bank profits and risk-taking, and for the new MPC to factor into its monetary policy decisions any effects on credit growth.
The pace of structural reforms has not picked up since our last visit in March. On a positive note, the implementation of the new bankruptcy law is most welcome, while progress in privatizing PHS is important. But the privatization effort more generally is unimpressive, leaving almost untapped a major source of non-debt budget financing while burdening the budget with subsidies and credit guarentees. Meeting the 2004 target for privatization receipts—almost double the likely realized value in 2003—will require a clear strategy executed with a greater sense of urgency than in the past. Also, as noted in the EC's recent monitoring report, improvements in judicial and administrative capacity, governance and anti-corruption measures are key to a more efficient functioning of the public sector.
Over the next few months Poland will face several important challenges—garnering political support for fiscal reform, appointing a new MPC, and committing to a stronger privatization program. Rising to each of them will be critical to the strength of the Polish economy for years to come.