Poland -- Aide Mémoire of the IMF Mission
April 7, 2004
The impending political changes in Poland come at a time of stark economic choices. The past several years have seen a disturbing drift in economic policies: fiscal deficits have risen, public debt has escalated sharply, and privatization has slowed to a virtual standstill. Through a 2-3 year slump in activity, the economy lost jobs, investment fell and income growth suffered. Fortunately, with inflation and the current account under control, a recovery is gaining momentum, offering the most propitious circumstances in recent years for a break with past policies. The new government will face a choice between policy action to address the economic challenges so as to establish the base for a sustained recovery or policy drift that will build up the adjustment burden for less benign times in the future.
We initiated our annual consultation discussions just as this political change was unfolding. We therefore focused our talks on the central macroeconomic problem in the Polish economy—the large and growing public debt burden—and the choices the new government will face in addressing it. This note briefly summarizes our views on this issue. We look forward to returning to complete our discussions once a new government has been formed. We will then provide a full concluding statement on economic developments, the outlook and the government's policy agenda.
The recent favorable combination of strong growth, low inflation, and contained current account deficit is likely to continue through 2004. Despite a tentative recovery in western Europe, GDP in Poland accelerated in 2003 reflecting a surge in exports and robust private consumption growth. The substantial slack in the economy kept inflation low. The main weakness was still-faltering private investment. In 2004, we expect continued export growth, building on strong competitiveness. A rebound in employment and faster wage growth are likely to further invigorate private consumption. Private investment will be helped by diminishing excess capacity and high profitability, but a clear recovery will probably await political clarity. Assuming a political outcome that does not disrupt business, consumer, and market sentiments, GDP growth is likely to reach 4 ½ - 5 percent in 2004, with the current account deficit below 3 percent of GDP.
The durability of the recovery, however, will require a renewal of investment that will be sustainable only with fiscal consolidation to stabilize public debt. Given the already high tax-to-GDP ratio and sizable infrastructure needs, fiscal adjustment must come primarily through restraint on current expenditure. We therefore see the Hausner plan, with its emphasis on rationalizing spending and some broadening of the tax base, as a well-focused approach to fiscal consolidation. Reforms to social transfers (particularly adjustments to old-age pension and pre-retirement benefits, streamlining the farmer pension scheme, tightening qualifications for disability support and reforming sickness benefits) and administrative measures get to the heart of the fiscal problem while setting up strong incentives to improve the supply side of the economy. Their full implementation, together with the elimination of preferential taxation, expansion of the tax base, and health care reforms currently being formulated would be a first credible step toward fiscal consolidation. We strongly urge the Parliament and the new government to move ahead swiftly with these reforms.
The new government will, however, need to confront the fact that these reforms alone will not stabilize the debt ratio under plausible assumptions about future growth. It will need to consider measures going beyond the spectrum of reforms outlined in the Hausner plan to include public administration reform, better targeting of social benefits, determined privatization, and improvements in revenue administration. Such measures will be crucial not only to halt the deterioration in the debt ratio, but also to free resources to adequately support the use of EU transfers and to set the stage for reducing the large tax wedge.
Reining in fiscal pressures will also help ensure that monetary policy can continue to support the recovery. We expect CPI inflation in 2004 to rise to, and perhaps briefly beyond, the top end of the inflation target range due to a decreasing output gap, modest one-off effects of relative price changes associated with EU accession, and other temporary shocks (rising world oil prices and pass-through of the zloty depreciation). Assuming that these temporary shocks dissipate in 2005, that fiscal adjustment promotes a rebound in investment, and that inflation expectations are contained, inflation should revert toward the middle of the target range. In such favorable circumstances, interest rates could be held broadly stable without putting the medium-term inflation target at risk, particularly in light of the credibility established by the previous and current MPC. But any influences that raise inflation expectations—and continued large fiscal deficits would be one such influence—would risk turning a temporary price increase into an inflation problem requiring an interest rate response.
The opportunities on the horizon now speak strongly for the urgency of fiscal adjustment. With EU accession, the growth of trade, a more solid structural and institutional base for attracting foreign investment, and financial support from the EU hold the key to significantly accelerating the catch-up, if combined with macroeconomic policy discipline. Moving ahead to adopt the euro would compound these potential benefits. To realize all these gains, the drift that has characterized fiscal policy for the past several years must be stopped. Time is of the essence.