Republic of Poland - Concluding Statement of the IMF Mission
November 20, 2006
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.
The opportunities for strong economic growth in Poland are opening up. The beneficial effects of past corporate restructuring, increasing openness to foreign competition, and EU membership are complementing a cyclical upturn. We expect GDP to rise by over 5 percent this year and about 5 percent in 2007. The expansion is well-balanced between consumption, investment and exports and bolstered by rising employment. Yet, as good as the near-term growth outlook is, it falls short of that in the other new EU members combined, where growth is likely to average above 6 percent in 2006-07. And, without steady improvements in economic policies, Poland's recent strong performance may prove to be largely cyclical so that after 2007 output growth would fall back toward recent estimates of potential (4-4½ percent). For Poland to fully reap the benefits of EU membership and to occupy a strong position in the European economy, policies that strengthen productive potential are crucial.
An immediate concern for macroeconomic policy is managing the cyclical upturn. Fiscal and monetary policies need to limit pressures on resources that could cause excessive wage and price increases. Thus, we commend the government for sticking to the PLN 30 billion deficit cap for the 2007 budget. But this has not gone far enough. For even though we expect the 2007 headline general government deficit to fall to about 3½ percent of GDP (including transfers to open pension funds), the deficit excluding temporary cyclical influences is likely to remain about 4 percent of GDP. We strongly urge committing to a lower deficit in 2008. Monetary policy still faces subdued wage and price pressures. But without any tightening, we expect pressures to emerge shortly, pushing CPI inflation to about 3 percent in mid-2007 and keeping it above the central 2½ percent target through 2008. This projection, though subject to much uncertainty, argues for starting a tightening cycle within the next few months to anchor inflation at 2½ percent. Subsequent decisions on the speed of the tightening should be based on reassessments of wage and price projections.
Securing strong growth beyond 2007 will present greater challenges. Many influences will affect investment, employment and productivity, determining whether or not growth in Poland will keep pace with that in the other new EU members. But as far as macroeconomic influences are concerned, experience across the region suggests that three will be key: establishing a strong fiscal position with low public debt and a lower level and simple structure of taxation; strengthening institutions that foster investor confidence; and adopting the euro.
The cyclical upturn is an opportunity to address fiscal problems that have for some time hindered Poland's growth potential. The tax wedge is excessive because of high social contributions, the tax system has other distortions, and rising public debt creates the threat that taxes will have to be raised further. Poorly targeted social transfers create disincentives to work. These developments need to be reversed to attract private investment and continue to create jobs, and there is no better time to address these problems than in a cyclical upturn. In this light, reductions in the deficit relative to GDP in 2006-07 are welcome, but they are not large enough even to halt the increase in public debt over the next few years based on our projections for growth. We urge you to plan a more ambitious fiscal adjustment incorporating three goals: first, to restrain spending growth-by addressing inefficiencies in social transfers, constraining administrative spending, and avoiding concessions on pensions, especially to special interest groups; second, to make room for cuts in the tax wedge; third, to build on the recent success in improving absorption of EU funds and ensure that cofinancing is a top spending priority.
Many countries find that pre-announced fiscal rules ease the political difficulties of making hard choices in an ambitious fiscal adjustment. The 60 percent of GDP ceiling on public debt and the PLN 30 billion cap on the state deficit are helpful in this way. But are these rules best for Poland? Based on IMF projections and assumptions, with state deficits of PLN 30 billion, it would take eight years just to get the general government deficit below 3 percent of GDP. Also, the deficit rule is highly procyclical, requiring too little adjustment in good times and too much in weaker economic conditions. In our view, Poland would be better served by a rule limiting the increase in real state spending (apart from that related to EU transfers) below potential growth (as determined by an independent assessor) combined with binding restrictions on borrowing by all other parts of the general government. This would ensure adequate restraint to achieve steady adjustment and avoid procyclicality. In any event, multi-year budgeting should be adopted to ensure that long-term implications of today's budget decisions are known.
Poland's ability to adapt institutions to attract more investment will ensure that it takes full advantage of EU membership. Significant improvements have already been made through greater flexibility in employment contracts, relative moderate corporate taxation, and better provisions for protecting equity investors. However, Poland has weak ratings in other areas-such as registering new businesses and closing old ones, enforcing contracts, combating corruption, and resolving legal issues quickly-and this needs improvement. Another key issue, particularly as demand for land and real estate rises, is to adapt zoning and regional plans to increase land availability. Experiences of earlier EU members show that those that did not create conditions for strong private supply responses to rising property prices encountered higher inflation and bottlenecks to growth.
With relatively slow GDP growth and significant corporate restructuring in recent years, Poland has been a latecomer in the region to rapid bank credit growth. This lag appears to be ending: credit to households is now rising at the rate of 30 percent while overall credit growth is up 20 percent on the year. Foreign exchange denominated mortgage lending is rising especially rapidly. Recommendation S, with its emphasis on guidance to banks and ensuring well-informed borrowers, seems to be a measured response to the risks of such lending. But at this juncture, protection from risks of rapid credit growth should reside primarily with strong bank supervision.
This means that the new financial supervisory arrangements are coming into effect in a challenging environment. The IMF remains concerned that the legislation establishing the KNF does not meet best practice in ensuring full independence. But we recognize that the credibility and effectiveness of the KNF will depend as much on its actions as it does on the enabling legislation: decisions clearly based on objective technical criteria will go a long way in dispelling doubts. Ensuring smooth integration of previously separate supervisory bodies will also be important. To achieve this, KNF, KNB, the NBP, and the financial community should cooperate closely, and KNF should continue to clarify transitional arrangements and any ambiguity in the new law that might be identified. For the pension, insurance and securities arms, the immediate task is to adopt new statutes and grant contracts to staff so that on-site inspections can begin promptly. For banking, the key issues are to ensure that supervision remains effective during the transitional year, the KNF leadership works closely with GINB staff to map out the merger and that an environment conducive to successful implementation of Basel II capital standards is maintained.
Vigorous pursuit of euro adoption would serve Poland well. In our view, membership in the euro zone will boost trade with other members, enhance conditions for foreign investment, and reduce exchange rate risk and the costs of foreign borrowing. These are unique opportunities, particularly for countries like Poland with low domestic savings rates yet large investment needs. Moreover, countries that do not work deliberately toward preparing their economies for euro adoption will be at a competitive disadvantage relative to other countries in the region that do. Already Poland enjoys benefits from market expectations that it will join the euro zone early in the next decade-without actions to sustain these expectations, these benefits, too, could be lost.
The urgency of creating conditions for strong growth is greater than ever. As European and global integration intensifies, the scope for using foreign capital to finance strong growth, as well as the competition for it, is increasing. At the same time, borders are opening to labor migration, and domestic job creation alongside rising productivity and incomes will be essential for maintaining a vibrant domestic labor force.
In closing we wish to thank our hosts for their cooperation and hospitality.