Warsaw, December 9, 2011
1. Poland’s robust and well-balanced economic growth in 2011 attests to its sound fundamentals and track record of strong policies. In the first three quarters of the year, real GDP grew by 4¼ percent, led by fixed investment and exports, and private sector employment grew by 2¼ percent. CPI inflation in October was 4¼ percent and core inflation (which excludes food and energy prices) was 2¾ percent. The current account deficit widened slightly to about 5 percent of GDP in the four quarters to 2011Q2 and was mostly financed by capital transfers from the EU (2 percent of GDP) and FDI inflows.
2. GDP growth is expected to slow and risks are firmly on the downside, reflecting the deteriorating external outlook. Financial strains in the rest of Europe have already led to an easing of capital inflows, an increase in interest rate spreads, and downward pressure on the exchange rate. Weakening external demand will dampen export growth and diminish appetite for investment projects, which in turn should lower import growth, and deleveraging by parent banks could hamper credit supply. While Poland may be less affected by the worsening external environment than some other countries, given its lower share of exports to GDP and well-capitalized and profitable banking system, we project that GDP growth will slow to 2½ percent in 2012, with large uncertainties around this forecast. Given the possibility of escalating financial and sovereign stress in the rest of Europe, risks to Poland are firmly on the downside. Poland’s Flexible Credit Line arrangement with the IMF provides insurance against these risks.
3. We welcome the ongoing substantial fiscal consolidation and the government’s ambitious plans for structural reforms. In 2011, the fiscal deficit is projected to fall to 5½ percent of GDP. For 2012, our preliminary assessment is that the additional fiscal measures in the draft budget will help reduce the deficit to 3¼ percent of GDP under the baseline outlook. This would constitute significant progress towards Poland’s medium-term objective (MTO) of a deficit of 1 percent of GDP, which is necessary to put debt firmly on a downward path. If growth was to deteriorate sharply, the government should consider allowing automatic stabilizers to operate, as further consolidation would dampen growth excessively. After 2012, additional permanent measures of about 1 percent of GDP will be required to achieve the MTO. We strongly support the government’s commitment to enact legislation in the first half of 2012 that will increase the statutory retirement age and reform the special pension schemes.
4. Given the expected slowdown in economic growth, monetary policy should be prepared to respond to signs of easing inflationary pressures. Over the past six months, with CPI inflation above the 2½ percent target but without evidence of second-round effects, and the economic outlook dimming, the central bank has appropriately kept the policy interest rate unchanged. We expect inflation to fall gradually, reflecting at first lower food and energy price inflation and then the output gap turning negative. We think inflation in 18-24 months time is now more likely to undershoot than overshoot the target. If inflationary pressures were to ease more quickly, possibly because growth was less than expected, then the policy rate should be cut.
5. We support the central bank’s recent interventions in the foreign exchange market, which were aimed at countering disorderly movements of the exchange rate but not at defending a particular level of the exchange rate. These interventions underline the importance of having foreign exchange reserves that are comfortable under all key metrics. While reserves exceed most measures of reserve adequacy, they are less than short-term external debt at remaining maturity plus the current account deficit.
6. The banking sector has continued to perform strongly, but—given the large external risks—it is important to further strengthen the sector’s resilience. The average capital adequacy ratio is 13½ percent, with Tier 1 capital representing 90 percent of total capital. Given the downside risks to the outlook and the associated risk to asset quality, we welcome the intention of the financial supervisor (KNF) to encourage banks with riskier profiles to retain profits, so as to build further capital buffers. Given banks’ large foreign liabilities and the associated risk of liquidity shortages, the authorities’ close monitoring of liquidity and the central bank’s readiness to provide liquidity support are appropriate. While the authorities already have a variety of tools to address problems that may emerge in banks, the work to broaden the range of available resolution instruments and allow the early involvement of the Bank Guarantee Fund should be brought to a speedy conclusion.
