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Republic of Poland and the IMF
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The IMF Executive Board on March 16, 1998 concluded the 1997 Article IV consultation1 with Poland.
Poland has been able to combine strong economic growth—the fastest in Eastern and Central Europe over the past four years—with substantial declines in inflation. Close to two-thirds of all jobs in the economy are now in the private sector, illustrating that the country’s transition remains firmly on track. Economic activity was robust in 1997. Strong investment spending and the fastest real retail sales increases since the transition started combined to push real GDP growth to 6.9 percent for the year. Investment was driven by strong demand, growing credit availability, and, increasingly, by foreign direct investment, while rapid increases in real wages served to underpin consumer spending. In the face of this strong growth, the unemployment rate declined noticeably. Contrary to initial fears, the serious floods that damaged the country last summer apparently had relatively limited macroeconomic effects.
This strong domestic spending had a negative effect on the current account which, led by rapidly growing imports, deteriorated from a surplus of more than 3 percent of GDP in 1995 to a deficit of 3.2 percent of GDP in 1997. International competitiveness does not appear to have been a problem. An index of the real effective exchange rate (unit labor cost basis) shows little loss of competitiveness over the past year and a half, suggesting that strong domestic demand has been the dominant factor behind the current account’s deterioration.
Inflation declined steadily in 1997. The December-to-December increase in the CPI dropped from 19 percent in 1996 to about 13 percent in 1997. Underlying this trend were healthy productivity growth, which kept unit labor costs constrained, and continued downward price pressure from imports. CPI inflation increased somewhat in January and February 1998, although PPI inflation declined.
Broad money and credit to nongovernment both registered vigorous growth in 1997. The monetary authorities tightened policy several times during 1997, both by raising reserve requirements and by increasing headline interest rates. Partly in response, the pace of expansion of money and credit showed signs of slowing down late in the year. For example, rates of increase of credit to the nongovernment sector (seasonally adjusted) fell to about 2 percent per month or less starting in October from close to 3 percent on average in the first nine months of the year. The zloty, managed via a currency basket arrangement with a ± 7 percent band with a central rate that depreciated by 1 percent a month throughout 1997, traded on the weak side of parity during the period of global financial market gyrations during the second half of the year, but appreciated sharply from January through March 1998. In late February 1998 the band was widened to ± 10 percent and the rate of crawl was reduced to 0.8 percent per month.
Assisted by a macroeconomy that exceeded official growth projections, the budget deficit of the general government was 1.8 percent of GDP in 1997—substantially below the initial target of about 3 percent of GDP, and an improved fiscal position from 1996. Contributing to the lower deficit were privatization revenues, value-added tax (VAT) revenues, and central bank transfers that were higher than expected, and cyclically sensitive expenditures—such as unemployment benefit payments—that were significantly below budget. Privatization revenues amounted to about 1½ percent of GDP. Spending on the flood emergency was largely offset by cutbacks elsewhere in the budget. Public debt declined as a percentage of GDP in 1997 for the fourth year in a row.
Favorable conditions are expected to continue in 1998, although the pace of domestic demand is expected to moderate somewhat. Slowing credit expansion is expected to cause some easing in the pace of investment spending, and more modest real wage increases will dampen consumption. Notwithstanding a slowdown in the growth of imports, the current account is expected to worsen, though at a much slower pace than in the last two years.
Executive Board Assessment
Executive Directors commended Poland for its continued record of impressive economic performance, as reflected in the achievement of sustained strong economic growth with attendant gains in living standards, combined with substantial declines in inflation. Directors also recognized the authorities’ achievements in advancing structural reforms. Directors saw Poland as a leader among transition economies. Despite this strong record, however, they were concerned that the current account position had deteriorated sharply over the previous two years, and that inflation remained high, especially when compared with Poland’s main trading partners. Directors remarked that real domestic demand had been increasing at unsustainablerates over the previous two years. As this was the primary factor behind the deterioration of the current account, Directors cautioned that such rapid growth should be stemmed to prevent a further worsening of the current account and to help achieve the disinflation objectives.
Several speakers pointed out that recent developments in Asia and other parts of Central Europe had demonstrated the importance of limiting external vulnerability and the associated disruptions. While recognizing the significant reliance in Poland on nondebt-creating inflows to finance the external deficit and the comfortable reserve position, Directors nonetheless underscored the need for addressing the weakening external position with an appropriate strengthening of macroeconomic policies. Directors also highlighted the importance of such policies for achieving a further reduction in the still high inflation rate and inflationary expectations in the economy. Directors therefore agreed that the main challenges for economic policies in 1998 are to stabilize the current account and maintain the momentum of disinflation. To this end, they saw the need to accelerate fiscal consolidation, accompanied by strong wage restraint, as well as to strengthen the pace of privatization and social security and health care reforms.
Directors welcomed the actions taken by the authorities to tighten monetary policy throughout 1997, and to keep the 1997 budget deficit below the initially targeted level, as steps in the right direction. In their judgment, however, additional action was now necessary. As monetary policy was already tight, the main burden should be borne by fiscal policy. Many speakers indicated that an appropriate target would be to balance the budgetary accounts of the general government in 1999 without increased reliance on privatization revenues. As a first step, they argued that, through firm implementation of the budget, the deficit in 1998 should be kept below the formal target, as had been done in recent years, with a focus on expenditure reduction. A few Directors did not see a clear case for stronger fiscal consolidation, and attached greater importance to other policies, such as reducing private expenditure through stronger wage restraint, in the effort to reduce inflation.
Directors agreed that monetary policy would have to be conducted carefully in 1998. Directors commented that maintaining the existing tight monetary stance was appropriate until the slower pace of credit expansion was confirmed, and the stance of fiscal policy gave confidence that policies were in place to control the pace of domestic demand growth. With real interest rates expected to decline gradually later in 1998 and in 1999, the rate of increase in money demand should slow significantly. Some speakers commented that the growth of the monetary aggregates would thus need to be monitored closely to prevent an inflationary policy bias.
Directors noted that the progressive reduction in the rate of crawl of the zloty had been a driving force behind the disinflation process in Poland in the last several years. They agreed that with the rate of crawl unchanged for 24 months, it had gone from imposing a ceiling on inflation to a floor. Most Directors welcomed the recent decision of the National Bank of Poland to lower the rate of crawl of the zloty, and a few speakers saw a need for further steps in this direction. Most Directors very much welcomed the widening of the band around the zloty’s central rate, as the greater flexibility of the rate would help discourage short-term capital flows and assist in the disinflation effort. Some speakers saw this as a step toward a more flexible exchange rate policy.
Directors welcomed the strengthening of the independence of the central bank, notably the primacy given to price stability as a goal of policy, and the prohibition on direct financing to the government by the central bank after October 1998. Some Directors expressed concern at the lack of staggered terms for Council members, which might undermine confidence in the continuity of policy. They suggested that this provision be revisited at an early stage.
Some Directors felt that the rapid expansion of credit during the past two years highlighted the need to strengthen bank supervision. They expressed concern about the rising bad loan ratios on installment loans, and recommended an early tightening of prudential rules.
Directors expressed concern that continued excessive wage growth could slow the momentum of disinflation, fuel demand for consumer goods, and contribute to a further worsening of the external sector. Directors urged the authorities to limit wage increases in state enterprises to the specified norm. In their view, wage increases that had consistently exceeded in recent years the limits recommended by the Tripartite Commission represented a missed opportunity to lower inflation more rapidly. Restraining the growth of real wages in the budgetary sphere to the 2 percent specified in the budget would help by providing an important demonstration effect to the private sector.
While noting the significant progress made on structural reform, Directors emphasized the importance of further efforts, both to enhance growth prospects and to achieve fiscal viability. The authorities were encouraged to accelerate the privatization process, including in the banking sector, to help improve efficiency. Many speakers stressed that, in addition to ensuring that wage increases in more sectors of the economy were in line with productivity growth, accelerating privatization would help improve corporate governance and foster the restructuring of the economy. While some Directors noted that strategic investors could play a significant role in the privatization of several sectors, they noted that this policy may not be appropriate in all areas.
Directors encouraged the authorities to press forward with pension reform, which should also help increase domestic savings, and with reform of the health care system.
Directors expressed concern about the use of payment arrears for the payment of taxes, and recommended that the use of arrears in fulfillment of tax obligations be terminated.
|Poland: Main Economic Indicators|
|Real economy (change in percent)|
|Unemployment rate (in percent)||16.4||16.0||14.9||13.6||10.5|
|Gross national saving (percent of GDP)||15.5||18.2||21.3||19.4||19.7|
|Gross domestic investment (percent of GDP)||15.6||15.9||18.0||20.4||22.9|
|Public finance (in percent of GDP)|
|General government balance||-2.9||-2.5||-2.3||-2.5||-1.8|
|Money and credit (end of period, percent change)|
|Net domestic assets1||21.7||22.5||5.3||19.8||11.7|
|Money and quasi-money||36.0||33.8||39.4||29.2||30.7|
|Lending rate (annual average in percent)||43.2||38.9||32.3||25.6||25.5|
|Balance of payments in convertible currencies|
|Trade balance (in percent of GDP)||-2.7||-0.9||-1.5||-6.1||-8.3|
|Current account (in percent of GDP)|
|Including unrecorded trade||-0.1||2.3||3.3||-1.0||-3.2|
|Gross official reserves (in billions of U.S. dollars)||4.3||6.0||15.0||18.0||20.7|
|Reserve cover (months of imports of GNFS)||3.0||3.6||6.5||6.0||5.9|
|External debt (end of period)2|
|(In billions of U.S. dollars)||48.4||42.2||44.0||40.6||38.1|
|External debt service ratio3|
|Fund position (in millions of SDRs)|
|Holdings of zloty (end-December 1997)||911.4|
|Holdings of SDRs (end-December 1997)||4.0|
|Exchange rate regime||Crawling band4|
|Present rate||Zl 3.46 per US$1 (Wednesday March 18)|
|Depreciation (-) against U.S. dollar (period average, in percent)||-24.9||-20.2||-6.3||-10.1||-17.8|
|Depreciation (-) of real effective exchange rate (relative CPIs, in percent)||7.6||0.9||8.0||8.8||2.4|
Sources: Central Statistical Office, Rocznik Statystyczny; data
provided by the authorities; and staff estimates.
1 In relation to broad money at end of the previous year.
2Including arrears and the Fund.
3In percent of exports of goods and nonfactor services in convertible currencies, including the Fund.
4Since May 16, 1995, the zloty has been allowed to float within a ± 7 percent band around the central rate, which depreciates at a fixed monthly rate (1.0 percent since January 8, 1996) against a basket of currencies.
1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
IMF EXTERNAL RELATIONS DEPARTMENT