IMF Executive Board Concludes 2010 Article IV Consultation with the Republic of PolandPublic Information Notice (PIN) No. 10/55
May 10, 2010
On May 7, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Poland.1
Poland is the only EU economy to have escaped a recession in 2009. Similar to its regional peers, it experienced spill-overs from the crisis through real and financial channels, as an abrupt slowdown in capital inflows caused a credit crunch and a sharp decline in investment. However, consumption held up relatively well, and the trade balance began to contribute positively to growth from the onset of the crisis. This reflected Poland’s large domestic market and attendant modest reliance on exports; a flexible exchange rate policy; and, not least, significant fiscal stimulus and monetary easing, as policymakers took advantage of the room for maneuver afforded by Poland’s contained external and internal imbalances on the eve of the crisis.
The rapid contraction in the trade balance resulted in a decline in the current account deficit from 5 to about 1½ percent of gross domestic product (GDP) in 2009. Foreign direct investment has declined notably, although higher retained earnings have cushioned the fall. Portfolio inflows have performed particularly well, especially since the middle of last year, driven by renewed external appetite for zloty-denominated assets, especially government debt. As a result, after its initial sharp fall, the zloty has been recovering steadily.
Fiscal policy has provided significant counter-cyclical stimulus, with discretionary relaxation estimated at 1¾ percent of GDP in 2008 and 2½ percent of GDP in 2009, mainly due to tax cuts enacted in 2007 but coming into effect with a delay. While the government initially intended to offset revenue shortfalls to the extent needed to maintain the state budget deficit below the limit of zloty 18 billion in 2009—through what would have been highly pro-cyclical expenditure cuts—it appropriately altered such plans at mid-year. As a result, the general government deficit increased from under 2 percent of GDP in 2007 to over 7 percent of GDP in 2009.
The Monetary Policy Council continued to cut rates through the first half of 2009, to 3.5 percent. It maintained a loosening stance until October 2009, when it changed its informal bias to neutral, reflecting an improved outlook and renewed concern about inflation. Nevertheless, helped by subdued wage growth and commodity prices, and renewed appreciation of the zloty, inflation has recently fallen from around 4 percent in mid-2009 to well within the National Bank of Poland’s tolerance range of
1½- 3½ percent. Core inflation followed a similar path, declining to around 2 percent in recent months.
The banking system has withstood the crisis relatively well, while facilities for exceptional liquidity support have been phased out. Capital adequacy ratios have risen to over 13 percent at end-2009, from 11 percent a year ago. Moreover, profits remained robust in 2009, reaching about two thirds of the record-high level of the preceding year. While nonperforming loans rose from around 4 percent in 2008 to about 7½ percent in 2009 as economic activity declined, their growth appears to be slowing. Banks’ balance-sheet restructuring is coming to an end. They have recently started to ease lending policies for housing loans and short-term corporate credits and resumed foreign-currency lending, especially for Euro-denominated mortgages.
Executive Board Assessment
Executive Directors expressed their deepest sympathy to the people and authorities of the Republic of Poland for the death of their President, his wife and many senior country officials in the recent airplane crash.
Directors commended the authorities for their swift and timely response to the global crisis. Anchored in a strong macroeconomic framework and financial system, and buttressed by access to the Flexible Credit Line, this response enabled Poland to escape a recession in 2009.
Directors noted that economic growth is set to increase gradually as the global environment improves, banks’ risk appetite reemerges, and the inflow of EU funds accelerates. Given the still fragile recovery and surrounding uncertainties, the timing and manner of the withdrawal of fiscal and monetary stimuli will have to be carefully managed.
Directors considered that policy interest rates should not be raised at this stage, in view of the contained outlook for inflation and the excess capacity in the economy. If increased capital inflows put persistent upward pressure on the zloty and inflation remains subdued, interest rates could be further cut, possibly complemented by transparent foreign-exchange interventions. Directors welcomed the authorities’ commitment to euro adoption, while not setting a target date at this juncture. This will allow them to continue to take all the steps, including on the structural front, for successful euro adoption at an appropriate time, while preserving exchange rate flexibility in the face of external shocks.
Directors stressed the need to gradually start withdrawing the fiscal stimulus while carefully balancing short-term cyclical priorities and longer-term objectives. They welcomed the steps already taken by the authorities to reduce the deficit and called for further measures, including reform of entitlement programs and revenue enhancements, to meet the deficit target of 3 percent of GDP. A number of Directors endorsed the authorities’ intention to achieve this target by 2012, noting that although ambitious, this would be achievable. A number of other Directors, however, were of the view that a somewhat more gradual consolidation would be preferable so as not to stifle the incipient recovery. In order to help anchor confidence in fiscal policy, Directors recommended introducing a permanent fiscal rule with a deficit or debt anchor consistent with the authorities’ medium-term targets.
Directors considered that, although the financial sector has been well buffered, continued vigilance is necessary. They welcomed the Polish Financial Supervision Authority’s recent recommendations aimed at strengthening lending standards for household loans. Directors noted that the renewed appetite for foreign-exchange lending could pose risks. They encouraged the authorities to ensure that such lending is funded and hedged on a longer-term basis as well as to raise capital requirements on foreign-exchange-denominated mortgages to reflect higher credit and valuation risks. Directors also underscored the importance of cross-border cooperation in this area.
Directors stressed that despite Poland’s strong fundamentals, raising its exceptionally low labor participation rate remains critical to boosting long-term growth. They encouraged labor supply-enhancing reforms with complementary measures such as equalizing and gradually increasing the retirement age and merging special pension schemes with the general scheme. This, together with vigorous pursuit of the ambitious privatization agenda, would help to enhance the economy’s flexibility and bolster its long-run potential.