ECONOMIC HEALTH CHECK
Strong Polish Economy Faces Risks, Needs to Remain Flexible
IMF Survey online
July 5, 2012
- Strong policies, protection under IMF's arrangement have contributed to strong performance
- But risks threaten outlook, some vulnerabilities remain, room for maneuver more limited
- Monetary policy, fiscal automatic stabilizers should support growth if needed
The Polish economy has, on average, performed better than peers throughout the crisis despite the challenging environment in Europe, the IMF said in its annual report on the state of the economy.
This reflected very strong fundamentals, sound policies, and confidence in the economy due in part to the Flexible Credit Line (FCL) arrangement with the IMF. The report added that―given the more limited room for maneuver on the fiscal front―monetary policy should be the first line of defense in providing support to the economy in the event the eurozone crisis intensifies.
The Polish economy grew by a solid 4¼ percent in 2011 despite a substantial decline in public spending. The banking system has remained profitable, well capitalized, and liquid. Credit expanded at a healthy pace, though banks are now tightening their conditions for lending. The IMF expects real GDP growth to moderate to 2½ percent in 2012, as both external and domestic demand are expected to weaken.
Increased international reserves and the precautionary FCL arrangement with the IMF have boosted market confidence and helped sustain access to external financing, the report said.
Risks and vulnerabilities
While Poland may be less affected than some other countries by the ongoing crisis in the eurozone, a deep recession or intensification of the crisis would have a severe impact on the economy.
“Trade and financial linkages with Europe are significant: nearly 60 percent of Poland’s exports are to core euro area countries and Poland is heavily integrated into the German manufacturing supply chain,” said Julie Kozack, IMF mission chief for Poland.
In 2010, the euro area accounted for over 75 percent of Poland’s foreign direct investment liabilities. The business sector relies heavily on lending from parent firms and about 60 percent of the banking system is owned by European banks.
The Polish economy is also vulnerable because of the large share of nonresident holdings of government bonds and significant external financing needs, estimated at about 30 percent of GDP in 2012, the report said. Such vulnerabilities could be harmful if investors become even more cautious than they are now.
The high share of foreign currency mortgages―about two-thirds of all mortgages are denominated in other currencies, the vast majority in Swiss franc―also continues to pose risks to balance sheets of banks and households.
Near-term policy challenges
“Poland’s economic prospects remain bright, but the outlook is clouded by uncertainty, mainly because of the ongoing crisis in the eurozone. Policymakers should remain flexible, and be ready to adjust policies if needed” said Kozack. The IMF’s report lists the following near-term policy priorities:
• On fiscal policy: fiscal tightening should continue in order to further reduce public debt over the medium term, which would rebuild fiscal buffers. To this end, it is important to protect priority spending, especially on much-needed infrastructure. In the event of a deeper downturn, there is some scope for countercyclical fiscal policies through the operation of automatic stabilizers, but this scope is more limited than in the past.
• On monetary policy: policy interest rates should not be raised—given the projected drop in inflation and lack of upward pressure on wages. Policymakers should consider reducing rates if the economy slows significantly and inflationary pressures weaken. In the event the crisis in the euro area worsens, the central bank should stand ready to provide emergency liquidity support. A more accommodating monetary policy would help support growth. But careful attention also needs to be paid to the exchange rate dynamics, and their implications for inflation and balance sheets.
• On financial policy: mortgage portfolios denominated in foreign currency and nonperforming loans continue to pose risks. The Polish supervisory authority has taken a number of steps to contain these risks, including stronger supervision of banks engaged in this type of lending and stricter regulations to reduce it. These efforts should continue, as banks are beginning to slow the issuance of these mortgages. A more proactive approach to dealing with nonperforming loans, including by stepping up voluntary out-of-court debt restructuring by banks, would help address those risks.
Boosting potential growth
Long-term economic prospects will depend on reforming the labor market, the business environment, and state-owned companies, the report said. The labor market can benefit from better targeting job-matching services to the needs of the local population. On the business climate, the government plans to make it easier to enter regulated professions and streamline decisions on construction permits and land use. Continuing the efforts to privatize state-owned companies would help promote an economy led by the private sector, the report said.