## tarea2024049 ## Source details **Canonical URL:** [tarea2024049](https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024049.pdf) ## Other formats - [Markdown version](/-/media/files/publications/tar/2024/english/tarea2024049.pdf.md) - [Structured JSON version](/-/media/files/publications/tar/2024/english/tarea2024049.pdf.json) --- ### Mission and Scope - A Fiscal Affairs Department (FAD) mission conducted virtual discussions from November 10, 2023, to May 31, 2024, in response to a request from the Minister of Finance. - Mission objectives: - (i) review the current stabilizing expenditure rule (SER); - (ii) strengthen provisions of the escape clause and correction mechanism in the fiscal rule; - (iii) align the SER to the EU fiscal framework. - Mission leadership and team: led by W. Raphael Lam; team members: Hassan Adan, Fazeer Sheik Rahim, Tjeerd Tim (all FAD), Kareem Ismail, and Gösta Ljungman (both EUR). - Principal contacts and contributors included officials and experts from the Ministry of Finance (MoF), Warsaw School of Economics, Budget Department at MoF, and internal IMF support staff. ### Executive Summary — Key Findings on the SER - Role and history - The SER has been a core component of Poland’s fiscal framework since its implementation in 2015 and helped reduce government debt prior to the pandemic by instilling budgetary discipline and coalescing political debate. - Strengths - Facilitated steady expenditures during recessions. - Enhanced debt sustainability. - Provides flexibility via provisions governing escape from the rule during severe shocks and subsequent return to the expenditure rule. - Weaknesses and implementation challenges - The SER is largely backward-looking and does not fully account for slower medium-term growth prospects. - Below-the-line financing (for example, transfer of government securities to public entities outside of the SER) has contributed to a rise in general government debt and may circumvent the SER. - The SER sets limits only for the next fiscal year; the lack of multi-year binding limits for budgetary entities hinders linkage to the medium-term fiscal framework (MTFF). - Pandemic, war in Ukraine, energy price spikes, ad-hoc amendments, expenditure exemptions, and transfers (for example to Bank Gospodarstwa Krajowego (BGK)) have complicated return to SER limits and may have undermined rule credibility. ### Recommended Design and Institutional Reforms - Preserve and strengthen the SER as the fiscal anchor; key recommended reforms include: - Revise SER formula to include correction of forecast errors on real growth and incorporate 2-3 years ahead growth forecasts in the medium term to determine limits. - Broaden coverage of the SER, including extending the legally-binding part of the SER. - Transition over the medium term to multi-year expenditure limits (binding medium-term expenditure limits) to better anchor debt sustainability and improve fiscal planning. - Improve forecasting capacity at MoF and publish in-depth ex-ante and ex-post assessments of compliance with the SER. - Establish an independent fiscal council (as planned) with a mandate to assess MoF macro-fiscal forecasts and monitor SER implementation, escape clause activation/extension/return, and costing of extraordinary support. ### Escape Clause: Flexibility and Refinements - Historical use - The escape clause was revised in 2020 to include epidemics and was appropriately activated during the pandemic. - Recommended refinements - Amend the provision (Article 112d in Public Finance Act) to include severe economic slowdown as a standalone trigger to activate the escape clause. - Revise the return clause such that the size and duration of adjustments consider both economic conditions and debt sustainability risks. - Mandate the fiscal council to monitor activation, extension, and return under the escape clause and to cost extraordinary measures and their implications for debt sustainability. - Track extraordinary support provided under the escape clause to set an appropriate expenditure base when returning to the SER limit. - Operational design options - Include “severe growth slowdown” as a standalone trigger with suggested threshold guidance: at 2−3 percentage points below the current moving average of historic growth and growth forecast and when growth is expected to be in the negative territory. - Limit suspension to the current fiscal year with option to extend for another fiscal year if criteria continue to be met and fiscal council endorses extension. - Use a notional-account or tracking approach (examples: Sweden, Switzerland) to record extraordinary spending for return calculations. ### Correction Mechanism: Simplification and Alignment with EU Framework - Recent changes - Correction mechanism simplified starting budget year 2024: Minimum annual fiscal adjustment of 0.5 percent of GDP when deficit exceeds or is projected to exceed 3 percent of GDP or general government debt (EU definition) exceeds 60 percent of GDP, provided the economy is not in recession. - During 2015-2023 the correction mechanism included a mandatory correction of 2 percentage points in SER expenditure per year when deficits exceeded 3 percent of GDP and progressive “debt brakes”. - Further refinements recommended - Revise the criterion in the correction mechanism from “economic conditions” to “the activation of escape clause” when determining whether fiscal adjustments should be undertaken. - Set the pace of fiscal adjustments such that implied expenditure from the SER is consistent with the EU-agreed net expenditure path. - Include a provision that specifies corrective action when expenditure outturn exceeds the SER limit and publish detailed explanations if expenditures exceed the SER limit. - Use parameter K transparently to reconcile SER limits with the EU fiscal framework and to implement minimum fiscal adjustments (for example a minimum fiscal adjustment of 0.5 percentage points of GDP via K). ### Aligning the SER with the EU Economic Governance Framework - Context - The new EU framework requires a binding multi-year net primary expenditure path and differentiates requirements by member state debt sustainability risks. - Key reconciliation challenges - Coverage and accounting differences: SER includes interest payments, cyclical unemployment benefits, and co-financing of EU projects; EU net expenditure uses ESA 2010 definitions and excludes those items. - Basis and timing: SER is on a cash basis with annual updates; EU net expenditure is set at the start of a four-year period and may not be updated later. - Simulation-based conclusions - With an appropriate correction mechanism, expenditure implied under the SER can be similar to the EU net expenditure path, but practical alignment requires addressing coverage and classification gaps and mapping timing differences through parameter K or other reconciliation measures. ### Simulations of the SER — Methods and Key Results - Analyses conducted - Counterfactual exercise applying the current SER from 2015 (escape clause activated in 2020; return to SER limit in 2022), assuming other macro variables equal actual outturns. - Model-based simulations using the MOF-EM model to evaluate responses to adverse shocks (growth slowdown, surge in interest rates, inflation surprises, rise in expenditures outside SER limits). - Counterfactual key findings - Under full compliance from 2015, government expenditures would have stabilized around 40 percent of GDP and placed debt on a steady downward trajectory during 2015-19. - Under compliance with the return clause, counterfactual government expenditure would have been 42 percent of GDP in 2021 versus actual around 44 percent of GDP; subsequently counterfactual points to a reduction to 40 percent of GDP. - Estimated covariance of primary expenditure to output gap in the counterfactual is comparable to other EU countries and lower than the covariance using Poland’s actual fiscal outturns. - MOF-EM model results and sensitivities - Growth shock assumptions: temporary adverse growth shock of 2.5 percentage points below baseline for four quarters in the mild scenario; 3 percentage points below baseline for the severe recession. - Debt outlook is sensitive to a permanent change in long-term interest rates but less so to exchange rate volatility. - Inflation surprises raise expenditures indexed to inflation (e.g., pension benefits), crowding out public investment under same aggregate SER limits. - Unexpected rises in expenditures outside legally-binding SER limits lead to higher debt even if legally-binding limits are complied with. - Modeling caveats - Counterfactual abstracts from impacts of compliance on other macro variables; assumes expenditures outside SER coverage follow identical dynamics. ### Implementation of the SER — Performance, Shocks, and Operational Weaknesses - Pre-pandemic performance - SER anchored fiscal policy leading up to the pandemic; government expenditure declined as a share of GDP and debt fell from 51.4 percent of GDP at end-2014 to 45.7 percent of GDP by end-2019. - SER expenditure accounts for 90 percent of general government expenditure and legally-binding limits account for about 70 percent of general government expenditure (national definition). - COVID-19 and escape clause application - Escape clause activated appropriately for the pandemic. - Government fiscal support in 2020 amounted to PLN 105.2 billion (Ministry of Finance). - Following return mechanism, most pandemic-related measures were unwound in 2021, improving the cyclically-adjusted primary balance by 5 percent of GDP. - Government expenditure reached 44 percent of GDP in 2021, about 2.2 percentage points higher than in 2019, implying further adjustments were needed in 2022 and after (requiring 2.6 percent of GDP lower expenditures). - 2022-23 shocks and ad-hoc measures - War in Ukraine and energy price spikes required extraordinary measures, including support for 1.3 million refugees from Ukraine. - Government used ad-hoc amendments to exclude certain expenditures and adopt a higher inflation component in the SER formula; additional investment clauses exempted some capital expenditures. - Governance and institutional gaps - No independent fiscal council currently provides detailed retrospective/prospective analysis or assesses realism of macro-fiscal forecasts used in the SER formula. - Multi-year expenditure guidance is not provided to budgetary entities subject to the SER. - Off-budget activities and below-the-line financing have widened the divergence between national and EU debt definitions (national debt in 2022: 39.3 percent of GDP; general government debt 49.2 percent of GDP; divergence 9.9 percentage points as of end-2022). ### Transitioning to Multi-year Rules and Periodic Review - Rationale and international practice - Several European countries operate binding aggregate multi-year expenditure limits (Denmark, Finland, Netherlands, Sweden); multi-year limits help strategic fiscal planning and fiscal prudence. - Options for Poland - (i) Continue current annual SER with application of SER formula in t+2 to t+4 for information only. - (ii) Binding SER limit for t+1 and indicative limits for t+2 to t+3 with explicit reconciliation when updates occur. - (iii) Binding limits for all years in the expenditure horizon (second to fourth year), with updates to offset accounting/classification changes, escape clause activation, or shifts between covered/non-covered sectors. - Transition design points - Set fixed expenditure limits 3-4 years in advance only if sufficient fiscal room (margin) is left uncommitted. - Maintain a margin between SER limit and budget expenditure—possibly rising over time—to manage uncertainties. - Periodic comprehensive reviews recommended every 5-6 years to recalibrate parameters to evolving macroeconomic conditions. ### Communication Strategy - Recommended elements - Use simple, clear messages to educate public on fiscal responsibility and SER revisions. - Inclusive dialogue and consultation with major stakeholders. - Begin early, disseminate through multiple channels, and present revisions and accompanying reforms (correction mechanism, escape clause, periodic review, fiscal council) as part of coherent framework. - Expected outcomes - Strengthen national ownership of fiscal rules. - Increase credibility and public trust. ### Key Numerical Findings and Timings (preserve source figures) - Fiscal deficit: 5 percent of GDP in 2023; around 3 percent of GDP in 2028. - SER expenditure accounts for 90 percent of general government expenditure; legally-binding limits account for about 70 percent. - National debt in 2022 (national definition): 39.3 percent of GDP; general government debt (EU definition): 49.2 percent of GDP. - Threshold for DRM inclusion: 0.03 percent of GDP. - SER calculation uses an 8-year geometric average of real GDP growth (6 past years, current year, year ahead). - Correction mechanism minimum fiscal adjustment since 2024: 0.5 percent of GDP. - Mandatory correction during 2015-2023 when deficits exceeded 3 percent: 2 percentage points in SER expenditure per year. - Return-to-SER after escape clause: 2-4 years, depending on economic recovery pace. - Government fiscal support in 2020: PLN 105.2 billion. - Additional fiscal adjustments indicated: - To return from 2021 expenditure level to SER limits required 2.6 percent of GDP lower expenditures. - For Budget 2024 calibration, SER expenditure base for 2023 set 1.2 percent of GDP lower to calculate 2024 SER limits. - Simulations and EU alignment: - Simulations suggest the EU fiscal framework would require potential adjustments of the structural primary balance of 0.5-0.6 percent of GDP per year. - Four-year adjustment (2025-28): improve structural primary balance by about 0.6 percent of GDP until 2028. - Seven-year adjustment (2025-31): minimum SPB by 2031 in simulation: -0.6 percent of GDP. - Projected nominal expenditure growth under forward-looking SER starting 2027: about 6 percent each year. - Average adjustment in structural primary balance under current SER (without correction): 0.2-0.3 percent of GDP versus 0.5 percent of GDP under EU framework. - Debt hitting 60 percent of GDP in current SER scenario: 2033 (as simulated). - Probability debt stays at or below 60 percent of GDP under stochastic shocks during adjustment: over 70 percent (given MOF forecast assumptions and adjustments). ### Consolidated Recommendations (selected items and timing) - Preserve the credibility of the SER by restricting ad-hoc amendments to the SER. (ST) — Implementing entity: MoF. - Revise the SER formula to include correction of forecast errors on real growth to better align with the EU framework. (ST) — Implementing entity: Macroeconomic Policy Dept., MoF. - Include forward-looking indicators on real growth in the SER formula and strengthen forecasting capacity at MoF. (MT) — Implementing entity: Macroeconomic Policy Dept., MoF. - Over the medium term, transition the SER to include multi-year limits on government expenditures. (MT) — Implementing entity: MoF. - Publish in-depth assessments of ex-ante and ex-post compliance of the SER after establishment of the fiscal council. (MT) — Implementing entity: MoF; Fiscal Council. - Establish an independent fiscal council as planned to assess compliance of the SER. (ST) — Implementing entities: MoF; Government. - Amend Article 112d in Public Finance Act to include severe economic slowdown as a standalone trigger for the escape clause and revise return clause to account for economic conditions and debt sustainability. (ST) — Implementing entities: MoF; Government. - Revise the correction mechanism criterion to tie adjustments to activation of the escape clause and publish detailed explanations if expenditures exceed the SER limit. (ST/MT) — Implementing entity: MoF. - Align SER limits with the EU net expenditure path and reconcile accounting differences. (ST) — Implementing entity: Macroeconomic Policy Dept., MoF. - Prepare a communication strategy to explain SER revisions and garner public support and trust. (ST) — Implementing entity: Macroeconomic Policy Dept., MoF. *IMF Technical Assistance Report — Preface and Executive Summary (tarea2024049)* ### Preface _________________________________________________________________________ 6 ### tarea2024049 - Preface _________________________________________________________________________ 6 ### Mission and Scope - A Fiscal Affairs Department (FAD) mission conducted virtual discussions from November 10, 2023, to May 31, 2024, in response to a request from the Minister of Finance. - The mission objectives were to: (i) review the current stabilizing expenditure rule (SER); (ii) strengthen provisions of the escape clause and correction mechanism in the fiscal rule; and (iii) align the SER to the EU fiscal framework. - Mission leadership and team: led by W. Raphael Lam; team members: Hassan Adan, Fazeer Sheik Rahim, Tjeerd Tim (all FAD), Kareem Ismail, and Gösta Ljungman (both EUR). - Principal contacts and contributors included officials and experts from the Ministry of Finance (MoF), Warsaw School of Economics, Budget Department at MoF, and internal IMF support staff. ### Executive Summary — Key Findings on the SER - The SER has been a core component of Poland’s fiscal framework since its implementation in 2015 and helped reduce government debt prior to the pandemic by instilling budgetary discipline and coalescing political debate. - Strengths of the SER: - Facilitated steady expenditures during recessions. - Enhanced debt sustainability. - Provides flexibility via provisions governing escape from the rule during severe shocks and subsequent return to the expenditure rule. - Weaknesses and implementation challenges: - The SER is largely backward-looking and does not fully account for slower medium-term growth prospects. - Below-the-line financing (for example, transfer of government securities to public entities outside of the SER) has contributed to a rise in general government debt and may circumvent the SER. - The SER sets limits only for the next fiscal year; the lack of multi-year binding limits for budgetary entities hinders linkage to the medium-term fiscal framework (MTFF). - Pandemic, war in Ukraine, energy price spikes, ad-hoc amendments, expenditure exemptions, and transfers (for example to Bank Gospodarstwa Krajowego (BGK)) have complicated return to SER limits and may have undermined rule credibility. ### Recommended Design and Institutional Reforms - Preserve and strengthen the SER as the fiscal anchor; key recommended reforms include: - Revise SER formula to include correction of forecast errors on real growth and incorporate 2-3 years ahead growth forecasts in the medium term to determine limits. - Broaden coverage of the SER, including extending the legally-binding part of the SER. - Transition over the medium term to multi-year expenditure limits (binding medium-term expenditure limits) to better anchor debt sustainability and improve fiscal planning. - Improve forecasting capacity at MoF and publish in-depth ex-ante and ex-post assessments of compliance with the SER. - Establish an independent fiscal council (as planned) with a mandate to assess MoF macro-fiscal forecasts and monitor SER implementation, escape clause activation/extension/return, and costing of extraordinary support. ### Escape Clause: Flexibility and Refinements - Historical use: - The escape clause was revised in 2020 to include epidemics and was appropriately activated during the pandemic. - Recommended refinements: - Amend the provision (Article 112d in Public Finance Act) to include severe economic slowdown as a standalone trigger to activate the escape clause. - Revise the return clause such that the size and duration of adjustments consider both economic conditions and debt sustainability risks. - Mandate the fiscal council to monitor activation, extension, and return under the escape clause and to cost extraordinary measures and their implications for debt sustainability. - Track extraordinary support provided under the escape clause to set an appropriate expenditure base when returning to the SER limit. ### Correction Mechanism: Simplification and Alignment with EU Framework - Recent simplification sets a minimum of annual fiscal adjustment when deficits or government debt exceed prespecified limits; this is a step in the right direction. - Further refinements recommended: - Revise the criterion in the correction mechanism from “economic conditions” to “the activation of escape clause” when determining whether fiscal adjustments should be undertaken. - Set the pace of fiscal adjustments such that implied expenditure from the SER is consistent with the EU-agreed net expenditure path. - Include a provision that specifies corrective action when expenditure outturn exceeds the SER limit and publish detailed explanations if expenditures exceed the SER limit. ### Aligning the SER with the EU Economic Governance Framework - Context: - The new EU framework requires a binding multi-year net primary expenditure path and differentiates requirements by member state debt sustainability risks. - Challenges and recommendations: - Reconcile differences in accounting treatments, sectoral coverage, and expenditure classification between Poland’s SER and the EU net expenditure path. - Recognize that the EU net expenditure path is set at the start of a four-year period and may not fully account for later macro-fiscal forecast updates; refinements to the correction mechanism and regular reconciliation are therefore necessary. - Simulations indicate that with an appropriate correction mechanism, expenditure implied under the SER can be similar to the EU net expenditure path, but practical alignment requires addressing coverage and classification gaps. ### Governance, Timing, and Periodic Review - Conduct a periodic comprehensive review of the SER every 5-6 years to recalibrate parameters to evolving macroeconomic conditions (for example, potential growth, demography, and tax revenue collections) and to avoid ad-hoc amendments or exemptions. - Transitioning to multi-year rules and building political and technical consensus: - Over the medium term (to be initiated and gradually implemented over the next 2-3 years), transition the SER to include multi-year limits on government expenditures. - Short-term (ST) actions are expected to be completed by mid-2025; medium-term (MT) actions are to be initiated and gradually implemented over the next 2-3 years and reflected in the next periodic review. ### Table of Key Recommendations — Selected Items (Summary) - Preserve the credibility of the SER by restricting ad-hoc amendments to the SER. (ST) — Implementing entity: MoF. - Revise the SER formula to include correction of forecast errors on real growth to better align with the EU framework. (ST) — Implementing entity: Macroeconomic Policy Dept., MoF. - Include forward-looking indicators on real growth in the SER formula and strengthen forecasting capacity at MoF. (MT) — Implementing entity: Macroeconomic Policy Dept., MoF. - Over the medium term, transition the SER to include multi-year limits on government expenditures. (MT) — Implementing entity: MoF. - Publish in-depth assessments of ex-ante and ex-post compliance of the SER after establishment of the fiscal council. (MT) — Implementing entity: MoF; Fiscal Council. - Establish an independent fiscal council as planned to assess compliance of the SER. (ST) — Implementing entities: MoF; Government. - Amend Article 112d in Public Finance Act to include severe economic slowdown as a standalone trigger for the escape clause and revise return clause to account for economic conditions and debt sustainability. (ST) — Implementing entities: MoF; Government. - Revise the correction mechanism criterion to tie adjustments to activation of the escape clause and publish detailed explanations if expenditures exceed the SER limit. (ST/MT) — Implementing entity: MoF. - Align SER limits with the EU net expenditure path and reconcile accounting differences. (ST) — Implementing entity: Macroeconomic Policy Dept., MoF. - Prepare a communication strategy to explain SER revisions and garner public support and trust. (ST) — Implementing entity: Macroeconomic Policy Dept., MoF. *IMF Technical Assistance Report — Preface and Executive Summary (tarea2024049)* ### 5. This report aims to support the authorities with reviewing the SER. It will i) assess the ### tarea2024049 - 5. This report aims to support the authorities with reviewing the SER. It will i) assess the ### Purpose and scope of the report - Assess the design and fiscal performance under the SER since its implementation in 2015 to identify strengths and potential shortcomings. - Propose options to strengthen the SER. - Highlight areas to align the national SER with the EGF. ### Context and key fiscal parameters - The SER became first binding during the 2015 budget process, the first year Poland met the deficit limit of 3 percent of GDP under the Stability and Growth Pact. - The SER complemented a constitutional debt limit of 60 percent of GDP. - National debt definition: central government + local government + Social Security Fund (national debt was 39.3 percent of GDP in 2022 compared to a general government debt of 49.2 percent of GDP). - SER expenditure accounts for 90 percent of general government expenditure and the legal-binding limits account for about 70 percent of general government expenditure (based on Poland’s definition in the Public Finance Act). - Discretionary Revenue Measures (DRMs) are included in the SER adjustment if expected to exceed 0.03 percent of GDP for the fiscal year after implementation. ### Design and mechanics of the SER - The SER in the Public Finance Act sets an upper limit for public expenditure for the next year based on a formula combining: - an 8-year geometric average of real GDP growth (6 years in the past, the current year and the year ahead), - expected headline CPI inflation (budget forecast by MOF with forecast error correction), - parameter K (exogenous adjustor related to the correction mechanism), - ΔDRM (change in discretionary revenue measures). - Time notation: year t refers to the next budget year (example: budget for 2025 (t) is set in 2024 (t-1); outturn for 2023 is fully available). - Since the 2023 budget, the SER includes backward corrections for inflation forecast errors (previously set as the inflation target of the National Bank of Poland). - Coverage: SER covers the central government, Social Insurance Fund and Bridging Pension Fund, local government units in the budget, and several funds such as the National Health Fund and Bank Guarantee Fund. Some funds (largest among them the EU Fund) are excluded from SER coverage. ### Escape clause and correction mechanism - Escape clause (Article 112d Public Finance Act) revised in 2020 to include: - national epidemic as a trigger; - an activation criterion based on economic conditions; - a mechanism to return to the expenditure limit after deactivation. - Return-to-SER timing: ranges from 2-4 years, depending on the pace of economic recovery. - Government discretion on size of additional spending upon activation (subject to parliament approval). - Correction mechanism simplified starting budget year 2024: - Minimum annual fiscal adjustment of 0.5 percent of GDP when deficit exceeds or is projected to exceed 3 percent of GDP or general government debt (EU definition) exceeds 60 percent of GDP, provided the economy is not in recession. - During 2015-2023 the correction mechanism included: a mandatory correction of 2 percentage points in SER expenditure per year when deficits exceeded 3 percent of GDP; progressive “debt brakes” (initially 50 and 55 percent of GDP, later revised to 43 and 48 percent of GDP); corrective actions when cumulative deviation from EU MTOs exceeded 6 percent of GDP. ### Criteria used by the report to assess the SER - Stabilizing expenditures amid cyclical shocks. - Safeguarding debt sustainability. - Allowing flexibility for exceptional events while preserving credibility. - Broad coverage of public finances balanced with administrative practicalities. - Supporting multi-annual fiscal planning and integration with the medium-term fiscal framework (MTFF) and budget process. ### Strengths of the current SER (design features) - Countercyclicality: formula-based SER uses moving average of real growth adjusted by expected inflation; significant DRMs affect expenditure limits. - Avoiding expenditure drift: limit based on trend growth and expected headline inflation can stabilize public expenditure share of GDP. - Debt sustainability support: correction mechanism anchored on debt and deficit levels consistent with EU Stability and Growth Pact. - Flexibility: escape clause allows fiscal support in severe shocks; defense clause introduced in 2023 to smooth delivery vs payment of defense spending (temporarily raises expenditure limits to be offset over time). - Enforcement and monitoring: government reporting obligations (Article 182 Public Finance Act); NIK audits ex-post compliance with expenditure limits. ### Weaknesses and risks identified - Calibration and backward-looking bias: - SER formula is largely backward looking and presumes stable long-term trend growth; challenge if trend growth is slowing. - Indexation to headline inflation could raise SER limits in high headline inflation environments and hinder disinflation by the NBP. - No systemic framework to account for growth forecast errors and potential forecast bias (partial ex-post inflation correction exists since 2022). - Reliance on the formula without a medium-term fiscal anchor may put public finances on a “wrong” path if revenue growth lags nominal GDP growth. - Annual focus and limited multi-year support: - SER is binding only for the year-ahead budget; outer year limits (second and third years) are indicative and subject to revision, limiting medium-term budgeting support. - Escape clause and correction mechanism gaps: - Current escape clause cannot be triggered solely by a major economic slowdown (e.g., global financial crisis). - Correction mechanism does not fully address noncompliance when actual expenditures exceed SER limits. - Coverage discrepancies and off-budget risks: - Legally-binding SER limit covers about 70 percent of total government expenditure after netting autonomous entities; sectoral coverage differs from EU general government scope. - Off-budget activity could contribute to debt risks even if SER limits complied with, via: - transfer of government securities for policy purposes to public entities not covered under SER (below-the-line financing, e.g., transfer to the BGK at zero cost or below market pricing), - direct borrowing by government entities. - DRM coverage can include revenue measures of entities outside SER coverage, creating consistency issues. - Differences between national and EU definitions of government debt can widen (figures noted showing divergence in national vs EU definitions and sovereign spreads). ### Operational and institutional weaknesses - No independent fiscal entity currently provides detailed retrospective/prospective analysis or assesses realism of macro-fiscal forecasts used in the SER formula. - Multi-year expenditure guidance is not provided to budgetary entities subject to the SER. ### Empirical observations referenced - SER first introduced in budget year 2015. - SER expenditure accounts for 90 percent of general government expenditure; legally-binding limits account for about 70 percent. - Threshold for DRM inclusion: 0.03 percent of GDP. - SER calculation uses an 8-year geometric average of real GDP growth (6 past years, current year, year ahead). - Correction mechanism minimum fiscal adjustment since 2024: 0.5 percent of GDP. - Mandatory correction during 2015-2023 when deficits exceeded 3 percent: 2 percentage points in SER expenditure per year. - Return-to-SER after escape clause: 2-4 years, depending on economic recovery pace. - National debt in 2022 (national definition): 39.3 percent of GDP; general government debt (EU definition): 49.2 percent of GDP. *IMF Technical Assistance Report | Section II: Assessment of the Current SER* ### Section III). ### tarea2024049 - Section III) ### C. Simulations of the SER - Purpose and methods - Two analyses assess SER performance on counter‑cyclicality, debt dynamics, and flexibility: - Counterfactual exercise applying the current SER from 2015 (escape clause activated in 2020; return to SER limit in 2022), assuming other macro variables equal actual outturns. - Model-based simulations using the MOF-EM model to evaluate responses to adverse shocks (growth slowdown, surge in interest rates, inflation surprises, rise in expenditures outside SER limits); details in Annex III. - Counterfactual exercise key findings - Under full compliance from 2015, government expenditures would have stabilized around 40 percent of GDP and placed debt on a steady downward trajectory during 2015-19. - Prior to the pandemic, actual outturns were close to the counterfactual; gaps widened from deviations from the non-binding SER limit in 2018-19 and moving some social spending outside SER coverage. - Strict application of the escape clause implies identical expenditures in both scenarios for 2020. - Under compliance with the return clause, counterfactual government expenditure would have been 42 percent of GDP in 2021 versus actual around 44 percent of GDP; subsequently counterfactual points to a reduction to 40 percent of GDP (ex-post levels depend on correction to inflation in 2022, reflected in 2023 per current SER). - Overall, the counterfactual fiscal path would have been very tight, despite a downward trajectory for debt. - Evidence of countercyclicality and debt impact - Estimated covariance of primary expenditure to output gap in the counterfactual is comparable to other EU countries and lower than the covariance using Poland’s actual fiscal outturns — indicating stronger compliance would have countercyclical properties. - MOF-EM model simulations: government expenditure exhibits some countercyclical response to a growth slowdown; structural primary balances decline initially then return to baseline; debt returns to baseline downward trajectory after shocks are phased out. - Growth shock assumptions in model simulations: temporary adverse growth shock of 2.5 percentage points below baseline for four quarters in the mild scenario; 3 percentage points below baseline for the severe recession. - Sensitivities and shock responses (model results) - Debt outlook is sensitive to a permanent change in long-term interest rates but less so to exchange rate volatility (owing to short maturity of outstanding debt and low share of foreign-currency denominated debt). - Inflation surprises raise expenditures indexed to inflation (e.g., pension benefits), crowding out public investment under same aggregate SER limits. - Unexpected rises in expenditures outside legally-binding SER limits lead to higher debt even if legally-binding limits are complied with. - Modeling caveats - Counterfactual abstracts from impacts of compliance on other macro variables (growth, revenues, inflation, real interest rates); substitutes expenditure path alone with SER-implied path and assumes expenditures outside SER coverage follow identical dynamics. - During escape years (2020 and 2021) the scenario assumes 2020 expenditures equal actual levels with the difference to SER limit corresponding to one-off pandemic spending; for 2021 compliance with return clause for the non-binding limit is assumed (within 2 years). *IMF staff estimates; MOF model-based simulations; WEO data cited in source.* ### D. Implementation of the SER - Pre-pandemic performance and publication - SER anchored fiscal policy leading up to the pandemic; largely complied with before the pandemic and contributed to improved fiscal balances and reduced debt. - Government expenditure declined as a share of GDP and debt fell from 51.4 percent of GDP at end-2014 to 45.7 percent of GDP by end-2019. - SER limits were published when formulating annual budgets, which authorities reported helped coalesce political debate and promote fiscal discipline. - Pre-pandemic implementation challenges - Government accommodated extra spending in 2019 by moving the 13th pension cash transfer program to an extrabudgetary fund to avoid exceeding the legally-binding SER limit. - Economic parameters entering the SER formula were occasionally revised (e.g., shift from expected headline inflation to NBP inflation target in 2015, later revised back to expected headline inflation in 2022). - COVID-19 response and escape clause - Escape clause was activated appropriately for the pandemic after a timely revision to include national epidemic as a trigger. - Government fiscal support in 2020 amounted to PLN 105.2 billion (Ministry of Finance). - Following the return mechanism, most pandemic-related measures were unwound in 2021, leading to significant improvement in cyclically-adjusted primary balance by 5 percent of GDP. - Government expenditure reached 44 percent of GDP in 2021, about 2.2 percentage points higher than in 2019, implying further adjustments were needed in 2022 and after to return to SER limits (requiring 2.6 percent of GDP lower expenditures). - 2022‑23 shocks and ad-hoc measures - War in Ukraine and energy price spikes in 2022-23 required extraordinary measures: mitigate energy price spikes, bolster defense spending, and support 1.3 million refugees from Ukraine. - Government adhered to return mechanism after 2020 escape clause expired but used ad-hoc amendments to exclude certain expenditures and adopt a higher inflation component in the SER formula. - Additional investment clauses exempted some capital expenditures from the SER limit (e.g., capital expenditures of local government units in Budget Act 2021); similar clauses used in 2022 and 2023. - Design and implementation shortcomings highlighted by severe shocks - Multiple revisions to the fiscal framework (escape clause, correction mechanism) were needed to respond to shocks and smooth adjustments, but public understanding was hampered by lack of independent fiscal oversight. - Ad-hoc exclusions and increased use of extrabudgetary bodies could have undermined SER credibility. - Widening discrepancy between national definition of government debt and general government debt was 9.9 percentage points of GDP as of end-2022, making the constitutional national debt limit an insufficient safeguard. - Lack of a multi-year expenditure path constrained transition to a risk-based approach and limited capacity to anchor a credible medium-term fiscal framework (MTFF). - Recent calibration and correction mechanism - Correction mechanism revised starting Budget 2024 to have a fiscal adjustment of 0.5 ppt of GDP (consistent with Poland’s EU convergence program). - This was calibrated by setting the SER expenditure base for 2023 1.2 percent of GDP lower to calculate 2024 SER limits. ### III. Revising the Stabilizing Expenditure Rule — A. Consideration of SER Parameters - Overall objective - Revising several economic parameters in the SER formula could improve effectiveness in maintaining fiscal discipline. - Growth parameter - Current SER places large weights on historical growth; with slowing growth prospects (MOF and IMF WEO forecasts), this could give rise to overspending (rising in terms of GDP) over the medium term. - Recommendation: shift to a more forward-looking growth indicator (example: 3‑year backward and 4‑year forward; t-3 to t+4) to better align with the EU framework and reflect latest developments. - Authorities’ simulations indicate stronger performance under such a forward-looking formula: smoother expenditure growth, stronger fiscal balance, and less debt buildup. - Transition to forward-looking formulation could be introduced after establishment of an independent fiscal council to assess macro-fiscal forecast quality. - Inflation parameter - Current SER adjusts expenditure limit for fiscal year inflation based on forecast of headline inflation; this can give volatile expenditure limits because headline inflation is typically more volatile than core inflation or central bank target. - In theory, price adjustments should correspond to prices relevant to government consumption and investment, which may differ from headline CPI that reflects household consumption. - In Poland, pension benefits are automatically indexed to CPI; other expenditures (e.g., healthcare) are not directly indexed but some are set as fixed shares of nominal GDP. - Simulations (MOF-EM NEMPF) suggest using moving averages of historical headline inflation will raise SER limits, leading to higher deficits and debt. - Consideration could be given to adjusting for prices using a less volatile indicator (e.g., GDP deflator) rather than headline CPI. - Forecast quality and neutrality - Unbiased forecasts are important: overoptimistic forecasts of growth and inflation raise expenditure limits and weaken fiscal discipline; negative forecast bias constrains expenditures and can create political pressure to amend rules. - Options to achieve unbiased forecasts: use independent forecasts, strengthen MoF forecasting capacity, or have assessment by an independent fiscal council. - Some countries (example given) require use of fiscal council forecasts in the budget process. - Supporting evidence - Cross-country analysis shows difference between official and consensus forecast (about 1 percent of GDP) is not statistically significant; consensus forecast tends to be closer to actual outcomes. *Sources: Ministry of Finance model-based simulations, IMF staff estimates, IMF WEO database, national authorities budget documents.* ### 26. Transparency in the discretionary revenue measures (DRM) and the adjustor parameter ### 26. Transparency in the discretionary revenue measures (DRM) and the adjustor parameter ### Transparency of DRM and the adjustor parameter (K) - DRM inclusion under the regulation should continue to ensure credibility of the SER. - Scope exists to include other discretionary revenues under the regulation (such as those related to the strengthening of revenue or customs administration but not change in tax policy). - The DRM adjustment should be narrowed only to those government entities covered by the SER. - Fiscal oversight on the revenue yields from DRM, such as through a fiscal council, would be important. - The adjustor parameter (K) is necessary to provide a reconciliation between the SER limit and the EU fiscal framework. - The adjustment of K should be transparent and well disclosed (both the current and historical levels) to enhance accountability. - All individual components that enter the SER formula—including expenditure base, growth and inflation projections, DRM levels, and the adjustor K—should continue to be reported in the explanatory note of the Budget Act. ### Broadening the Coverage of the SER - A broader coverage of the SER and its legally-binding limit could further support aggregate fiscal discipline by ensuring unambiguous accountability for compliance with the limit. - Current separation: overall SER covers close to 90 percent of general government expenditure; legally binding part covers around 70 percent of expenditure. - Government should consider broadening the coverage of the legally-binding portion of the SER, for example to cover the expenses of COVID Prevention Fund and the Help Fund under the SER limit. - The central government should have full control and responsibility for all expenditures that fall under the legally-binding portion of the SER. - Legally binding part currently covers various funds, including funds in the BGK; practices of extra-budgetary activity undermine budget unity and introduce ambiguity on responsibility for mismatches between budget allocations and expenditure commitments. - Mission was informed inclusion of non-budget entities in the legally binding part does not pose practical problems and controls are in place to avoid overspending. - Recommendation: government should have full authority over—and insight into—the finances of extra-budgetary funds to ensure no buildup of expenditure liabilities affecting SER compliance. ### Strengthening Compliance - Budgetary documents lack an in-depth discussion on compliance with the SER in the absence of an independent fiscal council. - Current oversight: - NIK (independent state audit body) conducts ex-post verification of spending against the SER limits and its application in the Budget Act. - Regional Chamber of Audit provides an audit for local government units (Budget Act Articles 230-240). - Gap: no independent fiscal council offers detailed retrospective or prospective analysis of adherence to the SER; such assessment could be conducted at general and budgetary-entity levels. - Compliance assessment should be conducted in conjunction with fiscal risks, other rules, and factors relevant to medium-term planning. - SER primarily addresses government expenditures; below-the-line financing activities affecting debt dynamics but not recorded as expenditures under the SER can carry significant implications for fiscal planning and sustainability. - MOF has other provisions outside the SER to control local government finances (e.g., restricting borrowings and ability to incur deficits or losses). - Upgrading monitoring mechanisms is necessary, especially to align with the EU fiscal framework. - Monitoring should be extended to assessing macroeconomic assumptions underlying the government budget and fiscal plans and the costing of policy measures, typically conducted by an independent fiscal council. - Recommendation: Establish an independent fiscal council with broad mandate and autonomy. The new fiscal council would: - evaluate macro-fiscal projections underpinning the MTFF and SER formula, including through debt sustainability analysis; - assess fiscal performance and compliance with the SER ex-ante, during the year, and ex-post; - assess activation, implementation, and exit of escape clauses and the implementation of correction mechanisms (World Bank 2024). - Fiscal council should have operational independence with resources commensurate its mandates and speak with one voice (Davoodi et al. 2022). ### Transitioning to a Multi-year Expenditure Rule over the Medium Term - Several European countries (Denmark, Finland, the Netherlands, Sweden) operate binding aggregate multi-year expenditure limits and cite them as important contributors to fiscal prudence. - Effective management of binding multi-year expenditure limits requires strong fiscal institutions. - MTFF comprises institutional arrangements for prioritizing, presenting, reporting and managing fiscal aggregates over a medium-term horizon; MTBF supports prioritizing, presenting, and managing the budget across multiple years and government entities. - Expenditure limits set well in advance of the annual budget process help separate aggregate fiscal policy decisions from budget prioritization discussions. - Countries with experience update limits to reflect changes in inflation or to offset accounting/classification changes; adjustments are reconciled and explained in budget documents. - Multi-year limits incentivize assessment of how spending programs evolve over several years and help plan new policies with a medium-term perspective. - Consideration for Poland: - The SER sets expenditure limit binding only for next fiscal year, limiting forward-looking budgetary guidance. - Legally-binding SER limit corresponds broadly to central government expenditure and a number of other entities; medium-term expenditure limits (anchored on an overall fiscal objective) are not set. - Explanatory note to the budgetary act presents SER expenditure for the next four years but these are indicative only. - Transitioning to a multi-year expenditure rule supported by a credible medium-term fiscal framework is a priority; a multi-year rule is consistent with requirements of the new EU economic governance reforms based on a 4-year or 7-year net expenditure path. - Medium-term limits allow more strategic fiscal planning; MOF currently nets out forecast expenditure for non-binding part of ceiling but this reduces ability to make strategic reallocations. - Division of the legally binding and non-binding parts of the SER should be separated into two stages: - Technical phase: MOF determines overall limit based on formula, baseline (no-policy-change) expenditure for entities, and expenditure room or savings requirement. - Fiscal policy phase: government determines broad allocation between legally binding and non-binding parts and between broad categories within legally-binding part. - Transitioning to a multi-year expenditure rule requires managing uncertainty: - Setting fixed expenditure limits for several years (3-4 years) in advance is practical only if sufficient fiscal room (margin) is left uncommitted within the expenditure limit. - Maintaining a margin between the SER limit and budget expenditure—possibly rising over time—helps manage uncertainties. - Note: actual execution of expenditure is often below the planned expenditure in the Convergence Program (an average difference of 1.4 percent of GDP between 2016 and 2022). - Transition will require broad political support and strong technical capacity across ministries; mission identifies three broad options to transition: i. Continue current annual SER (limits for next budget year (t+1)), complemented with application of SER formula in years t+2 to t+4 for information only; ii. Binding SER limit set for next budget year (t+1) and indicative limits for years t+2 to t+3, with explicit requirement to reconcile revisions when updated (e.g., when t+2 becomes next budget year); iii. Binding limits for all years in the expenditure horizon (second to the fourth year), with updates to offset accounting/classification changes, activation of escape clause, or if expenditure is shifted between sectors governed by the SER and outside the SER; changes clarified in budget documents. ### Periodic Review of the Fiscal Rules Framework - Good international practice supports periodic review of fiscal rule frameworks because structural economy features and shocks evolve over time. - Fiscal rules should be periodically revisited for performance and recalibrated by a fiscal council or committee of experts. - Example: The Netherlands conducted 17 periodic reviews since 1971 through an independent high-level expert advisory group. - In Poland, performance and design of the fiscal rule should be subject to periodic comprehensive reviews, ideally no more frequently than once every five or six years. - Authorities have concerns that formula-based SER could set expenditures on a ‘wrong’ trajectory over the long term as structure of the economy changes; periodic reviews help recalibrate. - Government has taken steps to strengthen fiscal rules under the Multi-Annual Plan adopted in April 2024. - Future periodic reviews can be conducted through an independent committee of experts and informed by compliance assessment by an independent fiscal council; reviews should not be too frequent to preserve credibility. ### Recommendations - Preserve credibility of the SER by restricting ad-hoc amendments to the SER, reporting all individual components that enter the SER formula, and aligning it to the EU fiscal framework. Example: transfer of treasury securities to government entities should be included in the SER to avoid below-the-line financing activity as a circumvention. - Revise the SER formula to include correction of growth forecast errors, more forward-looking indicators on real growth (for example, comprising 3-year historical growth rates, the current growth rate, and the 4-year growth forecast) after an independent fiscal council is established; include alternative indicator (such as GDP deflator instead of volatile headline CPI inflation rates) to adjust for price movements in the SER. - Improve forecasting by (i) strengthening the forecasting capacity at MOF (including analyzing forecast errors); (ii) mandating the fiscal council to assess the realism of macro-fiscal forecast published by MOF. - Broaden coverage, including expanding the entities and funds within the legally-binding part of the SER. - Publish an in-depth assessment of ex-ante and ex-post compliance of the SER, in conjunction with an assessment of the fiscal rules and fiscal risks. - Establish an independent fiscal council to provide fiscal oversight. - Over the medium term, transition the SER to include multi-year limits to strengthen linkages of the SER with the annual budgets and MTFF and improve fiscal credibility. - Conduct a periodic comprehensive review on the SER every 5-6 years to ensure it is well-calibrated and consistent with macroeconomic outlook and fiscal objectives. *IMF Technical Assistance Report | 26–31* ### 44. Well-designed escape clauses provide flexibility to deal with exceptional events, ### 44. Well-designed escape clauses provide flexibility to deal with exceptional events, ### Escape clauses: purpose and cross-country design considerations - Escape clauses relax or suspend the fiscal rule temporarily when severe shocks occur to provide flexibility to raise expenditure beyond rule limits while preserving credibility. - Typical exceptional events that can trigger escape clauses: natural disasters, war, state of national emergency, epidemics, or sharp economic slowdown. - Tradeoffs in trigger design: - Precision versus discretion: measurable triggers (e.g., growth slowdown) can specify minimum shock size, but pre-judging events or magnitudes may be difficult or counterproductive. - One option: limit the size of deviation from the fiscal rule rather than strictly define triggers, or involve a fiscal council in monitoring activation. - Activation and monitoring: - Activation typically requires parliamentary approval of the government proposal and often an evaluation by an independent fiscal council. - Example: Sweden — government proposes a change to the expenditure ceiling, the parliament (Riksdag) decides on activation, and the Swedish Fiscal Policy Council assesses the government proposal. - Return procedures: - Escape clauses often set timeframes or procedures for re-instating rule compliance and/or correcting deviations. - Example: Switzerland — deficits from exceptional spending during activation accumulate in a notional account, which needs to be remedied over the next six years. - Germany requires the government to put forward a plan to reduce extra borrowing “within a reasonable time frame.” ### National practice and linkage to EU framework - Several European countries link national escape clauses to the EU framework; in countries like France and Italy, national escape clauses are typically triggered automatically with an EU-wide escape clause. - Some countries (e.g., Germany) specify more stringent rules beyond deficit or debt limits. ### Considerations for Poland — limitations of current escape clause - Key limitations identified: - The escape clause is not applicable for a severe growth slowdown by itself because economic condition is not a standalone trigger. - Triggers focus narrowly on GDP growth; this can limit response to shocks (e.g., major natural disasters) that may not immediately slow growth. - The rigid return clause may not be resilient to multiple adverse shocks; Poland activated the escape clause for the pandemic but used ad-hoc exemptions during energy price spikes and the war in Ukraine in 2021-23. - There is no independent fiscal council to evaluate the implementation of the escape clause (activation, costing, exit, and return to SER limit). - Past ad-hoc measures: - An investment clause was introduced on an ad-hoc basis to exclude capital expenditures of local government units, state budget and BGK funds (2021-22) and investment spending by state special purpose funds (2023). - The implied fiscal adjustment in the return clause would yield a much deeper consolidation than required in the EU fiscal rules; to avoid an abrupt fiscal adjustment, the government revised the SER expenditure base for 2024 (1.2 percentage points lower) to accommodate a gradual adjustment. ### Options to strengthen Poland’s escape clause - Triggers and thresholds: - Include “severe growth slowdown” as a standalone trigger rather than a criterion tied to other triggers. - Set the threshold sufficiently low (example guidance: at 2−3 percentage points below the current moving average of historic growth and growth forecast and when growth is expected to be in the negative territory) to avoid misuse. - Standalone trigger enables swift response to severe shocks that do not immediately affect growth. - Procedures to trigger: - Authority to trigger should remain with the Sejm. - Task an independent fiscal council to assess activation or extension and to provide costing of additional fiscal measures. - Evidence: during the pandemic, more than half of fiscal councils worldwide evaluated the use of escape clauses and many assessed medium-term fiscal sustainability implications. - Duration of suspension: - Consider limiting suspension to the current fiscal year only, with an option to extend for another fiscal year if triggering criteria continue to be met and the fiscal council endorses extension. - Fiscal council to provide opinion on costing of extraordinary measures and impact on debt sustainability. - Example: EU-wide escape clause activated in 2020-21 and extended in 2022-23 due to the war in Ukraine. - Transition to re-instating SER limits: - Pace of adjustment: - Current provision to return to SER limits two years ahead appears appropriate. - A larger deviation more than 2-3 percent of GDP (equivalent to an adjustment of 1 ppt of GDP per year) may require a gradual but steady adjustment to balance macro stabilization and debt sustainability. - Current provision considers economic conditions mechanically; would benefit from incorporating debt sustainability risk as a criterion for determining return timing. - Expenditure base in SER: - Important to determine an expenditure base for compiling next-year SER limit (formula in Box 1). - Track the size, persistence, and types of extraordinary measures when escape clause is activated (examples: notional account in Sweden or Switzerland). - Tracking would aid appropriate expenditure base determination and guide the pace of adjustment. - Note on unwinding: the unwinding of excess spending depends on types of measures (one-off supports may unwind quickly; countercyclical support during severe recessions can be attuned to gradual recovery and debt sustainability risks). ### Correction mechanism: purpose and international experience - Purpose: - Specifies how government restores public finances when the fiscal rule is not complied with or not well anchored. - Often involves fiscal adjustments through raising revenues, expenditure freeze or cuts, and/or greater parliamentary oversight. - Enhances predictability of fiscal policy and credibility of the rule by indicating remedial actions. - Timing: - Corrective action usually takes place reactively (ex-post) after a breach, but some frameworks trigger preemptive action to contain fiscal slippage risks. - Examples: fiscal frameworks in Croatia, Poland, and Slovak Republic contain ‘debt brakes’ that require tighter action when debt-to-GDP approaches ceilings. - Triggers and magnitude: - Triggers can be based on one-off or cumulative deviations. - Finland, Ireland, Italy: assessment based on current year, previous year, or over previous two years. - Germany, Jamaica, Slovak Republic, Switzerland: corrective action when cumulative deviations reach a critical threshold. - Triggers can be single thresholds or progressive triggers with tighter measures (Croatia). - Magnitude of correction: - Some rules require restoring compliance in future years; others require full or partial unwinding of deviations progressively or immediately. - Example: Switzerland’s “debt brake” accrues deviations in a notional account; once negative balance exceeds 6 percent of expenditure, government must take measures to bring account within limit in 3 years. - Timeframe for correction: - Many rules require corrective action within one and a half to two years (Belgium, Finland, France); some allow up to three years (Grenada). - More stringent mechanisms may require immediate action or measures in the next budget. - Example: Slovak Republic requires a balanced budget submission in the next fiscal year if debt is within three percentage points of GDP of the ceiling. - Adjustment measures: - Some mechanisms are prescriptive (e.g., Slovak Republic freezes public sector wages if debt exceeds 50 percent of GDP and requires a spending cut by 3 percent if debt surpasses 55 percent of GDP). - Others leave discretion to government (Germany, Switzerland) or require qualitative actions (present explanations to parliament, submit supplementary budgets on request). ### Considerations for Poland — correction mechanism - Recent simplification of the correction mechanism: - Aims to balance macro stabilization and debt sustainability; made the mechanism more forward-looking and easier to communicate and implement. - Objectives going forward: - Continue to support SER implementation by reducing deficits and restoring fiscal discipline. - Align national SER to net expenditure paths agreed with the European Commission under the EU fiscal framework. - Limit likelihood of debt buildup exceeding 60 percent of GDP, including in stress scenarios. - Further refinements suggested: i. Align criterion with EU framework: - Replace ‘economic conditions’ criterion for fiscal adjustments with whether the escape clause of the SER is activated. - Rationale: the EU net expenditure path must be complied with unless EU-wide escape clause is triggered; using escape-clause activation is easier to monitor and communicate than economic forecasts. - Provision could require a minimum fiscal adjustment to the SER that matches the EU-agreed net expenditure path through adjusting parameter K. ii. Specify government action on ex-post non-compliance: - Regardless of deficit and debt levels, specify required government actions when expenditure outturn exceeds the SER limit. - Could be a separate provision in the Public Finance Act or embedded in the correction mechanism. - Example actions: government submits a report to the Sejm explaining noncompliance and indica ting corrective actions; precise measures could be left to government subject to parliamentary approval and fiscal council opinion. - Note: SER compliance can only be verified at fiscal year-end; corrective measures will be implemented in future budgets. ### Recommendations - Escape clause: - Amend the provision (Article 112d in Public Finance Act) to list severe economic slowdown as a standalone trigger to activate the escape clause. - Revise the return clause following escape clause expiry so size and duration of adjustments consider both economic conditions and debt sustainability risks; track extraordinary spending during activation to determine the SER expenditure base when returning to the rule. - Mandate the new independent fiscal council to assess escape clause implementation, including activation, extension, return to SER limits, costing of extraordinary measures, and implications for debt sustainability. - Correction mechanism: - Revise the criterion in the correction mechanism from ‘economic conditions’ to ‘the activation of escape clause’ when determining whether fiscal adjustments should be undertaken to better align SER to EU-agreed net expenditure path. - Specify actions or measures the government must take when expenditure outturn exceeds the SER limit in a given year, regardless of deficit or debt levels; this provision could be in the Public Finance Act or embedded in the correction mechanism. Types of measures and horizons can be left to government decisions subject to parliamentary approval and fiscal council opinions. ### Aligning SER to the EU Economic Governance Framework - EU reform (February 2024) requires member states to have a medium-term structural fiscal plan and a multi-year net primary expenditure path that meets debt sustainability criteria and safeguards. - Poland must ensure national SER is consistent with the expenditure path under the new EU framework both at outset and during implementation. - Challenges in consistency: - Implied expenditure growth paths under SER may differ from the EU framework. - Coverage/classification differences: SER includes interest payments, cyclical unemployment benefits, and co-financing of EU projects; EU net expenditure uses ESA 2010 definitions. - SER is on a cash basis; EU net expenditure is based on ESA 2010. - Timing mismatch: EU four-year net-expenditure paths versus SER’s annual update of next-year limit based on updated outturn and forecast data—SER must avoid future-year mismatches as parameters are updated. *Italic: IMF Technical Assistance Report | excerpt (pages 32–39) from tarea2024049 - 44. Well-designed escape clauses provide flexibility to deal with exceptional events,* ### 57. Poland is expected to enter the Excess Deficit Procedures (EDP) with the projected fiscal ### 57. Poland is expected to enter the Excess Deficit Procedures (EDP) with the projected fiscal ### EDP entry, requirements, and timing - Poland is expected to enter the Excess Deficit Procedures (EDP) with the projected fiscal deficit declining from 5 percent of GDP in 2023 to around 3 percent of GDP in 2028. - Under EDP Corrective Arm requirements, a minimum annual adjustment of 0.5 percent of GDP is required, set in terms of the structural balances but can be adjusted by the increase in interest payment in the period 2025–27. - Member states remain in the EDP until the fiscal deficit falls below 3 percent of GDP (deficit reference value). - For countries with debt higher than 60 percent of GDP and/or a deficit higher than 3 percent of GDP, the EU deficit resilience safeguard requires member states to establish a 1.5 percentage points “resilience” margin. - According to the EU framework, that would require a minimum adjustment of 0.4 (or 0.25) percent of GDP in the structural primary balance in a four-year (or seven-year) adjustment period. - When a country leaves the EDP with debt below 60 percent of GDP, technical information, that could include the deficit resilience safeguard, can be provided at the request by a Member State; however it is not mandatory. ### EU fiscal framework overview (Box 3) - The reformed EU economic governance framework (April 2024) requires multi-year adjustment plans for countries facing long-term fiscal risks and uses net primary expenditure as the single operational indicator. - Member states agree a four-year fiscal-structural plan with the Commission and Council; a seven-year adjustment period may be allowed for countries committing to structural reforms and public investments. - The framework distinguishes: an adjustment period (baseline four years) and a ten-year debt trajectory phase for long-term fiscal sustainability assessment. - Debt criterion: if debt is above 60 percent of GDP it should decline with a high probability; if below 60 percent of GDP it should not exceed 60 percent at the end of the ten-year horizon in the adjustment scenario and deterministic stress tests. - Deficit benchmark: by the end of the adjustment period, the general government deficit must be below 3 percent of GDP and projected to remain below this level over the ten-year debt trajectory. - Debt sustainability safeguard: over the adjustment period debt-to-GDP should fall on average by no less than 1 percentage point of GDP annually if debt is above 90 percent of GDP, and 0.5 percentage points of GDP annually if debt is between 60 and 90 percent of GDP. - Deficit resilience safeguard: as long as the general government structural balance is less than -1.5 percent of potential GDP, the annual improvement of the structural primary balance should not be less than 0.4 percentage points of potential GDP for a four-year adjustment period, and 0.25 for a seven-year adjustment period. ### Simulation methodology and questions - Simulations evaluate how fiscal adjustments under the EU fiscal framework compare with those implied by the SER, aligning annual SER limits to the EU framework. - Methodology considers debt sustainability risks of the EC framework and incorporates criteria, benchmarks and safeguards under the new EU governance reforms (Annex IV), using 2022 and 2023 Debt Sustainability Monitor (DSM) as an operational guide. - Simulations aim to answer: - i. What is the size of fiscal adjustments required under the new EU economic governance reforms? What are implications on fiscal balances and debt dynamics for Poland? - ii. How does the fiscal path under the EU framework compare to that based on the SER formula? ### Simulation results — potential net expenditure path (summary) - Simulations suggest the EU fiscal framework would require potential adjustments of the structural primary balance of 0.5-0.6 percent of GDP per year. - The projected exit of EDP by 2029 will be more gradual as Poland builds buffers to achieve the deficit resilience. Four-year adjustment (2025-28) - Under a four-year adjustment (2025-28), the deficit benchmark (deficit criterion) would generate the largest fiscal adjustments for Poland. - To attain the binding SPB target by 2028, Poland would be required to improve its structural primary balance by about 0.6 percent of GDP until 2028. - While not a requirement for Poland, an adjustment of 0.4 or 0.25 could be pursued in a consecutive plan to comply with the deficit resilience safeguard. - As Poland is expected to be under the EDP until 2028 in the simulation, the minimum SPB required is comparable but somewhat higher than the one derived from the deficit criterion. Seven-year adjustment (2025-31) - Under a seven-year adjustment (2025-31), Poland is expected to stay under the EDP until 2029 in the simulation; adjustments under the deficit criterion could only be activated in 2030 with the requirement of a minimum SPB of -0.6 percent of GDP by 2031. - Poland is envisaged to adjust by 0.5 percent of GDP until 2029 under the EDP (with the exclusion of higher interest expenditure ending in 2027 not having a material impact on the adjustment). - For 2030 and 2031, the authorities could establish a resilience margin of 1.5 percent of GDP to the deficit criterion by pursuing an adjustment of 0.25 percent in each of 2030 and 2031. Debt projections and risk - Based on the MOF macro-fiscal forecast assumptions, the debt ratio is expected to stay below 60 percent of GDP in both adjustment horizons. - The strict adjustment required either in EDP (2025-28) or the deficit resilience safeguard (if requested in the second plan) is projected to keep debt in check. - If stochastic shocks are introduced during the adjustment period, there is a high probability (over 70 percent) that debt would stay at or below 60 percent of GDP. ### Comparison with the SER — methodology for SER simulations - The expenditure path implied by the SER is compared to the net expenditure path of the EU fiscal framework using latest MOF projections and assuming stable revenue-to-GDP ratio over the years. - Simulation assumes no discretionary revenue measures (DRM=0) in the projected horizon. - Two simulation cases: - Case 1: SER limits based on mechanical application of the current SER formula and proposed SER formula with forward-looking growth, both without correction mechanism (parameter K=0). - Case 2: The two implied SER limits adjusting for correction mechanism (parameter K set so implied fiscal adjustments are at least or higher than under the EU net expenditure path). Current SER formula (without correction mechanism) - Expenditures implied under the current SER would lead to higher expenditures than under the EU net expenditure path, particularly in outer years 2027-29. - Without correction, the base effect in the SER carries forward higher expenditure to future limits — implying less fiscal tightening, a weaker structural primary balance, and higher debt than under the EU net expenditure path. - Average adjustment in the structural primary balance would be 0.2-0.3 percent of GDP, relative to 0.5 percent of GDP under the EU framework. - Based on this scenario, debt could reach 60 percent of GDP in 2033 and stay elevated for some time. - Numerical results with stochastic shocks show the likelihood of debt staying below 60 percent of GDP may be lower in the near-term. - Conclusion: additional fiscal efforts, possibly via the SER correction mechanism, are needed to meet net expenditure paths in the EU framework. Proposed SER formula (forward-looking, with correction mechanism) - Proposed SER formula includes a moving average of growth projections 3 years ahead and a 4-year historical growth component, plus an adjustment clause in the correction mechanism such that minimum fiscal adjustment is at least 0.5 percent of GDP each year, unless the Commission recommends a lower adjustment. - Simulation results: expenditures implied under the forward-looking SER with correction mechanism are similar to the potential EU net expenditure path. - Near-term expenditure is expected to grow slower starting from 2027 at about 6 percent each year in nominal terms. - Implied expenditure path is smoother than under the EU net expenditure path, implying gradual fiscal tightening of 0.5 percent of GDP over the adjustment period, except 2026 owing to phasing out of strong growth in 2023-24 in the SER formula. - Pace of adjustment is slightly more prudent than the EU net expenditure path, producing a gradual and stronger improvement in the structural primary balance. - Government debt is expected to stay below 60 percent of GDP over the horizon, slightly more favorable than under the EU net expenditure path. - Overall: the proposed revision to a SER formula with correction mechanism will align better with the net expenditure path in the EU fiscal framework. ### Key numerical findings and timings (preserve source figures) - Fiscal deficit: 5 percent of GDP in 2023; around 3 percent of GDP in 2028. - Minimum annual adjustment required under EDP Corrective Arm: 0.5 percent of GDP. - Deficit resilience safeguard margin: 1.5 percentage points. - Minimum adjustment under deficit resilience safeguard: 0.4 (four-year) or 0.25 (seven-year) percent of GDP in structural primary balance. - Simulated potential adjustments under EU framework: 0.5-0.6 percent of GDP per year. - Four-year adjustment SPB improvement required by 2028: about 0.6 percent of GDP. - Seven-year adjustment minimum SPB by 2031 in simulation: -0.6 percent of GDP. - EDP adjustments envisaged until 2028 (four-year) or until 2029 (seven-year simulation). - Projected nominal expenditure growth under forward-looking SER starting 2027: about 6 percent each year. - Average adjustment in structural primary balance under current SER (without correction): 0.2-0.3 percent of GDP versus 0.5 percent of GDP under EU framework. - Debt hitting 60 percent of GDP in current SER scenario: 2033 (as simulated). - Probability debt stays at or below 60 percent of GDP under stochastic shocks during adjustment: over 70 percent (given MOF forecast assumptions and adjustments). ### Aligning SER with EU fiscal framework — recommendations and reconciliation points - Revisions to the SER may be required to better align fiscal adjustment paths, but should not aim to replicate precisely the adjustment path agreed with the Commission and Council. - Options and considerations: - Use well-designed provisions in the SER correction mechanism to ensure SER-implied adjustments are consistent with EU net expenditure path; e.g., include a minimum fiscal adjustment of 0.5 percentage points of GDP via a one-off adjustment parameter K. - Reconcile timing differences: SER is set annually and updated annually; EU net expenditure path is set for next 4 or 7 years without subsequent updates. Mapping between SER limits and EU net expenditure path can be reflected through parameter K. - Address coverage and accounting differences: interest payments and cyclical unemployment benefits are excluded from EU-agreed net expenditures but not from SER limits; Poland uses cash basis accounting while EU uses accrual basis (ESA 2010). Provide explanations on sources of differences between SER expenditure and EU net expenditure to facilitate compliance. - Maintain broader coverage in SER (e.g., include EU co-financed projects) to preserve link of SER limits to debt-creating flows and strengthen fiscal transparency; use ex-post assessments and EGF flexibility when scaling up EU co-financed projects. - Allow occasional adjustments in determining the SER limit for the next budget year to ensure reconciliation and compliance with both the SER and the EU-agreed net expenditure path. *IMF Technical Assistance Report | excerpt from content unit 57 (as provided).* ### 67. When the SER is revised and upgraded, a well-crafted communication strategy would ### tarea2024049 - 67. When the SER is revised and upgraded, a well-crafted communication strategy would ### Communication strategy for revising the SER - Effective communication should: - Use simple, clear messages aimed at educating the public about the merits of fiscal responsibility. - Rely on an inclusive dialogue and consultation process with major stakeholders (Corbacho and Ter-Minassian 2013). - Begin early and be disseminated through multiple channels (speech, reports, press interviews, conferences) to a wide audience. - Stress the benefits of revising the SER to align with the post-pandemic economic outlook facing Poland and comply with the new EU economic governance reforms. - Present other provisions in the SER (such as the correction mechanisms, escape clauses, periodic review) and accompanying reforms (transition to medium-term expenditure rules and fiscal council) as part of a coherent and robust framework. - Expected outcomes of an effective communication strategy: - Strengthen national ownership of the fiscal rules. - Increase credibility of the fiscal rules. - Address policy priorities and improve Poland’s resilience against shocks. ### Recommendations (D) - Align the SER limits to be consistent with the net expenditure path agreed with the Commission and Council under the new EU fiscal framework. - Conduct quantitative assessment (including sensitivity analysis) of how the implied SER limits would compare with the EU-agreed net expenditure path. - Provide an explanation on the sources of differences between SER expenditure and EU-agreed net expenditure to help implement the fiscal rules and facilitate compliance. - Prepare a communication strategy on the revision of the fiscal rules to gain credibility and garner public support and trust. ### Key contextual findings on fiscal rules (Annex I highlights) - Over 100 countries have adopted at least one numerical fiscal rule as of end 2021. - As of 2021, 85 countries adopted fiscal rules that included an explicit ceiling on government debt. - More than 80 percent of countries with a debt ceiling have rules imposing constraints on the (nominal or structural) budget balance; among those, almost a third has expenditure limits. - During the pandemic: - Over 80 percent of countries with fiscal rules activated escape clauses or suspended fiscal rules (Davoodi and others 2022). - About half of countries with fiscal rules had deficits or debt exceeding the limits of their fiscal rules. ### Selected EU country examples of multi-year expenditure limits - Denmark: - Expenditure limits introduced in the Organic Budget Law in 2012. - Limits cover a rolling period of four years; legally binding nominal limits for central government, municipalities, and regions. - Finland: - Since 2003, successive governments set annual limits to primary non-cyclical expenditure in real terms for the four-year term; not set in law. - Currently about 75 percent of total central government spending, and about 37 percent of total general government spending fall under the limits. - Netherlands: - Since 1994, limits fixed in real terms for aggregate expenditure; cover general government. - Limits operationalized in a government agreement at the start of a government term. - Slovak Republic: - In March 2022, adopted annual public expenditure limits (PELs) over a fixed four-year period in nominal terms. - Exclusions account for approximately one-quarter of general government spending. - PEL adjustments: only when exiting the escape clause or when updated revenue forecast deviates by 3 percent of GDP or more from the initial forecast. - Sweden: - Expenditure rule since 1997; Organic Budget Law requires Government to propose an expenditure ceiling for the third year ahead; rolling framework with one additional year added annually. - Common practice: - Limits initially estimated by the Ministry of Finance, proposed by the Government, and approved by Parliament. ### Recent amendments to the Act of Public Finance related to the SER (Annex II summary) - 1 Act of 8 November 2013 amending the Act on Public Finance and some other acts (Dz.U. 2013 poz. 1646) - The stabilising expenditure rule replaced the temporary disciplinary expenditure rule. The SER first applied to the Budget Bill for 2015. - 2 Act of 9 May 2014 amending the Public Finance Act and the Act amending the Public Finance Act and other acts (Dz.U. 2014 poz. 911) - The prudential thresholds in correction mechanism reduced by 7 percentage points from level of 50% and 55% to 43% and 48% respectively. - Consolidation of financial flows between funds managed by the Social Insurance Institution (ZUS). - 3 Act of 22 July 2015 amending the Act on Public Finance (Dz.U. 2015 poz. 1190) - Inclusion of the Bank Guarantee Fund to the scope of SER. - 4 Act of 10 December 2015 amending the Act on Public Finance (Dz.U. 2015 poz. 2150) - Forecasted CPI and its following revisions due to forecast errors replaced by the inflation target of the National Bank of Poland. - The expenditure limit increased by the sum of positive one-off and temporary revenue measures which value is higher than 0.03% of GDP. - Consolidation of financial flows between funds managed by the President of the Agricultural Social Insurance Fund (KRUS). - 5 Act of 9 November 2018 and Act of 15 March 2019 (Dz. U. 2018 poz. 2243; Dz.U. 2019 poz. 875) - Modification of the SER starting point due to the exclusion of the Office of the Polish Financial Supervision Authority from the scope of units covered by the SER. - 6 Act of 28 May 2020 amending the Act on Public Finance (Dz. U. 2020 poz. 1175) - Introduction of a possibility to suspend SER during epidemic and simultaneous significant deterioration of the macroeconomic situation. - Introduction of a mechanism of automatic return to the application of the stabilising expenditure rule in a 2 to 4 years horizon. - 7 Act of 24 July 2020 (Dz.U. 2020 poz. 1423) - Investment clause introduced: 2021 spending limit de-facto increased by local government capital expenditure; capital and investment state budget expenditure planned for 2021 excluded from the expenditure limit. - 8 Act of 11 August 2021 amending the Act on Public Finance (Dz.U. 2021 poz.1535) - Amendment of escape and return clauses in SER to align with suggested policies in EU (extended general escape clause, clearing the growth indicator and correction mechanism from the pandemic impact). - Deactivation of a correction mechanism in the years of the escape clause and return clause. - Inclusion of other special purpose funds to the scope of SER (A3G RRP milestone). - Amendment of the investment clause - increase of the spending limit for local government capital expenditure and capital expenditure of budget and funds for the whole period of the return clause in SER (2021-2022). - Exclusion of the COVID-19 Counteracting Fund from the binding spending limit in SER. - The value of the change amounted to PLN 245 million which corresponded to 0.03 percent of SER expenditure of 2019. - 10 Act of 23 June 2022 amending the Act on Public Finance and the Act on Environmental Protection (Dz. U. 2022 poz. 1747) - In the SER formula, the inflation target of the Monetary Policy Council replaced by the forecast CPI and its forecast errors revisions. - Recalculation of the starting amount for calculating the SER for 2023 resulting from the replacement of the inflation target with the CPI rate, and replacing deflation with the index of 1.000. - Introduction of an ex post correction of inflation forecasts errors (starting from the 2022 forecast). - Inclusion of the National Fund for Environmental Protection and Water Management in the scope of the SER. - Extension of an investment clause for 2023 (with minor changes to its scope). - 11 Act of 16 November 2022 amending the Act on Tax on tax on certain financial institutions and certain other acts (Dz. U. 2022 poz. 2745) - Modification of the method of implementing the expenditure limit in 2022 - possibility to exceed the expenditure limit by the sum of the financial effects resulting from additional measures aimed at combating the negative effects of the energy crisis and the increase in the average annual consumer price index, as well as the financing of the armed forces. - Their value amounted to PLN 26,023,418 thousand (3,4% of expenditure limit). - 12 Act of 13 July 2023 amending the Public Finance Act and certain other acts (Dz. U. 2022 poz. 1641) - Change to the correction mechanism to make the required fiscal effort resulting from the SER consistent with the one implied by the EU rules. - Introduction of the defence clause. - Recalculating the base for SER expenditure for 2024 as the level corresponding to sum of the amount of SER expenditure in 2023. - Introduction of higher correction for 2024 – equal to 1.2% of GDP. - Source of the table: National authorities. ### Scenario analysis on the performance of SER (Annex III) - Model and objectives: - Uses Ministry of Finance Economic Model (MOF-EM) in Poland, which contains a system of equations based on estimated parameters using the vector autoregression model (VAR) (Ministry of Finance 2024). - Scenarios examine: (i) countercyclical properties of the SER; (ii) medium- to long-term implications for debt sustainability; (iii) sensitivity of priority spending (public investment, social transfers) to a change in the SER limit; (iv) flexibility of the SER in responding to severe shocks; (v) ability to return to the baseline following shocks. - Baseline uses MOF model results based on standard parameters and MOF’s macro-fiscal forecast as of December 2023. - Adverse shock scenarios simulated: 1. Growth slowdown: - Shock set to be a 1-standard deviation of real GDP growth for 2 consecutive years. - Revenue to GDP and primary expenditures follow the built-in elasticity identical to the baseline. - An alternative of more severe shocks is conducted to examine the impact of correction mechanism. 2. Tightening of global financing conditions: - Examines an abrupt tightening leading to a rise in sovereign yields in key advanced economies (US and Euro-area) and the risk premium in Poland. - Simulation considers a permanent increase of 100bps and 200bps for sovereign spreads in Poland. - Includes augmentation of capital outflow and a sharp depreciation of exchange rate—including pass through to domestic inflation. 3. A deterioration of primary balance: - Considers a temporary (one-year) deterioration of primary balance owing to unexpected developments. - Magnitude of shock set to be 1 and 2.5 percent of GDP over 3 years, with the latter large enough to examine properties of correction mechanism and cumulative base effects on the SER. - Deterioration has endogenous effects on interest rates built into the model. *IMF Technical Assistance Report* ### 4. Stronger inflation than expected. This scenario assumes the moderation of inflation is slower than ### 4. Stronger inflation than expected. This scenario assumes the moderation of inflation is slower than ### Scenario description - Assumes the moderation of inflation is slower than the forecast used in the SER formula. - The inflation surprise raises nominal spending indexed to inflation (relative to baseline), increasing the likelihood of expenditures exceeding the SER limit. - To comply with the overall SER limit, other types of expenditures, such as public investment, will tighten. ### Shock sizes and timing - The size of the shock is set at 2ppts or 4ppts higher for two consecutive years. ### Fiscal effects noted - Higher inflation leads to: - A rise in nominal spending indexed to inflation. - Higher revenues. - Lower debt (relative to baseline), despite higher nominal spending. - Binding SER limits imply tightening of other expenditures (for example, public investment) to remain within the SER cap. ### Interaction with coverage of the SER (related scenario) - An alternative scenario considers unexpected rises in net expenditures of entities not covered by the SER, which could lead to a rise in debt while complying with the SER. - Shock sizes assumed: 0.5 percent of GDP per year for five years for the baseline coverage scenario. - A more severe shock is considered to examine properties when debt is pushed above 60 percent of GDP to trigger the correction mechanism. - An alternative (not simulated) considers an unexpected rise in net expenditures of local governments (entities outside legally-binding SER limits but covered in the SER), which would: - Lead to a reduction of legally-binding expenditures (such as investment or priority spending) to comply with the overall SER. - Leave debt largely the same as in the baseline. ### Tail-risk scenario - Considers a tail-event combining several adverse shocks with strong interactions: - Growth slowdown. - A surge in risk premium. - A deterioration of primary balances. ### Sensitivity analyses - Several sensitivity analyses were performed to examine the impact of the SER on: - Government debt. - Interest payment. - Expenditure. - Fiscal balances. ### Annex IV — Fiscal adjustment paths under the SER and EU Fiscal Framework: methodology summary - The new EU fiscal framework aims at completing the fiscal adjustment within a four- or seven-year period. - Requires setting the SPB at the end of the adjustment period (2028 or 2031, under the four- or seven-year adjustment, respectively) at levels such that projected debt-to-GDP and fiscal deficit meet conditions specified in the debt sustainability analysis and related safeguards. - In this analysis, the SPB after the adjustment period is assumed to remain unchanged SPB* (the minimum level that meets all requirements of the new EU framework), except for ageing-related expenditure, which are added to the SPB. - Methodology largely based on the European Commission’s 2023 Debt Sustainability Monitor (DSM). - The analysis relies on (Darvas, Welslau, and Zettelmeyer 2023), noting it is not entirely identical to the European Commission’s approach described in the DSM 2023. - Potential fiscal adjustments are determined by ensuring: - A decline in debt-to-GDP ratio. - Deficits staying below 3 percent of GDP even when the baseline is subject to deterministic stress scenarios and stochastic shocks. - Those scenarios and criterion are considered after the adjustment period, i.e., in 2029 (or 2032) in case of four-year (or seven-year) adjustment period, respectively. ### Deterministic stress scenarios (specified) - Lower SPB: - SPB assumed permanently lower than baseline SPB* by 0.5 percent of GDP in every year after a short transitory period following the end of the adjustment period. - SPB is gradually lowered by 0.5 percentage points of GDP in two years if the adjustment lasts for four years (that is, by 0.25 percentage points in both years). - If the adjustment lasts for seven years, lowered in three years (that is, one-sixth percent of GDP in each year). - Adverse r-g: - The interest rate-growth differential is permanently higher by 1 percentage point than assumed in the baseline following the end of the adjustment period. - It immediately lowers growth by 0.5 percentage points in the first year after the end of the adjustment period and all subsequent years. - The 0.5 percentage-point higher interest rate applies to new borrowing from the first year after the end of the adjustment period but does not influence the interest rate on existing debt, so it takes time before the average effective interest rate to increase by ½ percentage point. - Financial stress: - Government borrowing rates rise temporarily, for one year only, by 1 percentage point for countries with a debt ratio below 90 percent of GDP. - For countries with debt levels exceeding 90 percent of GDP, the rise is 1 percentage point plus 0.06 times the gap between the debt level and 90 percent. ### Stochastic criterion (specified) - Stochastic projection of the debt-to-GDP ratio is based on drawing multiple shocks (10,000) from a joint-normal distribution of historical quarterly shocks for: - The primary balance. - Nominal short- and long-term interest rates. - Nominal GDP growth. - The exchange rate. - After transforming shocks to annual frequency and constructing shocks to the implicit interest rate, each series is combined with the projected deterministic path of the respective variables. - Recalculating the debt path for each draw is based on standard debt equation to arrive at a probability distribution of projected debt. ### Related safeguards in the new economic governance reforms - Excessive Deficit Procedures (EDP): - For countries in the EDP, the SPB needed to abide by the EDP adjustment requirement at 0.5 percent of GDP adjustment in structural primary terms until 2027 and 0.5 percent of GDP adjustment in overall structural balance after. - Debt sustainability safeguard: - During the adjustment period, the debt-to-GDP ratio should fall each year by no less than 1.0 percentage points of GDP for countries with a debt-to-GDP higher than 90 percent. - Fall by no less than 0.5 percentage points of GDP for countries with a debt-to-GDP between 60 and 90 percent. - This safeguard does not apply to countries while they are in the EDP. - Deficit resilience safeguard: - As long as the structural balance is below -1.5 percent of potential GDP, countries need to ensure that the fiscal adjustment is consistent with a minimum improvement of the SPB. - Minimum adjustment is 0.4 percent of potential GDP for countries in a four-year adjustment period, and 0.25 percent of GDP for countries in a seven-year adjustment period. - The safeguard is in practice optional for countries with debt-to-GDP below 60 and deficit-to-GDP below 3.0. *IMF Technical Assistance Report | 52–54* --- _Source: https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024049.pdf_