IMF Survey: Poland: Bright Spot in Recession-Hit Europe

IMF News, August 13, 2009

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IMF projection: a small contraction of about ¾ percent for 2009, based on a weak outlook for global trade and further expected declines in domestic investment, credit, and wage growth.
IMF projection: a modest recovery of about 1½ percent in 2010, predicated on a recovery in the global economy.
Context: growth in the euro area expected to decline by close to 5 percent in 2009; countries such as Bulgaria, Romania, and the Baltics likely to experience particularly sharp recessions.
Poland’s recent performance:
- Growth remained slightly positive in Q4 2008 and Q1 2009, helped by resilient consumption growth and limited exposure to the decline in world trade.
- The zloty quickly lost close to a third of its value following the demise of Lehman Brothers.
- Credit default swap (CDS) spreads rose but later declined after policy actions.

Key factors behind Poland’s resilience:
- Flexible exchange rate regime facilitating adjustment to the external shock.
- Approval of an IMF credit line (Flexible Credit Line) earlier in the year helped calm markets; the zloty stabilized at its new lower level, CDS spreads declined, and the government saw a decline in the interest rate it was paying on its bonds.
- Entry into the crisis with relatively healthy fundamentals allowed the government to implement countercyclical policies that cushion the downturn.
Structural note: Poland’s domestic economy is large and relatively closed compared to other similar countries, with exports playing a much smaller role.

National Bank of Poland actions and credibility:
- The central bank built strong anti-inflation credentials during the past decade, anchoring inflation expectations.
- Since November 2008, the policy rate has been lowered from 6 to 3.5 percent.
Outlook and cautions:
- IMF expects inflation to continue to decline, providing room for additional cuts in the policy rate.
- Such cuts are not expected to weaken the zloty further given Poland’s monetary policy stance and cyclical position relative to the euro area and the United States.
- Risk: negative spillovers from the region could put temporary pressure on the zloty; caution is called for when loosening monetary policy.

Fiscal history and current pressures:
- Authorities’ plans to adopt the euro and commitments under the Maastricht Treaty helped anchor expectations and facilitated reduction in 2007 of the fiscal deficit to below the Maastricht limit of 3 percent of GDP.
- Revenues expected to fall because of the downturn and important tax reforms coming into force in 2008 and 2009; the deficit is rising again.
- Permanent tax cuts enacted earlier but coming into effect now have provided an important stimulus during the slowdown but will keep the deficit above the Maastricht limit even as the economy recovers.
Policy trade-offs and recommended path:
- Drastic corrective action now would risk turning a mild recession into a more serious one.
- Authorities decided to increase the deficit limit for 2009 to mostly accommodate the expected shortfall in revenues.
- To fulfill medium-term targets (aim to reduce deficit to 1 percent of GDP by 2012), the authorities would need to start a sustained fiscal consolidation in 2010, provided the recovery takes hold as projected.
- IMF recommendation: revamp the fiscal framework to include multi-year binding limits on expenditures to help anchor confidence in targets.
Demographics:
- Poland’s early implementation of comprehensive pension reforms means that aging does not weigh heavily on the medium-term outlook.

Banking system resilience and vulnerabilities:
- Poland’s banking system has withstood global turbulence well, in part due to lower leverage—the credit expansion in Poland was less dramatic than elsewhere, having started later and from a lower base.
- The system is dominated by foreign-owned banks; parent banks have maintained their exposure and continued to provide funding and capital to Polish subsidiaries.
Authorities’ actions and further IMF advice:
- Authorities encouraged banks to retain profits and stepped up top-down stress testing and on-site inspections.
- IMF advises conducting bank-by-bank stress tests, which could be coordinated with neighboring countries to account for the regional dimension.
- Revival of credit will depend on external conditions; foreign-owned subsidiaries have been reluctant to lend to each other domestically, mirroring parents’ reluctance.
- Normalizing financial markets in Poland will depend substantially on normalizing markets globally.

Poland has fared much better than many neighbors but remains exposed to regional and global conditions.
Key policy implications emphasized by the IMF:
- Maintain cautious, credible monetary easing while monitoring exchange rate risks.
- Balance short-term cyclical support with medium-term fiscal consolidation starting in 2010 if recovery materializes.
- Strengthen fiscal framework via multi-year binding expenditure limits.
- Implement bank-by-bank stress testing, coordinated regionally, to reduce uncertainty and support interbank market functioning.

IMF Survey: Poland: Bright Spot in Recession-Hit Europe — August 13, 2009