Poland -- Concluding Statement of the 2009 Article IV Consultation
June 23, 2009
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Poland—Concluding Statement of the 2009 Article IV Consultation
Warsaw, June 23, 2009
• While Poland is likely to see a small contraction in output in 2009, it is doing better than most of its peers in Central and Eastern Europe. This reflects in part that Poland entered the crisis with smaller external and internal imbalances.
• We would recommend a further reduction in policy rates, although the MPC should move cautiously, taking into account implications for the zloty.
• As to fiscal policy, the room for maneuver is less, because policies were pro-cyclical before the crisis. Thus, the extent to which the deficit can be allowed to increase as the economy weakens depends on taking credible measures to strengthen confidence in the authorities’ commitment to medium-term consolidation targets.
• However, even with such policy adjustments, a sustained recovery will, to a large extent, be externally driven. In particular, because of the importance of foreign-owned banks, restoring a normal functioning of financial markets in Poland will depend much on restoring functioning markets globally.
1. The financial turmoil hit Poland swiftly in late 2008. Following the onset of the crisis, Poland experienced a rapid capital outflow, a significant depreciation of the zloty, and a freezing of the interbank market. The subsequent decline in credit growth, combined with lower exports, contributed to a marked decline in GDP growth. Still, Poland is performing better than most of its peers, because it entered the crisis without large external and internal imbalances, and its economy is less dependent on exports and less leveraged.
2. The mission projects a mild recession in 2009 and a slow recovery in 2010. Domestic demand is likely to contract further, as private investment retrenches, consumption weakens, unemployment rises, and credit and wage growth recede. Consequently, the mission projects GDP to decline by about ½ percent in 2009 and to only recover modestly by about 1 percent in 2010. With imports declining faster than exports, we expect a significant decline in the current account deficit. Inflation is expected to continue to ease.
3. Recovery will likely be externally driven. Moreover, it will critically depend on restoring the normal functioning of the international financial system. From the Polish perspective, such normalization is not only key to reviving growth in export markets, but also to restore credit growth as foreign-owned banks dominate the domestic financial sector. In this regard, our projection assumes a sustained improvement in the global economy and in the functioning of the international financial system, of which there are only tentative signs. This, and the precarious situation of several countries in the region, suggest that risks to the outlook are tilted to the downside.
B. Fiscal Policy
4. The fiscal position is deteriorating. In 2008, a discretionary relaxation enacted before the crisis, one-off spending increases, and revenue shortfalls led to a general government deficit of almost 4 percent of GDP, above the budget target and the Maastricht limit. The 2009 budget contained additional expenditure increases, based on what are proving to be optimistic growth assumptions. Under the mission’s most likely scenario, the deficit is expected to reach 6 percent of GDP in 2009. Moreover, due to the pre-crisis structural fiscal relaxation, it is expected to remain high even as the economy recovers, unless the authorities take corrective actions. In the mission’s view, permanent measures yielding at least 3 percent of GDP will be needed in the coming years to meet the medium-term target of a structural deficit of 1 percent of GDP. The authorities are currently working on adjusting policies for 2009 and formulating them for the following years.
5. Against this background, fiscal policy faces a difficult challenge of balancing short-term cyclical and medium-term sustainability considerations. On the one hand, allowing the deficit to reach 6 percent of GDP in 2009 would imply a deep fiscal adjustment in the coming years in order to reach the medium-term target. On the other hand, taking what would amount to pro-cyclical measures in order to slash the deficit would exacerbate the economic slowdown.
6. To reconcile these conflicting objectives, it is, in the mission’s view, essential to take steps to strengthen confidence in commitments to medium-term targets.
• A revised euro-adoption timetable that is ambitious yet realistic could help anchor confidence. However, as the credibility of such a timetable will depend on broader consideration regarding the readiness—economically and politically—to introduce the common currency, this alone might not be enough to strengthen the credibility of medium-term fiscal commitments at this time.
• In the mission’s view, a more important step to boost confidence is to overhaul the fiscal policy framework, which is short of international best practice, especially because medium-term expenditure ceilings have little bearing on annual targets. In particular, the mission recommends establishing multi-year binding commitments. This would strengthen confidence by providing safeguards against pro-cyclical policies, not least during good years.
If a significant upward revision of the deficit limit for 2009 goes hand-in-hand with an improved fiscal framework, the mission believes that markets will not be unsettled by a higher financing need in the short run, suggesting that the impact on the interest rate on government securities will be limited. Moreover, such policy should also reassure European partners that Poland is committed to achieving its medium-term targets even if it allows automatic stabilizers to work in the short-run.
7. The mission could support an increase in the general government deficit to about 5½ percent of GDP in 2009, requiring discretionary measures yielding about ½ percent of GDP, provided that medium-term fiscal expectations can be credibly anchored. On the assumption that a recovery will slowly get underway, permanent measures amounting to about 1 percent of GDP annually would be needed for a three year period, in order to meet—with some delay—the targets agreed with the EU. However, to prevent a strongly pro-cyclical stance, the authorities should be prepared to delay or significantly modify such adjustment if the economy does not begin to recover as assumed. In this regard, it is important to base the 2010 budget on cautious GDP projections to prevent a repeat of 2009, when what proved to be unrealistic assumptions led to the approval of large expenditure increases.
8. Spending reforms will be required to achieve durable medium-term adjustment. This is because statutory expenditures constitute a large proportion of the budget. Some possible options could be in the area of social spending, where recent increases have led to additional fiscal costs. This points to the need for better targeting child deductions in the personal income tax, disability contributions, and pension indexation.
C. Monetary Policy and the Foreign Exchange Market
9. Inflation is set to remain within the tolerance range for the foreseeable future. The recent uptick is likely to be temporary as it reflects primarily increases in international commodity prices and higher administrated prices. Credit growth—particularly, corporate lending—has slowed sharply, reflecting sluggish demand for credit and a tightening supply of loans in the face of persisting uncertainty in global markets, re-pricing of risks, and a strong preference for liquidity. Meanwhile, while still volatile, the zloty appears to have stabilized, CDS spreads have eased, and government bond yields remain stable, despite expectations of a notable increase in the government’s borrowing requirement. In this regard, the availability of the FCL appears to have reassured markets.
10. Against this background, the mission supports a continued loosening bias in monetary policy and believes that a further early cut in policy rates is warranted. Monetary policy should stand ready to accommodate fiscal policy if increases in the government’s borrowing requirements exert pressure on domestic interest rates. In recommending a further relaxation, the mission has taken into account that the MPC—after a decade of determined focus on inflation control—has succeeded in building considerable confidence in monetary policy.
11. The scope and pace for interest rate reduction will dependent on external financing constraints. Lower interest rates are not expected to weaken the zloty at this juncture. In fact, pressures on the exchange rate could continue to moderate as Poland’s cyclical position and monetary policy stance relative to those of the euro area and the US appear to be strengthening. Moreover, the weakening of the zloty that has already taken place has served to align the real exchange rate with fundamentals, and the current account is set to continue to improve. However, the risk of contagion from adverse developments in the region, not least the Baltics, and more generally from the still unsettled state of the global financial system, can not be excluded. However, recent experience suggests that such spillovers are likely to be transitory.
12. Restoring the normal functioning of the interbank market is likely to depend mainly on external factors. So far, measures to unfreeze the market have not succeeded in restoring transactions with longer maturities. To a large degree, the reluctance of foreign-owned subsidiaries to lend to each other in the Polish interbank market mirrors the reluctance of their parents to do so. This suggest that normalizing financial markets in Poland will, to a large degree, hinge on normalizing such markets globally.
D. Financial Sector Policies
13. The situation in the banking system is challenging. Slowing GDP growth and rising unemployment are increasing non-performing loans. At the same time, interest margins are being compressed as funding has become expensive, partly due to higher competition for domestic deposits. As a result, profits are being squeezed, and capital adequacy ratios are poised to decline. However, the system is well buffered—profitability and capital adequacy ratios were high going into the crisis—and top-down stress tests suggest that only an unexpected deep and prolonged recession will cause significant capital shortfall. Moreover, foreign exchange risks related to foreign currency options and mortgages have been limited and do not appear to be systemic.
14. Vigilance and pre-emptive measures by the authorities remain key in the current situation. In this regard, encouraging banks to boost capital buffers, mainly by retaining the record-high 2008 profits, has been effective. Timely information disclosure and clear policy communication can serve to bolster confidence. As a complement to the top-down stress test performed by the NBP, we see a case for the KNF’s conducting systematic, bottom-up, bank-by-bank stress tests based on a consistent set of macroeconomic projections. This would help identify emerging weaknesses and potential bank recapitalization needs, and more generally alleviate uncertainty in the financial system. A national effort in this regard would complement the EU’s approach of stress-testing major banking groups, and such an exercise could be coordinated with neighboring countries.
15. We support the KNF’s effort to strengthen supervision of credit unions (SKOK). While we have no evidence of problems in these institutions, we are concerned that they have no direct access to a lender of last resort facility, are not supervised by the KNF, and are not covered under the banking guarantee fund, but only by their internal insurance fund. While they are small (as a share of total banking assests) and, on their own, are unlikely to pose a systemic risk, any problems could have potential contagion effects on the rest of the financial system.
16. With the prospect that global deleveraging and regulatory reforms will reduce intermediation through banks, it should be a matter of priority to foster the development of domestic capital markets. The equity market has been growing with increasing number of IPO’s and market capitalization, aided by active measures such as an introduction of new corporate governance rules and a new trading platform for start-ups and new companies. The non-government bond market, however, remains small and illiquid. Measures to facilitate corporate debt issuance, such as enhancements in market infrastructure in the areas of custody and depository and streamlining issuance procedures, could support the development of the market. Moreover, to diversify funding of banks’ mortgage credit portfolio, universal banks should be allowed to issue covered bonds to mobilize longer-term funds and reduce maturity mismatch.
E. Structural Reforms
17. A primary challenge facing Poland is to boost potential growth by increasing its exceptionally low labor participation. In this regard, the reform of the early retirement provisions last year is a major step forward. Looking forward, efforts should focus on gradually increasing the retirement age and equalizing the retirement age of men and women. Moreover, there is also a need to reform special pension schemes with the goal of merging these in the general pension scheme. Labor market reforms could be complemented by continued efforts to improve the regulatory interface with business and the reinvigoration of the privatization plan.