Country Report Poland
Benefitting from firming external demand, Poland’s economy gradually turns the corner and its external position improves. Yet, weaker growth left its mark on public finances, forcing the government to take steps to avoid mandatory spending cuts.
Strengths (+) and weaknesses (-)
(+) A relatively large and diversified economy
Compared to its smaller regional peers, Poland’s economic resilience towards external shocks is underpinned by a sizeable domestic market and lower economic openness. Still, close supply chain integration with neighboring Germany contributes to business-cycle synchronicity.
(+) A stable, profitable and well-capitalized banking sector
Poland’s largely foreign-owned banking sector managed to further boost its already strong capital adequacy ratios, while keeping credit quality amid the recent economic slowdown stable.
(-) Elevated public debt levels limit fiscal space
Driven by recurrent sizeable budget deficits and weaker economic growth since the onset of the global economic crisis, Poland’s public debt level is approaching constitutional limits that impose pro-cyclical fiscal consolidation measures. However, a recently-presented pension system overhaul could increase fiscal space and strengthen the sovereign’s short-term fiscal metrics.
(-) A sizeable external financing requirement
Given an external financing requirement of about USD 150bn (30% of GDP) in 2013, considerable foreign participation in the local banking sector and rising foreign ownership of złoty-denominated government debt, Poland remains exposed to the withdrawal of external financing.
1. Poland’s economy seems to gradually turn the corner
Following a 15-months slowdown, Poland’s economy seems to have bottomed out in the first quarter, as strong net exports drove a 0.8% yoy expansion in the second quarter, up from a weak 0.5% yoy expansion in the first three months of the year. While Poland’s export sector benefits from strengthening growth in Germany, its improved situation has not yet had spill-over effects on currently weak domestic demand. So far, private consumption growth remained depressed by elevated unemployment levels and declining real wages, which sent consumer confidence tumbling and contributed to a rise in precautionary savings. Meanwhile, investments were held back by the government’s fiscal consolidation measures, enterprises’ ample spare capacity and doubts about the economic outlook. Domestic demand is expected to improve in the second half of this year, however, as unemployment gradually declines and real wage growth improves on the back of low inflation. The turnaround of the economy will likely be further boosted by the central bank’s recent easing cycle and the government’s decision to relax fiscal consolidation this year.
2. Lower-than-expected growth forces government to suspend legal debt limits
Poland’s weak economic performance left its mark on the country’s government finances, as tax revenues came in strongly weaker than expected, forcing the government in July to raise its budget deficit target for this year by about 1% of GDP. Given the weakness of domestic demand (and the marked decline of the current cabinet’s popularity), it refrained from additional tax hikes and opted for limited spending cuts and the temporary suspension of the first of the country’s legal limits on public debt accumulation in both 2013 and 2014, instead. The limit forbids an increase in budget deficits if public debt, currently amounting to about 55% of GDP, exceeds 50% of GDP. The two-year suspension of the first debt threshold is in line with the recent extension by the European Commission of Poland’s deadline to bring its budget deficit below 3% of GDP by 2015. While Poland’s government had initially hoped to exit the European Commission’s Excessive Deficit Procedure (EDP) in 2013, the temporary alteration of the budget law reflects the country’s marked economic slowdown rather than a fundamental shift in terms of fiscal discipline. The government’s decision not to increase public spending this year and use lower expenditures on the back of a recently presented pension reform (see below) to reduce next year’s budget deficit illustrates that it remains committed to exiting the EDP in 2015.
3. Government presents its long-awaited pension reform
Poland’s government presented a major pension reform in early September that could drastically change the role of private pension funds within the country’s pension system. As of next year, Poland’s 14 Open Pension Funds (OFEs) will be restricted from buying EU sovereign bonds and their current public debt holdings (USD 37bn, about 50% of total assets) will be transferred to the government-run Social Insurance Institution (ZUS). At the same time, investment restrictions regarding other asset classes will be relaxed. Unless participants declare that they still want to pay part of their pension premiums to the OFEs, they will switch to the ZUS by default. Private pension pots of people that are 10 years from retirement should be gradually shifted to ZUS. So far, it remains unclear how the OFEs will be compensated. According to Prime Minister Tusk, the reform aims at reducing risks for future pensioners, while restricting Poland’s public debt. Due to the transfer of public debt to the government-run ZUS, Poland’s public debt level could be lowered by up to 8% of GDP and next year’s budget deficit could be reduced by about 0.3% of GDP through lower borrowing costs. While parliamentary approval of the reform is likely, President Komorowski stressed his duty to assess the proposal’s constitutional conformity. If approved, the reform could create additional fiscal space, but this gain would come at the cost of reduced availability of local funds on domestic capital markets and, possibly, a tarnished reputation.
4. Recent current account surpluses helped amid concerns about US Federal Reserve tapering
Poland’s current account balance went into surplus in the second quarter, as improving exports and sluggish imports due to depressed domestic demand generated a surplus on the trade balance. The reduced dependency on foreign funding came at a welcome moment, as concerns about the impact of the Federal Reserve’s tapering led to an outflow of foreign funds from countries with large current account deficits. So far, Poland does not seem to be affected by this trend, as the złoty has remained relatively stable, while long-term bond yields stay well-below levels seen during the height of the global economic crisis. Notwithstanding, Poland remains exposed to the risk of foreign fund outflows, particularly so if the ECB were to tighten its monetary policy.
With a nominal GDP of USD 490bn in 2012 and a population of 38.5m inhabitants, Poland is the largest economy in the Central and Eastern European region. In contrast to its smaller peers, like the Czech Republic or Hungary, Poland benefits from a relatively large domestic market, which improves its resilience vis-à-vis external shocks. Nevertheless, the local manufacturing sector is increasingly integrated into German supply chains, which contributes to rising business cycle synchronicity between the two countries. In line with this development, Poland’s exports and imports are dominated by intra-industry trade, primarily with Germany. Notwithstanding these close ties, Poland avoided following Germany into recession in 2009 and managed to post continuous positive economic growth since the end of Communism in the early 1990’s. Convergence of GDP per capita levels between the two countries is far from complete, however, illustrating Poland’s considerable catch-up potential. Poland is expected introduce the euro in the coming years, but given its failure to meet the Maastricht treaty budget deficit criterion (3% of GDP) and the ongoing uncertainty regarding the euro area sovereign debt crisis, no definite accession date has been set yet. Consequently, it will likely keep its freely floating złoty in the years to come, whereby the central bank may at times opt to stabilize the exchange rate, given the country’s exposure to foreign-currency denominated debt. Poland’s social situation is stable and the current government enjoys a slim, yet shrinking, parliamentary majority. Provided incumbent prime minister Donald Tusk can complete his second term, the next general elections are scheduled for late 2015, while presidential elections will be held in mid-2015.