Poland country assessment

• Implementation of the announced fiscal consolidation strategy is vital. This is key to sustaining investor confidence amid broader concerns over sovereign exposures. It will require difficult choices in restraining social expenditures.
  
• Reducing the influence of the state remains an overriding priority. Continuation of the privatisation programme, in particular in key sectors such as energy and mining, is essential, even in less propitious market conditions. Full unbundling of the energy sector also remains a priority.
  
• Completion of the pension reform process could help the development of local capital markets. Corporate bond markets or mortgage-backed bonds could play an important role in bridging maturity mismatches on bank balance sheets and in making long-term funds available for private and public investment.  

Poland remains on an impressive growth path. Gross domestic product (GDP) growth accelerated to 3.8 per cent in 2010, and even picked up momentum in the first half of 2011. This is supported by growth in wages and disposable income and a slight drop in unemployment, which underpinned consumption, as well as the government’s capacity to absorb EU grant funds, which boosted public investment. Poland’s exports have benefited from the strong recovery in industrial production in Germany up to the second quarter of 2011. In the context of favourable growth the banking sector has remained profitable and well-capitalised, with private sector credit recently growing by about 9 per cent in annual terms, primarily due to renewed mortgage lending.
 

The underlying deficit was allowed to further widen last year to 7.9 per cent of GDP. The government has targeted a reduction in the deficit in 2011 to 5.6 per cent of GDP, which will stem partly from a reduction in contributions to mandatory pension funds, as well as a freeze in the public sector wage bill and cuts in certain social security expenditures. Accomplishing the targeted reduction in the government deficit to under 3 per cent next year (which would allow Poland to exit the EU’s Excessive Deficit Procedure), will depend on more broad-ranging reforms in social expenditures, especially early retirement benefits to farmers and uniformed personnel such as the military and police. One symptom of the so far loose fiscal policies has been the slight widening in the current account deficit, and market concerns over external vulnerabilities were further fuelled by a statistical correction of recent balance-of-payments data. Hence the central bank engaged in some rate tightening in early 2011. Amid rapid outflows of portfolio capital from emerging markets the zloty weakened in September 2011, prompting an unusual intervention by the national bank in the foreign exchange markets.
 

Trend growth of between 3 to 4 per cent over the medium term is feasible. However, this depends on whether capacity constraints can be overcome through stronger renewed bank lending to the corporate sector, and whether the necessary structural reforms are carried out. A key risk is that debt limits under national legislation (the 55 per cent of GDP legal limit and the constitutional threshold of 60 per cent of GDP) are reached, imposing the need for a sudden fiscal correction. Moreover, in 2011 Poland received substantial inflows into its government bond markets (about 4.5 per cent of GDP) where about 27 per cent of capitalisation is now owned by non-resident investors. This funding window would be susceptible to a further resurgence of risk aversion.

State involvement in the Polish economy remains extensive. This is especially the case in the power, natural resources and banking sectors. The country ranks 70th out of 183 countries in the World Bank’s Doing Business 2011 survey, which represents a slight improvement over the previous year. Rankings in dealing with construction permits, paying taxes and starting and closing a business all improved slightly. The government is seeking to address these bottlenecks and a deregulation package which aims to ease business activity and lower administrative costs of doing business was submitted to parliament in July 2011.
 

Poland has nevertheless remained attractive to foreign direct and portfolio investors. Notwithstanding the continued barriers in the investment environment, foreign direct investment (FDI) inflows have risen in the first half of 2011 relative to a year earlier, with notable foreign investment projects in particular in the BPO (Business Process Outsourcing) and research and development sectors. The 21 initial public offerings (IPOs) floated on the Warsaw Exchange in 2010 also attracted significant interest from portfolio investors, and the Warsaw Stock Exchange has further solidified its position as a regional equity platform.
 

The privatisation process has continued to accelerate. Following the streamlining of privatisation procedures in 2008, sales accelerated notably last year in favourable market conditions, and a number of significant deals went ahead, representing in total 1.6 per cent of GDP. Sales of minority stakes in power company PGE and the insurance company PZU, as well as a 64 per cent stake in the Warsaw Stock Exchange, underlined strong investor interest. With this volume the government has nearly met its target of a PLN 25 billion privatisation volume for the year. While the target for 2011 is again ambitious(standing at PLN 15 billion), market conditions became less propitious in the middle of the year. A number of examples highlighted the government’s reluctance to sell full majority stakes in particular in the energy and financial sectors. The sale of energy firm Energa to PGE, which remains state-owned, was blocked by the competition authority in January 2011 and this decision has now been taken to court. In the power sector the government’s policies, in particular with regard to full unbundling in the sector, remain unclear.
 

Infrastructure is being upgraded through the rapid absorption of EU structural funds. The total allocation to Poland under the 2007-13 EU budget plan is substantial, amounting to 22 per cent of Poland’s 2008 GDP. The availability of these grant funds may have constrained the involvement of other creditors. Since a law on public-private partnerships (PPPs) was passed in 2009, a substantial number of PPPs have been announced, although to date only 12 deals have been signed, amounting to less than €100 million.
 

Poland’s pension system has been curtailed. The initial pension reform in 1999 had a positive impact on capital market development, on easing future liabilities of the state pension system and building a savings culture among the workforce. However, at the end of 2010 it was announced that the contributions to open pension funds were to be reduced from 7.3 per cent of gross salaries to 2.3 per cent from May 2011, (rising to 3.5 per cent by 2017). This partial reversal of the earlier reforms was motivated by the substantial fiscal costs of moving from an unfunded to a partially funded pension system. The government was also concerned that an estimated 70 per cent of fund contributions were effectively returned to government accounts through either government bonds or privatised state-owned companies and that fee income of the industry appeared substantial. A broader redesign of benchmarks, of permissible investment portfolios and of the fee structure remains outstanding, although with over 15 per cent of GDP in invested assets, the sector will likely remain an important institutional investor.
 

Polish private bond markets remain underdeveloped. Poland has a highly liquid government bond market, which extends to very long maturities. However, the revision in the investment allocation of the open pension funds again highlights the opportunity from corporate bond markets. Capitalisation of the market remains negligible, even compared with other countries in the central Europe region. Bank issuance of bonds could help bridge maturity mismatches on balance sheets. Given the considerable investment need in both the public and the private sectors, bond markets could open an important source of more long-term funding.