core sector communique

EUROPEAN UNION ECONOMIES

Poland: European Success Story but Challenges Ahead

By Camilla Andersen
IMF Survey online

March 26, 2010

• GDP growth of 2¾ percent expected in 2010, rising to more than 3 percent
• Fiscal consolidation main challenge ahead, as country prepares for elections
• Limited export reliance, flexible exchange rate helped cushion crisis blow

The IMF is expecting Poland to post a growth rate of 2¾ percent in 2010, increasing to more than 3 percent in 2011. But upcoming elections are likely to provide a challenging backdrop to policies, the IMF’s Poul Thomsen tells IMF Survey online.

Poland stands out as the only economy in the 27-member European Union to have escaped a recession in 2009. Following the onset of the crisis, exports dropped and economic growth slowed, reflecting deep recessions in Poland’s main trading partners. There was also a sharp slowdown in credit growth as banks tightened their lending criteria. But Poland’s limited reliance on exports, flexible exchange rate, and sound economic policies helped cushion the blow of the crisis. Today, the country remains well positioned for a return to healthy growth.

Thomsen, the IMF’s mission chief for Poland, looks at the country’s prospects, as the world economy continues its recovery from the global financial crisis. He also discusses the unique set of circumstances that protected Poland’s economy during the crisis, including the government’s decision to access the IMF’s new loan instrument for strongly performing economies, the Flexible Credit Line (FCL).

IMF Survey online: As the only member of the European Union to avert outright recession during the global economic crisis, is Poland’s economy likely to rebound more quickly than its peers in central and eastern Europe?

Thomsen: Poland is likely to continue to perform better than most countries in the European Union and better than most of its peers in central and eastern Europe. The global economic environment is improving, and the balance sheet adjustment that happened in response to the crisis appears to have run its course. We also believe that there is new risk appetite among banks, which suggests that credit will start to slowly expand. Another boost to growth will come from the expected near tripling of EU funds to Poland in the next few years.

Against this background, we expect a continued recovery in domestic demand. As a result, we see GDP growth accelerating from 2¾ percent in 2010 to more than 3 percent in 2011.

IMF Survey online: With presidential and parliamentary elections coming up in 2010 and 2011, what are the main challenges for the government?

Thomsen: The main challenge is to begin withdrawing the large fiscal stimulus in order to gradually reduce the fiscal deficit.

Poland added significant fiscal stimulus during the crisis. Indeed, this was one of the major reasons why Poland did not fall into recession during the crisis. The government enacted a discretionary fiscal relaxation of 4½ percent of GDP and allowed the automatic stabilizers to work. As a result, the fiscal deficit rose from less than 2 percent of GDP in 2007 to more than 7 percent in 2009.

This fiscal policy response was entirely in line with the IMF’s recommendation to Poland and to other countries with sufficient space for fiscal maneuver during the crisis.

"Poland is likely to continue to perform better than most countries in the European Union and better than most of its peers in central and eastern Europe."

But now that Poland is in a relatively strong cyclical position compared to other countries, the time has come to gradually withdraw the fiscal stimulus. With three rounds of elections―local elections, followed by presidential and parliamentary elections―coming up during the next 18 months, this will pose challenges to policymakers.

So the main issue at this stage is to decide the speed with which Poland should reduce its fiscal deficit. Now, the government has set a target of reducing it to 3 percent by 2012. We actually think that might be too ambitious, and that the government might be better off targeting a reduction to 3 percent by, say, 2014. Even achieving this delayed goal would require additional fiscal measures compared to what is currently being planned.

IMF Survey online: Markets seem to hold a very favorable view of Poland’s economy. What can the government do to maximize the benefits and minimize the risks associated with capital inflows?

Thomsen: There clearly is a risk that strong performing emerging markets, like Poland, will be a target for large capital inflows, particularly as long as there still is a lot of liquidity in the global economy. This could lead to a situation where the zloty appreciates too fast.

In that case, given where Poland is right now, with inflation under control and perhaps even dropping below the official inflation target, there would be scope for lowering interest rates further to discourage capital inflows. Moreover, there may also be circumstances where the central bank can intervene without jeopardizing the inflation-targeting framework. Of course, if these measures do not work, and if capital inflows persist on a large scale and were to cause overheating, the classical advice is to tighten fiscal policy and allow the zloty to appreciate.

IMF Survey online: Looking back to the crisis, what were the key factors that enabled Poland to avoid a recession?

Thomsen: First, Poland is a fairly big economy with a large domestic market, which makes it less dependent on exports. During the crisis, this meant it was less exposed to negative spillovers through the trade channel than other countries in central and eastern Europe, for instance Hungary and the Czech Republic.

Second, Poland has a well capitalized and profitable banking system. That also helped mitigate possible contagion through the financial channel.

A third factor is that policymakers had considerable room for countercyclical monetary and fiscal policy, because Poland did not have any severe macroeconomic imbalances on the eve of the crisis.

"There clearly is a risk that strong performing emerging markets, like Poland, will be a target for large capital inflows."

Finally, the country has clearly been helped by its flexible exchange rate. Overall, the fact that Poland did so well speaks not only to its strong economic fundamentals, but also to good policy management and sound economic policies.

IMF Survey online: Poland was one of the first countries to access the IMF’s Flexible Credit Line. What impact did the FCL have?

Thomsen: It’s clear that the FCL had a positive impact on the markets, particularly on the market for zloty-denominated government bonds. It’s worth remembering that the government still intended to try to stick to the original deficit limit during first half of 2009.

Then, halfway through 2009, the deficit target was—appropriately—increased, allowing the general government deficit to rise from 3–4 percent to close to 7 percent of GDP. The availability of the credit line with the IMF was an important reason for the increase not to have spooked the markets. In other words, the FCL contributed to the room for maneuver that allowed policymakers to implement countercyclical policies.

IMF Survey online: Poland’s flexible exchange rate helped the country adjust during the crisis. How quickly should Poland seek to adopt the euro?

Thomsen: The authorities have never set an official date, although at some stage there was an unofficial target date of 2012. Given the adjustment effort that lies ahead for Poland in the next couple of years, one should not set an early date for ERM II entry.

More generally, in determining when to adopt the euro, policymakers should be mindful of how well their country has been served by the flexible exchange rate policy. That said, there is no doubt that euro adoption remains an important goal for Poland.