Poland, a country of 38 million, has been growing steadily over the past years, with 3.6 percent growth in 2015. However, some policies of the government, in office since November 2015, have dented investor sentiment and could slow down growth, according to the IMF.
Speaking to IMF Survey, Daria Zakharova, IMF mission chief for Poland, discussed the findings of the latest economic health check.
IMF Survey: Poland’s economy has been one of the best performers in Central and Eastern Europe in the past decade. What do you think contributed to this success?
Zakharova: The Polish economy has grown strongly and steadily even during the crisis: it was the only economy in Europe that did not go into recession then. Steady growth allowed Poland to close more than a quarter of its per capita income gap with the euro area over the last 20 years. Much of this major achievement can be attributed to Poland’s very strong policies and institutions, which helped successfully weather the global financial crisis and several bouts of market turbulence since then.
IMF Survey: Despite the steady growth, one ratings agency downgraded its sovereign ratings and another put a negative outlook to it. Are there clouds on the horizon?
Zakharova: Some recent decisions and announcements have made markets jittery and contributed to the Standard & Poor’s downgrade and Moody’s change of the outlook to negative. We don’t think that the authorities’ recent measures would necessarily have major repercussions for near-term growth, but depending on how they are implemented they could negatively affect longer-term and potential growth, by weakening investor sentiment.
A new risk factor on the horizon is the result of the United Kingdom’s vote to leave the European Union, which could affect Poland through trade, financial, and confidence channels, as well as spillovers from its potential impact on the euro area. So far financial spillovers have been manageable. The authorities are well equipped to handle market volatility.
IMF Survey: The Polish economy is growing at full capacity. Is there a danger of overheating?
Zakharova: Right now we’re not worried about overheating in Poland because inflation has been low for the past two years. The current account is almost in balance, and we don’t see any signs of asset price bubbles. In addition, the authorities are in a good position to handle systemic risks, including from potential overheating, as they have recently introduced a full-fledged macro-prudential framework.
However, it is true that while the economy is growing at its potential, fiscal policy is becoming expansionary. It is like pouring more fuel into the fire. Under these circumstances, there is a risk of overheating and asset price bubbles emerging. For these reasons, we advise the authorities to begin fiscal consolidation. Given the favorable economic conditions, now is a good time to reduce the deficit.
IMF Survey: There are persistent disparities between the poor eastern regions and the more prosperous western regions of Poland. What could the government do to balance them?
Zakharova: Indeed, it is almost like two different economies in one country: there is a mainly small-scale agricultural, poorer eastern region with high unemployment, and a more prosperous, faster-growing western part, plugged into the German supply chain. To reduce these disparities faster, the authorities should strengthen vocational training, aligning it with employer needs, scale up infrastructure to attract investment, and help workers’ transition out of agriculture into higher productivity sectors, such as manufacturing and services.
In this regard, the government should gradually phase out taxation incentives and retirement privileges to encourage people to continue small-scale farming. We understand that it is difficult to do this quickly. These measures should be carried out over time, and there should be supportive policies to assist the poor, in particular in Poland’s east.
IMF Survey: The government introduced a new child benefits program, a new banking tax, and it plans to reverse an earlier hike of the retirement age. How do you see the economic effect of these changes?
Zakharova: We are most concerned about the possible reversal of the retirement age increases. The current policy is to increase the retirement age for men from 65 to 67 by 2020, and for women from 60 to 67 by 2040. This, we think, is appropriate as Poland has one of the most adverse demographics in Europe: UN projections show that working age population may be reduced by as much as a third by 2060. Lowering the retirement age could thus weaken the social and financial sustainability of the pension system, and would also undermine growth by reducing the working population.
Another government measure was an introduction of a tax on bank assets, which could undermine credit expansion and, by doing so, reduce consumption and investment. By our calculations, growth could be reduced by as much as 0.4 percentage points by the end of 2016 because of this distortionary tax. A better alternative would be to replace the tax by a more growth-friendly financial activities tax, similar to that in Iceland, Israel, and Denmark.
With regard to the child benefits program, it benefits not just poor families, but also those in the upper income brackets. As a consequence, it is quite costly, at around one percent of GDP, thus complicating the much-needed fiscal consolidation. This program also discourages female labor force participation and does not necessarily encourage fertility. We recommend instead to redirect some of that budget toward child care, which has already proven to increase female labor force participation without negative implications for fertility.
IMF Survey: Poland wants to follow its neighbors and systematically convert Swiss franc mortgages into local currency. What are the risks of such a conversion, why does the IMF prefer a case-by-case treatment instead?
Zakharova: In Poland, about half a million households hold these foreign-exchange-denominated mortgages, which are mainly in Swiss francs. A blanket conversion that covers everyone would be very expensive, and the costs likely pushed onto banks. According to the Financial Supervision Authority in Poland, such a costly proposal as the one presented in January would lead to bankruptcies of several banks.
For these reasons, we could not support this particular proposal. The President’s office has recently unveiled several options for addressing the foreign currency mortgages. However, details and total costs of these proposals are not yet available. That said, the revised proposal is expected to take financial stability concerns into consideration.
IMF Survey: The European Commission officially warned Poland that changes to its constitutional tribunal endanger the rule of law. The IMF assessment warns that these measures could weaken institutions and calls for sound institutions in one of its recommendations. What exactly are you concerned about and what are the economic risks of these changes?
Zakharova: As I mentioned, we think that Poland’s strong institutions have been major contributors to steady growth, helping the country weather external shocks and the global financial crisis well. It is therefore of utmost importance to maintain strong policy frameworks and institutions in the future as well. From our perspective, solid institutions mean first and foremost a credible fiscal policy framework and an independent central bank. However, an independent and effective judiciary system, including the constitutional tribunal, is equally important to ensure accountability of executive and legislative branches.