DBRS Confirms Republic of Poland at A, Negative Trend

DBRS, Inc. has confirmed the Republic of Poland’s long-term foreign and local currency issuer ratings at A with a Negative trend, and short-term foreign and local currency issuer ratings at R-1 (low) with a Stable trend.

The A rating reflects Poland’s strong macroeconomic performance with Poland being one of the top growth performers in the EU. Credit strengths include Poland’s fiscal and monetary policy frameworks, flexible exchange rate regime and integration within the EU. Rating challenges include policy uncertainty and its implications for investments and adherence to deficit targets, potential pressure on bank profitability, and its ageing demographics.

President Duda’s proposal of a ‘gradual and voluntary’ rather than a ‘one-off and mandatory’conversion of foreign currency mortgage loans is encouraging. However, the Negative trend reflects the uncertainty of the terms of mortgage conversion on bank profitability, concerns over the fiscal outlook, and Poland’s strained relations with the EU, with the European Commission now adopting the “Rule of Law Recommendation”.

Poland’s ratings are underpinned by its solid macroeconomic performance, with it being among the top growth performers in the EU during the last decade. Growth averaged 3.8% during the last decade (2005-2015), supported by a strong policy framework including a credible inflation targeting regime, a flexible exchange rate policy and Poland being one of the largest beneficiaries of EU funds, which helped it integrate into Western Europe. While lower investments have resulted in near term trends in growth decelerating to 2.5% for the quarter ending September 2016, growth is likely to pick up in 2017. Key drivers on the consumption side include favorable trends in real wage growth and employment, while investments are likely to be supported by favorable financing conditions and EU transfers under the new 2014-2020 financial framework.

Poland has made progress consolidating its fiscal accounts with the headline deficit declining from over 7% levels after the crisis to 2.6% in 2015, thus enabling Poland to exit the EDP a year ahead of schedule. The budget targets deficits of 2.6% of GDP in 2016, 2.9% in 2017, 2.0% in 2018 and 1.3% in 2019. Despite the implementation of Family 500+ (child benefit scheme), one off revenue measures will likely enable the government to meet its 2.6% fiscal target for 2016. However, the outlook in the coming years is uncertain due to lack of revenue enhancing measures to offset the on-going PLN 500 child benefit program and the recent change in lowering the retirement age.

Poland’s debt ratios have stabilized (51.1% of GDP in 2015) with the underlying debt dynamics pointing to a relatively stable debt trajectory. Near term fiscal risks are mitigated by the benign interest rate environment and favorable debt composition. However, the recent lowering of the retirement age, coupled with Poland’s unfavorable demographics could impact the long-term stability of public finances.

Poland faces several policy-related and economic challenges. On the fiscal front, the outlook for 2017 and 2018 is uncertain, with a possibility of deficits exceeding budget targets. In addition to the Family 500 scheme, this is due to the recent lowering of the retirement age and the recent rise in income tax free thresholds.

Secondly, concerns on the banking sector have somewhat reduced with the presidential draft foreign currency mortgage restructuring bill pointing to a gradual central-bank and regulator led ‘voluntary’ conversion of foreign currency mortgages into zloty, rather than a one-time forced mandatory conversion by the government. However, profitability remains under pressure due to (1) uncertainty of terms of conversion including additional capital requirements on the existing Swiss franc denominated mortgages and (2) the impact of the 0.44% banking sector tax on the adjusted assets of the financial institutions.

Thirdly, business sentiment appears to be dented due to uncertainty around the new government’s policy measures and its lack of response to the European Commission’s “Rule of Law Recommendation” in July 2016. The constitutional court stalemate continues as Poland has not complied with the EC’s recommendation deadline of October to implement the necessary steps. Resolution of these issues is important for Poland’s credit profile, as failure to do so could take a toll both on real domestic investments and on other asset classes. For instance, while the composition of Poland’s public debt profile partially mitigates its exchange rate and refinancing risks, the relatively high share of foreign participation in the domestic bond market (currently at 35%) makes Poland vulnerable to bouts of volatility in risk-off environments.

Lastly, similar to other European nations, Poland faces the long term challenges arising from unfavorable demographic trends. The proposed reduction in the retirement age, combined with Poland’s unfavorable demographic outlook with its old-age dependency ratio (ratio of population aged 65+ per 100 of population aged 20-64) expected to increase from 20.9 % in 2010 to 58 % in 2050, could take a toll on the medium-term sustainability of public finances.

RATING DRIVERS
The ratings could be lowered if (1) Poland’s fiscal stance weakens materially and policy uncertainty undermines the economic outlook (2) mortgage conversion adversely impacts financial stability, and (3) if the government fails to address concerns regarding the Rule of Law resulting in a weaker investment climate. Conversely, the trend could be changed back to Stable, if the fiscal targets are adhered to, the government ensures that the impact of the foreign currency mortgage loan conversion doesn’t undermine financial institutions and Poland addresses the constitutional court crisis and concerns raised by the Europe Commission.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales. These can be found at http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include Ministry of Finance, National Bank of Poland, Central Statistics Office, Eurostat, IMF, OECD, European Commission, Haver Analytics, DBRS. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Rohini Malkani
Rating Committee Chair: Roger Lister
Initial Rating Date: 11 December 2015
Most Recent Rating Update: 10 June 2016