DBRS Confirms Republic of Poland at A, Stable Trend

DBRS, Inc. has confirmed the Republic of Poland’s Long-Term Foreign and Local Currency – Issuer Ratings at A. The Short-Term Foreign and Local Currency – Issuer Ratings have been confirmed at R-1 (low). The trend on all ratings is Stable.

The A rating reflects Poland’s strong macroeconomic performance, its fiscal and monetary policy frameworks, flexible exchange rate regime, and integration within the EU. Poland has been one of the top growth performers in the EU, exiting the Excessive Debt Procedure a year ahead of schedule and meeting its fiscal targets. Rating challenges include unfavorable demographics, policy uncertainty and Poland’s relatively low GDP per capita.

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 has been 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. Secondly, Poland has made progress consolidating its fiscal accounts enabling Poland to exit the EDP a year ahead of schedule. Poland also has a relatively solid fiscal framework that includes debt rules, which limit public debt to 60% of GDP with a threshold limit of 55% that activates austerity measures and a stabilizing expenditure rule which facilitates eliminating fiscal imbalances. Lastly, Poland’s EU membership is an integral component of its credit strength, both in terms of financial support and in preferential access to trade and financial markets.

Despite its credit strengths, Poland faces several policy-related political risks and economic challenges. First, the lack of response to the European Commission’s “Rule of Law” recommendation has so far not materially impacted the economic environment in Poland, but penal action by the EU could take a toll on real domestic investment and on other asset classes. This could impact Poland’s credit profile. While concerns regarding the banking sector have eased with the foreign currency mortgage restructuring bill pointing to a gradual regulator-led ‘voluntary’ conversion of foreign currency mortgages into zloty, profitability could come under pressure due to uncertain terms of conversion including additional capital requirements on the existing Swiss franc denominated mortgages. In addition, like other European nations, Poland’s demographic outlook is adverse. The reduction in the retirement age, combined with the expected increase in the old-age dependency ratio from 22.5% in 2015 to 56.3% in 2050, could take a toll on the medium-term sustainability of public finances and lead to a tightening of labor markets.

Poland’s political risk is important to the credit assessment, but we believe the impact of such risks is moderate at this time. Poland’s relations with the EU remain at the forefront of political news. Since taking office in October 2015, the Law and Justice Party (PiS party - right wing with strong nationalist leanings) has implemented some of its pre-election promises which could take a toll on Poland’s fiscal situation and its attractiveness as an investment destination. Measures implemented include the Family 500+ scheme, which is positive for domestic consumption, but has fiscal ramifications. The government also passed legislation lowering the retirement age to 65 years for men and 60 for women, which poses an additional burden on public finances. However, on a positive note, President Duda’s draft foreign currency mortgage restructuring bill points to a gradual regulator led ‘voluntary’ conversion of foreign currency mortgages into zloty, rather than the earlier proposal of a one-time forced mandatory conversion by the government. This significantly alleviates financial stability risks.

In addition to economic reforms, the PIS government has also proposed judicial reforms, made changes to Poland’s constitutional court and increased its control over the civil services and public media. Earlier this year in July, President Duda vetoed two of the three judicial reforms on the Supreme Court and National Judiciary Council, but agreed to sign the third bill relating to the lower courts. In November, the European Parliament backed the European Commission infringement proceeding under the EU’s “Framework to Strengthen the Rule of Law” against Poland which could result in Article 7 of the EU constitution being invoked. However, the decision to impose sanctions appears unlikely, as it would require a unanimous vote by all the EU members. Nonetheless rule of law is important in our credit assessment and DBRS is monitoring its resolution, as failure to do so could take a toll both on real domestic investments and on other asset classes.

Positive offsetting credit factors include Poland’s progress in consolidating its fiscal accounts, that is likely to be maintained. The headline deficit declined from over 7% of GDP after the crisis to 2.6% in 2015, thus enabling an exit from the Excessive Deficit Program in 2015. Moreover, despite the implementation of the new government’s spending proposals in 2016 which include the child benefit program, higher revenue collections have enabled the government to meet its 2.5% headline fiscal target. The deficit is likely to come in substantially lower than expected at 1.7% in 2017 and remain stable in 2018. The reduction in the deficit is primarily due to favorable macroeconomic conditions and an improvement in revenue efficiency, which is likely to offset expenditure arising from the on-going child benefit program and the lowering of the retirement age effective October 2017. Nonetheless, further progress on improving Poland’s tax efficiency and pension reforms are necessary for Poland to comply with its structural budgetary objectives over the medium term.

Poland’s prudent fiscal framework and its low levels of debt reflect the country’s commitment to meeting its fiscal targets. The government’s debt strategy of pre-financing future borrowing needs, resulted in Poland’s debt-to-GDP ratio rising to 54.1% in 2016 according to the ESA 2010 standards. Measured by domestic methodology the debt-to-GDP ratio was at 51.9%, lower than Poland’s “prudential” debt threshold of 55% which activates austerity measures” as well as the constitutional debt threshold of 60%. Debt dynamics are supported by a favorable growth-interest rate differential, and with low funding costs, Poland’s debt-to-GDP is expected to decline over the forecast period to 52.1% in 2021. Although debt dynamics remain vulnerable to adverse shocks, Poland’s public debt management has effectively resulted in a favourable debt profile, with the average maturity of government debt at 5.2 years. In addition, exchange rate and refinancing risks are partially mitigated as 68.6% of its State Treasury debt is denominated in local currency and 77.6% at fixed interest rates. However, the relatively high share of foreign investors in State Treasury debt (52.1%) and domestic debt (32.5%) makes Poland vulnerable to bouts of volatility in risk-off environments.

Along with the better than expected fiscal performance, Poland has been one of the fastest growing economies in the EU with growth averaging 3.8% during 2006-2016. Following the deceleration in growth to 2.9% in 2016, growth is estimated to increase to 4.2% and 3.8% respectively in 2017 and 2018. The recovery in growth is led by higher investments on the back of disbursement of EU funds under the new 2014-2020 financial framework. Consumption is likely to remain strong due to stable employment growth and higher disposable incomes thanks to the fiscal impulse of the Family 500 plus scheme. Because of its resilient growth, Poland has made progress in narrowing the gap in living standards with the EU. GDP per capita in purchasing power terms increased from 49% of the EU-28 average in 2004 to 69% in 2015. However, regional disparities and a tightening labor market could constrain further convergence and weigh on Poland’s growth potential.

Poland’s ratings are also supported by the credibility of its monetary framework and solid institutions. Following nearly three years of negative price growth driven by commodity prices, CPI turned positive in November 2016. Inflation is projected to average 1.6% in 2017, and rise further in 2018 due to higher commodity prices, but is still lower than the National Bank of Poland’s inflation target of 2.5%, with a symmetrical band of deviation of +/-1 percentage point. Poland’s banking sector remains stable, liquid and profitable, with the average total capital adequacy at 18.0% and Tier 1 capital ratio at 16.5% as in September 2017. Concerns on the sector have eased with the government passing control of the proposal to convert foreign currency mortgages to the Central Bank. The current funding structure of Polish banks adds to stability due to its reliance on household deposits versus market funding. Nonetheless, profitability could come under pressure due to uncertainty of terms of conversion including capital requirements on the existing Swiss franc denominated mortgages.

Poland’s macro-stability is also reflected in the external sector, where due to an improvement in both its trade and services balance, Poland’s current account deficit has narrowed from an average of 5% during 2005-2012 to around 1.5% during 2013-15, and to a nearly balanced position in 2016. While Poland’s net international investment position (NIIP) remains negative at EUR 255 bn (59.9% of GDP) at the end of 2016, external vulnerabilities are mitigated as stable flows (such as foreign direct investments and inter-company debt), constitute the major part of the NIIP. Poland’s gross external debt stands at EUR 319 bn or 75% of GDP, of which general government debt comprises 37.8% while trade credit and intercompany and corporate loans comprise majority of the rest. Risks are largely offset by a steady rise in Poland’s foreign exchange reserves from EUR 55bn in 2009 to EUR 95 bn currently. On November 3, 2017, Poland notified the IMF to end its access to the IMF’s flexible credit line (FCL), which gave it access to funding post the global financial crisis. Over the years, Poland treated the FCL as a precautionary buffer, while continuing to strengthen its foreign exchange reserves and fiscal position.

RATING DRIVERS

Upward rating action will depend on structural reforms to increase total factor productivity, thereby enabling Poland to sustain economic growth over the medium term. A reduction in the structural deficit combined with a steady decline in public debt could also put upward pressure on the ratings. The ratings could be lowered if Poland’s fiscal stance weakens materially leading to a marked deterioration in public debt dynamics. Similarly, a less predictable policy framework including the resolution with the EU on ‘Rule of Law’ or weaker economic performance, because of domestic or external shocks, that adversely affect growth, could put downward pressure on the ratings.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (high) – A (low) range. The main points of the rating committee discussion include Poland’s medium-term growth prospects, its fiscal outlook and concerns regarding the Rule of Law.

KEY INDICATORS
Fiscal Balance (% GDP): -2.5% (2016); -1.7% (2017F); -1.7% (2018F)
Gross Debt (% GDP): 54.1% (2016); 53.2% (2017F); 53.0% (2018F)
Nominal GDP (USD billions): 469 (2016); 510 (2017F); 571 (2018F)
GDP per capita (USD thousands): 12,361 (2016); 13,429 (2017F); 15,050 (2018F)
Real GDP growth (%): 2.9% (2016); 4.2% (2017F); 3.8% (2018F)
Consumer Price Inflation (%, eop): -0.2% (2016); 1.6% (2017F); 2.1% (2018F)
Domestic credit (% GDP): 86.7% (2016); 82.3 (Jun 2017)
Current Account (% GDP): -0.3% (2016); -0.9% (2017F); -1.2% (2018F)
International Investment Position (% GDP): -59.9% (2016); -63.1% (Jun 2017)
Gross External Debt (% GDP): 74.9% (2016); 72.0% (Jun-2017)
Foreign Exchange Reserves (% short-term external debt + current account deficit): 2.4% (2016); 2.7 (Jun-2017)
Governance Indicator (percentile rank): 73.5 (2016)
Human Development Index: 0.85 (2015)

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified are drawn from Eurostat. Real GDP and CPI are drawn from the Eurostat’s autumn forecast. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

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 on www.dbrs.com 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; European Commission; Haver Analytics; IMF, UNDP and DBRS. DBRS considers the information available to it for the purposes of providing this rating to be 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 in connection with this rating.

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, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: 11 December 2015
Last Rating Date: 9 June 2017

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.