DBRS Confirms Republic of Poland at A, Stable Trend

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

KEY RATING CONSIDERATIONS

The ratings confirmation reflects Poland’s continued strong macroeconomic performance, its prudent fiscal and monetary policy frameworks, its flexible exchange rate regime, and its good level of integration within the EU. Poland has been among the top growth performers in the EU over the last decade, with Q1 2018 GDP growth rising to 5.2% on an annual basis. Growth is expected to remain strong in the medium-term, led by private consumption and public-sector investments. Prudent fiscal management has resulted in a steady narrowing of the deficit. Higher revenues, due to a significant increase in revenue efficiency, led to a sharper than expected contraction in the deficit from 2.3% of GDP in 2016 to 1.7% in 2017. Deficits are likely to remain stable in the coming years.

Despite these strengths, Poland’s ratings are constrained by unfavorable demographics and its relatively low GDP per capita. DBRS is also monitoring the lack of response to the European Commission’s “Rule of Law” recommendation and its uncertain impact on future EU funding and institutional quality. Nonetheless, the confirmation of the stable trend reflects DBRS’s assessment that risks to the ratings currently are broadly balanced.

RATING DRIVERS

DBRS views that Poland is well placed in the A rating category. Upward rating drivers include: (1) structural reforms to increase total factor productivity, thereby enabling Poland to sustain economic growth over the medium term; and (2) a reduction in the structural deficit combined with a steady decline in public debt, beyond baseline expectations. Downward rating drivers include one or a combination of the following: (1) a relaxation of fiscal discipline contributing to a material reversal of the declining public debt ratio trajectory, or (2) a less predictable policy framework including uncertainty regarding the resolution with the EU on ‘Rule of Law’ or (3) weaker economic performance, because of domestic or external shocks, that adversely affect growth prospects.
 
RATING RATIONALE

Domestic and External Demand Support Poland’s Steady Income Convergence to EU Levels

Poland has been one of the fastest growing economies in the EU, with annual growth averaging 3.9% during 2004-2017. Growth is likely to remain strong, driven by both consumption and investment, and is projected to amount to 4.3% in 2018 and 3.7% in 2019. Furthermore, Poland is the largest beneficiary of the European Structural and Investment Funds (ESIF). Since joining the EU, Poland has been receiving nearly 20% of the EU’s Cohesion Funds and is expected to receive up to EUR 86 billion for the 2014-2020 period. This is equivalent to 2.7% of GDP annually and constitutes 54% of expected public investment. In addition, low financing costs, high capacity utilization levels, and strong corporate profits bode well for private investment. Stable employment growth, wage growth, and the fiscal impulse of the Family 500 plus scheme will continue to boost consumption as well. Because of its resilient growth, Poland has made significant progress in narrowing the gap in living standards with the EU. GDP per capita in purchasing power terms increased from 49% of the EU-27 average in 2004 to 69% in 2016.

External performance is expected to remain competitive. Similar to its Eastern European counterparts, Poland is fully integrated into the regional supply chain and manufactures a diverse range of high value-added components for machinery and transport equipment, electronics, and other sectors. Strong exports and lower prices of energy-related commodities have narrowed the trade balance while the development of business processing centers has resulted in Poland’s surplus on its services balance, stabilizing at 2% of GDP. This has resulted in a steady narrowing of the current account deficit to 0.4% over the last four years from annual average deficits of 5% during 2004-2012.

Strong Government Balance Sheet and Prudent Fiscal Management

Poland’s prudent fiscal framework and its low levels of debt reflect the country’s commitment to meeting its fiscal targets. 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 deficit coming 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 resulting in the VAT compliance gap narrowing sharply from 24.2% in 2015 to 14% in 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.

Improved fiscal and economic conditions have placed Poland’s debt as a share of GDP on a downward path. After peaking at 54.2% in 2016 according to the ESA 2010 standards, Poland’s debt-to-GDP decreased to 50.6% in 2017 and is expected to decline over the forecast period to 46.0% in 2021. Alternatively, according to the domestic definition, the debt-to-GDP ratio decreased from 51.9% in 2016 to 48.5% in 2017. This is lower than both Poland’s “prudential” debt threshold of 55% (which activates austerity measures) and the constitutional debt threshold of 60%. 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 5.1 years. In addition, exchange rate and interest rate risks are partially mitigated as 69.3% of its State Treasury debt is denominated in local currency and 77.1% at fixed interest rates. While the relatively high share of foreign investors in State Treasury debt (50.1%) and domestic debt (30.6%) makes Poland vulnerable to bouts of volatility in risk-off environments, an offset is the well diversified investor base.

Banking Concerns Have Eased and Ratings Are Supported by Poland’s Strong Monetary Framework

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 to 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. In its latest policy, the NBP confirmed that the current level of interest rates is conducive to growing the Polish economy on a sustainable path and maintaining macroeconomic balance.

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% in September 2017. Concerns about 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 to the system due to its reliance on household deposits rather than 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. However, it is unlikely to generate systemic risks as the foreign currency mortgage restructuring bill points to a gradual central bank and regulator-led, voluntary/case-by-case conversion of foreign currency loans into zloty rather than a one-time forced mandatory conversion by the government.

Poland’s Relations with the EU Remain at the Forefront of Political Risk

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. It has made changes to Poland’s constitutional court and increased its control over the civil services and public media. In November 2017, the European Parliament backed the European Commission (EC) infringement proceeding under the EU’s “Framework to Strengthen the Rule of Law” against Poland. The lack of response to the EC’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.

DBRS is also monitoring the EC proposal for the 2021-2027 EU Budget, also known the Multiannual Financial Framework (MFF). Poland, which has relied significantly on the EU budget to sustain its development, might be hit by the new proposal. This is due to (1) potential cuts to the structural and investment funds, (2) the possibility of linking the rule of law to funding, and (3) the likely increase in the national co-financing. However, near- to medium-term growth prospects are unlikely to be impacted as funds under the 2014-2020 MFF are likely to be available until 2023 (T+3 rule).

 
RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AA – A range. The main points discussed during the Rating Committee included the economic and fiscal performance, debt trajectory, EU funding and Rule of law and the political environment.

KEY INDICATORS

Fiscal Balance (% GDP): -1.7 (2017); -1.4 (2018F); -1.4 (2019F)
Gross Debt (% GDP): 50.6 (2017); 49.6 (2018F); 49.1 (2019F)
Nominal GDP (EUR billions): 465.1 (2017); 494.1 (2018F); 524.5 (2019F)
GDP per Capita (EUR): 12,104 (2017); 12,859 (2018F); 13,652 (2019F)
Real GDP growth (%): 4.7 (2017); 4.3 (2018F); 3.7 (2019F)
Consumer Price Inflation (%): 1.6 (2017); 1.3 (2018F); 2.5 (2019F)
Domestic Credit (% GDP): 127.2 (2016); 121.6 (2017)
Current Account (% GDP): 0.3 (2017); -0.9 (2018F); -1.2 (2019F)
International Investment Position (% GDP): -60.8 (2016); -60.8 (2017)
Gross External Debt (% GDP): 76.0 (2016); 66.5 (2017)
Governance Indicator (percentile rank): 73.6 (2016)
Human Development Index: 0.86 (2015)

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Real GDP and CPI are drawn from the Eurostat’s spring 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 www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.
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 for this rating action. 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 action.

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
Initial Rating Date: December 11, 2015
Last Rating Date: December 8, 2017

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