DBRS Confirms Republic of Poland at A, Stable Trend

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

KEY RATING CONSIDERATIONS

The confirmation of the ratings and trends reflects DBRS’s view that Poland is well placed in the A category. The ratings are supported by Poland’s continued strong macroeconomic performance, its prudent fiscal and monetary policy frameworks, its flexible exchange rate regime, and its increasing level of integration within the European Union (EU). Poland has been among the top growth performers in the EU over the last decade, with GDP growth rate in the third quarter of 2018 amounting to 5.1% on an annual basis. Poland’s strong growth performance coupled with an increase in revenue efficiency has accelerated fiscal consolidation and improved debt dynamics. The fiscal deficit is estimated to narrow to 0.9% this year, from 1.4% in 2017. The country’s impressive growth and fiscal performance has resulted in Poland being upgraded to ‘developed market’ status by international equity index providers in September 2018.

Despite these strengths, Poland’s ratings are constrained by unfavorable demographics and its relatively low GDP per capita. DBRS is also monitoring Poland’s relations with the European Commission in the context of institutional quality and the “Rule of Law” recommendation that could impact on the level of future EU funding. Nonetheless, the confirmation of the stable trend reflects DBRS’s assessment that risks to the ratings 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 EU’s resolution on the ‘Rule of Law’; or (3) a materially weaker economic performance, because of domestic or external shocks, that adversely affect growth prospects.

RATING RATIONALE

Poland Continues to Outperform EU Average Growth Rates with Broad-based Expansion

Poland has been one of the fastest growing economies in the EU, with annual growth averaging 3.9% during 2004-2017. This has resulted in GDP per capita in purchasing power terms increasing from 49% of the EU-27 average in 2004 to 69% in 2017. Recent economic performance has been strong with Q3 2018 GDP at 5.1%. The European Commission is projecting growth of 4.8% this year overall and 3.7% in 2019. Growth has been driven by both consumption and investment, supported by an inflow of temporary foreign workers alleviating labor shortages. The key pillars of investment include Poland’s high absorption of EU funds. Poland has been receiving nearly 20% of the EU’s Cohesion Funds, equivalent to 2.7% of GDP annually. These funds constitute 54% of expected public investment. Other factors supporting investment include low financing costs, high capacity utilization levels, and strong corporate profits. Consumption is likely to remain strong due to higher disposable incomes, thanks to wage growth and the fiscal impulse of the Family 500 plus scheme. While near term risks to the economic outlook are largely global in nature, including protectionist policies and a sharper than expected global growth slowdown, domestic challenges that could weigh on Poland’s long-term growth potential include regional disparities, adverse demographics, labor shortages, and the potential for lower EU funding.

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 coupled with growth of services related to the development of business processing centers, has resulted in Poland’s current account deficit narrowing to 0.4% over the last four years from annual average deficits of 5.0% during 2004-2012.

Strong Government Balance Sheet and Prudent Fiscal Management

Poland’s prudent fiscal framework is reflected in steadily declining public debt ratios and significant fiscal consolidation. 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. Moreover, despite the additional expenditure of the implementation of the child benefit program, higher economic activity and revenue collections enabled the deficit to come in substantially lower than expected at 1.4% in 2017. Current trends indicate the possibility of another year of fiscal outperformance in 2018. The reduction in the deficit is primarily due to the adherence of the stabilizing expenditure rule, favorable macroeconomic conditions and structural revenue gains which resulted in the VAT compliance gap narrowing sharply from 24.2% in 2015 to 14% in 2017. Nonetheless, continued progress on improving Poland’s tax efficiency is necessary for Poland to comply with its structural budgetary objectives over the medium term and to create space for aging costs and pubic investment, should the EU reduce financing from the Cohesion Fund.

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 43.4% in 2022. Using the national definition, the debt-to-GDP ratio decreased from 51.9% in 2016 to 48.4% in 2017 and is expected to decline to 40.7% in 2022. This is lower than both Poland’s “prudential” debt threshold of 55.0% (which activates austerity measures) and the constitutional debt threshold of 60.0%. Poland’s public debt management has effectively resulted in a favourable debt profile, with the average maturity of total government debt at 5.0 years. In addition, exchange rate and interest rate risks are partially mitigated as 70.2% of State Treasury debt is denominated in local currency and 76.4% at fixed interest rates. While the relatively high share of foreign investors in State Treasury debt (47.9%) and domestic debt (29.8%) makes Poland vulnerable to bouts of volatility in risk-off environments, the well diversified investor base mitigates against that risk. Furthermore, Poland’s recent upgrade to ‘developed market’ status by international equity index providers in September 2018 could enable a further diversification of its investor base and attract capital inflows.

Strong Monetary Framework and Risks to Financial Stability Appear Manageable

Poland’s ratings are also supported by the credibility of its monetary framework and solid institutions. After three years of deflation driven by commodity prices, CPI inflation turned positive in November 2016 and rose to 1.8% in October 2018. However, despite robust economic growth, tight labor market conditions and wage increases, inflation remains below the National Bank of Poland’s inflation target rate of 2.5% (with a symmetrical band of deviation of ±1 percentage point). Higher energy prices and service sector inflation could result in a further acceleration in inflation, but the pressure could be muted due to the current trend in oil prices and rising e-commerce. In addition, increased migration from the Ukraine is dampening wage growth. Recent European Commission projections forecast inflation at 1.2% in 2018 before rising to 2.6% in 2019, while central bank estimates put inflation at 1.8% and 3.2%, respectively. The National Bank of Poland in its October 2018 policy meeting confirmed that the current level of interest rates is conducive to sustainable economic growth and maintaining macroeconomic balance.

Poland’s banking sector remains stable, liquid, and profitable, with the average total capital adequacy at 18.1% and Tier 1 capital ratio at 16.2% in December 2017. The current funding structure of Polish banks adds to stability to the system due to its reliance on household deposits rather than market funding. Concerns about the sector have eased 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. Moreover, the share of foreign currency mortgage loans to total mortgage loans has been on a declining trend from 55% in 2012 to 32% in 2018.

Approval of The Supreme Court Judges Bill Bodes Well for Improving Poland’s Relations with the EU

Since taking office in October 2015, the Law and Justice Party (PiS party) has made changes to Poland’s constitutional court and increased its control over the civil services and public media. This has strained Poland’s relations with the EU, with the EU activating Article 7 of the Lisbon Treaty in December 2017 investigating Poland’s compliance with EU fundamental values. In addition, in June 2018, the European Commission (EC) issued a formal notice of an infringement process under the EU’s “Framework to Strengthen the Rule of Law”. As infringement proceedings are long drawn out and Article 7 needs a unanimous vote among all EU member states, Poland’s lack of response to the EC’s “Rule of Law” recommendation has so far not materially impacted the economic environment in Poland. However penal action by the EU could take a toll on investor sentiment towards Poland.

However, in October 2018, the European Court of Justice (ECJ) ordered a temporary suspension of the retirement law that lowered the ages of Supreme Court judges from 70 to 65 and, therefore, required more than one-third of the judges to step down, on ground of this action threatening to judicial independence. More recently, the Polish government has passed a bill allowing the Supreme Court judges to return to work. Once signed into law, the reversal could to some extent ease the tensions with the EU.

DBRS is also monitoring the European Commission’s 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 adversely affected by the new proposal. This is due to potential cuts to structural and investment funds, the possibility of linking the rule of law to funding, and the likely increase in 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 (low) to A range. The main points discussed during the Rating Committee included the economic and fiscal performance, EU funding and rule of law and the political environment.

KEY INDICATORS
Fiscal Balance (% GDP): -1.4 (2017); -0.9 (2018E); -0.9 (2019F)
Gross Debt (% GDP): 50.6 (2017); 49.2 (2018E); 48.3 (2019F)
Nominal GDP (EUR billions): 465.1 (2017); 494.7 (2018E); 520.2 (2019F)
GDP per Capita (EUR): 12,106 (2017); 12,872 (2018E); 13,541 (2019F)
Real GDP growth (%): 4.6 (2017); 4.8 (2018E); 3.7 (2019F)
Consumer Price Inflation (%): 1.6 (2017); 1.2 (2018E); 2.6 (2019F)
Domestic Credit (% GDP): 121.7 (2017); 122.5 (Jun-2018)
Current Account (% GDP): 0.2 (2017); -0.8 (2018E); -1.3 (2019F)
International Investment Position (% GDP): -61.3 (2017); -57.3 (Jun-2018)
Gross External Debt (% GDP): 67.2 (2017); 66.6 (Jun-2018)
Governance Indicator (percentile rank): 74.0 (2017)
Human Development Index: 0.87 (2017)

Notes:

All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. 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; IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

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

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Carlo Capuano, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer-Global FIG and Sovereign Ratings
Initial Rating Date: December 11, 2015
Last Rating Date: June 8, 2018

DBRS Ratings Limited
20 Fenchurch Street
31st Floor
London
EC3M 3BY
United Kingdom
Registered in England and Wales: No. 7139960

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