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 low public debt-to-GDP ratio, a sound monetary policy framework, a flexible exchange rate regime, and its integration within the European Union (EU). Poland has been among the top growth performers in the EU over the last decade. Despite a deceleration towards GDP potential growth rate and because of a weaker external environment, the country’s economic performance continues to be strong. Poland’s real GDP expanded by 4.7% on an annual basis in the first quarter of 2019. The country’s robust economic performance, coupled with an increase in revenue efficiency, has accelerated fiscal consolidation and improved debt dynamics over the past few years. The new fiscal stimulus package will likely result in a deterioration of the general government deficit to 1.5% on average in 2019-2020 but public debt-to-GDP is set to continue to decline gradually to 47.4% in 2020 from 48.9% in 2018.

Despite these strengths, Poland’s ratings are constrained by unfavorable demographics and still relatively low GDP per capita level, which is an outcome of its low level at the beginning of the transition. DBRS is also monitoring Poland’s relations with the European Commission (EC) in the context of institutional quality and the Rule of Law recommendation that could impact 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

Upward rating drivers include: (1) structural reforms to further support 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.

RATING RATIONALE

Despite a Slowdown, Poland Continues to Outperform the EU Average Growth Rate

Poland has been one of the fastest growing economies in the EU, with annual growth averaging 4.0% during 2004-2018. This has resulted in GDP per capita in purchasing power terms increasing from 50% of the EU-28 average in 2004 to 75% in 2018. After strong economic growth at 5.1% in 2018, the GDP growth is expected to decelerate. The EC is projecting GDP growth to slow down to 4.2% this year overall and to 3.6% in 2020, which is, however, well above the EU average forecast of 1.5% in the 2019-20 period. Growth is expected to be supported by buoyant private consumption on the back of a solid wage dynamics and new expansionary fiscal measures. Despite a modest decline in public investment growth, investments will likely remain a key growth driver due to Poland’s high absorption of EU funds. The country has been receiving nearly 20% of the EU’s structural and Investment Funds, equivalent to 2.6% of GDP annually. Other factors supporting investment include low financing costs, high capacity utilization levels, and strong corporate profits. Near-term risks to the economic outlook are largely global in nature. These include an escalation in protectionist policies, a sharper than expected global growth slowdown, a potential U.K. disorderly departure from the EU and changes to immigration policy by other EU countries which could add more pressure on labor shortages. Poland’s GDP growth in long-term could be constrained by regional disparities, adverse demographics, and the potential for lower EU funding.

Poland’s external position benefits from a high level of competitiveness, reflected in a growing export market share. 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 translated into Poland’s current account deficit narrowing to 0.4% over the last four years from annual average deficits of 5.0% during 2004-2012. Going forward, a weaker external environment and a declining household net savings rate will likely contribute to a moderate widening of the deficit. External debt is high at 63.8% of GDP, but risks are largely offset by a steady rise in its foreign exchange reserves at USD 117 billion in April 2019 from USD 62,2 billion at the end 2008 and a high share of foreign direct investment including inter-company debts.

Public Debt Trajectory Impact from the New Fiscal Expansionary Measures Expected to Remain Limited

Poland’s prudent fiscal framework is reflected in its steadily declining public debt ratio and its significant fiscal consolidation. Some fiscal relaxation is expected this year but its impact on the public debt-to-GDP trajectory is projected to be limited. The headline deficit, which peaked at 7.3% of GDP in 2010, has been steadily declining due to higher economic activity and revenue collection, with the deficit touching a multi-annual low of 0.4% in 2018. Ahead of the upcoming parliamentary elections, the government announced a set of expansionary fiscal measures which include a broadening in the scope of the PLN 500 family bonus, a one-off supplementary benefit for pensioners to be paid in 2019 and a reduction of the income tax. These measures combined with the decision to administer electricity prices in 2019 will be only partially compensated by revenue-enhancing measures even though Poland continues to make progress in increasing tax collections via broadening the tax base and reducing VAT evasion. The government is also expected to raise revenues from the conversion of the second pillar assets into third-pillar individual retirement accounts. The EC projects Poland’s nominal and structural deficit to rise to 1.6% of GDP and 2.8% in 2019, respectively. A more than expected deceleration in the projected growth might put pressure on the deficit.

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 gradually decreased to 48.9% in 2018. Despite the new package of expansionary fiscal measures, the EC projects a continuation of the decline of the public debt-to-GDP ratio although at a slower pace, towards 47.4% in 2020. Moreover, in DBRS’s view, in a stress scenario with GDP growth declining to 2.5% on average from 2019-23 combined with a deterioration in the primary balance of 1.3% on average in the same period, Poland’s public debt-to-GDP ratio is expected to remain below 55% of GDP.

The average maturity of total government debt is around five years. Exchange rate and interest rate risks are partially mitigated as 71.1% of State Treasury debt is denominated in local currency and 76.3% at fixed interest rates as of March 2019. While the relatively high share of foreign investors in State Treasury debt (44.7%) makes Poland vulnerable to bouts of volatility in risk-off environments, the well-diversified investor base somewhat mitigates that risk.

Strong Monetary Framework and Risks to Financial Stability Appear Manageable

Poland’s ratings are also supported by the credibility of its monetary framework and its solid institutions. After three years of deflation driven by commodity prices, CPI inflation turned positive in November 2016 and has picked up recently averaging 1.6% since January 2019. 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). In addition, increased migration from Ukraine is dampening wage growth. Recent EC projections forecast inflation at 1.8% in 2019 before rising to 2.5% in 2020, while the central bank anticipates 1.7% and 2.7%, respectively. The National Bank of Poland in its May 2019 policy meeting confirmed that the current level of interest rates is conducive to keeping the economy on a sustainable growth path and to maintaining macroeconomic stability.

Poland’s banking sector remains stable, liquid, and profitable, with the average total capital adequacy at 18.3% and Tier 1 capital ratio at 16.3% as end of 2018. The current funding structure of Polish banks adds 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. The portfolio of loans in foreign currency continues to decline and in March 2019 stood at 6.6% of the banking sector’s assets.

Uncertainty in Poland’s Relations with the EU Regarding The Rule of Law Remains a Point of Attention

Since taking office in October 2015, the Law and Justice Party (PiS party) has maintained broad political support which appears to not be impacted by the strained relationship with the EC regarding the rule of law. The PiS party’s 45.4% share of votes in the recent European election leaves it in a strong position ahead of the national elections to be held no later than November this year. This bodes well for policy continuity even though uncertainty over its relationship with the EU could continue.

Over the last years, a series of government changes to Poland’s judicial system and an increasing control over the civil service and public media have weighed on the country’s compliance with EU fundamental values. As a result, the EC activated Article 7 of the Lisbon Treaty in December 2017 and launched a series of infringement proceedings against Poland. The latest infringement procedure in April 2019, addresses the political abuse of Poland’s judicial system and follows the decision of the European Court of Justice (ECJ) in October 2018 to order a temporary suspension of the new retirement law that lowered the ages of Supreme Court judges from 70 to 65. In response, the Polish government backtracked and allowed judges to return to work, which in DBRS’s view reflects Poland’s commitment to the EU.

DBRS continues to monitor negotiations over the 2021-2027 EU Budget, also known as the Multiannual Financial Framework (MFF). Poland’s growth rate has been boosted by absorption of EU structural funds which is likely to be lower in the next MFF. The expected lower availability of funds is mainly due to the process of GDP catch up of Poland’s regions relative to the EU average as well as proposed cuts to the overall amount of structural and investment funds. At the same time, the EC’s proposal to link EU funding to the rule of law as a condition to be eligible to use the allocation granted may adversely affect Poland. However, near- to medium-term growth prospects are unlikely to be impacted as funds under the 2014-2020 MFF are expected to be available until 2023 (T+3 rule).

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AA (low) – A range. The main points discussed during the Rating Committee include rule of law, fiscal stimulus, EU funding and Poland’s economic performance.

KEY INDICATORS

Fiscal Balance (% GDP): -0.4 (2018); -1.6 (2019E); -1.4 (2020F)
Gross Debt (% GDP): 48.9 (2018); 48.2 (2019E); 47.4 (2020F)
Nominal GDP (EUR billions): 496.5 (2018); 523.0 (2019E); 555.3 (2020F)
GDP per Capita (EUR): 12,924 (2018); 13,618 (2019E); 14,471 (2020F)
Real GDP Growth (%): 5.1 (2018); 4.2 (2019E); 3.6 (2020F)
Consumer Price Inflation (%): 1.2 (2018); 1.8 (2019E); 2.5 (2020F)
Domestic Credit (% GDP): 120.2 (2018)
Current Account (% GDP): -0.7 (2018); -1.2 (2019E); -1.5 (2020F)
International Investment Position (% GDP): -55.7 (2018)
Gross External Debt (% GDP): 63.8 (2018)
Governance Indicator (percentile rank): 74.0 (2017)
Human Development Index: 0.87 (2017)

Notes:

All figures are Euro (EUR) in unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Fiscal balance (EC), Gross debt (EC), Nominal GDP (CSO,EC), GDP per Capita (EC), Real GDP Growth (EC), Inflation (EC), Domestic Credit (NBP/CSO/Haver), Current Account (NBP, IMF), International Investment Position (NBP/CSO/Haver), Gross External Debt (NBP/CSO/Haver). 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 (NBP), Central Statistics Office (CSO), Eurostat, European Commission (EC), 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.

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

Lead Analyst: Carlo Capuano, 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: December 7, 2018

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