DBRS Changes Trend on Republic of Poland to Negative, Confirms A Rating

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

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 and has exited the Excessive Debt Procedure a year ahead of schedule. Rating challenges include policy uncertainty under the new government, and its implications for adherence to deficit targets, the outlook for investments, potential pressure on bank profitability, Poland’s relatively low GDP per capita and its ageing demographics.

The change from a Stable to Negative trend reflects concerns over the fiscal outlook, implications for the financial system stemming from the conversion of foreign currency mortgage loans, and recent actions by the government resulting in strained relations with the EU as reflected in the European Commission adopting the “Rule of Law Opinion”.

Poland’s ratings are underpinned by its solid macroeconomic performance. Averaging GDP growth of 3.8% during the last decade (2005-2015), Poland is among the top performers in the EU. Poland’s outperformance is largely due its institutional framework – both monetary and fiscal, its focus on the quantity and quality of education and it being a beneficiary of EU funds. Ratings have also been underpinned by the credibility of Poland’s monetary framework. The new Monetary Policy Committee (MPC) has allayed concerns on any compromised independence in the new government’s tenure. DBRS expects growth to remain resilient led by domestic demand. Favorable trends in real wage growth and employment are the key drivers for consumption, while investment is likely to be supported by favorable financing conditions (including EU funds) and an uptick in corporate profitability.

Poland has made progress consolidating its fiscal accounts. The headline deficit declined from over 7% levels post the crisis to 2.6% in 2015, thus enabling Poland to exit the EDP a year ahead of schedule. Going forward, 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, but the outlook for 2017 is uncertain. This is due to the President’s spending proposals with revenue measures aimed at increasing tax efficiency possibly being insufficient to offset them.

Government debt remains moderate with Poland’s debt-GDP ratio at 51.3% in 2015. While this debt-GDP ratio is expected to rise marginally in 2017, it is largely due to financial obligations incurred for the implementation of new road projects. However, this is lower than the Maastricht threshold of 60% and the EU average of 86.8%. Debt ratios will likely decline in the coming years supported by a favorable growth-interest rate differential.

However, Poland faces several policy-related and economic challenges. On the fiscal front, the outlook for 2017 is uncertain with a possibility of the headline deficit breaching 3% of GDP despite a robust growth outlook. In addition to the Family 500 scheme, this is due to the President’s other proposed measures, such as lowering of the retirement age, raising income tax free thresholds and reducing VAT rates. The decision on the reduction of VAT is expected to be made in November, after the outcome of the first two measures.

Secondly, new policies could have adverse effects on bank profitability. This stems from several factors; (1) President’s proposals to convert the existing Swiss franc denominated mortgages into zlotys and (2) the impact on financial institutions of the 0.44% banking sector tax on their adjusted assets. The outcome of these policies, especially the conversion of foreign currency mortgages, could have implications for financial stability.

Thirdly, business sentiment appears to be dented due to uncertainty around the new government’s policy measures and its response to the European Commission’s “Rule of Law Opinion” on June 1, 2016. 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 with two-thirds of the public debt denominated in local currency, 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 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) policy action on conversion of foreign currency mortgage loans has an adverse impact on the financial system 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.

The key points discussed in the Rating Committee included uncertainty on the fiscal outlook, foreign currency mortgage conversion and concerns regarding the Rule of Law.

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 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, IMF, OECD, European Commission and Haver Analytics. 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