DBRS Confirms Republic of Poland at A, Changes Trend to Stable from Negative

DBRS, Inc. confirmed the Republic of Poland’s long-term foreign and local currency issuer ratings at A and changed the trend to Stable from Negative. DBRS also confirmed the short-term foreign and local currency issuer ratings at R-1 (low) with a 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 exiting the Excessive Debt Procedure a year ahead of schedule and has been meeting its fiscal targets. Rating challenges include potential pressure on bank profitability, unfavorable demographics, policy uncertainty and Poland’s relatively low GDP per capita.

The change in trend from negative to stable underlines DBRS’s view that (1) the on-going issue on the conversion of foreign currency mortgage loans to local currency loans is unlikely to undermine financial institutions (2) fiscal targets are being adhered to and (3) concerns regarding the rule of law have not materially impacted the economic environment.

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 averaged 3.8% during 2006-2016, 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. This enabled Poland to gain economic benefits from integration into Western Europe, resulting in Poland’s GDP per capita on a PPP basis reaching 69% of the EU average, up from 49% in 2004. The deceleration in growth from 3.8% in 2015 to 2.7% in 2016 was primarily due to lower investments – a result of the expiration of the previous EU financial framework, which led to a temporary decline in EU fund transfers. Growth is estimated to rise to 3.5% and 3.2% respectively in 2017 and 2018. Key drivers on the consumption side include favorable trends in real wage growth and employment, while investments are likely to be supported by favorable financing conditions and EU transfers under the new 2014-2020 financial framework.

Poland has made progress consolidating its fiscal accounts with the headline deficit declining from levels over 7% of GDP after the crisis to 2.6% in 2015, thus enabling Poland to exit the EDP a year ahead of schedule. Despite the implementation of the new government’s spending proposals in 2016, one-off revenue measures, including an improvement in tax collections, enabled a narrowing of the deficit to 2.4% of GDP. The government targets a deficit of 2.9% of GDP in 2017 and 2.5% in 2018. The fiscal outlook is challenging due to expenditure on the on-going child benefit program and changes in the retirement age. However, this is expected to be offset by an increase in revenue efficiency. 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% which activates austerity measures and stabilizing expenditure rule which facilitates eliminating fiscal imbalances.

Poland’s EU membership is an integral component of its credit strength, both in terms of financial support and in preferential access for trade and financial markets. Financial conditions have improved across the economy because of the ECB’s asset purchase program, refinancing and other monetary operations. Investment into Poland is driven largely by European and other international firms seeking to take advantage of lower labor costs and proximity to Europe’s main population centers.

Despite its credit strengths, Poland faces several policy-related and economic challenges. Similar to other European nations, Poland demographic outlook is adverse. 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 58.0% in 2050, could take a toll on the medium-term sustainability of public finances and also lead to a tightening of labor markets. Latest Eurostat projections indicate that Poland’s working-age population of 27 million people is likely to shrink by 11% in 2030 and 30% by 2060.

Concerns on the banking sector have reduced with the foreign currency mortgage restructuring bill pointing to a gradual central-bank and regulator led ‘voluntary’ conversion of foreign currency mortgages into zloty, rather than a one-time forced mandatory conversion by the government. However, profitability could come under pressure due to uncertainty of terms of conversion including additional capital requirements on the existing Swiss franc denominated mortgages and the impact of the 0.44% banking sector tax.

While the domestic growth story is strong, downside risks to the outlook stem from a disorderly Brexit scenario. Poland is one of the largest beneficiaries of EU transfers and given its demographics, if Brexit does lead to a reduction in EU transfers to the region, it will be difficult for Poland to maintain trend growth. Lastly, while the lack of response to the European Commission’s “Rule of Law” recommendation has so far not materially impacted the economic environment in Poland, 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.

RATING DRIVERS

Upward rating action will depend on Poland’s ability 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 or weaker economic performance, because of domestic or external shocks, that adversely affect growth, could put downward pressure on the ratings.

Notes:
The main points of the Rating Committee discussion included the European Commission’s Rule of Law recommendation, foreign currency mortgages and its impact on bank profitability and Poland’s growth and fiscal performance.

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 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 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, Senior Vice President
Rating Committee Chair: Roger Lister
Initial Rating Date: 11 December 2015
Most Recent Rating Update: 9 December 2016