DBRS Confirms Republic of Poland at A, Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the Republic of Poland’s Long-Term Foreign and Local Currency – Issuer Ratings at A. At the same time, DBRS Morningstar 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 Morningstar’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 and despite a recent deceleration reflecting a weaker external environment, economic growth remains above potential. Real GDP is expected to expand by 4.1% in 2019 and 3.3% in 2020. Following a significant cyclical improvement in the budget deficit to 0.2% of GDP in 2018, government fiscal stimulus has been placing higher pressure on the structural general government deficit, which is projected by the European Commission (EC) to rise to 2.2 % GDP this year from 1.4% registered in 2018. Although more gradual, public debt ratio is expected to continue to decline going forward from the 48.9% of GDP registered last year to 44.3% in 2021, mainly because of a strong nominal growth counteracting additional fiscal spending announced by the government.

Despite these strengths, Poland’s ratings are constrained by a still relatively low GDP per capita level and unfavorable demographic trends. In addition, DBRS Morningstar is also monitoring Poland’s relations with the EC in the context of the Rule of Law recommendations that could impact the country’s level of future EU funding. EU funds have historically been an important driver of growth for the country. Nonetheless, the confirmation of the stable trend reflects DBRS Morningstar’s assessment that risks to the ratings are broadly balanced.

RATING DRIVERS

Upward rating drivers include: (1) further progress with structural reforms leading to faster than expected economic convergence to the EU GDP per capita average level over the medium-term; or (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 increase in the public debt ratio; or (2) a less predictable policy framework possibly leading to a more confrontational stance with the EU authorities.

RATING RATIONALE

Despite the Slowdown, Poland’s GDP Growth Continues to Show a Notable Performance

Poland has been one of the fastest growing economies in the EU, with annual real GDP growth averaging 4.0% during the 2004-18 period. This has resulted in GDP per capita in purchasing power terms increasing from 50% of the EU-28 average in 2004 to 71% in 2018. DBRS Morningstar projects the convergence process to continue despite more moderate economic growth in coming years.

Real GDP growth, despite a deceleration towards its potential and the impact of a weaker GDP global growth, remains notable. Following the post-crisis peak at 5.1% in 2018 the EC projects output growth to slow down to 4.1% this year and to 3.3% in 2020. This is well above both the EU and regional peers’ GDP growth rate in the same period and reflects a supportive internal demand which makes Polish growth resilient to a less favourable external environment. Private consumption growth, although expected to gradually decline, will remain strong and will benefit from planned social transfers, solid wage dynamics and buoyant labour market. Near-term risks to the economic outlook are largely global in nature. These include an escalation in protectionist policies, a prolonged and sharper than expected slowdown in the EU economy and a potential disorderly departure of the U.K. from the bloc.

The lingering weaknesses in the external environment is likely to weigh on the export contribution to growth and on private investment because of a lower foreign demand. At the same time, the slower pace of absorption of EU funds could affect public investment dynamics. EU funds remain key for Poland, as the country has been receiving nearly 20% of the EU’s structural and Investment Funds, equivalent to 2.6% of GDP annually on average in the period 2014-2020. GDP growth in long-term could also be constrained by regional disparities and adverse demographics because of a decline in the working-age population. At the same time, due to the important contribution of immigrant workers from Eastern Europe, potential migration outflows might have a negative impact on Poland’s GDP potential. This means that additional structural reforms to sustain labor participation because of the ageing population may be needed.

Poland’s external position has improved over the past years and benefits from a high level of competitiveness, reflected in a growing export market share of goods and services and declining external debt as % of GDP. Like its Eastern European counterparts, Poland benefits from a full integration into the regional supply chain and manufactures a diverse range of high value-added components for machinery and transport equipment, electronics, and other sectors. A good performance in services related to the development of business processing centers along with an improvement in goods exports, has translated into Poland’s current account deficit narrowing to 0.5% over the last four years from annual average deficits of about 5.0% during 2004-2012. Current weaknesses in the external environment, however, have started to weigh on Poland’s export performance and in combination with a declining household net savings rate, will likely contribute to a moderate widening of the deficit. Over the medium-term, this could be also affected by a deterioration in external competitiveness. The government plans four increases in the minimum wage in the 2020-24 period. This could boost wage growth more than productivity gains.

External debt is high but is declining at 59.5% of GDP as of Q2 2019, and risks are largely offset by a steady rise in its foreign exchange reserves at USD 121.9 billion in October 2019, up from USD 62,2 billion at the end 2008, and a high share of foreign direct investment including inter-company debts. This makes the system more resilient to potential capital outflows.

Debt Ratio’s Impact from Higher Deficit Expected to be Limited

Poland’s prudent fiscal framework is reflected in its steadily declining public debt ratio and its significant fiscal consolidation. In addition, Poland’s constitution limits public debt to sixty percent of GDP (measured with the national definition). Recent fiscal relaxation, mainly in the form of increases in social expenditures will exercise pressure on the deficit, but public debt ratio will likely continue to fall, although more gradually. The EC projection, which, however, includes only elements incorporated in the draft budgetary law, points to a decline to 44.3% of GDP in 2021 from 48.9% of 2018. In DBRS Morningstar’s view, strong nominal growth will remain the main contributor to the gradual decline.

The headline deficit, which peaked at 7.4% of GDP in 2010, has been steadily declining due to higher economic activity and revenue collection. It reached a multi-year low of 0.2% of GDP in 2018. This year in February, ahead of the parliamentary elections, the government introduced a set of expansionary measures accounting for 1.1% of GDP and including 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 rate. These measures combined with the decision to counteract the increases in electricity prices in 2019 (0.4% of GDP) will be only partially compensated by higher revenues because of solid macroeconomic performance and robust dynamics in indirect taxes and social contributions. According to the EC, this will result in a deterioration in the structural deficit from 1.4% of GDP in 2018 to 2.2% this year.

The government doesn’t seem to show strong appetite for further progress with fiscal consolidation in coming years. Further expansionary measures have been announced recently, including additional payments to pensioners. This will likely affect negatively the general government balance further in coming years, following a temporary improvement in 2020 because of higher revenues stemming from the conversion of the second pillar assets into third-pillar individual retirement accounts. DBRS Morningstar, however, is of the view that deficit will remain below the 3% of GDP threshold.

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 debt ratio is projected to continue to decline this year to 47.4% of GDP. The average maturity of total government debt is around five years. Exchange rate and interest rate risks are partially mitigated as 72.3% of State Treasury debt is denominated in local currency and 74.4% at fixed interest rates as of September 2019. While the relatively high share of foreign investors in State Treasury debt (42.1%) makes Poland vulnerable to bouts of volatility in risk-off environments, the well-diversified investor base somewhat mitigates that risk.

The Monetary Framework is Strong and Risks to Financial Stability Appear Contained

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 to 2.2% on average since January 2019. An increase in unprocessed food prices over the last months reflecting unfavorable weather conditions along with robust economic growth, tight labor market conditions, and wage increases were the main drivers. With the end of the electricity price freezing next year, CPI inflation is expected to pick up slightly but to remain close to the National bank of Poland’s target of 2.5% (with a symmetrical band of deviation of ±1 percentage point). Latest projection from the NPB point to CPI inflation at 2.3% in 2019 and 2.8% in 2020.

Poland’s banking sector remains stable and liquid, but uncertainty regarding the conversion of foreign currency mortgages, has increased. With the average total capital ratio of 18.3% and Tier 1 capital ratio of 16.2% as of June 2019 Poland’s banking sector is well capitalised. Profitability remains above the EU average even if it has declined in recent years. The current funding structure of banks adds stability to the system due to its reliance on household deposits rather than market funding. Although the portfolio of mortgages loans in foreign currency has declined substantially to PLN 126 billion in September 2019 from the PLN 194 billion registered in December 2011, uncertainties regarding FX conversion have reemerged following the ruling from the European Court of Justice in early October 2019 on specific case regarding index mortgages in CHF. DBRS Morningstar believes that, depending on Polish courts’ verdicts and the number of legal claims, a negative impact on the banking system and on the economy is likely to be spread over time (DBRS Morningstar: “Uncertainty Remains for Polish Banks after ECJ Ruling on Swiss Franc Mortgages).

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

In the latest parliamentary election in October, the Law and Justice Party (PiS party) with around 43.6% of votes maintained the single-party majority in the lower house but did not reach enough seats to be able to amend the Constitution, and lost its majority in the Senate. The PiS party’s victory, in DBRS Morningstar’s view, bodes well for policy continuity but uncertainty over the country’s relationship with the EU is likely to continue. This is due to a series of government changes to Poland’s judicial system and increasing control over the civil service and public media, which have weighed on the country’s compliance with EU fundamental values over the past years. DBRS Morningstar is of the view that the Polish government will not assume an overly confrontational stance against the EU authorities but its policy-making concerning the respect of the rule of law and state interventionism risk undermining Poland’s institutional independence. This assessment has led to a negative adjustment in the “Political Environment” building block.

DBRS Morningstar continues to monitor also negotiations over the 2021-27 EU Budget, also known as the Multiannual Financial Framework (MFF). Poland’s growth rate has been boosted also 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 potential link of the 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 2014-20 MFF are expected to be available until 2023 (T+3 rule).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
http://www.dbrs.com/research/354103

Notes:

All figures are in Polish Zloty (PLN) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal 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), ECB, IMF, BIS, IFS, World Bank, UNDP, Haver Analytics. DBRS Morningstar 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar 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 Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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: Thomas R. Torgerson, Senior Vice President, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: December 11, 2015
Last Rating Date: June 7, 2019

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