DBRS Morningstar Confirms Republic of Poland at “A”, Stable Trend

DBRS Ratings GmbH (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 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 Stable trend reflects DBRS Morningstar’s view that Poland's sound fiscal and external accounts will continue to support its macroeconomic outlook, notwithstanding ongoing risks stemming from Russia's invasion of Ukraine. While Poland has effectively diversified its energy sources away from Russia, and the trade links are modest, the higher prices and funding costs resulting from the war weigh on real incomes and investment decisions. The European Commission (EC) forecasts significant slowing of the economy this year, even though strong labour markets and fiscal support reduce the risk of a prolonged slowdown. The current account deficit, which should gradually narrow over the next few years, is financed by steady capital inflows. On public finance, measures to ease pressures from rising prices and to support the military will widen the deficit this year but then decline to below 3% of GDP by mid-decade, according to the government projections. Public debt is expected to remain at a moderate level over the medium term.

The ratings are supported by Poland’s membership of the EU and its strong macroeconomic record. Poland has a credible and independent monetary policy, and its fiscal framework has kept public debt at moderate levels. Conversely, the ratings are constrained by the economy’s relatively low GDP-per-capita and its unfavourable demographics. Concerns over the rule of law and state interventionism are delaying COVID-related recovery support. DBRS Morningstar anticipates that a compromise solution will be reached around the disbursement of recovery funds to Poland, although an agreement is unlikely to occur until after the 2023 legislative. Further tensions with the EC regarding the rule of law could result in lower future EU funding, an important driver of Poland’s economic growth.

RATING DRIVERS
The ratings could be upgraded if: (1) fiscal consolidation results in a significant reduction in the structural deficit and in the public debt-to-GDP ratio; (2) stronger-than-expected economic growth accelerates GDP-per-capita convergence towards the EU average; or (3) there is clear progress implementing growth-enhancing reforms and improving the institutional framework.

The ratings could be downgraded if: (1) the public debt-to-GDP ratio materially increases over the medium term, or (2) confrontation with EU authorities leads to a significant reduction in EU funding over a prolonged period.

RATING RATIONALE
Economic Growth Will Slow This Year; Eventual Release of EU Money Would Support Medium-Term Growth Prospects

The Polish economy recovered from its contraction in 2020 to grow by 6.9% in 2021 and 5.1% in 2022. This was despite headwinds from Russia’s invasion of Ukraine. Poland was able over the course of last year to replace gas from Russia with alternatives, including via the Swinoujscie LNG terminal. The cost of the energy shock, nonetheless, still lingers. Elevated inflation and tighter monetary policy have started to bite and will slow the pace of growth. The harmonised index of consumer prices (HICP) in Poland, at 14.0% in April 2023 compared to a year earlier, remains well above the EU average of 8.1%. While base effects from lower energy prices should lower headline inflation over the coming months, strong wage growth and the pass-through of energy prices to core items will likely keep inflation sticky. HICP net of energy and unprocessed food advanced by 13.2% year-over-year in April 2023. The EC projects growth to slow to 0.7% in 2023, as high inflation and tighter financing conditions hit interest-rate sensitive sectors.

Easing price and financing conditions, strong labour markets, healthy private sector balance sheets, and persistently large inflows of foreign direct investment support a recovery starting next year, when the EC expects GDP growth of 2.7%. EU funds further bolster medium-term growth prospects. DBRS Morningstar is of the view that Polish authorities and EU officials will eventually make compromises sufficient to release the EUR 35.4 billion (5.6% of GDP) of Resilience and Recovery Funds (RRF). RRF is modest compared to the EUR 75.5 billion in EU Cohesion money (MFF 2021-2027) to Poland. Any additional problems with the disbursement of EU funds or prolonged delays could affect confidence and investment.

Fiscal Deficit To Widen In 2023; Expected To Narrow In The Coming Years

The government deficit amounted to 3.7% of GDP in 2022, up from 1.8% in 2021. The outcome was due to an increase in expenditures related to the energy crisis and the delivery of aid to displaced Ukrainians, and by a decrease in revenues due to reforms to personal income taxation. The deficit would have been wider were it not for high corporate tax receipts. Energy support measures, including freezes on electricity and gas prices will continue this year. While these schemes are partly funded by windfall profit taxes on energy producers, the net cost is expected to be 1.9% of GDP in 2023, compared to 2.4% in 2022. The government expects the deficit to widen to 4.7% of GDP in 2023 due to weaker economic growth, the indexation of public sector pensions, and additional spending on healthcare and defence. Election-related spending could surprise and place additional pressure on this year’s deficit. That said, the government expects the deficit to improve to 2.9% by 2025 as extraordinary support measures phase out and tax collection improves.

Public Debt to GDP Is Comparatively Low, Although It Is Forecast To Gradually Increase Over The Medium-Term

The debt-to-GDP ratio peaked at 57.1% in 2020 as a result of the pandemic, but the strong economic recoveries in 2021 and 2022 helped reduce the debt ratio to 49.1% last year. The trajectory is set to reverse again due to the significant slowdown in economic growth and expansionary fiscal policy. The government projects debt to gradually increase from the expected 50.3% of GDP in 2023 to 55.4% by 2026. While Poland’s comparatively low debt ratio allows it space to accommodate adverse shocks, stabilisation of the debt ratio in the absence of stronger economic growth will likely require more constrained fiscal policy in the years to come.

The management of Poland’s public debt is sound, although risks related to rising interest rates have increased. The relatively low average maturity of total outstanding debt (5.3 years as of April 2023) only partly delays increased roll-over costs. The yield on the benchmark 10-year Polish bond increased from 1.4% in January 2021 to 6.0% in May 2023. The rise in debt servicing is nonetheless expected to remain manageable. The government estimates interest costs to the Treasury will stabilise around 2.0% of GDP over the next few years, up from 0.9% on average over the last two years. The Treasury has high funding capacity, with liquid assets worth PLN 115.5 billion (3.8% of GDP) as of April 2023, and it typically meets annual funding needs early to reduce short-term pressures. Debt denominated in foreign currency declined to 24.3% as of February 2023 from 35.5% in 2014, reducing currency risk.

Moderate External Imbalances Gradually Improving

Poland’s external position is underpinned by competitive exports and ample inflows of capital from EU funds and foreign direct investment. The current account deficit deteriorated to around 3.0% of GDP last year as energy and commodity import bills rose from the global terms-of-trade shock. The EC expects easing supply bottlenecks and decelerating domestic demand will reduce the deficit towards balance by next year. Poland’s external debt position at 52.8% of GDP in the fourth quarter of 2022 remains high, but has steadily declined in recent years due to private sector deleveraging. The net international investment position improved to -33.9% in 2022, from -60.3% five years earlier. The economy benefits from important external shock absorbers such as a flexible exchange rate, large foreign-exchange reserves equal EUR 158 billion (24% of GDP or nearly five months of imports), and inward foreign direct investment roughly six times larger than portfolio investment inflows.

Bank Provisions and Capital Levels Help Mitigate Against FX Legal Risk

Costs to the Polish banking system stemming from the legal risk on foreign-exchange mortgages are potentially material and uncertainty remains elevated. The size of bank losses will depend on local court decisions, as well as rulings from both the Court of Justice of the EU and the Polish Supreme Court. In the meantime, the banking sector has increased reserves, estimated around 40% of the remaining Swiss franc-denominated mortgage portfolio, from 19% in June 2021. The uptick in out-of-court settlements might increase given recent local court verdicts against the banks. In DBRS Morningstar’s view, the legal decisions will play out over many years, and the banking system’s provisions against this risk specifically and the high capitalisation more broadly (15.2% Tier 1 capital ratio of September 2022) are important mitigants of systemic risk.

The rise in inflation since mid-2021 has resulted in significant and rapid monetary policy tightening. From October 2021 to September 2022, the NBP increased its reference rate from 0.10% to 6.75%, where it currently stands. Higher interest rates weigh on business investment and lending demand, and challenge borrowers who borrowed during the low-rate period. Roughly 90% of mortgages are at variable rates. However, financial stability risk from higher costs of capital appear contained. Household indebtedness is low, wage growth is strong, and the Borrowers Support Fund helps shelter vulnerable borrowers from the rise mortgage payments.

Disbursement of EU Recovery Funds Unlikely Until After the 2023 Election

Poland’s governance indicators are on average weaker than its EU peers. The institutional challenges are evident by the EC’s delays in disbursing COVID-related recovery money to Poland out of concern over the rule of law and state interventionism. This supports a negative assessment of the Political Environment Building Block. In DBRS Morningstar’s view, authorities will make the necessary agreements to release RRF given the importance of EU funds for Poland’s economic growth, as well as its role in supporting Ukrainian refugees. Reforms necessary to comply with the EC are caught up in Poland’s constitutional tribunal, reducing the likelihood of disbursal before the parliamentary election, expected on or before November 11, 2023. Recent polling from Politico shows voting intentions for the ruling Law and Justice party (PiS) declined to 35%, down from the 43.6% it garnered in the last election. The Civic Coalition (KO) is polling at 27%, roughly on par with 2019, and the recently formed Third Way (Poland 2050 & Polish Coalition) is polling at roughly 13%.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors
The human capital and human rights factor affects the ratings. Despite progress with narrowing the EU income gap, the country’s GDP per capita at around USD 18,279 in 2022 remains well below the EU average, according to the International Monetary Fund (IMF). DBRS Morningstar considers this factor significant and has taken it into account within the Economic Structure and Performance Building Block.

Governance (G) Factors
The institutional strength, governance, and transparency factor affects the ratings. This factor reflects a weaker institutional profile including the respect of the rule of law, which could weigh significantly on the EU funding. According to World Bank’s latest Worldwide Governance Indicators, Poland ranks in the 63.5 percentile for Government Effectiveness, in the 65.4 percentile for Rule of Law, and in the 63.8 percentile for Voice and Accountability. DBRS Morningstar considers this factor significant and has taken it into account within the Fiscal Management and Policy and Political Environment Building Blocks. At the same time, DBRS Morningstar views the bribery, corruption, and political risks factor as relevant to the ratings, also reflecting a weaker score in the control of corruption compared with the EU average.

There were no Environmental factors that had a significant or relevant effect on the credit analysis

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (17 May 2022) https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/414550.

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 (29 August 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include Ministry of Finance: The Public Finance Sector Debt Management Strategy in the years 2023-2026 (September 2022); State budget borrowing requirements’ financing plan and its background (May 2023), National Bank of Poland: Inflation and Economic Growth Projections (March 2023); Financial Stability report (December 2022), CSO (GSU), Eurostat, European Commission: Economic Forecast Spring 2023 (May 2023); 2022 Rule of Law Report Country Chapter on the rule of law situation in Poland (July 2022), European Central Bank (ECB), IMF, Polish Financial Supervision Authority, Bank for International Settlements, World Bank, Ministry of Climate and Environment: Energy Policy of Poland until 2040 (February 2021), Politico, The Social Progress Imperative, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: No

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/414549.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: December 11, 2015
Last Rating Date: November 25, 2022

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