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 CREDIT RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s view that Poland's resilient macroeconomic outlook balances risk stemming from still elevated inflation and higher interest rates. The price shock and higher financing conditions from Russia's invasion of Ukraine have weighed on real incomes and investment decisions, but strong employment growth and fiscal support reduce the risk of a prolonged economic slowdown. On public finances, measures to ease pressures from rising prices and to support the military will widen the deficit. Current government projections are for the fiscal imbalance to fall below 3% of GDP by mid-decade and for public debt to remain below 60%.

The credit ratings are supported by Poland’s membership of the European Union (EU) and its strong macroeconomic record. Poland’s fiscal framework has kept public debt at comparatively moderate levels despite the recent shocks. Conversely, the credit ratings are constrained by the economy’s relatively low GDP-per-capita and its unfavourable demographics. Concerns over the rule of law and political influence over state institutions have delayed COVID-related recovery support from the EU. DBRS Morningstar expects authorities to reach a compromise solution over time that allows for the disbursement of Resilience and Recovery Funds (RRF) to Poland. The likely next coalition government has made receipt of EU funding a priority.

CREDIT RATING DRIVERS
The credit 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 reforms and improving the institutional framework.

The credit 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.

CREDIT RATING RATIONALE
Election Results Increase Likelihood Of Disbursement Of EU Recovery Funds

The result of Poland’s parliamentary election in October 2023 suggests a likely change in the governing coalition. The incumbent United Right alliance, led by the Law and Justice Party (PiS), won a 35.4% plurality of the vote; however, the party does not appear to have sufficient support from junior parties to extend its mandate for a third consecutive term. The opposition Civic Coalition (KO, with 30.7% of the vote) led by former Prime Minister Donald Tusk is best positioned to eventually form a coalition government with the Third Way (14.4%) and The Left (8.6%).

Governance indicators are on average weaker in Poland 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 adjustment to the Political Environment building block assessment. The next government will likely confront resistance to making the changes necessary to comply with the EC’s recommendations, including from the Constitutional Tribunal and the presidential veto. Yet, DBRS Morningstar is of the view that the change in government will result in an easing of tensions between Poland and the EC and an increase in the likelihood that authorities will find a way to make sufficient progress to release RRF. Likely Prime Minster-elect Tusk appears to be prioritizing the receipt of EU funds.

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 by 5.3% in 2022. The cost of the energy price shock from Russia’s invasion of Ukraine has slowed the pace of growth this year. Following contractions in the first two quarters, due to the effect of elevated inflation and tighter monetary policy on domestic demand, the IMF forecasts real GDP to expand by 0.6% in 2023. Growth in the consumer price index (CPI) declined from the 18.4% peak in February 2023 to single digits in September 2023, as global food and energy prices moderated, and CPI declined to 6.5% on an annual basis in October 2023. Easing price and financing conditions, strong labour markets, healthy private sector balance sheets, and persistently large inflows of foreign direct investment support a recovery. The IMF forecasts the real economy to grow by 2.3% in 2024 and to expand by 3.2% at an annual rate on average from 2025 to 2027. The eventual release of EU funds – including the EUR 60 billion of RRF (9.2% of GDP, including loans and grants) and the EUR 75.5 billion in EU Cohesion money (MFF 2021-2027) – will further bolster medium-term growth prospects.

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

The fiscal deficit amounted to 3.7% of GDP in 2022, and the government expects it to widen to 5.6% of GDP in 2023. The deterioration is due to weaker economic growth, an increase in expenditures still related to the energy crisis, the delivery of aid to displaced Ukrainians, additional spending on healthcare and defence, and a decrease in revenues from reforms to personal income taxation. That said, the government expects the deficit to improve to 2.9% by 2025 as extraordinary support measures phase out, tax collection improves, and the growth of defence spending declines in the coming years from above 4.0% of GDP back towards 3.0%. DBRS Morningstar assumes relations between Poland and the EC will improve once the likely next coalition government takes over, resulting in greater compliance with EU-level fiscal rules and a more rapid than expected medium-term fiscal consolidation. This supports a positive adjustment to the Fiscal Management and Policy building block assessment.

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 57.2% in 2020 as a result of the fiscal and economic impact of the pandemic, but the strong economic recoveries in 2021 and 2022 helped reduce the debt ratio to 49.1% of GDP 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 49.3% of GDP in 2023 to 58.7% by 2027. 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 (5.1 years) only partly delays increased roll-over costs. The yield on the benchmark 10-year Polish bond increased from 1.4% in January 2021 to 5.8% in October 2023. The rise in debt servicing is nonetheless expected to remain manageable. The government estimates interest costs to the Treasury will remain around 2.0% of GDP until 2027, up from 1.1% in 2021. The Treasury has high funding capacity and it typically meets annual funding needs early to reduce short-term pressures. Debt denominated in foreign currency declined to 22% from 36% 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 2.4% of GDP last year as the 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 49.3% of GDP in the second quarter of 2023 remains high, but has steadily declined in recent years due to private sector deleveraging. The net international investment position improved to -33.8% 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 169 billion (roughly 26% of GDP), and inward foreign direct investment roughly seven 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 45% of the remaining Swiss franc-denominated mortgage portfolio at end-2022, from 19% in June 2021. The uptick in out-of-court settlements might continue to 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 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 National Bank of Poland (NBP) increased its reference rate from 0.10% to 6.75%. Due to the gradual retreat of inflation and to counter weaker economic activity this year, the NBP initiated its rate cutting cycle in September 2023 and has reduced its main policy rate by 100 basis points. The reference rate still remains elevated at 5.75%, which weighs on business investment and lending demand. The rapid rate increase also challenges property owners who borrowed during the low-rate period and at variable rates (roughly 90% of mortgages). However, financial stability risk from higher costs of capital appears contained. Household indebtedness is low, wage growth is strong, and the Borrowers Support Fund helps shelter vulnerable borrowers from the rise in mortgage payments.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

ESG Considerations had a significant effect on the credit analysis.

Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
The following Social factors had a significant effect on the credit analysis: The human capital and human rights factor affects the credit ratings. Despite progress with narrowing the EU income gap, the country’s GDP per capita at around USD 18,343 in 2022 remains well below the EU average, according to the IMF. DBRS Morningstar has taken this into account within the Economic Structure and Performance Building Block.

Governance (G) Factors
The following Governance factors had a significant effect on the credit analysis: The institutional strength, governance, and transparency factor affects the credit 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 61.8 percentile for Government Effectiveness, in the 64.2 percentile for Rule of Law, and in the 65.2 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 credit ratings, also reflecting a weaker score in the control of corruption compared with the EU average.

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 (04 July 2023) https://www.dbrsmorningstar.com/research/416784/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/423206.

Notes:
All figures are in Polish Zloty 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 (06 October 2023) https://www.dbrsmorningstar.com/research/421590/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/416784/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 2024-2027 (September 2023); State Budget 2024 (September 2023); National Bank of Poland: Inflation and Economic Growth Projections (July 2023); Financial Stability Report (June 2023), CSO (GSU), Eurostat, European Commission: Economic Forecast Summer 2023 (September 2023); 2023 Rule of Law Report Country Chapter on the rule of law situation in Poland (July 2023), 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, these are unsolicited credit ratings. These credit ratings were 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 credit 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://registers.esma.europa.eu/cerep-publication. 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 credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/423205.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Jason Graffam, Vice President, Credit Ratings, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: December 11, 2015
Last Rating Date: May 26, 2023

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