Morningstar DBRS Confirms Republic of Poland at "A", Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Poland's Long-Term Foreign and Local Currency - Issuer Ratings at "A". At the same time, Morningstar DBRS 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 Morningstar DBRS' view that the benefits to Poland's macroeconomic outlook from the new government's improved relations with the EU and the disbursement of EU transfers offset risk stemming from geopolitical tension and higher interest rates. The energy price shock and higher financing costs resulting from Russia's invasion of Ukraine weighed on real incomes and investment decisions last year, but the unlocking of sizable EU funds, strong employment growth, and fiscal support improve the country's growth prospects. On public finances, ongoing measures to ease pressures from higher prices and military expenditures will keep Poland's fiscal policy expansionary. The IMF's current projections over its forecast horizon are for the fiscal deficit to remain above the 3% of GDP Maastricht target and for the public debt-to GDP ratio to increase above 60%.

Poland's membership of the European Union (EU) and its strong macroeconomic record support the credit ratings. The country's fiscal framework has kept public debt at comparatively moderate levels despite the recent shocks. The new coalition government, in office since December 2023, started to repair the country's previously stressed relationship with the EU over rule of law concerns and political influence over state institutions. The government has met early reform milestones sufficient enough to allow for the disbursement of Resilience and Recovery Funds (RRF) to Poland. Conversely, the economy's relatively low GDP-per-capita, its unfavourable demographics, and its wide structural fiscal deficit constrain the credit ratings. Despite the new government's early efforts to restore independence to key state institutions, the presidential veto and the constitutional tribunal remain obstacles to the government's ambition to execute substantive reforms.

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) the re-emergence of problematic relations with the EU reduces EU funding and economic growth prospects over a prolonged period.

CREDIT RATING RATIONALE

The New Government Keen To Improve Governance And Relations With The EU, But Faces Resistance To Reforms

The outcome of Poland's parliamentary election in October 2023 resulted in a change in the governing coalition. Though the incumbent United Right alliance led by the Law and Justice Party (PiS) won a 35.4% plurality of the vote, the party did not 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 formed a coalition government in December 2023 with the Third Way (14.4%) and The Left (8.6%), and it has prioritized receipt of EU funds. The European Commission (EC) had withheld its disbursement of COVID-related recovery money to Poland out of concern over the rule of law and state interventionism. After the presentation of the new government's Action Plan for restoring the rule of law, the EC announced that Poland had met key milestones related to improving the independence of the judicial system and would unlock frozen funds up to EUR 137 billion (18% of GDP). In May 2024, the EC announced it would close its Article 7(1) TEU procedure on the rule of law in Poland, citing the government's progress implementing its Action Plan. The government has also attempted to reinforce the independence of the state media and monetary policy decisions at the central bank.

Despite the new government's effort to strengthen its institutions and improve relations with the EU, governance indicators are on average weaker in Poland than in its EU peers. Morningstar DBRS is of the view that the government will make only limited progress on reforms that comply with the EC's recommendations to fully restore judicial independence, at least until presidential elections in mid-2025. This is because the relationship between Prime Minister Tusk and President Duda is at times strained and the president has veto power over legislation. Resistance from the Constitutional Tribunal is an additional impediment.

The Economic Recovery Supported By Rebound In Domestic Demand

The cost of the energy price shock from Russia's invasion of Ukraine and the subsequent rapid rise in interest rates slowed the growth rate of the Polish economy to 0.2% in 2023, following an average expansion over 6% during the previous two years. Growth in the harmonized consumer price index (HCPI) declined from the 17.2% peak in February 2023 to single digits in August 2023, as global food and energy prices moderated. HCPI declined to 6.2% at the end of last year and was 2.7% on an annual basis as of March 2024. Looking ahead, the economic recovery will likely be supported by various domestic demand components. Easing price and financing conditions, strong labour markets, healthy private sector balance sheets, and supportive fiscal policy should all encourage a recovery in private consumption. Likewise, persistently large inflows of foreign direct investment and the release of EU funds including the EUR 60 billion of COVID recovery money (9.2% of GDP) will benefit domestic investment and bolster medium-term growth prospects. The IMF forecasts the real economy to grow by 3.1% in 2024 and to average a similar annual growth rate during 2025-2029.

The Polish economy is exposed to heightened external risks. The general slowdown of key European partners, including the weak performance of the Germany economy, amplification of protectionist trade policies globally, and another energy price shock (should it materialise) could weigh on output in Poland. Perhaps more importantly, a spill over of the war from neighbouring Ukraine into Poland, would have a high adverse impact on the Polish economy. However, Poland's economy is among the eastern European countries least reliant on Germany, it is well positioned to benefit from reshoring policies, and has effectively diversified its energy mix away from Russian energy imports. Furthermore, Morningstar DBRS considers a conventional conflict involving Russia and the NATO alliance as low probability, and the migratory consequences of the current conflict could have long-term benefits to Poland. The employment rate of working age war refugees from Ukraine in Poland, at 65%, is the highest among OECD countries.

Fiscal Consolidation Unlikely In The Near-Term Due To Structurally High Public Spending Needs

The new government's 2024 budget, adopted at the end of last year, keeps public spending commitments high over the forecast period. The increases in defense spending, public sector wages, and social support to households kept the fiscal deficit wide at 5.1% of GDP in 2023. Total military spending was roughly 4% of GDP last year, up from 2% previously, and net energy support measures totaled 0.7% of GDP. Defense spending will likely remain elevated over the next few years and energy support measures, already extended into 2024, may persist. The government's election promise to increase public wages by 20% and teachers' pay by 30% and additional social spending on households, including the childcare allowance, will also apply structural spending pressure in the coming years. The IMF expects Poland's structural deficit to reach 5.7% of potential GDP in 2024 and to remain high over the forecast period. Under current assumptions, the structural imbalance narrows only gradually to 4.1% by 2029. Morningstar DBRS assumes the improved relations between Poland and the EC will result 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

The debt-to-GDP ratio rose to 57.2% in 2020 as a result of the fiscal and economic impact of the pandemic. The strong post-pandemic economic recoveries helped reduce the debt ratio to 49.2% of GDP in 2022, although the downward trajectory reversed again last year due to the significant slowdown in economic growth and expansionary fiscal policy. The IMF expects debt to increase from the 49.6% of GDP result in 2023 to 59.5% by 2026, and to increase gradually thereafter. 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 (5.7 years as of March 2024) only partly delays increased roll-over costs. The yield on the benchmark 10-year Polish bond increased from 1.4% in January 2021 to 5.7% as of April 2024. The rise in debt servicing has nonetheless remained 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 typically 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 in 2022 as the energy and commodity import bill rose from the global terms-of-trade shock. Easing supply bottlenecks and decelerating domestic demand returned the current account to a 1.6% of GDP surplus in 2023. Poland's external debt position at 50.0% of GDP in 2023 remains high, but has steadily declined in recent years due to private sector deleveraging. The net international investment position improved to -31.5% in 2023, 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 188 billion (roughly 25% of GDP) as of the first quarter 2024, 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 63% of the remaining Swiss franc-denominated mortgage portfolio as of June 2023, 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 Morningstar DBRS' 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, the NBP initiated its rate cutting cycle in September 2023 and 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, AND 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 21,996 in 2023 remains well below the EU average, according to the IMF. Morningstar DBRS 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. Morningstar DBRS 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, Morningstar DBRS 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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/432523.

“Morningstar DBRS notes that this Press Release was amended on 1 October 2024, to update the link to the sensitivity analysis.”

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/432522.

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 (6 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.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 (December 2023); National Bank of Poland: Inflation and Economic Growth Projections (March 2024); Financial Stability Report (December 2023), CSO (GSU), Eurostat, European Commission: Economic Forecast Winter 2024; 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. Morningstar DBRS considers the information available to it for the purposes of providing this credit 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

Morningstar DBRS does not audit the information it receives in connection with the credit 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. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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/432522.

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

Lead Analyst: Jason Graffam, Senior Vice President, Global Sovereign Ratings and Financial Institutions Group
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: December 11, 2015
Last Rating Date: November 10, 2023

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