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 high 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 have improved the country's economic 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 projects by 2026 that Poland's fiscal deficit remains elevated at 5.0% of GDP and for public debt 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 its concerns with the country's rule of law and political influence over state institutions. The government has met early reform milestones sufficient 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 Improves Relations With The EU, But Faces Domestic Opposition 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 economic 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. Total EU transfers over multiple years under the Multiannual Financial Framework and NextGen EU funds total 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.

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 the Prime Minister and the President is at times strained and the President has veto power over legislation. Resistance from the Constitutional Tribunal is an additional impediment.

Fiscal Deficit Is Wide And Consolidation Appears Unlikely In The Near-Term Due To High Public Spending Demands

Poland's fiscal deficit is expected to reach 5.7% of GDP this year, according to the 2025 Budget. The government's large commitments to support households, to contain energy costs, and to increase public wages and defence spending are the main reasons for the high deficit. Looking ahead, spending pressures remain high given geopolitical risks and the government's spending priorities. Total military spending, already up to 4.3% of GDP, is set to increase to 4.7% in 2025. Net energy support measures decline from 0.5% of GDP in 2024 to 0.1% of GDP next year. The government's election promises 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.

The IMF foresees Poland's structural deficit to reach 5.0% of potential GDP in 2025 and to remain high over the forecast period. Under current IMF assumptions, the structural imbalance narrows only gradually to 4.0% by 2029. Furthermore, the European Commission in July 2024 formally launched excessive deficit procedures (EDPs) against member states, including Poland. It is worth noting that the government forecasts more budgetary discipline in its Medium-Term Fiscal Structural Plan (MTFSP). The government is targeting the structural deficit to reach 5.1% of potential GDP in 2024 and to narrow to 2.1% by 2028, although additional measures are likely necessary to meet these targets.

Public Debt To GDP Is Comparatively Low; Current Assumptions Point To An Uninterrupted Increase In The Debt Ratio

Poland's debt to GDP ratio is on pace to approach the 60% threshold by 2025, primarily stemming from higher structural fiscal deficits. The debt ratio recovered from the pandemic shock in 2022 when it declined to 48.8% of GDP, although the downward trajectory reversed again in 2023 due to the significant slowdown in economic growth and expansionary fiscal policy. The IMF expects debt to increase uninterrupted from 55.5% this year to 66.3% by 2029. Poland's debt ratio remains low compared to EU peers. However, stabilisation of the debt ratio in the absence of stronger economic growth will likely require more constrained fiscal policy in the years to come.

In our view, the Polish Treasury has a high funding capacity, and it typically meets annual funding needs early to reduce exposure to short-term market pressures. The relatively low average maturity of domestic outstanding debt (4.3 years as of September 2024) only partly delays increased roll-over costs. A material share of floating rate instruments, accounting for about one-third of total outstanding debt, also contributes to a swift pass-through of higher policy rates on interest costs. The yield on the benchmark 10-year Polish bond increased from 1.2% on average in January 2021 to 5.3% as of September 2024. The rise in debt servicing has nonetheless remained manageable. The IMF estimates interest costs to the Treasury will remain around 2.5% of GDP until 2027, up from 1.1% in 2021. The share of debt denominated in foreign currency declined to 24% from 36% in 2014. Foreign currency debt is predominantly in euros. Long average maturities on this debt reduce currency risk.

Poland's Economic Recovery Supported By Rebound In Domestic Demand; External Vulnerabilities Remain Elevated

Following flat economic growth in 2023, Poland's economy is set to rebound this year on the back of various domestic demand components. The IMF projects real GDP to grow by 3.0% in 2024 and by 3.5% in 2025. Easing price pressure 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. Still, we expect Poland's structural growth prospects to be weaker compared with the pre-pandemic period. The IMF forecasts economic growth to average 3.1% from 2024-2029, lower output than the 4.5% average growth economy recorded from 2014-2019.

The Polish economy is exposed to heightened external risks. The general slowdown of key European partners, amplification of protectionist trade policies globally, and adverse volatility in commodity prices could weigh on output in Poland. Perhaps more importantly, a spillover 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.

Price Pressures And Higher Interest Rates Likely To Persist; Bank Provisions And Capital Levels Help Mitigate Against FX Legal Risk

Persistent inflationary pressure will likely limit the scope for more aggressive monetary policy easing. The harmonised consumer price index (HCPI), which averaged year-over-year growth above 10% in 2022 and 2023, declined to 4.2% in September 2024. The downward trend in inflation reversed in April 2024 due to the increase in food and energy prices (as support measures are gradually unwound) and persistent service inflation (in part from strong wage growth and domestic demand). The EC forecasts HCPI to average 3.9% in 2024 and 4.5% in 2025, persistently above the National Bank of Poland`s (NBP's) policy inflation target of 2.5%. This will likely limit the scope for it to cut policy rates over the next year. The NBP has maintained its key policy rate at 5.75% since October 2023, weighing on private investment and lending demand. Comparatively high interest rates also challenge property owners who borrowed during the low-rate period and at variable rates (roughly 90% of mortgages). However, financial stability risk from higher rates 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.

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 provisions to cover the remaining Swiss franc denominated mortgage portfolio. 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.

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. Easing supply bottlenecks and subdued domestic demand drove the current account to a 1.6% of GDP surplus in 2023 following a terms-of-trade shock driven deficit of 2.4% in 2022, according to the IMF. The current account balance will likely weaken this year and thereafter as recovering domestic consumption increases import demands. Poland's gross external debt position, at 52% of GDP at the end of 2023, remains high but has steadily declined in recent years due to private sector deleveraging. The net international investment position improved to -32.6% 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 USD 206 billion (roughly 25% of GDP) as of the second quarter 2024, and inward foreign direct investment roughly seven times larger than portfolio investment inflows.

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 22,086 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 Factors in Credit Ratings at Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 credit rating include Ministry of Finance: National medium-term fiscal-structural plan 2025-2028 (October 2024); State Budget 2024 (December 2023); National Bank of Poland: Inflation and Economic Growth Projections (July 2024); Financial Stability Report (June 2024), Statistics Poland (GSU), Eurostat, European Commission: Economic Forecast Winter 2024; 2024 Rule of Law Report: Country Chapter on the rule of law situation in Poland (July 2024), European Central Bank (ECB), International Monetary Fund (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, Macrobond. 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://dbrs.morningstar.com/research/442694/.

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: May 15, 2024

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