IMF Wraps Up Poland Article IV Consultation

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1with the Republic of Poland and considered and endorsed the Staff Appraisal on a lapse-of-time basis without a meeting.

The Polish economy has slowed significantly amid still-high inflation. Following a rapid recovery from the pandemic, the Polish economy grew 5.1 percent in 2022, though the economy slowed considerably later in the year. With high inflation eroding real wage growth and investment facing headwinds from energy prices and interest rates, economic growth is projected at 0.3 percent in 2023 before a projected rebound in 2024. Over the medium term, Poland's potential growth is projected to remain around 3 percent, with strong investment, supported by Next Generation EU grants, temporarily offsetting the negative effects of population aging.

As the authorities implemented a personal income tax reform and temporarily reduced taxation on food and energy to prevent higher inflation, the general government deficit widened to 3.7 percent of GDP in 2022 from 1.8 percent of GDP in 2021, with general government debt declining to 50 percent of GDP. The general government deficit is projected to widen further to 4.5 percent of GDP in 2023, mainly due to the slowing economy. Over the medium term, the general government deficit is projected to stabilize around 3.5 percent of GDP and debt to increase to about 55 percent of GDP.

While the substantial increase in inflation in 2022 was driven primarily by external factors, including food and energy prices, core inflation also increased and remains at high levels. The central bank tightened monetary policy significantly in 2021-22 before pausing in late 2022. The projected stabilization of food and energy prices is projected to drive a significant decline in headline inflation in 2023, though the easing of core inflation is projected to be more protracted. Inflation is projected to decline near the target by the end of 2025.

Bank asset quality has remained stable, and sector-wide capital adequacy levels remain significantly above regulatory requirements. Supported by rising lending interest rates, banks remained profitable in 2022, despite the cost of mortgage credit holidays. The legal risks stemming from foreign-currency denominated mortgages remain the most significant source of uncertainty and potential losses for banks.

Executive Board Assessment2

After the rapid recovery from the pandemic, the Polish economy has weakened significantly amid still-high inflation. The economy slowed abruptly in 2022, facing energy price shocks, monetary policy tightening, and slowing external demand. Labor markets remain tight, though some signs of cooling have emerged. High inflation has been driven primarily by food and energy price shocks - exacerbated by Russia's war in Ukraine - though underlying inflation has also accelerated. The external position is preliminarily assessed to be broadly in line with medium-term fundamentals and desirable policies. Foreign exchange reserves are adequate to insulate against external shocks and disorderly market conditions.

Despite the projected slowdown in 2023, medium-term economic prospects remain favorable. In the near term, high inflation has eroded real wage growth, while investment faces headwinds from energy prices, interest rates, and declining housing activity. As shocks fade and real wage growth recovers, the economy is projected to rebound in 2024 and 2025. Nevertheless, considerable near-term uncertainty will require deft policy management as policymakers seek to lower inflation without incurring an excessive cost to economic output.

A fiscal expansion in 2023 should be avoided to help combat still-high inflation. While the fiscal deficit is projected to widen in 2023 mainly due to the slowing economy, any policy driven fiscal loosening should be avoided unless major downside risks materialize. Further energy price measures, if needed, should be temporary, targeted, and preserve price signals. Over the medium term, the authorities should create fiscal space to accommodate new defense and other expenditure priorities without placing general government debt on an upward trajectory. Ending the reliance on extra-budgetary funds and requiring all spending to go through the budgetary process would enhance fiscal transparency.

Monetary policy needs to be tight until price pressures are under control and a sustained reduction in inflation towards its target has been achieved. The expected stabilization of food and energy prices should reduce headline inflation in 2023. However, further disinflation hinges on an easing of underlying inflation. Monetary policy should remain data dependent and be tightened further if core inflation momentum, wage growth, and the economy fail to slow as projected. Foreign exchange intervention should continue to be reserved for disorderly market conditions.

While the banking sector has remained stable, there are significant legal and regulatory challenges. Asset quality has not deteriorated, and sector-wide capital adequacy levels remain significantly above regulatory requirements. However, ongoing challenges reduce banks' profitability and could limit their ability to provide credit to the economy over the medium term. Most importantly, to address the ongoing litigation of foreign exchange mortgages, banks should continue to proactively seek to reach voluntary agreements with clients to convert their mortgages into local currency. The authorities should also explore policy options to help reduce the uncertainty that foreign exchange mortgage legal risk casts over the banking sector. In addition, untargeted mortgage credit holidays are inefficient, costly, weaken monetary policy transmission, and should not be extended.

Ongoing public investments and structural reforms are needed to bolster longer-term economic growth and convergence and meet climate goals. Over the medium term, Poland's potential output would be supported by strong investment, projected to be financed in part by Next Generation EU grants, which would help temporarily counteract the negative effects of population aging. A sustained increase in immigration would increase Poland's competitiveness and raise medium-term growth. The successful integration of Ukrainian refugees could be furthered with additional training and skill development. Substantial investment in clean sources of energy is necessary to support sustainable economic growth and meet energy transition goals. Additional policy instruments may be needed to meet decarbonization targets, and the authorities are encouraged to consider a role for carbon taxation.

It is recommended that the next Article IV consultation be held on the standard 12-month cycle.