DBRS Morningstar Confirms Republic of Poland at “A”, Maintains 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 the Republic of Poland’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings remains Stable.

KEY RATING CONSIDERATIONS

The trend confirmation reflects DBRS Morningstar’s view that Poland’s strong macroeconomic fundamentals along with the sizeable amount of European Union (EU) funds will continue to support the country’s economic recovery. Poland was one of the least affected economies by the pandemic-related restrictions in the EU, with GDP declining only 2.7% in 2020, compared with a GDP drop of 6.1% for the EU. The significant government support has provided relief to both the corporate sector and the labour market but at the expense of a large increase in the fiscal deficit to 7.0% in 2020 from a deficit of 0.7% in 2019. As the vaccination campaign accelerates Poland should be well positioned to achieve pre-pandemic GDP levels by Q3 2021 and to grow at solid rates in the next two years, although new virus variants pose downside risks. Major progress with fiscal consolidation is likely to occur only after 2022, with the public debt-to-GDP returning to around 58% of GDP in 2024 after increasing again this year to 60% from the 2020 level of 57.5%.

The ratings are supported by Poland’s track record of strong macroeconomic performance, a relatively low public debt-to-GDP ratio, a sound monetary policy framework, a flexible exchange rate regime, and its integration within the EU. Despite these strengths, Poland’s ratings are constrained by what remains a relatively low GDP per capita level, and unfavourable demographic trends. In addition, some frictions with the European Commission (EC) have emerged, in particular in relation to policies regarding judicial independence. This remains a concern in terms of respect for the rule of law in Poland and could ultimately result in lower EU funding for the country in the future. EU funds are an important driver of growth for Poland. However, for the time being uncertainties have receded following the compromise reached in December last year in the European Council.

RATING DRIVERS

One or a combination of the following factors could lead to an upgrade: (1) fiscal consolidation leading to a significant reduction in the structural deficit and in the public debt-to-GDP ratio in the medium term; (2) stronger-than-expected economic growth resulting in further convergence to the EU average GDP per capita level; (3) progress in implementing growth-enhancing reforms accompanied by improvement in the institutional framework.

One or a combination of the following factors could lead to a downgrade: (1) a weaker-than-expected recovery hampering significantly the expected fiscal consolidation or a materialisation of a large amount of contingent liabilities in the medium term; (2) a more confrontational stance with EU authorities, leading to a significantly lower level of future EU funding.

RATING RATIONALE

The Risk of Losing EU Funds Has Receded for the Time Being

Benefitting from its EU membership, Poland is projected to continue to receive a substantial share of EU resources. This takes the form of cohesion policy funds from the Multiannual Financial Framework (MFF) that, along with funds stemming from the Next Generation EU (NGEU), will likely foster economic rebound in the coming years. Since the country joined the union, EU resources have largely contributed to solid economic growth rates, with the annual real GDP growth rate averaging 3.7% during the 2004-20 period, one of the highest in the EU. This has mirrored the GDP per capita convergence that in purchasing power standards (PPS) has increased from 50% to around 76% of the EU average in the same period. Poland is not only one of the largest beneficiaries of EU funds in terms of allocation but is also registering sound absorption rates compared with the EU average. This bodes well to Poland spending a further large amount of cohesion funds estimated at around EUR 75 billion from the current MFF (2021-27). In addition, the Polish government also aims to use EUR 23.9 billion of grants and EUR 12.2 billion of loans from the Recovery and Resilience Facility (RRF) to increase public investment and make important reforms to increase the country’s competitiveness, improve digitalisation and the health sector, as well as to foster the green transition.

The uncertainty over the conditionality of the disbursement of EU funds receded after an agreement in the European Council among all member states in December last year. The compromise enabled the approval of the current MFF and delayed the mechanism that could make some EU funds conditional on the respect of the rule of law. Member states could also appeal to the European Court of Justice, lengthening the time for resolution. This is important as since 2015 multiple changes implemented by the government to the judicial system have created frictions with the EC, leading to the launch of the Article 7 procedure of the Treaty of the European Union (TUE) as well as some infringements. In DBRS Morningstar’s view, some of the governing measures could weaken the independence of the judiciary and increase the risk of state interventionism. This weighed negatively on the Political Environment building block assessment.

Frictions among the parties forming the ruling coalition increased because of the veto of the junior party Solidarity Poland (SP) against the EU recovery plan which was considered by the party as harmful to the Polish sovereignty. This led the Law and Justice Party (PiS) to achieve an agreement with the left-wing party The Left and the centrist Poland 2050 group to overcome the veto at the beginning of May. In DBRS Morningstar’s view, frictions in the ruling coalition might re-emerge, but early national elections appear unlikely.

Fiscal Space Has Enabled the Government to Put in Place A Large Support Package

After two years of budgetary deficit, averaging around 0.5% of GDP, the magnitude of the COVID-19 shock prompted the government to deliver a sizeable economic support package including liquidity support to the private sector. The relatively low level of public debt, as well as the sound fiscal starting point, enabled the government to mitigate the impact of the pandemic to a great extent. The deterioration in the fiscal accounts, however, was significant but it is expected to be temporary and eventually to be followed by an improvement in the fiscal trajectory. The government amendment of the stabilizing expenditure rule enabled the deficit to rise to 7.0% of GDP in 2020. This, however, was much lower than the deficit of 11.8% of GDP estimated in the Budget in September last year, thanks to higher fiscal revenues, and a lower take-up rate of some government initiatives. Total above the line government measures were estimated to amount around 4.4% of GDP (PLN 103.2 billion) including non-returnable support amounting to 1.8% of GDP (PLN 41.2 billion) from the Polish Development Fund (PFR). By financing most of the measures with the Bank Gospodarstwa Krajowego (BGK) and the PFR, the government debt, measured in national definition, increased only to 47.8%, up by 4.6 percentage points from 2019. This allowed to adhere to the 55% debt-to-GDP ratio (in the national definition) threshold that otherwise had it been exceeded would have triggered fiscal consolidation measures according to the rule.

In the convergence programme in April 2021 the government assumed extension of the escape clause of the fiscal rule to 2022, with fiscal consolidation measures starting only in 2023. According to the government, however, despite the economic rebound and the winding down of some of the measures introduced last year, the deficit should only marginally improve to 6.9% of GDP this year before declining to 4.2% in 2022. The estimate, however, does not include the potential positive impact of the RRF, and should the economic recovery be more sustained the improvement could be faster. The latest forecast from the EC points to a substantial deficit improvement already this year to 4.3% of GDP before a further drop to 2.3% in 2022. However, the government in May has announced a series of measures also known as the “Polish Deal” which proposes an increase in expenditure in the health care sector as well as facilitating young family home borrowers and a tax reform. These measures are expected to provide further economic stimulus by increasing incomes but might weigh on the structural deficit reduction in the medium term, which already included important pre-pandemic measures.

Poland is Well Positioned for a Solid Rebound Supported by Pent-up Demand and EU Resources

The Polish economic performance will continue to benefit from the strong fundamentals as well as from the large flow of EU funds that are expected to remain an important economic driver in the years to come. The mild GDP contraction in 2020, provided that the pandemic is under control, should be followed by a solid rebound in the next two years limiting permanent impact on GDP potential.

The low exposure to the sectors most affected by the restrictions along with large and rapid government support, have enabled Polish GDP to contract by only 2.7% last year, one of the lowest GDP declines in the EU. Government measures providing liquidity as well as wage subsidies have supported both the corporate sector and the labour market, with total employment declining only 0.1% last year. As the pandemic recedes, the economy is well positioned to post a significant GDP rebound in the second half of the year supported by both domestic consumer pent-up demand and higher exports. The savings ratio has increased significantly during the last year, but the improvement in confidence is expected to translate into a boost in consumption and savings at least partially run down. Since the number of new cases is declining and the vaccine rollout accelerates, the government has been gradually easing restrictions since May. Provided that new vaccine-resistant coronavirus variants do not emerge and the economy absorbs the sizeable amount of EU resources, the EC projects GDP growth to rebound to 4.0% and 5.4%, in 2021 and 2022, respectively.

Looking at Poland’s long-term growth prospects, regional disparities and adverse demographics, including the decline in the working-age population, could weigh on the country’s potential growth. According to the government, the number of people working in the Polish economy is expected to increase slightly in 2021, and to stagnate in the following years. This could make the labour market tighter, increase inflation, and put more pressure on public finances in the long term. Successful reforms included in the Polish Recovery and Resilience Plan are expected to mitigate this impact.

The Risk of An Additional Material Rise in Public Debt is Limited by A Prudent Fiscal Framework and Likely Sound Recovery

After a steady decline in the public debt-to-GDP ratio in recent years, the economic recession brought about by the pandemic, along with the sharp rise in the primary deficit, translated into an increase of 12 percentage points in the public debt ratio to 57.5% in 2020. The EC projects debt-to-GDP to start declining this year to 57.1%, before declining further to 55.1% in 2022. DBRS Morningstar takes the view that Poland’s prudent fiscal framework should mitigate against a further material deterioration in public finances because Poland’s constitution limits the public debt-to-GDP ratio (measured with the national definition) to 60% of GDP. Moreover, sound economic growth is projected to resume, contributing to an improvement in the debt ratio in the medium term. Conversely, should the economic recovery be weaker than expected, contingent liabilities could materialise or less appetite for fiscal consolidation could emerge, contributing to a delay in Poland’s public finances improvement.

Poland’s public debt affordability remains sound despite the large increase in the stock. Interest rate costs continue to remain very low and benefit from the low interest rate environment, albeit a modest increase in the 10-year bond yield has occurred since the start of the year. The IMF projects total debt costs as a share of GDP to decline to 1.0% this year from 1.3% registered last year. The Treasury has already completed 71% (as of May 26th) of the funding of the State budget and the average time to maturity of the State debt has slightly increased to 4.88 years as of April 2021 from 4.63 years as of December 2020. This is because the Treasury has resumed its activity to issue debt with longer maturities after moving towards shorter maturities during the initial months of the pandemic last year when volatility was elevated. Exchange rate and interest rate risks remain partially mitigated as 75.3% of State Treasury debt is denominated in local currency and 77.5% at fixed interest rates as of February 2021. While the relatively high share of foreign investors in State Treasury debt at 34.7% makes Poland vulnerable to bouts of volatility in risk-off environments, the well-diversified investor base somewhat reduces that risk.

As the Economy Rebounds, Current Account Surplus Expected to Moderate

Poland’s external position has improved in recent times and benefits from a high level of competitiveness, reflected in a growing export market share of goods and services and declining external debt as a share of GDP. Last year, the fall in domestic demand coupled with low import prices translated into a sharp reduction in imports of goods, greater than the decline in exports causing the trade balance to widen to 2.3% of GDP in 2020 from 0.2% in 2019. Together with an improvement in the primary income balance because of a lower flow of income on direct investment, the current account surplus substantially increased to 3.5% of GDP from 0.5% registered in 2019. This positive momentum is expected to be temporary. As the economy rebounds the EC projects the surplus to gradually decline to more moderate levels of around 2.1% of GDP in 2022.

External debt is high but has been on a declining trend since 2016. Although it has slightly increased at the end of last year to 60.2% of GDP from 58.7% in 2019, it remains well below the peak of 76.3% registered in 2016. The IMF projects a substantial improvement in the external debt to 38% of GDP in 2025, thanks to the large flow of EU grants Poland will receive, which should boost the capital account surplus. Last year capital outflows at the beginning of the pandemic were temporary, and once authorities started to provide support receded promptly. Poland benefits from an elevated level of foreign exchange reserves at USD 140.8 billion in April 2021, up from USD 89.4 billion at the end of 2015, and a high share of foreign direct investment including inter-company debts. This makes the Polish economy more resilient to capital outflows.

High Capitalisation Expected to Weather the Impact of COVID-19 but Uncertainty Over Legal Risks Remains Elevated

The banking sector remains stable and liquid, showing an elevated level of capitalisation, although compressed interest rate margins and increasing provisions are reducing profitability. In DBRS Morningstar’s view, the large support provided by the government has been preserving the sound position of the Polish financial sector. Non-financial corporations entered the pandemic with sound liquidity buffers and benefitted from the rapid support in the form of guaranteed loans, which were in part forgivable. So far, credit quality has deteriorated only marginally, with the NPL ratio increasing to 5.1% as of Q4 2020 from 4.8% pre-pandemic, but as government measures are phased out a further deterioration is expected.

Profitability is declining due to low interest rate margins and higher provisions, in particular for legal risks. This is in response to the high uncertainty after the rise in litigations following the ruling decision of the European Court of Justice on the legacy exposure of mortgages indexed to Swiss francs in 2019. The banking sector has begun to increase provisions, which account for around 7% of total foreign exchange mortgage portfolio consisting of around PLN 117 billion. The impact on the sector is expected to be influenced by the future decision of the Polish Supreme Court that could determine the scope of potential losses for banks. The court has delayed its final decision over the recent months and by asking for an opinion from the National Bank of Poland, the Financial Supervisory Authority, and the financial ombudsman, it could adopt a balanced approach between the interest of the borrowers and the banks. However, the final impact will continue to depend also on the number of litigations, and the time to rule on single cases by local courts, spreading the losses over time, unless banks move to voluntary foreign exchange conversions. An unfavourable decision of the Polish Supreme Court could be challenging, in particular for small and medium-size banks with large exposure to foreign exchange mortgages. This could translate into a second round-effect on the economy with banks likely tightening lending standards when the economy is back on the recovery pace. However, the overall impact on the system will likely be cushioned by provisions and high level of capitalisation. DBRS Morningstar believes that the Polish banking system’s Tier 1 capital ratio of 18.77% as of December 2020 is an important buffer to absorb losses.

Poland’s ratings are also supported by the credibility of its monetary policy framework and its solid institutions. In response to the pandemic, the Narodowy Bank Polski (the National Bank of Poland (NBP)) has implemented several accommodative monetary policy measures. The cut in its policy interest rate and in the reserve ratio was accompanied by repo operations to provide liquidity and a secondary market asset purchase programme. Total debt securities and eligible assets guaranteed by the State Treasury purchased by the NBP amounted to 4.9% of GDP as end of March 2021 and the NBP has increased its scale of purchases by PLN 10 billion per months since April. NBP also offered bill discount credit aimed at refinancing loans granted to enterprises by banks. Over the last two months the consumer prices index has been on a rising trend and at 4.3% in April 2021 exceeded the upper band of the inflation target (2.5% YoY, +/- 1 percentage point). According to the NBP, inflation is expected to remain higher than the upper band in the coming months before declining next year towards the target when the transitory factors peter out. However, in DBRS Morningstar’s view, uncertainty regarding a more sustained inflation is rising and higher pressure on inflation might require tightening in monetary policy, constraining the recovery to some extent.

ESG CONSIDERATIONS
Human Capital and Human Rights (S) and Institutional Strength, Governance, and Transparency (G) were among the key drivers behind this rating action. Poland’s per capita GDP at around USD 15,653 in 2020 was low compared with the EU average. According to the latest World Bank Governance Indicators, Poland ranks in the 73rd percentile for the Government effectiveness, in the 66th percentile for Rule of Law, in the 70th percentile for Voice and Accountability. The respect of the Rule of Law remains a concern and could affect future EU funding in the future. These factors have been taken into account within the following building blocks: Economic Structure and Performance, Fiscal Management and Policy, and Political Environment.

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 at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/379350.

Notes:
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

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 https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include Ministry of Finance, Ministry of Finance - State budget borrowing requirements’ financing plan and its background (May 2021) - State Treasury Debt (April 2021) – Public debt Q4 2020 (March 2021) – Convergence Programme 2021 (April 2021), National Bank of Poland, National Bank of Poland - Inflation Report (March 2021), CSO (GSU), Ministry of Development Funds and Regional Policy, Eurostat, European Commission (Economic Forecast Spring 2021, Breakdown of Cohesion Policy allocations per Member State), European Central Bank (ECB), Polish Financial Supervisory Authority, IMF, European Banking Authority (EBA), BIS, World Bank, UNDP, European Commission 2020 Rule of Law report, Ministry of Climate and Environment, 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: NO
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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/379352.

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

Lead Analyst: Carlo Capuano, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: December 11, 2015
Last Rating Date: December 4, 2020

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