Fiscal consolidation has taken a break
Poland has a rules-based fiscal policy framework, which is a positive in theory. However, the PiS government that came into office in late 2015 embarked on a controversial economic policy course. It implemented a number of measures that have fundamentally weakened the independence and effectiveness of key state institutions, such as the constitutional court, public broadcasting, the civil service and the central bank. Moreover, the PiS softened some of the fiscal rules and introduced several fiscal stimulus measures, most of them boosting consumption via increased social benefits. This fiscal loosening indeed supported growth in 2017-2018 though surging capital spending, thanks to increased utilization of EU funding, and stronger external demand played a bigger role. Owing to the strong GDP growth in 2017-2019, both the fiscal deficit and total public debt declined in relation to GDP despite the lax fiscal policy stance.
Against the backdrop of the Covid-19-induced recession, this positive trend has reversed. The Polish government announced a large fiscal stimulus program worth more than 13% of GDP. This is the second largest program in CEE after Czechia (21%). Importantly, direct stimulus measures accounts for around 7.7% of GDP, which helped ease the immediate pressures of the crisis. The other part of the stimulus is mainly loans and loan guarantees, which were only partially utilized in 2020; the remainder can be used in 2021. As a result, we estimate the government to have posted a fiscal deficit of around -8.5% of GDP in 2020 and forecast shortfalls of -4.5% in 2021 and -3% in 2022. This should raise public debt from 46% of GDP in 2019 to more than 55% in 2021-2022.
Monetary easing includes QE-style measures
The monetary policy framework is based on inflation targeting. Since the beginning of 2004, the Monetary Policy Council (MPC) of Poland has pursued a continuous inflation target of 2.5%±1pp. As consumer price inflation was below or within the target range from February 2013 to end-2019, the MPC lowered its key policy interest rate to 1.5% by March 2015 and maintained that rate until February 2020 (even though inflation rose temporarily to an average 4.5% y/y in Q1 2020).
From March to May 2020, the MPC lowered the policy rate in three moves to just +0.1% in order to ease the impact of the Covid-19 crisis on the economy. This was justified as headline inflation fell back to 2.9% y/y in May 2020 and has since remained within the MPC’s inflation target range. The National Bank of Poland (NBP, the central bank) also purchased government bonds to ensure the smooth functioning of bond markets as well as sufficient liquidity for banks to support private sector credit. As of Q1 2021, such quantitative easing (QE-)like monetary easing amounted to nearly 5% of GDP. The NBP intends to continue QE in 2021 as the key policy interest rate is near zero. Yet, this measure is (still) different from QE in advanced economies and we assume it to remain smaller in scale. Nonetheless, close monitoring is warranted as excessive QE in an Emerging Market could unnerve market confidence and result in rising inflation in the medium term. For now, we forecast headline inflation to remain in the 2.5%±1pp target range in 2021.
FX purchases to counter upward pressures on the currency
Following three years of relative stability, the Polish zloty (PLN) lost around -6% in value against the EUR and the USD in March 2020 as international investors withdrew capital from all Emerging Markets as the coronavirus was spreading rapidly, causing widespread uncertainty. As the scale of the economic impact of the disease and the fact that Poland would not be among the worst-hit economies became clearer by mid-2020, the PLN regained half of the initial losses against the EUR and more than all of the losses versus the weakening USD in H2 2020. In order to curb the appreciation pressures on the PLN, the NBP has intervened in the foreign exchange (FX) market since December 2020 by purchasing FX, with the purpose of strengthening the transmission of accommodative monetary policy. The motives are threefold: First, the PLN is prevented from becoming overvalued, which could hold back export and GDP growth. Second, FX reserves are built up while external conditions are favorable. Indeed, official FX reserves held by the NBP rose to a new record high of USD140bn at end-2020. Third, if the FX purchases are not fully sterilized as in the case of Poland they represent a further loosening of monetary policy. We expect the second and third motives to be relatively successful in 2021 but the first motive (targeted weakening of the PLN) to be less successful; the PLN is forecast to remain broadly stable versus the EUR over 2021.