Standard&Poor tells Poland to pull her socks up

The zloty fell against both the dollar and the euro in the first week of September as Standard&Poor again threatened to lower Poland's credit rating. The government is preparing a strategy to keep the wolves at bay, but analysts are skeptical.

By Hilary Davies

The government is hopeful

"Unless the government sets about reforming public finance, we may revise Poland's credit rating," Standard&Poor's Beatriz Merino told Reuters. This follows an earlier warning from the agency, which was issued just this past June. The fall in the zloty, which would inevitably follow a demotion of Poland's credit rating, could be disastrous for the government, almost inevitably leading to a drastic increase in the public debt, and potential investors voting with their feet. Yet since the agency's decision will be taken only after the government's budget plans for 2004 are finalized, Vice-Premier Jerzy Hausner hopes to avoid the threat with strategies to reduce the budget deficit and also to reform taxes. This will be the topic of discussion when the Council of Ministers meets on September 16.

"The Minister of Finance is preparing a strategy for the period from now until 2006," Mr. Hausner told journalists, "although I'd prefer it if the period were defined up to the moment where Poland fulfils the Maastricht criteria." These criteria are planned for 2007, and require a budget deficit no greater than three percent GDP, and a public debt no higher than the constitutionally established ceiling of sixty percent. These two conditions are mandatory in order for Poland to join the euro-zone. According to Mr. Hausner, the plan involves far-reaching reforms to the pension system, as well as a rationalization of taxes, which he hopes will convince rating agencies that the government is "proposing safe and credible conditions for domestic growth."

But on a less positive note...

However, unless the economy picks up significantly, Standard&Poor's analyst, Moritz Kraemer, is not too optimistic about Poland's chances of meeting the Maastricht requirements anytime soon: "Technically possible, but politically difficult,' was his laconic comment. He also warned that if the public debt oversteps the constitutional limit of sixty percent by 2006, the situation will become extremely unstable - especially if the government has not planned for such a possibility.

Initial plans for the 2004 budget were discussed by the Council of Ministers last Tuesday, and have done little to lift the gloom. Based on an assumed five percent growth in GDP, the plans predict a 2004 budget deficit no greater than zł.45.5 billion - but economists are not impressed: "45.5 billion is the result of creative accounting," PKB's Krzysztof Rybinski told the Business Journal. "If you add up the budget deficit according to the 2003 methods, it comes to 64 billion."

Other analysts agree that that the budget deficit has (almost) been kept within the planned limits because the public sector deficit has not been counted within the official state budget deficit. "The expenditures are falsely lowered," says Marcin Mróz, senior economist at SG Bank, "while the main state agencies like ZUS (social security) and the Fundusz Pracy (labor fund) need funds, so are forced to increase their debts." Krzystof Rybinski is even more explicit: "The labor fund and the social fund both need zł.6 billion more than they are getting. That means that they will have to go and borrow from banks, which means that private business will be crowded out of the credit market."

Adding to the creative accounting theory - and the bad news - is the fact that the figure of zł.45.5 billion does not include around zł.11.4 billion that will have to be paid to the OFE (Open-end Pension Fund,) or over zł.4 billion of payments, which will go to the EU.

When discussing the growth of five percent, as predicted by the government, Rybinski is even more pessimistic: "I think that growth could be about five percent, following the easing of fiscal policy (the option of a nineteen percent line tax for businesses) but it will only last one or two years - which means it's good for the 2005 elections," he says. "Meanwhile, the public debt is likely to soon top fifty-five percent, which will be very destabilizing and the government will have to increase taxes."

"Safe and credible

conditions"?

How Standard&Poor react to the government's "safe and credible conditions" will depend heavily on the government's medium term strategy for financial reform, which will be discussed on September 16. But in Rybinski's view, "Credibility will be difficult for the government to come by."

Meanwhile, even unconfirmed rumors of the possible threat from Standard&Poor were enough to get the markets jiggling and the zloty toppling in the first week of September. It's a reaction which in itself seems to demonstrate that WSE investors' faith in Poland is already frail and easily shaken...