Council opinion

of 8 July 2008

on the updated convergence programme of Poland, 2007-2010

(2008/C 182/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [1], and in particular Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 8 July 2008, the Council examined the updated convergence programme of Poland, which covers the period 2007 to 2010 [2].

(2) Poland made recently progress in closing the gap with average EU income levels as real GDP growth picked up from around 4,5 % on average in 2003-2005 to above 6 % in 2006-2007. The labour-intensive output growth improved considerably the situation in the labour market as unemployment dropped from nearly 20 % in 2003 to 9,5 % in 2007. The fall in unemployment reflects, in addition to an extraordinary growth in employment, a shrinking labour force due to migration. Moreover, distortions of incentives to work enhanced by significant emigration increase the shortage of labour in some sectors. The tightening labour market puts pressure on wages; this, along with higher food and oil prices, has impacted negatively on HICP inflation which, after a period of successful moderation from 2005 to the first half of 2007, picked up significantly at the end of 2007. Since peaking at 6,25 % of GDP in 2003, the general government deficit declined on average by more than 1 percentage point annually to reach 2 % of GDP in 2007. In recent years, outturns were generally better than the targets thanks to positive growth surprises resulting in windfall revenues as well as the incomplete execution of expenditure plans. Further budgetary consolidation will hinge crucially on the reform of the social transfer system (mainly early pensions and disability benefits) and the increase of labour participation.

(3) The macroeconomic scenario underlying the programme envisages that real GDP growth will gradually decrease from 6,5 % in 2007 to 5,2 % on average over the rest of the programme period. Assessed against currently available information [3], this scenario appears to be based on plausible growth assumptions. The programme's projections for inflation appear to be on the low side reflecting slightly favourable assumptions on import prices and a relatively low increase in nominal compensation per employee.

(4) The 2007 general government deficit outturn was 2 % of GDP, compared to 3,4 % projected in the November 2006 convergence programme. Much higher real and nominal GDP growth than assumed in November 2006 was the main reason, but expenditure was also restrained. In particular, high profitability of companies allowed for growth in subsidies to be contained, while the rapid fall in unemployment and the absence of indexation imposed by the Hausner plan [4] also curtailed growth in social transfers. In addition, compensation of public sector employees was lower than planned. Finally, government investment was lower than projected because of a slower absorption of EU funds than planned. Overall, the expenditure-to-GDP ratio was 1,5 percentage point lower than projected in November 2006. On the revenue side, revenue from indirect taxes and social contributions turned out better than envisaged in November 2006, mainly thanks to a much higher employment and wage growth. These positive surprises were offset by a lower performance of other revenue items (direct taxes due to an increase in tax brackets). Overall, this led to a revenue ratio slightly below the planned one. With an improvement in the structural balance ratio by about 1,5 percentage point, budgetary implementation in the year 2007 more than fulfilled the invitation in the Council opinion of 27 February 2007 on the previous update of the convergence programme [5].

(5) The main goal of the budgetary strategy is a durable reduction of the structural general government deficit (cyclically-adjusted deficit net of one-off and other temporary measures) aimed at achieving the medium-term objective (MTO) for the budgetary position, which is a structural deficit of 1 % of GDP, in 2011, i.e. one year after the programme period. This is consistent with the previous convergence programme, which envisaged achieving the MTO "after 2010". After deteriorating by 0,5 percentage point to 2,5 % of GDP in 2008, the headline deficit is planned to improve to 1,5 % by 2010. The primary balance follows a similar path and is projected to increase from – 0,2 % of GDP in 2008 to 0,8 % in 2010. Against the backdrop of moderating output growth, the changes in the structural balance calculated according to the commonly agreed methodology are foreseen to be larger, with the structural deficit narrowing from about 2,75 % of GDP in 2008 to slightly above 1 % in 2010. The budgetary adjustment is expenditure-based and back-loaded to 2009 and 2010. In 2008, the deficit deterioration is mainly driven by a sharp increase in the investment ratio as well as a large cut in social contributions (partly compensated by an increase in other revenues). In 2009-2010, the consolidation is to be achieved mainly through restraint in compensation of employees, social transfers and intermediate consumption. The planned rate of deficit reduction between 2007 and 2009 is lower than in the previous update, however the starting point (2007) and each of the new deficit targets of the March 2008 update of the convergence programme are better than the targets in the November 2006 update.

(6) The risks to the budgetary projections in the programme appear broadly balanced in 2008, but the outcomes could be worse than projected in the programme afterwards. The 2008 deficit target in the programme is the same as in the spring 2008 forecast (2,5 % of GDP). The 2008 Q1 cash data for central budget point to a revenue performance above the budgetary projections, but the programme assumes slightly higher growth in 2008 than in the spring 2008 commission forecast and still mounting wage pressure in the public sector poses a risk for public finances.

On the other hand, higher inflation than assumed in the programme will reduce the expenditure ratio in 2008, as expenditure is predominantly fixed in nominal terms. However, in 2009, the higher 2008 inflation could stimulate wage growth in the public sector and lead to higher pensions and social benefits than assumed in the programme, further exacerbated by a reform of the indexation mechanism which links, as from 2008, social benefits not only to consumer prices but also partially to wages. While tax cuts have already been adopted by parliament, offsetting measures are yet to be specified and implemented. If further high employment growth assumed by the government is not maintained, the continuation of the 2006-2007 job-rich-growth-based budgetary consolidation after 2008 may be difficult. On the other hand, the track record for the development of the general government balance is good: revenues have turned out frequently higher than projected while expenditure plans have been under-executed.

(7) In view of this risk assessment, the budgetary stance in the programme seems consistent with a durable correction of the excessive deficit by 2007 as recommended by the Council. However, the safety margin against breaching the 3 % of GDP deficit limit could not be ensured within the programme period. In addition, the budgetary stance in the programme may not be sufficient to ensure that the MTO is achieved by 2011, as envisaged in the programme. As the economy enjoys favourable growth conditions, the pace of adjustment towards the MTO implied by the programme is insufficient and needs to be strengthened in 2008 to be in line with the Stability and Growth Pact. Thereafter, it should be backed up with measures. In addition, should inflationary and wage pressures materialise, a tighter fiscal stance than foreseen in the programme would be required to avoid overheating.

(8) Poland appears to be at low risk as regards the sustainability of public finances. Although the budgetary position in 2007 includes a small structural primary deficit based on the convergence programme, according to the projections made in 2005 and based on the common methodology, the long-term budgetary impact of ageing is among the lowest in the EU. However, as from 2008, social benefits will be indexed not only to consumer prices but also partially to wages, which will raise expenditure in the long-term. Further consolidation of public finances, including the reform of the early retirement (introduction of "bridge pensions" which limit early retirement to certain professions) as intended in the convergence programme, would therefore contribute to both stimulating labour activity and employment and limiting risks to the sustainability of public finances.

(9) The convergence programme seems to be consistent with the October 2007 implementation report of the national reform programme. In particular, both programmes envisage the reform of early retirement and disability benefits, the reform of the farmers' social fund, the healthcare reform, the reorganisation and decentralisation of public finances, the multi-annual task budgeting. The convergence programme does, however, not contain a qualitative assessment of the overall impact of the October 2007 implementation report of the national reform programme within the medium-term fiscal strategy (discussing, e.g., the impact on potential growth and employment). Though, the programme provides systematic information on the direct budgetary costs of the main reforms envisaged in the national reform programme.

(10) The budgetary strategy in the convergence programme is partly consistent with the country-specific broad economic policy guidelines, included in the integrated guidelines, in the area of budgetary policies issued in the context of the Lisbon strategy. While the programme envisages continued fiscal consolidation, further mechanisms to enhance control over expenditure are not mentioned.

(11) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has some gaps in the optional data.

The overall conclusion is that, following the correction of the general government deficit in 2007 and while the deficit and the debt will remain below the reference values of respectively 3 % and 60 % of GDP, the programme envisages a deterioration of the general government balance by 0,5 percentage point of GDP in 2008 and a back-loaded progress towards the MTO in the following years in a context of favourable growth prospects. In 2008, the projected structural deterioration by almost 0,5 percentage point of GDP is not in line with the Stability and Growth Pact. Given the risks to the budgetary targets from 2009, mainly due to a lack of specified measures, the MTO may not be achieved by 2011 as planned in the programme. Moreover, should inflationary pressures emerge, a tighter fiscal stance than foreseen in the programme would be required. As regards the long-term sustainability of public finances, Poland appears to be at low risk, but the early retirement system is in need of reform.

In view of the above assessment and the need to ensure sustainable public finances, Poland is invited to exploit the favourable growth conditions to strengthen the pace of structural adjustment towards the MTO, including in the light of possible inflationary pressures, by using any extra revenue and unspent resources for deficit reduction in 2008 and by specifying and implementing measures, especially on the expenditure side, in the following years.

Comparison of key macroeconomic and budgetary projections

Notes:

[6] [7] [8]

Source:

Convergence programme (CP); Commission services' spring 2008 economic forecasts (COM); Commission services' calculations.

| | 2006 | 2007 | 2008 | 2009 | 2010 |

Real GDP (% change) | CP Mar 2008 | 6,2 | 6,5 | 5,5 | 5,0 | 5,0 |

COM Apr 2008 | 6,2 | 6,5 | 5,3 | 5,0 | n.a. |

CP Nov 2006 | 5,4 | 5,1 | 5,1 | 5,6 | n.a. |

HICP inflation (%) | CP Mar 2008 | 1,3 | 2,6 | 3,5 | 2,9 | 2,5 |

COM Apr 2008 | 1,3 | 2,6 | 4,3 | 3,4 | n.a. |

CP Nov 2006 | 1,4 | 2,1 | 2,5 | 2,5 | n.a. |

Output gap [6] (% of potential GDP) | CP Mar 2008 | 0,5 | 1,1 | 0,7 | – 0,2 | – 0,9 |

COM Apr 2008 [7] | 0,6 | 1,2 | 0,5 | – 0,7 | n.a. |

CP Nov 2006 | 0,5 | 0,5 | 0,3 | 0,4 | n.a. |

Net lending/borrowing vis-à-vis the rest of the world (% of GDP) | CP Mar 2008 | – 2,6 | – 2,6 | – 3,5 | – 4,2 | – 4,6 |

COM Apr 2008 | – 2,5 | – 2,6 | – 2,3 | – 3,6 | n.a. |

CP Nov 2006 | – 1,6 | – 1,8 | – 2,2 | – 2,7 | n.a. |

General government balance (% of GDP) | CP Mar 2008 | – 3,8 | – 2,0 | – 2,5 | – 2,0 | – 1,5 |

COM Apr 2008 | – 3,8 | – 2,0 | – 2,5 | – 2,6 | n.a. |

CP Nov 2006 | – 3,9 | – 3,4 | – 3,1 | – 2,9 | n.a. |

Primary balance (% of GDP) | CP Mar 2008 | – 1,1 | 0,2 | – 0,2 | 0,3 | 0,8 |

COM Apr 2008 | – 1,1 | 0,6 | 0,2 | 0,1 | n.a. |

CP Nov 2006 | – 1,5 | – 1,0 | – 0,7 | – 0,6 | n.a. |

Cyclically-adjusted balance [6] (% of GDP) | CP Mar 2008 | – 4,0 | – 2,4 | – 2,8 | – 1,9 | – 1,1 |

COM Apr 2008 | – 4,0 | – 2,5 | – 2,7 | – 2,3 | n.a. |

CP Nov 2006 | – 4,1 | – 3,6 | – 3,2 | – 3,0 | n.a. |

Structural balance [8] (% of GDP) | CP Mar 2008 | – 4,0 | – 2,4 | – 2,8 | – 1,9 | – 1,1 |

COM Apr 2008 | – 4,0 | – 2,5 | – 2,7 | – 2,3 | n.a. |

CP Nov 2006 | – 4,1 | – 3,6 | – 3,2 | – 3,0 | n.a. |

Government gross debt (% of GDP) | CP Mar 2008 | 47,6 | 44,9 | 44,2 | 43,3 | 42,3 |

COM Apr 2008 | 47,6 | 45,2 | 44,5 | 44,1 | n.a. |

CP Nov 2006 | 48,9 | 50,0 | 50,3 | 50,2 | n.a. |

[1] OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

[2] The update was submitted 16 weeks beyond the 1 December deadline set in the code of conduct in view of the formation of a new government in November following the October general elections.

[3] The assessment takes notably into account the Commission services spring 2008 forecast and the Commission assessment of the October 2007 implementation report of the national reform programme.

[4] The most comprehensive and specific attempt at expenditure reform so far, proposed in 2003 and aimed at reducing public expenditure on social protection, public administration and State aids. Among other things, the Hausner plan replaced annual indexation with an indexation after cumulated inflation exceeds 5 % or every three years (whatever comes first).

[5] OJ C 72, 29.3.2007, p. 13.

[6] Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the information in the programmes.

[7] Based on estimated potential growth of 5,2 %, 5,9 %, 6,0 % and 6,2 % respectively in the period 2006-2009.

[8] Cyclically-adjusted balance excluding one-off and other temporary measures. There are no one-off and other temporary measures in the most recent programme and Commission services' autumn forecast.

--------------------------------------------------