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Scope Ratings GmbH has today affirmed Poland’s A+ long-term issuer and senior unsecured local- and foreign-currency ratings, along with its short-term issuer rating of S-1+ in both local and foreign currency. All Outlooks are Stable.

Rating drivers

Scope’s affirmation of the Republic of Poland’s A+ rating reflects the country’s robust macroeconomic performance with overall annual real GDP growth averaging 3.5% over 2009-2018. The ratings are moreover supported by credible fiscal and monetary policy frameworks, resulting in low economic volatility and manageable financial stability risks, alongside reduced external sector risks. Against these, the rating considers structural challenges posed by the country’s low savings rate, growing budgetary pressures, political headwinds and demographic limitations. The Stable Outlook reflects Scope’s expectation of broadly balanced risks to the ratings over the next 12-18 months.

Poland’s A+ rating is supported by the country’s strong macroeconomic fundamentals. Poland’s growth remained robust in 2018 at 5.1%, underpinned by a buoyant labour market with the unemployment rate now at historic lows of 3.3% as of September 2019 and strong public investment, benefitting from the rapid increase in the absorption of EU funds last year. Scope expects real growth to remain sturdy, although slowing to 4.0% this year, before 3.5% in 2020 against a potential growth rate of around 3.9%, reflecting economic capacity constraints, growing labour shortages and weaker demand from main trading partners. Private consumption will continue to be the main growth driver, supported by wage growth, high consumer confidence and planned fiscal stimulus including an increase in social benefits. Investment will be further underpinned by low interest rates and a sound banking system. The absorption of EU funds will fall from the current high level in the coming years covering the final phase of the current EU financial framework 2014-2020, which includes an additional three-year period during which countries can still draw funds. EU structural funds allocated to Poland for 2014-20 are among the highest in the EU relative to the size of the economy, at around 17% of Poland’s 2018 GDP.

Poland’s A+ ratings are further supported by the economy’s moderate current account vulnerabilities and increasing external competitiveness. The country ran nearly balanced current accounts between 2015 and 2018, despite strengthening consumption growth. In year 2018, Poland’s current account balance was slightly negative at -0.6% of GDP but improved to -0.3% of GDP in the year to August 2019. Despite anticipation of a reacceleration in import growth, driven by domestic demand and fiscal stimulus, Scope does not expect a meaningful deterioration in the current account balance going forward, abetted by an increasing competitiveness of Poland’s export sector, particularly in services exports. In addition, thanks to the significant inflow of immigrants, which has held wage growth pressures in check, unit labour costs in Poland are only gradually converging towards EU averages, supporting external sector competitiveness.

Poland’s resilience to date in the face of economic slowdowns in its largest trading partners is underpinned by a capital account surplus that includes EU structural fund inflows, which comfortably cover the economy’s modest current account deficit, in addition to a high quality of external funding sources, with foreign direct investment inflows constituting 47% of total external liabilities as of Q2 2019. Net inflows of foreign direct investment totalled around 2.5% of GDP in 2018, the highest level since 2011, helping the economy’s future resilience to possible capital flight in periods of financial market turbulence. Profit reinvestments into the manufacturing sector remain the key source of investment flows, thus contributing to further export growth, although the latter has slowed. Poland's net international investment position has continued to improve to -53% of GDP as of Q2 2019 (from a peak of -69% in 2014), helped by declines in the gross external debt to GDP ratio to 60% as of Q2 2019 (from 74% in 2012).

Poland’s A+ ratings are supported by favourable financing conditions, reflected by declining average state treasury debt servicing costs to 2.95% in 2018 (from 4.02% in 2014), notably reducing Poland’s interest payment burden over the last five years and allowing for greater fiscal space. At the same time, strong tax revenue growth and improved tax compliance supported the reduction of the general government deficit to 0.4% of GDP in 2018. While the deficit is expected to widen to around 1.5% of GDP in 2019, the 2020 draft budget foresees a general government deficit of 0.4% of GDP. Scope expects a deficit of around 2.0% of GDP in 2020, with the government remaining committed to keeping the deficit below the Maastricht threshold of 3% of GDP and to continue adherence to Poland’s expenditure growth rule. Challenges to the budget outcome include i) a stronger-than-expected moderation in revenue growth, ii) uncertainties related to the materialisation of one-off revenue measures, which include sales of licenses, and iii) increasing budgetary pressures on the expenditure side, as the government has stepped up spending on areas including pensions and child benefits.

Poland’s public debt ratio is moderate, although the trajectory of decline has slowed in the face of higher spending levels. General government debt decreased to 48.9% of GDP in 2018 from 50.6% in 2017 and is projected to continue a decline to 47.3% of GDP in 2019. Scope assesses Poland’s public-debt dynamics to remain sound due to their relative robustness across a number of scenarios over the forecast period to 2024 as well as the support provided by a constitutional public-debt brake mechanism, which caps public debt not to exceed 60% of GDP. Presently, Scope expects debt-to-GDP to gradually decline over the forecast period to around 45% of GDP in 2024, as robust economic growth and low financing costs allow some debt reduction despite modest primary fiscal deficits.

The Polish banking sector is profitable, liquid, and well capitalised. The average total capital ratio remains at 18% and the countercyclical buffer at 0%, reflecting a low risk of excessive lending and the stable quality of the loan portfolio. While low interest rates and strong income growth have contributed to robust activity on the real estate market, recent regulatory measures on LTV limits and creditworthiness assessment methods are limiting the risk of excessive expansion. In addition, risks associated with the portfolio of foreign currency mortgage loans (6.8% of banks’ assets in June 2019) and a potentially mandatory conversion of whole portfolios to Zloty are abating, given the heterogeneity of the contract types in this segment. The resulting impact on the operating costs of banks will be thus limited and spread over time, with the quality of the portfolio remaining very good and its value steadily decreasing (8% year-over-year).

Despite resilient economic growth, the Polish economy faces multiple challenges. While the short-to-medium-term growth outlook remains favourable, Poland’s long-term economic growth prospects are constrained by the expected decline in its working age population, underlining the need for higher labour market participation and increased skills in the workforce. The working age population has been falling by 1% annually since 2015, creating a steadily increasing skilled-labour shortage. However, large inflows of migrant workers including temporary employees, who are not part of labour force surveys and who are currently estimated at around one million persons, including 800,000 from Ukraine, have helped contain wage pressures and supported economic growth.

The low level of national savings is a further constraint to Poland’s long-term growth prospects, mirroring the low investment rate of the Polish non-financial corporate sector, which is dominated by labour intensive small- and medium-sized enterprises. While low national savings and weak business investment are typical in economies in Central and Eastern Europe, Poland’s savings rate (at 20.1% of GDP in 2018) has been substantially lower compared to its regional peers. To maintain growth rates of 3-4% p.a. over the longer term, Poland requires robust external funding, with the main investment burden to fall with foreign companies as EU structural funds will be reduced in step with economic convergence.

Parliamentary elections in October saw the ruling Law and Justice Party (PiS) government win a consecutive majority in the Sejm, Poland’s lower chamber, gaining 235 out of a total 460 seats, unchanged from the last election. However, the government lost control of the Senate after the main opposition parties Civic Coalition, The Left and Polish Coalition united around joint candidates, limiting the ruling party’s full control of the legislature for the first time in four years. The new parliamentary landscape contrasts with that during PiS’s first term in office when, with an absolute majority in the lower house and the Senate, as well as holding the country’s presidency, the party was able to push through budgetary laws and divisive legislation, sometimes in breach of Poland’s Constitution.

Reforms of the legal system prompted the European Commission to file cases with the European Court of Justice against Poland in addition to launching an Article 7 procedure for violations of the EU’s democratic rules. EU action has so far fallen short of imposing outright sanctions against the government, although a European Court of Justice ruling this June overturned a government policy lowering the retirement ages of supreme court judges. Scope expects that one outcome of the post-election political landscape in Poland may be more moderate policy making in the coming months, which might help defuse tensions with the EU to an extent as PiS faces a more difficult-than-expected electoral challenge ahead of the presidential vote next spring.

Disagreements with the EU over the European Commission’s ‘Rule of Law’ procedure are unlikely to subside. Moreover, future inward investments will also depend on key negotiations over the 2021-27 EU multi-annual financial framework. The EC is proposing to reduce Poland’s EU structural fund allocation for 2021-27 by around 20% compared to that over 2014-20, to account for the UK’s planned EU exit, Poland’s growing income convergence to the EU average, as well as proposed new criteria for EU fund allocations.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

The rating committee reviewed Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals and assigned an indicative ‘A’ (‘a’) rating range for the Republic of Poland. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches, depending on the size of relative credit strengths or weaknesses versus peers based on analysts’ qualitative analysis.

For the Republic of Poland, the following relative credit strengths have been identified: i) growth potential of the economy; ii) fiscal policy framework; and iii) market access and funding sources. Relative credit weaknesses are: i) vulnerability to short-term external shocks; and ii) weak recent events and policy decisions. The combined relative credit strengths and weaknesses generate a positive one-notch adjustment and indicate a sovereign rating of A+ for the Republic of Poland. A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope considers sustainability issues during the rating process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, on which Poland has moderate scores on a composite index of six World Bank Worldwide Governance Indicators in comparison to peers.

Poland’s performance across key social dimensions is mixed. Social factors are reflected in Poland’s comparatively moderate GDP per capita and high old-age dependency ratios. The government’s Plan for Responsible Growth has identified the low savings rate, low productivity growth and low labour force participation rate as the main economic challenges. It is Scope’s view that while some policies, such as lowering the retirement age in response to strengthening demographic headwinds, are not conducive to growth, other measures have been taken that will improve the country’s economic and social development prospects, supporting poverty reduction. While Poland’s poverty rate has been declining in recent years, Poland’s expenditure on R&D remains low at 1% of GDP, compared to 2.1% for the EU in 2017.

Finally, environmental factors are considered during the rating process, but did not play a direct role in this rating action.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that rating risks remain balanced.

The ratings/outlook could be upgraded if, individually or collectively: i) additional structural reforms are implemented, thereby raising the country’s medium-term growth potential; ii) fiscal performance were to improve, leading to further significant declines in public debt/GDP; and/or iii) the country’s external balance sheet were further strengthened.

Conversely, the ratings/outlook could be downgraded if, individually or collectively: i) economic growth slowed down for a protracted period; ii) fiscal slippage resulted in weakening debt sustainability; and/or iii) governance standards deteriorated, materially weakening economic conditions.

Rating committee
The main points discussed by the rating committee were: i) Poland’s growth potential; ii) fiscal policy framework; iii) demographics, labour market and productivity developments; iv) public debt sustainability; v) monetary policy framework; vi) external sector developments; vii) banking sector developments; viii) recent events and policy decisions; and iv) peers comparison.

Methodology
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the rating process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following substantially material sources of information were used to prepare the credit rating: public domain. Key sources of information for the rating include: Ministry of Finance of Poland, National Bank of Poland, Statistics Poland, BIS, European Commission, European Central Bank, Statistical Office of the European Communities (Eurostat), IMF, OECD, Haver Analytics and the World Bank.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Rating prepared by Jakob Suwalski, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first assigned by Scope in January 2003. The ratings/outlooks were last updated on 20 July 2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5, D-10785 Berlin.

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