EUROPEAN COMMISSION Brussels, 27.2.2019 SWD(2019) 1020 final COMMISSION STAFF WORKING DOCUMENT Country Report Poland 2019 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2019 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2019) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Competitiveness and investment Annex A: Overview Table Annex B: Commission Debt Sustainability Analysis and fiscal risks Annex C: Standard Tables Annex D: Investment Guidance on Cohesion Policy Funding 2021-2027 for Poland References LIST OF Tables Table 1.1:Key economic and financial indicators — Poland Table 2.1:Assessment of implementation of 2018 country-specific recommendations Table 3.2.1:Financial stability indicators of the Polish banking system

Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Projected cumulative GDP growth in 2017-2018 Graph 1.2: Employment, wages and unemployment rate, 2013-2018 Graph 1.3: Non-Polish citizens paying social contributions in Poland, 2012-2018 Graph 1.4: Gini coefficient of equivalised disposable income, 2005-2017 Graph 1.5: Change in regional GDP per capita in PPS relative to the EU average (2006-2016), depending on the 2006 starting point Graph 1.6: Unit value of capital goods exports Graph 2.1: Overall multiannual implementation of 2011-2018 CSRs to date Graph 3.1.1: Yearly change of tax-to-GDP ratios, 2016-2018 Graph 3.1.2: Pro-cyclicality of VAT revenue to private consumption ratio, 1995-2017 Graph 3.1.3: Medium-term public debt scenarios Graph 3.2.1: Lending developments Graph 3.3.1: Effects of retirement age changes on employment rate, 11Q1–18Q3

Graph 3.4.1: Private investment to GDP ratio Graph 3.4.2: Air pollution in regions according to number of days with exceeded PM10 limits, 2017 Graph 3.4.3: Urbanisation rate and regional GDP in PPS per capita, 2016 LIST OF Boxes Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Poland Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 3.4.1: Investment challenges and reforms in Poland Executive summary Poland is enjoying good economic times, ideal for addressing its main socio-economic challenges ( ). Current economic conditions are favourable with continuing strong growth and improving public finances. Unemployment is at a record low and social inequalities are gradually diminishing. However, in the long run Poland’s economic prospects depend on the economy’s capacity to move away from a model based on low labour costs towards a knowledge-based economy producing advanced products and services. In the meantime, the economic environment offers a unique opportunity to address structural issues, in particular related to ageing, a decreasing working-age population and low innovation levels. The Polish economy continued to enjoy strong economic growth. Household consumption and gradually increasing investment, in particular public investment supported by EU funds, remained the main drivers of GDP growth estimated at 5.1 % in 2018. Private consumption was driven by the best-in-history labour market situation, high consumer confidence and increasing household borrowing. Growth is expected to slow down but remain solid. While a buoyant labour market and high consumer confidence are projected to further support private consumption, its growth is set to slow from the rates observed in 2017-2018. This is due to higher inflation lowering real disposable incomes. Mainly thanks to EU funds, public investment is projected to further increase, while the increase in private investment is set to become more gradual. Both imports and exports are projected to rise, although the increase in exports may be affected by a weaker outlook for the global economy and international trade. Overall, Poland’s GDP is expected to rise by 3.5 % in 2019 and 3.2 % in 2020. Skills, migrant workers and investment play a major role for potential growth. For many years, the labour contribution to potential growth has remained small. With a projected decline in the working-age population, labour will present a drag on potential growth in the future. Given its already large share in the total work force, future migration trends are expected to have a substantial impact on growth. Another key to boosting productivity and growth is capital accumulation. Investment trends will increasingly depend on various non-tangible factors like perceptions of macroeconomic stability and the quality of Poland's institutions, policies, regulatory environment, and the rule of law. Poland is increasingly integrated into the global economy. Poland’s current account is close to balance and its net external debt narrowed during 2018. Exports remain highly diversified and gradually shifting towards higher-value-added products, partially driven by increasing integration into global production chains. Increasing investments to support innovation, education and skills development, better infrastructure and cleaner energy are crucial for Poland’s future growth. Investment remained low in recent years, leaving many opportunities untapped. In this context, support to vital innovations and greater take up of innovations, together with investment in education and skills, has a crucial role in increasing the growth potential. Expanded and modernised transport, communication and energy networks can also play a crucial productivity-enhancing role. Investment in childcare, long-term care and healthcare would help mitigate labour shortages. Finally, greater energy efficiency and more extensive use of renewables would allow Poland move towards cleaner energy and help limit air pollution. Annex D identifies key priorities for support by the European Regional Development Fund, the European Social Fund Plus and the Cohesion Fund over 2021-2027, building on the analysis of investment needs and challenges outlined in this report. Poland has made limited progress ( ) in addressing the 2018 country-specific recommendations. There has been limited progress in: ·increasing the efficiency of public spending;

·increasing labour market participation; ·strengthening the innovative capacity of the economy. There has been no progress in: ·removing remaining obstacles to more permanent types of employment; ·increasing the effective retirement age; ·reforming special pension arrangements; ·ensuring effective public and social consultations in the legislative process. ·Regarding progress in reaching the national targets under the Europe 2020 strategy, Poland performs well in the following areas: poverty reduction, tertiary education, reducing early school leaving and the employment rate. Progress is limited in R&D investment, energy efficiency, renewable energy and greenhouse gas emissions. Poland performs relatively well on the Social Scoreboard indicators supporting the European Pillar of Social Rights. In recent years, Poland made major progress in reducing the share of people at risk of poverty. However, a significant gender employment gap persists, related to factors like limited access to childcare for the youngest children and shortcomings in long-term care provision. The low effectiveness of Poland's efforts to help people find work limits the labour supply. Key structural issues analysed in this report, which point to particular challenges for Poland’s economy, are the following: ·The public finances have improved. The fiscal deficit is estimated to have further narrowed in 2018, supported by the robust economy and new measures to improve tax collection. Public debt as a share of GDP further declined and is significantly below the threshold of 60 % GDP. While no visible improvement in the structural balance was observed in 2016 and 2017, some improvement is likely to have materialised in 2018. Maintaining the observed improvements in tax collection is important if Poland is to finance its increased expenditure without negatively impacting public finances, also in the light of the expected slowdown in economic growth. Limiting the administrative burden linked to tax compliance is also of key importance. Further reforms of taxes are planned, including clearer assignment of Value added tax rates to goods and services. ·Work to reform the budgetary process continues. Its fiscal rules are stable but Poland remains the only Member State without an independent fiscal council. At the same time, the government continues work to address shortcomings in the budgetary process, including better medium-term planning. The ultimate goal of the planned reform is to increase the efficiency and effectiveness of spending, a crucial challenge considering the increase in fixed public expenditure in recent years. ·The banking sector is overall sound. Banks’ own equity levels are high and asset quality is gradually improving. Liquidity indicators point to a comfortable funding position, with ample space for future lending growth. Lending is supported by strong GDP growth, low unemployment and low private-sector debt. Banks’ profitability is gradually improving but lags behind peer countries, being one of the reasons for an ongoing consolidation in the sector. Foreign currency mortgage loans are being gradually paid off, while some uncertainty remains due to various draft laws potentially changing the situation. Steps are being taken to support capital market development. This could also help increase domestic savings. ·Independent financial supervision is crucial. The state controls about one third of the banking sector, as well as the biggest insurance company. This increases the importance of a strong, independent financial supervisor, with appropriate powers. The full effects of several recent changes to the functioning of the financial supervision remain to be seen. ·Labour shortages highlight the need for more people to enter the labour market. The unemployment rate stabilised below 4 %. Shortages of skilled labour hamper firms’ growth in many sectors. In addition to the crucially important net migration of foreigners and Polish citizens, increasing the labour supply depends on getting more people into the labour market. Participation in the labour force is hampered by various factors, such as insufficient availability of childcare and long-term care facilities, and the low statutory retirement age. The effective functioning of the labour market is negatively affected by unreformed special pension regimes and other factors. Although declining, the share of temporary employment contracts remains high. ·Skills development through investment in education and training is key to increasing labour market participation and productivity. While Poland has performed well in terms of early school leaving and basic skills at lower secondary level, there are concerns about the quality of tertiary education, teachers’ skills, and transversal skills development. Moreover, adults rarely engage in learning, and vocational training in enterprises is underutilised, particularly in smaller firms. In addition, the current policies to help people into jobs, in particular those focusing on skills upgrades, are not fully effective. A quality education and training system that takes the life-long perspective could be one crucial factor supporting future growth prospects. ·The risk of poverty has decreased, but challenges appear in the long run. In recent years, Poland has managed to significantly reduce the share of people at risk of poverty or social exclusion. However, future pension benefits are expected to be significantly lower in relation to wages than today, particularly for women. So unless the authorities decide to support the pension system with additional public funds which would impact the fiscal sustainability, the share of old people at risk of poverty may increase substantially. The problem is amplified by shortcomings in the long-term care system. ·The health system is struggling given low and mis-allocated resources. The number of practising doctors and nurses relative to population size is among the lowest in EU. Although the authorities announced plans to increase spending on healthcare, addressing the inefficiencies in spending is also crucial. ·Poland lags on innovation, with recent legal changes only partially addressing challenges. Despite past efforts to improve the R&D framework and significant support from EU funds, Poland’s innovation performance remains modest. Innovative activities by companies are hindered by a number of obstacles. Overall, the country’s innovation potential is hampered by underdeveloped science-business links. Some of these deficiencies, however, are addressed by the higher education reform, designed to boost the quality of Poland's science base. ·Progress in infrastructure investment is uneven. Investment in infrastructure in Poland is largely driven by EU funds. While road infrastructure development continues, the progress in modernising the railway network is slower, partly due to a lack of long-term planning and shortcomings in project management. Fast internet access infrastructure has developed quickly but ensuring broad access to ultra-fast internet remains a challenge. Poland is also facing the challenge of progressing towards circular economy, which limits benefits from the use of secondary raw materials.

·The energy sector faces the challenge of reducing greenhouse gas emissions and pollution. Electricity generation is dominated by coal, and strongly rising demand for electricity has recently been met by new, mainly coal power plants. The development of renewable energy sources has been negatively affected by regulatory changes. Poland faces a risk of missing its 2020 target of 15 % of energy from renewables. Rising wholesale electricity prices and gas stock-piling legislation may reduce the competitiveness of Poland’s energy sector and energy-intensive industries. Meanwhile, the greenhouse gas intensity of the Polish economy remains among the highest in the EU and high air pollution remains a major health-related concern. ·Regional disparities persist. All Polish regions have been developing fast for the last decade. There are still, however, strong disparities between them, partly explained by rural and urban divisions. Investing in connectivity could play an important role in helping reduce regional disparities. ·Investment remains affected by uncertainty. Private investment has remained subdued compared to peer countries, partially due to increased uncertainty. While the general business environment is favourable, some regulatory deficiencies weigh on confidence and certainty. New laws continue to be passed frequently in fast-track legislative procedures and without proper public consultation. The risk of a serious breach of the rule of law in Poland persist and the situation is deteriorating as many of the contested measures are being implemented and consolidated. This is affecting business trust as economic operators need to be sure that they are equally treated by an independent judiciary. Compliance with certain administrative requirements and procedures is burdensome and may prolong investment processes, in particular related to construction. In some sectors, state-owned and state-controlled companies continue to grow in importance, making it key to ensure a level playing field for private competitors. 1. Economic situation and outlook GDP growth Economic growth remained strong in 2018. Following years of strong expansion, real GDP growth reached 5.1 % in 2018, among the highest rates in the EU (Graph 1.1). The peak of the economic cycle was most likely reached in mid-2018. Domestic demand (especially consumption and investment) has remained the main driver of real GDP. The period of uninterrupted and fast growth of the Polish economy experienced over the last decade continued. Poland's economy expanded by 37 % in the decade leading up to 2018, almost three times faster than the euro area economy. 2018 was the 27th consecutive year of GDP expansion. In 2017, GDP per capita reached 70 % of the EU average (when accounting for different price levels between countries), up from 55 % a decade earlier. This success stands out not only in a European, but also in a global, comparison. Several factors contributed: reforms in the quarter of a century after 1989 which set strong institutions and the rule of law, responsible macroeconomic policies, improvements in the education system, and preventing the emergence of large inequalities. EU integration and EU funds (see Box 2.1) played an important role in all these areas. Private consumption was the key driver of growth. An increase in private consumption by 4.9 % in 2017 and by 4.5 % in 2018 was possible thanks to favourable labour market conditions, strong consumer confidence, easy access to credit and low inflation. The effects of increased fiscal transfers were visible in 2017, but faded as of 2018. In 2018, the growth of private consumption outpaced gains in real disposable income, resulting in a decline in the savings rate of households to an estimated low of 0.9 % of disposable income. Investment continued to gradually recover in 2018. Booming public investment was the main driver of overall investment growth, with the gross fixed capital formation expenditures expanding by 7.3 %. This was supported by an increasing utilisation of EU funds, and spending in the build-up to the local and regional elections in the autumn. Private investment growth remained positive, but relatively weak. Graph 1.1:Projected cumulative GDP growth in 2017-2018 Source: European Commission Growth is projected to rest close to potential in 2019 and to slow in 2020. A favourable labour market situation, high consumer confidence and increasing household credit are expected to continue supporting private consumption. Its growth is nevertheless likely to slow from the exceptionally high rates observed in 2017-2018 as higher inflation weighs on real disposable income. Public investment expenditure is projected to continue rising, helped by EU funds, although its growth rate is set to slow relative to the strong rates in 2018. Private investment is projected to strengthen gradually. Strong domestic demand is forecast to translate into higher imports. Exports are set to rise, although at a slower rate than observed in recent years given a somewhat weaker outlook for the global economy and international trade. Potential growth Potential growth is expected to increase in the short term, before slowing from 2020 onwards. The contribution to potential growth from capital decreased in 2016 and has been recovering only gradually since then (Table 1.1). The contribution to potential growth from labour has remained low and the demographic outlook – with a projected decline in the working age population – implies that labour is expected to be a drag to potential growth over the decades to come. This could be partly countered by migrant workers, whose number increased strongly in recent years. Available employment data appear to substantially underestimate the role of migrant workers in the economy. Hence, part of the apparent increase in the contribution of total factor productivity to potential growth, that is especially visible in 2017-18 (Table 1.1), may be explained by part of the labour force not being included in the statistics. Potential growth is expected to slow after 2020, mainly due to an even weaker labour contribution, which is projected to become negative around 2022. Migration trends and the evolution of skills will have significant implications for potential growth in the future. The working age (15-74) population has been slowly declining since 2008 and this trend is expected to continue in the decades to come. The working age population is projected to fall by around 18 % between 2015 and 2050 (European Commission, 2017a, 2018c). Migration flows are likely to be an increasingly important factor driving future working age population trends. At the same time, the realisation of the existing potential for increased labour force participation will depend on factors such as the appropriate investment in skills (Section 3.3). Capital accumulation stands to support potential growth more strongly, also thanks to its impact on productivity. Investment developments are particularly reactive to perceptions of macroeconomic stability and the quality of institutions, including the policy and regulatory environment (see Section 3.4). For many years, Poland has been characterised by a low ratio of investment to GDP, particularly for corporate investment. This can be partly explained by the relatively small size of the large-corporate sector, together with other factors (see Section 3.4). Some data issues may also lead to an underreporting of certain investment. Foreign direct investment has been a source of productivity gains in several sectors. Both capital deepening and skills upgrades have the potential to strengthen productivity growth. Labour market Slowing employment gains, record low unemployment and strong wage growth were visible in 2018. The cyclical position of the economy was reflected in labour market developments. The employment rate in the 20-64 age group rose above 72 % in the middle of 2018, while the activity rate reached 75 %. Employment gains, as captured by the labour force survey, slowed from 1.4 % in 2017 to an estimated 0.7 % in 2018 (Graph 1.2). This development was mainly the result of constrained labour supply, given the record low unemployment rate: 3.8 % in the third quarter of 2018. The average number of hours worked stabilised at low levels, suggesting an on-going shift to forms of employment that better match employees’ preferences, e.g. with regard to overtime. At above 7 %, wage growth broadly stabilised at the high level achieved in late 2017. Graph 1.2:Employment, wages and unemployment rate, 2013-2018 Source: Eurostat Employers find it increasingly difficult to hire people with the relevant skills. A shortage of labour force has continued to top the list of growth barriers (see Sections 3.3 and 3.4). Given the already high activity rates among skilled people, the employers’ competition for talent is likely to remain strong, also in the coming years, reinforcing wage pressures. Labour market participation rates remain low for certain groups. In contrast to the elevated labour force participation of highly educated people, older, less-skilled people and women are less economically active than their peers in most other EU member states (Section 3.3). The activity of people with disabilities also remains low. There are multiple causes of this, including weak labour market-relevant skills, a limited use of adult learning, barriers to geographic mobility, certain disincentives to work built into the social benefit system, and the low statutory retirement age of women.

Workers from outside the EU play an important role in the labour market. As discussed above, employment figures (Graph 1.2) are likely to underestimate employment growth. There are no precise estimates of the number of migrant workers. Employment procedures and necessary documents differ depending on a number of factors such as worker’s citizenship. Visa and residence permit data imply that in 2017, Ukrainian citizens’ share in total employment was around 4 % ( ). Poland stands out among the EU Member States in that immigration flows from outside the EU are predominantly motivated by seeking employment. In 2017, 87 % of all first residence permits issued by Poland were for employment reasons, by far the highest number in the EU. A key challenge lies in ensuring that Poland remains an attractive place to work, not only for temporary or seasonal workers. This follows from the already significant role played by migrant workers, the widespread labour shortages reported by firms and the unfavourable demographic outlook. One element of this is to ensure that migrant workers’ skills and competences are fully utilised (Section 3.3). An important trend observed in recent years was a gradual shift from temporary work to more permanent forms of employment and residence. Between 2012 and 2018, the six-fold increase in the number of foreign workers insured in the Social Insurance Institution has indicated a decline in informal work (Graph 1.3). At the same time, the future attractiveness of Poland for migrant workers and for Polish citizens (including those currently living abroad) will depend on policies and labour market conditions in home countries and in other EU Member States. Certain institutional features negatively affect the functioning of the labour market. In certain aspects the labour market can be described as highly flexible. This applies in particular to the ease of using non-standard contracts. However, several, largely institutional features limit flexibility, with potentially negative implications for some population groups. This applies in particular to the limited use of part-time employment, weaknesses in the functioning of public employment services, the social insurance implications of a transition from the farmers' special pension regime to the general social security regime and the still large differences in employment protection between some types of temporary and permanent work contracts (Section 3.3). Graph 1.3:Non-Polish citizens paying social contributions in Poland, 2012-2018 Source: Polish Social Insurance Institution Inequality Strong income growth for poorer households has helped limit inequality. Income inequality, as approximated by the Gini coefficient, has been declining since 2014 (Graph 1.4). The ratio of the total income received by the 20 % of the population with the highest income to that received by the 20 % with the lowest income also declined in 2016, to 4.6, close to the average of EU Member States ( ).This improvement can be explained by employment and wage growth as well as changes in the tax and benefit system. The role of social benefits in reducing inequalities increased while less progress was observed as regards the equality of opportunities. The role of the tax and benefit system in reducing inequality increased somewhat in 2016 due to the introduction of the universal child benefit. The pension system still plays the most significant inequality-reducing role within the tax-benefit system. A challenge remains to ensure that changes to the school structure introduced in 2017 do not restrain the role of the education system in reducing inequality of opportunities. The key risk lies in the earlier tracking into the vocational and general streams (European Commission, 2018c). Substantial differences in healthcare access remain. However, access to pre-school education appears to be improving, although at a different pace in various locations (Section 3.3). Graph 1.4:Gini coefficient of equivalised disposable income, 2005-2017 Source: Statistics Poland, Eurostat Regional differences Polish regions have seen some of the fastest growth in the EU for the last decade. All but one Polish region were among the 15 % EU regions with the fastest catch-up in terms of GDP per capita in the decade 2006-2016 (Graph 1.5). Growth was fastest in Mazowieckie, thanks to the economic strength of Warsaw. While Polish regions have been catching up with average EU income, there are signs of economic divergence within Poland, i.e. GDP is growing faster in more developed regions (Graph 1.5) ( ). However, the extent of regional differences within the country may be overestimated because official statistics do not fully account for people moving from less to more developed regions. Graph 1.5:Change in regional GDP per capita in PPS relative to the EU average (2006-2016), depending on the 2006 starting point Source: Eurostat Regional differences create serious policy challenges, though their extent is similar to that observed in other large EU Member States. Poland’s regional differences are like those of other larger EU Member States. The disparities in household consumption are lower than the regional differences in GDP per capita. Warsaw and other large cities are the centres of economic development. However, many smaller cities and rural areas struggle with the outmigration of young, highly skilled people, and access to high quality public services such as healthcare, education or public transport. Some regions, in particular in the north and east, are facing particular challenges, such as weaker transport linkages to large cities or a high proportion of low productivity sectors such as agriculture. External position Export performance has remained robust, reflecting strong external competitiveness. With its exports rising faster than GDP and total global imports, Poland has continued to gain shares in global markets for both goods and services. The surplus in the trade in services has continued to grow thanks to a strong performance in sectors such as telecommunications, computers, information services, transport and other business services. A broadly stable exchange rate and gradual — lower than in several other countries in the region — growth of unit labour costs have helped to maintain cost competitiveness. Graph 1.6:Unit value of capital goods exports Source: Eurostat Exports remain highly diversified and Poland is becoming increasingly integrated in global production chains. The long-term trend towards closer integration into global production chains, especially those centred in Germany, is visible. Germany’s share in total Polish exports increased to around 28 % in the first three quarters of 2018. At the same time, a gradual shift towards higher value-added products within these chains can be observed, with the unit value of intermediate and capital goods exports rising faster than in most regional peers (Graph 1.6). The current account remained close to balance. The current account has been close to balance since 2015. There have been limited changes in key components, with stable deficits in the primary income balance (around 4 % of GDP), a high and growing surplus in the trade of services (increasing to above 4 % of GDP in mid-2018 from around 3.5 % of GDP a year earlier) and a slowly deteriorating goods trade balance (0.2 % of GDP). Poland’s negative net international investment position narrowed during 2018. The net international investment position was -57 % of GDP at the end of the second quarter of 2018, continuing the trend of a gradual improvement since 2015. Between 2017 and 2018 foreign public debt fell the most among its components. The accumulated stock of net foreign direct investments (around 36 % of GDP in the second quarter of 2018) accounts for most of the net international investment position. Given the relative stability of direct investments, this limits the risks associated with a negative value of this indicator

Price developments Inflation stayed low in 2018. Volatile energy and food prices had the strongest impact on inflation during 2018. After reaching 2 % in late 2017, inflation as measured by harmonised index of consumer prices eased in spring to 0.7 % and then stayed below 1,6 % throughout the remainder of the year. The consumer price inflation targeted by the central bank followed a broadly similar path, not exceeding 2 % throughout the year, below the bank’s 2.5 % target. Going forward, delayed effects of stronger wage growth are projected to translate into higher inflation, including in the services sector. Harmonised index of consumer prices inflation is expected to exceed 2.5 % in the second half of 2019 and stay between 2.5 % and 3 % until the end of 2020. Trends in asset prices varied during 2018. The main index of the Warsaw Stock Exchange declined during the first half of 2018 and has remained broadly stable since then. During 2018 as a whole, the index declined by around 10 %. The Warsaw Stock Exchange performance was hence broadly similar to other markets in the region. In contrast, house prices accelerated, with growth reaching around 9 % annually in the secondary market in the largest cities in the third quarter of 2018. Financial sector The banking sector has remained strong, while capital market developments experienced setbacks. Risks to financial stability are waylaid by the banking sector’s strong capital buffers, comfortable profitability and liquidity and sound asset quality limit (see Section 3.2). This was confirmed by the November 2018 stress test undertaken by the European Banking Authority, where the two Polish banks were among the most stress-resistant of all of the 50 banks participating (EBA, 2018). While differences between banks are visible, and some banks continue to record losses, the sector’s profitability increased somewhat in 2018. Risks related to the uncertain outcome of policy discussions on reducing the remaining stock of foreign currency-denominated mortgage loans appear to have fallen in 2018. The Warsaw Stock Exchange was reclassified into the developed market category by one of the global index providers from September 2018. Meanwhile, the already lagging corporate bond market saw a setback after investors realised that they were likely to sustain heavy losses following the bankruptcy of one issuer that recently (in 2017) entered the Warsaw Stock Exchange. Monetary policy The National Bank of Poland has kept interest rates unchanged since March 2015. The Monetary Policy Council has continuously repeated its forward guidance of interest rates remaining unchanged, also in 2019. In its statements, the Council pointed to low core inflation and the behaviour of the headline price index being largely determined by factors outside the control of monetary policy, especially energy prices. The November 2018 inflation projection of the National Bank of Poland implied a high probability of inflation exceeding the 2.5 % target in 2019 and 2020, but remaining within the permissible band for deviations from the target. This is somewhat above the path implied by the European Commission 2019 winter interim forecast (see below). Public finances The headline fiscal deficit continued to decline in 2018, primarily due to strong revenues. Revenue from personal and corporate income tax and social security contributions increased strongly in 2018. This was driven by the peak of the economic cycle, strong wage growth and an on-going shift in employment towards contracts subject to higher social security contributions, as well as the effects of measures improving tax compliance. Indirect tax revenues were also on the rise driven by robust growth in private consumption, the cyclical upswing and effects of policy measures aimed at improving compliance (Section 3.1). With modest growth in current public expenditure, these factors resulted in a further reduction in the headline fiscal deficit from 1.4 % in 2017. New reforms, including new taxes, have a potential to broadly stabilise the headline fiscal deficit until 2020, despite expected slower economic growth. The structural balance has remained broadly stable since 2016. When adjusting for the effects of the economic cycle and excluding one-off and temporary measures, the dynamics of the fiscal balance looks different. Amid strong economic expansion, exceeding the potential growth, no visible improvement in the structural balance has been observed in 2016 and 2017. The cyclically-adjusted fiscal balance thus has not moved closer to the medium-term objective of 1 % of GDP ( ). Some improvement may be expected in 2018. Increases of certain categories of public expenditure that are difficult to reduce (including due to lowering of the statutory retirement age), coupled with not achieving medium-term objective come with certain risks. The room for counter-cyclical fiscal policy reaction may be more limited when economic conditions worsen. This situation could also create challenges in the medium- and long-term, given the expenditure pressures likely to arise in certain areas, e.g. linked to healthcare, pensions or infrastructure investment. The general government debt is on a declining path. A combination of fast nominal economic growth and the low headline deficit contributed to the continued decline in the general government debt-to-GDP ratio from 51 % at the end of 2017 to below 50 % at the end of 2018. The public debt is expected to continue falling gradually to around 47 % of GDP at the end of 2020.



Table 1.1:Key economic and financial indicators — Poland Source: Eurostat and ECB as of 31-1-2019, where available; European Commission for forecast figures (Winter forecast 2019 for real GDP and HICP, Autumn forecast 2018 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 43 % of all country-specific recommendations addressed to Poland have recorded at least ‘some progress' (see Graph 2.1). The successful introduction of the expenditure rule and far-reaching liberalisation of access to professional services resulted in ‘full implementation’ or 'substantial progress’ in the fields of product markets and public finance. In the labour market area, certain measures tackling labour market segmentation and participation helped to achieve 'some progress' in the respective CSRs. The introduction of tax incentives and improving access to finance for R&D activities also contributes to ‘some progress’ in relevant CSRs. Only limited progress was observed in life-long learning, enforcing contracts, and removing obstacles to infrastructure investment. So far, no progress was observed in reforming special pension regimes for farmers and miners, in establishing an independent fiscal council and limiting the use of reduced value added tax (VAT) rates. The 2017 reversal of the earlier statutory pension age reform resulted in an assessment of no progress in the area of the pension system. Poland corrected its deficit and increased tax compliance, while only limited or no progress was made in other public finance areas. As Poland had corrected its excessive fiscal deficit, the corresponding excessive deficit procedure was closed in 2015. While tax compliance improved, no progress was made in limiting the extensive use of reduced VAT rates (the recently proposed new VAT matrix can only partially address the issue, though without limiting the fiscal cost of reduced VAT rates). At the same time, Poland has started to reform its budget planning processes. While in 2012, the gradual increase in the statutory pension age was initiated to tackle the long-term sustainability of public finances and to ensure adequacy of pensions, the 2017 reversal of this reform is likely to have a negative impact on the effective retirement age. Only limited action was taken to reform special pension arrangements, mainly for the uniformed services. However, in 2018 the government announced plans to reverse some of the reforms as regards the pension system for police officers. No effective actions to reform the special pension arrangements for miners and farmers have been undertaken. Graph 2.1:Overall multiannual implementation of 2011-2018 CSRs to date Source: European Commission Different policy measures had mixed impact on labour market participation and skills and some actions have been taken to lower labour market segmentation. Increasing the availability of childcare in recent years acted to help taking up employment. At the same time, lowering of the statutory retirement in 2017 and lack of effective action to improve access to long-term care had the opposite effect. Several actions adopted during 2015-2017 help to reduce labour market segmentation: measures limiting the possibility to abuse temporary employment, increasing social security contributions on some non-standard labour contracts and introducing minimum hourly wage for some of these contracts. However, the work on the new labour codes stopped. Some solutions envisaged in the reforms of vocational education and of higher education can help foster labour market relevant skills. The full effects of these reforms remain to be seen. The lifelong learning strategy was adopted in September 2013, but coordination of adult learning policy remains inefficient. Progress on strengthening the innovative capacity of the economy and improving the regulatory environment was mixed. Despite measures taken, including number of amendments to the act on higher education, only limited progress was observed in ensuring better links between research, innovation and industry. Some progress was achieved in improving the effectiveness of R&D tax incentives and better targeting financial instruments at the innovation cycle. In 2016-2018, Poland has reformed its R&D tax incentives with new regulations and changes encouraging wider use of the R&D tax breaks. In the regulatory environment, substantial progress was made in liberalising access to professional services with the introduction of the 2013 - 2015 reform. Only limited progress was observed in other areas conducive to a friendly business regulatory environment. Certain changes to the legal procedure and introduction of electronic procedures slightly improved contract enforcement. The new Building Code was to simplify the requirements for construction permits and to streamline the spatial planning coverage, but its introduction remains protracted. New compliance measures introduced in recent years, e.g. split of tax base for companies, contribute to no progress in easing the administrative burden of tax compliance. The use of and quality of public and social consultations in the legislative process appears to have worsened in recent years.

Overall, Poland has made limited progress ( ) in addressing the 2018 CSRs. Limited progress was made in addressing recommendations on public finance. The work on reforming the budget process continued in 2018, with a focus on defining target solutions and their implementation plan. With an improved access to childcare there has been limited progress in increasing labour force participation, while no progress was observed in removing remaining obstacles to more permanent types of employment. In addition, no measures were taken to increase the effective retirement age and reform special pension arrangements. The announced change of certain provisions for police officers pension system seems to go in the opposite direction. There was also limited progress on supporting closer cooperation between business and research institutions. The Ministry of Science and Higher Education continued the industrial doctorate programme, but the establishment of the Łukasiewicz Research Network was staled as of August 2018. With the introduction of the package of five entrepreneurship laws only limited progress in improving the regulatory environment was observed. No progress was observed in ensuring effective public and social consultation in the legislative process, as the practice of fast legislative procedures with limited consultation continued throughout 2018.



Table 2.1:Assessment of implementation of 2018 country-specific recommendations Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Poland Poland is one of the largest beneficiaries of EU support. Financial allocations from European Structural and Investment Funds aiming to help Poland tackle development challenges amount to EUR 86 billion in the current EU multi-year budget (multiannual financial framework), equivalent to around 2.6 % of GDP in 2014-2020. As of the end of 2018, some EUR 62 billion (around 72 % of the total) have already been allocated to specific projects. In addition, EUR 4.2 billion was allocated to specific projects on strategic transport networks through a dedicated EU funding instrument, the Connecting Europe Facility. Furthermore, numerous Polish research institutions, innovative firms and individual researchers benefited from other EU funding instruments, notably Horizon 2020 which provided some EUR 400 million. European Structural and Investment Funds have contributed to shared prosperity and growth. Until 2023, regions will implement more than half of the Cohesion Policy budget. Thanks to its contribution, eleven Polish regions were among the 30 fastest growing EU regions in the last 12 years. Even the least developed regions increased their income levels from less than a third of the EU average in 2004 to between 40 % and 60 % in 2016 (Section 1). The ability of regional self-governments to identify and implement a development strategy and manage significant public investments, principally driven by EU funds, has been one of the main factors behind Poland's geographically widespread growth (OECD, 2018c). EU funding has helped to address policy challenges identified in the 2018 recommendations for Poland. European Structural and Investment Funds have been improving access to childcare by investing in over 370 thousand places in childcare facilities. Furthermore, until the end of 2017, more than 520 thousand unemployed including 310 thousand young persons received support. In 2018 alone, investments mainly driven by these funds have led to the building or modernisation of 1 425 km of national roads. EU Funds supported closer collaboration between business and research institutions, and R&D investments in the private sector. By the end of 2018, European Structural and Investment Funds helped 2 200 firms build cooperation with research institutions and 3 400 firms introduce new products in their markets. Horizon 2020 supported 1 100 research projects, covering a very broad spectrum from health, food security and sustainable use of biological resources to nuclear research. In addition, the Commission can provide tailor-made technical support upon a Member State's request via the Structural Reform Support Programme to help Member States implement growth-sustaining reforms to address challenges identified in the European Semester process or other national reforms. Poland is receiving support to strengthen the administrative capacity of the National Revenue Administration. The Commission is also assisting the authorities in their efforts to improve public financial management, and to enhance research, development and innovation. In addition, in 2018, work has started on the development of inland waterways in the light of new Polish Water Law, improving the quality of inclusive education and activities and measures to promote and encourage the implementation of energy audit in the enterprise sector. EU funding helps mobilise private investment. European Structural and Investment Funds alone mobilised additional private capital by allocating about EUR 2.7 billion in the form of loans, guarantees and equity. In addition, the European Fund for Strategic Investments has allocated EUR 3.8 billion in Poland. The bulk of this financing is provided under the infrastructure and innovation window. The European Fund for Strategic Investments is providing for instance EUR 33 million for the construction of 1 300 affordable houses for low income earners in the city of Poznań. Polish small and medium enterprises are supported by the dedicated component of the Fund, under which 13agreements with intermediary banks have been approved for a total of EUR 299 million, which should mobilize around EUR 3 billion of total financing. Around 45 thousand small and medium enterprises and companies are expected to benefit from this support. EU projects strengthen national, regional and local authorities and civil society EUR 2.6 billion has been allocated for building capacity in public administrations at different levels, and has promoted close cooperation with stakeholders. The Catching up Regions Initiative delivers targeted technical assistance and financing for tackling smog-related challenges in Poland. The Coal Regions in Transition Initiative seeks to improve socio-economic and technological transformation processes in three Polish regions with sizeable coal mining sectors. The Railway High Level Group, which brings together the national authorities, the beneficiaries and the European Commission, discusses systemic deficiencies and possible remedies for railway projects at a strategic level. The pilot action on frontloading administrative capacity building in Lubelskie aims to analyse and address the regional needs for building administrative capacity. https://cohesiondata.ec.europa.eu/countries/PL 3. Reform priorities 3.1.Public finances and taxation Tax system The tax burden in Poland is lower than in the EU, despite a recent increase. The tax-to-GDP ratio for Poland increased from 33.5 % in 2016 to 34.1 % in 2017, still well below the EU average of 39.0 %. This supported a decrease in the nominal fiscal deficit to 1.4 % of GDP in 2017 (Section 1). Value-added tax (VAT) revenue saw the biggest increase relative to GDP, from 7.2 % in 2016 to 7.8 % in 2017, driven also by better collection, and exceeding the EU average of 7.1 % of GDP. Taxes on labour remained among the lowest in the EU. Tax collection has improved. According to the most recent EU-wide study, in 2016 Poland managed to reduce by 3.5 pps the VAT gap, i.e. the difference between VAT revenue expected and actually collected (CASE and IAS, 2018). The 21 % VAT gap in 2016 was still well above the EU average of 12 %, however, this did not yet factor in the several legal changes that took place in 2016. A buoyant macroeconomic environment and the tax reforms in recent years contributed to a continued strong increase in tax revenue. Consequently, in 2017, revenue from both corporate and personal income taxes saw double-digit growth. Increases in revenue from those taxes as well as from social security contributions continued in 2018 (Graph 3.1.1). New measures to tackle tax avoidance and fraud entered into force in 2018. The extension of the requirement to provide a standard audit file for all companies, including 1.5 million micro-companies, was an important change implemented in 2018. On top of that, a voluntary split payment, a law to prevent the use of the financial sector for tax fraud and the so-called tobacco package entered into force. Geo-localisation for transport of certain goods was also deployed. A number of changes in corporate income tax aimed at to increasing tax revenue. The social security premiums payment system was simplified, which could also contribute to higher revenue. While the implementation of some new requirements faced organisational and technical issues, overall the measures appear to be functioning as intended. For instance, the share of entities failing to send regularly standard audit files declined during 2018, from over 5 % in January to 2.4 % in November. Graph 3.1.1:Yearly change of tax-to-GDP ratios, 2016-2018 Source: European Commission, Ministry of Finance Reforms of direct taxation continued into 2019. A major reform of corporate and personal income taxes entered into force in 2019. One objective was to increase compliance; another was to comply with EU directives. Certain measures were intended to simplify the tax system and lower the burden for some companies. On the one hand, the reform introduced: a new exit tax; a new tax on high earners; mandatory disclosure rules; and changes to the taxation of profits on cryptocurrencies and the withholding tax system. Poland also lowered the corporate income tax rate for small companies from 15 % to 9 % and simplified transfer pricing rules. In addition, a tax incentive to support innovation (‘IP Box’) was implemented. This supplemented an investment tax credit, which was increased in 2018 to support private investment. Preserving high tax revenue collection becomes increasingly important given the projected slowdown of GDP growth. The historical evidence shows that tax revenue efficiency tends to reflect cyclical developments in the economy (Graph 3.1.2; Sancak et al., 2010). Economic growth is set to gradually decelerate in the near future (Section 1). Anticipating this and maintaining the improvements in collection efficiency is important if Poland is to remain able to finance increased expenditure levels. Graph 3.1.2:Pro-cyclicality of VAT revenue to private consumption ratio, 1995-2017 Source: European Commission Recently implemented tax-related changes increased the administrative burden. A significant number of new requirements aimed at increasing tax collection make compliance more burdensome (World Bank, 2018training). These measures include the obligation of the monthly reporting of VAT returns, compulsory reporting of standard audit files by all entities, differentiating sources of profits in corporate income tax and, in the area of the VAT, an extension of the list of goods and services subject to a reverse charge mechanism. Consequently, even if the process of reporting, paying and — to a major extent — auditing taxes is now done electronically, time spent by a model Polish company on meeting its tax obligations increased considerably, from 260 hours in 2016 to 334 hours in 2017. At the same time, the adoption of new laws, including tax-related law, noticeably slowed in 2017 and 2018 from its peak in 2016. In 2018 the number of pages of new laws was projected to have dropped by over 50 % compared to 2016, to some 14 000 pages (Grant Thornton, 2018a), but this still adds significantly to compliance costs. Whereas the National Revenue Administration fulfils its tasks, some room for improvement has been identified. Although there were a number of technical, operational and human-resources related difficulties following the creation of the National Revenue Administration this service is performing well overall. This was also confirmed by the Supreme Audit Office (NIK, 2018b). Yet, while tangible results of the tax administration work are visible, the Supreme Audit Office has identified several shortcomings in 2016 and 2017. They covered things like the use of different approaches to taxpayers or insufficient reaction time to identified risks. The National Revenue Administration also faced challenges regarding its IT infrastructure and its capacity to attract and, even more, retain competent staff. The system of reduced VAT rates is costly, complex and error-prone. Reduced VAT rates continued to be applied to a large number of goods and services. This led to significant foregone revenue. According to the available data, the VAT gap caused by applying reduced rates was among the highest in the EU in 2016 (CASE and IAS, 2018) ( ). The Polish authorities provide similar estimates (MF, 2016). The current system of reduced rates may also cause errors and increase compliance costs (European Commission, 2018c). It happens that even tax authorities when issuing individual tax decisions do not clearly validate the assignment of reduced rates to particular products and services. This increases uncertainty for businesses ( ). The authorities plan to address some problems generated by the system of reduced VAT rates. In late 2018, Poland proposed a reform, recognising the inefficiency and uncertainty for taxpayers caused by the current setup ( ). Its aim is to eliminate some of the issues described above, including by implementing a clearer and unambiguous list of goods and services subject to VAT reduced rates and issuing binding information on the application of VAT rates. The main element of the proposal consists of moving from the national classification of goods to the EU common nomenclature. The reform does not however address the issue of high foregone revenue, since it is supposed to be budget neutral. The envisaged implementation date was set for 2020, while taxpayers would have the possibility to request binding rate decisions already in 2019. Self-employed workers can opt for flat rate income tax. Employees are subject to a personal income progressive tax regime with two tax rates of 18 % and 32 %. Simultaneously, around 0.5 million self-employed enjoy the right to a flat personal income tax rate of 19 %, which is advantageous for taxpayers with high incomes. These individuals may also opt for lower social security contributions than those in the general system. This comes, however, at the cost of lower future pension benefits. Poland does not fully use environmental taxes as effective policy tools. The implicit tax rate on energy remained comparatively low in Poland and there are a number of tax exemptions (European Commission, 2018c). However, from 2019 Poland applies a new emission charge on fuels. The revenue collected is to finance electro-mobility projects and fighting smog.

Fiscal framework The fiscal framework remained broadly unchanged in 2018. All components of the fiscal framework, i.e. numerical fiscal rules, a medium-term budgetary framework, independent fiscal institutions and budgetary procedures, remained unchanged. However, Poland amended its law on public finances so that it now requires that the draft budget should discuss the underlying macroeconomic forecast and its underlying assumptions. Moreover, macroeconomic forecasts used for the budget purposes must be compared with the forecasts of the European Commission and other independent bodies. Additionally, a relevant deficit and debt sensitivity analysis is compulsory. The new requirements were applied for the first time to the 2019 budget. The budget structure and classifications are complex and lead to inefficiencies. The state budget is divided into several dozen budget parts. At the same time, Poland uses a traditional, i.e. functional, as well as performance-based budget classification with the former playing a primary role. Budget classification is composed of a significant number of sections, chapters and paragraphs, mixing organisational and functional structure. This encompasses only a part of the general government sector. A significant part of expenditure is decided outside it. A major drawback of the current situation is that the accountability for funds is not always clearly assigned to relevant institutions. Thus, operational budget management, performance analysis, identification of inefficient spending and the reallocation of funds to priority areas are difficult. On top of that, Poland implemented performance-based budgeting that, in practice, is not used as a real tool for performance analysis. In contrast, it actually complicates the budget process. Medium and long-term budget planning remains limited. In spring every year, the government adopts a Multiannual Financial Plan. It consists of the convergence programme and a list of major state functions, each accompanied by performance indicators. The programme covers a three-year period, but it does not translate into targets for the relevant annual budgets. The convergence programme drafting is driven by EU requirements and has no direct implication for the actual budget process, while a comprehensive medium- or long-term national budgeting process has not yet been established. Poland is reforming its budget processes, including for the medium term. In 2018, work continued to address the identified weaknesses in the budgetary process. The ultimate objective of the reform is responsible and coherent budgeting that goes beyond one-year planning. One of the most challenging steps is the simplification of the budget structure. A unified classification, integrated with a new structure of the state budget, has been planned to replace the current dual classification. To make this possible, the authorities, supported by EU financing, are setting up a new chart of accounts aligned with the budget classification. This is expected to be delivered by 2020 and subsequently applied in stages. Poland also continues efforts to further enhance macroeconomic forecasting and reform the medium-term budgetary framework. The reform implementation will take several years. Its final target date is not yet known. Poland remains the only EU Member State with no fiscal council. Several analyses show that fiscal councils can improve fiscal governance, especially if combined with fiscal rules. When fiscal councils are properly empowered and staffed, they appear to limit the deficit bias and contribute to better budget processes ( ). Whereas the exact remit of fiscal councils varies between EU Member States, they fulfil an important role when informing the public on the main issues related to fiscal policy. Currently in Poland, some but not all of the functions usually assigned to fiscal councils are executed by several bodies, differing in terms of impact they can make. This scattered approach limits their potential influence on policymakers. Poland is the only EU Member State that has no plans to establish a fiscal council. Debt sustainability analysis and fiscal risks No major short-term risks to fiscal sustainability have been identified. General government debt is currently below 60 % of GDP and projected to decline further in the coming years. At the same time, by 2017, Poland has not yet reached its medium-term objective of a structural deficit of 1 % of GDP. The 2019 debt sustainability analysis (European Commission, 2019a) indicates low short-term fiscal sustainability risks for Poland. This was confirmed by an upgrade of the government debt rating by Standard & Poor’s. Two other rating agencies upheld their ratings in 2018. In the medium term, fiscal sustainability analysis also points to a low risk. Even without any adjustment in the structural primary balance relative to the baseline ‘no-fiscal policy change’ scenario, debt-to-GDP ratio would stay below the reference value of 60 % by 2033. In the ‘no-fiscal policy change’ scenario after 2020 and normal economic conditions, the general government debt would reach 48 % of GDP in 2029 (Graph 3.1.3). While this is a low debt-to-GDP ratio, it follows an ascending path towards the end of the projection period. This is due to factors such as increasing ageing costs (Annex B). Graph 3.1.3:Medium-term public debt scenarios Source: European Commission The only announced changes to special pension regimes are likely to increase the associated fiscal burden. No changes have been introduced to the costly special pension arrangements for miners and farmers. In late 2018, under the pressure of the striking police, the government promised to partly reverse the 2012 reform of their pension regime. Until now, police officers were entitled to retire after 25 years of service and after reaching 55 years of age. The new proposal abolishes the minimum age of 55 years – in extreme cases, allowing people to retire at 44. The impact of the proposal is to be exactly quantified, but it is likely to further increase the fiscal cost. The projected strong drop in pension adequacy can lead to political pressures, creating fiscal sustainability risks. On the surface, pension-related sustainability risks seem contained. In a simulated scenario (EPC and EC, 2018j), public pension expenditure remains contained to around 10 % of GDP in 2070, below the EU average. However, the ratio of average pension benefits to wages is expected to decline strongly. As an illustration, in this scenario close to one third of all pensioners would receive only the minimum pension, currently equivalent to around EUR 250 before tax. This is likely to create strong political pressure to increase pensions, resulting in fiscal sustainability risks. 3.2. Financial sector The banking sector is overall well capitalised and solid. For the sector as a whole, capital ratios remain significantly above regulatory minimum requirements. This remains the case even if these are to some extent negatively affected by higher risk weights on foreign currency-denominated mortgages. At the same time, while this part of portfolios is gradually diminishing, liquidity indicators, such as the liquidity coverage ratio (148 % in the second quarter of 2018 relative to a minimum requirement of 100 %), leave ample space for future loan growth (Table 3.2.1). Polish banks remain predominantly funded through domestic deposits, representing 61 % of the balance sheet. In turn, market funding make up 19 % of assets. This share may well increase since banks look bound to issue more securities to meet minimum requirements (by 2023) and to make more use of covered bonds following recent legal changes. Meeting the minimum requirement for own funds and eligible liabilities targets is likely to be challenging for the Polish banking sector that is not accustomed to funding its operations through fixed income instruments. Table 3.2.1:Financial stability indicators of the Polish banking system Source: ECB Bank lending has been growing modestly, driven by a supportive economic environment and low interest rates. Lending to the private sector has continued to increase at a rate broadly similar to nominal GDP growth (Graph 3.2.1). Unsecured consumer and corporate loans have increased the most. Banks’ growing appetite for higher yielding loans comes with risks in the medium and long run. These are mitigated by the favourable macroeconomic outlook and low indebtedness of households and non-financial corporations. For instance, household debt was equivalent to 36 % of GDP in mid-2018, compared to the euro area average of 58 %. The modest increase in mortgage lending (4 % annually in June 2018) coincides with around half of residential property transactions paid in cash as investment alternatives to bank deposits. Almost all mortgage loans are based on variable interest rates, implying risks once interest rates start increasing. Fixed interest rate products barely exist in the Polish banking sector. This is being addressed by the Financial Supervisory Authority through a revision of one recommendation. Graph 3.2.1:Lending developments Source: ECB Bank’s profitability has been gradually improving. Rapid GDP growth, a pickup in investments and low provisioning costs have helped the banking sector remain profitable. Profits remain negatively affected by low interest rates, given the importance of floating rate mortgages in banks’ assets. Banks have reduced funding costs, mostly by lowering deposit interest rates to historic lows. On the revenue side the focus on higher yielding small business and consumer loans is starting to pay off. In the first three quarters of 2018 the average return on assets increased slightly, while remaining below regional peers. Net profits are still being negatively impacted by the special levy on financial institutions (0.44 % of the value of assets excluding equity and Polish sovereign bonds). The booming economy has supported assets quality. The level of non-performing loans in the system has been gradually improving as robust economic growth makes it easier for indebted borrowers to manage repayments. Loans to non-financial corporations remain generally riskier than loans to households and mortgages have the lowest non-performing loans ratio (Table 3.2.1) ( ). There is uncertainty over potential legislation affecting the existing stock of foreign currency mortgage loans. Loans in foreign currency are decreasing by around 8 % annually and their quality is generally high with non-performing loans ratio around 3.7 %. Yet, the exchange rate risk makes these borrowers more vulnerable than Polish zloty borrowers. Also, most foreign currency mortgages have a high loan-to-value ratio, making it difficult to sell underlying properties. Several initiatives to address the issue have been announced, some risking the stability of the banking sector. None of them was eventually introduced, but uncertainty remains.

Concentration in the banking sector continues. Lower prospects for profit generation, growing capital requirements, and uncertainty about the final shape of the legislation addressing the issue of foreign currency mortgages are some of the factors that have pushed lenders towards mergers and acquisitions for the last few years. This trend is expected to continue, possibly leading to the emergence of a market with a small number of universal players and some specialised lenders, for instance mortgage banks. Simultaneously, the state directly or indirectly controls about 39 % of the sector’s total assets, including the two biggest lenders in the country. These two banks control about one third of the market across many segments of the banking sector. The process of consolidation is seen as ‘natural’ by the Financial Supervisory Authority as it looks to supervise a more efficient banking sector, able to compete in an increasingly digital world. Several changes aim to reinforce financial supervision and investor protection. Financial supervision was shaken in November 2018 by the allegations of corruption that led to the abrupt resignation of the head of the Financial Supervisory Authority. Tight interconnection between the sovereign and the financial system (see above) poses the particular supervisory challenge of paying close attention to the governance structure, to ensure that politics is kept at arms’ length from commercial decisions. In parallel, the legislator amended laws affecting financial supervision, in particular to modify the funding of the Authority’s office. Yet, the new law also enlarges the composition of the Authority, increasing the number of government representatives (). Additionally, the Authority obtained supplementary powers allowing it to authorise, through an administrative decision, the swift acquisition of a failing or likely to fail lender by a stronger financial institution. Poland’s capital market has matured. The transformation undergone by the Polish financial system is a success story (European Commission, 2018c). Today, the country’s financial sector increasingly resembles the structure of other well-developed markets. This was recently reflected in the promotion of Poland’s capital market from Advanced Emerging to Developed Market status by two index companies. To ease further enhancements, the Capital Markets Development Strategy project was launched The project has defined key challenges, including a list of 20 barriers to the further development of the Polish capital market. Some of the key challenges include low levels of savings and investment, especially by retail clients, insufficient efficiency, transparency and liquidity of many market segments, and lack of taxation incentives for issuers and investors. New employee’ capital pension funds could provide a boost to capital markets. The new scheme puts in place the framework for capital plans for voluntary savings contributions by employees, topped up by employers and the Polish state. It complements existing voluntary schemes and the mandatory pension schemes. Once implemented, between late 2019 and 2021, the new scheme is expected by the authorities to cover around 8.6 million employees (provided a participation rate of 75 %) and inject into capital markets funds equivalent to about 0.7 % of GDP annually, deepening domestic capital markets. The expected demand of the future pension funds for long-term assets could help develop various segments of the capital market, including banks’ long-term bonds, covered bonds and stocks. 3.3. Labour market, education and social policies Labour market Employment growth slowed in 2018, with unemployment stabilising at historically low levels. In the first three quarters of 2018, employment increased by around 0.5 %. New jobs were mainly created in manufacturing and some services sectors, while agricultural employment continued to fall. The number and share of permanent contracts has risen fast, while temporary employment continued to decline, although close to 24 % of all employees still had such contacts in the third quarter of 2018, well above the EU average. This resulted from a combination of an improved general labour market situation and a number of legislative changes that made temporary contracts relatively less attractive. Still, some features of the outdated Labour Code discourage employment on permanent contracts. The unemployment rate stabilised in the range of 3.6 – 3.8 % in mid-2018. Labour shortages and negative demographic outlook emphasise the challenge of increasing labour force participation and investment in skills. Difficulty in finding workers with appropriate skills has become a key problem for business growth in several sectors. This coincides with the shrinking working-age population (Section 1). The potential for increasing labour supply depends on migration (including the return of Polish citizens currently abroad) and on activating people currently detached from the labour market, such as those with low skills or facing different barriers and disincentives that prevent them starting to look for jobs. Labour market participation of young women has declined. At just above 63 % in the first half of 2018 the activity rate of women aged 15-64 was well below the EU average of 68 %. In the past, this gap used to be mainly explained by low labour market activity by women with below-tertiary education and by all women aged 50-64. This still holds true, but during 2017 and 2018, activity by young women aged 25-39 declined visibly. This may be linked to: rising pressure to take care of older family members (the population aged 80 and above increased by more than 100 thousand or 7 % between 2015 and 2018); insufficient availability of childcare facilities; and a generous child benefit scheme introduced in 2016 (Magda et al., 2018). The statistics on declared main reasons of inactivity are consistent with this. Between 2015 and 2017, the share of inactive women aged 25-49 pointing to caring responsibilities increased by almost 5 pps to 48 %. Only 4 % of men indicated the same barrier. Labour market participation by people with disabilities and their carers faces challenges. There has been little change in the activity rate of people with disabilities between 2013 and 2018 (27 % in the first half of 2018), despite a significant improvement observed in this period for the whole population. Available data point to a wide activity gap between Poland and the EU average ( ). Disability-related policies are not mainstreamed into other social policy areas. A range of barriers prevents higher labour market activity of people with disabilities. These include architectural, transport and communication barriers and underutilised technological solutions that could help people with disabilities live independently.. The government recently launched a program that is expected to partly address these challenges. Few older people are in work and lowering the retirement age aggravated this further. Employment rates of older people are significantly lower than the EU average, with the gap of almost 10 pps in 2018 in the 50-64 age group. Rates dropped visibly after the statutory retirement age was lowered in the fourth quarter of 2017 (Graph 3.3.1). The key factors contributing to this low labour market engagement are related to health, skills and the quality of jobs, including the satisfaction derived from work (Myck and Oczkowska, 2017). Part-time work, often used by older people in many EU countries, is relatively rarely used in Poland. Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights is designed as a compass for a renewed process of upward convergence towards better working and livi ng conditions in the European Union ( I ). It sets out twenty essential principles and rights in the areas of equal opportunities and access to the labour market; fair working conditions; and social protection and inclusion. Poland performs relatively well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights. Poland performs well in terms of access to the labour market. Indicators related to poverty and income inequality have been improving over the past years. At the same time, the country lags behind in areas such as digital skills development or early childcare. Despite overall good employment performance, the gender employment gap remains one of the important challenges. Although female employment and activity rates have been increasing, they are still well behind those of men. A number of institutional factors leading to inadequate work-life balance provisions, including a very low childcare coverage for children aged less than three, play a key role in this respect. Poland took steps to address this challenge, but it is too early to assess its effects. Poland's rate of early school leaving is very low. This owes to compulsory schooling and learning requirements as well as cultural and social factors. The attractiveness of the Polish labour market to migrants and returning Poles will be important for the future labour supply. Migrants from outside the EU and especially Ukraine already play an important role in the labour market (see Section 1). The influx of these workers could, however, decrease if other countries, also facing labour shortages, adopt policies to increase attractiveness of their labour markets. Similarly, the motivation of an estimated 2 million plus Polish citizens living in other EU countries to return to Poland will depend on factors like wage and other labour markets developments in Poland vis-à-vis other Member States, notably the United Kingdom and Germany. Recognition of migrants’ skills and their ability to work in professions in line with their skills and experience is an important element of a migrant-friendly environment. The government has initiated work on a migration strategy, but its content remains unknown. Vocational training in enterprises has risen, but is still underutilised especially by small firms. Between 2010 and 2015, the share of enterprises with 10 or more employees providing vocational training to staff increased significantly, from 23 % to 45 %. This was still much below the EU average of 73 %. This gap in training provision was larger in the smallest firms. Micro-businesses employ a large part of the labour force in Poland. Training of workers requires further investments. In addition, a lack of long-term skill strategies and understanding of the benefits of training in many small and medium enterprises is an important challenge. Active labour market policies, in particular those focused on skill upgrades, have limited reach and are not optimally structured. Institutional design implies that the main beneficiaries of these policies are people registered as unemployed. The impact on other groups, e.g. people receiving disability or old age pensions, or farmers, is limited. Moreover, some of the registered unemployed might not be genuinely interested in finding employment and improving their skills, e.g. because they work in the shadow economy and for them registration only serves as a guarantee of health insurance. Also, the training on offer is not always adapted to labour market needs. The coverage of unemployment benefits is low in comparison to other EU countries (European Commission, 2018d). A discussion on reforming public employment institutions started in 2018 with the publication of a draft law, but the process appears to have stalled and the draft is no longer publicly available. Graph 3.3.1:Effects of retirement age changes on employment rate, 11Q1–18Q3 Source: Eurostat, Polish Social Insurance institution (ZUS). Labour market outcomes and employment challenges differ between regions. There remain substantial differences in unemployment rates between and within regions. This in part reflects differences in human capital and in regions’ economic structures but also limitations on geographical mobility. Barriers include underdeveloped transport infrastructure and services (see Section 3.4), insufficient access to affordable housing in locations with high demand for labour (especially larger cities), disincentives in the benefit system and features of the unreformed special pension regime for farmers (European Commission, 2017a). Social dialogue faces challenges, in part due to the legislative practices of the government. Positive developments in 2018 included an extension of the rights of the Social Dialogue Council and a legal amendment giving all workers the right to join trade unions, regardless of the type of a work contract. The number of trade union members remains low and the representation of the rising share of temporary agency workers and immigrants constitutes an increasing challenge. The social partners report that the quality of consultations in the Social Dialogue Council has deteriorated, in particular due to government eschewing consultation of some key laws (Section 3.4; Eurofund, 2018; ETUC, 2019). Education and skills Remaining gaps in access to and provision of early childhood education and care require further investments. The number of facilities for children up to the age of three has increased in recent years, but access remains insufficient, in particular in rural areas and in some regions (GUS, 2018b). This flags as critically low in the Social Scoreboard supporting the European Pillar of Social Rights. Participation in pre-school education by children aged four and above is close to the EU average, but the situation in the age group 3–4 is worse in particular in rural areas and some regions.

While Polish lower secondary school pupils acquire high level of basic skills, transversal skills could be improved. The 2015 PISA results confirmed an above average level of skills attained by Polish lower secondary school pupils compared to other EU countries. Still, there is room for strengthening the role of schools in helping pupils develop transversal skills related to independent, creative and critical thinking or problem-solving (European Commission, 2018c). In addition, access to educational and professional counselling at all levels of education and its quality is still insufficient. Local authorities and schools face challenges adapting to the new school structure. Phasing out lower secondary schools will lead to a two-fold increase in the number of pupils starting secondary schools in 2019. This will result in overcrowding and associated difficulties in many secondary schools for several years (European Commission, 2017a). This change may also increase inequality in access to good quality schools in rural areas. Poland initiated a reform of initial vocational education and training. Such education currently takes place mainly in schools, with only limited work-based learning. The reform to be implemented from the 2019/2020 school year introduces measures to strengthen links with the labour market through changes in curricula, the financing system, practical training and increased involvement by employers. The financing formula is to take into account the extent to which schools’ offer matches the demand for specific occupations. Demand projections are to be co-ordinated by the Ministry of Education. Vocational schools also face difficulties in equipping pupils with general basic skills, such as numeracy and literacy. The average competences of teachers leave room for improvement, while teachers face low salaries. The financial attractiveness of the teaching profession is limited with teachers’ starting salaries being particularly low in comparison to the average wages of people with tertiary qualifications (OECD, 2018a). This likely contributes to the negative selection of those entering the profession and associated relatively low numeracy skills of teachers (Hanushek et al., 2018; Herbst, 2018). Teachers' training often lacks quality (NIK, 2017b). Progress has been made on special education needs but new rules on individualised teaching raise concerns. The inclusiveness of education has increased in recent years as more pupils with disabilities attended mainstream education (NIK, 2018d). The 2017 regulation on individualised teaching for pupils with special education needs was meant to strengthen this process. No assessment of its effects is yet available (RPO, 2018; MEN, 2018). Tertiary education continues to be the choice of a large share of young people, but concerns regarding its quality persist. In 2017, almost 46 % of people aged 30-34 had tertiary qualifications, well above the EU average. However, the quality of some of higher education institutions remains subpar. Weaknesses result from factors such as: the drawbacks of the quality assurance system; fragmentation of the higher education sector; its limited internationalisation and the suboptimal design of financial incentives (NIK, 2018a; OECD, 2018b; European Commission, 2017c). The supply of new researchers is small, with the ratio of new doctoral graduates to population aged 25-34 being among the lowest in the EU. A recent reform of the higher education system aims to improve quality. Eligibility to offer studies and a new classification of institutions will be based on periodic evaluations of scientific activities according to revised criteria. Doctoral studies will be reorganised, scholarships will be granted for all doctoral students and a mid-term evaluation of PhD students’ progress will be introduced. At the same time no significant changes have been proposed to improve the transparency of recruitment procedures at higher education institutions and planned wage increases might prove insufficient to attract talent. The full effects of the reform will only become visible in several years’ time. Adults rarely engage in education and training. Many adults have weak literacy, numeracy and digital skills (OECD, 2018b). It is also this group that participates in formal and non-formal education and learning particularly rarely. Some steps have been taken to implement the Upskilling Pathways Council Recommendation, but further efforts are needed to improve low adult participation in learning. In 2017, only 4 % of all people aged 25-64 declared participation in the four weeks prior to the survey compared to the EU average of 10.9 % ( ). In 2018, the government started to develop its Integrated Skills Strategy covering adult learning, but further efforts are needed to improve co-ordination of policies. Social inclusion Since 2008, Poland has registered the largest decrease in the risk of poverty or social exclusion rate in the EU. While in 2007/2008 the share of people at the risk of poverty or social exclusion still stood at 30.5 %, in 2016/2017 it was 19.5 % ( ). This was due to the improved labour market situation and increased family benefits in 2016. The latter helped reduce child poverty by one third, from 21 % in 2015 to 14 % in 2016. Income poverty risk is higher among less educated people and those in precarious employment. In 2016, the gap in income poverty rates between more and less educated adults was higher in Poland than the EU average. There remain large differences in poverty risks between regions and between urban and rural areas. The household budget survey for 2017 indicates an extreme poverty rate in rural areas, at 7.3 %, compared to 4.1 % in towns below 20 thousand inhabitants and only 1.5 % in large cities (above 0.5 million inhabitants) ( ). The difference in relative poverty rates between the best and worst performing regions exceeded 15 pps. The national relative poverty rate stood at 13.4 %, but exceeded 20 % in four regions. No overall assessment of the social benefits system in a broader policy context is available. The most important change in recent years was the introduction of the child benefit without changes in other elements of the social assistance. This increased the role of all social transfers (excluding pensions) in poverty reduction. Child benefit played an important role in overall poverty reduction but it contributed to the withdrawal of some women from the labour market (Magda et al., 2018). The long-term implications for women, including their future work prospects or pension rights, as well as for their children, remain to be seen ( ). Overall, poverty, health problems, disability and unemployment are the main reasons for people to seek social assistance (OIS, 2017). There is no comprehensive approach to the active inclusion of vulnerable people. The separation of social assistance and public employment offices has its rationale but limits options for offering integrated support to people in need. The deficits in provision of social services are partly filled by non-governmental organisations, though not in a systematic way (Golinowska, 2018). A comprehensive strategy for the socio-economic integration, including independent living of persons with disabilities and mental health problems is lacking. The support system is fragmented, lacks coordination and consistency between different forms of support and does not take full account of individual needs of the people with disabilities and their families (Badania Społeczne MSK, 2017). The availability of community-based services addressing individual needs, in particular assistant services and supported housing, is not sufficient and requires investments. The support system discourages persons with disabilities and carers from taking up jobs. The growing number of elderly and the forecast drop in adequacy of pensions, in particular for women, pose important long-term challenges. The population aged 80 and above is projected to increase more than two-fold between 2018 and 2040 and three-fold by 2070. At the same time, future pension benefits are expected to be significantly lower than at present. Some scenarios indicate that by the mid-2050s the ratio between pension benefits and the final salary will fall by around half compared to 2016 (SPC and EC, 2018). NIK (2018c) found that the care needs of the elderly were not properly diagnosed, and there were issues with access to and standards of home care services. The system of day-care centres and home care requires investments and stable financing to develop in line with needs. A mechanism for quality assurance and control and integration with healthcare services is also important to enable the elderly to live independently as long as possible ( ). A significant number of children remain in institutionalised foster care. At the end of 2017 this applied to around 17 thousand children, close to one fourth of all children in foster care. The deinstitutionalisation of foster care has progressed slowly in Poland (WiseEuropa et al., 2018). A system of support for families experiencing difficulties in fulfilling care and educational functions is being developed but this process faces challenges (Opening Doors, 2018). Health Health outcomes have continued to improve but remain below the EU average. Despite strong gains in recent decades, life expectancy remains three years below the EU average. Preventable and amenable mortality is above the EU average, which means that many deaths could be avoided through better control of the wider determinants of health and better quality of care. Further improvement of health promotion, disease prevention and diagnosis measures constitute a challenge and require investments. Improving the efficiency and co-ordination of healthcare remain priorities. The system is characterised by low efficiency of spending, high dependency on hospital care, underdeveloped primary care, lack of medical practitioners with certain specialisations, long waiting lists, and an inefficient referral system. Recent reform attempts have not been completed. Unmet needs for medical services declined in 2017, but remained among the highest in the EU. Waiting time and travelling distance remained among the highest in the EU, especially for people with low income. Access to and effectiveness of the healthcare system is affected by low spending and staff shortages. The government plans to increase public health expenditure from 4.6 % of GDP in 2016, well below the EU average of 7 %, to 6 % of GDP in 2024. The number of practising doctors and nurses relative to population size is among the lowest in EU. As one consequence, the number of carried surgeries is lowered by the insufficient number of surgeons and equipment gaps. The medical staff is ageing fast and the scale of emigration remains significant. Following protests in 2018, some increases in minimum wages, especially for new doctors, were agreed with the government. While the Ministry of Health already implements the Strategy for the Development of Nursing and Midwifery in Poland, and there were some improvements in working conditions for doctors, there is no overall formal structure or strategy on health workforce planning and forecast (Domagała and Klich, 2018).

The health care system remains overly hospital based, but strengthening of primary and ambulatory care has started. Health resources are unevenly spread across regions. Poland has developed maps of healthcare needs, but they have not yet become tools for supporting decisions on purchasing of health services and investments. Primary and ambulatory care are underdeveloped and lack resources, requiring further investments. Currently implemented pilot projects are expected to provide information on ways to limit unnecessary hospitalisations and improve coordinated care. Efficiency and quality of care can be improved by centralising procurement for hospitals and introducing fully interoperable electronic prescriptions, referrals, registration for patients and eventually electronic medical records. Long-term care is underdeveloped, lacking standardised services and a coherent strategic approach. Medical care homes are the institutions for providing care, but in fact most long-term care is provided by informal carers, often family members who have almost no institutional support. Inequalities in access to services across regions and long waiting times for residential care services are reported. Proper diagnosis of needs, standardised services and sufficient resources including for investment purposes could improve this situation. Investment Investment in skills, education, healthcare and social inclusion are important for improving long-term inclusive growth and associated social outcomes. Skills shortages are among the main obstacles to firms’ growth, pointing at the need to invest in training of the existing and potential labour force and strengthen the education system (notably vocational and tertiary education). Ensuring social cohesion and high employment requires investment in social inclusion and related services, healthcare as well as in the capacity of public employment services, childcare and long-term care services, paying due attention to geographical disparities in their availability. 3.4. Competitiveness and investment 3.4.1.Productivity and investment Investment and productivity trends Investment has been weak since 2016. The ratio between investment and GDP used to be slightly above the EU average in 2009-2015. It then declined strongly to 17.7 % in 2017, compared to the EU average of 20.2 %. This can be explained by developments in public and private investment. Public investment plays a relatively large role in Poland, with a significant contribution from EU funds. In 2008-2017, the average ratio of public investment to GDP amounted to 6.4 %, significantly above the EU average of 3.1 % and higher than in peer countries such as Slovakia, the Czech Republic or Hungary. EU funds directly financed close to a quarter of total public investment expenditure. In 2016, a transition year between two EU investment programming periods, a substantial drop in EU funds explained half of the total decrease in public investment expenditure. With the implementation of the EU investment programmes advancing, public investment is expected to rise much faster than GDP during 2019-2020 (see Section 1). The financial instruments of EU funds, such as loans or guarantees, also facilitate private investment financing, but their uptake remains limited ( ). Private investment remains subdued and the situation worsened after 2015. In 2008-2017, the average ratio of private investment to GDP amounted to 15 %, well below 22 % in the Czech Republic, 18 % in Slovakia, and the EU average of 17 % (Graph 3.4.1). This is predominantly because of the low level of corporate investment, despite significant support to private investment offered by EU funds (see Box 3.4.1). The concentration of the largest firms in certain regions implies that their investment outlays are also geographically concentrated. As an illustration, in the first half of 2018 around two thirds of all non-financial corporate investments by firms with 50 or more employees was carried out by firms headquartered in four (out of a total of 16) regions: Mazowieckie, Śląskie, Dolnośląskie and Wielkopolskie. Several structural and statistical factors add to low private investment in the last decade. Multiple structural and statistical reasons can contribute to the relatively low private and, in particular, corporate investment. First, this is related to the size of the companies. The largest firms, which are characterised by the highest investment per worker, account for a lower share of total employment than the average for EU countries for which data is available. At the same time, employment in microenterprises (with lowest investment intensity per worker) has been well above the EU average (European Commission, 2018c). Second, the particularly low investment in intellectual property products (for example software or patent rights) suggests some specific barriers to such investment, or statistical issues with recording such expenditure. Third, other statistical phenomena might play a role as well. An example is a sizeable decline of prices for investment goods relative to the GDP deflator, which was not observed in other EU countries (see also PKO BP, 2018). Graph 3.4.1:Private investment to GDP ratio Source: European Commission The strong decline in private investment in 2016 and its relative weakness since then is likely due to increased uncertainty. While structural and statistical reasons might help explain the low level over the last decade, they cannot explain the further decline in 2016 and the continued weakness since then (Graph 3.4.1). Uncertainty perceived by entrepreneurs appears to be among the key reasons (NBP, 2018). Sources of uncertainty in Poland include in particular the instability of the regulatory framework resulting from weaknesses in the legislative process. This is frequently quoted by business in Poland as an important factor (see Section 3.4.4). Increasing difficulties in finding adequately skilled workforce are another important reason. Labour productivity has been growing fast in Poland, from a low starting point. Labour productivity growth continued to be among the strongest in the EU. Between 2010 and 2017, real labour productivity per hour worked increased by close to 20 %, almost three times stronger than for the EU as a whole (7 %). This