Council opinion of 8 July 2008 on the updated convergence programme of Poland, 2007-2010
Date: 2008-07-08
Institutions: Council of the European Union
Subjects: Poland, budget estimate, economic convergence, economic forecasting, public finance, stability programme

C 182/6

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Official Journal of the European Union

19.7.2008

COUNCIL OPINION

of 8 July 2008

on the updated convergence programme of Poland, 2007-2010

(2008/C 182/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

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

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

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

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

(3)

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

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

(2) The update was submitted 16 weeks beyond the 1 December deadline set in the code of conduct in view of the formation

of a new government in November following the October general elections.

(3) The assessment takes notably into account the Commission services spring 2008 forecast and the Commission assessment

of the October 2007 implementation report of the national reform programme.

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(4)

(5)

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

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

the convergence programme are better

(6)

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

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

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

(2) OJ C 72, 29.3.2007, p. 13.

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(7)

(8)

(9)

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

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

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

(10)

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

(11) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme has some gaps in the optional data.

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

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

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Comparison of key macroeconomic and budgetary projections

2006

2007

2008

2009

2010

Real GDP
(% change)

HICP inflation
(%)

Output gap (1)
(% of potential GDP)

Net lending/borrowing
vis-à-vis the rest of the
world
(% of GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance (1)
(% of GDP)

Structural balance (3)
(% of GDP)

Government gross debt
(% of GDP)

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008 (2)

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

CP Mar 2008

COM Apr 2008

CP Nov 2006

6,2

6,2

5,4

1,3

1,3

1,4

0,5

0,6

0,5

– 2,6

– 2,5

– 1,6

– 3,8

– 3,8

– 3,9

– 1,1

– 1,1

– 1,5

– 4,0

– 4,0

– 4,1

– 4,0

– 4,0

– 4,1

47,6

47,6

48,9

6,5

6,5

5,1

2,6

2,6

2,1

1,1

1,2

0,5

– 2,6

– 2,6

– 1,8

– 2,0

– 2,0

– 3,4

0,2

0,6

– 1,0

– 2,4

– 2,5

– 3,6

– 2,4

– 2,5

– 3,6

44,9

45,2

50,0

5,5

5,3

5,1

3,5

4,3

2,5

0,7

0,5

0,3

– 3,5

– 2,3

– 2,2

– 2,5

– 2,5

– 3,1

– 0,2

0,2

– 0,7

– 2,8

– 2,7

– 3,2

– 2,8

– 2,7

– 3,2

44,2

44,5

50,3

5,0

5,0

5,6

2,9

3,4

2,5

– 0,2

– 0,7

0,4

– 4,2

– 3,6

– 2,7

– 2,0

– 2,6

– 2,9

0,3

0,1

– 0,6

– 1,9

– 2,3

– 3,0

– 1,9

– 2,3

– 3,0

43,3

44,1

50,2

5,0

n.a.

n.a.

2,5

n.a.

n.a.

– 0,9

n.a.

n.a.

– 4,6

n.a.

n.a.

– 1,5

n.a.

n.a.

0,8

n.a.

n.a.

– 1,1

n.a.

n.a.

– 1,1

n.a.

n.a.

42,3

n.a.

n.a.

Notes:
(1) Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the

information in the programmes.

(2) Based on estimated potential growth of 5,2 %, 5,9 %, 6,0 % and 6,2 % respectively in the period 2006-2009.
(3) Cyclically-adjusted balance excluding one-off and other temporary measures. There are no one-off and other temporary measures in

the most recent programme and Commission services' autumn forecast.

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