Poland - Second Programmatic Development Policy Loan Program

Document of The WorldBank FOR OFFICIAL USEONLY ReportNo. 48644-PL INTERNATIONAL BANKFORRECONSTRUCTIONAND DEVELOPMENT PROGRAMDOCUMENT FORA PROPOSEDLOAN INTHE AMOUNT OF EUR1BILLION (US$1,300,240,000 EQUIVALENT) TO THE REPUBLIC OF POLAND TO SUPPORTAN EMPLOYMENT, ENTREPRENEURSHIP,AND HUMANCAPITAL DEVELOPMENTPOLICY PROGRAM DEVELOPMENTPOLICY LOAN (SECONDINA PROGRAMOF THREE) June 3,2009 HumanDevelopment Sector Management Unit Central and SouthCentral Europe andthe Baltic Countries Department Europe andCentral Asia Regional Office Thisdocument has a restricted distribution and maybe used byrecipients only inthe performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.  POLAND CURRENCY EQUIVALENTS (Exchange Rate Effective as o f April 30,2009) US$ 1.00: EUR0.769: PLN 3.338 variable ABBREVIATIONS, ACRONYMS& TERMS AAA Analytic and Advisory Activities M O E Ministry of Economy ALMP Active Labor Market Programs MOF Ministry of Finance BEEPS Business Environment and Enterprise M O H Ministry of Health Performance Survey M O T Ministry o f Treasury CEE Central andEastern Europe MTEF Medium-TermExpenditure CP Convergence Program Framework DB Doing Business MYSFP Multi-Year State Financial Plan D C Defined Contribution pension plan, in NBP NationalBank ofPoland Poland, funded and privately managed NDC Notional DefinedContribution, pay- EC European Commission as-you-go pension plan ECA Europe and Central Asia Region NFZ National Health Fund ECB European Central Bank NHS National Health Service ERM2 Exchange Rate Mechanism (2nd NUTS Nomenclature o f Temtorial Units for phase) Statistics (EUgeocode identification) ESA European System o f Accounts OECD Organization for Economic ESF European Social Fund Cooperation and Development EU EuropeanUnion PARSP Post Accession Rural Support Project FDI Foreign Direct Investments PBB Performance Based Budgeting GDP Gross Domestic Product PFM Public Finance Management Gmina Municipality/commune administrative PISA Programfor InternationalStudent unit(2,478) Assessment GNI Gross NationalIncome Pis Law and Justice Party GUS Main Statistical Office PIT Personal Income Tax HBS HouseholdBudget Survey Powiat County administrative unit, (379) IALS International Adult Literacy Survey NUTS3 IBRD International Bank for Reconstruction PPP Public Private Partnerships and Development SME Small and Medium Enterprises IFIs International Financial Institutions SOE State Owned Enterprises I M F International Monetary Fund TA Technical Assistance KRUS Farmers' Insurance Fund TC Technical Cooperation LFS Labor Force Survey VAT Value Added Tax LM Labor Market Voivodeships Province administrative unit (16), Matura Exam taken at the end of secondary NUTS2 education zus Social Insurance Fund M I C Middle Income Country MLSP Ministry of Labor and Social Policy MNE Ministry ofNationalEducation Vice President: Shigeo Katsu Country Director: Theodore 0.Ahlers (Acting) Sector Director: Tamar Manuelyan Atinc Task Team Leader: TrumanPackard .. 11  FOR OFFICIAL USE ONLY REPUBLIC OF POLAND SECOND PROGRAMMATICPOLICY LOAN (PL2) TABLE CONTENTS OF LOANAND PROGRAMSUMMARY iv IINTRODUCTION 1 I1 COUNTRY CONTEXT .. ......................................................................................................... .................................................................................. .............................................................................................. 3 2.1. RECENTECONOMICDEVELOPMENTSINPOLAND................................................. 3 2.2. MACROECONOMICOUTLOOK AND DEBT SUSTAINABILITY ............................... 6 2.3. SOCIALIMPACT OF THE SLOWDOWNAND THE GOVERNMENT'S PLANS........9 I11 THE GOVERNMENT'S REFORMPROGRAM . 14 I V POLICY FOCUSAND THE BANK-SUPPORTEDPROGRAM . ................................................ ....................... 18 4.1. LINKTO COUNTRY PARTNERSHIPSTRATEGY ...................................................... 19 4.2. RELATIONSHIPTO OTHER BANK OPERATIONS..................................................... 21 21 V THE PROPOSEDPOLICY LOAN .4.3. ANALYTICAL UNDERPININGS .................................................................................... ......................................................................... 27 5.1. PROGRAMOBJECTIVES ................................................................................................ 27 5.2. REFORMS SUPPORTED BY THIS LOAN- PRIORACTIONS FORPL2 ...................28 5.3. CONTINUATION OF THE REFORMPROGRAMDURING 2009: TRIGGERS FOR PL3 ............................................................................................................................................ 34 5.4. CONSULTATIONPROCESS ........................................................................................... 41 5.5. ANALYTICAL AND ADVISORY ASSISTANCE.......................................................... 41 V I OPERATIONIMPLEMENTATION . ..................................................................... 42 6.1. POVERTYAND SOCIAL IMPACT ................................................................................ 42 6.2. ENVIRONMENTAL ASPECTS ....................................................................................... 45 6.3. IMPLEMENTATIONMONITOFUNGAND EVALUATION ......................................... 46 6.4. FIDUCIARY ASPECTS AND PROCUREMENT ............................................................ 46 6.5. DISBURSEMENTAND AUDITING ............................................................................... 48 VI1 RISKSAND RISK MITIGATION . ....................................................................... ANNEX 1:GOVERNMENT'S LETTER OF DEVELOPMENTPOLICY (LDP) .................48 50 ANNEX 2: POLICY MATRIX................................................................................................. 53 ANNEX 3: MONITORING AND RESULTSFRAMEWORK ............................................... 67 ANNEX 4: ASSESSMENT FROMINTERNATIONAL MONETARY FUND ..................... 78 ANNEX 5: STATUS OF BANK GROUP OPERATIONSINPOLAND................................ 89 ANNEX 6: POLANDAT A GLANCE .................................................................................... 91 ANNEX 7: MAPOF POLAND ................................................................................................ 93 This loan. the secondina program ofpolicy lendingandanalytical advisory assistaw to the Republic of Poland. was preparedby an IBRDteam consisting of Charles Griffin (Sr .Advisor. ECAVP). MukeshChawla (Sector Manager. HDNHE).Alberto Rodriguez (Country Sector Coordinator.ECSHD). JanRutk66ski (Lead Economist. ECSHD). Kaspar Richter (Sr .Economist. ECSPE). LeszekKasek (Economist. ECSPE). Anita Schwarz (Lead Economist. ECSHD). Ufuk Guven(Economist. ECSHD). Owen Smith (Economist ECSHD). EwaKorczyc (Research Analyst. ECSPE). Marta Michalska(ProgramAssistant. ECCPL) and Truman Packard(Task TeamLeader. Sr .Economist. ECSHD) .ReginaNesiama(Program Assistant. ECSHD) and(MalgorzataMichnowska (Program Assistant. ECCPL) providedessential support Radoslaw Czapski(Operations Officer. ECSSD). Anna Kowalczyk (Communications . Associate. ECCPL). Heinz Rudolph (Sr .FinancialSector Specialist. FPDFS). RobertoRocha(Sr Adviser. MNSED). . andJohnPollner (Lead FinancialOfficer .ECSPF) arovidedvaluableinaut to the team . This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not be otherwise disclosed without World Bank authorization.  LOANANDPROGRAMSUMMARY REPUBLICOFPOLAND EMPLOYMENT,ENTREPRENEURSHIPAND HUMANCAPITAL DEVELOPMENT POLICY PROGRAM (SEC INDPOLICY LOANINA PROGRAMOF THREE) Borrower REPUBLIC OF POLAND Implementation MINISTRY OF FINANCE Agency ~~~ ~~ Amount EUR 1Billion(US$1,300,240,000 equivalent) Terms Euro-denominated IBRDFlexible Loan at six-month LIBOR for Euro plus Variable Spread, payable in30 years, including a five year grace period. Front- end fee o f 0.25 percent o f the loanamount to be paidby the borrower from own funds. Tranching Single tranche Description This is the second policy loan (PL2) in a program o f three lending operations supporting a policy program aimed at accelerating Poland's convergence with average EU living standards. PL2 will continue to support reform o f public financial management, the business environment, and improvements o f labor market efficiency in line with the first loan, as well as structural improvements to the finance and provision o f health, education and social protection services. The second lending operation inthe program has the following objectives: (i) to support structural reforms that will ensure fiscal consolidation over the medium term; (ii) to protect priority investment programs and the up-front fiscal costs of structural reforms critical to meeting Poland's goals o f convergence with the rest o f the EU; and (iii)to mitigate the social cost o f the economic crisis. Inthe months since the first policy loan in the program was disbursed, the external economic environment has changed dramatically, causing growth in Poland to slow sharply. To better manage the uncertainty that the world economic crisis has introduced into Poland's outlook and fiscal targets, while pushing ahead with the reform o f public financial management and improvements in the business environment, the Government is now focusing on elements o f the program specifically targeting the labor market, education, health and social protection. Consequently, PL2 continues to support reforms initiated with the first loan, and expands its focus to structural improvements and maintaining critical programs inthe social sectors. The Government has met all o f the agreed prior actions for the second loan. These are : (i) satisfactory continued implementation o f the 2009 budget in light o f the changed economic outlook including consideration o f the assessments by the European Union and the IMF; (ii)submission to Parliament o f an amended Law on Public Finance satisfactory to the Bank; (iii) amendments to the Law on Freedom o f Business Operations that unify and coordinate business inspection procedures, scheduling and duration among all inspection authorities; (iv) offer for sale (through stock exchange or by auction) or via competitive tenders the first 80 public sector enterprises in the privatization program (or those constituting 10 percent o f aggregate asset value); (v) implementation o f the government program to increase labor force participation o f older workers, known as "50+"; (vi) enactment o f the Law on Bridging Pensions that reduces the number o f people eligible for early retirement from 1.7 million to 300,000, while safeguarding the base level o f pensions for those affected by the change; (vii) approval of an implementation plan for the participation o f public hospitals inavoluntary program that would convert them into corporate entities operating under the Commercial Code; (viii) adoption by the National Health Fund(NFZ) iv  o f a payment system based on diagnostically related groups (DRGs) for 90 percent o f all hospital services; (ix) passage o f a law to initiate a pre-primary program for 5 year-old children (Grade 0), implemented initially on a voluntary basis but on a mandatory basis beginning in 2012; and (x) provision for a reserve in the 2009 budget to protect vulnerable households affected by the economic downturn. As a condition of effectiveness, the Government has agreed to initiate the process o f revising its 2009 budget in form and substance consistent with the measuresbeing supported by this Program. Benefits The actions supported by PL2 constitute substantive structural reforms that will support fiscal consolidation over the mediumterm. Ina sharply slowing economy, and as government revenues fall, PL2 will help to protect priority programs andthe up-front fiscal costs o f structural reforms critical to meeting Poland's goals o f convergence with the rest o f the EU. Furthermore, the financial support provided by PL2 and accompanying AAA will helpthe Government to mitigate the social cost o f the economic crisis. R i S k S There are three principal risks as the Government takes the next step in its reform program in partnership with the World Bank. First, the medium-term macroeconomic scenario o f slowing economic growth is subject to further downside risks. While the exogenous risk cannot be fully mitigated, as a condition o f effectiveness, the Government has agreed to initiate the process o f revising its 2009 budget consistent with the measures being supported by the program. Second, Poland's external and financial vulnerability may be further affected by the risk o f contagion from other countries in the region, and access to external financing sources may become more difficult and more expensive. Third, the projecteddeteriorationo feconomic prospects may undermine support for the Government and reduce its willingness to continue its structural reforms. Reform momentum is already constrained by the risk o f Presidential veto on new legislation passedinParliament, inparticular inthe area o f social services. To mitigate this, the Bank can support the Polish Government with communications about the necessity o f the reform measures proposed under this program. OperationIDNumber P116125 V  IBRD PROGRAMDOCUMENT FORA PROPOSEDSECONDPROGRAMMATICPOLICY LOANTO THE REPUBLIC OF POLAND TO SUPPORTAN EMPLOYMENT, ENTREPRENEURSHIP,AND HUMANCAPITAL DEVELOPMENT POLICY PROGRAM I.INTRODUCTION 1. This is the second policy loan (PL2) in the amount of EUR 1 billion (US$1,300,240,000 equivalent) in a program of three lending operations supporting a reform program aimed at accelerating Poland's convergence with average EuropeanUnion(EU) livingstandards. Polandhas made impressive progress towards creating a modern, market-based economy. It has successfully acceded to the EU. However, constraints to the country's continued rapid convergence with its EU partners are becoming visible. Key challenges identifiedby the Government and the Bank, which this program is designedto address, are: supporting structural budget and public sector management reforms to ensure fiscal consolidation and reduction o f the government's deficit to levels consistent with its obligations under the EU's Stability and Growth Pact, increasing the supply and skills o f the labor force, and strengthening the business environment. PL2 includes, as an elaboration o f the public financial management, private sector development, and skills agendas, a more complete treatment of reforms in social sector spending that will contribute to efficient, equitable, and effective investments inthe Polish population through education and health programs, as well as a more robust safety net for the vulnerable that is consistent with labor market policies. In parallel with this series o f policy loans, the Bank has undertaken a Public Expenditure Review (PER) that focuses on the same sectors as the loans. It will be discussed with the government in mid-2009. It provides the analytical underpinnings o f this loan and i s intendedto assist the government informulating further structural reforms insocial sector spendingthat will affect budgets in2010 andbeyond. 2. The first loan in the program (PL1) supported policy actions to strengthen public financial management, increase participation in the labor market, and improvethe environmentfor doingbusiness. Consistent with the convergence aims o f the program, the policy actions takenby the Government prior to presentation o fthe first loan to the Board in December 2008, included: satisfactory implementation o f the 2008 budgetandpresentation o fthe 2009 budgetbillconsistent with the Convergence Program and personal income tax (PIT); a reduction in payroll taxes to reduce the tax wedge on labor; elimination of work permits for foreign workers from neighboring countries to increase labor supply; tightening eligibility requirements for disability benefits; presentation o f legislation to Parliament that reduces the minimum capital required to start a business; andthe approval o f a privatizationprogram encompassing the sale o f 740 state owned enterprises. 1  3. This operation, the second loan in the series (PLZ), will continue to support reforms in public financial management, the business environment, and improvements of labor market efficiency in line with the first loan, as well as structuralimprovementsto the financeandprovisionof health, educationand social protection services. The second lending operation in the program has the following objectives: (i) to support structural reforms that will ensure fiscal consolidation over the mediumterm; (ii) protect priority investment programs andthe up-front fiscal costs of to structural reforms critical to meeting Poland's goals of convergence with the rest o f the EU; and (iii) mitigate the social cost of the economic crisis. Inthe months since the to first loan in the program was disbursed, the external economic environment has changed dramatically, causing growth in Poland to slow sharply. To better manage the uncertainty that the world economic crisis has introduced to Poland's outlook and fiscal targets, while pushing ahead with reform of public financial management and improvements inthe business environment, the Government is now focusing on the part of the program specifically targeting the labor market, education, health and social protection. The second lending operation in the program (PL2) continues to support reforms initiated with the first loan and expands the focus to include structural improvements in, andthe maintenance of, criticalprograms inthe social sectors. 4. Government has met all of the agreed prior actions for the second loan (as reported in Section V). These are: (i) satisfactory continued implementation of the 2009 budget in light of the changed economic outlook, including consideration o f the assessments by the European Union and the IMF; (ii)submission to Parliament o f the amendedLaw onPublic Finance satisfactory to the Bank; (iii) amendmentsto the Law on Freedom of Business Operations that unify, and coordinate business inspection procedures, scheduling and duration among all inspection authorities; (iv) offer for sale (through stock exchange or by auction) or via competitive tenders the first 80 public sector enterprises in the privatization program (or those constituting 10 percent of aggregate asset value); (v) implementation o f the government program to increase labor force participation of older workers, known as "50+"; (vi) enactment o f the Law on Bridging Pensions that reduces the number o f people eligible for early retirement from 1.7 million to 300,000, while safeguarding the base level of pensions for those affected by the change; (vii) approval of an implementation plan for the participation of public hospitals ina voluntary program that would convert them into corporate entities operating under the Commercial Code; (viii) adoption by the National Health Fund (NFZ) of a payment system based on diagnostically related groups (DRGs) for 90 percent o f all hospital services; (ix) passage of a law to initiate a pre-primary program for 5 year-old children(Grade 0), implementedinitially on a voluntary basis but on a mandatory basis beginning in 2012; and (x) provision for a reserve in the 2009 budget to protect vulnerable households affected by the economic downturn. Poland and the world continue to cope with extraordinary economic conditions, and risks of hrther deterioration remain high. As a condition o f effectiveness, the Government has agreedto initiate the process of revising its 2009 budget in form and substance consistent with the measures being supported by this program, a measure that highlights its continued commitment to the first prior action of this loaninthe uncertain economic environment. 2  11.COUNTRYCONTEXT 2.1. RECENTECONOMICDEVELOPMENTSINPOLAND 5. Poland has successfully managed its integrationinto the EU since accession in 2004. The EU and its institutions are now Poland's main external partners, to which the World Bank is committed to play a supporting role. Poland also has access to considerable external financing, including EU Structural and Cohesion Funds on a grant basis.' 6. The Government has political room to continue pursuing a substantial reform agenda with the objective of convergence with EU partners, although upcomingelections will increasepoliticaldebate around reforms. The Government, created by the Civic Platform and the Polish Peasant's Party and led by Prime Minister Donald Tusk, operates without any major political tensions and enjoys strong social support. However, the Government's lack o f a qualified majority in Parliament poses obstacles to its reform program that are likely to grow over the coming months as Presidential elections in the Fall 2010 approach. Controversial reform measures are at risk o f veto by the President Lech Kaczynski of the opposition Law and Justice (Pis) party, as has been demonstrated on several recent occasions. In some cases, such as the tightening of early retirement conditions, the Government was able to overcome the Presidential veto with support from other parties. Elections to the European Parliament and Sub-National Governments scheduled for June 2009 are expected to generate heated political debate. 7. Polandhas thus far avoided the direct impacts of the financialcrisis, and its vulnerability remains moderate, but the country is being affected by the deterioration in the external economic environment. Among the EU new member states, Poland i s in better fiscal and financial shape but i s affected by the ongoing crisis through declining demand for Polish exports, a slowdown o f credit activity, and lower FDIinflows. Polandis less reliant on external demand than other, more open countries in the region and will be relatively less affected by a recession in the Euro area. At the onset o f the crisis, the Polish economy was in a strong position after five years o f rapid growth and historically low unemployment. Inflation, the current account deficit, external debt, the fiscal deficit, and public debt are moderate. The financial system remains relatively sound. Nevertheless, the weakening o f the zloty inthe last quarter o f 2008 and early 2009 and high volatility o f the exchange rate show that there i s little room for complacency on the part ofthe authorities. 8. Poland'sfinancialsystem is well poisedto cope with the increasinglyadverse externalenvironment. While the banking systemis dominated by foreign banks whose external fbndingconditions appear to have deteriorated - owing to problems of the parent banks - some domestic banks of significant size operate in the sector as well, including a large state-owned bank. Credit growth in Poland and the overall ratio o f credit-to-GDP 'The new CPS presents details o fthe programs o f the EUand related institutions inPoland. 3  has been moderate and much lower than in most o f the other countries in the region. Most o f the credit expansion has been financed through domestic deposits, although foreign financing has been playing an increasing role in recent years. A large share o f domestic investment has been financed through enterprise profits. While there are some concerns for foreign currency mortgage lending, the overall level o f this lending i s relatively small. The recent depreciation o f the zloty follows a period o f very strong appreciation in 2007 and 2008. Bank profits have reached record highs in recent years and banks remain well capitalized. However, credit conditions are likely to tighten significantly this year and some enterprises may find it difficult to roll over maturing short-term loans (which constitute about one-half o ftotal enterprise loans). 9. The rapid deteriorationof the external environment, especially in the Euro zone, and tightening of financial markets have slowed growth in Poland. In 2008, the Polish economy expanded by 4.8 percent, down from 6.7 percent growth in 2007, as year-on-year growth moderated from 5 percent in the third quarter to 2.9 percent in the fourth quarter. Weak global demand has undermined the supply response o f exports to the 25 percent depreciation o f the zloty relative to the Euro since the end o f September 2008 so that the contribution o f net exports to growth i s likely to remain broadly neutral during 2009. With private investment declining, the 2009 growth outcome will hinge critically on private consumption. Overall, the Government's real growth projection o f 1.7 percent compares to April projections o f 0.5 percent by the World Bank and -0.7 percent by the IMF. Inany case, forecasts are subject to an unusual degree o funcertainty inthe current environment. 10. Higherthan plannedgovernmentconsumptionandlower than assumed non- tax revenues together with the slowdown in economic activity towards the end of 2008 contributed to an unexpected increase in the fiscal deficit. The 2008 general government fiscal deficit reached 3.9 percent o f GDP, some 1.2 percentage points higher than projected by the Government in the December 2008 Convergence Program. This was due to higher-than-expected deficits o f both local and central governments (due to higher than planned expenditure and lower than expected revenue), while social security funds performed accordingto plan. Basedon the fiscal outcome for 2008, the EC opened Excessive Deficit Procedures on May 13, 2009.2 Excessive Deficit Procedures are ~~ ~ ~~ The EC reported the following: "The general government deficit inPolandreached 3.9% o f GDP in 2008, above andnot close to the 3% reference value. The breach o f the threshold mainly reflects the fact that good times were only to a certain extent used as an opportunity to consolidate public finances and undertake deep reforms on the expenditure side. Poland's general government deficit over the past five years averaged 4.3% of GDP, at the same time as GDP growth on average exceeded 5%. The Polish authorities have revised their 2009 deficit target to 4.6% o f GDP which shows that the excess over the reference value is not temporary. The Commission services' spring forecast projects the deficit to increase to 6.6% this year and, under unchangedpolicies, to further widen in2010. The reduction insocial contributions, an increase inpersonal income tax reliefs for families, and a generousindexation o fpensions and social benefits increased the deficit in2008. Inaddition, higher-than-planned intermediate consumption and investment, as well as a drop inrevenues at the end o f2008 due to the economic slowdown, all resulted ina higher than expected deficit both at the central and local government level. The excess over the reference value cannot be qualified as exceptional within the meaningof the Treaty and the SGP nor can itbe considered temporary. This suggests that the deficit criterion inthe Treaty is not fulfilled. General government gross debt remains below the 60% o f GDP reference value." The excessive 4  triggered when the deficit-to-GDP ratio exceeds 3 percent or debt-to-GDP ratio exceeds 60 percent and which requires countries to produce a plan for how this will be corrected. The EC is expected to come to a conclusion inJuly 2009 on the existence o f an excessive deficit. This would give Poland until January 2010 to take corrective actions. These corrective actions would be presented in an updated Convergence Program expected in December 2009. 11. Inflation accelerated to 4.2 percent on average in 2008, from 2.5 percent in 2007, but the peak was reached in the first half of 2008 and inflation has eased significantly since. With GDP growth expected to slow sharply in 2009 and world commodity prices falling, expectations for inflation have eased and the National Bank o f Poland (NBP) began reducing interest rates inlate 2008. Inflation i s projectedto return to around the middleo f its target range o f 1.5 to 3.5 percent in2009. 12. The balance of payments has come under some pressure but Poland's external position remains strong. The current account deficit remained at around 5.5 percent o f GDP in 2008, but weaker capital inflows have been associated with a sharp depreciation o f the zloty following strong appreciation inrecent years. Followinga hiatus o f 7 months, the government returned to international capital markets with a Euro 1 billion issue inJanuary 2009 at a spread o f around 300 basis points above German Bunds. In early May 2009, Poland successfully placed a EUR750 million issue at a spread o f about 40 basis points below the January level. Poland's external debt o f about 56 percent o f GDP i s moderate by regional standards, but gross financing needs are sizeable and could add further strains on the balance o f payments. Inflows o f EU funds and FDI should finance a major part o f the external gap. Poland's floating exchange rate regime i s serving it well to help absorb the external shock. 13. The Government approached the IMF for a USD 20.5 billion one-year facility under the new Flexible Credit Line (FCL), which was approved in M a y 2009. The primary objective o f the Government's application i s to obtain the IMF's "seal o f approval" on its macroeconomic policies, to strengthen market confidence and to differentiate Poland from other regional economies. The IMF Board approved the request inMay 2009. The financial market reacted positively to the news. 14. After a remarkable improvement of labor market performance in recent years, unemployment is expected to rise in 2009 on the back of the economic slowdown. In recent years, Poland recorded an unprecedented improvement in labor market performance. The unemployment rate measured by the labor force survey (LFS) fell from over 20 percent in2004 to around 7 percent in2008. The data disaggregated by gender indicate that unemployment among women remains higher than among men but also decreased considerably, from 19 percent in 2004 to around 8 percent in 2008. deficit procedure is also to be opened against Romania, Lithuania and Malta. A similar procedure against France, Spain, Ireland, Greece, UK and Hungary is already inprogress. Source: IP/O9/752,Brussels, 13 May 2009. "Commission presents reports under the excessive deficit procedure for Lithuania, Malta, Polandand Romania." Accessed June 1,2009, at http://euroDa.eu/raDid/~ressReleasesAc tion.do?reference=IP/O9/752&fo~a~PDF&a~ed=O&lan~ua~e=EN &guiLanguarte=en 5  Unemployment i s expected to rise back into the double digits as the economy slows sharply. InJanuary 2009, the inflow to unemployment was a quarter higher than a year earlier, and the number o f the newly registered unemployed due to layoffs was twice as high. The registeredunemployment rate reached 11.2 percent inMarch2009. Figure1.At RiskofPovertyRateinthe EUS3(percent) 1 1 12 !- Czech Estonia Latvla Lithuani Hungary Poland Slovenia Slovakia I I .I I I I IRepublic ~ Source: Eurostat. 15. The decline in unemploymentfrom 2004 to 2007 was accompaniedby lower poverty rates. Relative poverty levels (measured using the Eurostat Laeken "at risk of poverty" statistic) have decreased. Poverty i s concentrated in rural areas, among the long-term unemployed, and households with many children (see Figure 1). Nonetheless, despite vibrant growth o f real GDP and domestic consumption, Poland still has a relatively high poverty rate compared to other countries in the region, especially among children. Absolute poverty levels are considerably lower although measurement depends on the choice o f poverty line. When measured as the percentage o f population below the social assistanceeligibility income threshold, poverty dropped from 19 percent in2004 to 14.6 percent in 2007. The poverty gap also narrowed, meaning that the incomes o f the poor moved closer to those o f the non-poor. The main determinants o f absolute poverty in Poland include: rural residence, low educational attainment o f a household head, unemployment o f a household member, and a higher number o f children in the household. 2.2. MACROECONOMICOUTLOOKAND DEBTSUSTAINABILITY 16. Medium-termeconomic prospects for Polandhavebeen seriouslyaffectedby shrinkingexternaldemandandtighter internationaland domestic creditconditions. Growth is now projected to recover slowly from 0.5 percent in 2009 to 1.0 percent in 2010, provided the external environment improves. Inflation i s expected to remain stable The EUpoverty measure ("at riskofpoverty rate") is defined as the share o fthe population livingin households with income below 60 percent of the national median disposable income after transfers. 6  at around the central inflation target o f 2.5 percent. Lower domestic absorption should lead to a significant moderation o f imports and an improvement in the external current account deficit (around 4 percent o f GDP in 2009-2010). Table 1 shows recent macroeconomic forecasts for Poland prepared by the Government and international organizations. Table 1. Economic developments and prospects in Poland 2004-2011 (change inpercent unless otherwise indicated) 2004 2005 2006 2007 2008 2009 2010 2011 CP December2008 6.7 5.1 3.7 4.0 4.5 -- Real GDP (% change) EC Spring Forecast May 2009 6.6 4.8 -1.4 0.8 IMFWE0 April 2009 5'3 3'6 6'2 6.7 4.8 -0.7 1.3 -- WB May 2009 6.7 4.8 0.5 1.0 3.0 CP December2008 5.0 5.3 4.5 3.7 3.8 Private consumption EC Spring Forecast May 2009 5.0 5.3 0.6 0.2 -- (% change) IMFWE0 April 2009 4'3 2'1 5.0 5.3 1.0 1.5 -- WB May 2009 5.0 5.4 1.9 1.4 4.4 CP December2008 17.6 6.5 4.4 5.0 8.6 Gross fixed capital EC Spring Forecast May 2009 17.6 7.9 -6.2 -0.8 -- formation (% change) IMFWE0 April 2009 6'4 6'5 14" 17.6 7.9 -4.5 2.5 -- CP December2008 2.6 4.2 2.9 2.5 2.5 Consumer prices (% EC Spring Forecast May 2009 2.6 4.2 2.6 1.9 change) IMFWE0 April 2009 3'6 2'2 2.5 4.2 2.1 2.6 ---- WB May 2009 2.5 4.2 3.1 2.7 2.5 CP December2008 -4.7 -5.1 -4.2 -3.6 -3.8 Current Account EC Spring Forecast May 2009 -5.1 -5.3 -4.7 -3.7 Deficit (% of GDP) IMF WE0 April 2009 -4.4 -1.2 -2.9 -4.7 -5.5 -4.5 -3.9 ---- WB May 2009 -4.7 -5.5 -4.3 -3.6 -4.1 Source: Poland's Convergence Program-Update December 2008; recent publications o f international financial institutions; and World Bank staff. 17. The global financial crisis has worsened Poland's macroeconomic and fiscal outlook, even though it is faring better than other countries in the region. With limited resources in a fast evolving economic environment, the Government faces the difficult challenge o f reconciling three objectives: to ensure fiscal consolidation over the medium term; to protect priority programs for economic and social development so that growth prospects are enhanced; and to mitigate the potential social cost o f the economic crisis. 18. The Government took precautionary steps in January and February to ensure adherence to the state budget deficit target for 2009, but additional steps will be required. In late January 2009, the Government revised downwards the 2009 real GDP growth forecast from 3.7 percent, as estimated inthe December 2008 Convergence Program, to 1.7 percent. To compensate for the expected shortfall in revenue, line ministries were asked to prepare plans for reducing state budget expenditures. Certain expenditure items, such as pension and disability payments, capitation grants to local governments for primary and secondary education, public sector wages, debt servicing, and co-financing for the absorption o f EUfunds, were protected from these reductions. In addition, the Government shiftedtransport infrastructure spending o f 0.8 percent o f GDP off the state budget to the National Road Fund. While this measure reduces the state budgetdeficit, itleaves the general government deficit unchanged. 7  19. During the second review of the 2009 budget implementationplanned for June 2009, the Government expects to decide on the adoption of a supplementary budget,which could include a combination of additional expenditure rationalization and an increase in the state budget deficit target. In the Government's latest projection, the general government fiscal deficit could reach 4.6 percent of GDP in 2009. The EC's springforecast shows a fiscal deficit of 6.6 percent ofGDP. 20. In the recent update of the Euro adoption roadmap, the Government reiterated its commitment to adopt the Euro in 2012. However, it abandoned plans for entry to European Exchange Rate Mechanism (ERM2) inmid-2009 due to exchange rate volatility, lack ofpoliticalconsensus on the requiredconstitutional changes andweak fiscal performance. Furthermore, Euro adoption in 2012 would require the Government to reduce the general government fiscal deficit to below 3 percent of GDP by 2010. A slow economic recovery would make it difficult to achieve the required fiscal consolidation. In line with the recent EC forecast, the headline fiscal deficit is to deteriorate further to 7.3 percent of GDP in 2010 under the assumption o f no additional policy changes. Table2. Fiscaldevelopments andprospectsinPoland2004-2011 (percent o f GDP unless otherwise indicated) Source 2004 2005 2006 2007 2008F 2009F 2010 F 2011 F CP December 2008 -2.0 -2.7 -2.5 -2.3 -1.9 EC Spring Forecast May 2009 -5.7 -4.3 -3.8 -1.9 -3.9 -6.6 -7.3 Fiscal balance GO~FiscalNotification,April2009 . -1.9 -3.9 -4.6 -- --_- IMF FCLArrangement, April 2009* -- -3.9 -3.9 -2.0 -3.9 -4.3 -4.2 -- CP December 2008 -2.4 -3.2 -2.6 -2.0 -1.8 EC Spring Forecast May 2009 -5.9 -4.1 -4.1 -3.2 -6.0 -5.6 Structural Gov.FiscalNotification,April2009 _- __ IMF FCL Arrangement, April 2009' -- __ _- ___- -5.3 __ -_ -_ _- __--__ CP December 2008 0.5 -0.3 0.1 0.2 0.5 -- Primary balance EC Spring Forecast May 2009 -1.2 -0.3 -1.1 0.4 -1.7 -3.7 -4.3 Gov. Fiscal Notification,April 2009 __ _ _ __ __ -_ IMF FCL Arrangement, April 2009' -- -1.3 -1.3 0.3 -1.7 -1.8 -1.5 -- CP December 2008 44.9 45.9 45.8 45.5 44.8 Public debt EC Spring Forecast May 2009 45.7 47.1 47.7 44.9 47.1 53.6 59.7 -- G O ~Fiscal Notification, April 2009 . 44.9 47.1 51.0 -- IMF FCLArrangement, April 2009* -- 47.5 47.8 44.9 47.1 51.6 53.3 __-- CP December 2008 6.7 5.1 3.7 4.0 4.5 EC Spring Forecast May 2009 6.6 4.8 -1.4 0.8 Real (%change) OD' Gov. Fiscal Notification.Aoril 2009 5'3 3'6 6'2 6.6 4.8 __ _- ____ IMF FCLArrangement,A&~I2009' 6.7 4.8 -0.7 1.3 -- CP December 2008 __ __ _- 1.1 1.2 0.1 -0.4 -0.4 ____ EC Spring Forecast May 2009 0.6 0.1 1.7 3.4 3.5 -1.5 -3.8 -- Output gap Gov. Fiscal Notification, April 2009 __ _- -_ -_ IMF FCL Arrangement, April 2009' ---- __ __ ____ __ ___- __ *) Based on IMFdefinition(includingpension reform costs) Source: Poland's Convergence Programs, Spring 2009 FiscalNotification, and EC Spring Forecast, May 2009. 21. The 2010 budget will be critical for the Euro adoption agenda and should envisage firm commitment to medium-term fiscal consolidation. This commitment should be institutionally strengthenedby rapid passage of the amendment to the Public Finance Law aimed at consolidating budgetary units, strengthening precautionary debt 8  rules, increasing performance orientation in the budget, and strengthening the medium- term fiscal framework. In particular, introduction o f elements o f a Medium Term Expenditure Framework (MTEF) should enhance the credibility o f the gradual fiscal consolidation path from 2010, facilitate a permanent reduction of the structural fiscal deficit, and stabilize the public debt-to-GDP ratio. 22. Poland's economic and fiscal outlook remains subject to unusually large uncertaintyinview of the unclearprospectsfor globaleconomic recovery. While the forceful policy responses in many countries have contained the risks o f a systemic financial meltdown, there are reasons to remain concerned about the potential impact on activity o f the financial crisis. The process of deleveraging could be more protractedthan has beenfactored into the macroeconomic projections for emerging markets. Another risk relates to the growing risks o f deflationary conditions inadvanced economies. 2.3. SOCIALIMPACT OFTHE SLOWDOWNAND THE GOVERNMENT'S PLANS 23. So far the impact of the crisis on labor market conditions - and by implicationon poverty-has been moderate. Layoffs have occurred largely inexport- oriented industries and inconstruction. The most vulnerable groups - those that face the highest risk o f unemployment if the crisis deepens - include less skilled workers in manufacturing and construction. In contrast, households that depend primarily on subsistence agriculture - among whom the rate o f poverty i s highest- are to some extent insulated from the impact o f the crisis, at least temporarily. 24. The primary transmissionchannel of the economic slowdown is through the labor market. It is therefore critical that Poland's social protection system be able to respond effectively to increasing unemployment and vulnerability. Labor market programs -bothpassive(unemployment benefits) andactive(public works, employment subsidies, and training) are financed from the Labor Fund. The Fundi s financed from a 2.45 percent payroll tax. 25. Thanks to low unemployment in recent years, the Labor Fund has accumulateda large surplus that will be the main source of contingentresources to address the impact of the crisis. In2008, the revenues of the Labor Fundaccounted for 0.7 percent o f GDP, and the surplus o f the Fund represented close to 60 percent o f expenditures. This has generated a substantial reserve with which to respond to growing unemployment using a combination o f both passive and active measures. The Government i s confident that sufficient resources are available to address the potential surge inunemployment and provide the unemployed with income support andjob search assistance. Local labor offices can also organize public works to provide temporary employment opportunities should these become necessary. 26. Using the Labor Fund proactively, the Government is putting in place measures to increasethe adaptability of the labor market to the downturn, with the support of labor unions and employers. In the context o f the program, and with the agreement o f social partners, measures are planned that will help workers smooth hours 9  and increase flexibility during an economic downturn. Further, labor unions and employers are coming to an agreement that would allow employers to reduce wages temporarily as an alternative to employment adjustment that would be applied selectively during the crisis. The Government plans to complement this agreement by financing a subsidy to workers whose wages are reduced o f up to 50 percent o f the minimumwage, financed from the Labor Fund. These measures are expected to reduce pressure for higher unemployment by providing more flexibility to adjust hours. As o f the negotiation o f PL2, the Government does not plan to introduce additional large scale public works, although this remains an option for local governments, and finding has been prioritized to protect EU-funded infrastructureprojects. Concerns remain for the part o f the labor force working informally and not covered with rights to unemployment protection. 27. The ability of Poland's targeted social assistance programs for the poorest households to respond quickly is more limited, but the Government is deploying better targeted resources to vulnerable parts of the country. Means tested social assistance in Poland is comprehensive and relatively well targeted when compared to means tested programs inother countries inCentral Europe (see Box l), although leakage o f targeted benefits to non-poor and otherwise ineligible groups remains a challenge. Social assistance programs are financed from general revenues, and by law are adjusted every three years to take into account o f changes inthe cost o f living. As shown inTable 3, about a third o f households receive pension benefits. Both pensions and labor market programs are fairly evenly distributed across deciles, except they reach somewhat fewer households among the richest 20 percent. Social assistance benefits reach almost half o f households, but they are concentrated within the lower half o f the distribution. Table 4 shows the percentage o f transfers reaching each decile. Except for pensions, which are related to earnings and are therefore skewed to the richest, Table 4 shows a somewhat stronger pattern o f targeting o f expenditures than might be expected from Table 3. Table 3. Social Protection Coverage (%ofHouseholdsinEachGroup who ReportReceivingBenefits) Deciles by Household Consumption Total 1 2 3 4 5 6 7 8 9 10 All social protection 72.3 84.8 82.2 79.8 77.5 76.4 12.6 70.6 66.1 61.6 51.0 All social insurance 45.6 44.0 47.5 49.2 49.4 50.6 48.2 47.7 45.5 41.8 32.3 OldAge Retirement Pension 30.5 23.2 27.7 30.5 33.4 34.7 33.7 33.3 33.2 31.1 24.5 AIL labor market programs 5.3 6.3 6.8 6.0 5.9 6.5 5.9 5.5 4.1 3.8 2.6 Unemployment benefits & assistance 2.7 3.9 4.0 3.0 2.9 3.1 3.0 2.3 2.1 1.8 1.1 Early retirement benefits 2.1 2.5 2.9 3.O 3.1 3.5 2.9 3.4 2.0 2.0 1.5 All social assistance 47.6 63.6 58.9 56.0 51.7 49.2 45.6 43.8 40.1 36.6 30.5 Familyallowance (andcomplemeting benefits) 24.2 47.3 40.6 36.0 29.9 25.0 21.1 16.9 12.2 8.6 4.0 Carer's benefit & nursingbenefit 3.1 5.3 6.2 5.0 4.8 3.6 3.4 2.9 2.5 2.1 1.3 HousingBenefit 5.0 11.3 9.6 8.1 6.2 4.4 4.2 2.6 1.7 1.1 0.6 Social assistance(permanent social pension) 1.6 2.8 2.6 1.9 1.9 1.7 1.5 1.0 1.0 0.7 0.6 Social assistance(temporary benefits, cash & inkind) 5.1 15.9 9.6 6.5 5.6 3.7 3.5 2.5 2.2 1.4 0.5 Source: Staffestimates using HBS 2007 10  Table 4. Social Protection Targeting4 (%ofTotalTransfersReportedGoingto HouseholdsinEachGroup) Decilesby HouseholdConsumption Total 1 2 3 4 5 6 7 8 9 10 CGHdl CGHql AU socialprotection 100.0 7.0 8.0 9.0 9.8 10.2 10.8 11.5 11.6 11.7 10.4 0.7 0.7 All socialinsurance 100.0 5.6 7.0 8.4 9.6 10.2 11.0 12.1 12.3 12.6 11.3 0.6 0.6 Old Age Retirement Pension 100.0 4.6 6.0 7.7 9.2 10.2 11.1 12.3 12.8 13.6 12.5 0.5 0.5 All labor marketprograms 100.0 9.0 11.4 10.8 11.3 12.2 11.3 11.9 8.5 7.8 5.7 0.9 1.0 Unemployment benefits& assistance 100.0 13.9 13.9 12.0 9.4 10.6 10.9 9.3 8.5 6.5 4.9 1.4 1.4 Early retirementbenefits 100.0 6.6 10.1 10.2 12.3 13.0 11.6 13.2 8.6 8.5 6.1 0.7 0.8 All social assistance 100.0 16.9 14.7 12.7 11.4 9.3 9.1 7.4 7.1 6.4 5.0 1.7 1.6 Family allowance(and complemetingbenefits) 100.0 19.4 16.5 15.0 12.6 10.0 8.3 7.0 5.4 4.1 1.8 1.9 1.8 Carer'sbenefit & nursingbenefit 100.0 13.5 15.2 14.3 14.2 9.3 10.1 8.2 7.1 4.9 3.3 1.3 1.4 Housing Benefit 100.0 19.6 19.1 16.5 13.5 9.8 8.6 5.3 3.8 2.2 1.6 2.0 1.9 Social assistancebermanent social pension) 100.0 17.0 16.1 11.9 12.6 9.6 11.4 7.0 6.4 4.2 3.7 1.7 1.7 Socialassistance(temporary benefits,cash &inkind) 100.0 25.2 17.4 11.5 10.2 6.8 7.4 6.3 6.1 7.2 2.0 2.5 2.1 Source: Staff estimates usingHBS 2007 Notes: CGHdl: CGHindicator constructedfor targeting to decile 1 CGHql: CGHindicator constructedfor targeting to quintil 1 28. As the downturn becomes more severe, Government anticipates the need to use budget resources for social assistance and emergency interventions more efficiently. General revenues are declining as the tax base shrinks, lowering tax receipts. At this juncture, no additional emergency assistance programs are being considered. However, the Government is preparing for increased household vulnerability by mapping the regions that are likely to be hit hardest by the crisis (see Box 2). Furthermore, new taxes have been passed on alcoholic drinks, tobacco products and luxury cars which are expected to generate PLN 1.14 billion that would finance additional assistance to households (a measure supported in this program). Some o f these funds will be used to finance a response to the anticipated needs o f households in the parts o f Poland that are likely to feel the impact o f the economic crisis deepest. The Prime Minister's Office (PMO) and the Ministry o f Labor and Social Policy (MLSP) are proposing that the next regular adjustment of family benefits (scheduled for November 2009) be targeted only to families with three or more children. This approach would improve targeting to the poorest families and reduce the cost o f the adjustment from PLN 3.0 billion to P L N 0.7 billion. InTable 4, CGHis the "Coady-Grosh-Hoddinnott"indicator as cited from Ringold, D.andL. Kasek, (2007) "Social Assistance inthe New EUMember States: StrengtheningPerformance and Labor Market Incentives" Working Paper No. 117, Washington DC. The CGH indicator is constructed by dividing the actual outcome by the neutral outcome for the bottomquintile (or decile) o fthe distribution ofhouseholds (by consumption). Ifthe poorest 20 percent ofhouseholdsreceived 30 percentofbenefits, the CGH indicator would be (30/20) = 1.5, i.e. targeting has ledto the poorest quintile receiving 50 percent more than they would have received hadbenefits been distributedevenly. As a means o f comparisonwith neighboring countries, a regional study on social assistance inthe new EUmember states found social assistance inLithuaniato be the best targeted with a CGHjust over 3.00. At the other extreme are social assistancebenefits inRussia with a CGH o f 1.10. 11  Box 1.Unemploymentand Social AssistanceinPoland Expenditures on the social safety net absorbed about 1.4 percent o f GDP in2006. The main programs include means tested social assistance (0.2 percent), a housing benefit for the poor (0.1 percent), means- tested family benefits (0.8 percent), and unemployment benefits (0.3 percent). Means tested programs are well-targeted relative to similar programs in neighboring countries, although substantial leakage to non-poor groups is still a concern. Poland, along with the Czech Republic and Slovenia, are the only countries among those inthe region that joined the EUinMay 2004 that target family benefits based on a means test. Since 2004, all benefits targeted to children have beenconsolidated with family benefits, contributing to the relatively more progressive distribution o f Poland's social assistanceprograms. In2007 about 47 percent ofthe population received some form of social assistance. About 24.2 percent received means tested family allowances and complementary benefits, and 6.7 percent received targeted social assistance cash and in-kindbenefits. Only 10 percent o f the unemployed (and only 2.7 percent o f the population) received an unemployment benefit, which reflects tight eligibility conditions for these benefits (12 months o f covered employment in the preceding 18 months) their limited duration (6 months, 12 months in high unemployment regions, and 18 months in regions where the unemployment rate is twice the national average), and the large share o f long-term job-seekers among the unemployed. The number o f recipients o f unemployment benefits surged in the last couple o f months (in February 2009 it was nearly 1/3 higher than a year earlier). The average social assistance cash benefit accounts for about 15 percent o f the average wage and 44 percent o f the minimum wage (2007). The average family benefit accounts for 6.5 percent o f the minimumwage (2 percent ofthe averagewage), however, inover 50 percent ofcases it is supplemented, which doubles its amount. The regular unemployment benefit accounts for some 20 percent o f the average wage and 50 percent o f the minimumwage. Young workers (contribution record o f less than 5 years) receive a benefit that i s 20 percent lower, and older workers (contribution record over 20 years) receive a benefit that is 20 percent higher. Coverage is fairly good, with 85 percent o f households in the first decile and 82 percent in the second decile receiving some form o f social protection. This includes "contributory" social insurance benefits, primarily old-age pensions. Not surprisingly, the coverage o f social insurance benefits is relatively even across the consumption distribution. Social assistance - programs that are universally available to households with children regardless o f their means, and means-tested programs - cover over 64 percent o fhouseholds inthe poorest group. Although most social assistance benefits are means tested, there is room for improving their targeting efficiency. Estimates for 2007 show that gains intargeting efficiency could be made to mop up leakage o f means tested social assistance benefits being received by households in the higher consumption quintiles (see Table 4). However, a majority o f families covered by social assistance programs are families with children (7 1 percent), nearly half o f them representing single parent or pensioner families. Furthermore, 44 percent o f families who receive social assistance live in rural areas where the rate o f poverty i s highest. This incidence is greater than the share o f these households inthe population leading to progressive outcomes. 29. The ability of the social safety net to respond could be hampered by an ongoingprocess that began in 2004 of devolving financingresponsibility for social assistance to sub-national governments. The Ministry of Labor and Social Policy (MLSP) is continuing the process started with the Administrative Reform of 1999 that decentralizes benefits and services for the poorest households, and since 2004 devolves a portion of financing for these services. Local governments in Poland perform a set o f tasks delegatedto them, with financing, by the central government. They also are free to take on their "own tasks," with their own financing, as they see fit to serve their communities. Prior to 2004, local governments were only responsible for delivering social benefits and services, but since then, have taken responsibility for hllyfinancing a 12  growing set of "own tasks" in this sphere, along with a greater share of tax revenue to cover these obligations. MLSP is pushing ahead with its policy o f shifting social assistance activities to the set of "own tasks." With the shift in financing responsibility, local governments have a strong incentive to look for savings and to be more efficient. In other parts o f the region, this incentive has sometimes led to compromised standards and uneven delivery o f entitlements to the poorest households across municipalities of Box 2. MappingHouseholdVulnerability to the EconomicCrisis To better prepare to meet the needs o f households vulnerable to the crisis the Government, through the PMO, is planning targeted regional interventions to support the powiats (counties) that are most affected. There are 379 powiats inPoland, each considered a local labor market. The Government's plan is to strengthen local capacity to weather the crisis, byboth improvingthe effectiveness o f existing programs (employment and social assistance) and ifnecessary,byallocating additional resources for emergency assistance. This initiativehas three components and will be implemented in three corresponding stages. The first component i s the creation o f a crisis vulnerability map, meant to identifypowiats that are at the highest risk of suffering from the economic crisis. The map (see Box Figure) has been constructed based on 50 indicators characterizing powiats' economic structure, labor market conditions and their degree o f urbanization. Factor analysis was applied to construct a composite measure o f powiats' vulnerability to the crisis. Four groups o f vulnerable powiats are identified, with the potential that somepowiats may fall into more than one group: Group A (Red in the Map, "Powiaty typ I ' y : Industrial and urbanizedpowiats with strong labor markets; Group B (Orange, "Powiaty typ II'y: Mixed industrial-agricultural powiats, moderately urbanized with relatively strong labor markets; Group C (Green Pin, "Powiaty ehportujqce")): Export orientedpowiats; Group D (Grid, "Powiaty nu liicie"): Otherpowiats that are vulnerable basedon expert opinion. Note that this mapping is focused on the impact o f economic recession, notjust poverty indicators. Thus, vulnerable powiats include some o f the most developedwith strong economies, rather than the poor, lagging regions. They are particularly susceptibleto higher unemployment rates and tend to contain manypeople livingclose to povertywho have migrated to these prosperous places to seek opportunities. The lagging regions rural, predominantly - agricultural - are insulated from the crisis, at least temporarily, and benefit from longer term anti-poverty programs aimed at structural problems. 13  different incomes. The PER examines to what extent the shift infinancing responsibility has changed the coverage and targeting efficiency of spending on social assistance. An important consideration is whether the process of decentralizing not only administration but financing of targeted social assistance programs to sub-national governments, has impaired their ability to respond. Reflecting this concern, MLSP is closely monitoring sub-national governments to ensure they meet the needs o f households eligible for targeted social assistance. 111.THE GOVERNMENT'SREFORMPROGRAM 30. Despite this economic uncertainty, convergence to average EU living standards remains the Government's overarching policy objective, for which it sees adoption of the Euroas a key step. InSeptember 2008, Prime Minister Tusk announced that Polandwas committed to Euro adoption from 2012, an ambitious target even before the economic crisis. It will require maintaining financial stability and ensuring that the Maastricht Criteria' are met in a sustainable manner, includingthrough a continuation of a restrained fiscal policy. An acceleration of structural reforms aimed at increasing the efficiency o f public spending - particularly in the social sectors - and flexibility in the labor market will be needed both to support Euro adoption and a quick recovery of growth. 31. The authorities have taken steps to preserve financial stability in the current difficult external environment. Inreaction to the escalation of the global crisis in the fall of 2008, the NBP, the Government, Parliament and the Financial Supervision Authority have taken steps to maintain confidence and support the effective functioning ofthe financial system. InOctober, the NBP announceda "package of confidence" aimed at preserving trust and liquidity in financial markets through expansion of its term liquiditymanagementoperationsandforeign exchange swap operations. 32. The Government is committed to maintaining fiscal discipline. The 2009 budget will be amended in July 2009 to reflect weaker growth and revenue prospects. The most recent statements by the Ministry of Finance, following Poland's application for a Flexible Credit Line from the IMF, suggest that the Government will attempt to reach its original budget deficit goal of PLN 18.2 billion. Because o f the slowdown in growth, the Government estimates that the budget deficit will increase to 4.6 percent o f GDP in 2009, up from the original estimate of 2.5 percent. Obviously stringent fiscal discipline would be neededto preserve market confidence, allow for further interest rate cuts, andmeetthe criteria for adoption o fthe Euro in2012. A candidate to adopt the Euro as its currency must meetthe Maastricht or Convergence Criteria, which are a set ofmacroeconomic indicators that measureprice stability (to show inflation is controlled); soundnessand sustainability o fpublic finances (through limits on government borrowing and national debt); exchange-rate stability (through participation inthe Exchange Rate Mechanism for at least two years without strong deviations from central rate); and long-term interest rates (to assessthe durability ofthe convergence achieved by fulfilling the other criteria). For more details see http://ec.euroDa.eu/economv financelthe eurolioining euro9413 en.htm. 14  33. Need for flexibility on the macro framework. This loan provides an opportunity for the World Bank to support the Government o f Poland in an uncertain environment in which the Bank's support could contribute materially to increased confidence in the Government's program, helping to lower its financing costs, reduce pressures on the currency, and increase the feasibility of maintaining a challenging trajectory to joining the Euro zone. The Government i s committed to initiating revisions to its budget after it has more informationon the economic and budgetary record from the first half o f the year. On May 6, 2009, the IMF Board approved an FCL of US$20.58 billion, which i s based on the country's track record rather than specific conditionality connected to the current policy regime (see the Box 3). Box 3. IMFFlexible CreditLine Excerpt from IMF Press ReleaseNo. 09/85, "IMF Overhauls Lending Framework," March 24,2009 "The IMF is introducing a new credit line for countries with very strong fundamentals, policies, and track records o f policy implementation. Access to the FCL credit line will be particularly useful for crisis prevention purposes. FCL arrangements would be approved for countries meeting pre-set qualification criteria. Access under the FCL would be determined on a case-by-case basis. Disbursements under the FCL would not be phased or conditioned to policy understandings as is the case under a traditional Fund-supported program. This flexible access is justified by the very strong track records o f countries that qualify for the FCL, which give confidence that their economic policies will remain strong. The pre-set qualification criteria are at the core ofthe FCL and serve to signal the Fund's confidence in the qualifying member's policies and ability to take corrective measures when needed. At the heart o f the qualification process i s an assessment that the member (a) has very strong economic fundamentals and institutional policy frameworks; (b) i s implementing-and has a sustained track record o f implementing-very strong policies, and (c) remains committed to maintaining such policies in the future. The relevant criteria for the purposes o f assessing qualification for an FCL arrangement include: (i)a sustainable external position; (ii) capital account position dominated by private flows; a (iii)trackrecordofsteadysovereignaccesstointernationalcapitalmarketsatfavorableterms;(iv)a a reserve position that is relatively comfortable when the FCL is requested on a precautionary basis; (v) sound public finances, including a sustainable public debt position; (vi) low and stable inflation, inthe context o f a sound monetary and exchange rate policy framework; (vii) the absence o f bank solvency problems that pose an immediate threat o f a systemic banking crisis; (viii) effective financial sector supervision; and (ix) data transparency and integrity. Strong performance against all these criteria would not be necessary to secure qualification under the FCL, as compensating factors, including corrective policy measuresunderway, would be taken into account inthe qualification process." 34. Management of Macroeconomic Risks. In approving Poland's FCL, the IMF concluded, "The authorities have responded in a timely and effective manner to the global downturn. They have embarked on a monetary loosening cycle, and stand ready to cut ratesfurther if downside risks to the economy materialize. Financial sector stability has been safeguarded, through liquidity provision and intensified surveillance. Despite the slowdown in growth, the authorities remain committed to the 2009 state budget, primarily by cutting expenditure at the state level. They reaffirmed theirfull commitment to strengthen the medium-termfiscalframework to maintain a sustainablepathfor public 15  debt."6 Acknowledging that Poland continues to operate in an extremely uncertain economic environment with a high risk o f a further deterioration, the Government has agreed to a condition of effectiveness requiring that the government has initiated the process of revising its 2009 budget in form and substance consistent with the measures being supported by the Program. This condition aims, inparticular, to review continued compliance with the first prior action of this loan, "Satisfactory continued implementation of the 2009 budget in light o f the changed economic outlook (including consideration of EC and IMF assessments)". This effectiveness condition would provide upto 90 days after signing for review of 2009 budget implementation. 35. To improve the quality of public financial management, the Government i s gradually pushing ahead with reforms aimed at ensuring sustainable fiscal consolidation. A new law on public finance was submitted and is currently being discussed in Parliamentary committees. The Government expects the measure to be passed in the fall of 2009. The draft law incorporates an organizational consolidation of budgetary units and institutional measures that would make the budget more transparent and predictable over the medium-term (through a 4-year budget planning horizon), and more performance oriented. The draft law also aims to take corrective measurestriggered by increasesinpublic debt andto strengthenexpenditure control through newregulations on internal control and external audit. 36. To boost labor force participation,the Governmenthas launcheda package of measures to reduce incentives for people to remain inactive that have been created by social transfers and associated taxes, particularly among women and older workers. The tax wedge on labor was substantially reduced by a cut in payroll taxes by seven percentage points in 2007 and 2008. The Government also prepared a comprehensive program, known as "Intergenerational Solidarity - 50+", which includes a number of incentives to stimulate labor force participationbyolder workers, inparticular a substantial tightening of early retirement provisions. "Bridge pensions" for those employed in special difficult conditions, effective from 2009, replaced generous early retirement schemes. The Government expects these reforms to reduce the number of people eligible for early retirement pensions from about 1.7 million to around 300 thousand. Inthe mediumterm, the Government intends to raise labor force participation by improving workforce skills and developing opportunities for life-long learning, reforming labor market intermediation services, improving the impact o f active labor market programs, supporting women willing to re-enter the labor market after child birth, andpromoting longer working lives through social campaigns. 37. To support and complement reforms to the labor market, the Government has pursueda programof reformin education. The Government's education reform agenda aims to reduce the gap between needs and available skills in the labor force, to develop flexible skills and a strong base for lifelong learning, and to address long- standing problems in the financing o f higher education and research. It i s struggling to "IMF ExecutiveBoard Approves US$20.58 BillionArrangement for PolandUnder the FlexibleCredit Line," PressReleaseNo. 091153, May 6,2009. AccessedMay 13,2009 at http://www.imf.ore/external/n~/sec/~r/2009/~rO9 153.htm 16  adjust the education systemto a declining population while redeploying limitedresources to increase its competitiveness and the equity o f its subsidies for human capital investments. 38. At the primary and secondary levels of the education system, the Government's reform objective is to adjust to demographic trends that will not be easy to change. Since 2000, primary and secondary enrollments have droppedby almost 1.5 million students to about 5.5 million in total. Two major constraints slow the adjustment o f teachers and schools to the number o f students. The Teacher's Charter governs employment relations between all levels o f government and teachers. It limits the ability o f municipalities to demand more from their teachers or to reduce their numbers. A second constraint is a requirement that the capitation-driven education subvention not decrease intotal amount below the previous year's level; hence localities with falling numberso f students are under less pressure than they otherwise would be to make appropriate adjustments. The response o f Government has been to give municipalities more tools to adjust supply to demand at the primary levels o f the education systemwhile also taking this opportunity to pull younger cohorts - ages 6, 5,4, and 3 - into schools both to prepare them for formal education and to use excess educational resources more effectively. 39. The Government's reform strategy in education charts a course of actions to improve secondary and tertiary instruction and to increase the efficiency of research spending. At the secondary level, the Government has increased quality by delaying the tracking o f students into vocational education and by simplifying the vocational track so that it converges with general education. The success o f this effort has led to improvements in Polish students' performance on international examinations and, inturn, to an evenmore energetic effort to converge tracks and delay tracking to the tenth grade. At the university level, the Government's focus i s to rationalize public subsidies in higher education and become one o f the first Eastern European countries to start allocating state-financed tuition and housing subsidies as well as subsidies for student loans based on need, starting in 2010. Finally, the Government i s preparing reforms to increase the relevance o f research. As o f 2009, Poland is increasing allocations to research while trying to move from a preponderance o f basic research to a greater share o f research with a direct impact on the economy. It i s shifting as well to a system o fprofessionally refereed, competitive grants. 40. The key challenges of health sector in Poland are to maintain services to all during a financial downturn, to achieve higher efficiency in resource allocation, and to improve the quality and appropriateness of service delivery. In this regard, the major impediment for two decades has been the overhang o f an economically unviable hospital sector characterized by excessive infrastructure and beds. Despite substantial progress rationalizing the hospital network and cutting down the number o f beds, with important exceptions, hospitals have continued to accumulate public debts (failure to pay social security and other taxes) and civil debts (borrowings and receivables owed to suppliers). 17  41. The Government plans to address the hospital debt problem through an initiative to corporatize hospitals under commercial law so that debts are treated as for a commercial enterprise, subject to commercial audit standards and bankruptcy. Corporatization will be done initially using a voluntary approach because a law makingit compulsory was vetoed inearly 2009. The voluntary window was openedby a resolution by the Cabinet of Ministers taken in February 2009, with implementing arrangements approved inMay 2009. Inthe past eight years, 72 hospitals have been corporatized as a result of local government decisions. 90 percent of these hospitals are current in their accounts. In contrast, the roughly 630 hospitals operating as government organizations have runup about PLN10.5 billion of debt on roughlyPLN25 billion inannualrevenue (a 42 percent debt-to-revenueratio, about 25 percent inpublic debt and75 percent indebtto other firms and banks). The Government expects about 210 hospitals to join the corporatizationprogram. The public hospitals will beliquidated, with the MOF financing the public debt and the local authorities taking on most of the private debt. When a hospital emerges from liquidation as a new entity under the commercial code, it will be debt free, will be operating under an approved 5-year restructuring program, and will be monitored twice yearly for financial and technical adherence to the program. The MOH and NFZ estimate that virtually all hospitals can operate on a cash basis, with the revenues they earn, once current debt service requirements are removed. The corporatized hospitals are expected to have surpluses once they emerge from liquidation, which would allow them to invest inthemselves as well. The program will be monitored through yearly reports to the CouncilofMinisters. 42. To further rein in costs, Poland is implementing DRGs (Diagnostically Related Groups) as a cost accounting mechanism in all facilities in 2009. This i s a major step forward in shifting reimbursementsfrom inputs to outputs. DRGs will allow NFZ to stop reimbursing hospitals based on their activities and start paying a predeterminedrate based on a patient's diagnosis. DRG financing creates an incentive for hospitals and doctors to economize in the use of resources. It facilitates cost comparisons across facilities andthe use of treatmentprotocols to improve patient care. 43. The corporatization of hospitals allows the MOH and NFZ to improve the accreditation and regulatory framework under which hospitals and clinics operate. The MOH has drafted enabling regulations to develop this framework, which will create a tool that can be usedin conjunction with DRG-based reimbursementsto raise the cost- effectiveness and quality of the health services beingfinanced. Other reforms, including the introduction of a multiple competitive private insurance system and the expansion of long-term care services, are seen as longer term challenges for which the Government is beginning to develop options. Monitoring and evaluation remains an underused tool in the health sector even though excellent methods are now available to improve the efficacy of spending, and the Government plans to begin developing this capability as part of its performance-basebudgeting initiative. IV. POLICY FOCUSAND THE BANK-SUPPORTEDPROGRAM 44. The EU has become Poland's main external partner. The EU has committed EUR 67 billion in grants to Poland over the period 2007-2013, equivalent to about 4 18  percent o f Poland's GDP per year, to support income convergence o f the country and its regions with the wealthier parts o f Europe. This support is focused on development o f a knowledge economy and infrastructure. The EIB has increased its lendingsubstantially in recent years to provide co-financing for the EU structural and cohesion funds through loans on attractive terms. Further increases are envisaged in response to the ongoing global financial and economic crisis. The EIB has traditionally focused on infrastructure projects (especially transport) but has become more involved in other sectors o f the economy, including sub-national lending. The EBRD has largely phased out o f Poland and the EU's new member states, as has the IFC, although this may change again in response to the crisis. 45. The Bank adds value to Poland's convergence agenda by focusing its support in areas where it has an established track record of experience, particularly public financial management, labor market efficiency, structural improvements to the social sector expenditures, and encouraging a culture o f evaluation and performance. The Bank has worked with the Government to marshal knowledge and international experience on performance based budgeting and the effective use o f MTEF. The Bank's labor economists have engaged with the Government on reform o f unemployment insurance, increasing flexibility in the labor market, encouraging labor market participation, and making active labor market programs more cost-effective. Their work has been complemented by technical collaboration with the ministries handling education, science, and higher education on issues in education financing, testing, and shifting the focus to general education and life-long learning. The Bank has been engaged for over a decade insupport ofPoland's pensionandhealthsector reforms. 46. These engagements complement the EU's Lisbon Agenda in support of growth and competitiveness. Both education and health are largely excluded from the EU Acquis Communuutuire and EU-support programs. The World Bank was deeply engaged with Poland in these areas prior to accession in 2004. Subsequently, it has maintained technical involvement through cross-country AAA focused on the accession countries, and ineducation it re-engaged technically beginningin2008. 4.1. LINKTO COUNTRYPARTNERSHIPSTRATEGY 47. The second operation in the program is being presented alongside a new CountryPartnershipStrategy (CPS). As described above, the CPS aims to situate the Bank's engagement inPoland firmly inthe context o f other external partners and focuses on niche areas o f engagement where the Bank can add value. The Bank's strategic partnership with Poland i s based on four pillars: (i) Growth and Competitiveness; (ii) Public Sector Reform; (iii) and Spatial Inclusion; and (iv) Regional and Global Social Public Goods. Public financial management reform, labor market efficiency and social sector reform are key elements o f the first three pillars. As such, the policy lending series provides an anchor for the strategic dialogue between the World Bank and the Polish authorities, supported by analytical work andtechnical co-operation activities. 19  Box 4. SupportingHighand SustainableEconomicGrowthinPolandover the MediumTerm Although recent economic performance has been impressive, Poland still faces constraints which may slow down the real convergence process. In2007, Poland's GDP per capita at purchasing power parity amounted to 53.6 percent o f the average for the EU-27. A continuedrapidreduction o f the income gap requires high and sustainable growth based on productivity increases, higher employment, and increased investment rates. Potential medium- to long-term growth rates are estimated at around 4.5 percent, assuming a continued gradual increase in employment rates, rapid investment growth, and continued robust productivity growth. There is broad consensus among the government and its internationalpartners that policy interventions aimed at promoting high and sustainable growth should be focused on the following three broad areas that characterize this policy program: (a) Public finance and administrative reforms aimed at continued fiscal consolidation, lowering o f the tax burden, re-orientation o f spending towards more productive areas, improved public financial management, and improved public administration (public finance and administrative reform); (b) Promoting private sector investment through an improved investment climate, more product market flexibility, and restructuring o fkey sectors (structural reforms); and (c) Increasing labor force participation and employment to mher reduce poverty and encourage social inclusion (labor supply mobilization). Public finance reforms are required to improve the quality and efficiency of public finances. Further fiscal consolidation i s needed to improve macroeconomic stability and provide room for countercyclical fiscal policy. A lower tax burden and simpler tax system would encourage formal private sector activity. A re-orientation and restructuring o f spending would provide fiscal space for increased productive spending, notably on infrastructure, and improved outcomes in health and education. Public financial management reforms would improve the transparency and predictability o f public finances. Public administration reforms would improve management, service delivery, policy coordination, and a capacity and results orientation at all levels o f government (including the reform and modernization o f Poland's courts). Structural reforms are needed to improve the general investment climate and support the restructuringof low-productivity sectors. Polandranked76 out o f 181countries onDoing Business Indicators. For starting a business, construction, and paying taxes, it ranked 142 or worse. Further deregulation that includes a simplification o f its onerous legal, tax, and administrative environment for entrepreneurship and business development continues to be a priority. In addition, by restructuring sectors such as coal and energy generation, removing incentives for people to remain in low- productivity agriculture, and accelerating the privatization process (including in what are considered strategic sectors), the Government could facilitate a faster shift from old industrial, low-productivity sectors to newjob-rich, high-productivity sectors. Labor suppry mobilization is needed to raise low employment rates, not least among the older cohorts and women, and to improve the skills of the workforce. Reform o f the system o f social protection and labor taxation, development o f more flexible forms o f employment, improving and evaluating active labor market programs targeted at disadvantaged groups, and promoting life-long learning are important actions to increase labor force participation and productivity. The Government's actions to limit the number o f professions entitled to early retirement i s in line with the principles o f the pension reform introduced in 1999 and supports increased labor force participation. Yet it still has a pressing need to increase the pace o f reform inthe education system to improve labor market relevance and skills. While outward migration has been a concern following EU accession, remittances have been substantial, and people are beginning to return as economic prospects improve at home. Source: New PolandCountry Partnership Strategy 48. The overarching goal of the CPS is to supportPoland's convergencetowards 20  EU living standards. The program o f policy lending is an important instrument in the strategy. In the short term, as Poland faces an outlook o f high economic uncertainty created by the global economic crisis, it will be important for the Bank to support adequate social safety nets during the economic downturn and changes in labor market regulation likely to accelerate economic recovery. Inthe medium-term the program i s not yet well defined but will support the resumption o f growth and convergence with EU living standards. New modalities o f engagement are being explored, including sub- sovereign activities and a move towards cost-sharing or fee-based services. 4.2. RELATIONSHIPTO OTHERBANKOPERATIONS 49. The reforms supportedinthe programwill benefitfrom prior Bankfinanced assistance at the local level. The Post Accession Rural Support Project (PARSP), approved by the Bank in 2005, provides assistance to rural gminas to enhance the capacity o f local governments to identify, plan, and execute social protection strategies through a Social Inclusion Program (SIP). The project i s implemented in 500 rural gminas, where it has helped to increase the capacity o f local governments as well as to engage communities - by emphasizing participation and building on social capital - in monitoring the use o f resources and social transfers. As the reforms supported by the program o f policy lending help to put more decisions into the hands o f local authorities, the capacity created with support of the PARSP will become critical. The Bank has also provided support to the agricultural insurance fund (KRUS) reform to improve the efficiency o f the KRUS Agency by strengthening its administrative and analytic capacities, its management, and its decision-makingprocesses. 4.3. ANALYTICAL UNDERPININGS 50. The specific measures supported by the program have been identified through analyticalwork conducted prior to and in parallelwith loan preparation. The measures selected for support inthe second andthirdpolicy loans are fully owned by the government and address core policy issues in each o f the sectors. Inmany cases, the economic and financial crisis has given specific actions particular urgency, as explained in this section, and the pressure may mount during the coming months for additional structural reforms to reduce long-term expenditure obligations while redirecting resources in the short term to the social protection system to respond to additional demands inthe constrained fiscal environment. 51. The reformof public financialmanagementpracticeshas become even more importantthan beforethe crisis. Two major reforms -the introduction o fmedium-term expenditure frameworks (MTEF) and performance-based budgeting (PBB) - have been central elements in improving the management o f public finances. MTEFs have been developed and refined by many countries to help build fiscal policy credibility and predictability via a strategic, multi-year, budget planning perspective. At the same time, PBB concepts and methods have been important in many countries to bring a greater focus on the results from government spending. International experience suggests that, implemented together, PBB and MTEF reforms can significantly raise the quality and consistency o f forward estimates o f public expenditures through common use o f policy- 21  based expenditure programs and program- and activity-based costing methodologies. These budget reforms have been on the agenda of most new EU Member States and candidate countrie~.~ 52. Polandhas made substantialprogressin the last three years in performance budgeting and will introduce a multi-year system of budget preparation. An indicative performance budget - including a programmatic breakdown o f expenditures, program objectives, and key performance indicators - is now presented to the Parliament for information alongside the traditional annual budget. Further steps will be requiredto move from this promising start to a position where the budget is appropriated on a program basis and budgeting becomes truly performance-informed. Accounting and financial management information systems would need to be reformed to support budgeting by program. Performance indicators and program evaluation mechanisms would be required. On-going refinement o f the program structure and definition o f program objectives would needto be institutionalized. 53. Improved institutional collaboration in the design and implementation of these reforms will be crucial to their success. The key element o f the government's medium-termbudgetinginitiative is a new Multi-Year State Financial Plan (MYSFP), to be voted on by the parliament. The MYSFP will be a four-year fixed plan covering the period o f each government's term in office. It i s not expected to set binding multi-year aggregate fiscal limits but will instead focus on improved fiscal projections and a statement o f the government's medium-term fiscal policy. For this to make a difference to macro-fiscal policy, the required statement o f medium-term fiscal policy should be specific (e.g. including numerical fiscal targets) rather than general in nature. However, the most important requirement for improved medium-term budgeting in Poland i s a substantial improvement in the quality o f projections o f medium-term expenditures and revenues. Only on the basis of much better projections will it be possible to properly assess, and then take action to ensure, the compatibility o f existing expenditure and revenue policies with mediumterm aggregate fiscal policy.* 54. With respect to the labor market, the priorities lie in maintaining (and hopefully increasing) labor force participation,,particularly among older people. Until2007, the unemployment rate was indouble digits and the employment to working age population ratio was around 55 percent, far below the Lisbon target o f 70 percent adopted by the EU. One major factor contributing to the low ratio was the low labor force participation rate among older workers, which i s the lowest inthe EU. Inaddition, the incidence o f long-term unemployment was high, leading to labor market exclusion and poverty. Labor resources were thus substantially underutilized. In this context the Kasek L.,Webber D. (ed.), Performance-based budgeting and medium-term expenditurefiameworks in Emerging Europe, forthcoming, World Bank Study. The success ofperformance budgeting and medium-term budgetinginPolandrequires substantial additional capacity building, extending the thematic scope o fthe major performance budgeting training effort which is currently underway with EUsupport. Further technical support would be beneficial ina number ofareas, includingaccountinghancial management information systems, evaluation and performance indicator development. 22  Government has undertaken reforms aimed at increasing the employmentipopulation ratio, especially among older workers. 55. Recent improvements in employment and labor market efficiency will be challenged by the crisis. The improvements in economic activity and employment could be severely hampered by the global economic crisis. Since the last quarter o f 2008 the unemployment rate has started to increase again. The Government faces a challenge o f preventing large scale job losses, mass unemployment and labor market exclusion. It i s focused on measures that will not only help employers and workers mitigate the costs o f the downturn but will also prepare the labor market for a recovery. To cope with these challenges the Government recently initiated tripartite negotiations, including trade unions' and employers' representatives, on an "anti-crisis package." In addition, the Government decided to reform the unemployment benefit system to strengthenjob search incentives and to shorten the duration of unemployment. Finally, the Government plans to improve the efficiency and targeting o f active labor market programs (such as (re)training, wage subsidies and public works) to help the unemployed find new jobs and prevent long-term unemployment. 56. Featuresof Poland's retirementincome security (pension) system encourage early retirement, at a substantial fiscal cost, and contributeto the low labor force participation of older workers. In most pension systems in the region the rate of system dependency (the ratio o f beneficiaries to contributors) is high relative to population dependency (the ratio o f elderly to the working age population).' The number o f beneficiaries per contributor i s significantly higher than the ratio o f retirement-age population to working-age population, leading to highpension expenditures coupled with moderately low revenues and a fiscal problem. Two o f the most common reasons for the high system dependency rates are the high rate o f disability pensions awarded to those below the normal retirement age and the high rate o f early retirement pensions. Reducing these components will help bring down pension expenditures and help raise additional contribution revenue, bringing the systems closer to balance. Reducing incentives for choosing disability pensions and tightening the criteria for early retirement will both help to reduce system dependency rates and increase the fiscal sustainability of the publicly managed pillar. 57. As privatelymanaged, mandatoryretirementsavings gaininimportanceas a part of old-age income security, the funded pillar of the pensionsystem will need to become moreefficient. The payout options needto be designed so that they are flexible enough to withstand market fluctuations while protecting workers. The use o f multiple portfolios with a mandatory shift toward a fixed income portfolio inthe years just prior to retirement i s being pursued as a way o f protecting workers against sudden drops in the valuation of financial assets just prior to retirement. Measures40 lower costs to affiliates will help increase the balances availableto participatingworkers when they retire. See MukeshChawlaet al. (2007) From Red to Gray: The "Third Transition" ofAging Populations in Eastern Europe and the Former Soviet Union,available at http://go.worldbank.org/OOQO6F6QKO. 23  58. The foundation to accelerating Poland's convergence with EU living standards, is improvingthe return on the country's investmentin education. Total spending on education in Poland stood at 5.25 percent o f GDP in2007, which i s slightly higher than the OECD average, but in absolute amount it i s less than half the OECD average because o f Poland's lower GDP. How Poland spends its money on education i s critical to its effectiveness inbuildinghuman capital equitably and investing in its fiture productivity and competitiveness. 59. Primary and secondary education are fully decentralized to local governments. Management o f schools became a responsibility o f local governments in 1999, the complete antithesis o f the old management structures relying on central administration. Gminas manage primary schools. Powiats and Voivodeships are responsible for secondary and post-secondary schools. Public colleges and universities are funded directly by the State. The Ministry o f Finance transfers an education subvention to local governments through an algorithm that emphasize student enrollment. A share of tax revenues (51% o f the personal income tax and 24% o f the corporate income tax) i s transferred to local governments, and an equalization grant that takes into account local revenues i s also distributed. These finds are transferred from the Ministry o f Finance to 2,487 municipal governments, over 300 counties, and 16 regions. Local governments autonomously decide how the money i s spent. Infact, they may fund non- educational expenditures with the education subvention, as it enters their budgets as an "unmarked" grant with no specific earmarking. In practice, local governments spend more than the amount o f the education subvention on schools, and for the country as a whole, it covers approximately 100 percent o f the wage bill, with localities covering the remainingcosts through other revenues. 60. At the primary and secondary levels of the educationsystem, there has been a precipitousdrop in the number of students, caused by demographic trends that will not be easy to change. Since 2000, primary and secondary enrollments have dropped by almost 1.5 million students to about 5.5 million in total. While some urban schools continue to grow, rural schools are extremely hard hit by the declining number o f children. Inthe past 4 years, college and university enrollments have leveled off at about 2 million, after nearly tripling inthe 1990s. Unless Poland's already high enrollment rate at the tertiary level, which stands at about 50 percent today, continues to increase, the smaller cohorts will soon also drag tertiary enrollments down. It is difficult for the systemto adjust fast enough to maintain efficient use o f education finds. The Teacher's Charter limits both the ability o f municipalities to demand more from their teachers and to reduce their numbers. The figure below shows the inadequate adjustment o f the number o f teachers to the decline in the student population. As this discrepancy is compounded year by year, the stock o f teachers relative to the stock o f students has become increasingly distorted: a 16 percent decline in students was accompanied by only a 6 percent decrease in teacher full time equivalents. A second constraint requires that the education subvention not decrease in total amount below the previous year's level; hence localities with falling numbers o f students are under less pressure than they otherwise would be to make appropriate adjustments. Municipalities require more flexibility to adjust supply to demand at the primary levels o f the education system while also taking this opportunity to pull younger cohorts - ages 6, 5, 4, and 3 - into schools 24  both to prepare them for formal education and to use excess educational resources more effectively. The latter effort should increase Poland's low enrollment o f children in preschool and correct the inequity caused by much higher enrollment rates in cities relative to rural areas. Figure2. Dynamicsof enrollment and teachers employment2000-2007 2001 2002 2003 2004 2005 2006 2007 O,O% -0,5% -1,O% -1,5% -2,0% -2,5% I -3,0% -3,5% I year to year change in the numberof teachers -4,0% ` year to year change in the number of students -4,5% 61. At higher levels of education, the priorities are to improve quality and to achieve greater equity. At the secondary level, the Government has increased quality by delaying the tracking o f students into vocational education and simplifying the vocational track so that it converges with general education. The success o f this effort has led to improvements in Polish students' performance on international examinations and, inturn, to an even more energetic effort to converge tracks and delay tracking to the tenth grade. In addition, the Government has overhauled achievement testing by introducing external exams at all levels and reforming the school-leaving exam (matura) at the secondary level. Recently the authorities added foreign language testing to both types o f exams and for the first time in2009/10 will introduce mathematics testing to the matura. At the university level, a hallmark of Poland's development since 1989 has been a flourishing network o f private institutions to meet an explosion o f pent-up demand for tertiary places. Unfortunately, the system o f financing has not kept pace with the change inthecompositionofstudents andthe market. Merit-based, all-expenses-paid entrance to public university day classes has always skewed public subsidies to better-off households, but the introduction o f unsubsidized night classes and full-cost private options for students not qualifying for public subsidies has made outcomes more inequitable. To a large degree, better-off families succeed ingetting subsidies and poorer 25  families pay. A subsidized student loan program was introduced, but take-up by banks and students has been low, as the design o f the program makes it unattractiveto potential lenders and borrowers. Starting in2010, Polandwill begin to rationalize public subsidies in higher education and become one of the first Eastern European countries to start allocating a significant share o f state-financed tuition and housing subsidies, as well as subsidies for student loans, based on need. 62. Poland's performancein improvinghealththroughambitiousreformsof the health sector has been impressive. Through a series o f reforms since 1997, the Government has achieved virtually 100 percent coverage o f the population through its public health insurance system, using a combination o f social health insurance and general budget financing. Workers who lose their jobs retain insurance and access to services, but the payment o f premiums is shifted to another source o f funds. A measure o f the relative success o f Poland in improving health outcomes i s shown in Figure 3, which compares Poland with its neighbor, Ukraine, as well as the EU countries before 2004. Although health care i s only part o f the explanation, o f course, Poland has been one o f the best performers inEastern Europe inimproving health. Convergence with the EU, never feasible before 1990, becomes possible as the rate o f improvement has started to accelerate. Figure3. LifeExpectancyat Birth,inPolandandNeighboringCountries May2004 Source: WHO Health for All Database 63. The measures supported by the program are aimed at modernizing the hospital network. Poland's ability to reallocate funding to primary and preventive programs has been limited by its inherited stock o f outmoded, costly, and inefficiently large hospitals. Like schools, the hospitals are owned by local governments and other entities such as universities, so the central government can only affect decisions through the insurance payment mechanism, legal requirements, and incentives. Nevertheless, the 26  Government has whittled away at the number o f beds successfully since 2005, which reduces costs and has begun to "right-size" the system relative to the need for beds. However, with important exceptions, hospitals have consistently accumulated public debts (failure to pay social security and other taxes) and civil debts (borrowings and receivables owed to suppliers). The program o f hospital "corporatization" launched by the Government this year, supported bythis loan, is key to increasingefficiency o f health service delivery. V. THE PROPOSED POLICY LOAN 64. This is the second lending operation in a program of three. The second lending operation (PL2) will support reforms to public financial management, further steps to strengthen the private sector, structural measures to improve labor market efficiency, greater openness to private sector development, and reforms to the finance and provision o f health, education and social protection. The latter three areas account for about 62 percent o f public spending, down from 65 percent in 2003. Of spending on social protection, 9.4 percent o f GDP i s spent on old age pensions. See Table 5. Table 5. GeneralGovernmentExpenditure,by Sector (Percentage o f GDP) 2003 2004 2005 2006 2007 Total 44.6 42.6 43.3 43.8 42.2 General public services 6.3 6.3 6.3 6 5.5 Defence 1.2 1 1.I 1.2 1.4 Publicorder and safety 1.7 1.6 1.7 I.8 1.8 1Economicaffairs 3.4 3.4 3.8 4.4 4.6 I Environmentalprotection 0.6 0.6 0.6 0.6 0.6 Housingand communityamenities 1.4 1.4 1.4 1.2 1.I Health 4.3 4.2 4.4 4.6 4.6 Recreation,cultureand religion 1 1 1 1.I 1.I Education 6.1 5.7 6.1 6 5.7 Socialprotection 18.8 17.6 17 16.9 15.8 Source: Eurostat 5.1. PROGRAMOBJECTIVES 65. The second lending operation will continue to support the convergence agenda,butwill focus morenarrowlyon sector reforms. The first loan inthe program (PL1) supported a broad range o f policy actions to strengthen public finance management, improved business environment, and higher labor market participation. The policy actions taken by the Government prior to presentation o f the first loan to the Board included: satisfactory implementation o f the 2008 budgetandpresentation of 2009 budget bill consistent with the Convergence Program; a reduction in payroll taxes to lower the cost o f labor; elimination o f required work permits for foreign workers from neighboring countries to increase the labor supply; tightening eligibility requirements for disability benefits; legislation that reduces the minimum capital required to start a 27  business; and the approval o f a privatization program encompassing the sale o f 740 state owned enterprises. As reported in the sections below, the Government has met all the triggers agreed for the second operation PL2. 66. The second lendingoperationin the program(PL2) will continue to support reformsinitiatedwith the first loanwhile broadeningthe focus to includestructural improvementsin, and maintenanceof, criticalprogramsin the social sectors. Inthe months since the first loan was disbursed, the external economic environment has changed substantially, causing growth in Poland to slow sharply. To better manage the uncertainty that the economic crisis has introduced to Poland's outlook and fiscal targets, as well to push ahead with reform o f public financial management, the Government is now focusing on the part o f the program specifically targeting the labor market, education, health and social protection. The second operation has the following development policy objectives: (i)to support structural reforms that will ensure fiscal consolidation over the medium term; (ii) to protect priority investment programs and the up-front fiscal costs o f structural reforms critical to meeting Poland's goals o f convergence with the rest o f the EU; and (iii) to mitigate the social cost o f the economic crisis. Intaking stock o f the Government's progress inmeeting the triggers for PL2, its careful fiscal management amidst growing constraints; policy achievements in education and health; and the steps it has taken to mitigate the impact o f the crisis, should be taken into account. 5.2. REFORMSSUPPORTEDBYTHISLOAN PRIORACTIONSFORPL2 - (see Annex 2 PolicyMatrix) 67. Public Financial Management. AAer three years o f strong economic performance, even though Poland is faring better than other countries in the region, the global financial crisis has worsened its macroeconomic and fiscal outlook. With fewer resources and in a fast evolving economic environment, the Government faces a difficult challenge to reconcile longer term with shorter term fiscal objectives. Inpublic financial management, PL2 supports three prior actions: Satisfactory continuing implementation of the 2009 budget in light of changingeconomic circumstances. InJanuary, line ministrieswere prepared for the need to curtail discretionary expenditure by 10 percent. Certain priority expenditure items were protected from expenditure reductions. For example, in the education sector, the per-capita transfer to sub-national governments was set aside before the 10 percent savings were identified; while inhealth, financing for specific public health programs was set aside. The Government is expected to present a supplementary budget in late June or July that makes the January cuts permanent and may include other cuts and revenue measures. As a condition o f effectiveness, the Government has agreed to initiate the process o f revising its 2009 budget in form and substance consistent with the measures being supported by the program. Throughout the program, the Bank will continue to consult with the IMF and the E C on their assessmento f Poland's fiscal policy stance. 28  . Further advances in the preparationand introductionof performance-based budget and medium-term expenditure framework (MTEF). These institutional reforms can help to prioritize expenditures and support medium-term fiscal consolidation. The introduction o f a performance-based budget for 2009 was a major achievement. As part o f the 2010 budget preparation, Government envisages broadening the coverage, improving the classification o f functions, clarifying objectives, and developing indicators. Submission to Parliamentof the amended Law on Public Finance: The law, which incorporates institutional measures to improve public financial management, was submitted to Parliament in late 2008 and is expected to be adopted by Parliament in fall 2009. The amended law includes provisions for a four-year rollingmedium-termexpenditure framework. 68. Private Sector Reforms. The Government has focused on two specific aspects o f private sector development: improving its regulatory interface with businesses and continuing to privatize remaining state-owned enterprises. The privatization program was rejuvenated by the current government after lapsing for several years. In both . aspects, the prior actions agreed for PL2 have been met, namely: Amendment of the Law on Freedom of Business Operations to unify and coordinate business inspectionprocedures, scheduling and duration among all inspectionauthorities. The Act was amended in late 2008, and the changes in business inspection have been in full effect since March 2009. This amendment limits the amount o f time inspections can take place and the number o f inspections that a business can be subjected to at the same time. It opens additional avenues o f appeal for business owners who disputeinspection findings. The amended law creates a "one-stop shop" for business licensing and registration, makes it substantially less onerous for businesses to cease operations either temporarily or permanently, and reduces the ability o f government officials to reject regulatory submissions for incompleteness, allowing them to be amended. Inaddition, the Government began an intensive effort to catalogue all inspections done by all branches o f government to remove additional redundancies and inconsistencies, with the intention o f reorganizing like activities . into one agency. This work will be supported by PL3. Offer of the first 80 publicsector enterprisesinthe privatizationprogram(or those constituting10 percentof aggregateasset value) for sale on the market (through stock exchange or by auction) or via competitive tenders. Despite difficult market conditions, out o f 740 firms in its privatization program, the Government sold shares o f 75 companies in 2008 and 11 in 2009, or 86 in total. The program continues to put together packages for sale and has recently introduced auctions. Large power firms are expected to be sold in 2009 (Enea) and 2010 (Tauron and Energa), causing a steep rise inexpected revenues from the program at exactly the time that the Government may have additional financing needs due to the economic downturn. 29  69. Labor MarketReforms. Turningto labor and employment, the Governmenthas continued to implement the reform program documented in PLl. Key prior actions for the second lendingoperationare: . Implementation of the government program to increase labor force participation of older workers, known as "50+." In 2008 the Government markedly reduced the tax wedge for labor by reducing disability payroll taxes by six percentage points. A second major issue the Government has faced i s the low participation rate o f older workers. It has addressed this problem by reducing eligibility for early retirement, reducing some o f the social security contributions as they near retirement age, and making older workers eligible for employment services. These changes have been implemented in the first quarter o f 2009. In addition, legislation is being prepared to allow those with disability pensions to . work without losing their benefits. Improvements to the incentive structure of unemployment benefits. Legislation was enacted in December 2008 to raise benefits to improve the consumption-smoothing function o f unemployment insurance, but at the same time benefits were reduced after 3 months o f unemployment to encourage job search. These changes have beenimplemented as o f January 2009.'' 70. Education Sector Reforms. There has been substantial progress in reforming Poland's education system, focused on expanding access to preschool education and improving the efficiency and quality o f primary and secondary education. Current reform efforts in higher education are also set to deliver more equitable access and more relevant skills among graduates. The lending program recognizes this progress. Key . actions takenby the Government supported by PL2 are: Legislationapprovedthat initiates a compulsorypre-primary programfor 5 year-old children (Grade 0) starting from 2011/12 and begins voluntary implementation in 2009/10. The same law initiates a compulsory school programfor 6 year-old childrenfrom 2012/13. Given 40 years o f accumulated evidence o f the impact o f early childhood education in helping children succeed once they are in formal school, Poland will require 5-year-old children to enter school beginning in the 2011/12 school years. These children will then become the first mandatory class o f 6-year-olds in regular primary school the following year. Up to that point, it will be voluntary for 5-year-olds but mandatory for 6- year-olds to be in kindergarten. This reform will help Poland catch up to other EU members in investing in the early participation o f children in formal education. ~~ ~ ~ ~~ ~~ loCurrently the unemployment benefit i s a flat rate set at PLN 504 (for comparison, the minimumwage in Poland is PLN 1260). FromJanuary 2010, the amount will rise to PLN 717 duringthe first 3 months o f unemployment, and to PLN 580 thereafter. The maximum duration o fbenefits is 6 months inpowiats (districts) where the rate o funemployment is less than 125% o f the national average, 12 months inpowiats where unemployment is less than 200% o f the national average, and 18 months where unemployment is greater than 200% o f the national average. 30  . Developmentof primary and secondary education: The other elements of the matrix capture the Government's efforts to help municipalities manage the reduced need for classrooms and teachers as cohort sizes shrink; to attract and retain young, well educated teachers by raising entry-level salaries relative to those of older teachers; and to improve quality and outcomes through the reform o f vocational education, improved testing, and analysis o f test results to improve schooling. 71. Health Sector Reforms. Polandhas developed a robust and adequately financed health insurance program that protects citizens from the adverse consequences o f health costs. For years it has struggled with a number o f efficiency problems that are being effectively addressed by the Government through a series o f structural reforms. For example, a key element o f health sector reform that has never been successfully tackled has been the tendency o f hospitals to accumulate debt, which i s periodically paid off at tremendous cost to national and local government budgets, only to be run up again. In addition, incentives to control costs in the hospital sector have never been successfully imposed. The resultant drain on resources for hospitals has limited authorities' ability to shift resources to programs that would be more effective inimproving the health o f the population. A core structural initiative o f the Government i s to gain control over these . persistent problems. Supported by PL2, key actions inthe Governments program are: Approve an implementationplanfor the participationof publichospitalsin a voluntaryprogramthat would converttheminto corporateentitiesoperating under the Commercial Code. . The Government has developed a program to corporatize hospitals under commercial law. After a veto by the President in February 2009, and supported by a Cabinet Resolution, the original plan to make this change compulsory will be implemented as a voluntary change o f status. By May 2009, the voluntary program will open for business. Once corporatized, hospitals will follow commercial financial reporting requirements and will face . the possibility o fbankruptcy ifthey cannot pay their bills. Adoption of DRGbased payments system for 90 percent of all payments fromNFZ to hospitals. A complement to the corporatization program will be to account for costs in hospitals and outpatient clinics using Diagnostically Related Groups, which gives the insurance system a tool for reimbursement that shifts from inputs to outputs and which has an in-built incentive structure to reduce costs and to standardize care against treatment guidelines for diagnostically related conditions. 2009 will be the first full year o f using DRGs to account for costs. In2009 and 2010 they will be analyzed and will start to affect tariffs paid . byNFZ, the national insurer. Other elements of the reformprogramcomplementthese structural changes with similar efforts for hospitals that cannot participate in the corporatization program and initiatives to improve the quality o f care and evaluation o f programs inhealth. 31  72. In Social Protection- starting with contributory social insurance/pensions - the Government has made substantial progress. To increase the long-term financial sustainability o f the publicly financed part o f the pension system, the key prior action for PL2 is: Enactment of the Law on Bridging Pensions reducing the number of people eligible for early retirement from 1.7 million to 300,000, while safeguarding the base level of pensions for persons affected by the change. This reform i s expected to increase the effective retirement age, increase participation in the labor market, and improve fiscal sustainability, while maintaining the base level o fpensions for those close to retirement age. 73. The Government has made substantial efforts to secure passage of additional legislation to strengthen the pension system but has faced political opposition. The Government recognizes the importance o f making the disability/survivor benefit consistent with the reformed first pillar old-age benefit. A draft law was presentedby the Government and adopted by the Parliament, but it was vetoed by the President. Similarly, an annuity law that defines the payout provisions for the lifetime pension from the funded pillar (which was originally envisioned as a trigger for PL3) was presented and adopted by the Parliament in December 2008, but this measure was also vetoed by the President. The path forward for these measures is unclear at the moment given the political obstacles. However, on both counts, while legislationwould be desirable now, it i s not urgently needed, and it will not be essential until cohorts with a significant balance o f accumulated savings in their private retirement accounts begin to retire in 2014. MLSP estimates they have a 5-year window for a more favorable political environment to submitthese reforms again. 74. In social assistance, the single priority is to ensure that a responsive safety net can meet greater needs anticipated in the wake of the economic crisis. The Government, ledby the PMO, has taken the initiative on a number o f fronts to prepare for increased vulnerability, as described in earlier sections. Reflecting the imperative to prepare Poland's social assistance programs for the crisis, the key prior action taken by the Government, supported byPL2 is: Provision of a reserve in the 2009 budget to protect households vulnerable to the crisis: The higher levies on alcohol and luxury cars passed in 2008 are generating a PLN 1140 million reserve to address the needs o f households made vulnerable by the economic slowdown. The Government i s mapping the areas o f the country where households and workers are especially vulnerable to an economic downturn. 75. Table 6 summarizes progress for the core prior actions for PL2. These are the prior actions that were part ofthe loan agreement. Table 6. Agreed Prior Actions for the Second Policy Loan, PL2 Area Prior Action Status PublicFinancialManagement 32  Area Prior Action Status 1. Satisfactorycontinuedimplementationofthe Done, althoughit is adynamic processthat our 2009 budget inlight of the changedeconomic assessmentandloandocumentationacknowledge. outlook. AssessmentofEC andIMFwould be Governmentplans asupplementarybudget to adjustto considered. changedeconomic conditions. IMF assessmentfor FCL is completeandpositive. The nextArticle 4 consultationis plannedfor June. The EC excessive debt procedurewill be consideredinformulationof the 2009 supplementarybudget andbeyond. 2. Submissionto Parliamentof amendedLaw on Done. PublicFinance. Labor Market Reforms 3. Implementationof the government programto Done: Programreducesthe cost of employment and increaselabor force participationof older workers, ensures the availability of public employment known as "50+" programsto olderparticipantsinthe labor force. PensionReforms 4. Enactmentofthe Law onBridging Pensions Done. Law passedandsignedby President. which reducesthe number ofpeopleeligible for earlyretirementfrom 1.7 missionto 300,000, while safeguardingthebaselevelof pensionsfor those affectedby the change. . Private Sector Development 5. Amendments to the Law onFreedomofBusiness Done. The Government amendedthe law inlate2008 Operationsthat unify andcoordinatebusiness andthe changesintroducedhavebeeninfull effect inspectionprocedures,schedulingandduration sinceMarch 2009. amongall inspectionauthorities. , 6. Offer for sale on the market(throughstock Done. exchange or by auction) or via competitivetenders the first 80 public sectorenterprises intheprogram (or those constituting 10percentof aggregateasset Health Sector 7. Approvalof animplementationplanfor the Done: The programwill beginwith authorityof the participationofpublic hospitals inavoluntary CouncilofMinistersby midMay. programthat would convert them into corporate entities operatingunder the CommercialCode. 8. Adopt DRG-basedpaymentssystemfor 90%of Done: DRGsare beingimplemented, dataavailable all paymentsfrom NFZ to hospitals. beginningin2008. EducationReform 9. Passa lawto initiate acompulsory pre-primary Done: Law has beenpassed. programfor 5 year-oldchildren(Grade 0) starting from 2011/12andbeginimplementingit on a voluntarybasis in2009/10. The same law initiatesa compulsoryschoolprogramfor 6 year-oldchildren from 2012/13. [Mandatoryfor 6 year-olds today in kindergarten; compulsoryinregular primary school Social Assistance 10. Provisionfor areserve inthe2009 budgetto Done. The SocialSolidarityReserve(PLN 1.14 protectthevulnerableaffectedby the economic billion) is inthe State budgetfor 2009. It is financed downturn. from an increaseinthe excisetax on alcoholicdrinks andcars with enginecapacity above 2000cm3. 33  5.3. CONTINUATIONOFTHE REFORMPROGRAMDURING2009: TRIGGERS FORPL3 (see Annex 2 Policy Matrix) 76. The PMO, MOF, sector ministries,andthe Bankhavecome to a preliminary agreement on the triggersfor the proposedthird policy loan(PL3). These measures represent milestones in the Government's program that are expected to be completed by the end of November 2009. Reaching these milestones would trigger the third policy loan inthe program. The milestones and issues surrounding them are described briefly below 77. Public financial management. The trigger for PL3 is the approval of the 2010 budget consistent with the medium term fiscal consolidation, taking into account assessments by the Bank, the IMF, and the EC. Inaddition, the Government is expected to begin implementing the amendedLaw on Public Finance. The MOF has already taken several steps to improve the quality ofbudget performance information. At the request of the MOF, IMF experts reviewed the education function of the program classification in early 2009. Recently, the MOF commissioned external consultants to review and evaluate an additional five functions. Based on this work, the MOF will revise the performance information includedinthe budget documentation bythe end 2009. 78. Despite the slowdownin economic growth, the Ministry of Economy(MOE) continues its efforts to improve Poland's environmentfor doing business. The MOE has taken on the task of further reforming the Government's business inspectionapparatus which operates across ministries and affects whole sectors of private economic activity. Indiscussions of the proposed third policy loan (PL3), the following actions are proposed as prior . actions inthe area ofprivate sector development: Completion of background work and a draft Government strategy for "Rationalization of InspectionProcesses in Poland:" The most difficult and time consuming task - identification of overlapping inspection requirements in over 500 pieces o f legislation - has been completed. With additional technical assistance being discussedwith the Bank, the MOE will draw up a plan of action to rationalize business inspection process to further improve the environment for . doing business. Appointment of a high-level inter-ministerial task force to review the strategy and prioritize actions for implementationof the reforms: The next step will be to reorganize government inspection and monitoring structures to reduce onerous, inconsistent, and repetitive procedures while retaining the legitimate purpose o f core inspection. As it touches on inspection regimes in almost all the ministries, implementation of the rationalization plan will require commitment from the Council of Ministers. The formation of a high level, inter- ministerial task force with a mandate to formulate a strategy and implement the rationalization planis an agreedkey action. 34  . Privatization program continues. Despite difficult conditions in the equity markets, the Government is moving ahead with its programof selling State shares in businesses. If successful, there will be a large spike in revenue from privatizations in2009 and 2010 even though the number o f firms sold i s likely to . decline. Continue business process simplification. Apart from the effort to simplify inspections, the Government has made substantial progress in simplifying the construction permit process while maintaining environmental protections and improving the basis for landuse planning at the local level. 79. As the economy slows, the Governmentis preparingadditionallabor reforms expected in the second half of 2009 that will mitigate the immediate effects of the crisis, but just as importantly, they will support future employment when the economy begins to recover. These measures include critical amendments to the labor code to increase labor market adaptability, policies that use the Labor Fund to reduce household vulnerability to the economic slowdown, and improvements in active labor market programs (ALMPs)' The Labor Fundhas a substantial surplus - amassedduring the recent periodo fhigheconomic growth andrelatively low unemployment - that can be used proactively to face challenges posed by the economic slowdown. With some important reservations, the Government's plans appear both prudent and farsighted given the current economic uncertainty. The policies are aligned with the convergence agenda, and with respect to employment, the Lisbon goals. Specific measures planned for the . second halfo f 2009 that would be supported by PL3 include: Temporary legislation that will allow employers to redistribute working hours over a longer period: As a crisis measure, the Government is securing agreement with employers and trade unions to increase work-time flexibility to cushion the impact o f the crisis. The temporary measure would allow employers to redistribute working hours over a 12 month (rather than the current 3 month) period. The measure would encourage the labor market to adjust through working hours to discourage layoffs as the economy slows.12 This measure provides l1The main active labor programs are: training; apprenticeships (on-the-job training) for school leavers; wage subsidies; public works; and business start-up support. The regulatory framework for the provision o f employment services (Law on the Promotion of Employment) is defined by the MLSP. The Ministry allocates resources from the Labor Fundto districts (according to a pre-defined algorithm) to finance programs, sets quality standards for employment services, and plays a coordinating role. The Ministry intendsto improve the efficiency o femployment services by allowing greater competition inthe sector, including the entry o fnon-public providers, public-private partnerships, and contracting out o f selected services. The rationale for the reforms, including the introduction o f activation policies, is to increase the currently low employment rates among certain groups (youth, low-skilled workers, older workers) and to reduce the incidence o f long-term unemployment, which is relatively high despite the relatively low overall unemployment rate. ''The idea is to give employers the possibility to reduce work hours during periods o f low demand and increase them duringperiods o fhigh demand, provided that the total number o f work hours within 12 months i s unchanged and the work week does not exceed48 hours. Moreover, employers are not required to pay an overtime premiumas long as the total yearly amount o f work hours i s not exceeded. This measure is meant to stabilize employment by allowing employers to adjust labor inputby adjusting work hours rather than employment levels. Workers would face a lower risko fjob loss and unemployment 35  . workers and their households with additional tools with which to manage downturns inthe economic cycle. To prepare for the recovery, higher quality employment services: The authorities will develop a monitoring and evaluation system for active labor market programs implemented by local employment offices to ensure support i s . givento programs that demonstrate a measurable positive impact. Liberalizingprovisionof employmentservices: Planned reforms will improve the efficiency o f public employment services by allowing services to be contracted-out to private providers. 80. The Government'sreformsare expected to contributeto better labor market performance - to better absorb the impact of the slowdown and prepare for Poland's economic recovery. The Bank team i s helping to estimate the cost implications o f each measure and offer ideas for their design. For example, options being considered for a "technical leave" scheme assume that workers would be paid the minimumwage financed inequal proportionby employers andthe State (from the Labor Fund).13 This may be too generous and too costly, requiring revenues o fthe Labor Fund to be significantly increased, either by increasing the contribution rate (currently 0.1 percent o fpayroll), or by providing a subsidy from the national budget. Ineither case the opportunity cost could be ~ubstantia1.l~There are other new labor market measures being introduced as an "Anti-Crisis Package" agreed between employers and trade unions within the Tripartite Socio-Economic Commission. Items in this package may incur substantial costs for the Government and could hinder labor market performance (e.g. the proposal to raise the minimumwage to 50 percent o f the average wage, from the current level o f 37.3 percent). There i s a risk that items in the package being discussed could create additional contingent liabilities and distortions that would worsen employment outcomes and slow Poland's recovery. 81. In education, the Governmentwill sustain the pace of measures to improve performanceand equity. The steps agreed in discussion o f PL3 are aimed at ensuring adequate financing o f the new programs for 5- and 6-year olds and improving the equity o f higher education finance. The proposedprior actions ineducation policy for PL3 are: duringthe period ofdownturn. Underthe proposedchange, for example, a worker could be puton2 month leave during an economically slow period, then work 48 hours a week for the remaining 10 months. This is a temporary measurethrough 2011and i s limitedto employers experiencing a fall inproduction or revenues. Implementation o fthe measurerequires that a collective agreement is signedbetweenthe employer and the enterprise's trade unions. l3With the support o f labor unions and to help businesses manage the downturn at a lower social cost, employers would be given the option to put workers on mandatory temporary leave (commonly referred to as "technical leave") duringwhich employers pay reduced wages, andworkers' incomes are subsidized from the Labor Fund. This is a measurebeing negotiated betweenemployers and labor unions independently o fGovernment. l4As part of its assistanceto the Government, the Bank team has beensuggesting alternatives to the MLSP that could be proposed inthe current discussions between employers and labor unions. The Bank team and its counterparts are monitoringthis dialogue closely, providing technical feedback where and when it i s appropriate. 36  . Adequate budget to finance educational programs for 5 and 6 year-olds enacted in 2008 and first implemented in 2009. In the 2010 budget, the Government will fund the pre-school program fully. Financing will include preparatory activities by local governments for the forthcoming mandatory preschool program by supporting gminas to adopt diversified supply options . includingnon-publicly managed institutions. Shift public resources for financing educationfinance toward students with greater material need. By September 2009, the Government expects to have reformed the student loan program so that students coming from poorer households will receive a higher proportion o f subsidies (without expanding the fiscal cost o f subsidies, but by targeting these resources). In addition, it will introduce legislationto shift a larger share of public stipends for tertiary education to a needsbasis, while reserving funds for performance prizes duringthe periodo f matriculation. 82. In the healthsector, the Governmentwill continue its programof structural reformsto improveefficiency.The measuresthat are planned, supported byPL3 are: Adequate budget proposedin 2010 to finance hospitalsto be liquidatedand corporatized through December 2010 (estimated to be approximately 80 hospitals). Even though the voluntary program o f corporatization will begin in 2009, it i s expected to take approximately 4-8 months to get a hospital to the stage of being corporatized. It would have to be liquidated first, its debts cleaned up, then resurrected as a corporation. The process will require negotiation and agreement among many parties. Therefore, the MOF and MOH expect the major costs related to this program to begin in the 2010 budget. The success o f the process depends critically on its being fully budgeted to meet demand for the . program. Managingother hospitals. Because the corporatization program is voluntary, it i s assumed that some o f the worst-off hospitals will not be able to participate. The M O H plans to develop a program to monitor them closely. In addition, a separate program for university-affiliated hospitals will need to be developed because they cannot legally participate in the corporatization program as it is . currently set up. Accreditation and evaluation. The MOH also proposes to develop its accreditation program, which will become a means to become more selective in contracting with provider organizations under NFZ. As part o f improved public sector management, the corporatization program will be evaluated annually and a report prepared for the Council o f Ministers. 83. Looking beyond these lending operations, plans for multiple insurers to replace NHZ and reform of Long Term Care are under development. The MOH believes that introducing multiple insurers could open the system to additional competition and choice for patients. However, such a change would also create risks; the 37  MOH isjust at the beginning o f the analysis and design work necessary to develop these options in this area. Financing options for long-term care (care o f the elderly and immobile, LTC) are also being considered, but this policy area requires broad consultation and cross-ministerial cooperation (the MOH, MLSP, MOF, and local governments). The Government i s at an early stage inpublic discussions and formulation o f options, making this i s an area where the Bank can add technical value although the timingo factions isnot suitable for inclusion inthe current series o fpolicyloans. 84. Inpensions policy the Government thinksthe time is right to pursue changes to the privately managed funded pillar of the system to increase investment options and lower management fees. Given the political obstacles to full enactment o f the pensionreform measures passed by the Parliament, the Government has decided to focus on improving the performance o f the private funded pillar. Looking ahead to PL3, the following measures are agreed triggers: . Introduction of legislation allowing multiple portfolio options: Most countries in Central and Eastern Europe that introduced funded individual retirement savings pillars - including Slovakia, Hungary and Estonia - have allowed multiple portfolio options for workers' mandatory savings. Multiple portfolio options provide more instruments with which affiliates can manage financial risk . as they approach retirement." Introduction of legislation to further reduce management fees: Poland's pension funds operate with relatively low administrative costs and fees. This outcome is due to centralizedrevenue collection arrangements and regulation that caps management fees. Total fees amount to 160 basis points on assets, which i s reasonable given the short period the funded pillar has been operating and the small volume o f assetsunder management. However, to increase the accumulated savings balances workers can rely on at retirement, and to safeguard the funded pillar from political threat, the Government plans hrther measures to reduce fees.l6 l5The portfolios o fPolish pension funds are not well diversified. A preponderance o f government bonds is observed inthe pensionportfolios o f most countries that have recently introduced mandatory funded pension systems (the secondpillar), although inPoland the funds have relatively larger holdings o f domestic equity and investments inprivately-issuedfixed income instruments. The lack o f diversification o f pension find portfolios reflects inpart some investment restrictions. The crisis and its impact on capital markets reinforces the need to combine greater choice infunded private pensionpillars with better default options for portfolio allocation. The multi-fundor "lifestyle model" was pioneered inChile at the beginning o f the decade to give affiliated workers more options to manage financial risk as they approached retirement. Proponents o f greater investment choices didnot expect low financial literacy to be a barrier. Affiliates were slow to exercise their choices, those who did selected portfolios irrationally, and once they chose a portfolio rarely changed their allocations. Lifecycle funds provide a better risk allocation along the working life o f individuals. They alter the default "do nothing" portfolio allocation progressively away fiom variable return securities to fixed return options as individuals get older. (Rudolph, H.and R. Rocha, "Competition and Performance inthe Polish SecondPillar" mimeo). The Bank is advising the authorities on the importance o f setting age-related default options as more investment choices are offered. l6Fees on contributions are capped at 7 percent for all new contracts issued after 2004. This cap will be progressively reduced to 3.5 percent inthe year 2014. All but one fundmanager currently charges the 38  85. As partofthe AAA accompanyingthe program,the Bankteamis helpingthe authorities to project the financial outlook for the public Notional Defined Contribution,pay-as-you-go,pensionpillarunderdifferenteconomic scenarios. The authorities report that the revenues o f the pension or social insurance system (ZUS) have not been significantly affected by the economic slowdown although contributions have been slightly lower than projected up to March 2009. The real impact o f the crisis can only be evaluated at the end o fthe second quarter o fthe year. The Bank team is modeling several different scenarios for the public N D C pension pillar, assuming different developments in the economic outlook, to have a better understanding o f the short and long-term financial ba1an~e.l~ 86. For social assistance, with an increasingly constrained fiscal envelope, the Government's strategy is to use resources more effectivelyby improvingtargeting. In2009, to increase the family benefit across the board under the regular 3-year benefit adjustment cycle would cost approximately PLN 3 billion. However, in response to budgetary pressures, the Government is preparing to allocate this adjustment more efficiently by targeting it better. The core action inthis area that would serve as a trigger . for the lendingprogram is: Council of Ministers decision to limit the scheduled increase in family benefitsto households with three or more children: Instead o f an across-the- board adjustment, the Government i s planning to spend only PLN 0.7 billion by targeting the adjustment infamily benefits to the poorest families - those with 3 or more children. 87. In the area of social services for vulnerable groups, MLSP has noted an increaseinthe number of childrenbeingleft infoster care. The Ministryexpects this trend to continue as household incomes are put under strain. As a way to lower the cost o f care and to improve social outcomes, the Ministryi s seeking to shift the system away from institutional to household-based foster care. As a key prior action for PL3 to improve foster care services, MLSP i s planning to: Present legislationthat shifts the provision of foster care from a primarily institutionalto a family-based model. The shift has a small up-front cost o f maximum contribution fee. Fees on assets are capped according to the volume o fassets under management (Rudolph, H.and R. Rocha, "Competition andPerformance inthe Polish SecondPillar" mimeo). The Government is drafting legislation that would accelerate the pace o f fee reductions. l7As discussedinarecent review bythe European Commission ofPoland's Convergence Programupdate, the Government projects pension expenditure to drop from 12.6 percent o f GDP in2006 to 10.9 percent in 2010 to 9.6 percent in2020 and 8.3 percent in2050. This would be a substantial achievement o f the 1999 reform and follow-on measures, despite a rapidly aging population. This said, Polandi s one o fthe few EU countries where the retirement age for menand women still differs (65 and 60 respectively). Possible gradual leveling o fthe retirementage for men and women, combined with firther measuresto stimulate employment and to reduce early retirementbenefits, could contribute to boosting labor participation among women o f age 50+, currently one o f the lowest inEurope. (see European Commission Directorate General OfEconomic And Financial Affairs, Brussels, 4 March 2009, ECFIN/G3(2009)Rep/50415-EN, "Poland: Macro FiscalAssessment, An Analysis OfThe December 2008 Update OfThe Convergence Programme"), 39  PLN 30 million but is expected to translate into considerable medium term financial savings, as well as betterquality care for abandonedorphaned children. 88. Furthermore, the Bank's work with the Government on a Long Term Care reforni will also have important implications for the delivery social care. As discussed earlier, although not yet ready for support as part o f PL3, inthe context o f the longer lending program, and keeping a focus on important structural reforms, the Government i s conducting analysis o f LTC structures and outcomes in Poland and how they compare with other countries inthe region. A team o f Bank specialists in this area will contributeto this effort. The Bank's LTC staffhave engaged ina technical exchange with the Senatorial Working Group examining reform options, chaired by Senate Commission on Family and Social Policy. LTC reform i s a clear area where the Bank can add considerable technical value, as well as draw benefit from an exchange with the Government over the coming months. 89. Linking employment and social assistance, the Government i s planning to take a number of steps to support activation of long-term unemployed reducing dependence on social assistance. The MLSP has presented plans to strengthening the links between agencies administering active labor market programs and social assistance to help recipients o f social assistance move back into the labor force. The Ministry i s eager to improve the coordination between public employment services (which are under district governments) and social assistance administered by the social welfare offices (which are run by local governments). Better information sharing and coordination o f benefits between employment and social assistance offices would improve client services and encourage the movement o f people out o f long-term unemployment and social assistanceand into the labor market. 90. Table 7 summarizes the core triggers for the third policy loan, which is expected to be prepared between July and December 2009. Table 7. Agreed Triggers for the Third Policy Loan, PL3 PublicFinancialManagement 1. Approvalofthe 2010budget consistentwith mediumterm fiscal consolidation. Assessments of EC and IMFwould be considered. Labor MarketReforms 2. Allow employersto redistributeworkinghoursover 12 monthsratherthan the current3 monthsto encourage adjustmentof working hours anddiscouragelayoffs, as ameasureto mitigatethe economiccrisis. PensionReforms 3. Introducelegislationto enablemultiple portfolios within the secondpillar. 4. Introducelegislationto reduce fees by fundmanagers. PrivateSector Development 5. Completionofbackgroundwork andadraft Governmentstrategy for "Rationalizationof Inspection ProcessesinPoland"by the Ministry of Economy, appointmentof ahigh-levelinter-ministerialtask force to reviewthe strategyandprioritize actionsby the Governmentfor implementationo fthe reforms, andactionby the CouncilofMinistersto initiate the first steps inthe reformprogram. HealthSector 6. Adequatebudgetproposedin2010 to financehospitals to be liquidatedor corporatizedthroughDecember 2010 (estimatedto be approximately80 hospitals). EducationReform 40  Area Trigger 7. Adequatebudgetto finance educationalprograms for 5 and6 year-olds enactedin2008 andimplementedin 2009. The Governmentwill financepreparatoryactivitiesin local governments for 5-year-oldsby supporting Gminasto adopt diversifiedsupply options includingnon-publiclymanagedinstitutions. 8. Shift governmentsubsidiesinthe student loanprogramto asliding scale to increasethe subsidy for poorer students. Introducelegislationto reorientGovernmenthigher-educationsubsidiesfor students to thematerial Social Assistance 9. Triennial cost-of-living adjustment in2009 for family benefitswill be limited to those familieswith 3+ 5.4. CONSULTATIONPROCESS 91. All legislative measures particularly social sector reforms in Poland are - - subjected to a demandingconsultationprocesswith social partners and groups likely to be impacted by particular proposed reforms. The consultation process i s an important institutional feature of Poland's process o f government. The reforms supported by this operation have been subject to extensive stakeholder consultations. For example, the program Generational Solidarity 50+ was consulted with all stakeholders - trade unions, employers' associations and local govenunent representatives as well as with other institutions dealing with labor issues. Education and health reforms have beensubjected to long periods o f consultation among all stakeholders as they have been developed and before submission to Parliament. During consideration by Parliament, they have been subjected to extensive coverage by the news media, public discussions, and hearings and debate inParliament. 5.5. ANALYTICAL ANDADVISORY ASSISTANCE 92. The Bank's analytical and advisory services can support the Government's program. Currently a Bank team is preparing the first Public Expenditure Review for Poland since 2003 and since the country's accession to the EU. This was a key element inthe analytical assistance agreed inthe negotiation of the first lendingoperation. The PER not only provides analytical support for the implementation of performance based budgeting and the MTEF, but from extensive analysis o f the social sectors, lays the technical foundations for the measures supported inPL2 and PL3. 93. As part of the agreements reached for the second loan, several pieces of technical assistance have been requested. To help the Government meet some of the triggers for PL3 outlined inthe matrix inAnnex 2, the following technical assistance will be provided by the Bank, financed through trust fundresources identified by the Country Management Unit. The specific TA being discussed with the Government i s presented in Table 8. It is unlikely that resources will be available to provide all of the inputs requested o f the Bank. 41  Table8. Programof FurtherAnalyticalandAdvisoryAssistance AAA Item MinistrylAgency a) Performance basedbudgeting anduse o f a mediumterm expenditure MOF framework (including technical assistanceto help design and establish institutional structures for rigorous monitoringand impact evaluation as part o f the budget allocation process). b) Rationalization ofLicensingActivities withinGovernment MOP c) International good practice inconsolidation and coordination o f business MOE inspectionprocedures acrosspublic sector agencies d) Development o fa monitoring andimpact evaluationprotocol for employment assistance and social assistanceprograms I MLSP 1 I e) Assessment and taxation o f farmers' incomes 1MLSP f ) Actuarial analysis o fthe long-term financial stability o fthe pension I svstem. under different macroeconomic scenarios MLSP/ZUS g) Identifyingbamers to closer ties between employment assistanceand MLSP social assistance (strategy to "activate" long term unemployed) h) Analysis andreformoptions for LongTerm Care M L S P M O H i) Evidence-basedprioritizationofhealthfinancing(NICE-styleevaluation) MOH j) Hospitalcorporatizationgoodpractice; MOH k) Strategic use o f accreditation, DRGs, and other reimbursement MOH mechanisms to elicit improvements inquality, cost consciousness in delivery o f care, and consumer satisfaction. 1) Analysis o fhousehold vulnerability to the economic slowdown and crisis PM's Office (to support the vulnerability mapping already underway) m) Analysis ofPISA results and implications for policymaking. Impact of MNE NGO-managed schools on expenditures, costs o f operation, and effectiveness. n) Technicalassistanceandanalytics ofhigher education subsidyallocation MSHEMOF options. VI. OPERATIONIMPLEMENTATION 6.1. POVERTYAND SOCIAL IMPACT 94. Householddata available through 2007 show Poland's substantial strides in lowering poverty. Even absolute poverty levels are considerably lower. Poverty - measured as the percentageof population below the social assistance income threshold - dropped from 19 percent in 2004 to 14.6 percent in 2007. The poverty gap also narrowed, meaning that the incomes of the poor moved closer to those of the non-poor. The main determinants of poverty in Poland include: rural residence, low educational attainment of a household head, unemployment of a household member, and a large number of children in the household. Table 9 shows the improvement in poverty indicators from 2004 through 2007. 42  Table 9. PovertyinPolandsinceAccession Poverty rate Percentage of Dopulation livingin households below 2004 2005 2006 2007 50% of medianexpenditure 20 18 17.7 17.3 Social assistancethreshold 19 18 15.1 14.6 Subsistenceminimum 12 12 7.8 6.6 Poverty gap Distance below poverty line 2004 2005 2006 2007 50% of medianexpenditure 23 22 21 21 Social assistancethreshold 24 23 21 21 Subsistenceminimum 22 22 19 19 Source: HBS 2007 95. Although not a reason for complacency, and while there is still room for efficiency gains, poorer households are well served by the social protectionsystem. The multiple elements o f Poland's social protection system (pensions, family benefits, and social assistancetaken as a whole) cover 72 percent o f the population, and 85 percent o f the poorest 10percent o f the population (according to HBS 2007 data). Reflecting the geography o f Poland's poor areas, the social protection system covers 86 percent o f the rural population at risk o f poverty - i.e. those who consume less than 60 percent of median consumption by EU convention (as compared to 82 percent o f the urban population inthe same category o f consumption). 96. The measures being supported by the second operation in the program are expectedto have a substantialandbeneficialimpact reducingpovertyby improving services inthe mediumand longterm, whileprotectingvulnerablehouseholdsin the immediateterm. The Government's "50+ Program" improves the labor market options o f older people by reducing the costs o f employing workers who are close to the retirement age. It ensures that public employment services are available to active people aged 45 and older to help them remain in the labor force longer. Indesigningthe fiscal savings measure that reduces the number o f people eligible for early retirement (from 1.7 million to 300,000) the Government included important safety net safeguards that protect the base level pension benefits received by households affected by the reform. By initiating measures that lower the age at which formal education begins, the Government expects to give children a head start to achieve better learning performance and education outcomes. After a short period during which the new education structures will be voluntary, they will be made mandatory to ensure the benefits o f earlier instruction accrue to all children, including those from lower-income households. Finally, the expected revenue from the new taxes on alcohol, tobacco products and luxury cars, will give the Government extraresources withwhich to target supplementary social assistance as the current crisis unfolds. 97. As the program proceeds to the third lending operation, further positive social impact is expected, particularlyin the short term to mitigatethe crisis. First, the program supports measures that increase working time flexibility, as part o f the "anti- 43  crisis package" agreed by the social partners. The measures will be in place until 2011, will cover enterprises which are experiencing sharp falls in production due to the economic crisis, and are expected to discourage lay-offs. Second, the program supports reforms to the unemployment benefit system that increase the total amount o f benefits, but also introducebenefit reductions after three months o fjob search. These changes are expected to improve the efficiency o f the system by strengthening labor supply incentives while providing the unemployed with better income support. The program also includes reforms that shift the structure o f Government subsidies for higher education financing hrther away from purely merit based criteria and toward greater consideration o f household means. In doing so, the Government expects to lower the percentage o f applicants for student loans whose applications are rejected for insufficient collateral guarantees, from over 10percent to 8 percent by the endo f 2010. Finally, andwith direct impact on the poorest and most vulnerable households, the Government plans to target the triennial adjustment o f family benefits to recipients with three or more children. Given the close correlation between the number o f dependent children and poverty (see Table lo), this targeted adjustment i s expected to redistribute between 0.4 and 1 percentage point o f spending on family benefits from non-poor to poor households (dependingon the size o f the adjustment, still to be determined), and to reduce the share o f families with 3 or more children who are poor, by between 1.3 to 3.4 percentage points.18 Table 10. DistributionofHouseholdsbyNumber of DependentChildrenand ConsumptionDecile Households by Consumption Decile 1 2 3 4 5 6 7 8 9 10 no children 6.9 7.9 8.6 9.5 10.1 10.6 10.9 11.3 11.7 12.8 1 child 6.8 6.4 8.1 8.9 9.9 9.3 11.7 11.7 12.6 14.5 2 children 9.1 9.8 10.6 10.5 10.2 10.3 9.9 9.8 10.2 9.5 3 children 14.7 15.7 12.9 12.1 9.6 10.0 8.3 7.2 5.7 3.7 4+children 25.3 17.7 14.4 10.2 9.3 6.8 5.8 4.8 3.6 2.1 Source: HBS 2007 Note: The distribution across the deciles sums to loo%, Le. 25.3 percent ofhouseholds with 4 or more dependent children are inthe 1` consumption decile. 98. The Government's growing concern is for the flow of newly vulnerable households into poverty in the wake of slowing economic growth. Facing the economic crisis the Government is planning targeted regional interventions to support powiats that are most affected by the drop ineconomic activity. There are 379powiats in Poland and they are each considered a local labor market. The Government i s planning to strengthen local capacity to weather the crisis, by both improving the effectiveness o f '*Three ~ ~~ targeted benefit adjustments have been simulatedfor households who inthe 2007 H B S and who reported3 or more dependent children: an increase inmonthlybenefits of 20 zlotys, 40 zlotys and 60 zlotys. The three adjustments redistribute 0.4%, 0.7% and 1%, respectively, of spendingon family benefits fiom non-poor to poor households. 44  existing programs (employment and social assistance programs) and if eventually necessary, by allocating additional resources and implementing extraordinaryprograms. 99. As discussed earlier, the PMO is leading efforts to map vulnerability to the crisis in order to eventuallytarget interventions. This initiative has three components and will be implemented in three corresponding stages. The first component i s the creation o f a regional "crisis vulnerability" map to identifypowiats that are at highest risk o f suffering from the current global economic crisis. The second i s the implementation o f a monitoring system that will screen powiats that are actually hit by the crisis. The final component i s the creation o f an agency with a mandate to support to worst affected powiats. The initiative will be ready by September 2009. As shown in Box 2, by definition, the regions that are considered the most vulnerable to short-term dislocations are the also those with an export-oriented economy, rather than the poor, lagging regions. The latter - rural, predominantly agricultural region - are insulated from the crisis, at least temporarily, and well covered by existing social protectionprograms. 100. The Governmentwill monitor the crisis' impact by tracking a large number of indicators. Leading indicators include changes in tax revenues, social security payments, inflows into unemployment and outflows fiom unemployment to jobs. Lagging indicators include changes in the unemployment rate, the number o f social assistance recipients, and the number o f contributors to the social security system. The data will be compiled, processed and analyzed by a special regional monitoring unit under the PMO. The Government plans to have the monitoring system operational by the endo fJune. 101. The Governmentis consideringa new agency to representits crisis initiative at the local level. The role o f the agency will be to determine and recommend ways to support thepowiats most affected by the crisis. This could include strengthening existing institutions and mechanisms, as well as designing and implementing new special programs financed from government reserves and extraordinary funds. The mandate o f the new agency would include negotiating and signing contracts with powiat governments to implement special programs. The Government expects the agency to be created and ready to operate by the end o f September 2009. This crisis initiative is tentatively planned to last for two years. However, if it proves to be an effective means o f strengthening local capacity to respond to regional economic shocks then it may become institutionalizedon a permanent basis. 6.2. ENVIRONMENTAL ASPECTS 102. The specific policiessupported by the second policy loanin the programare not likely to have significant effects on Poland's environment, forests, and other natural resources. Unanticipated and unintended risks o f adverse effects to the environment and natural resources are minor, although acknowledged. However, Poland has adequate environmental controls in place. Poland's environmental legislation and regulation i s reinforcedby EUenvironmental directives, including the EU's guidelines on adoption o f environmental assessments at the planning and programming level (June 2001) and the EU's Environmental Liabilities Directive settingout liability for damage to 45  properties and natural resources (April 2007). Pre-privatization environmental audits are required to determine the existence and scope o f any liabilities of companies in state hands, manifestedas contamination on realproperty or other conduits. The quantification of such liabilities is then used as part o f the overall valuation of the state enterprise for purposes o f negotiating a fair purchase price with the private party. Private sector bidders o f enterprises will be subject to the environmental provisions embodied inPolish and EU law once they acquire previous state assets inthe process o f ownership transfer. 6.3. IMPLEMENTATIONMONITORINGANDEVALUATION 103. The Bank continues to work closely with the MOF, PMO and sector Ministriesto monitor and assess reformprogressand impactsduring the course of the program. Monitoring and evaluation will be supported by the various Ministries as well as budgetary, legislative and economic data provided by the authorities and verified inofficial disclosures, directives andregulations. Baseline andupdated data areprovided by the respective specialized agencies for the pertinent functions and tracked according to the indicators and outcome measures as shown in the Monitoring and Results Framework. 6.4. FIDUCIARYASPECTSAND PROCUREMENT 104. The fiduciary risk to this operation arising from Poland's public financial management system and use of budget resources is low. As part o f its accession process to the EU, Poland has achieved significant progress in reforming its public financial management system (PFM).19 It has upgraded its legislative framework, inline with the EU acquis, introduced an internal audit function, and prepared for the EU accreditation process o f fund-managing agencies. Poland has also made significant improvements related to the public availability and coverage o f fiscal information, particularly the adequacy o f accounting and reporting standards and regularity o f reconciliations o fbank accounts. 105. The PFM reform agenda supported by this program will enhance budget transparency, predictability and performance-orientationover the medium term. The proposed amended Law on Public Finance, expected to be adopted in2009, enhances budget transparency,predictability and performance-orientation over the medium term. It introduces performance-oriented multi-year budget planning, integration o f remaining ExtraBudgetary Fundsand externally-financed expenditures within the State Budget, and strengthened internal control over public expenditures and debt via new regulations on internal audit and internal control. These measures, if adequately implemented, will result in significant progress in the country public financial management. However, one of the mainchallenges is implementationo f the proposed reforms on the operational level as most of the detailed procedures need to be defined and applied in practice. Furthermore, to achieve expected results o f the reform, the introduction o f performance budgeting should be supported by additional changes in the financial control framework l 9The status o f the PFM was derived from the World Bank's ongoing monitoring o f PFM reform and previous diagnostic works conducted by the Bank and external organizations. 46  including accountability, updated and compatible budget classification, accounting and reporting systems, and an integrated financial management information system. 106. Other areas of ongoing reform include cash management. This includes the introduction o f a single treasury account (TSA) system, computerization o f all cash transactions and central monitoring o f commitments and liabilities. The State Budget TREZOR computerized system includes the 1st and 2nd tier State budget holders, with the remaining units to be included in the final stage. In 2005, the TREZOR system gained an ability to communicate with the National Bank o f Poland's accounting system, allowing direct coordination o f pending payment orders and State Budget cash availability, improving internal controls. 107. Inthe area of external audit, Poland is advanced inrelation to availability of the audit reports to the public, independence o f the Supreme Audit Institution (NIK)from the executive, and control o f the NIK budget, providing a well functioning public financial accountability and assurance mechanism for the legislature and the public. 108. The National Bank of Poland is part of the European System of Central Banks,andit has upgradeditsaccountingand reportingpoliciesin accordance with the guidelinesof the EuropeanCentralBank. Its financial management and operations are transparently disclosed and presented on its website. The NBP's annual financial statements are regularly audited. The most recently available audit reports (for 2004- 2008) have unqualified audit opinions and were approved by the Council o f Ministers. Overall, the fiduciary risk to this operation arising from Poland's public financial management system anduse of budget resources and its foreign exchange environment as controlled by the Central Bank i s low. 109. Finally, Poland has made significant progress in reforming its public procurementsystem. Adoption o f a new law inJanuary 2004 made Poland a pioneer in Central and Eastern Europe in settingup a sound public procurement system that met the requirements o f the EU. InApril 2006 and April 2007 the Public Procurement Law was further amended to implement the provisions o f the EU directives 2004/18/EC and 2004/17/EC, on the (i)coordination o f procurement procedures for the award o f public works, supply, and service contracts and (ii)coordination o f procedures o f entities operating in the water, energy, transport and postal services sectors. The latest amendment to the Public Procurement Law entered into force in October 2008 to adjust the Law to EC directives but also to enhance and streamline the implementation o f procurement procedures, Improvements and hrther simplifications o f the public procurement system were also a result o f the development and upgrading o f e- government procurement tools. Other areas o f ongoing reform relate to: (i) increasingthe effectiveness o f public expenditures; (ii)strengthening competition in public procurement; (iii) facilitating access o f SMEs as bidders; (iv) improving the quality o f procured goods, works, and services; and (v) promoting innovative and ecological solutions inpublic procurement. 47  6.5. DISBURSEMENTANDAUDITING 110. As with the first loanin the program, loanproceeds will be disbursedin one single tranche to the foreigncurrencynationalbudget account at the NationalBank of Poland (Central Bank). Disbursement will be made upon declaration o f loan effectiveness and submission o f a withdrawal application to IBRD.At the request o f the MOF, IBRD will deposit the proceeds o f the loan into the foreign currency national budget account indicated by the Government that forms part o f the budget management system o f the country. The proposed loan will follow the Bank's disbursement procedures for development policy lending. Disbursements will not be linkedto specific purchases, thus no procurement requirements will be necessary. The Government shall maintain accounts and records with respect to the deposit o f loan proceeds inthe NBP. If the loan proceeds are used for ineligible purposes as defined inthe loan agreement, IBRD will require the borrower to refundthe amount directly to IBRD. 111. No additional fiduciary arrangements will be required. The Bank will not require an audit o f the Deposit account but will require the Government to provide confirmation to the Bank inthe form o f an official letter from the Ministryo f Finance on the amounts deposited in the foreign currency account within 30 days o f receiving the funds. VII. RISKS AND RISKMITIGATION 112. The medium-termmacroeconomic scenario of slowing economic growth and moderatinginflationis subject to further downsiderisks.While inflationary pressures have abated significantly with the recent global slowdown and tighter credit conditions as well as moderation o f wage pressure, the depreciation o f the zloty could rekindle inflationary pressures. Poland has one o f the most solid financial systems in Europe, but the interbank market continues to experience problems due to lack o f confidence. The authorities may need to respond with additional confidence-restoring and liquidity- enhancing measures. In the context o f the Euro adoption agenda requiring fiscal discipline, the supply side o f the economy needs to be firther stimulated through acceleration o f structural reforms. While the exogenous risk cannot be mitigated, one option is for the Bank to scale up its lending operations ifthe risk materialized. 113. The deterioration of Poland's economic outlook raises fiscal risks to the program. Although the assumptions on which the 2009 budget and Convergence Program are based are clearly outdated, and the Government has exercised good judgment inimplementinginformal savings measures, a formal revision to the budget has not yet been announced. This could pose a fiscal risk to the measures beingsupported by this loan. However, as a condition o feffectiveness, the Governmenthas agreedto initiate the process o f revising its 2009 budget in form and substance consistent with the measures being supported by the program, to ensure continued compliance with the first prior action o f this loan. In addition, the third loan in this series will provide opportunities to engage with the authorities inthe development o f the 2010 budget. 48  114. Poland's external and financial vulnerability may be further affected by global and regional developments. Recent developments demonstrate the risk of contagion from other countries in the region, and access to external financing sources may become more difficult and more expensive. Enteringthe ERM2 during significant volatility on global financial markets poses risks for exchange rate stability as requiredby the relevant Maastricht criterion over a minimum two-year period. At the same time, there i s risk o f a misaligned EUR/PLN central parity in ERM2 and during the ultimate conversion rate from zloty into euro. On the other hand, the Government's commitment to euro adoption lends credibility to fiscal policy and may help preserve confidence in a very difficult external environment, even ifthe current economic circumstances force the exact date o f entry into the single currency to be reconsidered. 115. The projected deterioration of economic prospects may undermine social support for the Government and reduce its willingness to push for additional structuralreforms.Reformmomentum is already constrained bythe risk o fPresidential veto on new legislation passed in Parliament, in particular in the area o f social services. Inthis context, there is a risk of general elections earlier than scheduled for fall 2011. This may be provoked, for example, by internal tensions inthe governing Civic Platform and in the coalition if Prime Minister Tusk decides to run for President in 2010. The Government's lack o f a constitutional majority in Parliament and elusive compromise with the opposition Pis, which demands a referendum on euro adoption, could complicate the euro adoption plan and aggravate risks related to the ERM2 transition period. 49  ANNEX 1:GOVERNMENT'SLETTEROFDEVELOPMENTPOLICY(LDP) Mr.RobertB.Zoelllck President The World Ikrak 1818HStreet,NW Washington, I1.C. 20433 UnitedStatesofAmerica DearMr.President, As you are aware, the Republic of Poland and the International h b for Reconstruction and Development h v e sig& Ihr Public Fiaanoe Management, Ernploymmt, and Private Sector Development Pm,grammatic Policy Loan on December 23, 2008 in the amount of EUR 975 million (USD 1.25 billionequivalent). which constilutd the first of thrcc loamtotalingUSD 3.75 million. The loan is aimed at supportingPoland's efforts in the areas ofeconomic and social reforms. Currently. the Polishadministrationis working in close coqxratim with World Bank staffon the cxccutionofthc first loanBS well asonidentifyingobjectivesto besupportedbythe second loanofthe swim. Therefore, I wish to request the International Hank for Reconstructionand Development to deliver the secondof the Development Policy Loans, includingthe associatedtechnical cooperation program, in the amountof approx. EUR 1 billion(USD 1.3 billionequivalent). The overarching god set out for the Fmployment, Entrcppencurshipand Human Capital Dcvclopment Policy Program is that of accclcratingPoland's convergence with the EU. Taking into consideration the deterioration of rhe external environment that significantly and adversely impacls the condition and pcrfimanccof the Polisheconomy. thc attainment of the above g d requiresthe accomplishment ofthe followringdetailed objectives:(i) achievingmedium&nnfiscal mbilization throughrcinfmcingstructural rcforms. (ii)ensuring sufficient support for the priority programs crucial for the convergence objective, (iii)mitigatingthe socialcostoftheeconomiccrisis. 50  The loan shall focus on a compreheasive set of key reforms and policy actions identified under thc DPL program. In addition Lo buildingon the achievements and continuing the efforts of the refomi program supportedby tbe first DPL inthe areas ofpublic finance management. private scctor development andthe labor market. the DPL liwaq envisagedto focuson moredetailedsector reforms. Publlc FinanceManPgtmrnt Inlight the prevailingeconomic cavironmentthe task of matchingshort krm fiscal goals with strategic considerations becomes increasingly difficult but also requires the execution of accurate mEaSUrCS to accomplish them. In that respea the key developments in lhis ares to be supported under the DPL programincludethe implemmtationofthe amended2009 budget. consideringthe nmssary adjustments resulting f m intensive efforts towards the institutionat reform of the budgeting procedures, etlcompassing improvements towards the full implementation of the principles of performance-based budgeting(PBR) and the medium-tenn expenditure f m e w d (MTEF) in the mneded law on public finance, expectedto be adopted inlate2009. Educationaector The worsening demographic trends will require greater flexibility within the education sector so as to facilitate the necessary adjustmcnts towards the actual needs of the populationin lhis ana. The sectoT- wide reformptm include increaseddelegationofdecision-makingpowerstowards localgovernmentand introducing mandatory education for younger age groups. 0th key developments 81c Linked with the simplification and M e r alignment between vocational and general education and the continued implementationofexternaltesting, specificallyfor the secondary leahgexamination(maruru). Healthsector The main challenge facing the Polish health sector remains the delivery of quality service under the adverse financial conditions.The primarygoal in that respect is to impmve the quality ofmanagement, in order to avoid the accumulation of debts of hospitals and subsequently LO e w the burdenon the state budget. The proposedremedy to the issue of indebtednessis the participationof hospitalsin a voluntary programto cxravcrl lhrm into cmpoweentities, subjw lo lhe provisions of the commercialcode BS wll as corresponding financial audit procedures. An additional measure to enhance the payments systcm in healthcam will be the adoption of BI DRO-basd s y s m for payments from the National Health Fundto hospitals. Labormark4 and peasion reforms Consideringthe sevm impact of& economic turmoil on the labor markel, lhe DPLprogramprovidesa suitable tod to counter the negative develojments and provide a boost towards the convergence 2 51  objectivesin this ma. Thc "SO+" programaimed at imxcased labor force participationof oldcr workers aod the intcrconnccted chaages in the provisions governing the eligibility for early retirement h u l d ensure the proper impetus towards convergence with the respective EU staadatds. The newly introduced incentive struclure of' unemployment bcncfits is also apactcd to contributeto thc impvcd standingof the Polisheconomy inthis respect. Ifdy believcthatthesupportbytbeWorldBank,involvingbothf-e tlnd expertise, of the ambitious reform p r o m ofthe PolishChvemment will provide thc crucialadditional impetus towards the fulfillment of the objectives set out in it. Concurrently, I am confident that our cooperation ghall providevaluableexperienceto the Bank towards the provisionofsimilarassistance toothcrclientswithin the c m t highly volatilc CCMlomicenvironment. Yourssincerely. Jm&nceni-Roa towski MinistetofFiaance 3 52  3E  2E Y Ya  I I   L      I a 3  tt % Z w w d U 4 .-c 4a 8  w  sE 3 8c  k i E W eEr:  V B a  Ee!a Y  s z s z s 8m 10 m s z soq s s s s z 4 ? ? 10 m I? cu d c  0 b  g G   m  L I 3     ANNEX4: ASSESSMENTFROMINTERNATIONALMONETARYFUND On May 6, 2009, the IMF's Board approved a Flexible Credit Line for Poland in the amount of US$20.58 billion. The Board made its decision with reference to the Staff Report "Arrangement under a Flexible Credit Line" prepared by the Fund's European Department in consultation with other departments. The Staff Report was completed on April 24,2009. Section Iof the StaffReport is provided inthis Annex, and includesthe Fund's assessment andoutlook for Poland. 78  I.Conim A. Very StrongFundamentals 1. Poland's macroeconomicperformance hasbeenvery strong.Output growth in recentyears-averaging about 6 percent in200&084as k e nwell-balanced, as EU accession bolsteredbusiness confidence and spurreda long-awaited rise ininvestment (Table 1).Private consumption growth has also beenrobust, driven by rapidlyrisingreal wages. increasing employment. and record-high credit growth. The output response reflected primarilya significant increase inlabor utilization. altlioiigh risinginvestmentand producti\ity also played a role. Emerging capcity constraints, not least inthe labor market, hadcaused some moderate weakening of output growtheven before the global crisis beganto spill over to Poland.Moreover, itlflationarypressures startedto increase inearly 2007 but suchpressures reminedmanageable. 2. Despitea boomingeconomy, the current accountdeficit has remainedrelatively low and the external positionsustainable.Even as export growthwas robust andPoland conthied to gainexport market shares. buoyant imports resultedinsome widening of the current account deficit. However, as a s h e of GDP. this deficit has remainedrelatively low andexternaldebt has beenstable at about 40-50 percent ofGDP(Tables 2 and3).l Staff estimates suggest that the real exchange rate is broadly in I Poland:CurrentAccount Balance I (In percentof GDP) 2 0 1.8 -2 1.6 -4 1.4 EE3CurrentAccount Balance(94 of GDP) -8 ` -PolishExports Market Share,rhs -10 1.0 2003 2004 2005 2006 2007 2008 Sources: NBP; IMF Directionof Trade. The estimatedunderlyingciurentaccountdeficitisconsistentwiththe debt-stabilizinglevel inthe niediwn tena 'Prelimmy CGERestinlates(March. 2009) suggest that estimateddeviationsfiointhe ecpulibriuunreal exchangeratearewithinthe nlawofenor ofthe estimation. 79  n 4. e a\-oidance of reute imbalances duringthe boomyears owes muchto very strongandtimely policyresponse: 80  July2008. Still. the fiscal deficit exceeded3 percent o fGDPin2008, pritllarily due to revenue shortfalls associatedwith a markedslowdown inthe economy in late 2008. Spendingcuts infoiuth q i m e r o f 2008 allowed the state budget to remainontarget (witha small tuargin), but these cuts didnot offset higher deficits at lower levels of government (Tables 5 wd 6). Financialsector.Bankingsupervisionhasbeenstrengthened to be fidly compliantwith EUlaws and directives. As foreign ciurencydenomhated mortgagelendinggainedpace. supvisors responded ina timely manner with measuresthat. ineffect, placedconstraints onFX-lending. Furthermore, the institutional h e w o r k for finwcialstability has beenbuttressed bythe imificationof h c i a l silyervisionimder the aegis o f the PolishFinancial SupervisionAuthority(KNF)onJanuary 1,208 andthe recent creationo fthe Financial Stability C o d t t e e . The codttee-cotuprised o frepresentatives fromtheMinistryo fFinance, the NationalBanko fPolandandthe KNF- providesa f o m l h e w o r kthat has edmced informationalflows and analytical activities andhas been actively engaged infiuthering contingency planllillg. Structud reforms. Inview ofthe einerging labor d e t bottlenecks, stnichual policies have focused onboostingt i e exceptionally low labor participationrate. The tax wedge has been loweredby cutting inhalfdisability contributions and eligibility for early retirement has been significantly curtailed, slashing the numberofeligible workers fiomabove one millionto about 250,000.The authorities have also givenpriority to deregulationandcompleting their privatizationplan. 5. The Fundhasstronglysupported the authorities' policy stance. The mostrecent Article IVconsllltationwas concluded inApril 2008 (Coimtry ReportNo. 08/130), with ExecutiveDirectors assessingpolicies very positively. Directors notedthe strongandwell- balanced growthandcredible institutions, andwelcomed the commitment to macroeconotllic stability. reinvigoration o f structural reforms, and adoption o f the euro. They recognizedthe lirnitedupwardpressuresoncore inflation, despite risingdemandpressures. andnotedthat this reflectedthe credibility o f the authorities' stronganti-inflation policy. They stressedthe importance of strengthening the medium-termbudgetaryframework andwelcomed the authorities' determinationto speedup fiscal consolidation andreduce the mediiuu-term deficit. Finally, Directors notedthe soiudness o f the bankingsystemandthe limited exposure to the US subprime market. 81  C. Spillover fromthe GlobalCrisis 6. Despitevery strongfundamentals, Poland's economy is now beingseverely affectedby the global crisis, albeit lessso than other countriesinthe region. Spillovers are affectingPolandthroughbothreal andhancialsector channels (Figures 1-3): e Real sector channel.Exportvalues 5 contracted by 35 percent (year-on- 0 year) inearly 2009. While the &are o f exports inGDPo fabout -5 -5 40percent isrelatively low -10 -10 comparedto most countriesinthe i q z i o ~ e f l e c t i n the huger size of g -I5 -15 the Polisheconomy-the -20 -20 ql,g contraction inexports is very large V i g f j g anditishavinga si_pificantimpact onthe economy. GDPgrowthfell sowce Eumtd fromabout 5 percent (year-on-year) earlier in2008 to 1%percent iuthe fourthquarter, ststaiuedbyrelatively robust private c o m i q t i o n growth. Hi& fiequency indicators suggest that economic activity has slowedfiuther inthe early 2009. Specifically, industrial output declinedbyabout 10percent. Financial sector channel.There is no evidence that foreignbrurkshave b e p n to reduce exposures to their Polish subsidiaries. Nonetheless, a shap slowdown incredit growthis underway. as parent bankshave significantly ciutailed net iuflows, which until recently fimded about halfo f credit growth. Indeed, surveys suggestthat banksbeganti_nllteuingcredit criteria drmatically duringthe last quarter o f 2008, particdarly for corporate borrowing.Meanwhile, the interbank market h s remainedpartiallyfrozen despite liquidity-e&mcinnp measures. 7. ButPolandhasmaintainedaccess to internationalcapitalmarkets. -le sovereign and 5-year CDS spreadshave recently eased, they remain about 200 basis points higher than at endSeptember. The authorities placed a 1 billionbondat about 300 basis p i n t s above GemanBundsinJanwuy. Inaddition, Poland's domestic debt market has continnedto attract strongdemand for government paper, iucliding fiom foreign investors, who boughta sigmficant share o f the Treasurybillsandbondsissuedduringthe March auctiom. Nevertheless, withFDIcoverage of the current account deficit decliningrapidly andcoritinuedportfolio outflows. the zlotyhascomeuder sipificantpressure, depreciating byabout 35 percent against the euro since end-September 2008. 82  D. StrongPolicy Responseto the Recent Spillovers 8. The authorities have responded ina timely and effective manner to the downturn:monettuypolicyhas beeneasing: financial sectorsurveillance has intensified, with importautpro-active ineasuues: while fiscal policy hasbalanced shoit-term cyclical considerations with long-teim policy objectives. Specifically. 0 Monetary policy: 011the basis o fcyclicalconsiderations andtakitlgaccount o f euro interest rate cuts. the MPC has embarked ona looseningcycle, reducing policyratesby225 basispints sinceNovember. The mostrecent cuts were tempered byconcern about pressuresonthe zloty. The MPChas umderscored that it stands ready to cut rates filrther ifdownside risks to the economy materialize, while monitoringthe exchange rate pass through andpotential balance-sheeteffects. 0 Financialsector. The Polish authorities have beenactively safeguarding financial sector stability (Box 1). Notably, to increase domestic liquidity the NBP has arrangeddollar, Swiss franc, aiideuro swaps, widened the list o fcollateral that canbe usedat its discoumtwindow, midwill extendthe mahuityofreyo transactions effective May 1.Moreover. as the interbankmarket froze late last year, the authorities have proposedto guaranteeinteihauk: transactions, althoitgli concern about adverse signaling effects could limitthe effectiveness o f this. hi addition, the firecueiicy o f stress testiug andon-site inspections hasbeen stepped utpto fiwther tailor recommendations to individualbanks and,whenappropriate, encouragesmaller institutions to consolidate. 0 Fiscalpolicy: With a view to adheiingto their EUcomitmeuts andeuro adoptiontimetable, the nuthoiitiesremaindetermined to ensurethat the state budget deficit does iiot exceedthe budpet limit o f zl.18.2 billion hi2009-even thought h y foreseeGDP growth to be sietllfcantly weaker thanassumed inthe budget. They intend to achieve this primarilybycutting expenditure at the state level. While the deficit ofthe general goveiment will remainabove 3 percent o f GDP in2009,111part becauseofIiplierdeficits at lower levels o fgovemient, these pro-cyclical expenditure cuts at the state levelwill sipificantlylimit the extent to which automatic stabilizeis are at play. Ths, at the ctuxeutjumctwe, the authorities' concern about the negative implications o fa Iidier nominaldeficit for borrowingcosts andtheir euro adoptiontimetable are outweighing the benefits of allowinga strongcoiuiter-cyclical impact though automatic stabilizers. 83  E. Outlook 9. NotwithstandingPoland's solidfundamentalsand soundpolicyresponse, the intensificationof adverse spilloverswillweigh on the outlook.The authorities are likelyto reduce fiuther their forecast for realGDP growth in2009: intheir View, the economy is projectedto continue to expand this year, although at a very slow pace. They take confidence fromthe still robustgrowthindomestic consumption evident inearly 2009. StaPs baseline projectionenvisages a somewhat sharper slowdown ineconomic activity, with growth falliug fiomabout 4%percent in2008 to about -%percent in2009, reflectinglessfavorable assumptions about growth inmainexport markets andthe view that domestic demand growth is set to slownotably from its current pace. The projectedrecovery o fgrowthto about 1%percent in2010 h g e s onthe realizationo fcunmt WE0 assirmptions. 10. Inflationis set to fall further. As world oilpriceshaveM e nandwage developments havetracked realactivity. price pressureshave easedmarkedlysince last sumner.despite the sharp zloty depreciation. Withgrowthwell belowpotential, inflationis projectedto remainw i t h its tolerance range for the foreseeable fiilure. 11. The balanceofpaymentsis expectedto continueto befinanced through accessto financial marketswithout unduepressureson the zloty. Declininghportvolumes and firvorable t e r m oftrade developments-weakening comnodity prices, notably oil prices- will more thanoffset a projected decline inexports and the ciurent account positionis set to Lerasl~llyimprove. Whde FDIinflows are declining andPolandfaces rolloverrequirements o fabout $105billion(25 percent ofGDP)in2009. staffs baseline scenario that Polandcan continue to satisfy its financingneedsthrough &et borrowing. 12. Risksto thebankingsectorhaveincreased,butare expectedto remain manageable.Recent data suggest that bankswill remainprofitable, with solvency ratios that are declining.but will remain at comfortable levels in2009. The zloty depreciation has promptedthe authorities to revisitforeign current risksinthe bankingsector thou$ its hlance sheet impact oncorpoiates andhouseholds. Onthe corporate side. there have been soue concerns regardingFXoptions that were contracted whenthe zloty was strong. The vast majority o fthese derivatives have been foundto be associatedwith export hedging.;only a smallportionwas overhedged becauseexport demandprojections haveprovenoptimistic. Inthesecases. bankshavebeenencouragedtonegotiatewiththeir client suitable loanterm andensuredthat banksprovisionfor possible losses. Onthehouseholdside, the authorities have seennoworsening inthe quality o fbanks' FX-denominatedmortgage portfolios and this asset chss has continuedto exhibit the lowestNPLratios (0.6 percent at end-2008 compared to 4.4 percent for total lending). reflectingoffsetting declines inFX-interest rates andearlier regulatoryrecommendations regardingFXlending. 84  Figure 1. Poland: RecentEconomic Developments,2001-09 50 40 40 25 25 m 20 m 30 15 15 20 10 10 0 10 5 5 0 0 0 -20 - I -10 -5 -lo4o - ....-.lmpats E m -M -15 -15 -30 10 40 0 0 3 0 30 -10 -10 20 20 -m -20 10 10 -30 0 40 ..-...consuner -10 Business 50 -20 2001 2oM 2005 2007 2009 2001 2003 2005 2007 2009 sourceS: EuropeanCammission;Bbomberg;and Haver. 85  Figure 2. Poland:RecentFinancialMarketsDevelopments April 2008- April2009 Sharpzlotydepreciationagainstthe e m reversedcwrse ...whilethestock marketmovedintandemwithregional recerlliy... peers. im ExchangeRateper E m 120 im 120 (April21, rnos=loo) (Apnl21,2008= 100) Stock MarketIndex - 110 - 100 - 9 0 9 0 - - 8 0 - 70 80 - - 80 6 0 - - Poland 7 0 - ----. _ _ _- 60 CzechRepuMi I I I i I I I 60 30 """""" 30 Sovereignbondspreadstrendedhgher,butremain contained relativeto CEE peers... 1200 12M) Euro EMBIG SovereignSpreads loo0 - (In basiipoints) -lo00 8 0 0 - 6 0 0 - 400- Czech Republic ' 0100 I Source: Bloomberg. 86  figlure 3. Poland: Balanceof Payments Deveioprnents,2 ~ ~ ~ - ~ 8 4 4 8 6 2 2 5 5 0 O 4 4 -2 -2 3 4 4 3 -6 -6 2 2 -8 8 1 i -10 -10 0 0 m 2008 2004 2005 2006 2007 2008 20 25 10 5 0 -5 -10 7 7 3 3 6 6 2 2 5 5 4 1 1 3 43 O 0 2 2 -1 -1 1 1 -2 -2 0 0 -3 -3 Sources:EuropeanCommission; Bloomberg;andHaver. 87  Box 1.Measuresto Safegnard FinancialSector Stab- Toincremebank's capitolbiflws Encouragedbanksto retainearningsto boostonncapital.Withallp f i t sfroru2008 retained capitaldequacymtiowouldiucreaseby 1.5 percentagepoiuts. Topim.rde:lop andforeign ctiireiiq Iiqinidit.v 0 weeklythree-mth (andstartingInMay.six&) r e poperatlomhawbeenintroduced. Therangeofcollateralfor Lombardcrectthasbeenbroadenedandhaircutsreduced. 0 TheNBPstartedpviduqt euro swaps todomesticbanks. NBPhassecuredjmticipatiouintheweekly euro-Sn;iss h cexchangemapoperationsofthe S ~ i sNationalB a d andthe Ewosystem s A repo linewiththeECBofupto 10 billionhasbee11madealailableto theNBP. Tointens@$nancwI sector siiivedlonre h dfreqwncyofstresstestingandonsitelarpections. Requestedbankstoreviewtheir lendingpolicyrmnd contingencyp h . Request4banksto submit daily reportsonnewexposuresto fmignentities. Topivnprhissuecoirecmr nieosiws Steppedupinclivdualmeasurestowardscertain banks.Foremny.de. earlywafnhgswere issued to somebanksto stop mortgagelendinginforeip currencywhen they started experiencingFX fimdmgdifficulties. * Issuedreconnnendationsto a coupleofsinallbanksto increasetheir capitalbaseas their CARS were Elllmpcloseto 8 percent. Plannedconsolidationfor s d banks that are not viable. Toboost co?$dence in theqstein TheBankGumanteeFumllawhasbeend e dto increasedx la-elofdepositguaranteefrom t22.500 to SO.OOO andeliminateEO'murawe. A draftlawto guaranteeinterbanklendinghasbeensubmittedtotheparliament.Tbe governmenthassetasided.40billionfor these guarantees. Toincreme coordi,lotiosbetween ogencies FrequentmeetingsoftheFinancialStabilityC&ttee to discussissuesandmxtsures.The committee was legallyestablishedinthe fdlof2008 anditis coIllprisedofrepremtativesfrom them P . KNFandMOF. 0 TheKNFhas beeninclose contactwithparentbanksandsupenisors. Toboost donrediccredit Increasedthe capitalofstate-ownedBGKbankbyd.2 billionenablingit to lendabout A. 20billionto domesticfirms. A $500d o ncreditline fromthe WorldBankfor PolishSMEsisinthepipeline. 88  ANNEX 5: STATUSOFBANKGROUPOPERATIONSINPOLAND Poland:PlannedandActualDeliveries,FY05-09 A. LendingDeliveries Protection Subtotal FY07 184.0 I FY08 I None I I None 1 - 1 FY09 None I I Development Policy Loan I 1,250.0 (DPL) Subtotal FY09 1,250.0 TotalFY05-09 620.5-680.5 Total FY05-09 1,859.5 11Approved on July 1,2004, prior to the CPS. The operationwas includedinthe previous CAS 89  B. Non-LendingDeliveries,FYOS-OS (excludingRegionalStudies) FY07 None OwnershipPolicy for SOEs HardCoal Sector Dialogue FY08 None PerformanceBasedBudgetingConference Insolvencyand CreditorRights ROSC 90  ANNEX 6: POLANDAT A GLANCE Poland at a glance Y12/09 Europe& Upper I Key DevelopmentIndicators Central mddle Poland Asia incane Age distribution, 2007 (2008) Pcpulstion,mid-year(millions) 38.1 446 a 4 Slrfxe aea(tbusadsq. km) 23,972 41,497 Pcpuldion gavth ( O h ) 0.0 0.2 0.7 Urbanppuldion(% oftotal populaticn) 64 75 GNI (Atlas method, U S balions) 373.2 2,697 5,854 GNI percapita(Atlasmetimd, US$) 9790 6,052 7,107 GNI DercaDitaIFPP,intemdionrl $) 15500 11.262 12.072 6 4 2 0 2 4 6 GDP growth(%) 4.9 6.9 5.8 I GDP percapita growth (%) 4.9 6.7 50 percentof toblpopulalon (mostfecent esdimate, 2003-2008) Prxeltyheadcourt ratio d $1.25a day (PPP,%) <2 4 Pweftyheadcourtratio d $2.00a day (PPP, %) <2 9 i_i Under-5mottalty mte(per 1,000) Life expectancyat birth(years) 70 71 Infant mortalty(per1,003 Ikebirths) 21 21 I 6 0 1 Child mdnutition(% ofchldren mder5) i 50 Adult Steracy,male (% d ages 15an3 ol&r) 100 99 95 Adrlt Heraw, female (%of ages 15andolder) 99 96 93 Gross primaryenmlmert, male (% d age group) 98 112 10 Grcssprimaryenmilmert,female (% of agegrmp) 96 109 Access to animprovedwater wurce (% cf population) 95 95 0 Access to improvedsatitationfadlites(% ofpopuhtion) 89 83 Net Aid Flows 1980 I990 2000 2008 a I IUS$ nilionsf Net ODA a d offcialad 1920 1,396 I,524 Growth of GDP and GDP per capita (Oh) Top ddonors (h2000: European Canmission 289 838 1,101 8 Franc? 2 197 197 6 Postria 27 124 83 4 2 0 Ad (%of GNI) 2.4 0.8 0.6 P Ad percapita(US$) 35 36 40 4 6 a Lcmg-Term EconomicTrends -N) 95 05 Consumer prices(annual% chage) 70.3 10.1 4.2 GDP 'mplicitdeflator (annual% change) 55.2 7.2 31 Exchangerate(mnua1average, bcal perUS$) 0.9 4.3 24 Terms d trade index(2000 = 103) 104 100 102 198040 1990-2000 2000-08 (averageannudgrowth %) Pcpuldion,mid-year(mibns) 358 38.1 38.5 323I 0.7 0.1 -0.1 GDP (US$ milloffi) 58,976 171,276 526,923 4.7 4.3 (%ofGDq Agcutture 8.3 5.0 4.2 0.5 1.3 Indrstry 50.1 31.7 30.9 7.1 5.6 Mnufadurirg 18.5 17.0 9.9 8.2 services 41.6 63.3 64.9 5.I 4.0 Householdfnalconsumptioneqerditure 48.0 63.1 60.6 5.2 3.7 GeneralgovY finalcoffiumpionexpendibre 19.3 18.5 17.9 3.7 3.7 Grcsscadtalformatiin 25.6 24.8 250 10.6 6.6 Exportsof gods a d services 286 27.1 39.5 11.3 10.2 Impr6 ofgoodsand sewices 21.5 33.5 430 16.7 9.3 Grcsssavirgs 15.9 18.8 232 Note:Figuresin italics arefcr yearsotherthm those specified. 2008data are pdimnary. ..indicatesdaB are not wailable. a. Aid &ta are f u 2037. Develcpmentkommics, Dwebpmert Data Group (DECDG)  Poland Balanceof Paymentsand Trade 2000 2008 I Governanceindlcators,2000 and2007 (US$ m'lbns) Totalmerchmdise emorts (bb) 31.729 185.647 Totalmerchmdise 'mports (af) 49,023 195,906 Vaceanc acMunBbhty Net tra& in wods and services -10,904 -19,371 Pdllcalsebltty Cunent aocaint batance - 10,343 -29,029 i6a %ofGDP 6 . 0 -5.5 Regulatoryquality Workers' remittances and Ruleof h w compensationofemployes (receipts) 1,726 10,496 ConeoIof cormptlon Reserves,ircbdirg gold 27,466 6,180 0 25 fo 75 100 Central Government Finance a2007 Country'spercenlle rank(C- 100) e2CKXI hgher mfues mpiy bfb?rmfms (% of GDP) Current revenue (lncbdirg grants) 38.1 39.2 Taxrevenue 19.8 22.8 Currentexpendture 38.2 37.8 Technology and Infrastructure 2000 2007 Overal surplus'defcit -3.0 3.9 Paved roads (% of total) 68.3 69.7 Himest margin4 tax rate (%) Fixedfine md moblephone hdiwdllal 40 40 subscnbfts (per 100 pmple) 46 136 Copcrab 28 19 Hightectnoicgy exprk (%of marufacbrd exports) 3.3 38 ExternalDebt and Resource flows Environment (US$ niRbnsf Totaldebt aitstmdirgand dsbursed 64,834 217,376 Agmutural land(%of landarea) 60 52 Totaldebt service 10,156 17,435 Forestsea(% oflandarea) 30.6 DebtreAef(HBC, MDRO - - Natanaliyprotededareas(Ohof lard area) 56 Totaldebt (% of GDP) 37.9 41.3 Freshwzierresources per capita (cu meters) 1,402 1,453 Totaldebt service(% of Bcpcrts) Freshwzierwithcfawl (bXlan cublc meters) 16.2 Foreig, dirediwestment(net inflows) 9,343 19,198 COPemissonsper capita(mt) 7.8 Z9 Patfdb equity(mt inlows) 447 -2,134 GDPper unit of energy use (2005PPP$ per kgof OB eplivafert) 5.1 57 Enwavuse DFI capita (ka d oileaulvdent) 2,325 2.562 L-J FTvab,152e40 U S millions Private Sector Development 2000 2008 Timereplired tostat abueness (days) - 31 Costto start a busiress (% of GNIper capita) 18.8 Timerepliredtorqister property(days) -- 197 Rankedas a mqorcmstrantto tuslness 2000 2007 (%of mmagerssunieytxlwho igreed) Taxrates 57.5 Access tdcost of Ranarg .... 50.7 Stockmarket capitalnation(% ofGDP) 18.3 48.8 Bmk captal toasset rata (%) 7.1 7.4 Note:Figuresint a l a arefcr yearsotherthm those specifid. 2008data aepreliminary. 5112/09 .. indicatesdab are not walatle. -indicates cbservatim isnot applicatle Develcpment Ecommics, Dwebpmert Data Group (DECDG). 92   IBRD 33467R POLAND SELECTED CITIES AND TOWNS PROVINCE (WOJEW