Poland - Country partnership strategy for the period 2009-13

Documentof The World Bank FOR OFFICIAL USEONLY ReportNo. 48666-PL INTERNATIONAL BANK FORRECONSTRUCTION AND DEVELOPMENT POLAND COUNTRY PARTNERSHIP STRATEGY FOR THE PERIOD 2009-13 June 2,2009 Centraland South-CentralEuropeand the BalticCountries Europeand CentralAsia Region This document has restricteddistribution and may be usedby recipientsonly inthe performanceof their official duties. Its contentsmay not otherwise be disclosedwithout World Bank authorization.  Date of LastCountryPartnershipStrategy: March29, 2005 CURRENCY EQUIVALENTS (ExchangeRateas ofJune 2,2009) Currency Unit= PolishZloty (PLN) US$l.OO = 3.13 PLN FISCAL YEAR January 1-December 31 ABBREVIATIONS AND ACRONYMS AAA Analytic andAdvisory Activities IFC International FinanceCorporation AAU Assigned Amount Unit IF1 International FinancialInstitution AHK Polish-GermanChamber of Industry and Commerce IMF International Monetary Fund CAT DDO CatastropheDeferredDrawdownOption LA LisbonAgenda CEM Country EconomicMemorandum LFS Labor Force Survey CIS Commonwealthof Independent States MIC Middle Income Countries CIT Corporate IncomeTax MOH Ministryof Health COP14 Conference of the Parties MTEF Medium-TermExpenditureFramework CP ConvergenceProgram NATO North Atlantic Treaty Organization CPS Country PartnershipStrategy NBP National Bank of Poland CTF CleanTechnology Fund NFZ NationalHealthInsuranceFund DPL DevelopmentPolicy Loan NGO Non-Governmentalorganization DRG DiagnosisRelated Group NHF NationalHealthFund EBRD EuropeanBank for Reconstructionand Development N M S New Member States EC European Commission OECD Organizationfor Economic Cooperation and ECA EuropeandCentral Asia Development ECB European CentralBank PER Public ExpenditureReview EIB EuropeanInvestmentBank PIT Personal IncomeTax ERM2 EuropeanExchangeRateMechanism Pis Law andJusticeparty ESW Economic and Sector Work PKOBP PowszechnaKasaOszczqdnoSciBank Polski EU EuropeanUnion PLN PolishZloty EU8 MemberStates thatjoined the EUon May 1, 2004, PO Civic Platform excludingMalta andCyprus Powiat County administrative unit, (379) NUTS3 EUlO EU8 plus Member States thatjoined the EUon PPP Public Private Partnerships January 1,2007 PSL PolishPeasant's Party FBS Fee-basedService R&D Researchand Development FCL FlexibleCredit Line SME Small- and medium-sizedenterprises FDI Foreigndirect investment SWAP Sector Wide Approach FIAS ForeignInvestmentAdvisory Service TA Technicalassistance FSAP Financial Sector AssessmentProgram TEN-T Trans-EuropeanTransport Network GDDKiA General Directoratefor Public Roads andMotorways UNFCC UnitedNations Framework Conventionon Climate GDP Gross DomesticProduct Change GEF Global EnvironmentFacility USD United States dollar GIS Green InvestmentScheme VAT Value AddedTax IBRD InternationalBank for Reconstructionand WDR World Development Report Development IBRD Vice President Shigeo Katsu Director Theodore Ahlers Team Leader Thomas Laursen  FOR OFFICIAL USEONLY TABLE OF CONTENTS I. Introduction ................................................................................... 1 I1. Country Context., ............................................................................ 1 A Geopolitical Context, EURelations. and Political Situation ................................. 1 B Economic Developments.Labor Markets and Poverty Profile....................... 2 C Medium-Term Economic and Fiscal Outlook . .......................................... 6 I11. Country DevelopmentProgram .......................................................... 10 A Overarching Objectives., 10 B GovernmentPriorities.. .. ................................................................. .................................................................. 11 IV. World Bank Program ....................................................................... 13 A Implementation of 2005 CPS and Lessons Learned . ................................... 13 B. External Partners andKey Areas ofWorld BankValue-added ...................... 15 C Strategic Pillars of Collaboration . ......................................................... 17 Pillar 1: Social and Spatial Inclusion ................................................ 18 Pillar 2: Public Sector Reform ..................................................... -21 Pillar 3: Growth and Competitiveness ............................................ -22 ....................................... D. Proposed Program.......................................................................... Pillar 4: Regional and Global Public Goods 25 27 E Poverty and Social Impact . ................................................................. 29 F Results Framework., . ....................................................................... 30 V . Risks ............................................................................................. 30 VI . Consultationswith Government and Other Partners., ................................ 31 Boxes. Charts. Figures. Tables: Box 1: Poverty in Poland since EUAccession Box 2: Supporting High and Sustainable Economic Growth inPoland over the Medium Term Box 3: External Partners Chart 1: At Risk of Poverty Rate in the EU8 (percent) Chart 2: Public Debt Sustainability Figure 1 EIB Lending to Poland in 1990-2008 Figure 2 EBRD Commitments by year Table 1: Poverty in Poland since EU Accession Table 2: Economic Developments and Prospects in Poland2004-2011 Table 3: Fiscal Developments and Prospects in Poland2004-2011 Table 4: Proposed IBRDLending Programand SelectedNon-lending Services 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.  Annexes: A1 Results Framework A2 Polandat a Glance B2 Selected IndicatorsofBank Portfolio Performance andManagement B3 IBRDProgram Summary IFC ProgramSummary B4 PolandSummary ofNon-lendingServices B5 Poland Social Indicators B6 PolandKey Economic Indicators B7 PolandKey Exposure Indicators B8 IBRDOperationsPortfolio IFC OperationsPortfolio C 2005 CPS CompletionReport Map (IBRD 33467R) The Poland Partnership Strategy was prepared by a core team comprised of the following World Bank Group staff: Thomas Laursen (TTL), Radek Czapski, Charles Griffin, Leszek Kasek, Ewa Korczyc, Anna Kowalczyk, Albert0 Rodriguez, Jan Rutkowski, and Penny Williams. Henry Kerali, Christine Kessides, John Pollner, and Gary Stuggins also provided helpful contributions. This document has a restricteddistributionand may be usedby recipientsonly inthe performanceof their official duties. Its contents may not otherwise be disclosedwithout the World Bank authorization  Poland-Country PartnershipStrategy 2009-13 I.INTRODUCTION 1. This Country Partnership Strategy (CPS) sets out the country context, country development program, and envisaged World Bank program for Polandfor the period 2009- 13, the remaining five years of the 2007-13 European Union (EU) financial perspective. It also discusses the risks to this strategy and the planned consultationswith Government and other partners. The CPS replaces the open-ended2005 CPS, which has been superseded by recent crisis-relatedevents in the globaleconomy, althoughseveral aspects of it remainvalid. 2. The CPS should be viewed as a flexibletool to support the Bank's work in Poland, in line with the strategy for middle-incomecountries (MIC). The Bank's dialoguewith Poland is constantly evolving depending on external and domestic political and economic circumstances, and this strategy reflects more our current assessment of priorities and potentialfor Bank engagement in Poland than a firmly agreed strategy and pipeline with the Government, at least beyond the first year. The Government is interested in a continued partnership with the Bank, includingboth borrowing(at least in the current adverse external environment) and analytic and advisory Activities (AAA) drawing on the Bank's global knowledge. It is envisaged that while lending may be increased significantly in the coming couple of years, it would be phased out gradually over the mediumterm. Meanwhile, AAA would be expectedto increasinglybe providedon a fee-for-servicebasis. 3. Although a secondary partner to the EU, the Bank can continue to add significant value to Poland's development and convergence agenda for many years to come, while its active policy dialogue and technical cooperationalso benefitsthe Bankthrough enhancing its knowledge to the benefit of other client countriesboth in the regionand beyond. This is thus a win-win relationship. 4. A Regional Framework paper for the ten countries in the Central and South-Central Europe and the Baltic region is under preparation. The Framework will provide a broad diagnosis of the key challenges facing the countries inthe region; describe the Bank's value- added; and outline the main areas of Bank activity in the region. This Poland CPS shares common elements with the proposedFrameworkpaper. 11.COUNTRYCONTEXT A. GeopoliticalContext, EURelations. and PoliticalSituation 5. Poland has successfully managed its integration into 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 has access to considerable externalfinancing, including large volumes of EU Structural and Cohesion Funds on a grant basis and market financing (although absorptionof EU funds has been somewhat slow and market financing recently has become more difficult with the escalation o f the global economic and financial crisis). While external relations are anchored in EU and North Atlantic Treaty Organization (NATO) membership, for historical reasons Poland is also seeking closer ties with its Eastern neighbors, particularly with Ukraine to support closer integrationwith the EUand co-hostingofthe 2012 European Soccer Championship. 1  6. The majority Government, formed after elections in late 2007 by the Civic Platform (PO) and the Polish Peasant's Party (PSL) and led by Prime Minister Donald Tusk of PO, has remained broadly stable and enjoys strong social support. Recent opinion polls show that support for the PO oscillates around 50 percent and that of PSL around 5 percent. 7. However, lack of qualified majority in Parliament may make it increasingly difficult for the Government to advance its reform program over the next year and a half as Presidential elections in fall 2010 approach. Consensus for major reform initiatives may not be achieved given the strong opposition Law and Justice (Pis) party which also occupies the Presidency. In some cases, such as the recent-tighteningof early retirement conditions, the Government was able to overcome a Presidential veto through support from the smaller opposition Social Democratic party. Elections to the European Parliament scheduled for mid-2009 and subsequent Local Government elections are expected to generate heated political debate. 8. Poland does not have serious governance problems. Poland has a strong multi- party democracy and a vibrant, free press. Governance indicators suggest Poland is inthe 50- 75* percentile in governance matters worldwide' and roughly equal to its peers in Transparency ratings.* Poland's Ministry of Interior and Administration prepared a national anti-corruption strategy in 2002 and this is updated regularly. Since 2006, the Central Anti-corruption Bureau has also been involved in anti-corruption activities, most recently focusing on prevention and education. B.Economic Developments,Labor Markets and Poverty 9. Poland is being strongly affected by the deterioration in the external environment, but its vulnerability remains moderate. The initial position of the Polish economy has been robust and able to face the repercussions of the global crisis after five years of strong growth and a historically low`unemployment rate. Meanwhile, inflation, the current account deficit and external debt as well as public debt are moderate, and the financial system is relatively sound. While Poland avoided much of the initial, direct financial market shock, it is being strongly affected by second-round effects through the real economy: declining demand for Polish exports, tightening of credit conditions, and lower FDI inflows. The sharp weakening of the zloty in the last quarter of 2008 and early 2009 showedthat there is little room for complacency. 10. Poland's financial system is well-poised to cope with the current adverse external environment. While the banking system is dominated by foreign banks whose external funding conditions appear to have deteriorated owing to the problems in parent banks, there are also some significant domestic banks including a large state-owned bank. Further, credit growth in Poland and the overall level of credit-to-gross domestic product (GDP) has been moderate and much lower than in most of the other countries in the region, and most of the credit expansion has been financed through domestic deposits, although foreign financing has been playing an increasing role in recent years. A large share of domestic investment has been financed through enterprise profits. While there are some concerns related to foreign currency mortgage lending, the overall level of lending is relatively small and the recent depreciation of the zloty has taken place after the strong real ' World Governance Indicators2008. Polandranks 58`h in Transparency International's Corruption PerceptionsIndex, equal to Lithuania and only slightly behindregional peers such as Hungary, Latvia and the Slovak Republic. 2  exchange rate appreciationin 2007 and muchof 2008. Bankprofitshave beenrecord-highin recent years and all banks remain well-capitalized, Credit conditions are likely to tighten significantly this year and some enterprises may find it difficult to roll-over maturingshort- term loans (whichconstituteabout one-halfoftotalenterprise loans). 11. Growth has slowed sharply but could remain slightly positive in 2009. Growth was expectedto slow down for cyclical reasons, but while growth remainedbuoyant at close to 5 percent in the third quarter of 2008, the economy slowed more sharply to less than 3 percent growth in the fourth quarter of 2008 and 0.8 percent in the first quarter of 2009 in connection with the worsening of international financial and economic conditions. Investment growth has slowed sharply while consumption growth remains more resilient with continued real wage increases, only slowly increasingunemployment, and still robust credit growth. Poland is 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. In 2009, the contributionof net exports is likely to remainbroadly neutralas weaker prospectsfor exports will be accompanied by moderation of imports due to lower domestic absorption and exchange rate depreciation.Overall, in the best case scenario, growth could remain slightly positive at 0-1 percent in 2009. However,forecasts are subject to unusuallylarge uncertainty in the current environment and there could be significant variations in growth in both directions, dependingmainly on external developments (notably inthe e~ro-zone).~ 12. The higher than planned Government consumption and lower than assumed non-tax revenues other than social contributions (largely EU funds) 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 of GDP, some 1.2 percentage pointshigherthan projectedby the Government inthe December2008 ConvergenceProgram. This was due to higher-than-expecteddeficits of both local and central Governments (due to higher than planned expenditure and lower than expected revenue), while social security funds performedaccordingto plan. Poland is very likely to enter the EU Excessive Deficit Procedure, which is triggered when the deficit-to- GDP ratio exceeds 3 percent or debt-to-GDP ratio exceeds 60 percent and which requires countriesto produce a plan for how this will be corrected. The EC initiatedthis process on May 13. 13. Inflation accelerated in 2008, but the peak was reached in August and inflation eased significantly as the crisis escalated. With GDP growth expected to slow sharply in 2009 and world commodity prices falling, expectations for inflation have eased and the National Bank of Poland (NBP) began reducing interest rates in late 2008. Inflation is projected to return to around the middle of the target range of 1.5-3.5 percent in 2009 althoughin April it remainedabove the upper endofthe target range. 14. The balance of payments has come under some pressure but Poland's external position remains relatively strong. The current account deficit widened slightly to 5% percent of GDP in 2008, while weaker capital inflows were associated with a sharp depreciationof the zloty in late 2008 and early 2009 following strong appreciationin recent years. Following a hiatus of seven months, the Government returnedto internationalcapital markets with a euro 1 billion issue in January at a spread of about 300 basis points above German Bunds and 5-year mat~rity.~In early May, the issue was re-opened and Poland The IMF andEC project a decline in GDP of 0.7% and 1.4%in Poland, respectively. At the end of April 2009, the City of Warsaw successfully placed a 5-year fixed rate euro-denominatedbond of EUR 200 million, pricedat around470 basispoints above German Bunds. 3  successfully placed EUR750 million at a spread of about 40 basis points below the January level. Poland's external debt of about 56 percent of GDP is moderate by regional standards, but gross financingneedsare ~izeable.~However, the IMFprecautionaryFlexibleCreditLine (FCL) arrangement of USD20.6 billion approved in May should safeguardagainst downside risks in financial markets. The ongoing economic slowdown and recent zloty depreciation should translate into a lower current account deficit (about 4 percent of GDP in 2009). Inflows of EU funds and FDI should finance a major part of the external gap. In current circumstances, Poland's floating exchange rate regime is serving it well to help absorb the externalshock. 15. 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 of labor market conditions. The LaborForce Survey (LFS) unemploymentrate fell from over 20 percent in 2004 to about 7 percent in 2008. The data disaggregatedby gender indicatethat female unemployment rates in Poland remain slightly higher than those for men, but also decreased considerably. Unemployment is expected to rise back to over 10 percent this year in tandem with the economic slowdown. 16. The decline in unemployment was associated with lower poverty. Relative poverty levels6have decreased (see Chart 1) and are now concentrated in rural areas and among the long-term unemployed. Nonetheless, despite vibrant growth of real GDP and domestic consumption, Poland still has a relatively high poverty rate compared to other countries in the region, especially among children, although the 2004 reform to the family benefit system has led to an improvement in the income status of families with children, including single-parent families. Absolute poverty levels are considerably lower although measurementdependsonthe choice of poverty line (see Box 1, Table 1). !JI? Chart 1. At Riskof Poverty Rate in the EU8 (percent) ii g &$ c v Source: Eurostat. About one-third of external debt is short term. Foreign currency reserves of USD 64 billion (April 2009) provide a cushion to absorb externalpressures; coveringabout 95 percent o f short-term debt. The EUpoverty measure ("at risk of poverty") is definedas the share ofthe populationliving in households with income below 60 percent of the national median disposable incomeafter transfers. 4  BOX 1. POVERTY INPOLAND SINCE EUACCESSION Household data available through 2007 show Poland's substantial strides in lowering poverty. Poverty - measured as the percentage o f 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 householdhead, unemployment of a householdmember, and a large number of children inthe household. Poorer households are generally well served by the social protection system. The multiple elements of Poland's socialprotectionsystem (pensions, family benefits, and social assistancetaken as a whole) cover 76 percent ofthe population, and 95 percent ofthe poorest 20 percent. The system provides benefits to 98 percent of households in extreme poverty. Reflectingthe geography of Poland's poor areas, the system covers 81 percent of the rural population(as comparedto 73 percent ofthe urbanpopulation). The Government's growing concernis for the newly vulnerable households in the wake of slowingeconomic growth. The Government is planningtargeted regionalinterventionsto support the powiuts that are most affected by the drop in economic activity by both improving the effectiveness of existing programs (employment and social assistance programs) and, if necessary, by allocating additional resources and implementing extraordinaryprograms. Vulnerability to the crisis is being mapped to target interventions. This initiative has three components: first, the creationof a regionalcrisis vulnerability map to identifypowiuts that are at the highest risk of suffering from the current global economic crisis; second, implementationof a monitoring system that will screenpowiuts that are actually hit by the crisis; and third, the creation of an agency with a mandate to support the worst affected powiuts. The initiative will be ready by September 2009. The regions that are considered the most vulnerableto the crisis are those with an export-orientedeconomy, rather than the poor, lagging regions. The latter - rural, predominantly agricultural regions - are insulated from the crisis, at leasttemporarily,andwell covered by existingsocial protectionprograms. Table 1. Poverty in Poland since EUAccession Poverty rate Percentageof population living in households below 2004 2005 2006 2007 50% of median expenditure 20 18 17.7 17.3 Social assistancethreshold 19 18 15.1 14.6 Subsistence minimum 12 12 7.8 6.6 Poverty gap Distance below poverty line 2004 2005 2006 2007 50% of median expenditure 23 22 21 21 Socialassistancethreshold 24 23 21 21 Subsistence minimum 22 22 19 19 Source: HBS2007 17. The authorities have taken steps to preserve financial stability in the current difficult external environment. Inreactionto the escalation of the global crisis in the fall of 2008, the NBP, the GovernmentParliamentand the Financial Supervision Authority took 5  steps to maintainconfidence and support the effective functioningo fthe financial system. In October, the NBP announced a "package of confidence" aimed at preserving trust and liquidity in financialmarketsthrough expansion of its term liquidity managementoperations and foreign exchange swap operations. The European Central Bank (ECB) agreedto provide a EUR 10 billion rep0 facility. Further, the Parliamentapproved a bill raisingthe household deposit insurance limit from euro 22,500 to euro 50,000. Legislation regulating state guarantees for interbank deposits has been adopted by Parliament and is currently awaiting the President's approval.The NBP also introducedother measures supportingbank liquidity like early buy back of T-bonds maturing in 2012 or extending the maturity o f rep0 operations. In late November, the NBP started reducinginterest rates (for the first time since March 2006), with a series of cuts bringing the rate down from 6 percent in November to 3.75 percent in May. 18. Meanwhile, the Government has also moved to support the economy. In late November, the Government announced a 7 percent of GDP "Plan for Stability and Development" aimed at supportingthe economy in 2009-2010, including a doubling of the limit on state guarantees, support for lending to small- and medium-size enterprises, acceleration of investments co-financed from EU structural funds, new investments in renewable energy, already scheduled personal income tax cuts and value added tax (VAT) simplification, and creationof a Reserve of Social Solidarityto support people vulnerableto the projectedeconomic slowdown(financedthroughhigher luxuryexcise taxes). While some of these measureswere plannedeven before the crisis, and new direct spending programs are only a smaller part of this package, it nevertheless constitutes an appropriate response to the crisis in a constrained fiscal environment. C. Medium-TermEconomicandFiscalOutlook 19. The global financial crisis has worsened Poland's macroeconomic and fiscal outlook, although Poland is faring better than other countries in the region. With fewer resources and in a fast evolving economic environment, the Government faces the difficult challenge of reconcilingthree objectives:ensuring fiscal consolidationover the mediumterm as required under the EU Excessive Deficit Procedure; protecting priority programs for economic and social development to enhance growth prospects; and mitigating the social costs of the crisis. The room for fiscal maneuver is constrained both by the need to preserve public debt below levels that trigger corrective action accordingto the Constitution and the Government's aim tojoin the euro-zone in 2012 (discussed in moredetailbelow). 20. Growth is projected to recover only slowly in 2010 in tandem with the expected easing of the crisis and expected slow recovery in industrialized countries. Growth is likely to remain subdued through 2010, with most projections around 1 percent, before a stronger recovery in 2011. Inflation is expected to remain stable at around the central inflation target of 2.5 percent. Lower domestic absorption should lead to a significant moderationo f importsand an improvementin the external current account deficit (around 4 percent of GDP in 2009-2010). Table 1 shows the recent macroeconomic forecasts for Poland prepared by the Government and international organizations. Needless to say, projectionsfor next year are even more uncertainthan for this year. 6  Table 2. EconomicDevelopmentsand ProspectsinPoland2004-2011 (change inpercentunless otherwise indicated) 2004 2005 2006 2007 2008 2004 2010 2011 CP December 2008 6.7 5.1 3.7 4.0 4.5 Real GDP (% change) EC Spring Forecast May 5.3 4.8 -1.4 0.8 IMF WE0 April 2009 3'6 62 i:; 4.8 -0.7 1.3 ---- WB May 2009 6.7 4.8 0.5 1.0 3.0 CP December 2008 5.0 5.3 4.5 3.7 3.8 Private consumption EC Spring Forecast May 2009 4,3 2,1 5.3 0.6 0.2 (% change) IMF WE0 April 2009 5'0 E:: 5.3 1.0 1.5 ---- WB May 2009 5 0 5 4 1 9 1 4 4 4 CP December 2008 176 6 5 4 4 5 0 8 6 Grossfixed capital EC Spring Forecast May 2009 6,4 17.6 7.9 -6.2 -0.8 -- formation (% change) IMF WE0 April 2009 6'5 14" 17.6 7.9 -4.5 2.5 -- CP December 2008 2.6 4.2 2.9 2.5 2.5 Consumer prices (% EC Spring Forecast May 2009 3,6 2,2 2.6 4.2 2.6 1.9 -- change) IMF WE0 April 2009 2.5 4.2 2.1 2.6 -- WB May 2009 2.5 4.2 3.1 2.7 2.5 CP December 2008 -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 -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 ConvergenceProgram (CP) Update December 2008; recent publicationsof international - financial institutions; and World Bank staff. 2 1. Against this background, the fiscal position is likely to weaken further in 2009 and possibly 2010. The Government is trying to adhere to fiscal targets for the state budget, while financing infrastructure investment through extra-budgetary borrowing and allowing automatic stabilizersto operate in the rest of the general Government (social security funds and local Governments). In late January 2009, the Government revised downwards the 2009 real GDP growth forecast from 3.7 percent, as estimated in the December 2008 Convergence Program, to 1.7 percent. To compensate for the expected shortfall in revenue, line ministries were asked to prepare plans for reducingstate budget expenditures by 0.8 percent of GDP. Certainexpenditure items, suchas pensionand disabilitypayments, capitationgrants to local Governments for primary and secondary education, public sector wages, debt servicing, and co-financing for the absorption of EU funds, were protected from these reductions. In addition, the Government shiftedtransport infrastructurespending of 0.8 percent of GDP off the state budget to the National Road Funde7With growth prospects further weakening, a formal amendment o f the budget is expected in June/July. This could includea combination of additional expenditure rationalization and possibly an increase in the state budget deficit target.The Government is now projectingthe general Government fiscal deficit to reach 4.6 percent of GDP in 2009.8 'While this measure reducesthe state budget deficit, it leavesthe general Governmentdeficit unchanged. * This is slightly higher than the IMF but lower than the EC which expects a deficit of 6.6 percent of GDP (but this assumes to corrective action). 7  Table 3.FiscalDevelopmentsand Prospects in Poland 2004-2011 (percent of GDP unless-otherwiseindicated) Source 2004 2005 2006 2007 2008 F 2009 F 2010 F 2011 F CP December 2008 -2.0 -2.7 -2.5 -2.3 -1.9 -- Fiscal balance EC Spring Forecast May 2009 -5.7 -4.3 -3.8 -1.9 -3.9 -6.6 -7.3 G O ~Fiscal Notification, April 2009 . -1.9 -3.9 -4.6 -- I IMF FCL Arrangement, 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 -- Structural balance EC Spring Forecast May 2009 -5.9 -4.1 -4.1 -3.2 -5.3 -6.0 -5.6 Gov. Fiscal Notification, ADril 2009 _- - I I IMF FCL Arrangement, April 2009' - -- - - -- __- I 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 - - - - I 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 -- Gov. Fiscal Notification, April 2009 44.9 47.1 51.0 - __ CP December 2008 6.7 5.1 3.7 4.0 4.5 Real GDP (% change) EC Spring Forecast May 2009 6,6 6.6 4.8 -1.4 0.8 Gov. Fiscal Notification, April 2009 5.3 3.6 6.2 4,8 I - --_ IMF FCL Arrangement, April 2009" 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 IMF definition (including pension reform costs) Source: Poland's CP and EC Spring Forecast, May 2009. 22. The 2010 budget will need to strike a careful balance between maintaining reasonable fiscal discipline as required under the EU excessive deficit procedure and necessary for euro adoption, and supporting the recovery. It is too early to judge the appropriate fiscal stance for next year, but it will be critical for the budget to be placed in a strong, Medium-Term Expenditure Framework (MTEF) consistent with renewed fiscal consolidation that targets an ambitious reduction in the structural fiscal deficit, at least stabilizes public debt, and supports euro adoption.This commitment shouldbe institutionally strengthened by rapid passage of the amendment to the Public Finance Law aimed at enhancing the MTEF,' consolidatingbudgetary units, strengthening precautionarydebt rules, and increasing performance-orientationin the budget. Giventhe recent loweringoftaxes and the expenditure pressures arising from the need to protect or expand productive spending in e.g. infrastructureand education and to strengthen social safety nets during the downturn, medium-term fiscal consolidation will require ambitious expenditure reforms aimed at rationalizing unproductive and inefficient spending programs, including in health and remainingprivilegedpensionarrangements. 23. Analysis done by the IMF in the context of the FCL suggests that public debt is sustainable over the medium term even in the presence of moderate further shocks. Fiscal rules on public debt - embedded in the PolishPublic Finance Law - prompt corrective action when public debt reaches 50 and 55 percent of GDP and there is the 60 percent of GDP cap imposedby the Constitution. Further efforts will be neededgoing forward to establishatruly strongMTEF. 8  Chart 2. Public Debt Sustainability: (public debt in percentof GDP) Baselineand h1~.4orical suenarius Infeest Rate Shock (ingerwaat) 70 =t----%/ e25 ea SbkDdr 58 7 --* Fl _ . _ . - * - Historical 45 50 13 8 4 0 / , , , , 35 HistoricaP: 3 3hl 2003 2005 2007 ?DM MI1 2013 2003 LXCS 2007 200'61 2011 2013 %nary B a l m Shack and No Policy ChangeScenao 70 [mstmrpnrnaryba!anfie) 1 85 - Gmh 61 65 t do - shock .+.# 55 - 50 - 3aselne 53 45 - 4a - 3 5 - Htstc+ical: 4.2 30 Rea!Deprecabm and Cuntingenr LJb&biesSfaockrs 31 2OOQ 2011 2013 Swrces: Interntonal MonetaryFwnd: Pdishaulhanties:and IMF staff edrrnates. I!shadeclamasrepresentdualdata Individualshcckswepemwnmt!mehat!standarddeviationshocks.F~uresinthe buxw represen! m r a p pmfectimsfor &e respec- vanabm m the &adme:and scendnc beingprewnted. Ten-year histot;caiawn* for