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Off-budget spending stirs doubts about Poland“s finances

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2022-12-21T14:03:01Z

As Poland heads for an election year grappling with stagflation, government moves to shift large chunks of its spending off-budget risk damaging its reputation for rock-solid state finances.

Off-budget spending, where the cost of activities deemed to have special characteristics is not included in the official budget, is widely used across the world. In Poland, it was initially deployed for spending to weather the pandemic but now encompasses a surge in military and other expenditures.

The International Monetary Fund and credit rating agencies say the practice, while currently contained in scope, weakens oversight and could harm A-rated Poland’s institutional strength if it becomes entrenched or widens further.

“Budget funds are becoming less and less transparent,” Supreme Audit Office President Marian Banas told Reuters.

“Confidence in Poland is unfortunately slowly declining. We are being watched by all financial and business institutions in the world, and if we do not improve the situation, do not stop this disturbing trend, capital will move away from Poland.”

Neither the IMF, nor rating agencies see risks to the sustainability of Poland’s debt, which at 52% of national output is well below levels on the euro zone periphery. Importantly, they note that the off-budget spending still gets captured under European accounting rules.

But with eastern Europe’s largest economy facing a cost-of-living crisis that has dented support for its ruling nationalists, economists see emerging fiscal risks if spending is increased.

“I think the question is about the scale of these activities and the timeline,” said Karen Vartapetov, Director, Sovereign Ratings at S&P Global Ratings.

“If they are relatively limited in scope and time, fiscal risks are contained. But if they turn into (a) more permanent quasi-fiscal channel, risks could build over time.”

Asked for comment on such worries, Poland’s finance ministry said it met rating agencies on a regular basis and answered any questions or concerns they had.

“Poland – despite the external turmoil associated first with the pandemic and then with the Russian invasion of Ukraine – maintains a high investment rating with a stable outlook,” it said in an emailed reply to questions.

Poland has seen the second-steepest rise in bond yields in the European Union since November 2021 based on European Central Bank data, with long-term yields rising over 400 basis points.

On Wednesday, Polish five-year bonds traded at yields of around 6.8%, off peaks above 9% hit in late October but still near their highest since the 2008 global financial crisis.

In recent years, Poland’s off-budget spending has gone from insubstantial amounts to several percentage points’ worth of GDP, based on spending tracked by economists and rating agencies.

The concerns are centred around off-budget financing done via entities such as the Polish Development Fund (PFR) and state development bank BGK amid general pressure on state finances from slowing growth and higher spending needs.

“The (government) 2023 deficit target of 4.4% of GDP understates the full picture of Poland’s public finances next year,” economists at Bank of America said in a note.

They estimated the two entities, plus a fund set up to provide compensation for energy price shocks, would cover fiscal pledges worth about 2 percentage points of GDP next year, with spending equivalent to another 1.6 points of GDP earmarked for a new army fund and largely financed through BGK.

S&P sees the 2023 budget deficit at 5.8% of GDP, betting on a strong 2024 consolidation effort after the election due in October or November. The European Commission sees a 5.5% shortfall next year – one of the highest in the EU – with hardly any improvement in 2024.

BGK, which had debt worth just 3.85 billion zloty at the end of last year, plans to ramp up borrowing through funds under its management by 134 billion zloty by the end of 2023, with some 40% earmarked for military spending, largely via foreign loans, the finance ministry told Reuters.

Geoff Gottlieb, IMF senior resident representative in Poland, told Reuters spending outside the budget process “complicates a clear discussion of the policy trade-offs and can undermine credibility”.

“The best practice is for the formal budget process to include all budgetary and extra-budgetary activities in order to facilitate policy analysis and promote accountability,” he said.

Poland is heading into 2023 with double-digit price growth, a stalling economy, decade-high borrowing costs and – crucially – EU grants worth 23.9 billion euros still in limbo amid a row over the Polish judiciary and other issues.

PFR, which is pre-financing projects under Poland’s plan to receive EU post-pandemic recovery funds, sees outlays at 15 billion to 20 billion zloty next year, using liquidity from repaid pandemic support loans. PFR’s borrowing was nearly 3% of GDP at the end of 2021.

“Overall, the lack of (EU recovery) funds would impact investment and growth over the medium term, and could also affect confidence in the short term,” said Federico Barriga Salazar, director, primary rating analyst at Fitch Ratings.

“If you stop receiving EU funds, because there is no agreement on the reforms, then that might send a bad message to the outside world and that would lead to a further weakening of the zloty and make this monetary/inflation challenge harder.”

Polish Prime Minister Mateusz Morawiecki last week took the unusual step of pleading with opposition lawmakers to pass judicial reforms needed to get EU funds flowing amid resistance from an ultra-conservative coalition partner.

“The PiS leadership is aware that the absence of this sum would be felt acutely by the economy during the crisis, impacting the party’s prospects of retaining power,” Mai Doan at Bank of America said. The finance ministry said it saw no risk to the budget even in case of more delays to recovery funds.

The IMF says if Warsaw proceeds with EU-related spending in hopes of an eventual agreement, that could put upward pressure on near-term borrowing needs, which should be “monitored carefully” in light of higher-than-normal financing costs.

(1 euro = 4.6658 zlotys)

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