Polish Convergence Regime Assessed

by Ulrika Lomas, for LawAndTax-News.com, Brussels

07 March 2006

Having examined its updated convergence programme, the European Commission announced last week that Poland, which is subject to the excessive deficit procedure, has not presented a budgetary strategy that would enable it to correct its excessive deficit in 2007 as required by the Council.

It has therefore called on Poland to strengthen its budgetary adjustment in 2006, improve the long-term sustainability of public finances and strengthen expenditure controls.

“Although the budgetary outcomes in 2004 and 2005 were better than expected, the Polish convergence programme does not provide a budgetary adjustment path sufficient to correct the excessive deficit by 2007, as recommended by the Council, or even 2008, despite good growth prospects,” observed Economic and Monetary Affairs Commissioner, Joaquín Almunia.

Poland submitted its convergence programme, covering the period 2005-2008, on 19 January 2006. Based on a macroeconomic scenario which is essentially plausible (though slightly optimistic for 2008), the programme aims to gradually reduce the general government deficit so as to bring it below the 3% of GDP Treaty reference value by 2009, as opposed to a deadline of 2007 set in a July 2004 Council recommendation. However, no explicit deficit target is set for the year 2009, which is beyond the programme horizon.

Poland currently includes as government revenue the contributions to funded pension schemes. Without these contributions the general government balance, according to the updated programme, would be -4.7% in 2005, -4.6% in 2006, -4.1% in 2007 and -3.7% in 2008. Under a Eurostat decision, Member States that include contributions to second pillar funded schemes as government revenue must cease to do so from next year.

The programme sets a medium-term objective for the Polish public finances of a deficit of around 1% of GDP in structural terms (i.e. in cyclically-adjusted terms and net of one-off and temporary measures). This is in line with the Pact, according to the EC, but would only be achieved after 2010, well beyond the programme horizon.

Also, the projected budgetary outcomes could turn out worse despite a good track record in achieving -- even overachieving -- the 2004 and 2005 targets. This is because the tax elasticity assumptions are rather optimistic, in particular in 2006. Furthermore, the growth assumptions in 2008 also seem rather favourable. Additionally, what amounts to a very comprehensive pension reform is being undermined by the granting of special treatment to certain groups and there is parliamentary support for expenditure initiatives that seem incompatible with the planned reduction of the deficit.

According to the Council Recommendation of 5 July 2004, Poland should correct its excessive deficit by 2007. The programme, however, sees the deficit at 2.2% of GDP for that year, if pension funds are included in the general government sector, and 4.1% if they are excluded. Even in 2008, the deficit target, excluding pension funds, is significantly above the reference value (3.7%).

In a statement, the European Commission announced that:

"It is clear, therefore, that Poland does not plan for the correction of the excessive deficit by the deadline imposed by the Council. Consequently, the Commission intends to take further steps under the excessive deficit procedure."

"In the meantime, it would be appropriate for Poland to strengthen the adjustment in 2006, in particular by allocating any higher-than-budgeted revenues or lower-than-budgeted expenditure to deficit reduction; improve the long-run sustainability of the reformed pension system and; enhance the institutional framework of its public finances by introducing a medium-term expenditure rule."

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