FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF EURO 1 BILLION

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No PL INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF EURO 1 BILLION (US$ 1,307.8 MILLION EQUIVALENT) TO THE REPUBLIC OF POLAND FOR THE SECOND PUBLIC FINANCE DEVELOPMENT POLICY LOAN May 20, 2013 Poverty Reduction and Economic Management Europe and Central Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. i

2 REPUBLIC OF POLAND CURRENCY EQUIVALENTS (Exchange Rate Effective as of May 17, 2013) EUR 1.00: USD 1.286: PLN ABBREVIATIONS, ACRONYMS & TERMS AAA BFG CoM CPI CPS CPSPR DPL EC ECA EDP ESA EU FCL FDI GDP GNI GUS HBS IBRD IFIs ILO IMF LFS Analytic and Advisory Activities Bank Guarantee Fund Council of Ministers Consumer Price Index Country Partnership Strategy Country Partnership Strategy Progress Report Development Policy Loan European Commission Europe and Central Asia Region Excessive Deficit Procedure European System of Accounts European Union Flexible Credit Line Foreign Direct Investments Gross Domestic Product Gross National Income National Statistical Office Household Budget Survey International Bank for Reconstruction and Development International Financial Institutions International Labor Organization International Monetary Fund Labor Force Survey LG MoF MoH MoLSP MPC MTO MYSFP NBP NFZ NIK OECD PER PFA PFM PIT PLN PSIA RER SGP SME TA VAT ZUS Local Government Ministry of Finance Ministry of Health Ministry of Labor and Social Protection Monetary Policy Council Medium Term Objective Multi-Year State Financial Plan National Bank of Poland National Health Insurance Fund Supreme Audit Office Organization for Economic Cooperation and Development Public Expenditure Review Public Finance Act Public Finance Management Personal Income Tax Polish Zloty Poverty and Social Impact Analysis Regular Economic Report Stability and Growth Pact Small and Medium Enterprises Technical Assistance Value-Added Tax Social Insurance Institution Vice President: Country Director: Sector Director: Sector Manager: Task Team Leaders: Co-Task Team Leader: Philippe Le Houerou Mamta Murthi Yvonne Tsikata Satu Kahkonen Gallina A. Vincelette Ewa Korczyc ii

3 REPUBLIC OF POLAND SECOND PUBLIC FINANCE DEVELOPMENT POLICY LOAN (DPL2) TABLE OF CONTENTS I. INTRODUCTION AND COUNTRY CONTEXT... 1 II. MACROECONOMIC POLICY FRAMEWORK RECENT ECONOMIC DEVELOPMENTS MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY RELATIONS WITH THE IMF... 9 III. THE GOVERNMENT S REFORM PROGRAM... 9 IV. THE PROPOSED POLICY LOAN LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION PRIOR ACTIONS AND RESULTS CONSOLIDATING PUBLIC FINANCES STRENGTHENING FISCAL INSTITUTIONS ADVANCING LONG-TERM FISCAL REFORMS ANALYTICAL UNDERPINNINGS LINK TO CPS AND OTHER BANK OPERATIONS CONSULTATIONS AND COLLABORATION...18 V. OTHER DESIGN AND APPRAISAL ISSUES POVERTY AND SOCIAL IMPACT ENVIRONMENTAL ASPECTS FIDUCIARY, DISBURSEMENT AND AUDITING ASPECTS IMPLEMENTATION MONITORING AND EVALUATION...22 VI. RISKS AND MITIGATION ANNEX 1: POLICY AND RESULTS MATRIX...25 ANNEX 2: LETTER OF DEVELOPMENT POLICY...27 ANNEX 3: IMF RELATIONS NOTE...30 This loan was prepared by an IBRD team comprising John Balafoutis, Agnès Couffinhal, Joseph Formoso, Daria Goldstein, Herwig Immervoll, Ewa Korczyc (co-ttl), Marcin Piatkowski, Wolfhart Pohl, John D. Pollner, Marc Robinson, Anita Schwarz, Nistha Sinha, Emilia Skrok, Kenneth Simler, Victoria Strokova, Ramya Sundaram, Gallina A. Vincelette (TTL) and Iwona Warzecha. Malgorzata Michnowska and Maria Andreina Clower provided support to the team. iii

4

5 LOAN AND PROGRAM SUMMARY REPUBLIC OF POLAND SECOND PUBLIC FINANCE DEVELOPMENT POLICY LOAN Borrower Implementation Agency Financing Data Operation Type Main Policy Areas Program Development Objective(s) REPUBLIC OF POLAND MINISTRY OF FINANCE IBRD Loan Terms: IBRD Flexible Loan in EUR at 6-month EURIBOR for EUR plus variable spread, with 18-year maturity, including 5.5 years of grace period, level repayment of principal and commitmentlinked repayment schedule. Amount: EURO 1,000.0 million (USD 1,307.8 million equivalent) Programmatic (2 nd of 2), single-tranche Public finance, pensions, health and social assistance This is the second in a series of two development policy loans supporting the government of Poland s goal of strengthening public finances. The DPL program is central to the Bank s engagement in the country in the area of public finance reform, as described in the Country Partnership Strategy Progress Report (CPSPR) presented to the Board on June 7, The CPSPR highlights that the DPL program is expected to support Poland s fiscal consolidation agenda, while strengthening fiscal institutions and improving the efficiency and sustainability of social spending. The programmatic DPL is structured around three pillars with the following development objectives: (i) consolidating public finances to ensure a steady decline of the fiscal deficit to stabilize and over the medium term reduce public debt; (ii) strengthening fiscal institutions to ingrain a prudent fiscal stance (including at the subnational level) over the medium term; and (iii) advancing long-term fiscal reforms to secure the sustainability of social spending in view of Poland s demographic challenge. These policies aim to enhance Poland s economic resilience in the face of adverse times and to protect fiscal space for key growth-enhancing investments. Results Indicators 1. By the end of 2013, the public debt-to-gdp ratio (national definition) is stabilized at or below the 2011 level 2. By the end of 2013, the local governments debt-to-gdp ratio (ESA 95 definition) is stabilized at or below the 2011 level 3. By the end of 2013, the social security funds deficit-to-gdp ratio (ESA 95 definition) is reduced compared to Hospital arrears are reduced by 8 percent by end-2013 compared to end The last-resort minimum income benefit for a typical poor family is increased in 2013 compared to 2011 Overall Risk Rating Moderate Operation ID Number P iv

6

7 IBRD PROGRAM DOCUMENT FOR A PROPOSED SECOND PUBLIC FINANCE DEVELOPMENT POLICY LOAN TO THE REPUBLIC OF POLAND I. INTRODUCTION AND COUNTRY CONTEXT 1. This proposed second development policy loan (DPL2), in a programmatic series of two development policy loans, supports the government of Poland in strengthening its public finances. After the deterioration in the fiscal accounts induced by the global financial crisis and continued external pressures, 1 the Polish authorities view strengthening public finances critical to maintain economic resilience, preserve favorable access to financial markets, protect fiscal space for strategic growth-enabling investments, and secure fiscal sustainability. The DPL series is central to the Bank s engagement in Poland as described in the Country Partnership Strategy Progress Report (CPSPR) presented to the Board on June 7, The proposed amount for the second loan (DPL2) is EUR 1 billion. 2. Sound macroeconomic policies coupled with limited external imbalances have helped Poland maintain economic growth despite the slowdown and economic uncertainty in Europe since Poland is the only European Union (EU) country that has grown continuously over the last five years. Moreover, its economy has expanded faster than any other economy in the EU since 2007 (Figure 1). As a result, Poland has reduced the per capita-income gap with EU15 countries by almost 10 percentage points to 58 percent over the last four years Notwithstanding these positive developments over the past few years, Poland is not immune to the protracted recession in the Euro area. Due to the prevailing uncertainty in the Euro area, subdued global demand and weakening domestic demand, growth slowed to 2 percent in 2012 and is expected to slow even further in Poland is closely tied through production, trade and finance with the Euro area, facilitating the spread of both adverse and positive developments from the west to the east of the EU. Since the global crisis in 2008, policies have been geared towards rebuilding the policy space to counter adverse shocks. The Government has taken steps to strengthen medium- and long-term fiscal sustainability. Since the economic slowdown in the second half of 2012, the Government has been putting more emphasis on policies aimed at boosting Poland s economic growth, while preserving sustainable fiscal stance through supporting investment, further deregulation in the product and labor markets, and support to families. This DPL directly supports the authorities efforts to strengthen public finance in a growth-friendly manner. 4. Poverty has remained low. Poverty has been on a declining trend since 2004 (Figure 2). 3 Poverty continued its descent in each year after 2008, albeit at a slower pace than in the period The fiscal deficit widened from 1.9 percent of GDP in 2007 to 7.9 percent of GDP in 2010 and public debt level increased from 45 percent of GDP to 54.8 percent of GDP over the same period. 2 The group of EU15 countries comprises: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom. 3 The social assistance threshold is used in Poland as one of several poverty thresholds. However, because thresholds are infrequently adjusted, their real value changes over time. Alternative poverty measurements are therefore more informative. The ECAPOV US$5 per day poverty line is set in constant 2005 USD adjusted for Purchasing Power 1

8 2008. The poverty profile remains broadly unchanged. The incidence of poverty is high among the unemployed, families with household heads with low education, families with many children, and households in small towns and rural areas. The Gini coefficient suggests that inequality has remained essentially unchanged over the last seven years. Figure 1: EU27 Countries Output Level in 2012, 2007= EL LV IT IE PT SI EE HU DK ES FI LT UK NL LU FR CY CZ RO BE AT BG DE SE MT SK PL Source: Eurostat, World Bank staff estimates. Figure 2: Poverty and Inequality in Poland, Gini coefficient Social assistance threshold ECAPOV $5/day Eurostat poverty or social exclusion Note: See footnote 4 for definitions of the poverty lines. Source: HBS, GUS, World Bank staff calculations 5. Prime Minister Tusk began a second term in office in November 2011, with the next general election scheduled for late The new coalition government has a small majority in Parliament, but faces a divided opposition. The Government was elected with a strong mandate for reform, particularly in the areas of public finance, financial sector stability and the business environment. This second term in office opened a window of opportunity to launch necessary, albeit politically difficult, reforms. II. MACROECONOMIC POLICY FRAMEWORK 2.1. RECENT ECONOMIC DEVELOPMENTS 6. Poland s economy has performed well during and after the 2008 global financial crisis. Strong macroeconomic fundamentals, including limited macroeconomic imbalances at the onset of the crisis, large and diversified domestic economy, close trade and supply chain linkages to Germany and adequate policy mix prior to and during the crisis, helped the economy withstand external shocks. Accommodative monetary policy and automatic fiscal stabilizers supported economic growth, while solid banking regulation and supervision strengthened the resilience of the financial sector. In 2010 and 2011, the real gross domestic product (GDP) growth accelerated to around 4 percent on the back of strong consumption and improved labor market conditions. Investment rebounded, driven by the absorption of EU funds and spending for the 2012 European Soccer Championship. Parity. The Eurostat poverty or social exclusion concept uses a composite indicator that measures the proportion of the population living in households that have one or more of the following deprivations: (1) equivalized disposable household income after social transfers that is less than 60 percent of national median income, (2) severe material deprivation, measured as being unable to afford at least four of nine basic goods or services, or (3) low work intensity, defined as the sum of hours worked by working-age household members being less than 20 percent of their potential working hours. 2

9 7. Economic activity started to weaken considerably in Overall, the economy grew by 1.9 percent in 2012, but the macroeconomic picture changed substantially throughout the year. While in the first quarter the economy expanded by 3.5 percent, it slowed to 0.7 percent in the fourth quarter on the back of weakening domestic demand. Lower consumer and business confidence, a slack labor market, and declines in real wages, hampered consumption growth. Investment activity subsided due to the end of the investment cycle related to the EU financial perspective , the completion of investments for the European Soccer Championships and the ongoing fiscal consolidation. Despite lower demand among Poland s trading partners, net exports supported growth. High frequency short-term indicators for industrial production and construction point to a continued weakness of the economy, which is likely to bottom out in the first quarter of The labor market proved resilient in the times of the global crisis, but deteriorated in 2012 and early Unemployment rates according to the Labor Force Survey (LFS) stayed at around 9.5 percent during , that is a 2 percentage-points increase from the pre-crisis level. Over 2012, the harmonized unemployment rate (seasonally adjusted) increased to around 10.4 percent in December 2012 and continued to rise to 10.6 percent in January and February As a result of slowing output growth and uncertain growth prospects, the crisis-induced labor hoarding came to an end as employers started to reduce employment rather than working hours. In addition, weaker performance of construction and labor-intensive manufacturing led to significant layoffs in these sectors. 9. While external imbalances have narrowed, vulnerabilities remain. The current account deficit narrowed from 6.6 percent of GDP in 2008 to 3.5 percent in The biggest improvement came from the trade balance, as exports grew faster than imports. The effect was partially countered by the deterioration in the income account, reflecting increased transfers to foreign holders of sovereign debt. The share of portfolio inflows into the bond market increased substantially as foreign investors (mainly real money investors with long investment horizons) purchased government bonds, which in early 2013 reached record low yields (10 year bonds below 4.5 percent). At the same time, the process of orderly financial sector deleveraging continued with funding withdrawal by foreign banks. Nearly 90 percent of the current account deficit was financed by net foreign direct investment (FDI) (around 0.9 percent of GDP) and EU capital transfers (around 2.2 percent of GDP in 2012). External debt, which was around 55 percent of GDP in the pre-crisis period, increased to around 70 percent of GDP by end-2012, reflecting the increase in government indebtedness. The share of short-term debt in total external debt dropped to 19.2 percent in December 2012 from around 25 percent in The level of international reserves remained broadly adequate, covering 5.6 months of imports of goods and services (as of February 2013). 10. Monetary policy helped the adjustment during , anchored inflation expectations during the rebound , and become accommodative towards the end of During the global financial crisis, the flexible exchange rate facilitated the economy s adjustment to external shocks. Monetary policy was accommodative with cuts in policy rates and liquidity provision. Inflation pressures increased in 2011, mostly driven by higher food and energy prices, a value added tax (VAT) hike, robust domestic demand, and PLN depreciation. In response, the Monetary Policy Council (MPC) hiked policy rates by a cumulative 1 percentage point in the first half of 2011 and another 25 basis points in May Headline inflation declined subsequently to 3.4 percent in October 2012 from its peak of 5 percent in May In response to slowing output growth and muted wage pressures, the MPC started an easing cycle. Between November 2012 and March 2013, the policy rate was cut by 150 basis points to 3.25 percent. While the overall inflation 3

10 rate in 2012 was at 3.7 percent, a level above the National Bank of Poland (NBP) tolerance band of percent, inflation rate in March 2013 was already below the lower limit of NBP s tolerance band (1 percent). According to the IMF s assessment, Poland s real effective exchange rate is broadly consistent with fundamentals The financial sector has proven resilient. The banking sector has not required public support and remains well capitalized, liquid and profitable. The capital adequacy ratio remained strong (at 14.7 percent in December 2012, 90 percent of which is Core Tier 1 capital), and liquidity was high. According to preliminary data, the profit of the banking sector stood at over PLN 16 billion in 2012, which is almost 4 percent higher than in the record-breaking year of The deleveraging of the Euro area banks has been orderly: the fall in foreign funding was offset by rising domestic deposits. Private sector credit growth slowed to less than 1 percent at the end of 2012 (from above 13 percent a year ago) on account of deteriorating business and consumer confidence. 12. Yet, the financial sector has vulnerabilities. While these are not vulnerabilities of systemic nature, they stem from: (i) a large overhang of FX-denominated mortgages, 55 percent of total residential mortgages at end-2012; (ii) a still high level of nonperforming loans (NPLs) at around 8.8 percent of the loan portfolio in 2012, concentrated on consumer credit and corporate loans; and (iii) possible pressures on bank funding and volatility of capital flows. Yet, stress tests suggest that even under severe scenarios, the share of assets at risk is small, liquidity sufficient and contagion risks limited. 13. The Government has pursued counter-cyclical fiscal policies that cushioned the slowdown in and supported the recovery in The general government deficit increased from 3.7 percent of GDP in 2008 to 7.9 percent of GDP in The increase in fiscal imbalances resulted in a rise of public debt from 47.1 percent of GDP in 2008 to 54.8 percent of GDP in The rise was contained by strong public debt and liquidity management, 5 stable interest rates on Polish debt, and stepped up privatization. 14. With the growth rebound in 2011, the Government initiated a process of fiscal consolidation, which has helped to put public debt on a declining path (Table 1). The general government headline deficit declined to 5 percent of GDP in 2011 and further to 3.9 percent in The structural consolidation was even more significant the structural deficit dropped from 5.1 percent of GDP to 3.4 percent of GDP in The fiscal effort was a result of a combination of revenue and expenditure measures: The main measures on the revenue side were: (i) a change in the pension system that shifted 5 percentage points of the contribution from the funded second pillar to the first pillar (sub-account managed by the Social Insurance Institution (ZUS)); (ii) a one percentage-point increase in the VAT statutory rate; (iii) a 2 percentage-points increase in the statutory rate on disability contributions paid by employers; (iv) a new tax on copper and silver; (v) revenues from CO2 emission rights auctions; (vi) no adjustments to personal income tax (PIT) thresholds; and (vii) increases in various excise taxes. 4 International Monetary Fund, Article IV, Staff Report, July The 2010 amendment of the Law on Public Finance introduced consolidation of cash management by compulsory or voluntary depositing temporary free cash resources of public sector entities to MoF accounts. This aimed at more efficient cash liquidity management to limit public debt. 4

11 The growth in government spending was contained by: (i) a temporary fiscal rule 6 limiting increases in all newly enacted and existing discretionary expenditure items to 1 percentage point over the rate of inflation (CPI); and (ii) a nominal freeze of the budgetary sphere wage bill 7, and (iii) phasing out of early retirement schemes MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 15. Given the challenging external environment, economic growth in Poland is likely to remain weak in With continued recession in the Euro area and slower pace of growth in Germany and other major trade partners, Poland s GDP growth rate is expected to be around 1.3 percent in With growth in exports outpacing that of imports and a relatively weak PLN, net exports are expected to have a positive contribution to growth. Domestic demand will remain subdued. Investment growth is projected to be negative in 2013, as business confidence continues to be weak and firms postpone investment decisions. Lower availability of EU funds at the end of the programming period and the ongoing fiscal consolidation will result in a further decline in public investment. The recently announced Polish Investment Program 8 is still being designed and is unlikely to support investment activity in The deceleration of investment activity will translate into weak performance in the manufacturing and construction sectors. Public consumption will continue to be restrained by the ongoing fiscal consolidation, while private consumption is expected to be affected by negative labor market developments. In the second half of 2013, private consumption should start to recover gradually on the back of rising real wages supported by lower inflation, pension indexation and easing credit conditions Over the medium-term growth is expected to strengthen to around 3.5 percent. The external demand is expected to recover. At the moment, the EU economy is likely to bottom out in the first half of 2013 and return to growth in 2014, as confidence gradually rebounds. 10 The Polish economy will benefit from the improved external environment. Growth is projected to strengthen to around 2.4 percent in 2014 and further to 3.5 percent by the end of forecasting period. In addition to external factors, Poland s growth would pick up on the back of domestic factors: higher investment activity related to the receipt of EU structural funds 11 and the kick-off of the Polish Investment Program. Private consumption will remain subdued. The unemployment rate is expected to decline in 2015, once growth strengthens (Table 1). 17. Monetary policy is projected to remain accommodative. The inflation rate is forecasted to stay close to the lower limit of the NBP s tolerance band through the forecasting period. Lack of 6 The temporary fiscal rule was introduced as an amendment to the Public Finance Act in December The rule is automatically enforced when Poland is under the EDP. 7 The 475,000 employees of the state budgetary sphere are public sector employees directly under the control of the central government. 8 The Polish Investment Program announced by the Prime Minister in October 2012 is aimed at providing financial resources for investment into energy, infrastructure, and R&D in Poland. Part of the privatization proceeds will be used to boost the capital base of the state development bank (BGK) and a special investment vehicle (Polskie Inwestycje Rozwojowe) to leverage private sector resources for investment. The total value of the Program for is expected to be around PLN 40 billion (US$13 billion). 9 The recent decision of the Financial Supervisor to relax credit underwriting standards (Recommendation T) and a Government s guarantee scheme for SMEs are factors contributing to the easing of credit conditions in Poland. 10 Assessment of the external environment is based on EC Winter Economic Forecast, European Commission, March The EU economy is expected to grow 0.1 percent in 2013 and 1.6 percent in 2014; the Euro area is expected to remain in recession in 2013 (-0.3 percent) and return to growth in 2014 (1.4 percent). 11 Poland will get EUR 73 billion for for cohesion policy, roughly 2.5 percent of GDP annually. 5

12 domestic demand pressures and moderating commodity prices are likely to keep the inflation rate in check and may lead to further monetary easing in the first half of 2013, although the 50 basis points cut from March 2013 makes further cuts less likely. Real economy Table 1: Key Macroeconomic Indicators (change in percent unless otherwise indicated) (f) 2014 (f) 2015 (f) 2016 (f) Annual percentage change, unless otherwise indicated GDP (billion zloty) 1, , , , , , ,902.1 Real GDP Per Capita GDP (In US$ Atlas Method) 12,390 12,340 12,670 12,900 13,080 13,590 14,290 Contributions: Consumption Investment Net exports Imports Exports Unemployment rate (ILO definition) CPI (average) Fiscal Accounts Percent of GDP, unless otherwise indicated Expenditures Revenues General Government Balance Structural Government Balance General Government Debt (ESA95) Genral Government Debt (national methodology) Selected Monetary Accounts Annual percentage change, unless otherwise indicated Base Money Credit to non-government (eop) Interest (key policy interest rate, eop) Balance of Payments Percent of GDP, unless otherwise indicated Current Account Balance Imports Exports Foreign Direct Investment Gross Reserves (in millions US$, eop) 93,514 97, , In months of next years imports As % of short-term external debt External Debt Terms of Trade (index 1995=100) Exchange Rate (average) Other memo items e.g., GDP nominal (in billions of US$) Source: Ministry of Finance (MoF), IMF, World Bank staff estimates. Notes: The main difference between the national and ESA 95 definitions of public debt is that the former excludes debt of the National Road Fund (included under the ESA 95 definition). (f) refers to forecasts for on key macroeconomic variables. 18. On the external side, the current account deficit is expected to stay close to 3.5 percent of GDP over the medium term. It is projected to be financed mostly by FDI inflows and EU transfers (Table 2). The external debt will remain close to 70 percent of GDP over the medium term and its maturity structure is not expected to change significantly from 2012 (Table 3). External 6

13 debt roll-over rates are expected to be around the average of the last four years, i.e. around 110 percent. The sustainability of the external debt position is generally robust according to standard stress scenarios, including an increase in nominal interest rates, lower GDP growth and a higher current account deficit (Figure 3). In addition, private sector flows and continued favorable access to international capital markets suggest that external financing needs can be met. By the end of February 2013, over 50 percent of government s financing needs for 2013 were covered. Table 2: Medium-term Projections of External Financing Requirements and Sources (US$ billions) BOP financing requirements and Sources Source: World Bank staff estimates Financing requirements (US$) Current account deficit Short term debt amortizations Medium and Long term debt amortization (excl. IMF) Financing Sources (US$) FDI and portfolio equity investments (net) Capital grants Short term debt disbursements Medium and Long term debt disbursements (excl. IMF) Change in reserves IMF credit (net) Table 3: External Debt, 2012 (US$, billion) USD, bln Share of total debt % of GDP Monetary authorities General government Banks Other sectors of which intercompany lending Total external debt long-term short-term Source: NBP, World Bank staff estimates. Notes: Due to exchange rate differences between average and end-of-period rate, the external debt to GDP ratio differs from the one in table 1. Figure 3. External Debt Sustainability 12 (External debt projections as percent of GDP) Figure 4.Public Debt Sustainability 12 (Public debt projections as percent of GDP) Source: MoF, NBP, World Bank staff calculations. Notes: The shaded area reflects historical values. The nominal interest rate is at baseline plus one-half standard deviation, real GDP growth is at baseline minus one-half standard deviations, non-interest current account is at baseline minus one-half standard deviations. Source: MoF, World Bank staff calculations. Notes: The shaded area reflects historical values. Real interest rate is at baseline plus one standard deviation. Real GDP growth is at baseline minus one-half standard deviation. Primary balance is at baseline minus one-half standard deviation 12 Public debt in Poland is largely domestic. Under the described GDP growth shock scenario, public debt is more sensitive to changes in GDP than external debt. Under this scenario, the current account deficit narrows leading to a lower external debt in year (t+1), while the general government primary deficit increases (as automatic stabilizers increase expenditures, while revenue collection suffers), thus leading to a higher public debt. 7

14 19. Despite the slowdown in economic growth, the Government is committed to strengthening its fiscal balances over the medium term. The fiscal deficit is projected at around 3.5 percent of GDP in While the deficit reduction path is delayed as compared to the one projected in the Convergence Program Update of April 2012 due to a weaker growth outlook, it remains consistent with Poland s commitment under the Excessive Deficit Procedure (EDP) (Table 4). In 2014, the general government deficit is expected to decline to close to 3 percent of GDP. The revenue-to-gdp ratio is expected to decline over the forecasting horizon due to: the end of the temporary increase in VAT rates in 2014, a decrease in pension contributions retained in the first pillar, and a reinstatement of VAT reimbursement for company cars. The expenditure-to-gdp ratio is planned to decline even more, mainly due to a decrease in public investment. Over the medium term, the Government is expected to gradually reduce its structural fiscal deficit to 1 percent of GDP in line with its medium-term objective (MTO). By the end of the forecasting period, the structural deficit is projected to decline to 1.5 percent of GDP from almost 3 Table 4: Fiscal Developments and Prospects (percent of GDP unless otherwise indicated, ESA 95, General Government) (f) Overall Balance Primary balance Total Revenues Taxes Indirect taxes Direct taxes Capital taxes <0.1 <0.1 <0.1 <0.1 <0.1 Social contributions Sales Other current revenue Capital revenue Total expenditure Intermediate consumption Compensation of employees Interest Subsidies Social benefits Other current expenditure Capital transfers payable Capital investments General Government Financing External (net) Domestic (net) of which: privatization Source: MoF, IMF, World Bank staff estimates. Note: General Government Financing refers to the forecasted period only. percent in The fiscal adjustment is supported by structural reforms in the areas of pensions; social assistance; and health to secure the sustainability of public finances and to protect fiscal space needed for strategic infrastructure and human capital investments (see Section III). 20. The public debt to GDP ratio is expected to stabilize in Weaker output growth is likely to slow the path of public debt reduction. Per the ESA 95 methodology, public debt is projected to be close to 56 percent of GDP in 2013 and 2014 before it declines to 55 percent in This would ensure that Poland s public debt remains below the Maastricht ceiling of 60 percent of GDP (per ESA 95 methodology) and the national debt limit of 55 percent of GDP (per national methodology). 14 Stress tests suggest that the debt path is sensitive to a growth shock, 15 which might put the level of public debt above the EU threshold of 60 percent of GDP (Figure 4). 13 Given the external uncertainties, a budget revision might be required in the second half of 2013 to reflect the slowing pace of economic growth. 14 The Public Finance Act prompts corrective action when the public debt reaches 55 percent of GDP, in addition to the constitutional ceiling for public debt at 60 percent of GDP. Starting in 2013, the Government is planning to change the rules for calculating public debt to GDP ratio (national methodology) with respect to the applicability of sanctions. In 8

15 21. The macroeconomic policy framework is considered adequate for the proposed operation. The macroeconomic policies implemented during and after the global financial crisis facilitated the needed adjustment, economic resilience and growth. With uncertainty in the external environment, current macroeconomic policies are geared to mitigate the negative effects of shocks through prudent fiscal and monetary policies, while keeping external imbalances in check and maintaining the financial system adequately capitalized. Downside risks to the macroeconomic outlook include further instability in the Euro area and external debt deleveraging through parent bank funding of local subsidiaries (see Section VI) RELATIONS WITH THE IMF 22. The Executive Board of the International Monetary Fund (IMF) approved a successor two-year arrangement for Poland under the Flexible Credit Line (FCL) in the amount of US$33.8 billion in January The IMF Executive Board considered that, despite the slowdown, the Polish economy has shown resilience since the onset of the global economic crisis thanks to very strong economic fundamentals and policy frameworks, and skillful macroeconomic management. The FCL arrangements have allowed for a more flexible policy response to the global crisis while preserving favorable access to international capital markets. The IMF Board also concluded that Poland continues to meet the qualification criteria for access to FCL resources. The Polish authorities intend to continue to treat this arrangement as precautionary. An IMF-World Bank FSAP mission took place in February-March III. THE GOVERNMENT S REFORM PROGRAM 23. Strengthening public finances and sustaining medium-term economic growth are the core priorities of the Government s reform agenda. Following parliamentary elections in 2011, Prime Minister Tusk launched a medium-term program aimed at: (i) strengthening public finances, (ii) safeguarding financial sector stability, and (iii) supporting private sector growth. At that time, fiscal consolidation and medium- and long-term fiscal reforms were priority areas for the Government, which was focused on rebuilding fiscal space to enable proper response to adverse external shocks. The Government was successful in the implementation of its fiscal consolidation strategy in 2011 and 2012 (even despite significantly lower growth rate), which delivered cumulative fiscal savings of around 4 percentage points of GDP by end-2012 and put the government debt-to- GDP ratio on a declining path. An ambitious reform agenda related to medium- and long-term fiscal sustainability issues, particularly in social sectors, was delivered. For example in the area of pensions, the Government managed to increase and equalize the retirement age and introduce changes to the uniformed services pension system. The Government is currently reviewing the entitlements to early pensions of other professional groups such as miners, establishing a pay-out mechanism from the second pillar and reviewing the functioning of the second pension pillar. 24. The Prime Minister announced in October 2012 reform measures aiming to boost economic growth and protect jobs. These measures include a bold off-budget medium-term investment program, 16 a guarantee scheme for small and medium enterprises (SMEs), a broadening of the tax base, regulatory reforms aimed at boosting resilience of the financial sector, an increase in case public debt to GDP ratio exceeds any of the precautionary thresholds, the ratio will be re-calculated using the average (instead of end-of period) exchange rate for the calculation of public debt stock. Corrective actions will be triggered only if the re-calculated ratio is not with compliance with public debt safety thresholds. 15 In this scenario real GDP growth rate is at baseline minus 2 percentage points in each year of the projection period. 16 See footnote 11. 9

16 the flexibility of the labor market, and further deregulation of the economy. In addition, the Government supports families and helps them enter and (re)enter the labor market to address pressures due to an aging population. 17 New spending measures included in the Government program are in line with the fiscal consolidation goals and within the public debt safety thresholds. In calendar year 2013, the Government intends to announce regulations for providing annuities from the pension funds, which may result in increasing public liabilities. IV. THE PROPOSED POLICY LOAN 4.1 LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION 25. The DPL program supports the Government s priority of strengthening public finances. The policy measures are encapsulated in three core areas: (i) consolidating public finances in the short term; (ii) strengthening institutions to ensure a prudent fiscal stance over the medium term; and (iii) advancing long-term structural fiscal reforms. The objectives of this DPL program are to stabilize public debt levels at the national and local government level, and over the medium term (beyond the scope of this operation) reduce public debt. The program is also geared towards securing the fiscal sustainability of social programs, including in the context of an aging population. Lastly, these reforms aim to create the needed fiscal space to support pro-growth policies over the medium term. 26. Adjustments to the scope and the timeframe of Government s reform agenda led to modifications of some indicative DPL2 triggers without compromising the strength and integrity of the DPL program (Table 5). The DPL program presented to the IBRD Board of Executive Directors in June 2012 outlined eight indicative triggers for the proposed DPL2. Four indicative triggers became prior actions of DPL2. One additional prior action was added to reflect the authorities efforts in strengthening macro-prudential policies. Two indicative triggers were reformulated to better reflect the Government s plans, and two other triggers were dropped due to the broadening of the scope of the government s reform agenda. Namely, the indicative trigger on health was dropped as the Ministry of Health (MoH) embedded the creation of a tariff agency into a larger sectoral reform program, currently under design. The broader health sector reform envisions liquidating the central agency of the health insurance fund (NFZ), decentralizing its powers to regional agencies, and creating a new central agency responsible for costing, health technology assessment, quality assurance, development of health information systems, and oversight of public and private health insurers. The trigger focusing on income accounting for farmers was dropped as the Government decided to bundle the income accounting with the introduction of income taxation for farmers. With this decision the scope of the reform significantly expanded, affecting the time frame of its implementation. Despite these modifications, the original outcome indicators of the DPL program are on track to be achieved. 17 Poland is among the European countries with the worst demographic outlook, where the working age population is projected to shrink by around 10 million people by 2060 from 27 million in 2010 to around 17 million in

17 Table 5: DPL2 Indicative Triggers and Prior Actions DPL2 Indicative Triggers DPL2 Prior Actions Notes Enact a Budget Law for 2013 in line with the requirements of the EU Excessive Deficit Unchanged. 18 Procedure Enact amendments to the Public Finance Act to introduce a cap on the aggregate deficit of local governments. Enact amendments to the Public Finance Act to strengthen the quality of LGs multi-year financial forecasts and start implementation by introducing a template and periodic reporting requirements. Reformulated. The reformulation focuses on strengthening the quality of multi-year financial forecasts by LGs and making them an effective tool for public Enact a permanent fiscal rule to limit growth of public expenditures to trend GDP growth. MoF designs assumptions for the permanent fiscal rule to limit growth of public expenditure to trend GDP to foster compliance with the EU requirements under the ratified Treaty on Stability, Coordination and Governance in the EMU. MoF sends for inter-ministerial consultations the draft law on bank resolution to strengthen the stability of its financial system. Enact amendments to the law on pensions to increase statutory retirement age and start implementation. Enact amendments to the pension legislation on uniformed services to increase length of service and introduce minimum retirement age. Enact legislation to introduce income accounting for farmers for tax purposes. Enact a Law establishing a tariff agency to adequately price health procedures. Enact amendments to social assistance and family benefits legislations to: (i) increase the income threshold for the last-resort minimum-income social assistance benefit that tops up the incomes of the poorest; and (ii) improve targeting of the benefit for caregivers of disabled dependents. finance management. Reformulated. The reformulation reflects Government s changed timeline for the enactment of the permanent fiscal rule, and signals its strong commitment to this reform. New (added). Unchanged. Unchanged. Dropped. Now imbedded in a reform program with a significantly expanded scope. Dropped. Now imbedded in a reform program with a significantly expanded scope. Unchanged PRIOR ACTIONS AND RESULTS CONSOLIDATING PUBLIC FINANCES 27. Ensuring a further decline in the structural deficit to stabilize and over the medium term reduce public debt and maintain Poland s favorable access to capital markets is a key priority of the Polish Government. Building on the progress made in 2011 and 2012, a further reduction in the fiscal deficit is crucial to adhere to Poland s commitment under the EDP, to meet the MTO of a structural fiscal deficit of 1 percent of GDP over the medium term, to rebuild fiscal policy buffers to counter external shocks, and to protect priority growth-enhancing spending. 28. The expected result of the measures supported under this pillar is to stabilize the public debt-to-gdp ratio. The fiscally responsible budgets for 2012 and 2013 have directly contributed to a decrease in the general government deficit from close to 8 percent of GDP in 2010 to 3.9 percent of GDP in The reduction in the fiscal deficit in 2012 has been instrumental for putting public debt on a downward path (Table 4). 18 In 2013, Poland remains subject to the EDP. Hence, the DPL2 prior action formulation relates to the 2013 Budget Law s requirement to remain in line with the EU EDP. 11

18 DPL2 Prior action: Enact a Budget Law for 2013 in line with the requirements of the EU Excessive Deficit Procedure. 29. The fiscal measures embedded in the 2013 budget are expected to bring further reduction in the headline deficit (Table 6). The headline fiscal deficit is estimated to decrease by 0.4 percentage point of GDP to 3.5 percent of GDP in 2013, which would allow Poland to exit the Excessive Deficit Procedure. On the revenue side, the 2013 fiscal consolidation relies on tax and social insurance contribution measures initiated in the past two years as well as one-off measures introduced in The increase in the VAT rate in 2011 and the increase in the statutory rate on disability contributions paid by employers in 2012 will render fiscal savings also in The new measures in the 2013 budget are mainly of a one-off nature and include the sale of CO2 emission rights, digital dividends, and revenues from the new system of traffic control. On the expenditure side, the fiscal consolidation in 2013 is based on containment measures. Similar to the revenue side, a number of measures were introduced in the context of 2011 and 2012 budgets, but their continued implementation will bring fiscal savings in These measures include the temporary CPI +1 rule that limits the growth rate of discretionary expenditures to one percentage point over the CPI rate, the nominal freeze of the wage bill in the state budget, and fiscal savings from the abolition of early retirement schemes (Table 6). Table 6. Estimated Fiscal Impact of Measures in the 2013 Budget (Percent of GDP) Revenue Expenditure Sale of CO 2 emission rights 0.2 Temporary Expenditure Rule (CPI+1) 0.2 Revenues from New Toll system 0.1 Freeze in budgetary wage bill 0.1 Digital dividends 0.1 Abolition of early retirement schemes 0.3 Redirection of pensions contributions -0.2 Increase in disability contribution 0.1 Freeze in PIT Thresholds 0.1 TOTAL 0.4 TOTAL 0.6 Source: MoF; IMF, World Bank estimations STRENGTHENING FISCAL INSTITUTIONS 30. Measures related to strengthening fiscal institutions are crucial to ingrain a prudent fiscal stance over the medium-term. The Government policies under this pillar will help in: (i) containing the growth of public expenditures through the introduction of a permanent fiscal rule; (ii) increasing the LGs reporting requirements and implementing the guidelines for the Multiannual Financial Forecast (MFF) to ensure control of the deficit and debt of the LGs; and (iii) enhancing the macro-prudential framework, which contributes to strengthening the resilience of the economy against systemic shocks and the need for costly banks recapitalizations. 31. The expected result of the measures under this DPL pillar is to stabilize LG s debtto-gdp ratio. Stronger fiscal institutions are expected to contribute to this outcome. In 2012, the LG s debt-to-gdp ratio has already decreased to 4.2 percent of GDP. 32. DPL2 Prior action: MoF designs assumptions for the permanent fiscal rule to limit growth of public expenditure to trend GDP to foster compliance with the EU requirements under the ratified Treaty on Stability, Coordination and Governance in the Economic and Monetary Union. 12

19 33. The proposed rule is an expenditure rule with a debt limit. The expenditure rule element would halt aggregate expenditures from growing faster than the trend nominal GDP, preventing pro-cyclical expenditure hikes. The debt limit element of the rule requires that expenditure growth be less than the trend GDP growth if public debt is too high relative to specified benchmarks. 19 When the public debt exceeds these benchmarks, any required reduction in the ratio is permanent, i.e. the rule is formulated to prevent the government from increasing future expenditure so as to restore the pre-existing expenditure-to-gdp ratio. Thus, the current design would introduce a one-way downward bias in the government expenditures-to-gdp ratio. The rule also contains a safeguard clause in case of severe crisis: the requirement for slower expenditure growth due to debt exceeding the benchmark levels is suspended only during severe recessions (defined as forecasted GDP growth at least 2-3 percent below trend). 37. The expenditure rule directly addresses the reason behind excessive deficits in Poland the excessive rate of growth of expenditures. An expenditure rule is more relevant at this time than a budget balance rule due to the complexities of measuring the structural fiscal balance. The expenditure rule would allow for the unrestricted operation of automatic stabilizers on the revenue side in case of a downturn. However, unlike the EU directive approach, the expenditure ceiling set by the rule is not affected by revenue increases (reductions) due to tax policy changes. DPL2 Prior action: Enact amendments to the Public Finance Act to strengthen the quality of LGs multi-year financial forecasts and start implementation by introducing a template and periodic reporting requirements. 34. Keeping a prudent fiscal stance over the medium term requires the Government to constrain the deficits of both the central and local governments. The MTO requirement for a structural deficit not exceeding 1 percent of GDP applies to the general government budget balance (i.e. the aggregated balances of local and central governments). Thus, budgetary performance and debt of LGs over the medium term is subject to limits, controls, and monitoring by the central government. 35. Existing legislation is presently sufficient to effectively control the aggregate LG deficit. Restrictions imposed by existing fiscal rules (Box 1), in particular the debt-servicing ratio rule and the golden rule, have proven to work effectively. The LG aggregate deficit has declined from 1.2 percent of GDP in 2010 to 0.7 percent of GDP in 2011, and further to 0.4 percent of GDP in 2012, mainly due to current spending reduction. As a result the aggregate LG debt-to-gdp ratio has also decreased. In these circumstances, the government has abandoned the introduction of a new explicit mechanism to limit aggregate deficit of LGs The introduction of a template and periodic reporting requirements of MFF by LGs will make the general government fiscal projections more realistic and effective for longterm financial planning. Since 2011, LGs have prepared MFF to enhance their long-term fiscal planning. However, the limited capacity of LGs, the different reporting standards used by various LGs, the very long-term horizon of fiscal projections, and the lack of obligations to report fiscal 19 If debt exceeds 40 percent of GDP, expenditure growth is limited to 80 percent of the trend nominal GDP growth. If debt exceeds 55 percent of GDP (or if the excessive deficit procedure is applied to Poland), a sharper consolidation is required, with expenditure growth limited to 70 percent of the trend nominal GDP growth. 20 Designing a sub-national fiscal rule is one possible way to explicitly limit the LG aggregate deficit. The key difficulty in the design of such a rule is to devise a mechanism to allocate deficit rights between LG units which is equitable and does not have major adverse effects on the efficient execution of debt-financed capital projects. 13

20 plans to the MoF have hindered the use of the tool. The recent improvements to the MFF, i.e. the establishment of a single template, the introduction of regular reporting in electronic format, and the shortening of a projection period are geared to make fiscal projections realistic and the MFF tool useful for public finance management. Box 1. Sub-national Fiscal Rules in Poland The Public Finance Act (PFA) lays out the following rules for LGs: (i) the debt of an individual LG unit may not exceed 60 percent of their revenue (excluding debt issued for pre-financing bridge financing of projects co-financed from EU funds); (ii) debt service (which includes debt repayment plus interest paid and guarantees due in a current year) may not exceed 15 percent of a local government unit's revenue (iii) the golden rule of a balanced current budget which implies no current (operational) deficit (since 2011). In addition, LGs face restrictions on their budgets if total public debt (state and local administrations debt combined) exceeds the limits of 55 percent and 60 percent of national GDP set in the Public Finance Act 21. Starting from 2014, the uniform ceiling on LG debt (60 percent of revenue) will be removed. In its place, LGs ability to incur new debt will depend on the debt-servicing ratio, and will therefore vary between different local government units. Under the Public Finance Act, debt servicing expenditure/total revenue cannot exceed the last three years average current balance plus revenue from asset sales/total revenue (Pursuant to provisions of PFA, LG unit, which will not generate operating surplus for the period will not be allowed to contract debts in 2014). DPL2 Prior action: MoF sends for inter-ministerial consultations the draft law on bank resolution to strengthen the stability of its financial system. 37. The government is pursuing a series of reforms to strengthen the macro-prudential oversight of the financial system and avoid costly fiscal recapitalizations or bank bail-outs. Cognizant of the need to strengthen the capacity of the financial system to support the economy, a bank resolution framework is being set up. The framework designates the Bank Guarantee Fund (BFG) as the resolution agency, equipped with a complete set of resolution tools. The new tools will allow starting the resolution procedure before a bank reaches full insolvency, partial transferring of a bank s balance sheet to other banks, applying administrative versus judicial powers, and deploying new debt write-down tools. Under the rules, BFG will not be allowed to provide open bank assistance/loans to banks unless these constitute part of a formal resolution process using the least cost criteria. The draft legislation is in line with the new EU Directive and the resolution principles espoused by the Financial Stability Board ADVANCING LONG-TERM FISCAL REFORMS 38. Strengthening public finances requires long-term structural reforms to secure sustainability across sectors. Since 2011, the Government has initiated structural measures of medium- and long-term nature with a focus on current transfers (pensions) and other public services (such as health care, social assistance). The focus of these reforms has been three-fold: (i) securing long-term sustainability of public finances by tackling the challenge of aging; (ii) creating fiscal space for pro-growth expenditures in the medium and long term; and (iii) supporting fiscal consolidation. The fiscal-structural measures supported by the DPL program are expected to yield fiscal savings between 0.7 and 1.1 percent of GDP annually (Table 7). 21 If the public debt exceeds the second prudential threshold (55 percent debt to GDP) local authorities have to adopt budgets adopt a budget with a deficit lower than in the previous year by a percentage calculated using a special formula. After crossing the third prudential threshold (i.e. 60 percent debt to GDP) LG expenditures cannot be higher than their revenues and local authorities cannot issue new guarantees. 14

21 Table 7. Estimated Fiscal Impact of Selected Measure Aimed to Advance Fiscal Sustainability (Percent of GDP, ) Annual average Retirement Age 1/ Uniformed Services' Pension Farmers Health Contribution 2/ 0.01 Child-birth Allowance Social Assistance 3/ na na TOTAL SAVINGS Notes: 1/ Excludes the marginal impact of the partial pension option 2/ In February 2012, the Government started collecting health insurance contributions from farmers with landholdings above six hectares. 3/ Net effect of savings from targeting care givers benefits and increase spending on social assistance Source: MoF; MoLSP; World Bank staff calculations. 39. The expected results of the measures supported under this DPL pillar are to: (i) reduce the social security funds deficit-to-gdp ratio, (ii) reduce hospital arrears, and (iii) improve the last-resort minimum income benefit for poor families. Positive results towards achieving the set result indicators under the third DPL pillar are already visible. The social security funds deficit turned into surplus of 0.2 percent of GDP in While the Law on Therapeutic Activities has not yet delivered a reduction in hospital arrears, 22 it has contributed to the restructuring and corporatization of the hospital sector. 23 Because it increases the financial accountability of hospital owners, the process will ultimately lead to an improvement of the financial sustainability of the hospital sector and also result in a reduction in hospital arrears. The adjustments in social benefits have increased the coverage and generosity of the last-resort minimum income benefit (see Section 5.1). 24 DPL2 Prior action: Enact amendments to the Law on Pensions to increase statutory retirement age and start implementation. 40. In 2012, the retirement age was increased in Poland. Retirement ages for both men and women are being raised from the current 65 for men and 60 for women to 67 for both men and women at the rate of 3 months per calendar year. As a result, the retirement age will be 67 for men retiring at the end of 2020 and for women retiring at the end of In response to concerns about individuals not being able to work that long, the Government instituted a new partial pension for men/women at least 65/62 years old, respectively, and with at least 40 years of pension contributions in the case of men and 35 years in the case of women. This new partial pension will be based on a half of the entitlement accumulated until that age and not subject to a minimum pension, 22 There are many channels through which the incentives put in place by the 2011 Law on Therapeutic Services can be expected to improve the financial standing, including the debts and arrears of public hospitals. In the most direct manner, under the law, hospital founders can or may have to transform some facilities into commercial code companies or liquidate them. In both instances, they would be obligated to restructure and absorb at least some of the arrears and debt of the facilities, which would mathematically decrease their stocks. More generally though, as hospital founders have to cover the facilities deficits at the end of each year, they would be interested in improving the management, including financial, of hospitals, which would bring about improvements in the medium term. 23 As of March 2013, 26 hospitals have decided to change their legal status. Another 22 hospitals are getting ready to change their legal form. So far, no hospital closure has been reported. 24 The law that came into effect in October 2012 raised the minimum-income threshold for social assistance from PLN 477 to PLN 542 per month for single-person households, and from PLN 351 per capita per month to PLN 456 per capita per month for households with more than one person. 15

22 with the other half of the entitlement added when the person reaches the age of 67. Focus group studies conducted in 2012 by the Bank indicated that majority of older workers wanted to continue working, but the mechanism to allow part-time work while collecting a pension did not exist. The new partial pension may provide a remedy to that problem. 41. From an adequacy of benefits point of view, raising the retirement age results in an almost 50 percent increase in the projected future benefits for women. The increase in benefits is expected to occur both because individuals will reach retirement with increased years of contributions and therefore a larger account balance in their pension accounts, and because, under the notional account scheme that Poland has adopted, the account balance is divided by life expectancy at the age when a person retires to determine the initial pension benefit. Since life expectancy at age 67 is lower than at age 60 for women or 65 for men, the benefit level will increase even if the individual does not continue working until the new retirement age. DPL2 Prior action: Enact amendments to the pension legislation on uniformed services to increase length of service and introduce a minimum retirement age. 42. In 2012, eligibility criteria for uniformed pensions were tightened. Previously individuals could retire after 15 years of service regardless of age, with some allowed to retire even earlier. The new law applies only to new entrants to uniformed services, which include police, firemen, border guards, security at government offices, military, and penitentiary. It stipulates that an individual must be at least 55 years of age and at least 25 years of service. Benefits will be based on 60 percent of the average salary during a period of 3 consecutive years rather than on the final salary as previously, reducing the incentive for promoting a higher level just before retirement. While previously the benefits were equal to 2.6 percent of the final salary per year of service, the new benefit formula pays a lower rate, 1.6 percent, for the first 25 years and 3 percent per year for service years above 25. Uniformed personnel who do not meet the 25 year minimum service requirement will have an amount equivalent to the value of contributions they would have made on their past salaries transferred to the national system. 43. While the uniformed service pensions will not be harmonized with the national pension scheme, they are moving towards similar parameters. The first wave of retirement on this new system will take place in January This reform is expected to reduce incentives toward higher last salaries, but otherwise may be fiscally neutral. The greater objective is to create more equity and to bring the uniformed services pensions closer to the national system, and hence decrease the fiscal imbalance of the Social Security Funds. DPL2 Prior action: Enact amendments to social assistance and family benefits legislations to: (i) increase the income threshold for the last-resort minimum-income social assistance benefit that tops up the incomes of the poorest; and (ii) improve targeting of the benefit for caregivers of disabled dependents. 44. These two social assistance measures improve benefits adequacy and targeting in fiscally prudent way. The social assistance income threshold that determines eligibility for the last-resort minimumincome benefit and the family benefits, respectively, was raised with resolutions that entered into force in October and November The legislation also partially raises the minimum-income benefit ceiling that caps benefits that apply to some qualifying recipient families, and it increases 16

23 family benefit amounts. The aim of these legislative changes is to make income support payments more generous for the poorest benefit recipients, and to improve their coverage. To improve the targeting of the benefit for caregivers and thus free up resources to better support those in need, the government has passed legislation to separate the caregiver/nursing allowance from the special care allowance. Parent(s) caring for a disabled child and forgoing their job(s) will continue to receive the nursing benefit regardless of income. Special care allowance will cover individuals caring for disabled adults. The legislation introduces an income threshold that determines benefit entitlements based on income. The objective is to improve the targeting by limiting entitlements for families of severely disabled adults with relatively high incomes, and to limit eligibility to those caregivers who require compensation for forgone earnings (i.e. excluding those who already receive other social benefits such as pensions, social assistance, parental leave allowance). The resulting budgetary savings are intended to partly finance the extension of minimum-income benefit entitlements ANALYTICAL UNDERPINNINGS 45. The DPL program rests on extensive analytical and advisory work undertaken by the Bank. Table 8 lists recent AAA activities and their link to the prior actions supported by DPL2. Table 8. Analytical Underpinnings of the DPL Program Prior actions Analytical Underpinnings Enact a Budget Law for 2013 in line with the requirements of the EU Excessive Deficit Procedure MoF designs assumptions for the permanent fiscal rule to limit growth of public expenditure to trend GDP to foster compliance with the EU requirements under the ratified Treaty on Stability, Coordination and Governance in the Economic and Monetary Union. Enact amendments to the Public Finance Act to strengthen the quality of LGs multi-year financial forecasts and start implementation by introducing a template and periodic reporting requirements. MoF sends for inter-ministerial consultations the draft law on bank resolution to strengthen the stability of its financial system. CONSOLIDATING PUBLIC FINANCES - Public expenditure review (PER) on the needed fiscal consolidation (2010) - EU New Member States Regular Economic Reports (RERs 2012 and 2013) on deficit controls, debt stabilization and gradual debt reduction STRENGTHENING FISCAL INSTITUTIONS - PER on strengthening fiscal framework through expenditure ceilings (2010) - Fiscal Rules Policy Note on the sub-national rule and the permanent expenditure rule (2012) - TA on debt management for LGs, including advice on fiscal risks and LG fiscal rules ( ) - TA on developing a manual for LGs, including on how to increase LGs forecasting capacity, ongoing - TA on the bank insolvency regime, ongoing - World Bank-IMF FSAP on the needed steps to establish a bank resolution framework (2013) ADVANCING LONG TERM FISCAL REFORMS Enact amendments to the Law on Pensions to increase statutory retirement age and start implementation. Enact amendments to the pension legislation on uniformed services to increase length of service and introduce minimum retirement age. Enact amendments to social assistance and family benefits legislations to: (i) increase the income threshold for the last-resort minimum-income social assistance benefit that tops up the incomes of the poorest; and (ii) improve targeting of the benefit for caregivers of disabled dependents. - PER (2010) on the needed parametric changes to the pension system, including increasing retirement age - Policy paper on the implications of the global financial crisis on mandatory pension systems in ECA (2011) - Policy notes on the poverty and social aspect of raising the retirement age and changes to uniformed pensions in Poland (2013) - TA/training on pension reform: simulating retirement age increase and other parametric changes ( ) - Regional study on pensions (includes Poland) on the importance of reducing early retirement and pension adequacy (2013) - TA Activation and Skills for Employability and Protection, ongoing - Policy note on drivers of in-work poverty in Poland (2012) - Policy note on in-work support through tax credits or cash benefits to improve targeting of safety nets (2012) - Policy note on social assistance reforms, benefits adequacy and coverage of programs for the poorest (2013) 17

24 4.4. LINK TO CPS AND OTHER BANK OPERATIONS 46. The proposed DPL series is central to the Bank s engagement in Poland, as emphasized in the Country Partnership Strategy Progress Report FY09-13 (CPSPR). The CPSPR discussed by the Board on June 7, 2011 highlights that fiscal consolidation is among Poland s main economic policy challenges, and states that this process needs to be supported by further improvements to fiscal institutions and structural reforms to help secure the sustainability of social programs. The outcomes expected under the DPL series are aligned with those envisaged by the CPS, including fiscal consolidation, strengthened fiscal institutions, and fiscally sustainable transfers and social spending. While the new CPS is being developed, it is already clear that public finances will remain one of the strategic areas of the World Bank s involvement in Poland CONSULTATIONS AND COLLABORATION 47. All legislative measures and reforms in Poland are subject to a thorough consultation process with social partners, civil society and groups likely to be impacted. The consultation process is an important institutional feature of Poland s process of government. Public consultations are compulsory by law for all new policy initiatives. According to the regulatory guidelines for this process, 25 stakeholders need to be involved throughout the policy-making and legislation preparation. The Government uses various methods to consult the public, including public hearings and meetings, citizen s panels, surveys, consultations through electronic means (e.g., government websites) and media. In addition, the rules on public consultation set the minimum period for interministerial consultations at 21 days and for external consultations with the public at 30 days. Regular legislative procedures ensure careful scrutiny during consideration by Parliament, and hearings and debate in Parliament receive large coverage by the news media. Regular updates to the process are posted in government websites. 48. The authorities have carried out an extensive consultation process with a wide range of stakeholders on each policy reform supported by this operation. An illustrative example relates to the amendment to the pension law to increase statutory retirement age. The amendment was widely debated and consulted with trade unions, employer organizations, women's organizations, farmers unions, the tripartite committee 26 as well as with NGOs and think tanks. Public debate forum on the changes to the retirement age legislation was established by the Presidential Administration. The consultation was extended beyond the period provided by the guidelines to more than two months. Inputs of this consultation process were reflected in the final draft of the amendments. 49. The Bank has collaborated closely with the IMF and the European Commission (EC) on this program. The staff of the Bank and the Fund collaborated closely, with exchanges on macroeconomic, fiscal and structural reforms. The measures under the proposed DPL program have been discussed with both the IMF and the EC to ensure that they reinforce and complement their support to Poland. 25 The Ministry of Economy has developed guidelines called Principles of Consultations Carried out upon Preparation of Government Documents. 26 Tripartite Commission (Komisja Trójstronna) was established as a forum for national social dialogue in 1994, under a 'State Enterprise Pact'. It includes representatives of the trade unions, employers and the Government. 18

25 V. OTHER DESIGN AND APPRAISAL ISSUES 5.1. POVERTY AND SOCIAL IMPACT 50. The DPL2 prior actions related to fiscal consolidation and fiscal institutions are likely to support poverty reduction. Fiscal consolidation and the introduction of fiscal rules are critical to maintaining capital market access and thus to support investments and employment. Key components of social safety net spending are excluded from measures underpinning the fiscal consolidation process, thereby maintaining support to the most vulnerable. Moreover, the policy actions supported under pillars I and II of the DPL2 are expected to contribute indirectly to the improvement of living standards through strengthened stability and solvency of public finances. 51. The DPL2 prior action related to the increase in the mandatory retirement age is expected to raise pension benefits, especially for women. 27 Data from the 2010 LFS show that among those 50 or older, nearly 40 percent of women and 30 percent of men are retired and that most people retired at the applicable mandatory retirement age. If workers continue to respond in a similar way, a gradual increase in the retirement age will likely increase the years spent in the labor market. In addition, the increase in the retirement age will partially offset the trend of diminishing benefits, all else being equal. Simulations based on earnings data from the LFS show that there are significant gains in pension benefits from postponing retirement, especially for women. For men and women who start working and enter the labor market in 2011, simulations show that under the defined contribution system postponing retirement increases pension benefits (as a share of economy-wide wages). 28 This gain in pension benefits will be experienced by workers of all education levels. Since tertiary educated workers earn more than those with less education, the simulated pension benefits are higher (Box 2) Given the slow phase-in of the increase in the retirement age, no adverse impacts are expected on wages or on unemployment rates. Keeping workers in the labor force longer has the potential for exerting downward pressure on wages, but this is mitigated by several factors, especially by the slow phase-in of the increased retirement age, the shrinking size of the working age population under the current retirement ages and the fact that it is not retroactive, so that current retirees are not forced back into the labor force. Older workers who cannot find employment or who are too disabled to work have safety nets in the form of social assistance and disability pensions, respectively. Other mitigating considerations are that many pensioners are already working in retirement, and tend to have different skill sets from younger workers. Thus, they are unlikely to be competing with new entrants for jobs. Pension benefits are an important source of transfers for households. Simulations suggest that all else equal, in the absence of national pension benefits, the five-dollar-a-day poverty rate would go up from 15 percent to 35 percent. These simulations also suggest that if the replacement rates (pensions as a share of average wage) decline, as they are 27 The PSIA focuses on the impact of retirement age increase, ceteris paribus. The impact of any other policy changes would need to be assessed separately and monitored from an old-age poverty and income security perspective. 28 For example, if men with tertiary education entering the labor market in 2011 retire at age 67, then they will receive an initial pension that is 63 percent of economy-wide or prevailing wages; if they retire early at 65 then their initial pension is 57 percent of economy-wide wages. The gains in postponing retirement are larger for women. Assuming that tertiaryeducated women entering the labor market in 2011 have an uninterrupted tenure in the labor market, postponing retirement to age 67 will give them a pension that is 50 percent of economy-wide wages as opposed to pension benefits that are less than 40 percent of wages if they retire early at 60 or A recent study, based on a 1 percent sample of Social Insurance Institution (ZUS) contributors, finds little or no gender gap in benefits when administrative data on reported earnings are used for simulations. 19

26 projected to do in the future even with the retirement age increase, then the poverty reducing impact of pension benefits will be significantly diluted. Box 2. Pensions Design in Poland: Responding to Gender Differences The increase in the mandatory retirement age and closing of gender differences in the retirement age help improve gender equality. But gender gaps in the labor market and women s primary care-giver role at home can limit these gains. Employment rates are the lowest for younger and older women a pattern consistent with care responsibilities which the early retirement option for women supported (Figure 5). As pension benefits simulated using the LFS data show (Figure 6), for all cases and education categories, men s pension benefits are higher than those of women s. The Reconciliation between work and family life in 2010 survey conducted by the Polish Central Statistical Office found that women, rather than men, reduced work responsibilities or withdrew from work in order to take care of children or care for elderly dependent. A qualitative study on gender issues conducted in Poland as part of the 2012 World Development Report on Gender Equality also confirmed that the care work was seen as primarily women s responsibility by both men and women. At the same time, the reform will leave unchanged key features of the pension system that are protective of women s caregiver roles: a) noncontributory periods, such as when employed women take their maternity leave, are counted towards pension contribution based on the maternity allowance (average of earnings of last 12 months) and the government continues to make contributions on behalf of these women; b) under the new law women can avail of the partial pension option at age 62; c) family (or survivor) pensions support those women who either never entered the labor market or who earned less than their husbands. The recent increase in the mandatory retirement age (supported by the DPL series) gives women additional years to make up for lost the labor market time due to the child birth or child care. However, older women s care responsibilities (looking after parents or grandchildren) will still compete with longer stays in the labor market. The availability of survivor pensions will, in the short term, remain important for women s income in the old age. They are, however, inadequate fixes for interventions in the labor market that help increase women s labor market participation and earnings and thus have the most potential to also raise women s pension benefits. Figure 5. Employment Rate by Age, 2010 Source: Staff calculations using LFS Employment to population ratio. Figure 6. Simulated First Year Pension Benefits for Labor Market Entrants of 2011 (As share of economy-wide wage in the first year of retirement) Source: Staff estimates using PROST model for Poland 53. The reform to uniformed services pensions is not expected to have an impact on poverty. Because those employed in uniformed services tend to be in upper income quintiles, these reforms to the pension system are not expected to adversely affect their retirement income. 54. By increasing the eligibility thresholds for the minimum-income benefits, the social assistance reform supported by the DPL2 will help to reduce poverty incidence and depth by increasing the coverage and generosity of the program. 30 First, the program coverage will 30 There are a number of methodological challenges for the PSIA in accurately assessing poverty impact of the reform. First, the main source of household survey data, HBS, does not separate social assistance in the form of cash and kind. However, applying the eligibility threshold for cash transfers it is possible to infer which households are recipients of inkind transfers. Second, the HBS data also do not distinguish between permanent and temporary cash beneficiaries a distinction that is important for evaluating the effect of the reform on single-person households that face different 20

27 increase by extending benefits to those whose incomes are above the current thresholds but below the new thresholds. When the new threshold is applied, the share of the population eligible for the program by the income criterion is simulated to increase from 8.0 to 12.3 percent. Second, the program generosity will increase as benefits to current beneficiaries increase in line with the increased thresholds. The increase in minimum-income thresholds partially reverses the erosion in the value of the benefits due to inflation since thresholds were last set in Thresholds and benefits are adjusted for inflation infrequently in Poland, leading to minimum-income thresholds falling below the subsistence minimum threshold. The minimum-income benefit thresholds set in 2012 are once again greater than the subsistence minimum. Even so, for single-person households the new thresholds are less than the 2006 thresholds after adjusting for inflation adjusted using the food CPI adjusted using the total CPI. Infrequent adjustments for inflation will reduce the real value of the 2012 thresholds until adjustments are made next in The overall design of the reform produces progressive incidence of benefits. The benefits for those who become eligible for the program under the higher thresholds will be modest, because their incomes are closer to the threshold (Table 9). Similarly, those who are recipients before the reform are the poorest households, and post-reform their benefits increase by an average of PLN 34 to PLN 69 per person per month, reaching an average of PLN 136 to PLN 272, depending on what portion of their 50 percent share local governments actually pay out. The real value of the benefits will diminish because of inflation until thresholds are adjusted again in Table 9. Incidence of Minimum-Income Social Assistance Benefits Incidence (before & after reform) Before reform After reform (simulated) Income eligible (percent of population) Income eligible recipients (percent of population) Average benefit amount (PLN per capita per month) At 50 percent At 100 percent At 50 percent At 100 percent Single-person households Pre-reform recipients New recipients Multiple-person households (2 adults and 2 children) Pre-reform recipients New recipients TOTAL Pre-reform recipients New recipients Source: World Bank staff calculations using the 2011 Household Budget Survey (HBS). Note: The 50 percent and 100 percent columns indicate the amounts corresponding to receiving 50 percent of the benefit amount (the guaranteed amount from the central government) and 100 percent (the combined amount from central and local governments). Simulations take into account PLN 20 per capita minimum payments to recipient households and apply a PLN 529 benefit cap on all single-person households. 55. The introduction of an income threshold and strict eligibility guidelines for the special caregiver benefit are expected to limit the take up to low-income care providers. Income thresholds have been introduced for relatives of disabled adults who wish to act as caregivers; the attendance benefits for mother or father of disabled children will not be subject to income tests, as before. In order for a caregiver to be eligible, the sum of their own income and that of the care receiver s family must be PLN 623 per person per month or less. In addition, the benefit caps depending on whether they are permanent or temporary beneficiaries. The PSIA simulates the effect of the reform on single-person households by applying the benefit cap for permanent beneficiaries to all single person households. 21

28 caregiver must neither be engaged in income generating work nor be a recipient of any other benefits (pensions, disability benefits, parental leave allowance). Qualifying caregivers receive PLN 520 per month. The combined effect of the eligibility criteria and the benefit amount is expected to improve poverty targeting, but will limit the coverage of those eligible. One reason for the expected limited coverage is that the amount of the caregiver benefit, PLN 520 per month, is about 33 percent of the average wage for personal-service workers and caregivers could potentially earn more by opting to work. Another reason for the expected coverage decline of this benefit is the exclusion of those potential caregivers receiving any other benefit even if they meet the income threshold. The incidence of such cases is very limited, but going forward it is important to monitor them ENVIRONMENTAL ASPECTS 56. The specific policies supported by the DPL series are not likely to have significant effects on Poland s environment, forests, water resources, habitats or other natural resources. The risk of unanticipated adverse effects to the environment and natural resources is very small. Credible scenarios for any significant, direct or indirect negative impacts appear very unlikely. Poland has adequate environmental controls in place and environmental legislation and regulations are closely aligned with EU environmental directives (e.g. EIA Directive 85/337/EEC, as amended by Council Directive 97/11/EC). Poland has adopted the EU s guidelines on integration of environmental assessments into the planning and programming of projects (June 2001) and the EU s Environmental Liabilities Directive setting out liability for damage to properties and natural resources (April 2007). Since the country's accession to the EU in 2004, Polish environmental authorities have rapidly developed technical skills and administrative structures required for effective licensing, monitoring and enforcement. Thus any impacts potentially caused by measures in the DPL operation would be captured by the established processes for screening and assessing projects, and for ensuring that appropriate responses for impact minimization, mitigation and management are included in project designs FIDUCIARY, DISBURSEMENT AND AUDITING ASPECTS 57. The overall fiduciary risk to this operation arising from Poland s public financial management system (PFM), the use of budget resources and its foreign exchange environment as controlled by the Central Bank is moderate. Following significant improvements during EU accreditation process, the PFM system encompasses enhanced budget transparency, predictability and performance-orientation over the medium term. The reform agenda (based on the 2009 PFA, amended in 2010) introduced a performance-oriented four year rolling budget planning with a binding annual cash-based budget, cash management consolidation, and strengthened internal audit, internal and management control over public expenditures and debt via new regulations on corrective actions triggered by debt thresholds. Public procurement legislation is based on EU Directives with the most recent update in 2012 on defense and security directive. Further efforts are expected to streamline the flow of funds processes, harmonize public sector accounting, reporting standards and practices supported by enhanced IT systems. 58. The MoF discloses publicly the state budget act along with the monthly and quarterly state budget execution reports based on a national cash methodology covering main revenue and expenditures aggregates within 1-2 months after the end of a period. It also publishes quarterly aggregate reports on budget execution by LGs. Annual cash based reports on the central state budget execution are published after being audited by the Supreme Audit Office (NIK) within 6 months after the end of the year. Accrual based ESA 95-compliant reports 22

29 for the general government are available on quarterly basis on the website of the MoF, the Central Statistical Office, and Eurostat within 3-4 months from the end of the quarter. The functional breakdown of general government expenditures is presented within 12 months. 59. In the area of external audit, Poland has a well-functioning public financial accountability and assurance mechanism for the legislature and the public. Poland is advanced in the availability of the audit reports to the public, and independence of the NIK. At the LG level, 16 Regional Accounting Chambers the responsibility to supervise and control financial, fiscal and procurement activities of self-governing entities. The PFA also requires that annual financial statements prepared by large LGs be audited by independent statutory auditors. In the area of internal audit, a Public Finance Sector Audit Department of the MoF coordinates management control and internal audit in public finance sector units, which follow International Standards for the Professional Practice of Internal Auditing. 60. The NBP accounting and reporting policies are defined by the Monetary Policy Council, and are in line the guidelines of the European Central Bank. In managing the foreign exchange reserves, while striving to maximize the return on the assets, the NBP gives priority to their safe investment and a requisite level of liquidity. An independent auditor selected by the Monetary Policy Council regularly audits the NBP s annual financial statements. The most recently available audit reports (for ) have unqualified audit opinions and were approved by the Monetary Policy Council. The IMF latest limited scope safeguard assessment report of 2009 confirmed that the control environment of the NBP is satisfactory. 61. Loan proceeds will be disbursed in one single tranche to the foreign currency national budget account at the NBP, which forms part of the country s foreign currency reserves, and of the country s budget management system. Disbursements will not be linked to specific purchases, thus no procurement requirements will be necessary. The Bank will not require an audit of the Deposit account but will require the Government to provide confirmation to the Bank on the amounts deposited in the foreign currency account within 30 days of receiving the funds IMPLEMENTATION MONITORING AND EVALUATION 62. The Bank continues to work closely with the MoF, the Prime Minister s Office and sector ministries to monitor and assess the reforms progress and impact during the course of the program. Monitoring and evaluation is supported by the various ministries as well as budgetary, legislative and economic data provided by the authorities and verified in official disclosures, directives and regulations. Baseline and updated data are provided by the respective specialized agencies and official statistics. They are tracked according to the indicators and outcome measures shown in the monitoring and results framework of the policy matrix (Annex 1). VI. RISKS AND MITIGATION 63. The overall risk to the operation is moderate. 64. Macroeconomic risks are related to external and domestic factors. External risks stem primarily from the slow Euro area economic recovery and are transmitted through external trade and financial links. Further weakening of demand in the EU could place pressures on Poland s exports and investment growth. Over a half (53 percent) of total Polish exports during the first half of 2012 went to the Euro area and a bit over one quarter to Germany. In addition, potential 23

30 instability in the Euro area could have spillover effects and negatively affect Poland through the exchange rate channel. Since FX-denominated bonds constitute around 31 percent of total public debt, Poland s debt-to-gdp ratio is vulnerable to PLN depreciation. Moreover, with about 60 percent of the banking system owned by Euro area banks, Poland remains vulnerable to external debt deleveraging through parent bank funding of local subsidiaries. Also, the level of NPLs remains elevated. Domestic risks relate to the impact of slowing economic growth (in particular private consumption) on the pace of fiscal consolidation. In addition, the Government is currently contemplating measures related to the pension liabilities which could have an impact on the longterm fiscal sustainability. Annuity provision from the private pension funds may result in increasing Government liabilities if public institutions, rather than private, take on the longevity risk in providing annuities. In the short and the medium term, such a measure would improve the fiscal balances as funds held in private pension funds come in as revenue to the public system. However, in the longer run, the public system takes on the additional liability of providing pensions from these funds. 65. There are a number of mitigating factors against the macroeconomic risks, including: (i) flexible monetary policy will continue to cushion the impact of external shocks; (ii) the solid track record of macroeconomic management will help to shore up market confidence as long as credible commitment and implementation of medium-term fiscal and structural reforms is observed; (iii) the significant prefunding of government s financing needs and a large liquidity cushion have helped mitigate the impact of external risks; (iv) the medium-term off-budget investment program will help sustain the financing of pro-growth investment, without disturbing the fiscal consolidation path; (v) the strong record of utilization of EU structural funds will continue to support investment and growth; and (vi) ongoing strong policy dialogue on fiscal issues, including in the social sectors. The key mitigating factors against the financial sector risks include adequately capitalized (CAR at 15 percent in 2012), liquid, and profitable banks and an effective and strong financial supervision. The banking system s moderate loan-to-deposit ratio helps mitigate deleveraging risk (an overall loan-to-deposit ratio of 113 percent and an average loan-to-deposit ratio of just under 100 percent for banks with parents in European economies under stress). Deleveraging was so far outpaced by the growth of domestic deposits. The authorities have taken steps to strengthen the financial sector, including through tightening standards on foreign currency lending to households. Further, the authorities could draw on the FCL with the IMF (US$34 billion), which so far has been treated as strictly precautionary. 66. Political discontent against reforms could potentially undermine support for the Government s agenda and reduce its ability to implement the needed fiscal and structural reforms. Loss of support to the agenda of strengthening public finances could induce loss of consumer and investor confidence and entice market volatility. The key mitigating factors against this risk are the Government s strong electoral mandate from the parliamentary elections in 2011 and its strong reform implementation record to date. Albeit with a small majority, the ruling coalition has been effective in securing political support for its reform agenda. The next parliamentary elections will be held in There are no other significant risks to the operation. The poverty and social impacts of policy measures supported under this DPL series are expected to be either positive or negligible (Section 5.1.). There are no likely risks arising from the program on Poland s environment, forests, water resources, habitats or other natural resources (Section 5.2.). The fiduciary risks are moderate due to the advanced PFM system in the country and the management of foreign exchange by the NBP (Section 5.3). 24

31 ANNEX 1: POLICY AND RESULTS MATRIX DPL1 Prior Actions DPL2 Prior Actions Results CONSOLIDATING PUBLIC FINANCES Objective: Ensuring a steady decline of the fiscal deficit to stabilize and over the medium term reduce public debt. Enact a Budget Law for 2013 in line with the requirements of the EU Excessive Deficit Procedure. Enact a Budget Law for 2012 in line with the requirements of the EU Excessive Deficit Procedure. CoM adopts plans for gradual implementation of deficit limitations of LGs as indicated in its Convergence Program Update Public debt-to-gdp ratio (national definition) is stabilized Baseline: 54 percent of GDP 2011 Target: At or below 54 percent of GDP in 2013 STRENGTHENING FISCAL INSTITUTIONS Objective: Strengthening institutions to ingrain a prudent fiscal stance (including at the sub-national level) over the medium term. Enact amendments to the Public Finance Act to strengthen the quality of LGs multi-year financial forecasts and start implementation by introducing a template and periodic reporting requirements. MoF designs assumptions for the permanent fiscal rule to limit growth of public expenditure to trend GDP to foster compliance with the EU requirements under the ratified Treaty on Stability, Coordination and Governance in the Economic and Monetary Union. MoF sends for inter-ministerial consultations the draft law on bank resolution to strengthen the stability of its financial system. LGs debt-to-gdp ratio (ESA 95 definition) is stabilized Baseline: 4.3 percent of GDP in 2011 Target: At or below 4.3 percent of GDP in

32 CoM adopts and submits to Parliament draft amendments to the Law on Pensions for the increase of the statutory retirement age. CoM adopts and submits to Parliament draft amendments to the pensions legislation on uniformed services to increase length of service and introduce minimum retirement age. Enact the Law on Farmers Health Insurance Contributions. Enact the Law on Therapeutic Activity to: (i) make LGs and other public entities that own health facilities accountable for their financial results; and (ii) advance the agenda of hospital corporatization and restructuring. CoM adopts and submits to Parliament draft amendments to the Law on Family Benefits to improve targeting of the child-birth allowance. ADVANCING LONG TERM FISCAL REFORMS Objective: Securing fiscal sustainability of social spending in view of Poland s demographic challenge. Enact amendments to the law on pensions to increase statutory retirement age and start implementation. Enact amendments to the pension legislation on uniformed services to increase length of service and introduce minimum retirement age. Enact amendments to social assistance and family benefits legislations to: (i) increase the income threshold for the last-resort minimum-income social assistance benefit that tops up the incomes of the poorest; and (ii) improve targeting of the benefit for caregivers of disabled dependents. Social security funds deficit-to-gdp ratio (ESA 95 definition) is reduced Baseline: 0.2 percent of GDP in 2010 Target: Lower than 0.2 percent of GDP in 2013 Hospital arrears are reduced Baseline: PLN 2.4 billion in 2011 Target: At or below PLN 2.2 billion (reduction by 8 percent) in 2013 The last-resort minimum income benefit for a typical poor family 31 is improved Baseline: 36 percent of the Eurostat "atrisk-of-poverty" threshold in 2011 Target: Above 36 percent of the Eurostat "at-risk-of-poverty" threshold in A typical poor family is defined as a two-parent household with two pre-school aged children with a benefit package comprised of minimum income social assistance benefit plus family benefit and no other income sources. 26

33 ANNEX 2: LETTER OF DEVELOPMENT POLICY I? i!l, REPUBLIC Of POLAND DEPUTY PRIME MINISTER MINISTER OF FINANCE Jan Vinunt-Rostowski Warsaw,bMay 2013 DZI 1912/1-8/PKF/ 131 DJ) lo~~c h M r. Jim Yong Kim President Wo:ld Bank ISIS H Street NW Washington D.C Uni:ed States of America Dear Mr. Kim, Uneer the second term of office of Prime Minister Tusk, the Polish Government is pll!suing a comprehensive program of economic and social reforms, the aim of which is to strength:n the ecooomy in coping with negative spillovers from the ongoing financial and economic rurbulence in the external environment. The World Bank has played a significant role in supponing this agenda through lending projects, technical assislanee and knowledge sharing, for which I am Vei)' grateful. I am writing to request your approval of the programmatic Public Finance Development Policy Loa1 (OPT..), for BUR I billion. The loan is the second in a series of two lending operatiom. The first loan was presented to the IBRD Board of Executive Directors in June The current operation, prepared in close collaboration with the World Bank, builds directly on the fiscal reforms supported by the first loan and is targeted at reforms most critical for strengthening the sustainability of public finances and fostering growth. Matroeconomic Framework In lite past four years, in spite of the uncertain external environment. Poland's CCOIOmic fun(amentals have remained strong, underpinned by ~und macroeeonomic policie3. As a consequence, Poland has enjoyed the highest economic growth among the EU countries. This strong performance can be credited to Poland's considerable diversification of the economy, limi:ed external imbalances prior to the crisis and the pntdent macroeconomic policies. Countercyclical policies were vital to lessening the economic slowdown, however, a crucial side effect thereof were higher fiscal deficit and public debt levels. In response, strong fiscal consolidation efforts were initiated in 2011, which reduced the general government deficit from 7.9 percent of GOP in 2010 to 3.9 percent in 2012 and put public debt-to-gop ratio on a downward path. Going forward, despite a significantly weaker growth outlook, the Polish Government is commined to maintaining a balanced approach of pursuing conservative fiscal policy, while acti ely supporting economic growth in the private sector. lbese efforts are aimed at further 27

34 trimming the structural deficit towards Poland's medium-term objective and ensuring further reduction in debt-to-gop ratio. Go\'ernment Program The Government is committed to continuing the reform program announced after the Parliamentary elections in October 2011 and reiterated in the Prime Minister's speech to the Parliament in autumn Given the prolonged uncertainty in the external environment and the slowdown in the Po lish ~nomy, the short-term reform agenda is focused on further rebuilding fiscal buffers, supporting private sector-driven growth, and increasing the resilience of the financial sector. At the same time, the authorities will remain devoted to pursuing reforms aimed at improving public finances over the medium and long term. In 2013, in order to consolidate public finances., we strive to continue to control the expenditure side of the budget through a temporary fiscal rule, limiting growth of discretionary expenditures to I percentage point over the CPI rate, further phnsing-out of early retirement schemes and a nominal freeze of the public sector wage bill. On the revenue side we rely on maintaining the freeze of PIT thresholds and on one-off revenues from C02 emission rights and revenues from the new toll system. Thanks to the measures already undertaken and carried out further fiscal consolidation, structural deficit will be reduced in 2013 and subsequent years. To support private sector growth, a new program was announced, consisting of guarantees for SME lending and a government investment fund. The latter is aimed at providing financial resources for investment into energy, infrastructure and R&D in Poland. Using privatization proceeds to boost the capital base of the state development hnnk (Bank Gospodarstwa Krajowego), the Government intends to mobilize resources held by private investors to support investment in Po land. In addition, further improvements to the doing business environment are being introduced by simplifying court procedures and extending rights to secured creditors in businesses closures. We have also launched the first professional occupation deregulation package to improve access to many professions. Reform efforts have continued since 20 II in the area of strengthening the resilience of the financial sector. There is ongoing work on developing a formal macroprudential framework, which would establish a Systemic Risk Board and set forth the policy objectives of a macroprudential function. With the help form the World Bank and the IMF, Poland is just about to finalize the legislative proceedings regarding the banks' resolution framework. The draft law has been sent for interministerial consultations and included in the Government's legislative plan for2013. Additional reform efforts are also aimed at strengthening fiscal institutions and increasing sustainability of public finances over the medium and long term. To strengthen fiscallnslltutlons, in line with the recently ratified EU fiscal requirements, we will implement a permanent stabilizing expenditure rule to limit the growth of expenditures to the:: Lrend gruwlh rettc- of ODP. This will eru;ure further fiscal consolidation and reinforce the long-term stability of public finances. The Government has closely monitored the indebtedness of the local government sector and introduced regulations to strengthen the quality of multi-year financial forecasts by local governments. Over the medium-term, it is also committed to program-based budgeting to improve the efficiency of public spending. 28

35 To ensure the sustainability of the pension system, the statutory retirement age was increased to 67 years for both men and women. This law was implemented in January The special pension schemes for the uniformed services have also undergone reform. Starting January 2013, for the new entrants into the uniformed services a minimum retirement age was established and their length of service increased. The Government remains firmly committed to further efforts in the area of pensions - including reviewing entitlements to early pensions of other professional groups (inrer alia miners), establishing a pay-out mechanism from the second pillar and reviewing the functioning of the second pension pillar. In hcallh policy, one of the key actions aims to introduce the costing of health services with the objective of improving incentives and transparency of financing in the hospital sector, as part of a larger reform program. The plan is to bundle the creation of this tariff agency with reforms aimed at abolishing the central agency of the health insurance fund and conferring its powers to regional agencies, and at creating a new central agency responsible, in addition to the valuation of medical services, for health technology assessment, quality assurance, the development of health information systems and the oversight of public health insurers. The Ministry of Health is also working on reforms in the area of clinical hospitals, the reimbursement of drug costs, supplementary health insurance and clinical trials. The scope of the planned reforms in the agricultural sector was also extended. In order to bring farmers into the regular tax net in 20 I 4, the decision to introduce income accounting and income taxation for farmers in two phases was revised in favor of a one step approach. In order to improve targeting and increase beneftts for the poorest people in a fiscally neutral way, social assistance benefits were reformed. The introduction of income testing helps to target the benefit to care-givers of the adult disabled. The savings achieved under the care-giver beneftt reform were used to augment the minimum income benefit to the poorest. Going forward, the Government will continue to provide protection for the poor along with promoting integration of excluded populations into the labor market. The Ministry of Labor is embarking on an ambitious program to improve the quality of employment services provided. Such reforms will serve to ensure that the poorest and most excluded populations also receive dividends in future growth and prosperity. I strongly believe that the World Bank can provide valuable support to our reform program. The World Bank's financial assistance and expertise is a crucial impetus towards the fulfillment of the program objectives. Yours Sincerely, 29

36 ANNEX 3: IMF RELATIONS NOTE A ~!i International Monetary Fund IMF Executive Board Approves New Two Year US$33.8 Billion Flexible Credit Line Arrangement for Poland Press Reiease No. 13/17 Januaf')' 18, The Executive Board of t he International Monetary Fund ( IMF) today approved a successor two-y ear arrangem ent for Poland under t he Flexible Credit Une {FCL) in an amount equivalent to SOR 22 billion (about US$33.8 billion, or 1,303 percent of quota). Poland's first FCL arrangem ent was approved on May 6, 2009 (see Press Release No ). Successor arrangements were approved on July 2, 2010 (see Press Release No ), and January 21, 2011 (see Press Release No ). The Polish authorities have stated that they intend to treat the arrangement as precautlona.-y and do not intend to draw on t he FCL. Following the Executive Board discussion of Poland, Mr. David Upton, First Deputy Managing IJin=:rtn r ~nd Act1ng Chairrran of the Soard, made the following statement: ''Poland has very strong economic fundamentals and policy frameworks. A credible inflation targeting reg1me has helped contah'l innation, while the flexible exchange rate has played a key stabilizing role, and the sound financial superv sory framework has contributed to a wellcapitalized, liquid, and profitable banking system. Broadly adequate international reserves and t he precaut1onary FCL arrangement have helped maintain m arket confidence. "The authorities' skillful macroeconom ic management underpinned Poland's sohd recovery in , allowing a gradual restoration of policy buffers despite t he challenging external environment. These efforts lndu::led substantial fiscal consolidation, steady reserve accumulation, m easures to mitigate risks related to foreign currency lending, and reforms to boost long-term growth potential. ''However, th e economy Is feeling the e ffe-cts of h eadwin<t~ from tr-e rest of Europe, and growth has ;lowed since early Economic activi ty is projected to rroderate further in 2013, with risks stemming from Poland's substant ial trade and financial linkages in the reg1on. The authorities are com mitted to cont inue to implement sound economic and fin an ci~l polidq$ th;.t Gupport economic growth o,n d improve the resilience of the banking sys:em. "Nevertheless, heightened risks to t he balance of payments remain a key concern for Poland, and t he challenging!mf' ~WftANAl RfUftON:i be~aiittht:nt 30

37 growth env ronment may also make the country more vulnerable to external shocks. Against this background, a successor two-year FCL arrangement, which the authorities intend to continue to treat as precautionary, will bolster Poland's buffers against heightened external risks, help sustain market confidence, and contmue to support the authorities' overall macroeconomic strategy; Mr. Upton said. The FCL was established on March 24, 2009 and further enhanced on August 30, 2010 (see Press Release No. 10/321). The FCL IS avauaote to countries w th very strong fundamentals, polides, and track records of policy implementation and is particularly useful for crisis prevention purposes. FCL arrangements are approved for countries meeting pre-set qualification criteria (see Press Release No. 09/85). The FCL Is a renewable credit line, which could be approved for either one or two years. Twoyear arrangements involve a rev1ew of eligibility aftet the first year. lf the country draws on t he -credit line, the repayment period is between three and five years. There is no cap on access to fund resources under the FCL, and access Is determined on a case-by-ca$e basis. Qualified countries have the full amount available up-front, with no ongoing conditions. There is flextbility to either draw on the credit line at the t ime it is approved, or treat it as precautionary. Poland Is a member or the IMF Stnce 1986 and has a quota of SDR 1, million (about US$2, million). 31