Analysis-New Polish government inherits troubled budget legacy

By Pawel Florkiewicz, Karol Badohal and Gergely Szakacs

WARSAW (Reuters) – Last-minute spending by Poland’s outgoing nationalists since their mid-October election defeat has added to strains on the budget, complicating new Prime Minister Donald Tusk’s efforts to deliver on campaign pledges.

A Reuters tally of new spending commitments since Poland’s Law and Justice (PiS) party lost its parliamentary majority on Oct. 15 showed outlays ranging from subsidies for coal mines to bonuses for company managers and other items adding up to around one full percentage point of gross domestic product.

While that tally is small compared with the size of central Europe’s largest economy, they come on top of big-ticket items baked into Poland’s budget, including NATO’s highest military spending and big hikes in wages and social transfers that already put the 2023 deficit at nearly 6% of GDP based on the European Commission’s latest forecast.

“In recent days, with great ease you (PiS) started making decisions worth many billions of zlotys, but you completely didn’t think about how to secure the financing for them,” Tusk said on Tuesday as he unveiled his government’s agenda.

His incoming government has already signalled it could delay the launch of its costliest pledge, raising the income tax threshold to 60,000 zloty ($14,939) per year, as it races to redraw Poland’s 2024 budget ahead of an end-January deadline.

There was no immediate comment from the Finance Ministry or PiS officials.

Outgoing Prime Minister Mateusz Morawiecki has blamed the deficit on high military spending worth some 4% of GDP amid the war in neighbouring Ukraine and said finances were otherwise in a better shape than in some countries in western Europe.

With jubilant opponents of PiS cheering the transfer of power after eight years of nationalist rule marred by repeated clashes with Brussels, Tusk’s pro-EU government will face pressure from day one to deliver on his hefty campaign promises.

‘POPULISM TRAP’

Beneath Tusk’s policy dilemmas, a deeper problem is lurking: some local economists say the large-scale election pledges of Poland’s warring parties have locked the country in a “populism trap”, with a heavy election calendar featuring European and presidential ballots limiting prospects for consolidation.

“The busy electoral calendar in the next two years could discourage the government from taking on difficult policy challenges, including reducing sizeable fiscal imbalances,” Fitch Ratings Senior Director Federico Baraga-Salazar said.

“The next administration faces difficult policy choices to tackle medium-term expenditure rigidities and potentially higher-for-longer interest rates,” he said, adding that Poland could require larger budget cuts from 2025.

Economists at Citigroup have estimated that Tusk delivering on all of his election pledges, worth up to 3.5% of GDP, could send Poland’s budget deficit soaring above 7% of GDP in 2025, a level not seen even at the height of the COVID pandemic.

“With elections fast approaching, the new government will seek to fulfil some of its election promises aimed at appeasing key voting blocs,” analysts at think-tank Eurasia Group said.

“Weak growth, likely to fall short of the budget’s projected 3%, also puts upward pressure on the deficit-to-GDP ratio.”

Poland’s five-year bond yields have fallen by nearly 40 basis points since Tusk’s election triumph in October, while the zloty is trading near its strongest levels since early 2020, buoyed by hopes of an end to years of bickering with the EU.

Poland has seen tens of billions of euros of EU funds frozen due to a dispute with Brussels over democratic standards, but Tusk, a former European Council president, has vowed to mend relations and unblock the cash.

While the release of recovery funds could boost investment, they would be neutral for the budget balance, Citigroup has said, as inflows are offset by spending.

Citigroup now sees no reduction in the budget deficit next year, putting Poland on a podium alongside Slovakia and Romania as the EU’s worst fiscal offenders based on a comparison with the European Commission’s latest forecasts.

“In our scenario, we assume quite arbitrarily that in 2024 alone, approximately one third (based on costs) of the pre-election proposals will be implemented,” it said.

“This would mean a deficit of approximately 5.8% throughout 2024, i.e. a similarly loose fiscal policy as in 2023.”

($1 = 4.0164 zlotys)

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