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Poland-EU dispute over rule of law challenges long-run credit outlook


Poland’s credit outlook is under pressure as institutional disputes with the European Commission risk compromising the country’s investment outlook despite recent signals that the government in Poland is seeking solutions.

Long-standing weakening of Poland’s independent judiciary and tensions between the government and the EU are clouding an otherwise robust outlook for economic growth and put at risk fiscal consolidation.

 

Tensions between the government of Poland and the EU are clouding an otherwise robust outlook for economic growth and put at risk fiscal consolidation

 

The rule-of-law dispute also casts doubt over government receipt of critical EU funding, particularly after the European Court of Justice this week dismissed legal challenges of Poland and Hungary to EU rules. The EU can now go ahead and withhold funding from member states in cases of rule-of-law violation.

The dispute also raises question marks over whether Poland would receive EU support such as balance of payments assistance in an event of a future economic shock. These are relevant concerns for the country’s sovereign credit ratings.

Such setbacks in EU-Poland relations are especially pertinent today considering how Poland’s public finances have weakened compared with prior to the Covid-19 crisis. The increase of public debt since the crisis is unlikely to be fully reversed over a foreseeable future – seen remaining above 50% of GDP in coming years (Figure 1) – despite strong recovery (4.7% growth estimated this year and 4.1% in 2023). Built-in rigidities in welfare expenditure are one reason. Another is a prospect of modest fiscal slippage ahead of parliamentary elections scheduled for 2023.

 

Figure 1: General government debt-to-GDP and real growth, %

Source: IMFWEO, Scope Ratings GmbH forecasts.

 

This was the context underlying Scope Ratings’ decision of 14 January to revise Poland’s Outlook to Negative from Stable on its A+ sovereign ratings.

 

There have been some signs of a more constructive approach in Warsaw to meeting EU concerns

We recognise that there have been some signs of a more constructive approach in Poland to meeting EU concerns. Polish President Andrzej Duda proposed a bill to replace the controversial Disciplinary Chamber of the Supreme Court. Parliament subsequently made a separate proposal for changing the chamber with an aim of preventing judges from being disciplined for the content of their rulings. Nevertheless, it remains unclear whether such proposals will pass. Any final bill needs, moreover, to satisfy EU requirements.

Furthermore, there are indications of other contentious issues. In December, the European Commission opened infringement proceedings associated with a separate breach of the primacy of EU law after a 2021 Polish Constitutional Tribunal decision. The longevity of such disputes surrounding judicial independence and the rule of law suggests that there is no obvious middle ground for the two sides even if the Polish government were to compromise on some issues.

 

EU measures to bolster the rule of law among member states have intensified in recent years

EU measures to bolster the rule of law among member states have intensified in recent years – notably after 2021 inception of ‘Rule of Law Conditionality’ – which could have multi-billion-euro consequences for Poland. Poland’s post-Covid Recovery and Resilience Plan has not yet been approved, delaying reception of EUR 36bn in EU recovery funding, equivalent to 5.3% of average 2022-26 annual GDP.

The European Commission could furthermore suspend payments to Poland under the 2021-27 multiannual budget if it thought violations of the rule of law “affect or seriously risk affecting” management of EU financing. The EU budget earmarked for Poland is worth EUR 110.1bn, by far the largest nominal sum for a member state and equivalent to 15.8% of average estimated 2021-27 GDP.

 

The European Commission could furthermore suspend payments to Poland under the 2021-27 multiannual budget if it thought violations of the rule of law “affect or seriously risk affecting” management of EU financing

 

A scenario of a Poland exit from the EU or even a loss of EU voting rights – likely to be vetoed via Hungary – remain unlikely, however institutional disagreements undermine an investment outlook premised in part on EU financing. In addition, extra costs incurred from monetary penalties, comparatively less buoyant long-run growth and resulting wider budget deficits add up with time, especially were government to replace delayed EU funding with national funding.

 


Author of the article:

Dennis Shen

Macroeconomist and a Director in sovereign ratings with Scope Ratings in Berlin, Germany. Primary sovereign analyst for Poland. In the past, Dennis was European Economist with Alliance Bernstein in London. Dennis graduated from the MPA in International Development from the London School of Economics and completed undergraduate studies at Cornell University.

 

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