Polish Parliament Enacts 2005 Budget with Lower

UNCLAS WARSAW 000026

SIPDIS


Sensitive

STATE FOR EUR/NCE TARA ERATH AND MICHAEL SESSUMS
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS AND MWILSON
TREASURY FOR OASIA MATTHEW GAERTNER AND ERIC MEYER
FRANKFURT FOR TREASURY JIM WALLAR

E.O. 12958: N/A
TAGS: EFIN ECON PREL PL
SUBJECT: Polish Parliament Enacts 2005 Budget with Lower
Deficit

Ref: 2004 Warsaw 3343

(U) This cable is sensitive, but unclassified, and NOT for
Internet distribution.


1. (SBU) Summary: Just before Christmas, the Polish
Government completed work on a 2005 budget which has a lower
deficit for the first time in three years (forecast at 3.7%
of GDP compared to 4.8% in 2004). In drafting the 2005
budget, the GOP built on its success in 2004 in revitalizing
the privatization program, which enabled the government to
meet its year-end debt targets. The 2005 budget expects
that revenues will increase 8.9%, based on continued strong
export growth and an increase in investments, while
expenditures will increase only 1.4% in real terms. There
is some concern that the GOP may have difficulty passing
three fiscal reform measures in parliament expected to save
$1.45 billion. Some of these potential losses in savings
could be made up by increased privatization sales during the
year. Market reaction has been positive, lauding the
government for generally realistic targets. Although
upcoming general elections in 2005 will make this year more
uncertain than last, the 2005 budget will provide a good
base for the new government in drafting its own financial
program. End Summary.


2. (U) On December 23, President Kwasniewski signed the 2005
budget, completing its enactment. This budget is noteworthy
for several reasons. In addition to paying a full year's
worth of EU membership dues for the first time, Poland will
pay up front significant co-financing obligations for
Structural and Cohesion funds from the budget. Despite
these challenges, the GOP reversed the trend of the last
three years and lowered its budget deficit to 35 billion
Zloty ($11.29 billion),a significant reduction from 2004's
deficit target of 45 billion Zloty ($12.23 billion at the
then-current exchange rate). This will reduce Poland's
deficit-to-GDP ratio from 4.8% in 2004 to 3.7% in 2005 on
track to meet the commitment Poland made in its convergence
plan to lower this figure to 3% by 2007. Finally, this
budget will be the last passed by this parliament, as
general elections will be held in 2005.

Revenues:
- - - - - - -


3. (U) The 2005 budget forecasts that revenues of 174.7
billion Zloty ($56.35 billion) and expenditures of 209.7
billion Zloty ($67.65 billion),for a deficit of 35 billion
Zloty ($11.29 billion). In real terms, revenues are
expected to increase by 8.9%, while expenditures will grow
by 1.4%. The most important sources of revenue will be VAT
(42%),followed by excise taxes (24%) and Personal Income
Tax (PIT, 13%). The government also forecast that it would
receive 5.7 billion Zloty ($1.84 billion) in privatization
revenues, a figure the market believes is low.

Planned Budget Revenues (in billions of Zloty; one dollar
equals 3.1 Zloty)

2004 2005 budget Percent change

Total 156.1 174.7 11.9
Total Taxes 136.8 154.4 12.8
(of which)
VAT 63.5 73.0 14.9
Excise 37.2 43.0 15.6
Lottery Tax 0.8 0.9 12.5
PIT 22.1 23.5 6.3
CIT 13.2 14.7 11.4
Non-tax
Revenues 16.9 16.5 -2.4
(of which)
Dividends 1.3 1.0 -23.0
NBP profits 4.0 4.6 15.0
Customs Duties 2.2 1.5 -25.0
Budget Unit
Revenues 7.6 7.6 -
Local Gov
Payments 1.2 1.2 -
EU budget
Support 2.3 2.7 17.4

Expenditures


- - - - - - - -


4. (U) Overall expenditures are set to increase 1.4% in real
terms. The sectors that will see the biggest increases
include information technology, defense, justice and
education. Overall spending on defense will increase by more
than 11% in nominal terms, in part reflecting Poland's
participation in NATO modernization, in part reflecting a
reclassification of budget items to include spending under
defense which had previously been listed in the education
and cultural sectors of the budget. This budget calls for
a one percent nominal increase in social expenditures (a
1.9% decrease when inflation is factored in) to 63.5 billion
Zloty ($20.48 billion). Roughly half of this amount will be
transferred as subsidies to the Farmers Social Security
System (KRUS, 14.2 billion Zloty, $4.58 billion) and the
General Social Security Fund (FUS, 18.6 billion Zloty, $6
billion). There is a 12% decrease in real terms on
infrastructure spending, reflecting expected EU assistance.

Main items of budgetary spending:
(in billions of Zlotys)
2004 budget 2005 budget Percent change

Total 199.9 209.7 4.4
(of which)
Agriculture 3.1 2.6 -17.6
Forestry 0.04 0.03 -18.3
Fishery 0.033 0.026 -19.3
Mining 2.1 1.7 -18.9
Industry 0.33 0.25 -24.3
Trade 0.92 0.73 -20.6
Hotels/
Restaurants 0.02 0.02 -
Transport/
Communications 5.0 4.1 -18.2
Tourism 0.04 0.03 -11.7
Housing 1.6 1.4 -11.0
Services 0.6 0.4 -34.7
Info Tech 0.15 0.2 27.4
Science 2.9 2.9 -
Public Admin 7.8 7.7 -1.4
Admin Organs 1.6 1.9 15.0
Defense 11.3 12.6 11.4
Social Security 46.0 43.0 -6.6
Public Security 8.7 9.0 3.0
Justice 6.4 7.0 9.9
Debt Service 26.8 27.4 2.4
Various
Settlements 42.9 49.4 15.0
Education 1.1 1.3 18.3
Higher Education 8.9 9.6 7.6
Health care 3.6 3.7 1.9
Social Welfare 10.4 11.4 9.7
Other social
Policy items 5.3 8.0 49.6

A Question of Assumptions:
- - - - - - - - - - - - - - - - -


5. (U) In preparing the budget, the Finance Ministry assumes
that inflation will average 3.0% in 2005, and that economic
growth will average 5%, both of which the markets regard as
reasonable projections. Parliament arbitrarily increased
the expectations for excise tax revenue by 800 million Zloty
to justify increased spending on several pet projects.
Market analysts are not sure the government will be able to
raise this amount from excise. In constructing its
expenditure plans, the government also assumed that
parliament would pass three reform bills as part of the
Hausner plan: a bill reforming the Social Security Fund
(FUS),saving 200 million Zloty; a bill increasing social
security contributions from larger companies, increasing
revenues by 1.6 billion Zloty; and a bill reforming the
Agricultural Social Security System (KRUS),saving 1.7
billion Zloty. Finally, parliament passed a bill
reinstating a 50% Personal Income Tax rate on the richest
Poles over the government's objections, which parliament
expects will raise 250 million Zloty. The GOP has dragged
its feet about implementing the bill, raising serious
questions about whether it will generate any revenue. Taken
together, these shortfalls total 4.5 billion Zloty ($1.45
billion).


Macroeconomic assumptions:
2004 2005

GDP, billion Zlotys 884.0 952.6
GDP growth % 5.7 5.0
Domestic demand growth % 4.7 5.1
CPI year end % 4.0 2.8
CPI average % 3.4 3.0
Unemployment rate % 19.3 18.2
PLN/USD, average 3.75 3.68
PLN/EUR, average 4.6 4.42
Current account deficit, % of GDP 1.6 2.2


Debt Levels:
- - - - - - - - -


6. (U) The budget forecasts debt-to-GDP will be at 48.2%
(using ESA-95 methodology) by the end of 2005, under the 50%
level at which the constitution begins to impose
restrictions. Government debt is expected to dip just below
51% at the end of 2004, a slight reduction from the 2003
total of 51.6%. In the budget, the government forecasts
that its budget deficit will be 3.7% of GDP in 2005, which
will decline to 3.1% in 2006 and 2.7% in 2007, on track to
meet the important Maastricht criteria of 3.0% deficit-GDP
ratio.


7. (SBU) Some analysts see financing of the deficit as the
weakest link in the 2005 budget. The net government
borrowing requirement is 46.5 billion Zloty, a slight
decline from 2004's requirement of 50.8 billion Zloty. The
Ministry of Finance has created some room for maneuver for
itself by planning on borrowing more than the expected
decrease in the deficit would imply. This is intended to
leave room in case the government receives less money from
privatization than planned, has to pay more than planned for
pre-financing EU assistance and/or in case it has to extend
emergency loans to local health care units. There may also
be some positive carryover from the 2004 budget if the final
deficit is lower than has been assumed in the 2005 budget
(the 2005 budget forecasts that the final 2004 deficit will
be 1.6 billion Zloty lower than expected, while market
analysts have concluded it could be up to 4 billion Zloty
lower). Finally, the GOP may also have created some wiggle
room by using a conservative Zloty/dollar exchange rate
forecast of 3.68 for 2005. Should the average exchange rate
for the year be closer to today's rate of 3.1, the GOP could
save up to one billion dollars in debt service costs.

Comment:
- - - - - - -


8. (SBU) Financial markets are very pleased with this
budget. The government has continued the trend begun in
2004 of increasing transparency, with fewer items off-budget
and based on sober projections for growth and income. In
drafting this budget, the GOP faced several challenges. The
GOP managed to lower the budget deficit for the first time
in three years despite the fact that Poland will have to pay
its first full year of dues to the EU, and pay up front its
contribution to EU Structural and Cohesion Funds. This feat
is all the more remarkable considering that it was done by a
technocratic government with low levels of popular support
and that general elections are expected in the summer or
fall of 2005. The revival of privatization is a big part of
the story. For the first time since 2000, the Finance
Ministry did not have to make up shortfalls in revenue late
in the year, allowing the government to meet its debt
targets. Despite being largely written off by market
analysts, the government intends to campaign for important
structural reforms to the social security systems, which
will be important if Poland is to meet its target of
adopting the Euro by 2009. At the very least, the pressure
to enact fiscal reforms is expected to mute parliament's
inclination to pursue populist spending programs in advance
of the general elections. Regardless of the outcome of
elections, the 2005 budget will provide a good base for the
new government to begin work on its financial program.

Ashe