POLAND'S EURO ADOPTION A DISTANT PROSPECT

UNCLAS SECTION 01 OF 03 WARSAW 001529

SIPDIS

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STATE FOR EUR/NCE DAVID KOSTELANCIK AND MICHAEL SESSUMS
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS, MWILSON, JKIMBALL
TREASURY FOR OASIA MATTHEW GAERTNER
FRANKFURT FOR TREASURY JIM WALLAR

E.O. 12958: N/A
TAGS: EFIN ECON PREL PL
SUBJECT: POLAND'S EURO ADOPTION A DISTANT PROSPECT

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

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SUMMARY
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1. (SBU) Begin Summary. Poland has not yet set a target date for
Eurozone entry even though it must eventually adopt the Euro. The
Euro convergence issue, however, is being actively debated among
economists and politicians in Poland. Bankers, as expected, support
fast Euro adoption, while most GOP representatives prefer to take
time and do their homework in order to fulfill the Maastricht
criteria and prepare the legislative framework. Newly confirmed
Prime Minister Jaroslaw Kaczinski did not discuss Euro adoption
while outlining his priorities. In light of the current political
situation, a realistic date for Euro convergence in Poland is 2012
at the earliest. (End Summary).

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Background information
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2. (U) Poland, in ratifying the EU Accession Treaty, committed
itself to eventually becoming a full member of the EMU (European
Monetery Union) and adopting the Euro. While the other EU-10
countries have set target dates for meeting the necessary economic
provisions, Poland does not have a set timeline or plan for Eurozone
entry. Recently appointed Minister of Finance Stanislaw Kluza
stated that he expects Poland will fulfill the Maastricht criteria
by 2009 and begin discussions on Euro adoption. He recently stated
that "Giving a date neither speeds up nor slows down the date for
entering the Eurozone - however, a missed target date, like in the
case of Hungary, can undermine confidence in the economic policy of
a country."


3. (U) While adopting the Euro has advantages and disadvantages,
studies done by Polish authorities including the National Bank of
Poland and the Finance Ministry, and international organizations
suggest that Poland would gain substantially from joining the
Eurozone. Some economists argue that now, while the economy is
growing at an annual rate of nearly five percent, is the best time
to join. Others believe that it is necessary to further develop and
stabilize the economy before moving forward with the Euro. There is
consensus, however, that as long as there is no GOP commitment to
enter the Eurozone at a pre-determined date, there will be no
motivation or pressure on the government to take the steps necessary
to fulfill the Maastricht criteria. Public support for Euro
adoption is slowly increasing, but many Poles are afraid of the
potential for abuse and cheating on prices during the changeover.


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Poland is close to meeting the Maastricht Criteria
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4. (U) Poland is close to meeting all of the Maastricht criteria,
including inflation rate, long-term interest rates, fiscal deficit,
public debt and exchange rate stability. For instance, Poland has
been meeting the inflation standard since early 2003, with a short
break caused by the price adjustment related to EU accession in

2004. This criterion requires that inflation be no more than 1.5
percentage points higher than the average of three EU member states
with lowest inflation, or approximately 2.7% at present. Poland's
inflation rate of 1.4% is significantly below the standard.


5. (U) The interest rate criterion states that long term interest
rates, or rates of return on 10-year bonds, cannot be more than two
percentage points higher than the average long term interest rates
of the three EU member countries with the lowest inflation rates.
Poland's long term interest rates are currently at 5.0%, below the
5.9% limit as determined by the standard.


6. (U) Strict fiscal rules contained in the Polish constitution
guarantee fulfillment of the debt criterion, even though debt levels
have been rising (41.9 % in 2004 and 42.5% in 2005). What will be
most difficult to realize is the 3 percent limit on the general
government deficit. In 2005, abnormally strong budget revenues
allowed the criterion to be met (2.9%). The Ministry of Finance, in
its updated Convergence Program 2006-2008 published in January 2006,
confirmed that it expects a steady reduction of fiscal deficits in
the upcoming years. The update assumes continued special treatment
of Open Pension Funds when calculating the deficit. In 1999, Poland
created open pension funds and placed them in the private sector,
making Poland's long run fiscal position better than that of some
existing members of the Eurozone, but inflated the budget deficit in
the short run. Without continued special treatment of the funds,
the government deficit will exceed 3 percent of GDP.

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Poland Vis a Vis Other Visegrad (V4) Countries
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7. (U) Poland's current status in fulfilling the Maastricht
Criteria is often compared to that of the other three Visegrad
countries: the Czech Republic, Slovakia and Hungary. While none of
the V4 countries have met all of the Maastricht criteria, Poland is
behind the rest in its planning for currency convergence. Slovakia
was admitted into the ERM II in November 2005, while Hungry is the
V4 country that has met the fewest of the Maastricht criteria at the
present time. Nonetheless, all of the EU-10 nations with the
exception of Poland have set target dates for Euro adoption.

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CASE-BRE Euro Convergence Seminar
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8. (U) A Euro convergence seminar sponsored by the Center for
Social and Economic Studies (CASE) and BRE bank was recently held in
Warsaw. Panelists included Jaroslaw Pietras, Secretary of State in
the Ministry of Finance, Jerzy Pruski, First Deputy President of the
National Bank of Poland and Maciej Krzak, the chief economist of
commercial bank Societe Generale. Since Poland is expected to
eventually join the Eurozone, the panelists' presentations and the
discussion that followed revolved around when the Euro should be
adopted rather than if. Although each panelist offered a different
perspective on the issue, Pruski and Krzak generally agreed that
more timely Eurozone entry would be better for Poland's continued
economic development while GOP representative Pietras voiced several
legislative obstacles and potential drawbacks to rapid entry.


9. (U) All participants agreed that Poland could potentially
benefit by becoming a full member of the EMU, but stressed the
importance of choosing the right moment for entering to maximize the
benefits. They argued that if Poland used the Euro, businesses will
be more willing to trade and to carry out transactions in Poland due
to lower costs, thereby increasing efficiency. There is also
evidence that joining the Eurozone will increase foreign direct
investment. Most importantly, Polish investors will gain better
access to Euro capital markets and benefit from the increased
transparency of the financial system.

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Three Points of View: Central Bank, Commercial Bank and GOP
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10. (U) Jerzy Pruski offered the Polish National Bank perspective
that Poland should strive to adopt the Euro as quickly as possible.
He pointed out that international trade would increase as a result
of Eurozone entry, which would boost economic growth and
development. In addition, any potential adverse effects to Poland's
economy would be small due to its high level of integration with the
rest of the EU. Pruski believes that Poland should attempt to begin
its participation in the ERM II soon, in order to take advantage of
the current favorable macroeconomic situation. He argues that
Poland is experiencing the best configuration of macroeconomic
parameters since 1998: GDP is at its potential, inflation is low,
the current account deficit is at its historically lowest level, and
there is external, and to a great extent, internal equilibrium.
Pruski is convinced that postponing the decision on the Euro means
wasting an opportunity that may not reappear.


11. (U) Maciej Krzak from Societe Generale also argued for quick
adherence to the Maastricht criteria and timely entry into the
monetary union. He emphasized that Poland should adopt the Euro at
approximately the same time as its neighbors -- particularly the
other three V4 countries. Krzak saw this aspect of timing to be the
most crucial in terms of keeping Poland competitive and low-risk in
the eyes of investors. He argued that if other V4 countries adopt
the Euro first, outside businesses and investors may choose to go
there instead of Poland, taking economic development with them.


12. (U) Jaroslaw Pietras of the Finance Ministry maintained that
Poland is not yet ready for Euro convergence. He pointed out the
need to align legislation related to monetary and exchange-rate
management, including a change in the constitution. He also
mentioned drawbacks to entry into the EMU such as the loss of
control over monetary policy and possible higher levels of
inflation. He enumerated the nation's priorities as economic growth
and social solidarity. While the Finance Ministry recognizes
potential benefits of the common currency, Pietras stated that Euro
adoption is a major technical and logistical challenge affecting all
sectors of society and hence requires a well designed plan and sound
institutional backing. He also pointed out that non-Euro zone
economies currently are experiencing a faster rate of growth than
the EMU member states, a fact Poland - which is still catching up to
the EU-15 - cannot afford to disregard. Nonetheless, he stated that
the government hopes to meet the convergence criteria during the
current Parliament's term (which ends in 2009) and that a
convergence timeline will most likely be established when the
criteria are met.

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Comment
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13. (SBU) When the ruling Law and Justice party won the 2005
parliamentary elections, it declared that Euro adoption was not a
priority. PiS politicians continue to maintain this position and it
is our opinion that the decision on targeting a date for Eurozone
entry is unlikely to be made before the next parliamentary elections
in 2009. Thus, the earliest date for Polish Euro adoption would be

2012. The divergence of views on Euro adoption in Poland polarizes
both economists and politicians. Even within institutions that
support Euro adoption, such as the National Bank, there are credible
voices that are opposed to the move. While most economists agree
that Euro adoption will eventually benefit the economy, most
politicians and the public will need to be convinced. Until a
target date is set, it is unlikely that the Ministry of Finance will
take the necessary political and legislative steps to allow Euro
adoption. Thus, Polish Euro convergence policy, like most other
economic policy, will continue to drift

HILLAS