Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 46439-PL

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT FOR A PROPOSED LOAN

IN THE AMOUNT OF EUR 975.0 MILLION (US$1.25 BILLION EQUIVALENT)

TO THE

REPUBLIC OF POLAND

FOR A

PUBLIC FINANCE MANAGEMENT, EMPLOYMENT, AND PRlVATE SECTOR DEVELOPMENT PROGRAMMATIC POLICY LOAN

November 20,2008

Poverty Reduction and Economic Management Unit Central Europe and the Baltic Countries Department Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

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AAA BEEPS

BPH CEE CIT CP DB EC ECA ECB ERM2 ESA ESF ESW EU FDI FY GDP GNI GUS IALS IBRD

IFIs IMF I T KRUS LM

___

Vice President: Shigeo Katsu

Sector Director: Luca Barbone Task Team Leader: Thomas Laursen

Country Director: Orsalia Kalantzopoulos

POLAND

CURRENCY EQUIVALENTS (Exchange Rate Effective as o f October 3 1, 2008)

US$ l .oo PLN 2.6970

ABBREVIATIONS AND ACRONYMS

Analytic and Advisory Activities Business Environment and Enterprise Performance Survey Bank Przemyslowo Handlowy Central and Eastern Europe Corporate Income Tax Convergence Program Doing Business European Commission Europe and Central Asia Region European Central Bank Exchange Rate Mechanism (2nd phase) European System o f Accounts European Social Fund Economic Sector Work European Union Foreign Direct Investments Fiscal Year Gross Domestic Product Gross National Income Main Statistical Office International Adult Literacy Survey International Bank for Reconstruction and Development International Financial Institutions International Monetary Fund Information Technology Farmers’ Insurance Fund Labor Market

M I C MLSP MNE MOE MOF M O H M O T MTEF M T O NBP NHF NHS NMS OECD

PBB PFM PISA PIT PPP RIA SME SOE TA TC VAT WB WE0 zus

Middle Income Country Ministry o f Labor and Social Policy Ministry o f National Education Ministry o f Economy Ministry o f Finance Ministry o f Health Ministry o f Treasury Medium-Term Expenditure Framework Medium-Term Objective National Bank o f Poland National Health Fund National Health Service New Member States o f the European Union Organization for Economic Cooperation and Development Performance Based Budgeting Public Finance Management Program for International Student Assessment Personal Income Tax Public Private Partnerships Regulatory Impact Assessment Small and Medium Enterprises State Owned Enterprises Technical Assistance Technical Cooperation Value Added Tax World Bank World Economic Outlook Social Insurance Fund

FOR OFFICIAL USE ONLY

POLAND

PUBLIC FINANCE MANAGEMENT. EMPLOYMENT. AND PRIVATE SECTOR

DEVELOPMENT PROGRAMMATIC POLICY LOAN

TABLE OF CONTENTS

LOAN AND PROGRAM SUMMARY ............................................................................................... 3

I .

I1 *

I11 .

I V .

V .

V I .

BACKGROUND AND RATIONALE .................................................................................... 5

RECENT MACROECONOMIC DEVELOPMENTS AND PROSPECTS ............................ 8

THE GOVERNMENT’S REFORM PROGRAM ................................................................. 17

POLICY FOCUS OF BANK-SUPPORTED PROGRAM .................................................... 21

THE PROPOSED LOAN ....................................................................................................... 35

OPERATION IMPLEMENTATION .................................................................................... 39

ANNEXES

ANNEX 1 . POLICY MATRIX ......................................................................................................... 45

ANNEX 2 . TECHNICAL COOPERATION WITH WORLD BANK AND PROPOSED BANK KNOWLEDGE SERVICES (AAA) UNDER PROGRAMMATIC POLICY LOAN ..................... 51

ANNEX 3: MONITORING OF RESULTS FRAMEWORK ........................................................... 53

ANNEX 4 . ASSESSMENT LETTER FROM INTERNATIONAL MONETARY FUND .............. 57

ANNEX 5 . POLAND AT-A-GLANCE ............................................................................................. 61

ANNEX 6 . POLAND DOING BUSINESS INDICATORS .............................................................. 63

ANNEX 7 . LETTER FROM GOVERNMENT OF THE REPUBLIC OF POLAND ...................... 64

The loan was prepared by an IBRD team consisting o f Thomas Laursen (Task Team Leader). John Balafoutis. Leszek Kasek. John Pollner. Albert0 Rodriguez. Jan Rutkowski. Pia Schneider. and Anita Schwarz .

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties . I t s contents may not be otherwise disclosed without Wor ld Bank authorization .

2

LOAN AND PROGRAM SUMMARY

POLAND

PUBLIC FINANCE MANAGEMENT, EMPLOYMENT, AND PRIVATE SECTOR DEVELOPMENT PROGRAMMATIC POLICY LOAN

Borrower

Implementing Agency

Amount

Terms

Tranching

Description

Benefits

Risks

P O L A N D

MINISTRY OF F INANCE

EUR 975.0 mi l l ion (US$1.25 bi l l ion equivalent)

Euro-denominated IBRD Flexible Loan at six-month L I B O R for euro plus Fixed Spread, payable in 30 years, including five year grace period. Front-end fee o f 25 basis points to be paid by the borrower f rom own funds. Single tranche

The Government o f Poland has requested a US$1.25 bi l l ion equivalent Development Policy Loan in support o f i t s fiscal reform and consolidation plans and broader economic reform program. The loan would be the first in a programmatic series o f three policy loans within a total lending envelope o f US$3.75 bi l l ion equivalent over the next 2 to 3 years.

The programmatic policy lending program would support the government’s plans to enhance the quality and efficiency o f public finances, increase the supply o f relevant and skilled labor, and strengthen the business environment. The programmatic series wil l be accompanied by a program o f technical cooperation and knowledge sharing to complement and extend existing reform plans and priorities. The policy focus o f each operation would be closely aligned with the government’s current reform priorities and the political feasibility o f specific reforms. The Bank’s engagement with Poland on key policy issues provides important experience and knowledge to the Bank as well, which will be relevant for our collaboration with other countries in the region.

Deterioration of macroeconomic balances. The medium-term macroeconomic scenario o f slowing economic growth and moderating inflation i s subject to further downside risks. While inflationary pressures have abated significantly with the recent global slowdown and tighter credit conditions, wage growth has been relatively robust, and the recent depreciation o f the zloty could rekindle inflationary pressures. Poland has one o f the most solid

3

Operation ID Number

financial systems in Europe, but, nevertheless, the authorities have responded to rising pressures with confidence-restoring and liquidity-enhancing measures. Going forward, fiscal policy wi l l need to play a key role in managing demand flexibly while the supply side needs to be further stimulated through acceleration o f structural reforms. Public sector wage growth will need to be contained, in particular to help send the right signal to private labor markets. The proposed series o f operations supports this policy mix through i t s emphasis on fiscal discipline and reform, labor market and pension reform, deregulation, privatization, and overall policy coordination. The Government’s announcement o f an ambitious plan to adopt the euro in 2012 helped to anchor financial market expectations and lends further credibility to i t s medium-term fiscal plans. Weakening political support for reform. The political environment-with the Government’s lack o f qualified majority in Parliament and risk o f Presidential veto on new proposed legislation-may make it increasingly difficult for the Government to advance i t s reform program over the next two years as Presidential elections approach. However, the inherent flexibility o f the proposed programmatic approach will allow program content to evolve in step with government priorities. Insufficient institutional cupacity. Policy formulation in Poland has tended to be fragmented and technical and administrative capacity in some ministries i s weaker than desirable. The proposed programmatic series would help strengthen policy coordination and technical/administrative capacity through the Bank’s analytic and advisory services. P112765

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I. BACKGROUND AND RATIONALE

1. Poland has made impressive progress towards creating a modern, market-based economy, and has successfully managed its integration into the European Union (EU) since accession in 2004. Recent macroeconomic performance has been favorable, with strong output growth and a rapid decline in unemployment combined with low inflation and external imbalances. Meanwhile, buoyant tax revenues have led to a decline in the fiscal deficit. Growth has been built on a vibrant private sector which now accounts for three-quarters o f the economy. High growth in domestic consumption reflects the rapid increase in living standards for most Polish citizens. Likewise, poverty levels have decreased and are now concentrated in rural areas and among the long-term unemployed. But the reform momentum has slowed following EU accession, and the strong growth over the last few years reflects to a significant extent a rebound from the economic downturn in the earlier part o f the decade combined with a favorable external environment.

2. The constraints to continued rapid convergence to average EU income levels are becoming visible. Notably, infrastructure development has been lagging and bottlenecks are emerging in the labor market-xacerbated by outward migration, including o f skilled and highly educated workers-fueling acceleration in wage growth that i s adding to inflationary pressures and increasing the external current account deficit. The business environment has been hampered by excessive regulation and high costs. Lack o f fiscal space, combined with technical and administrative constraints, has also contributed to a slower rate o f absorption o f EU funds. Environmental commitments and the challenges posed by global warming at the same time call for,further efforts to improve energy efficiency. Growth diagnostics are discussed in more detail in Box 1 below.

3. The key challenges now will thus be to enhance the quality and efficiency of public finances, increase the supply o f relevant and skilled labor, and strengthen the business environment. Along the road to adopting comprehensive EU standards and practices, further strengthening o f public administration capacity and reforming public finances will be essential. Poland intends to increase the quality o f i t s public services (including the quality and relevance to the labor market o f the skills o f graduates from the education system) and make room for financing o f critical infrastructure and other investments while further lowering the high tax burden, not least o n labor. To this end, the Government will strive to improve the efficiency o f social and pension spending and the targeting o f social assistance programs. The development o f an effective medium- term expenditure framework, consistent with continued lowering o f the fiscal deficit and reduced public debt servicing costs, and increased performance-orientation in the management o f public resources are key complements in this regard. Streamlining o f business regulations, improvements in public-private partnership frameworks, privatization in strategic sectors, and enhanced efficiency o f the judiciary sector are needed to maintain the ongoing stimulus in private investment. The program o f the new Government, which came into power in late 2007, augurs wel l for addressing these critical challenges, although concrete strategies and policies in many areas remain to be fully articulated.

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4. The World Bank has been a close partner of Poland in supporting its successful transformation and EU integration, both by helping design and implement policies and institutional reform, and addressing the social costs o f transition. The focus o f the World Bank during the 1990s and early 2000s was on private sector development, strengthening social support services, rebuilding basic infrastructure, and protecting the environment. Working closely with successive governments, World Bank support has been provided through a combination o f analytic and financial services and technical cooperation (TC). Since World Bank lending to Poland started in 1990, financial commitments total US$6.4 bi l l ion for 45 projects. Currently, eight investment projects are under implementation in support o f roads rehabilitation and modernization, port improvements, energy efficiency, river basin flood prevention, and social services in rural areas. Recent analytic and advisory activities includes studies on growth, employment and living standards; the fiscal framework for growth (public expenditure and institutional review); Doing Business and investment climate assessments; a knowledge economy assessment; legal barriers to contract enforcement; and regional economic and public finance reports.

5 . The World Bank has been adjusting its partnership model in Poland to reflect the country’s major progress and evolving needs. The nature o f Poland’s challenges and reform agenda has changed considerably since the earlier days o f World Bank involvement. The EU and i t s institutions are now Poland’s main external partners, to which the World Bank i s committed to play a supporting role. Poland also has access to considerable external financing, including large volumes o f EU Structural and Cohesion Funds on a grant basis. In this context, the nature o f the relationship has moved to a more selective engagement, with more flexibility to respond to Poland’s priorities and increased focus on areas where the World Bank can offer the most value added. At the same time, support for broader policy reform continues to be most effectively provided through bundling o f lending and technical cooperation as this helps to strengthen pol icy coordination and consistency and build consensus around reforms.

6. The new Government and the Bank have recently focused on defining a more strategic re-engagement in core policy areas. The Bank has renewed its dialogue with several line ministries under the new government, and there is interest in technical cooperation and knowledge-sharing in key policy areas such as strengthening the business environment, infrastructure development, regional development, public finance and administrative reform, and climate change.

7. The proposed operation i s fully consistent with the diagnostics, strategic pillars o f engagement and Bank value-added in the 2005 Country Partnership Strategy. The 2005 CPS for Poland included three pillars: fiscal consolidation, convergence/ competitiveness, and employment and poverty. The proposed operation (discussed in the following), while not foreseen in the CPS, i s fully consistent with Bank intervention along the envisaged strategic pillars o f engagement. The operation focuses on core areas o f Bank value-added, notably public finance reforms, labor market and pension reforms, and private sector development.’ The broad and strategic 2005 CPS envisaged

The challenges o f tackling labor market rigidities and population aging are prevalent across Central and Eastern Europe. Engagement with Poland on these key economic policy issues wi l l provide the Bank with important experience and knowledge, which wi l l be relevant for our engagement with other countries in the region.

6

elaboration o f annual, more concrete business plans, but no such plans were agreed in FY07-08 given the rapid changes on the political scene.

BOX 1. SUPPORTING HIGH AND SUSTAINABLE ECONOMIC GROWTH M POLAND

Although recent economic performance has been impressive, Poland still faces important growth constraints which may slow down the real convergence process over the medium-long term. In 2007, Poland’s GDP per capita at purchasing power parity amounted to 53.6 percent o f the average for the EU-27. A continued rapid reduction o f the income gap requires high and sustainable growth based on sustained productivity increases and higher employment and investment rates (potential medium to long te rm growth rates are estimated at 4.5 to5.0 percent assuming a continued gradual increase in employment rates, rapid investment growth, and continued robust productivity growth).

Wh i le the Bank has not completed any core diagnostic work on Poland recently, many key issues have been covered in the Bank’s regional economic studies. There is broad consensus (including among the EC, the IMF, and the OECD) that policy interventions aimed at promoting high and sustainable growth should be focused on the following three broad areas:

(a) Public finance and administrative reforms aimed at continued fiscal consolidation, lowering o f the tax burden, re- orientation o f spending towards more productive areas, improved public finance management, and enhanced public administration (public finance and administrative reform);

(b) Promoting private sector investment through an improved investment climate, more product market flexibility, and restructuring o f key sectors (structural reforms); and

(c) Increasing labor force participation and employment including in order to further reduce poverty and encourage social inclusion (labor supply mobilization).

Publicfinance reforms are required in order to improve the quality and efficiency of public finances. Further fiscal consolidation i s needed to improve macroeconomic stability and provide room for countercyclical fiscal policy. A lower tax burden and simpler tax system i s needed to encourage formal private sector activity. A re-orientation and restructuring of spending i s needed to provide fiscal space for increased productive spending, notably on infrastructure, and improved outcomes o f key public services (including health and education). Public finance management reforms are needed to enhance the transparency and predictability o f public finances and should include introduction o f a medium-term expenditure framework and enhanced performance-orientation in spending ministries and agencies. Public administration reforms are needed to support more efficient management and service delivery, including better policy coordination. This should include reforming and modernizing Poland’s courts (which are a source o f major delay for business transactions) and enhancing the capacity and results-orientation o f the civil service and the public administration at all levels o f government.

Structural reforms are needed to improve the general investment climate and support the restructuring o f low- productivity sectors. Poland ranks low on Doing Business Indicators even among i t s regional peers, and further deregulation i s needed. This should include a simplification o f Poland’s onerous legal, tax and administrative environment for entrepreneurship and business development. Licensing requirements and business startup regulations are particularly burdensome. In addition, the Government could facilitate the continued shift away from old industrial and low-productivity sectors to new job-rich, high-productivity sectors. This would include restructuring sectors such as coal or energy generation and removing incentives for people to remain in low-productivity agriculture while accelerating the privatization process (including in what are considered strategic sectors). The Government could also further support the high productivity sectors by promoting private sector research and development to increase the overall level of R&D expenditures as well as its composition in line with successful innovating economies, including through provision o f seed capital for developing early stage technologies.

Labor supply mobilization i s needed to raise low employment rates, not least among the older cohorts, and improve the skills of the workforce. This requires reform o f the system o f social protection and labor taxation in order to enhance incentives to work along with development o f more flexible forms o f employment, improved active labor market programs targeted at disadvantaged worker groups and promotion o f life-long learning. Limiting the number o f professions entitled to early retirement would be in line with the principles o f the pension reform introduced in 1999 and in support o f increased labor force participation. Continued reforms in the education system are also needed to improve labor market relevance and skills. Wh i le outward migration has been a concern following EU accession, remittances have been substantial, and people are beginning to return as economic prospects improve at home.

7

8. The proposed operation i s also consistent with the Bank’s new Regional Partnership Strategy currently under preparation. The new Regional Partnership Strategy (planned for Board discussion in March 2009) will update the 2004 Framework paper for the EU-8 countries and replace individual Country Partnership Strategies for new EU Member States. The aim o f the regional approach i s to set out the broad themes on which the Bank will engage with countries across the region over the next few years while the instruments for engagement wi l l be determined by each country’s relationship with the Bank. The overarching theme wi l l be to help countries meet the Lisbon Agenda. The proposed operation f i t s well within the proposed areas o f engagement, which include: global and regional public goods (including climate change and financial stability); growth and competitiveness (including investment climate reforms and labor market flexibility); social and spatial inclusion; and public sector reform (including public finance and administrative reform).

9. The Bank has engaged in close consultations with both the International Monetary Fund and the European Commission, who are supportive o f continued Bank policy lending as long as it support further restructuring o f public finances and fiscal consolidation and i s fully consistent with EU commitments, including the Broad Economic Policy Guidelines, Poland’s Convergence Program and Council Opinions on this, and EC assessments o f Poland’s National Lisbon Strategy implementation.

11. RECENT MACROECONOMIC DEVELOPMENTS AND PROSPECTS

10. Robust growth has remained well-balanced and other macroeconomic fundamentals broadly sound despite unfavorable global trends. Strong growth has been creating new jobs. Rising labor demand and, to a lesser degree, external migration, have reduced the unemployment rate to 7 percent in 2008 from 20 percent a few years ago (Box 2). In l ine with global tendencies, from late 2007 inflation accelerated above the inflation target (of 2.5 +/-1 percent), driven largely by cost factors (higher food and energy prices) but also rising unit labor costs resulting from the sharp labor market tightening. In response, interest rates were hiked gradually from spring 2007, while accompanying zloty appreciation made monetary conditions even more restrictive. Although the external current account deficit widened further to 4.7 percent o f GDP in 2007, it remained moderate by historical and regional standards and was almost fully financed by net foreign direct investment (FDI). In addition, the foreign-debt-to-GDP ratio stabilized at around 47 percent o f GDP in 2007.

8

Box 2. RECENT LABOR MARKET DEVELOPMENTS Labor market conditions in Poland have improved considerably in the last few years. The unemployment rate fell from about 20 percent in 2003 to 7 percent in Q2-2008. The growth in employment was accompanied by strong growth in real wages, which averaged 3 percent per year over the last 5 years, accelerating in the last two years. However, despite the considerable progress in reducing unemployment, labor market outcomes remain unsatisfactory in Poland. The employment/population ratio i s one o f the lowest in the EU (57 percent against the EU average o f about 65 percent) and far from the Lisbon target o f 70 percent. The low employment rate i s primarily due to the low labor force participation o f older workers (ages 55 to 64), which at only 32 percent i s the lowest in the EU. The very low labor force participation of older workers i s primarily accounted for by the availability o f generous early retirement schemes.

While long-term unemployment looms large in Poland, i t s incidence has recently declined significantly (from 50 to 30 percent over the last year). Still, many o f the unemployed cannot find a job despite strong labor demand, a sign o f labor market, and consequently social, exclusion.

The improvement in labor market conditions has had a profound positive effect on poverty. As a result, the official poverty rate dropped by almost 5 percentage points in just three years: from the peak of 19.2 percent in 2004 to 14.6 percent in 2007, with the trend continuing in 2008.

Although labor resources are substantially underutilized in Poland, many firms face acute labor and s k i l l shortages. The strong growth in labor demand has brought about labor shortages, aggravated by out-migration of skilled workers. The job vacancy rate has increased and employers now cite lack of skilled labor as the most important obstacle to the operation and growth o f their firms. Skill shortages indicate that unemployment in Poland has a significant structural component, because the unemployed do not possess the skills that are required by employers. If not addressed, skill shortages may become a constraint on investment and firm growth and thus hinder future economic expansion. I t i s encouraging that the rapid outflow o f workers to other EU countries following EU accession now appears to have subsided as employment and income prospects have improved at home, including with the rapid appreciation o f the zloty.

I n short, within just a few years, the Polish economy has moved from a shortage of jobs to a shortage of skilled workers. The table below summarizes these developments.

Main indicators of labor market conditions and poverty in Poland, 2001-2007 2001 2002 2003 2004 2005 2006 2007

Percent Employment rate, population 15-64 53.4 51.5 51.2 51.7 52.8 54.5 57.0 Employment rate, population 55-64 27.4 26.1 26.9 26.2 27.2 28.1 29.7

Youth unemployment rate 39.2 41.6 41.4 40.1 36.9 29.8 21.7 Long-term u n em p loy m en t (% of total) 50.0 54.4 55.1 53.7 57.7 56.2 51.4 Real wage growth, yea r-to-year 2.4 0.7 3.3 0.5 1.7 3.8 6.0 Poverty in cide n tea) 15.0 18.5 19.2 19.2 18.0 15.1 14.6 a) Official poverty line. Source: Central Statistical Office, Ministry of Labor and Social Affairs.

Unemployment rate 18.7 20.2 19.7 19.4 18 14 9.7

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11. The fiscal stance improved significantly in 2006-07 in tandem with the economic upturn. The general government deficit, in l ine with ESA95 methodology and including the costs o f pension reform (around 2 percent o f GDP per annum), amounted to 2 percent o f GDP in 2007 compared to 3.8 percent o f GDP in 2006 and 4.3 percent o f GDP in 2005. This impressive outcome was achieved due to strong revenues and tight spending control. Due to strong nominal GDP growth, zloty appreciation, and a primary fiscal surplus o f around 0.5 percent o f GDP, the public debt-to-GDP ratio declined from over 47 percent o f GDP in 2005-2006 to 45 percent o f GDP in 20072. At the end o f 2007, Poland met the reference values for deficit and debt (officially the fiscal criterion was fulfilled after the abrogation o f the Excessive Defici t Procedure in July 2008) and fulfilled the inflation and interest rate criteria o f the Maastricht Treaty.

12. Due to the timing of the budget cycle, the Tusk cabinet had little opportunity to introduce any major changes in the draft budget for 2008, which implied a deterioration o f the fiscal policy stance in 2008 by around 0.5 percentage points o f GDP as compared to the surprisingly good fiscal performance in 2007. This outturn i s due to policy measures adopted before the October 2007 parliamentary elections, both reducing public revenues (a second cut o f the disability pension contribution rate and income tax re l ie f for families with children), and increasing expenses (more generous pension indexation). This effect will be only in part offset by deficit-decreasing factors (higher inflation, better tax compliance and broader tax base due to tax wedge reduction, and excise duty hikes). During the Parliamentary debate after the elections, the state budget deficit for 2008 was reduced rather symbolically as compared to the draft budget prepared by the former Government.

13. The latest Convergence Program adopted by the Tusk Government in March 2008 envisaged a more ambitious fiscal consolidation in 2009-10 than earlier programmed. The difference resulted both from the good revenue outcome in 2007 and a firm commitment to fiscal discipline. In 2009-10, the official fiscal path envisaged an improvement o f the headline and primary fiscal balances by 0.5 percent o f GDP per year. At the same time, the structural deficit was to be reduced by 0.6 percent o f GDP in 2009 and 0.7 percent o f GDP in 2010. The fiscal adjustment was expected to occur against the background o f real GDP growing close to i ts potential rate o f 4.5-5 percent per annum. The structural deficit was set to reach the medium-term objective (MTO), as defined in the Stability and Growth Pact at around -1 percent o f GDP, in 2011-0ne year after the time horizon o f the Convergence Program. Even with the temporary fiscal policy relaxation targeted in 2008, public debt would remain on a downward trend and decline from around 45 percent o f GDP in 2007 to around 42 percent o f GDP in 2010.

In 2007, Poland’s nominal GDP increased by 10.2 percent. The Zloty appreciated significantly against currencies, in which public debt i s denominated (6.2 percent against the Euro and 16.3 percent against the US dollar). At end-2007, 24.2 percent o f State Treasury debt was denominated in foreign currencies, with a dominating role o f the Euro (1 7.4 percent o f the total debt), while the U S dollar constituted 2.7 percent, the Japanese Yen 1.8 percent, the Swiss Franc 1.7 percent and other currencies 0.6 percent.. At the same time, interest payments o f 2.4 percent o f GDP in 2007 were pushing the public debt-to-GDP ratio up. In 2007, the average term to maturity (ATM) o f marketable domestic State Treasury debt increased to 5.30 years from 5.1 1 years in 2006, while the A T M o f foreign State Treasury debt remained unchanged as compared to the previous year and amounted to 8.28 years.

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Table 1. Fiscal developments and prospects in Poland 2004-2011 (percent o f GDP unless otherwise indicated)

Source 2004 2005 2006 2007 2008 F 2009 F 2010 F 2011 F CP March 2008 -3.8 -2.0 -2.5 -2.0 -1.5

Fiscal balance Government September 2008 -5.7 -4.3 -3.8 -2.0 -2.5 -2.0 -1.5 -1.0 EC Autumn Forecast 2008 -3.8 -2.0 -2.3 -2.5 -2.4 CP March 2008 -3.7 -2.2 -2.7 -2.1 -1.4

EC Autumn Forecast 2008 -3.9 -2.6 -2.9 -2.5 -2.0 Structural balance Government September 2008 -5.9 -4.2

CP March 2008 -1 .I 0.2 -0.2 0.3 0.8

EC Autumn Forecast 2008 -1 .I 0.5 0.2 0.2 0.4

CP March 2008 47.6 44.9 44.2 43.3 42.3

EC Autumn Forecast 2008 47.7 44.9 43.9 43.6 43.1 CP March 2008 6.2 6.5 5.5 5.0 5.0

GDP Government September 2008 5.3 3.6 6.2 6.6 5.5 4.8 4.9 5.0 (%change) EC Autumn Forecast 2008 6.2 6.6 5.4 3.8 4.2

CP March 2008 -0.3 0.6 0.5 0.1 -0.1 Output gap Government September 2008 0.4‘ -0.3*

EC Autumn Forecast 2008 0.3 1.7 1.4 -0.1 -0.9

Primary balance Government September 2008 -1.2’ -0.3*

Public debt Government September 2008 45.7 47.1 47.7 45.2 44.3 43.9 43.1 42.1

Note: *) based on Poland’s Convergence Program. Update 2005, published in January 2006. Source: Poland’s Convergence Programs (CP) and EC Economic Forecast, Autumn 2008; Budget for 2009, approved by the Government in September 2008.

Chart 1. Structural deficit in 2004-2011, percent o f GDP

Chart 2. General government debt and deficit in 2006-2011, percent o f GDP

2004 2005 2006 2007 2008 2009 2010 2011 0 ,

Medium term objective

-2

3

2006 2007 2008 2009 2010 2011

1 47.7 T

I -GG gross debt (right hand side) -5

Source: Poland’s Convergence Program. Update 2007, published in March 2008.

Source: Budget draft for 2009

14. Planned policy measures would have little impact in 2008 but result in faster decrease o f public expenditures than revenues in 2009-2010. As compared to the expected outcome o f 2008, the adjustment would be broadly equally distributed over 2009 and 2010. Over the two years, overall expenditures would decline by 2.4 percent of GDP and focus on social spending and current operational spending. At the same time, revenues would decline by 1.3 percent o f GDP. The combination o f lower expenditures, a lower overall tax burden, and a declining share of direct taxes in the structure of tax

49 48 47 46 45 44 43 42 41 40 39

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receipts, would enhance long-term growth prospects although further budget neutral tax and expenditure cuts would be desirable given the sti l l quite large public sector.

Chart 3. Public Revenues, Expenditure, and Deficit in 2004-2010, percent o f GDP

Chart 4. Composition of Fiscal Deficit Reduc in 2009-2010, percent o f GDP

Total expendltures T “

ion

Total revenue

Subsidies 5

4

48

46

44 -3 Other spending 02010

42 -2 Groooflxed capltai formation

Social payments 40

-1 38 Total revenue Current operaUonal expenditures

36 0 2004 2005 2006 2007 2008 2009 2010

3 -2.5 -2 -1.5 -1 0 . 5 0 0.5

Source: Poland Convergence Program, Update 2007 (published in March 2008).

15. The EC on June 11, 2008 recommended closing Poland’s Excessive Deficit Procedure (imposed in 2004). In mid-2008, the EC made i t s recommendation on the basis of Poland’s updated Convergence Program and confirmed that the deficit was reduced below the reference value o f 3 percent o f GDP in a credible and sustainable manner. Nevertheless, the EC, in Recommendation for a Council Opinion on the Updated Convergence Program o f Poland (adopted also on June 1 l), invited Poland to exploit the favorable growth conditions to strengthen the pace o f structural adjustment towards the MTO, in particular in order to contain possible inflationary pressures, by using any extra revenue and unspent resources for deficit reduction in 2008 and by specifying and implementing measures, especially on the expenditure side, in the following years. These views were echoed by the European Council in i t s opinion, which also noted that “given the risks to the budgetary targets from 2009, mainly due to a lack o f specified measures, the MTO may not be achieved by 2011 as planned in the program. Moreover, should inflationary pressures appear, a tighter fiscal stance than foreseen in the program would be required.” The IMF endorsed the Government’s fiscal consolidation plans in i t s April 2008 Article IV consultation, but also expressed some concern owing to the downside macroeconomic risks and the absence o f well-specified measures to achieve the fiscal targets.

16. Poland has not been immune to the ongoing global financial crisis despite relatively moderate external vulnerability. Since the beginning o f September 2008, the headline equity index (WIG) has declined by 30 percent. Outf low o f foreign investors from emerging markets resulted in heavy depreciation o f the zloty-since early September, the zloty has fallen by 20 percent against the U S dollar and 8 percent against the euro. The re-pricing o f r isk has also been reflected in widening government bond spreads-Poland’s Euro-denominated sovereign bond spreads were at 23 7 basis points in early November, 150 basis points higher then in September 2008, though relative to other emerging market economies these increases are on the l o w side. Poland’s external

12

vulnerability is considered moderate. While external debt amounts to about 50 percent o f GDP and the short-term debt on a “remaining maturity basis” and short-term debt in relation to foreign exchange reserves are high, Poland seems better positioned than other emerging markets. For instance, output i s close to potential, the current account deficit i s low, and private sector credit growth, while s t i l l averaging in nominal terms some 30 percent per year, i s much lower than in other transition countries.

17. In addition, the authorities have reacted with confidence-restoring and liquidity-enhancing measures, highlighting their commitment to sound macroeconomic management. In particular, in late October 2008, the Government announced a roadmap to euro adoption in 2012,3 which helped to anchor financial market expectations. The Polish banking system i s widely considered to be relatively robust (See Box 3), but the National Bank o f Poland took precautionary steps and expanded i t s te rm liquidity management operations and FX swap facility in euro and U S dollar. The Government also increased guarantees for bank deposits to EUR 50,000 from EUR 22,500 and proposed a law to support financial market institutions facing insufficient liquidity. The support may be granted in the form o f the state treasury guarantees, lending treasury papers, sale o f treasury papers with a delayed maturity or spreading the repayments into installments. The Financial Supervision Authority issued recommendations on tightening of existing lending rules. As a result, a number o f banks have already introduced restrictions on Swiss Franc loans, tightened lending procedures, and introduced new mortgage lending regulations, including higher margins, stricter creditworthiness assessment criteria and increases in the amount required for down payments.

18. GDP growth prospects have deteriorated markedly, and the IMF expects a sharp slowdown from 5.0 percent this year to 2.9 percent in 2009, while a more moderate slowdown (to 4 percent in 2009) i s projected by the Bank which i s close to the recent EC forecasts and market consensus. Because the markets have not yet stabilized, the projections are s t i l l subject to unusually large uncertainty, and downside risks dominate. In recent weeks, virtually al l international financial organizations and private financial institutions have lowered their global growth forecasts, including for Poland, and the Government o f Poland i s also revisiting i t s macroeconomic forecasts. An updated Convergence Program i s due in December 2008.

19. Although the slowdown in the second half of 2008 and into 2009 was expected for cyclical reasons, the escalation of the international financial crisis and sharper than envisaged slowdown in the global economy and euro-zone, combined with tighter domestic credit conditions, are exacerbating the downturn. High frequency indicators-industrial and construction production or retail sale-suggest a modest slowdown in the third quarter o f 2008 while confidence indicators suggest a sharper deterioration in economic conditions (see Chart 5).

This would imply joining the ERM-2 around the middle o f 2009.

BOX 3. POLAND’S BANKING SYSTEM

I n 2007, the performance of Polish banks was very good. The banks’ aggregated return on equity reached 28.6 percent, resulting from improvements in virtually all areas including: (i) an increase in net interest margin; (ii) a substantial increase in fee income from banking products and mutual funds; and (iii) a decrease in the cost to income ratio, and lower risk charges. The profitability o f other financial sector institutions was also robust. According to the Polish Financial Supervision Authority (PFSA), through September 2008 the net financial profit o f Polish banks equaled to P L N 12.7 bil l ion as compared to P L N 10.5 bil l ion a year ago (21 percent increase y/y). However, the profitability i s expected to decline in 2008 and a few years beyond, for various reasons including that: (i) the collapse in equity value has led to redemptions from mutual funds for the f i rs t time in years, thereby reducing fee income for banks; and (ii) the cost o f risks i s expected to increase with the slower economic growth and lower real estate prices.

Poland has one of the most solid financial systems in Europe. According to the IMF Article IV report o f 2008, Poland has little, if any, exposure to U S sub-prime mortgage assets. The National Bank o f Poland Stability Report o f June 2008 confirms this and highlights that insurance companies and pension funds are also not exposed to the US sub-prime crisis. Foreign capital inflows have held up well compared to other European emerging markets. In contrast, the stock market retrenchment has been more severe given the strong gains o f the last years.

Starting from January 1, 2008, financial supervision i s carried out by the PFSA, after the integration o f financial and banking supervision in view o f the growing significance o f multinational financial groups and cross- sector financial products. Tasks o f the PFSA are more broadly defined than i t s predecessors, including undertaking measures aimed at ensuring the stability, safety and transparency o f the financial market, and consumer issues such as clients’ complaints, financial education, and codes o f best practice. Banking regulations and supervision practices are harmonized with EU directives and practices, and 7 o f the 9 largest banks are controlled by foreign banks. The Solvency Ratio o f Polish banks has fallen after the implementation o f Base1 11, to 11 percent at the end o f 2007 (from 14 percent in 2006) and to an estimated 10.2 percent in 2008.

I n 2008, credit growth remained strong (at 25-30 percent year-on-year), especially in the mortgage market, but started slowing (from annual growth rates over 40 percent in 2006-07) under the impact o f rising interest rates, falling real estate prices, and tighter lending standards. The private sector (households and enterprises) credit to GDP ratio increased from 3 1 percent in 2006 to 39 percent in 2007 and to 45, percent in mid-2008. The penetration o f deposits has also increased, from 42 percent o f GDP in 2007 to 45 percent in mid-2008. Nevertheless, these numbers remain among the lowest in the EU and well below the EU average, and future growth should be significantly slower.

Generally, the Polish banking system i s sound, albeit with some vulnerability; and the high profitability related to outstanding macroeconomic performance and booming markets i s not sustainable over the medium-term. - Banks’ foreign debt increased in recent years, but the level i s relatively low (in mid-2008, it amounted 13.4

percent o f GDP as compared to 38.1 percent o f GDP on average in the EU10). Therefore, banks in Poland are not as much dependent on foreign financing as banks in other countries in the region. The loan to deposit ratio i s around 100 percent, much lower than in most other countries in the region. Credit expansion i s mainly financed from domestic deposits. Foreign currency loans constitute around one-quarter o f total loans to the private sector, a lower share than elsewhere in the region. However, as much as 49 percent o f retail mortgage debt outstanding i s denominated in foreign currency, mainly the Swiss Franc. The share o f Swiss Franc-denominated business fel l since mid- 2006 when supervisory restrictions were implemented (imposing stricter LTV ratios and requiring banks to conduct depreciation stress tests). Macroeconomic and property price corrections should make mortgage lending in foreign currency riskier. Bank ownership i s well diversified. Foreign investors control around three-quarters o f the assets o f the banking sector in Poland, but the ownership structure i s well balanced in terms o f country o f origin although mainly from Western Europe.

-

-

-

14

25 70 - 60 -

20 50 - 40 - 15

30 - 10 20 - 10 - 5

0

0 0 -

V I -10 - -20 - -30 - -1 0

Retail sales

V " " " " " " " '

30 7

2 5 1 n Economic Sentiment Indicator

26 7

2o 15 I

20. The IMF's updated World Economic Outlook (WEO) assumes a sharp slowdown of economic activity with zero growth in investment and associated import compression resulting in a strong improvement o f external and internal imbalances. The current account deficit is projected to narrow to 2.6 percent o f GDP and inflation to decline to close to the 2.5 percent N B P inflation target in 2009 (Table 2). The Bank and EC assume a slower deceleration in domestic demand growth, but even in these more optimistic GDP growth scenarios, the external current account deficit should remain

15

within relatively safe l imits while inflation should ease from its current elevated level towards the N B P target.

21. Under these circumstances, a case can be made for fiscal policy to allow automatic stabilizers to operate in 2009 while staying within medium-term fiscal boundaries. The macroeconomic assumptions underlying the 2009 budget bill (4.8 percent growth) have been overtaken by events and sticking to the targeted deficit would imply an untimely fiscal withdrawal. Given the below-potential growth and fiscal consolidation to date, automatic stabilizers-operating on the revenue side-would provide a welcome counter-cyclical impulse. Fiscal pol icy should, nonetheless, remain governed by the budget envelope and the authorities’ overarching medium-term objective. Fiscal performance so far in 2008 has been better than targeted (in January- October 2008, the state budget deficit amounted to 43 percent o f the original annual target), and the expected stronger base in 2008, combined with the legally binding state budget deficit target in 2009, will help protect the fiscal position in 2009. The Government is also planning some institutional reforms with a new law on public finance (including consolidation o f budgetary units, a Medium-Term Fiscal Framework with state-budget deficit ceilings, and advances in performance budgeting), which would help contain public expenditures and add credibility to medium-term fiscal commitments. Overall, the Bank finds the macroeconomic pol icy framework to be adequate for a development pol icy operation.

22. The global economic outlook remains uncertain. According to the most recent WE0 Update, financial conditions continue to present serious downside risks. While the forceful pol icy responses in many countries have contained the risks o f a systemic financial meltdown, there are reasons to remain concerned about the potential impact on activity o f the financial crisis. The process o f deleveraging could be more intense and protracted than factored into the macroeconomic projections for emerging markets. Intense deleveraging could also increase the r isks o f substantial capital f low reversals and disorderly exchange rate depreciations for many emerging economies. Another downside risk relates to growing r isks for deflationary conditions in advanced economies, although these are s t i l l small given well-anchored inflation expectations. In the current setting, upside risks are limited. Nonetheless, it i s possible that the financial sector policy measures, once fully specified and implemented, foster a more rapid-than-expected improvement in financial conditions. In the meantime, the relatively strong balance sheets o f nonfinancial corporations might help forestall a major cutback o f investment across both advanced and developing countries. Under such conditions, confidence could also recover rapidly and spending by households and f i r m s quickly rebound.

’ In recent years, the current account deficit has been low for regional and Poland’s historical standards and largely financed with net FDI inflows (90 percent coverage in 2007 and more than 100 percent in 2004- 2006). FDI inflows were well-diversified by sectors. Over the last 4 years, 53 percent o f FDI went to services (financial intermediation 20 percent, trade 15 percent, transport and communication 7 percent, real estate and business activities 5%, and other 6 percent), 43 percent manufacturing (mainly metal and mechanical products, motor vehicles, food products, wood, publishing and printing, chemical, and rubber and plastic products), and the remaining 4 percent to other sectors (electricity, gas and water, and construction). After EU accession, the real effective exchange rate o f the Zloty has been appreciating (1 1.4 percent in 2005,2.0 percent in 2006, and 4.3 percent in 2007, according to ECB data).

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Table 2. Economic developments and prospects in Poland 2004-2011 (change in percent unless otherwise indicated)

2004 2005 2006 2007 2008 2009 2010 2011 CP March 2008 6.2 6.5 5.5 5.0 5.0 Government September 2008 6.6 5.5 4.8 4.9 5.0

Real GDP IMF W E 0 October 2008 6.2 6.6 5.2 3.8 4.8 4.9 (%change) World Bank October 2008 5'3 3'6 6.2 6.7 5.4 4.0 4.7 5.0

EC Autumn Forecast 2008 6.2 6.6 5.4 3.8 4.2 IMF November 2008 6.2 6.7 5.0 2.9 3.6 CP March 2008 4.8 5.2 6.0 5.4 4.5 Government September 2008 5.0 5.6 5.1 4.2 4.0

(% change) World Bank October 2008 5.0 5.0 5.4 4.1 4.1 4.3 4.3 2.1 Private consumption IMF W E 0 October 2008

EC Autumn Forecast 2008 5.0 5.0 5.0 4.5 3.4 IMF November 2008 5.0 5.0 5.0 2.5 3.5 CP March 2008 5.8 1 .o 2.0 1.5 1.6 Government September 2008 5.8 2.5 2.5 2.0 2.0

3.7 2.4 0.9 1.1 2.8 3.1 5.2 6,1 Public consumption IMF W E 0 October 2008

(%change) World Bank October 2008 EC Autumn Forecast 2008 6.1 5.8 1.7 1.2 1.5 IMF November 2008 6.1 3.7 1.0 1.0 2.5 CP March 2008 15.6 20.4 14.5 10.0 10.0 - Government September 2008 - 17.6 14.5 10.0 11.4 10.2 IMF W E 0 October 2008

EC Autumn Forecast 2008 14.9 17.6 13.8 8.8 8.4

Gross fixed capital

change) (% World Bank October 2008 6'4 6'5 14.9 17.6 11.6 8.6 10.4 11.6 formation

IMF November 2008 14.9 17.6 15.0 0.0 11.0 - CP March 2008 1.3 2.6 3.5 2.9 2.5 Government September 2008 2.5 4.4 2.9 2.5 2.5

Consumer prices IMF W E 0 October 2008 1.0 2.5 4.0 3.3 3.8 2.9 (% change) World Bank October 2008 3'6 2'2 1.3 2.5 4.2 3.4 2.5 2.5

EC Autumn Forecast 2008 1.3 2.6 4.3 3.5 2.6 IMF November 2008 1.0 2.5 4.1 2.7 2.9

CP March 2008 -3.2 -3.7 -4.8 -5.4 -5.8 - Account Government September 2008 -3.8 -5.2 -5.8 6.0 -6.2

IMF W E 0 October 2008 -2.7 -3.8 -4.7 -5.7 -5.9 -5.9 4'4 -1'2 -2.7 -4.7 -4.7 -5.4 -5.8 -5.6 Deficit World Bank October 2008

(% Of GDP) EC Autumn Forecast 2008 -2.9 -4.5 -5.2 -6.1 8 . 2 IMF November 2008 -2.7 -3.7 -4.6 -2.6 -3.3 -

Source: Poland's Convergence Programs (CP); Budget Act for 2009; recent publications o f international financial institutions; and World Bank staff.

111. THE GOVERNMENT'S REFORM PROGRAM

23. The current Government formed by PM Donald Tusk after the October 2007 elections has restarted the structural reform agenda. Economic pol icy objectives in the medium-term were set by the Government in the March 2008 Convergence Program. These objectives are: (i) reduction o f the tax burden (personal income tax reduction and simplification in 2009, and possible further personal and corporate income tax reduction in 2010-1 1); (ii) increase o f labor activity; (iii) increase o f growth-enhancing expenditure and restructuring o f social spending; (iv) acceleration o f privatization; (v) economic liberalization (elimination o f obstacles for doing business, administration reform, and better functioning o f judiciary); (vi) reduction o f the public debt-to-GDP ratio through gradual reduction o f the fiscal deficit; and (vii) preparation o f Poland's economy for Euro adoption. In September 2008, P M Tusk announced that Poland was committed to meeting the Maastricht criteria and obtaining the go-ahead from the EU for Euro adoption in

17

201 1, making it possible to introduce the Euro from 2012, a very ambitious but feasible target.

24. While structural, market-oriented reforms generally slowed down in 2006-07, there were some positive steps. Larger privatization projects virtually stalled, and despite lengthy discussions around the “Kluska package,” a one-stop shop service for starting a business was not created. Some steps were taken to strengthen the institutional budgetary framework, including the adoption o f a nominal state budget deficit anchor although this rule proved inadequate in the environment o f strong economic growth. On the revenue side, labor taxes were reduced through a reduction o f mandatory disability contributions in 2007-08, indexation o f personal income tax brackets, and tax allowances for children. The former Government also scheduled personal income tax (PIT) rates reduction and simplification f rom 2009 (from the current three 19, 30, and 40 percent brackets to two 18 and 32 percent brackets), advocated for organizational changes in the public finance sector, and took the f i rst steps in introducing performance-based budgeting (PBB).

25. While the Tusk Government announced a comprehensive array of economic reforms when it took office, implementation started only fully in the context o f the work on the 2009 budget. The reforms will focus both o n reducing the impulse from public finances and strengthening the economy’s supply response - mainly through fiscal measures aimed at a steady reduction o f the structural deficit and reforms aimed at boosting labor force participation. The following provides a brief overview o f key reform directions, while more detail i s provided in Section V in areas covered by this policy loan.

26. Decentralization. The Convergence Program and the Strategic Governance Plan, published after 100 days o f the Government, identify changes in public administration and decentralization as an important medium-term task. Changes aimed at enhanced division o f competence between the central and local administration will be implemented and enhance the efficiency o f public expenditure and absorption o f EU funds.

27. Public Finance Management (PFM). To improve the quality o f public finance, the Government aims at consolidating public finance units, relaxing budget rigidities, making the existing austerity measures in the event o f critical increases in public debt more restrictive, and introducing a 4-year budget planning and PBB system. The specific regulations regarding these areas were included in the draft amendments to the Act on Public Finance published by the Ministry o f Finance in late August.

28. Tax policy. The Tusk Government maintained the scheduled P IT simplification and reduction o f tax rates to 18 percent and 32 percent, but also announced further changes on the revenue side (to be implemented from 2009) oriented towards shifting the tax burden from direct to indirect taxes. In direct taxes, additional changes include favorable tax treatment o f taxpayers working abroad and a tax allowance in corporate income tax (CIT) for producers o f bio-components. In indirect taxes, simplified procedures and a uniform tax refund period will be introduced in VAT and excise duties on tobacco products will

18

be hiked in l ine with EU harmonization requirements. Moreover, the excise on LPG gas wi l l be increased.

29. Labor market and pension reforms. To boost labor force participation, the Government plans to lower social spending and associated taxes, and limit eligibility to social security benefits. The tax wedge on labor has already been substantially reduced by cutting the payroll taxes by seven percentage points during the last year. The Government also prepared a comprehensive program, known as “Intergenerational Solidarity - 50+”, which includes a number o f incentives to stimulate labor force participation by older workers, in particular a substantial tightening o f early retirement provisions. It i s estimated that the reforms wi l l reduce the number o f persons eligible to early retirement pensions from about 900 thousand to less than 250 thousand. The 50+ program i s expected to be adopted by parliament by the end o f 2008. At the same time, the Government intends to raise labor force participation by improving workforce sk i l ls and developing opportunities for life-long learning, although reforms in this area are less advanced.

30. Liberalization of the economy. Streamlining the regulatory environment for doing business, in order to support more rapid investment growth, i s a high priority for the new Government. Reform proposals include amendments to the laws on the freedom o f economic activity and accounting (already submitted to Parliament). Work i s underway on a package o f laws (“Szejnfeldpackage”) aimed at facilitating the start-up and closure o f a business (e.g., through introduction o f a possibility for temporary suspension o f business activity and creation o f one-stop shop services for starting a business), reducing red tape, simplifying licensing and inspection procedures, and enhancing tax administration. Poland’s position in the Doing Business ranking could significantly improve after the implementation o f the planned changes. The Government has also announced an ambitious privatization agenda aimed at selling state shares in more than 700 enterprises over the coming three years.

3 1. Strengthening of education policies and outcomes. The Government recognizes the importance o f addressing the sk i l ls gap that has developed as a result o f the rapid changes in the job market and the challenges o f reform in secondary and higher education. Building on early successes in education reform, the Government intends to continue strengthening and expanding the teaching o f general secondary education by: (a) further delaying tracking into specialized training to loth grade; (b) reforming the curriculum in upper secondary education to better integrate vocational training with general education; and (c) establishing stronger and more stable national examinations, including a revamp o f the matura test and the inclusion o f mandatory math testing at the exit o f secondary education. Because o f the widely recognized and documented impact o f high-quality early education, the Government also intends to expand and strengthen the schooling o f 5 and 6 year olds, by linking their classrooms to primary schools and by developing age- appropriate curricula to better respond to the needs o f these children. Further, the Government intends to gradually support the expansion o f preschool (for 3- and 4-year old children) through increased flexibility for non-public managed institutions to flourish. Finally, the Government intends to maintain i t s proactive role in adjusting the school network as needed, using incentives and accountability to entice gminas (municipalities)

19

to engage in this effort. Teacher attrition i s seen as an important factor to allow this flexible management to succeed.

32. Healthcare reform. The central objectives o f the health sector reforms in Poland are enhanced resource mobilization and improved efficiency in resource allocation. The Government aims to achieve these goals with provider payment reforms in hospitals, health financing reforms, and rationalization o f the hospital sector. Case-based payments in the hospital sector are being introduced from July 1, 2008. The Government is also reviewing options to reform the current single health insurance system. Current plans envisage the re-organization o f the National Health Fund (NHF) into six-seven regional insurers, which would then be transformed into insurance companies that could compete for members and providers without geographic restrictions. Private insurers would also be allowed to enter the market under the same conditions as the public insurers and compete for the same business. In the next phase, the focus would be on developing a risk-equalization mechanism between insurers to set a disincentive for risk-selection, and introduce innovative provider payment and contracting reforms to al low insurers to become more efficient by contracting with more efficient providers. There would also be need for an independent regulatory authority and insurance supervisory bodies which would have the oversight o f the insurance and provider market. In order to improve efficiency in hospitals, the Government i s also planning to corporatize public hospitals and change their ownership structure. Finally, a monitoring and evaluation framework i s needed to define a baseline for cost, productivity and access indicators, and conduct regular follow-up surveys against which the progress made under these reforms will be measured. The MOH plans to use results from analysis to adjust reforms in provider payment, insurance and hospital restructuring and ensure they contribute to overall health policy objectives.

33. Increase of growth-enhancing expenditure, especially on transport infrastructure. In the medium-term, the most important infrastructure investments will be focused on road construction and modernization financed both f rom the national budget and EU structural funds. Expenditure associated with the road construction program (with EU funds included) will r ise from 1.6 percent o f GDP in 2008 to 2-2% percent o f GDP in 2009-20 10. Multi-year infrastructure investments related to the Euro 20 12 Soccer Championship will include roads, airports, stadiums6 and accommodation facilities (road investments will be realized within the National Road Construction Program 2008-201 2, approved by the former Government in September 2007). As pointed out in the latest OECD survey o f Poland, the legal framework needs to be streamlined in many areas to keep the tight deadlines for many transport investments. Public procurement (especially the ease with which multiple appeals can be launched), issuance o f building permits, and environmental impact assessments are key in this regard. Vigilance over possible collusive behavior among suppliers o f building materials and ensuring competitive tendering procedures i s also critical. Further, better coordination among various ministries and implementing bodies in EU funds absorption i s required. The adoption o f a multi-year budgeting system could facilitate these efforts.

On 24 June, 2008 the Government approved a multi-year program related to the construction o f six stadiums in Poland.

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IV. POLICY FOCUS OF BANK-SUPPORTED PROGRAM

A. Public Finance Management

34. While Poland has made progress in recent years in bringing down the fiscal deficit and debt-to-GDP ratio, spending levels have remained high. Further required fiscal consolidation will need to rely more on streamlining expenditures while improving the efficiency o f key spending programs. Poland will need to make additional fiscal space available to co-finance increasing inflows o f EU funds and reduce excessive tax rates to stimulate higher employment and growth. Looking further ahead, population aging will exert pressure o n pension spending-despite an important earlier reform o f the pension scheme-and boost demand for health care.

BOX 4. ANALYTIC UNDERPINNING FOR PFM REFORM SUPPORT

Poland’s proposed reforms’ broadly respond to recent international assessments~ including those of the World Bank and the IMF, which pointed to numerous shortcomings of the Polish fiscal framework. Budget +agmentation, mainly due to the existence o f multiple extra budgetary funds leads to inefficient allocation o f budget resources. Although some progress in this area has been made recently, there are s t i l l agencies and funds that do not appear in the budget. Their number declined in recent years, but the amount o f money they receive actually increased. Budget process is only very loosely connected with the Government’s policies. In fact spending ministers act more l ike mere administrators o f existing laws and programs, rather than managers o f policy and programs. Additionally, international assessments call for strengthening of the accountability +amework within the public sector by creating incentives for improved public service delivery.

In the area of Performance-Based Budgeting, the planned reforms also benefit from widespread discussion in Poland of the international experience. The European Commission suggested P F M enhancements in numerous assessments to Poland’s Convergence Program Updates and demonstrated useful lessons in different editions o f “Public finances in E W ’ . An international conference with the participation o f the OECD and IMF o n P B B was organized with Bank DarticiDation in November 2007 in Warsaw.

35. The key challenges in the area of public finance management can be summarized as: (i) ensuring a continued gradual reduction in the fiscal deficit to help stabilize the economy and meet requirements for Euro adoption in a sustainable way; and (ii) improving the quality o f public finances through a lowering o f the tax burden and

’ The proposals were outlined in the justifications to the budget acts 2007, 2008, 2009, in the circulars to 2008 and 2009 budgets, and in the Justification to the Public Finance Act [August 20081 - Poland’s MoF, Draft New Act on Public Finance, published on the website on 22 August, 2008, http:llwww.mf.gov.plldokument.php?const=l&dzial=l53&id=135646&typ=news.

For example: World Bank, January 2003, Poland: Toward a Fiscal Framework for Growth, Public Expenditure and Institutional Review, PREM, ECA, Washington DC; World Bank Policy Papers on Financial Accountability; IMF: Poland - Developing a multi-annualfiscal framework, Allen R., Allard C., Jacobs D., Robinson M. and Sierhej R., April 2008; IMF ROSC (2004); Webber D., 2007a, The Introduction of Performance-Based Budgeting in Poland: An Assessment of Progress, Achievements and Next Steps, note prepared in conjunction with the author’s participation in the “International Conference on Performance Budgeting: Lessons for Poland”, co-organized by the World Bank, and held in Warsaw in November 2007.

21

increased emphasis on productive spending. (See Box 4 for related analytic work.) Addressing these challenges will require actions in a number o f areas:

Consolidating spending units and focusing on general government activities. The budget i s too fragmented and there i s a need for organizational consolidation o f numerous public units (various funds and agencies) as their finances are not transparent.

Introducing performance-based budgeting (PBB). This would help strengthen the link between pol icy formulation and budgeting while enhancing the efficiency o f spending programs and accountability o f managers. It would also support much-improved budgetary classification and reporting systems and higher quality o f forward estimates used in the MTEF (see below), which suggests to implement them jointly.

Introducing an effective Medium-Term Expenditure Framework (MTEF). The budget should be formulated in the context o f a MTEF that sets firm ceilings on spending over a multi-year horizon-ideally longer for capital pen ding.^ Enhancing administrative capacity in the public sector. Progress in the areas outlined above has to go hand in hand with efforts to enhance the general administrative capacity o f the Government and Public Sector. This includes in particular improved management o f human resources.

36. Some progress has been made on introducing PBB, but it will remain an agenda item for many years to come. The Chancellery o f the former Prime Minister launched an initiative to implement PBB in 2006, but in early 2008 the Tusk Government decided to transfer this activity to the Ministry o f Finance. Some progress has already been made: (i) definition o f a general roadmap for transition to PBB; (ii) a reclassification exercise o f the 2008 State budget according to “functions” and “tasks” (to be further broken down to sub-tasks); (iii) a preliminary exercise in the definition o f indicators; (iv) a revised budget circular for the 2009 State budget outlining criteria for aligning the budget with the PBB methodology; and (v) launching o f a training program on PBB through the European Institute o f Public Administration. Substantial efforts are s t i l l necessary to: (i) incorporate elements such as program evaluations as part o f the P B B framework; (ii) define processes, responsibilities, and information systems for the management o f performance indicators; (iii) implement associated reforms that may be needed in P F M systems (such as accounting or reporting) to accommodate PBB concepts; and, more basically, (iv) ensure the ongoing evolution o f the PBB strategy as new concepts are widely discussed and accepted.

0

The IMF has recommended introduction o f a multi-annual fiscal framework with expenditure ceilings and strengthening o f fiscal institutions, and has recently provided technical assistance in this area. The IMF proposed introduction o f binding expenditure ceilings that would be set for four years at the beginning of each electoral cycle and include most government expenditure. The IMF also pointed to the need for strengthening fiscal institutions to support the introduction o f a multi-annual fiscal framework and improving fiscal transparency. Further, i t noted that performance-based budgeting reforms could be supportive for MTEF implementation.

22

37. As mentioned in Section 111, the Tusk Government announced reforms on the public finance agenda and a draft new law on public finance was published by the Ministry o f Finance in August 2008. It incorporates institutional measures making the budget more transparent and predictable over the medium-term and more performance- oriented. The draft law also aims to tighten further corrective measures triggered by critical increases in public debt, and expenditure control will be strengthened through new regulations on internal control and audit and consolidation o f budgetary units.

38. The Bank has been actively involved in public finance management reform in Poland for many years. In 2002-2003, the World Bank prepared a comprehensive Public Expenditure and Institutional Review. In recent years, the World Bank has shifted i t s activities in this area in the N e w EU Member States more in the direction o f regional, cross-country comparative analytic work on fiscal reform issues, combined with country- based TC (moreover, many fiscally relevant topics were covered in the EU8+2 regular economic reports). For example, the Bank has provided technical support to the Ministry o f Finance in its deliberations on possible reform o f the ministry. I t has also supported the process o f PBB development through the co-financing and organization o f an international conference on performance-based budgeting focused on lessons for Poland, in Warsaw in early November 2007, and a program o f continued technical cooperation i s under discussion. Moreover, in response to a request from the Ministry o f Finance, the Bank has proposed a broader program o f analytic and advisory services in the area o f P F M (including l i n k s between public finances and labor supply as wel l as budget rigidities). This work could be done in the context o f a Public Expenditure Review.

B. Labor Market Policies

39. The Government realizes that mobilizing labor supply i s critical for sustainable economic growth, especially given population aging and the steadily increasing demographic dependency ratio. In addition, the Polish economy already suffers from shortages o f skilled labor. The expensive social security system supports inactivity and i s financed by high labor taxes. In particular, the availability o f generous early retirement (and to a lesser extent disability) schemes i s fiscally costly and results in very l o w labor force participation o f older workers (aged 55-64). The implied high level o f labor taxes inhibits labor demand by raising labor costs and discourages labor supply by lowering the take-home pay. Further, the l o w skills and productivity o f a significant fraction o f the workforce i s reflected in a l o w employment/population ratio and a high incidence o f long-term unemployment among the less educated workers. (See Box 5 for related analytic work.)

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Box 5. ANALYTIC UNDERPINNING FOR LABOR MARKET REFORM SUPPORT

The labor component o f the DPL reflects the results o f the analytic work done by the World Bank, UNDP, the Ministry o f Labor and Social Policy (MLSP) as well as by the Polish independent research institutes in recent years. The main objective o f the labor component o f the DPL i s to increase the employment/working age population ratio, which i s low in Poland by the EU standards, despite the recent sharp fall in the unemployment rate. This i s consistent with the government analysis o f the priorities for labor market reforms as stated in the MLSP (2008).'0 World Bank (2007)" documents that the employment/population ratio in Poland i s one o f the lowest in EU and argues that the primary cause i s the low labor force participation rate, especially among older workers. The report shows that the actual retirement age in Poland i s the lowest in EU8+2 despite the fact that the official retirement age i s the highest. Accordingly, the report attributes the low labor force participation rate in Poland to easy access to various early retirement schemes. This conclusion i s consistent with that presented in a recent comprehensive analysis o f the Polish labor market in Bukowski (2007, 2008).12

The labor component o f the DPL also contains policies to increase the employment/population ratio by reducing the incidence o f long term unemployment and the ski l ls mismatch. These policies refer to improving the functioning o f Public Employment Services, including improving cost-effectiveness and targeting efficiency o f active labor market programs. This again reflects the findings o f the analysis carried out by MLSP (2008), Bukowski (2007,2008) and the findings o f an earlier study o f the Polish labor market done by UNDP (2005).13 These studies have consistently identified social exclusion to be closely associated with poor sk i l ls and a major cause o f long-term unemployment in Poland.

10. T h e low labor force participation by older workers i s a result o f the generous early retirement policies introduced in the 1990s to alleviate labor market tensions associated with intensive enterprise restructuring. These policies by design were meant to be temporary and the Government started to phase out early retirement benefits in the mid 2000s, when the pace o f enterprise restructuring decelerated and job opportunities began to improve, enhancing the chances for older worker to find new employment.

41. Those who fail to find a new job are s t i l l eligible to severance pay, unemployment benefit and social assistance. The biggest outstanding challenge i s to

lo Ministry of Labor and Social Policy (2008), Priorytety Reformy Rynku Pracy, Warszawa. (Priorities for Labor Market Reform).

World Bank (2007), Labor Markets in EU8+2: From the Shortage of Jobs to the Shortage o f Skilled Workers, World Bank EU8+2 Regular Economic Report, Special Topic, September.

Bukowski, M. ed. (2007), Zatrudnienie w Polsce 2006. Produktywnos dla Pracy, Ministerstwo Pracy i Polityki Spolecznej, Warszawa. (Employment in Poland 2007: Productivity for Jobs). Bukowski, M. ed. (2008), Zatrudnienie w Polsce 2007: Bezpieczenstwo na Elastycznym Rynku Pracy, Ministerstwo Pracy i Polityki Spolecznej, Warszawa. (Employment in Poland 2007: Striving for Flexicurity).

l3 UNDP (2005), W trosce o prace. Raport o Rozwoju Spolecznym Polski 2004, Warszawa. (Enhancing Job Opportunities. Human Development Report).

12

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raise the effective retirement age. This requires abolishing early retirement privileges granted to some occupational groups, such as teachers or railway workers by equalizing the retirement age for these with that o f the rest o f the population. At the same time, the Government plans to raise salaries o f some o f the groups (mainly teachers) who are to lose the early retirement privileges.

42. Recent Reforms and Progress (2005-07). Faced with unsatisfactory labor market outcomes, consecutive Polish governments have undertaken a number of labor market reforms aimed at fostering labor demand and improving labor supply incentives. The most recent measures include:

(a) Reduction in the tax wedge on labor. The disability pension contribution rate was lowered by 7 percentage points, f rom 13 to 6 percent o f payroll. The employer part was lowered by 2 percentage points and the employee part was lowered by 5 percentage points. The reduction was done in two steps: in July 2007 (3 percentage points) and in January 2008 (4 percentage points). Before the reform, the tax wedge o n labor in Poland was in the upper-end o f the EU range, while after the reform it is in the middle o f the EU range.

(b) Limiting early retirement options for the unemployed. Eligibility conditions for pre-retirement allowances were substantially tightened in 2004. This followed earlier policy o f limiting pre-retirement benefits. As a result, the coverage o f both benefits was considerably reduced and both benefits are being gradually phased-out (the pre- retirement benefits were repealed in 2002).

(c) Relaxing regulations on employment of foreign workers. Work permits were abolished for workers f rom neighboring countries employed on a temporary basis (for no more than 6 months during the year). Furthermore, the costs o f work permits for other foreign workers were significantly reduced. These measures were meant to address the emerging labor shortages. They are also a f i rs t step toward increasing employment o f foreign workers, which is necessary given population aging.

43. Government Reform Objectives and Plans. I n a recently prepared document “The Priorities for Labor Market Reforms,” the Ministry of Labor and Social Protection identified the following three main objectives:

(a) To increase labor force participation and employment rates. This particularly refers to the older workers (among which the labor force participation rate is particularly low) so as to reach the Lisbon targets (70 percent overall employment rate and 50 percent employment rate for older workers). Increasing labor force participation by older workers requires primarily reforming the social security system so as to limit the availability o f early retirement benefits.

(b) To lower structural unemployment and prevent labor market exclusion. Unemployment in Poland i s increasingly due to the sk i l ls mismatch rather than to deficient demand for labor. This i s associated with labor market exclusion of disadvantaged groups and reflected in a high incidence o f long-term unemployment.

(c) To improve the targeting and cost-effectiveness of active labor market programs. Available evidence suggests that these programs are poorly targeted, have limited net

25

impact, and are thus not cost-effective. Accordingly, efficient use o f public funds requires that the programs are monitored and evaluated and then redesigned so as to increase their impact and efficiency.

44. Government reform plans include the following:

Employmentlpopulation 15-64 ratio Labor force participation rate for workers aged 55-64

Early retirement pensions as percent o f all newly awarded

(a) Implementation of the government program to increase labor force participation of older workers, known as “50+”. The plan envisages, inter alia: (i) reducing the eligibility to early retirement pensions; (ii) lowering the cost o f employing workers in pre-retirement age (60/55) by reducing some o f the social security contributions; and (iii) extending the eligibility for public employment services to the employed workers aged 45+.

(b) Preparation of draft amendments to the “Law on retirement and disability pensions ’’ whereby the receipt of a disability pension can be combined without limits with earnings from work. This measure i s intended to encourage labor force participation o f the disabled and to foster their social inclusion.

(c) Development of cost-effective active labor market programs to reduce structural unemployment and foster labor market inclusion. This includes: (i) Extension o f the scope o f labor market information and monitoring (including the development o f a consolidated database o f employment and social assistance office clients) to inform employment policy, and (ii) Evaluation o f targeting efficiency and the net impact o f active labor market programs and adjustment o f program design and program mix to reflect evaluation results.

(d) Implementation of a program to reduce the administrative cost of employing the first worker (including “one-stop shop”). Over the medium term, the Government also aims to improve the responsiveness o f the education system to changing labor market needs and equipping students with key employability skills.

Table 3. T h e Government’s Results Indicators for Labor M a r k e t Reform

57,O percent 58.5 percent 60.0 3 1,8 percent 32,3 percent 33,2 percent

80 percent 40 percent 30 percent

2010-11 (target) 2009-10 2007

(baseline) Indicators

pensions Long-term unemployment as percent o f total unemployment Unemployed who received job search assistance and vocational

47 percent 43 percent 41 percent 18 percent 26 percent 3 1 percent

45. T h e Bank was recently requested by the Ministry o f L a b o r and Social Policy to provide technical cooperation to identify priorities for labor market reforms and recommend policies to improve labor market outcomes. These priorities were presented in a report produced jo int ly by the Ministry and the Bank, which is meant to be adopted as an official document o f the Ministry. The Ministry i s interested in future collaboration with the Bank in the fol lowing three closely related areas: (i) improving functions and the coordination between employment and social welfare offices; (ii) improving the targeting

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and cost-effectiveness o f active labor market programs; (iii) designing modem activation policies.

C. Pension Reform

46. Faced with increased deficits in its pension system, Poland undertook a major pension reform in the late 1990s which was implemented beginning in 1999. The new Polish pension system moved from a defined-benefit basis to a defined contribution basis, where individual contributions are recorded and the pension at retirement is based on the contributions plus notional interest earned on those contributions. The actual system contains two components, a publicly managed component and a privately managed component. In the publicly managed component, contributions o f 19.52 percent o f wage are paid to the public pension agency, which records the contributions and accrues an interest rate equal to the rate o f growth o f the wage bill o n the contributions. The balance in this account is then divided by l i f e expectancy at retirement to determine the public portion o f the pension. Despite the defined contribution mechanisms for benefit determination, the public pension agency takes the contributions and uses them to finance pension benefits for current pensioners. A second component, managed by private pension funds, takes an additional 7.3 percent o f wage as contribution, which i s then invested by private pension funds in capital market instruments which generate a market- determined rate o f return. This money becomes available at retirement age and i s converted into a stream o f pension payments by either the pension fund or an insurance company. (See Box 6 o n related analytic work.)

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BOX 6. ANALYTIC UNDERPINNINGS FOR PENSION REFORM SUPPORT

The pension system reform elements in the policy matrix supporting the loan address several o f the important issues commonly cited in Europe and Central Asia (ECA) pension systems. As noted in the World Bank publication From Red to Gray: The "Third Transition" of Aging Populations in Eastern Europe and the Former Soviet Union (World Bank Working Paper), in most ECA pension systems the rate of system dependency i s high relative to population dependency. The number o f beneficiaries per contributor i s significantly higher than the percentage o f retirement age population relative to working age population, leading to high pension expenditures coupled with moderately low revenues and a resulting fiscal problem. Two o f the most common reasons for the high system dependency rates are the high rate of disability pensions awarded to those below the normal retirement age and the high rate o f early retirement pensions. Reducing these components will help bring down pension expenditures and help raise additional contribution revenue, bringing the systems closer to balance. Two of the reform measures to be undertaken by the Polish Government, the redesign of the disability benefit system to reduce incentives for choosing disability pensions and the tightening o f criteria for early retirement, will both help to reduce system dependency rates and bring the Polish system into better fiscal balance.

A third element of the policy matrix addresses the issue of payout options for the funded pillar. The ongoing financial crisis emphasizes the importance o f adequately designing payout options such that individuals are not forced to annuitize their pension savings at retirement or at a particular age under adverse market conditions. The payout options need to be designed so that they are flexible enough to withstand market fluctuations while protecting workers. The use o f multiple portfolios with a mandatory shift toward a fixed income portfolio in the years just prior to retirement i s being suggested as a way o f protecting workers against sudden drops in the valuation of financial assets just prior to retirement.

47. Given the enormous changes undertaken in the pension system, there were a number of issues which were not addressed at the time of the initial pension reform, namely reform o f the disability pension system, early retirement provisions, the payout mechanisms for funded pensions, reform o f the agricultural pension system, and linkages between administration o f social assistance benefits and social insurance benefits.

(a) Disability pensions. While the benefit provision for old age pensions was completely altered, the old formula remained for those considered disabled. Rather than integrating the disability financing with the old age financing as i s common in almost all other countries, a separate contribution rate o f 13 percent o f wage was charged to employees and employers for financing disability pensioners, which was the highest contribution rate for disability anywhere in the world. The disability pension system during the 1990's was also used to provide re l ie f to workers who were displaced during the labor market transformation, resulting in large numbers o f disabled.

0 Progress thus far. The contribution rate for financing disability was reduced from 13 percent o f wage to 6 percent o f wage in 2 stages, June 2007 and January 2008. Eligibility conditions for disability were tightened, resulting in a drop in the number o f new disability pensions awarded from 86,000 per year in 2001 to 50,000 per year in 2007. The total number o f disability pensioners was reduced by over 40 percent from 2.5 mill ion in 2001 to 1.5 million in 2007.

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Reform plans. The disability benefit formula is expected to be redesigned to be consistent with the old age formula, using the same notional account calculation, with credit given for the period between the age o f disability and the retirement age eliminating the incentives to retire under the currently more generous disability formula.

(b) Early retirement. In addition to those who earned the right to early retirement by being part o f particular occupations, a l l workers 5 years short o f retirement who lost their jobs and were registered as unemployed had the right to receive 80 percent o f their old age pension during the 5-year period before retirement. These were known as pre- retirement pensions. In addition, there were a multitude o f occupations which had rights to early retirement.

Progress thus far. Pre-retirement benefits were l imited to those who not only lost their jobs, but whose former employers became bankrupt. The level o f the benefit was also reduced to a flat benefit irrespective o f earnings and unrelated to the old age pension. However, even as recently as 2007, after these reforms were implemented, 82 percent o f a l l new old age pensioners were retiring before the minimum retirement age.

Reform plans. The Government plans to limit the number o f occupations eligible for early retirement, with the expectation o f reducing the number o f early retirees f rom more than 900,000 per year to 250,000, and to introduce actuarial adjustments for early retirement pensions.

(c) Reforms to the funded system. Critical elements o f the funded system were not fully specified at the start o f the reform, including how the funded system would pay benefits. Given the rules on entry, the f i rs t women are expected to retire f rom the funded system in 2009. Mandatory funded systems always contain a trade-off between offering freedom o f choice for participants and providing appropriate supervision and security. Initially, the Polish authorities opted for a conservative approach with each pension fund offering only one portfolio. N o w that the system has functioned wel l for a number o f years, more choices could be provided to individuals without jeopardizing either the capacity to supervise or the safety o f the portfolio.

Reform Plans. The Government is preparing legislation which specifies the payout provisions for those retiring with funded pensions during 2009- 13. The Government also has plans to develop longer-term annuities market and options and introduce multiple portfolio choices with potentially multiple fee structures for those retiring beyond 20 13. The funded component could thus become more attractive to workers, encouraging greater compliance.

(d) Farmers’ pension system. Farmers, defined as those owning and farming at least one hectare o f land, receive pension coverage through a separate system, KRUS, which has much lower contribution rates but provides the same minimum pension as the main pension system, ZUS. Contributions cover less than 15 percent o f expenditures in this

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system. The system provides a major element o f social protection as those in the rural areas are poorer than those in urban areas and provides a mechanism o f old age protection for the rural poor without the large contributory cost o f belonging to ZUS. However, rural income i s rising as the agricultural payments f rom the European community are phased in, which both make higher contribution rates more affordable for some farmers and raise the demand for higher pensions than are currently being provided.

0 Reform Plans. The Government plans to study options for reforming KRUS, but this is very much a medium-term issue and not an issue the Government plans to address in the short run.

(e) Information sharing and administrative integration of social protection benefits. Currently, a variety o f social benefits are available in Poland, including social assistance, unemployment benefits, and pensions. One basis for social assistance eligibility i s unemployment, which i s verified by registration with the employment office. The individual applying for social assistance has to f i rs t register with the employment office and then present evidence o f this registration to the social assistance office. Ideally, the social assistance office should be able to access the employment office information electronically and verify the individual’s status without requiring a separate set o f documentation. Such a system would lower transaction costs for individuals and for the offices administering the programs, as well as helping the Government design a comprehensive social protection program which covers al l the various social risks.

Reform Plans. The Government will soon decide among alternate designs o f an information system which allows the sharing o f information across various social protection agencies.

48. The Bank has had a long-standing involvement with the Polish authorities on pension reform with staff exchanges between Bank staff and key pension reform officials in Poland, which has led to continued informal dialogue and information sharing. In addition, the Bank has financed administrative reforms in KRUS as well as policy studies looking at reform options for KRUS. Going forward, the Bank will continue i t s dialogue with the Polish authorities as the new phases o f the pension reform involving the payouts f rom the funded pillar unfold, will provide assistance to KRUS in modeling pol icy reform options, and will provide assistance on the administrative linkages between social protection services, particularly on linkages between social assistance and employment offices.

D. Private Sector Development

49. The Government o f Poland i s presently engaged in a major reform effort to facilitate the growth o f private enterprise. This involves two main pillars: (i) legal and regulatory changes to reduce the costs borne by the private sector o f establishing and conducting business; and (ii) a new phase o f privatization to transfer ownership o f remaining state enterprises to the private sector. (See Box 7 on related analytic work.)

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BOX 7. ANALYTIC UNDERPINNINGS FOR PRIVATE SECTOR DEVELOPMENT SUPPORT

In the area o f business regulatory environment, the Bank has evaluated a number of legislative initiatives being undertaken by the Government to reduce the regulatory burdens of enterprises. The evaluation has also been linked to the Bank Group’s Doing Business indicators to determine the impact of government reforms on the Doing Business assessment. High impact reform areas have been identified and documented, and are currently under discussion with the authorities.

In the privatization area, the Bank has had a long standing engagement. Several pieces o f analytic work were conducted in the past few years relating to the management and governance arrangements for state-owned enterprises and suggested reforms that would impact firm performance. More recently, with the need to consider the privatization of multiple, small state minority shares in remaining enterprises, the Bank has consolidated worldwide experiences and documented the operational and financial mechanisms which are suited for privatizing such small shares without pooling them into investment funds which would create investor disincentives given the varying performance quality and sector composition of underlying enterprise shares. Financial options for risk sharing on future performance of larger state enterprises have also been examined in order to set risk sharing incentives for the management of enterprises with uncertain profit and cost prospects and low equity bases, requiring upfront strategic investment. More recent work with the Government has involved the analysis of public-private partnerships as a mode o f transferring state run sector (e.g.: various infrastructure services) to private management with options of lease/buy. The Government wishes continued Bank engagement in the above areas so as to provide the menu of options to consider for the privatization and PPP arrangements to divest state ownership and management to the private sector.

Further, considerable analytic work has been done on governance in state-owned enterprises, including by the Bank, in recent years.

Reducing Administrative and Legal Barriers for the Business Environment

50. The reform program on reducing barriers to private enterprise has progressed swiftly since the new Government took office. Following initiatives from the Executive Branch, the Parliament recently approved laws to increase areas for special economic zones aimed at promoting high productivity, employment and innovation, with accompanying tax incentives for qualifying enterprises. Another l aw was approved to help the Polish Agency for Enterprise Development support micro, small- and medium- size enterprises, including their capacity for adaptation and innovation. Also, legislation was approved recently providing lending incentives to finance private enterprises’ technological capabilities and upgrading.

51. A number o f other legislative bills were recently submitted to Parliament including an Accountancy Law setting out different/graduated financial reporting requirements for small versus large enterprises, based on revenue volume generated, so as to reduce reporting burdens. Other initiatives now in Parliament include a bill o f law to provide seasonal businesses more flexibility in meeting regulatory reporting requirements, a bill o f l aw allowing enterprises to engage contracts in currencies other than the zloty without asking for prior central bank authorization, and a change to the commercial l aw to sharply reduce minimum capital requirements for starting a business.

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Upcoming Challenges in Business Regulatory Reform 52. The Government has an ambitious plan in the next 24 months to continue already started reforms and expand them to reduce the costs for businesses and further encourage private enterprise. A large planned project involves the analysis o f al l regulatory steps for both starting businesses and providing licenses and other authorizations. In the interim, other more immediate steps are being taken to analyze the feasibility o f setting up a “one stop shop” for enterprise start-up and registration procedures as wel l as unifying the inspection system to ensure coordination, minimal time spent and to avoid overlap among the various inspection authorities overseeing private enterprises. I t i s also proposed that enterprises need no longer obtain new certification letters from public agencies to prove their good standing when applying for licenses or permits, with a signed truthful statement by the company (e.g., on tax compliance, licenses) as being deemed sufficient. The Government also plans to institute a system allowing businesses to maintain commercial receipts in electronic format and i s considering setting up a system for electronic filing o f tax returns.

53. T o enhance labor mobility, much progress has been made on defining new proposals, for example to limit employers’ liability for long sick leaves taken, to provide incentives for hiring university graduates for short periods, and for medium term plans to make working hours legally flexible thus removing rigidities regarding employer obligations for higher night-time pay above base pay, for example, and other inflexible contract obligations.

Second/Future Phase Reforms -Administrative Costs of Regulation

54. A second phase following the above initiatives i s already under consideration and involves an overhaul o f al l sector/Ministerial requirements for registering and starting business operations and subsequent licensing. To implement these reforms systematically, the Government intends to conduct a costing analysis o f each regulatory step currently in place. The intent i s to reduce or modify the regulatory requirements and free up enterprises’ management and administration time for productive activity while estimating economy-wide savings achieved (with a target aimed at a 25 percent reduction in the cost o f regulation). At the same time public accountability reforms are expected to specify much more clearly individuals’ functions, roles and responsibilities in public agencies to ensure that regulatory changes or decisions issued are properly scrutinized and reviewed. Other reforms are also under consideration, including making it easier for SMEs to bid under public tenders or contracts and simplifying the diverse requirements for product regulation while maintaining the requisite safety standards under such regulation.

55. At the corporate level, the Government i s analyzing the means by which cooperative enterprises can more easily and swiftly be legally converted to commercial companies and to institute more broadly the acceptance o f electronic signatures as legally binding. Reforms are also anticipated in credit registry procedures so that enterprises that have paid o f f debts can be removed from bad debtor status once a reasonable new payment record has been set.

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56. At the public sector level, besides the direct role o f public agencies in regulatory procedures, the Government i s emphasizing the principles embodied in regulatory impact assessments, including consultations and consensus building among stakeholders, for any new initiatives underway, including cost-cutting ones. Since the reform agenda i s broad, i t also requires awareness o f the process o f reform itself, that is, the legislative approval procedure which the Government and lawmakers are critically examining with a v iew towards simplifying it, clarifying steps needed, and managing it better according to priorities, review procedures and overall readiness and quality o f proposed legislative packages.

The Privatization Program and Associated Reforms

57. Another pillar o f the private sector development agenda i s a final privatization phase. In the 1990s and mid-2000s the successive Polish Governments privatized a large mass o f State-Owned Enterprises (SOEs) through various means including tenders, mass privatizations and other methods. However, there s t i l l remain a small yet not insignificant number o f residual enterprises which are becoming an administrative drain on the State and should rightly be reconstituted as private sector industries. For some o f these, the State i s the majority shareholder, but some 2-300 are small enterprises with only minority holdings by the State.

58. The Government recently announced a plan to privatize 740 enterprises and liquidate or wind down another 350. A small share o f enterprises (e.g. in the energy sector) will not be privatized given the need for the Government to f i rs t consider strategic needs and choices for the economy in such specialized sectors. In addition to the official announcement o f i t s privatization plans, the Government has approved a number o f reforms to carry out this process. This includes the removal o f previously existing legal impediments to se l l enterprises v ia an auction process or through the stock exchange, two methods which would provide open public information to al l investors regarding such opportunities. Administratively, some restrictions are being removed, including the need to have a Council o f Ministers decision to proceed with privatizations o f enterprises with less than a 25 percent State shareholding. In addition, the Ministry o f Treasury would be permitted to have the sole responsibility for conducting pre-privatization analyses involving legal status issues and asset valuation, prior to offering enterprises for sale.

59. A major reform from a social perspective i s the Government’s earmarking of a specified portion o f privatization revenues to increase the pre-funding of the public pension system which i s in need o f reserves given actuarial and demographic trends in Poland.

60. The privatization reforms will, for a number o f companies, involve an initial program of commercialization so as to better corporatize and prepare companies for receptivity to the market. Among some o f the corporate governance reforms envisaged i s the creation o f independent company boards and management that can turnaround companies with revenue potential, as well as market-based remuneration for key management staff to dissuade unproductive rent seeking. Separately, to encourage

33

public/private partnerships, the Government will reduce the Ministerial authorizations or interventions required for these deals to move forward.

61. As part o f the overall privatization effort, the Government i s committed to an open transparent consultative process with full public disclosure and involvement of key stakeholders such as labodtrade unions, public officials, the private sector, and existing enterprise managers. The privatization program has already resulted in signed privatization agreements for 15 companies, active offers initiated for 55, as wel l as 35 enterprises placed under a program o f commercialization prior to privatization.

Challenges and Follow-Up Phases in Privatization 62. The main challenges will involve meeting the privatization targets for the mass o f enterprises to be offered, especially in the more difficult external environment brought about by the international financial crisis. Market receptivity may not exist in al l sectodindustries and the financial condition and turnaround potential for certain enterprises will need to be assessed. Any restructuring methods, treatment o f liabilities, and means to increase the asset value o f the enterprises will be crucial in determining whether an equilibrium price will be reached between buyer and seller. A further liquidation program will also need to be considered for enterprises that after valuing their assets and equity do not show prospects o f recovery.

63. Technical collaboration between Poland and the Bank in the above areas has recently focused on a diagnosis o f regulatory reforms needed to reduce the administrative barriers affecting private enterprise operations, and identifying the high impact non-legal changes that might be effected to improve the business environment. Further, in the area o f state assets, collaboration with the Bank has moved from privatization projects to analyzing designs for setting up public private partnerships for the operation o f infrastructure services. Going forward, collaboration i s expected to continue on business environment reforms including broader consultation, impact estimates, implementation methods, continued work on novel and alternative privatization instruments and private financing o f infrastructure, and integration o f financial and investor markets with neighboring countries.

E. Fiscal Costs o f Reforms Supported by the Operation

64. The reforms on the agenda generate substantial and immediate costs for the budget, while the resulting savings will be phased in only over a longer period o f time. According to off icial estimates, the reduction o f the labor tax wedge translates into net fiscal costs o f 1.3 percent o f GDP in 2008 rising to about 2.0 percent o f GDP in 2009- 2010 due to the scheduled PIT rates reduction and simplification. Positive effects should materialize over the medium term as employment and growth i s stimulated, but the effect i s difficult to quantify. The overall program 50+ will cost around 0.2 percent o f GDP per annum in the short-medium-term, but will have positive longer-term implications as older people are reactivated or become better able to remain longer in the workforce. The introduction o f bridge pensions based on medical criteria will yield savings only gradually as new cohorts enter the existing early retirement age period as the current stock o f early retirees will not be affected (official estimates are that budget costs o f early

34

retirement w i l l decline from four to five billion zlotys in case the system was le f t unchanged to 500-600 million zlotys under the proposed reform). l4 The privatization program wi l l generate some one-time revenues that can be used to partially finance the short-term costs o f the reforms. l5 The deregulation program should support additional private investment and growth, but again the impact o f this i s very hard to quantify.

v. THE PROPOSED LOAN

A. Operation Description

65. The proposed US$1.25 billion equivalent Development Policy Loan, the first in a programmatic series o f three policy loans within a total lending envelope of up to US$3.75 billion equivalent, would support the Government’s plans to enhance the quality and efficiency of public finances, increase the supply of relevant and skilled labor, and strengthen the business environment. The core focus on raising labor force participation and employment would span supply-side incentives (including social protection policies and labor taxes), skills, and labor demand (including through deregulation and privatization). Particular attention will be paid to raising employment rates o f low-employment and vulnerable groups (including the elderly, people on disability pensions, youth, and socially-excluded minorities). The program would be carefully aligned to Poland’s commitments to the EU, notably the Convergence Program and associated Council Opinions and the National Lisbon Reform Program and regular Commission assessments. (See Box 8 on the application o f good practice principles on conditionality to this operation.)

l4 In fact, there may be a negative short-term impact as current workers eligible for early retirement but s t i l l working take advantage o f the existing regulations before new ones are introduced. l5 The most recent official projections assume PLN 2.3 billion (0.2 percent o f GDP) in proceeds in 2008. According to unofficial figures, the companies to be privatized in 2008-1 1 have a market value o f some PLN 30 billion.

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Box 8. Good Practice Principles o n Conditionality

Principle 1: Reinforce Ownership

The operation supports a key subset o f policy actions within a broader government program. This government program benefits from well-established participatory processes and consultation on critical elements. A large body of analytic work supports the policy directions o f the government program as well as the conditions set out in this operation, prepared by the Bank and others over a number o f years (see Boxes 4 to 7). The programmatic series wi l l be accompanied by a program o f technical cooperation and knowledge sharing to complement and extend existing reform plans and priorities. i s discussing a menu o f technical cooperation. The policy focus o f each operation i s to be closely aligned with the government’s ongoing reform priorities and the political feasibility o f specific reforms.

Principle 2: Agree up front with the government and otherfinancial partners on a coordinated accountability framework

The Bank’s support i s summarized in a brief and focused policy matrix. No other donors are currently providing budget support. The Bank has engaged in close consultations with both the International Monetary Fund and the European Commission, who are supportive o f continued Bank policy lending as long as it support further restructuring o f public finances and fiscal consolidation and i s fully consistent with EU commitments, including the Broad Economic Policy Guidelines, Poland’s Convergence Program and Council Opinions on this, and EC assessments o f Poland’s National Lisbon Strategy implementation.

Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances

The Bank has prepared this programmatic series in response to an explicit government request, after a hiatus in such lending support for some years. The timing o f delivery o f this operation, aiming to deliver disbursements before the end o f the calendar year, and the subsequent ones in the series, wi l l be driven by the government’s schedule and financing needs. The policy reforms supported by the operation draw on various analytic work over a number o f years and derive from careful evaluation o f policy options.

Principle 4: Choose only actions critical for achieving results as conditions for disbursement

The Bank’s policy matrix uses a limited set o f conditions (6 in total), and it contains 12 benchmarks for the first operation, all selected for their criticality in delivering the expected results o f the programmatic series and demonstrating an appropriate discipline in design for a middle-income client.

Principle 5: Conduct transparent progress reviews conducive to predictable and performance-basedfinancial support

As agreed with the government, the first operation i s timed to country’s budget cycle (to disburse before the end o f calendar 2008). The financing o f the subsequent operations has already been announced. The accompanying package o f technical cooperation wi l l lead into preparation o f the next operation, which i s expected to be available well in advance o f the closing o f the government’s next fiscal year. A limited number o f outcome indicators, closely linked to the supported policy actions, have been selected to measure the impact o f the operational series, and these wi l l be tracked as part o f the operation implementation.

B. Policy Areas

66. T h e policy focus o f each operation will b e closely aligned with the government’s current r e f o r m priorities and the political feasibility o f specific reforms. The f i rst loan will support current efforts to further lower labor taxes (both social security contributions and personal income taxes), restrict generous early retirement provisions, strengthen active labor market policies, streamline business regulations, and revitalize the remaining privatization agenda. All prior actions for the f i rs t loan have been met, including submission to Parliament o f the draft budget for 2009 consistent with Poland’s

36

Convergence Program Update and Council Opinion on this. These prior actions and the triggers for the second operation are presented in Table 4 below and in more detail in Annex 1.

Employment and pensions

Private sector development

rable 4. Prior Actions for F i rs t ODeration and T

-Tightened eligibility criteria for disability pensions -Disability contribution reduced by 7 pp

-Relaxation of regulations on foreign workers -Reduced minimum capital requirements for business start-ups -Government approval of privatization plan covering 740 enterprises

in ‘07-‘08

I Prior Actions PL1 I -2008 budget implementation on track Fiscal and

PFM -Draft budget 2009 in line with CP target and EU recommendations; PIT reform

ggers for Second Operation Triggers PL2 -2008 budget outcome and 2009 budget in line with CP targets and EU recommendations; PIT reform -Amendment to law on public finance -Implementation of 50+ program -New law on bridging pensions aimed at reducing occupational categories eligible for early retirement; actuarial adjustment of early retirement pensions

-Simplification o f inspection procedures -Offer of first 80 enterprises (or at least 10 percent o f assets) for sale

C. Participatory Processes and Consultations

67. Various aspects of the reforms supported by this operation have been subject to extensive stakeholder consultations. On the program Generational Solidarity 50+, the Government started wide ranging consultations with all stakeholders once the draft program was ready in March 2008. In particular, the draft was sent for opinion to trade unions, employers’ associations and local government representatives as well as to other institutions dealing with labor issues (NGOs, research community, etc.). The consultations with stakeholders are s t i l l under way, and the main forum for the dialogue i s the Tripartite Commission for Socio-Economic Affairs. The perception o f the relevant trade unions i s that the costs o f the program (the loss o f the right to early retirement) outweigh i t s benefits in terms o f higher lifetime earnings and thus the unions oppose the reform. In contrast, it i s strongly supported by employers.

68. On the privatization program, the Government has instituted a structured dialogue with pertinent stakeholders and a transparent public information process. This process i s used to inform civil society and stakeholders at every stage o f the privatization process. All privatizations require public information disclosure on the agreement and conclusion o f a social package (salary, severance, benefits, other) to be offered to employees. The monetary value o f investment commitments and obligations guaranteed by new investor/owners i s also made transparent and disclosed. The Government has already held numerous consultations with social partners such as trade unions in the industries affected, notably in regard to the potential employment effects o f the planned privatizations.

D. Related Technical Cooperation Program

69. The program of technical cooperation and knowledge sharing associated with the programmatic policy loans would focus both on complementing existing reform

37

plans and priorities and supporting the preparation of reforms in others areas that could become priorities and focus o f subsequent operations in the programmatic series. The envisaged program o f analytic and advisory activities (AAA) over the next 12 months i s summarized in Table 5 below (see Annex 2 for more details). This program has been discussed with the relevant l ine ministries. While several activities could be financed from the Bank’s own budgetary resources, some may need to rely on cost- sharing or fee-for-service arrangements.

Policy Area

Table 5. Summary o f Analytic and Advisory Activities (AAA): Envisaged Technical Cooperation and Knowledge Exchange

Envisaged A A A

Employment and pensions

Private sector development

Education reform

-Tax policy reform (TC) -Performance-based budgeting and MTEF (TC) -Subnational Public Expenditure Reviews (TC) -Contribution to LM Commission Study -Social service delivery framework and decentralization (TC) -KRUS modeling tools (TC) -Costing/reducing business regulations (TC) -Public Private Partnership Methods (TC) -Options for privatizing minority stakes (TC) -Skills for the labor market (AAA) -Labor Market Observatories (AAA) -Policy-making and curricular pertinence (TC)

I -Responsive higher education kstitutions (TC) I -Feasibility study o f health insurance reform (ESW) Health reform

-Hospital commercialization (TC) -Monitoring framework and analysis (TC)

70. Further, the Bank has discussed a broader program of technical cooperation and knowledge exchange as part of its recent strategic dialogue. In addition to the areas covered under the programmatic policy loans, this could include support for reforms related to infrastructure development, regional development, and climate change. In each case, the Bank has developed a program o f technical cooperation in collaboration with the related l ine Ministries which needs to be confirmed in the context o f finalizing the programmatic Policy Loan Program. Several o f these activities would have to rely on cost-sharing and fee-for-service arrangements given the Bank’s budgetary constraints.

E. Related Policy Areas with Ongoing Engagement

71. Reforms in the health and education sectors, which are closely related to the intent and objective of the programmatic series, but where the planning o f further reforms i s less advanced and/or the current political feasibility i s limited, may be included at a later stage in this programmatic reform series. The policy framework reflected in the Policy Matr ix (Annex 1) includes the reform areas where the Government’s three year program i s fully defined. In the meantime, the Government i s interested in working with the Bank on the preparation o f reforms in these related policy areas and they have therefore been included in the technical cooperation program

38

associated with this loan (Table 5 above). Table 6 provides information on the reform

Education Reform

Healthcare Reform

directions in these related sectors.

Areas for near-term reforms -Curricular reform for secondary education upper-secondary education -School network efficiency -Age appropriate curriculum for

Areas fo r Medium-term reforms -Integration o f general and vocational

-Curricular reform for upper-secondary vocational education -Reduce rigidities in teacher charter -Mandatory enrollment o f 5-year olds to grade 0 -Life-long learning -Continued hospital payment reforms

dvisory

-Case-based payment (NHS DRGs) in hospitals -Health insurance reform -Restructuring and commercialization o f hospitals -Monitoring and evaluation framework

productivity, cost and access

VI. OPERATION IMPLEMENTATION

A. Poverty and Social Impact Analysis

72. L i k e other EU countries, Poland has an elaborate and comprehensive monitoring system to track progress in reducing poverty and social exclusion. In 2001, the Laeken European Council endorsed a set o f 18 common indicators-the so- called “Laeken indicators”-to monitor the fight against poverty and social exclusion. Indicator 1, the “at-risk-of-poverty-rate”, i s calculated as the share o f persons with an equivalized total net income below 60 percent o f the national median income in each country. Using this measure, Poland had the highest poverty rate (2 1 percent) o f al l EUlO countries in 2005, However, recent improvements in labor market conditions noted earlier have had a significantly positive impact in reducing the incidence o f poverty. Moreover, new analytic work by the World Bank shows that the tax and benefit system in Poland plays a very strong redistributive role in the country, reducing overall income inequality considerably compared to what it would have been in the absence o f these redistributive taxes and public transfers. l6

73. T h e European Commission’s 2007 “Joint Report on Social Protection and Social Inclusion” identified several key social inclusion challenges. While Eurostat data show considerable recent progress in reducing unemployment, employment rates in Poland remain l o w compared to other EUlO countries, wel l short o f the Lisbon target o f achieving an employment rate o f 70 percent by 2010. The at-risk-of-poverty rate among children in Poland is, as in other EUlO countries, considerably higher than the population as a whole: however, unlike in most other EU countries, people aged 65 years and older

l6 World Bank EUlO Regular Economic Report October 2008 special topic: Income hequality in EU8 Countries, and the Role of Taxes and Transfers in Reducing it.

39

face poverty risks considerably lower than the rest o f the population. Looking ahead, the EC report notes the fol lowing key challenges for Poland: (i) promote active inclusion by decreasing inequalities in the education system, further developing active labor market instruments, particularly for young people, women, and older workers, implementing policies to make work pay for recipients o f various forms o f social transfers and providing social services needed to support reintegration in employment; (ii) strengthen the administrative capacity o f social assistance and labor market institutions, supported by mechanisms improving coordination policies at various levels; and (iii) continue the pension reform process by reforming farmers’ and disability pension schemes and organizing conversion o f funded pension savings into safe annuities.

74. The labor market and pension reforms supported under the policy loan will generate higher employment, incomes and pensions and thus reduce poverty. The reforms are expected to raise employment rates o f older workers as wel l as to reduce youth- and long-term unemployment thus benefiting several o f the most vulnerable groups. The most contentious part o f the program i s the limitation o f access to early retirement schemes. Early retirement benefits and allowances for the unemployed have largely been phased out, but this was done during a period o f rapidly falling unemployment which mitigated any potential negative effects. Limiting early retirement options in the future will not be associated with termination o f any monetary benefits but instead the right to retire early will be granted solely on medical grounds to occupational groups working in hazardous conditions. This implies that some groups, most notably teachers and railway workers, will lose the right to early retirement. Instead, however, they will work longer, reach higher income levels, accumulate more funds in their notional contribution accounts, and receive higher future old-age pensions thus protecting them from the risk o f old-age poverty (people who retire early are more likely to end up with a minimum pension). To the extent that leisure i s valued highly, the reforms may o f course lower individual welfare.

75. In general, the Government provides a fairly comprehensive safety net in the form of unemployment and social assistance benefits. This safety net mitigates the potential poverty and social implications o f the policy agenda supported under the loan, including the limitation o f early retirement and any j o b loss that might be associated with privatization. The unemployment benefit requires workers to be registered with the public labor office and to have worked at least 365 days in the last 18 months preceding registration at wages equivalent to at least hal f the minimum wage. The benefits vary between six and 18 months in duration depending on the regional unemployment rate. The level o f benefit provided i s approximately equal to the guaranteed minimum income per capita. The social assistance system provides the difference between the guaranteed minimum income per capita and the actual income o f a family, but i s also based on factors such as long-term unemployment and d i~abi1 i ty . l~ Family benefits are also provided on a means-tested basis to families with children.

” The last assessment o f the social assistance system i s based on data from 2003, which showed i t to be reasonably well-targeted. In 2004, responsibility for the social assistance program was transferred to local governments. It would be important to assess how well the locally financed and organized social assistance system i s functioning and this i s envisaged as part o f the AAA program associated with the policy loan.

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B. Environmental Aspects

76. The specific country policies supported by the operation are not likely to cause significant effects on the country’s environment, forests, and other natural resources; moreover, Poland has adequate environmental controls in place. Poland’s environmental legislation and regulation i s reinforced by EU environmental directives, including the EU’s guidelines on adoption o f environmental assessments at the planning and programming level (June 200 1) and the EU’s Environmental Liabilities Directive setting out liability for damage to properties and natural resources (April 2007). As far as the privatization program i s concerned, pre-privatization environmental audits are required to determine the existence and scope o f any such liabilities o f companies in state hands, manifested as contamination on real property or other conduits. The quantification o f such liabilities i s then used as part o f the overall valuation o f the state enterprise for purposes o f negotiating a fair purchase price with the private party. Private sector bidders o f enterprises will be subject to the environmental provisions embodied in Polish and EU law once they acquire previous state assets in the process o f ownership transfer.

C. Monitoring and Evaluation

77. The Bank will work closely with the Ministry of Finance and sector Ministries to monitor and assess reform progress and impacts during the life of the Program. Monitoring and evaluation wi l l be 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 wi l l be provided by the respective specialized agencies for the pertinent functions, and tracked according to the indicators and outcome measures as shown in the Monitoring and Results Framework (Annex 3).

D. Fiduciary Aspects

78. As part of its accession process to the European Union, Poland has achieved significant progress in reforming its public financial management system (PFM). l8 It has upgraded i t s legislative framework, in l ine with the EU acquis, introduced internal audit, and prepared for EU accreditations process o f fund managing agencies. Poland has also made significant improvements related to the public availability and coverage o f fiscal information, particularly the adequacy o f accounting and reporting standards and regularity o f reconciliations o f bank accounts.

79. Other areas o f reform include cash management. This includes the introduction o f a single treasury account (TSA) system, computerization o f all cash transactions and central monitoring o f commitments and liabilities, development o f the State Budget Trezor IT system and i t s implementation in several stages to include initially the lSt and 2”d tier State budget holders, with the remaining units to be all included in the final stage,

The status o f the PFM was derived from the World Bank’s ongoing monitoring o f PFM reform and previous diagnostic works conducted by the Bank and external organizations.

41

an inter-system interface connecting the N B P accounting system with the Trezor system, making possible an online correlation between pending payment orders and State Budget cash availability, and internal control.

80. In furthering its PFM reform agenda, the Government has issued a draft new law on public finance expected to be adopted in 2008. The draft law enhances budget transparency, predictability and performance-orientation over the medium-term. As discussed elsewhere in this document, it introduces inter alia: multi-year budget planning, integration o f remaining Extra Budgetary Funds and externally-financed expenditures within the State Budget, and strengthened internal control over public expenditures via new regulations o n internal audit and internal control.

81. In the area of external audit, Poland i s advanced in relation to availability o f the audit reports to the public, independence o f the Supreme Audit Institution (NIK) from the executive, and control o f the NIK budget, providing a well functioning public financial accountability and assurance mechanism for the legislature and the public.

82. The National Bank of Poland i s part of the European System of Central Banks, and it has upgraded its accounting and reporting policies in accordance with the guidelines o f the European Central Bank. I t s financial management and operations are transparently disclosed and presented on i t s website. The NBP’s annual financial statements are regularly audited and the most recently available audit reports (for 2004- 07) have unqualified audit opinions and were approved by the Council o f Ministers. Overall, the fiduciary risk to this operation arising from Poland’s public financial management system and use o f budget resources and i t s foreign exchange environment as controlled by the Central Bank i s low.

E. Disbursement

83. Loan proceeds will be disbursed in one single tranche to the foreign currency national budget account at the National Bank of Poland (Central Bank). Disbursement will be made upon declaration o f loan effectiveness and submission of a withdrawal application to the IBRD. At the request o f the MOF, the IBRD will deposit the proceeds o f the loan into the foreign currency national budget account indicated by the Government that forms part o f the budget management system o f the country. The proposed loan will fo l low the Bank’s disbursement procedures for development policy lending. Disbursements will not be linked to specific purchases, thus no procurement requirements will be necessary. The Government shall maintain accounts and records with respect to the deposit o f loan proceeds in the National Bank o f Poland (NBP). If the loan proceeds are used for ineligible purposes as defined in the loan agreement, IBRD will require the borrower to refund the amount directly to IBRD.

84. N o additional fiduciary arrangements will be required. The Bank will not require an audit o f the Deposit account but will require the Government to provide confirmation to the Bank in the form o f an official letter from the Ministry o f Finance on the amounts deposited in the foreign currency account within 30 days o f receiving the funds.

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F. Risks and Risk Mitigation

85. Deterioration of macroeconomic balances. Growth in Poland has been well- balanced and the country is less exposed to a slowdown in Western Europe than other new EU members. The baseline medium-term macroeconomic scenario o f slowing but firm economic growth and moderating inflation is, however, subject to downside risks. While this scenario takes into account the ongoing slowdown in the global economy and the euro-zone, there i s significant uncertainty about global economic prospects and r isks are likely to be mainly o n the downside. At the same time, inflationary pressures both worldwide and in Poland, fueled by higher food and fue l prices, may become more resil ient if inflationary expectations rise and become more entrenched, including through faster wage growth. The recent depreciation o f the zloty could add to inflationary pressures. Meanwhile, the recent sharper than expected global economic downturn and easing o f commodity prices as well as tighter credit conditions will help contain inflationary pressures.

86. At the same time, fiscal policy will need to play a key role in constraining demand while the supply side needs to be further stimulated through structural reforms. Also, public sector wage growth needs to be contained including to send the right signal to private labor markets. The proposed operation supports this policy m i x through i t s emphasis on fiscal consolidation and reform, labor market and pension reform, deregulation, and privatization, and overall policy coordination.

87. While fiscal targets through 2011 are broadly realistic based on baseline macroeconomic projections, the measures needed to offset the negative short-term fiscal impact o f planned reforms remain to be fully articulated and the risks of slower growth discussed above could undermine the envisaged fiscal consolidation process. Although the European Commission on June 1 1, 2008 recommended closing Poland’s Excessive Defici t Procedure (imposed in 2004), both the European Council and the IMF have expressed concerns about the feasibility o f fiscal targets in 2009-10 in the absence o f clear measures and given the macroeconomic risks.

88. The execution of the budget in 2008 has remained tight and the outcome for the year i s expected to be better than programmed providing a stronger base for 2009. The 2009 budget envisages firm control over total public spending. Further, the deficit target limit in Poland i s binding providing additional assurance that program goals will be met. Nevertheless, the fiscal outcome in 2009 may be somewhat weaker than targeted owing to the weaker than earlier expected growth, but the IMF believes that allowing automatic stabilizers to operate on the revenue side is an appropriate policy response in the current environment. Looking further ahead, the Bank’s involvement and cooperation with the Government on the implementation o f its reform program would facilitate the establishment o f clear spending priorities in key policy areas. This would support the achievement o f fiscal targets over the medium term.

89. The markets could react to Poland’s request to the Bank, either positively, as the Bank i s giving a seal o f approval o f the reform program; o r negatively, if the request i s misconstrued as due to financial o r economic difficulties. Poland has until

43

recently been raising sizeable financing in international markets at attractive spreads, thus demonstrating market confidence in i t s economic prospects, although the most recent spill-over from the global and regional financial problems have also affected Poland. The proposed Bank loan is very small compared to regular market financing and refinancing operations and would signal Bank support for Government’s reform program. This reduces the risk that the loan would be perceived as emergency financing. In addition, the Bank will work with the authorities to carefully manage communications with the markets and ensure that the basis for the request i s fully understood.

90. Weakening political support for reform. The political environment-with the Government’s lack o f qualified majority in Parliament and risk o f Presidential vetoes on new proposed legislation-may make it increasingly dif f icult for the Government to advance i t s reform program over the next two years as Presidential elections approach. However, the inherent flexibility o f the proposed programmatic approach will allow program content to evolve in step with government priorities.

9 1. Insufficient institutional capacity. Policy formulation in Poland has tended to be fragmented and technical and administrative capacity in some ministries i s weaker than desirable. The proposed programmatic series would help strengthen pol icy coordination and technical/administrative capacity through the Bank’s analytic and advisory services.

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ANNEX 2. TECHNICAL COOPERATION WITH WORLD BANK AND PROPOSED BANK KNOWLEDGE SERVICES (AAA)

UNDER PROGRAMMATIC POLICY LOAN

Public Finance Management

The proposed Technical Cooperation (TC) on Public Finance Management intends to support the Government in the improvement o f the management o f public funds. Pending confirmation from the Ministry o f Finance, the T C program will include studies o n l i n k s between public finances and labor supply, budget rigidities, and continued work on performance-based budgeting.

An alternative to this program i s a poverty and social impact analysis, which is currently being discussed with the new deputy finance minister responsible for taxes. Moreover, within the series o f cross-country comparative studies on public finance reform, there i s the ongoing regional study on P B B and medium-term expenditure frameworks (MTEF), in which Poland i s covered among five other countries in the region.

Labor Markets and Employment

The T C in the area o f employment and labor markets intends to improve the capacity o f the Ministry o f Labor and Social Policy to design and implement modern, cost-effective labor market programs aimed at reducing structural unemployment. The main area where the Ministry o f Labor expressed interest in Bank TC i s on improving functions and coordination between employment and social welfare offices. Specifically, the Ministry expressed interest in finding out what information i s shared between employment and welfare agencies in other countries.

Other topics o f interest to the Government that could be pursued if additional funding for T C i s identified (or cost-sharing by the Government secured) include: (a) improving the targeting and cost-effectiveness o f active labor market programs; and (b) designing modern activation policies, especially those targeted at socially-excluded groups (the long-term unemployed, youth from disadvantaged backgrounds, etc.). In addition, T C can be used to strengthen the capacity o f the Ministry o f Labor to monitor and evaluate the net impact o f labor market programs, so as to select the most cost-effective interventions.

Pensions and Social Assistance

The TC program o n pensions and social assistance aims to provide support and global experience to the Government's efforts for modernizing the pensions and social assistance systems. The technical cooperation activities include modeling and pol icy assistance for the agricultural pension system. KRUS and the Ministry o f Agriculture requested Bank assistance in developing a pension model which could be used to look at the various reform options for KRUS. A l ist o f the data required to calibrate the Bank's PROST model was shared with the Ministry o f Agriculture and calibration and training will be provided to the Ministry and KRUS once the required data have been received.

Other topics o f interest to the Government that could be pursued if additional funding for T C is identified (or cost-sharing by the Government secured) include: (a) review o f social assistance legislation and implementation; and (b) review and sharing o f international best-practice in integration o f various types o f social benefits and information-sharing across benefit types.

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Private Sector Development

The T C in the area o f private sector development includes: (a) implementation o f business regulatory reform recommendations in l ine with Doing Business diagnosis; (b) implementation o f public private partnerships (PPP) for infrastructurehegional projects and private participation in finance instruments; and (c) methods, based on best practice, for privatizing minority-owned government shares in enterprises as wel l as majority stakes including options for alternative mechanisms.

Other topics o f interest to the Government that could be pursued if additional funding for T C i s identified (or cost-sharing by the Government secured) include: (a) developing a regulatory impact assessment methodology; (b) costing the value o f reductions in regulatory barriers; (c) evaluation o f new government initiatives in the context o f Doing Business impact; (d) achieving efficiency in the legislative reform process; (e) integration o f Polish and Ukrainian financial markets for insurance and banking; (f) financial governance and management structures for state- owned and regional enterprises.

Heal th Sector

The T C program in the health sector intends to support implementation o f health insurance and hospital reforms. The Bank would engage in a global knowledge-sharing agenda on key issues that include the introduction o f health insurance competition, the associated regulatory agencies and supervisory bodies, the different types o f non-public insurers, and risk-equalization mechanisms. With regard to hospital reform, knowledge-sharing topics could include public- private partnerships and corporatization, hospital debt management, and approaches to increase financial and management autonomy.

Education Sector

The T C program in education covers two Ministries (Ministry o f National Education and Ministry o f Science and Higher Education) and has been designed in collaboration with these Ministries. The objective o f the program i s to provide global knowledge to inform policies targeted at the upgrading o f skills for competitiveness in Poland. The T C program in the education sector will support global knowledge sharing on: (a) reforms in Higher Education; (b) the World-Class University implementation (and its specific implications for Poland); and (c) new global trends in Science curricula in basic education. ‘Also, the T C program will support the Ministry o f National Education in the development o f a strong analytic program on PISA, including a partnership to convene an international event in Poland that will promote the use o f PISA analysis for policy-making.

Other topics o f interest to the Government that could be pursued if additional funding for T C i s identified (or cost-sharing by the Government secured) include a Policy Note on global efforts to create Labor Market Observatories and a Policy Note on the lessons o f the implementation process o f “Grade Zero” in countries that have made recent progress in this area.

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ANNEX 4. ASSESSMENT LETTER FROM INTERNATIONAL MONETARY FUND

Poland-Assessment Letter to the Wor ld Bank November 19,2008

Economic Developments and Outlook

Poland liss until recently experienced strong economic growth.' Driven by an EU- accession-related investmelit boom and by a robust expansion in private consumption- reflecting. r is ing employment aud strong wage g rowth4DP grouth had been nmiii ig above potential for two to t h e e years. Not surprisingly, therefore. growth had begun to slow in face o f eniergirig domestic resource constraints. notably in the labor market. even before being hit by spillovers froin the global ttmioil. Whi le wage increases had been s i p i f i c a n t l y exceeding procluctivity gains for a number o f years, only starting in mid-2007 did the resulting increase in unit labor cost begin to b e reflected in rising core-inflation and endogenously s lowiug output growth.

But growth i s now slowing sharply as the economy i s being affected by spillovers, through real and financial channels. With a notable slowdown already evident f~um f@Ii f i e q ~ ~ e ~ i c y indicators and w i t h a l l o f Poland's n m h Western export markets expected to be in recessioxi in 2009. Staff's baselhie projection has growth fallin_e from about 5 percent in 2008 to less than 3 percent iti 2009. well below potential. Pxt ic t i lar ly worrisome. whereas Poland was spared serious fir iaiicial spillover until recently. capital outflows have been associated with about a 12 percent depreciation of the zloty (against the euro) and with a decline in equity p i k e s o f about 30 percent since end-Augwt, Fear of c o u n t e i p r t y risks has frozen the interbank and FX-swap markets, and actions by t l ie NBP-incltidiug an increased frequency o f open maiket operations md the infroduction o f a FX-swap facility-have been to l itt le avai l so far. In staff's view. i ts baseline projection is subject to dowmside risks ffom a possibly stronger slowdown in export iiiarkets and more serious deleveraging aid confidence crisis in financial tiiarkets.

Inflationary pressures are set to moderate. Despite cumulative increases in policy rates o f 200 bps since April 2007, above-potential growth clrove inf lat ion w e l l outside the NBP's tolemice mnse of 1% to 3 $5 percent, to 4.4 percent by September. However. with growth set to fa l l be low poteiit ial and with declining food arid energy prices, revised projections by staff suggest that in f la t ion i s now set to re tun to witliu the tolerance range in the first half o f 2009.

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2

The current nccount defici t i s i ie la t iWy low, but f inancing pressures have risen. Tile 32- month rolling current account deficit rose fioni 3.7 percent at end-2007 to 4.9 percent o f GDP at end-September, lait i s projected to narrow padual ly again as the ecoxioniy slows. The deficit l a s been mostly f m n c e d by noxi-debt creating flows, and exteinal debt has remained largely constaiit at a relatively comfortable level of about 50 percent o f GDP. Despite this. tlie global turmoil llas been associated wifii a notable ti_ghteiiing o f Polaiid’s access to exteiual fiiianciug, and interest rate spends have risen si_gnificantJy. dthougli s t i l l less than in most other countries in the region.

Policy pr ior i t ies

Macroeconomic policies shouId be refocused, but r e f o r m to boost potential growth remain a pr ior i ty . The rapid cyclical downtutu arid the atteiidaiit drop in output to well below potential points to the need to refocus nmcroeconoiilic policies, froin being conceined w i th overheating to having a neutml if iiot stimulative bias. However. th is shodd iiot mask that tlie economy will a_eaiii face si_dficant structural obstacles to potential growth once cyclical coiiditioiis iioiii iakze. Thus, a key challenge facing pol icy makers at this jui ictwe wil l be to conthiu-veil as iiimecliate pressures 0x1 resources ease-with the reinvigoration o f refoims that has been slowly getting underway during the recent year., not least re form a b e d at boosting labor participation through changes in the pension aiid disability payiierit systems :

e Monetary pol icy: with inflatioti pressures expected to recede. the MPC tightly s l M e d to a neutral pol icy stauce in October. Still. with GDP growth set to fal l well below potexitial, and coiisidering the aforeiiieiitioiied downside risks, the question arises o f whether to begin loosening cycle. On the other hand. the difficult external finalleirig eiiviromueiit and the recent pressures on the zloty suggest cautiotliiig in intitaing such a cycle at th is juncture. On balance, staff recommends. putting 011 hold such a loosening stance. If however. there i s evidence of downside risks to the baseline growth forecast timtexklizing, staff would cautiously loosen inoiietary policy, provided that exteimal financing pressures do not intensify. Nonetheless. the aiitfiorities should eiisure that the plan of actiori regarding the banking sector- particularly the interbank guarautee sctierue-be iriiplemeiitecl expeditiously arid tailored specifically to address liquidity constraints.

e Fiscal policy: staff agrees with the authorities’ target o f reducing the s t~ i i c tu id deficit to one percent o f GDP by 201 1. Staff also believes that the 2009 budget and the three-year spetlcting envelope are broadly consistent with the mediuuii-teimi deficit tarset. I t wou ld be inappropiiate. in staffs view, to change the expenditure patti in response to cyclical considerations, iiot least because expenditme plans have been calibrated w i t h a view to snpporthig medium-teim stmchwal changes. but also

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3

because the cyclical component in expenclihwes i s relatively s n ~ l l . However. automatic stabilizers should be allowed to operate on the revenue side in order to p ro i ide a welcome counter-cyclical impulse at this jtnictwe. although the attendant increase in the fiscal deficit should not be such as to breech hfaastiicht limits.

e FiuaEcial sector supeivisiou: Global f m n c i a l conditions underscore t l ie irnpoi-tauce of continuing to intensify financial sector suiveillance. W‘hile tlie balking system s t i l l has a s u q k s o f short-term fiuding. ro l l over risk in smaller baks could be significant. particularly in the c u m i t global eiivironment. Regardless, domestic credit i i s k s - s t e n u i ~ i g fimi tlie economic dovcuhmi and household’s unliedged FX borrowing-are poised to iise. BaI&S continue to have sufficient capital to meet rep la to ry requirements, but capital adequacy ratios, cunently at 10.8 percent. have been declining, reflecting robust leiicling growth and regulatory cbanges. In this contexF. the authorities will need to rennin vigilant and. if needed. take decisive actions as the real effects o f t l ie tuuiiiuil works i ts way through the economy.

a Struc tura l reforms: Boostiug labor participation, particularly those above 50 years o f age, holds the key to raise long-iun growth and avoid buinpinp up against resource constraints. Refonnhg the generous provisions for early retirement, by tighteaing giideliues for eligibil i ty and fiu-tlier ratiormlizinp the system for disability payments are essential. In addit ion re fon i iug the faiiiier’s pension scheme (EXUS). with the ultimate goal o f merging i t into the general Yystem, will also contribute to raise participation atld reallocate labor to more productive sectors. Other important refoxms to make the econotiiy more flexible include fiu-ther deregulation to enhance the business clinia te and completing t l ie autliori ties ’ piivatiza tion plan.

The decision t o adopt the euro by 2012 i s much welcomed. T h i ~ i s likely to catalyze reforms md aiichor policies during a period o f increased iuicertainty ancl humoil, The plat envisages Emf2 entry in the first ha l f o f 2009 and, fol lowing the coiimission’s approval. euro adoption on January 1. 20 12. Besides acldressing corstihttional imnpediinents before ERM2 participation. t h i s wil l require steadfast progress in t i x a l consolidatiou ancl stnictual reforms iioted above to boost growth and provide tl ie needed f lexibi l i ty to thrive in the euro area.

Fund relations

The last Art icle ni- consultatian was concluded on Apr i l 16. 2005. wlMcli was followed by a b k e f fact-finding staff v is i t in September 2008. A TA niissiou focusing on ti iediimi-tern budgetary framework visited Warsaw at end-March.

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4

Table I. Poland: Selected Economic Indicators, 2005-10

2005 2006 2007 2008 2009 2010 PKIJ Proj Pmj.

Actrvity and prices GDP (change in percent)

Domeshc demand Pnvate cortsumpbon growth Public consumptron growth Domestlc fixed investment growth Net external demand (contnbution to grow811

Average End of period

CPll infl&on (change in percent)

Unemployment rate (average accordtng to Labor Fwce Survey) Gross domestic savmg (ratio to GDP) f l Gross domestic rnvestment (ratio to GDP)

Public finances (percent of GDP) General government revenues General government expenditures 2/ General government balance 21

Public dm 3 accwding to ESA95

according to ESA95

Money and credrt Pflvate credit (12-month change) Broad money(l2inonth change) Money market rate (em) 13-week t-brll rate (eop) Poky Rate 46 Corporate lending rate (1 year) 51

Current a c m t balance (transactions, miBh5 U.S. doilars) &lance of payments

Percent of GDP C/A halance plus net FDI, percent of GDP

Ex@ of G o d s (miEliom U S dollars) Exp01-I volume grawth

Imports of Goods (millions U S. dollars) Import volume g W h Net MI imparts (millrons U S. dollars)

Terms of trade (index 19515=100)

FDI, net (in percent of GDP) Official reserves (millions CI S. rballats)

Total external debt [percent af GDP)

Exchange rate regime Zbty per US$, p e n d average 61 Zkoty per Euro, penod average 61 Reat effective exchange rate (INS, CPI based) 7/

months of imports

Exchange rate

percent change

3 6 2 5 2 1 5 2 6 5 1 1

2 1 0 7

17 7 18 4 19 3

39 I 43 0 -3 9 -4 3 47 5 47 1

12 6 13 1 4 6 4 3 4 5 7 1

-3,705 -1 2 1 1

96,395 8 0

99,161 4 7

97 5

2 3 42,571

5 2 43 7

Fhoating 3 23 4 03

136 1 11 7

6 2 7 3 5 0 6 1

14 9 -1 1

1 0 1 4

13 8 190 21 1

39 8 43 7 -3 9 -3 8

47 8 47 7

229 16 0 4 2 n a 4 0 5 9

-9,200 -2 7 0 2

117,468 14 6

124,474 17 3

97 2

2 9 48,484

4 7 49 6

3 10 390

139 1 2 2

6 7 8 6 5 0 3 7

17 6 -2 1

2 5 4 0 9 6

21 7 24 3

40 0 41 6 -1 6 -2 0 43 5

295 13 4 5 7 n.a 5 0 6 1

-15,905 -3 7 -0 2

144,609

5.0 6.5 5.0 1 .O

15.0 -1.8

4.2 3.4 7.9

22.8 26.3

39.3 41.6 -2.3

... 41.8

...

. . .

. . .

. . .

. . . . .

. . .

2.8 1.3 2.5 1 .O 0.0 1.4

2.9 3.0 8.4

23.4 25.0

40.2 43.2 -2.9

. . . 42.3

...

. . .

. . .

. . .

. . . . .

. . .

3.6 4.9 3.5 2.5

11.0 -1.4

2.9 2.8 8.8

24 6 3 . 6

40.3 42.9 -2.6

42.7 ... ...

...

. . .

. . .

. . .

. . .

...

-24,769 -15.163 -20,162 -46 -27 -34 -0.8 -0.8 -1.3

178,369 175,416 192,045 9.1 6.8 2.5 7.7

1M0,162 201,272 188,122 214,137 13.6 10.4 -1.1 11.2

99.3 996 1023 101 6

3.6 3 8 1 9 2.0 65,746 69,075 70,565 70,917

4.9 4.1 4.5 4 0 549 505 485 468

. . . 2.77 3.01 ... 3.79 383 . . . .

144.6 162.6 . . . . 3.9 12.5 . . . . . .

Sources Pdish authontres, and IMF staff estlrnates I/ Derived as total savings minus the current account ~~IIBLIS capital transfers 21 Fund definition (including pension r e f m costs) 3/ Pdish definitim of debt including nsk wghted stock of outstanding guarantees 4/ Yield on 7-day NBP money market bills Y The methododogy fcr comput~ng interest rates was changed in 2004 to fulfill ECB requtrements. 6/ For 2008, exchange rate as of November 18 7/ Annual average (1995=100); for 2008, average JarrSept

60

ANNEX 5. POLAND AT-A-GLANCE

Poland a t a glance 10/24/08

Key Development Indicators

(2007)

Population, mid-year (millions) Surface area (thousand sq. km) Population growth (%) Urban population (%of total population)

GNI (Atlas method, US$ billions) GNI per capita (Atlas method, US$) GNI per capita (PPP. international $)

GDP growth (“h) GDP per capita growth ( O h )

(most recent estimate, 200&2007)

Poverty headcount ratio at $1.25 a day (PPP, %) Poverty headcount ratio at $2.00 a day (PPP, %) Life expectancy at birth (years) Infant mortality (per 1,000 live births) Child malnutrition (% of children under 5)

Adult literacy, male (% of ages 15 and older) Adult literacy, female (Oh of ages 15 and older) Gross primary enrollment, male (% of age group) Gross primary enrollment, female (% of age group)

Access to an improved water source (“h of population) Access to improved sanitation facilities (% of population)

Poland

38.1

-0.1

375.3 9,860

15,330

6.7 6.8

74 8

100 99

Europe & Central

Asia

445 23,972

0.0 64

2,694 6,051

11,116

6.8 6.7

5 11 69 23

99 96 98 96

95 89

upper middle

income

823 41,497

0.6 75

5,750 6,967

1 1,868

5.8 5.1

70 22

94 92

112 109

95 83

Net Aid Flows

(US$ m////ons) Net ODA and official aid Top 3 donors (in 2006)

European Commission France Austria

Aid (% of GNI) Aid per capita (US$)

Long-Term Economic Trends

Consumer prices (annual %change) GDP implicit deflator (annual % change)

Exchange rate (annual average, local per US$) Terms of trade index (2000 = 100)

Population, mid-year (millions) GDP (US$ millions)

Agriculture Industry

Services

Household final consumption expenditure General gov’t final consumption expenditure Gross capital formation

Exports of goods and services Imports of goods and services Gross savings

Manufacturing

1980

35.6

1990 2000

1,320 1,396

289 838 2 197

27 124

2.4 0.8 35 36

70.3 10.1 55.2 7.2

0.9 4.3 104 100

38.1 38.6 58,976 171,276

(% of GDP) 8.3 5.0

50.1 31.7 18.5

41.6 63.3

48.0 63.1 19.3 18.5 25.6 24.8

28.6 27.1 21.5 33.5 15.9 19.0

2007 a

1,524

1,101 197 83

0.6 40

2.5 3.3

2.8 106

38.1 422,090

4.3 31.1 17.5 64.6

60.0 18.9 23.8

40.9 43.6 20.1

Age distribution, 2007

Male Female

0-4 , i o 5 0 5 i o

percent

I Under-5 mortality rate (per 1,000)

I 601

Growth of GDP and GDP per capita (“A)

8 6 4 2 0 2 4 E

95 05

GDP Der caDita I -GDP -

1980-90 1990-2000 2000-07 (average annual gmwth %)

0.7 0.1 -0.2 4.7 4.1

0.5 2.0 7. 1 5.2 9.9 8.0 5.1 3.5

5.2 3.5 3.7 4.0

10.6 4.9

11.3 10.3 16.7 8.8

Note: Figures in italics are for years other than those specified. 2007 data are preliminary. .. indicates data are not available. a. Aid data are for 2006.

Development Economics, Development Data Group (DECDG)

61

Poland

Balance of Payments and Trade

(US$ miliions) Total merchandise exports (fob) Total merchandise imports (cif) Net tade in goods and services

Current account balance as a %of GDP

Workers remittances and compensation of employees (receipts)

Reserves, including gold

Central Government Finance

(% of GDP) Current revenue (including grants)

Current expenditure

hera l l surplusldeficit

Highest marginal tax rate (%)

Tax revenue

Individual Cor p ra te

External Debt and Resource Flows

(US$ millions) Total debt outstanding and disbursed Total debt service Debt relief (HIPC, MDRI)

Total debt (% d GDP) Total debt servioe (%of exports)

Foreign direct investment (net inflows) Portfolio equity (net inflows)

2000 2007 Technology and Infrasttucture 2000 2007

Paved roads (% of total) 31,729 139,654 Fi=d line and mobile phone 49,023 165,216 subscribers (per 100 people)

-10,902 -11,532 High technology exports ( O h of manufactured exports)

-9,981 -15,905 -5.6 -3.8

1,726 10,671

27,466 65,745

38.1 40.1 19.8 22.8 38.2 37.6

-3.0 -2.0

40 40 26 19

64,634 182,940 10,156 48,392 - -

37.9 43.3

9,343 19,196 447 -2,134

I Cornposttbn of total external debt, 2006

b t h e r m u l t b

Private Sedor Development 2000 2008

Time required to start a business (days) - 31 Cost b start a business (%of GNI per capita) Time required to register property(days) - 197

Ranked asa major constraint tu business 2000 2007

Tax rates .. 57.5 Access to/cost of financing .. 50.7

- 18.8

(% of managers surveyed vvho agreed)

Environment

Agricultural land ( O h of land area) Forest area ( O h of land area) Nationally protected areas (% of land area)

Freshwater resources per capita (cu. meters) Freshwater withdrawal (% of internal resources)

CO2 emissions per capita (mt)

GDP per unit denergy use (2005 PPP $ perkg of oil equivalent)

Energy use per capita (kg of oilequivalent)

66.3 69.7

46 136

3.3 3.6

60 52 30.6 9.6

.. 1,404 30.2

7.8 8.0

5.0 5.6

2,326 2,436

7

(US$ mi///ons)

IBRD Total debt outstanding and disbursed 2,229 1,870 Disbursements 349 3 Pnmipal repayments 199 261 Interest payments 122 89

IDA Total debt outstanding and disbursed Disbursements Total debt service

IFC (fscal year) Total disbursed and outstanding pwtfdio 111 46

dwhich IFCown account 91 48 Disbursements for IFC own account 8 0 Portfolio sales, prepayments and

repaymentsfor IFC own account 21 10

MlGA Gross emasure 2 0 New guarantees 0 0

Stock market capitalizaaon (% d GDP) Bank capital to asset ratio (%)

18.3 49.1 7.1 7.9

Note: Figures in italics are for years other than those specified. 2007 data are preliminary. .. indicates data are not available. - indicates observaaon is not applicable.

Development Economics, Development Data Group (DECDG).

10/24/08

62

ANNEX 6. POLAND DOING BUSINESS INDICATORS

Poland: Doing Business 2009

IEase of Doing Business Rank 76 I

Starting a Business Rank -Procedures (number) -Time (days) -Cost (% of income per capita) -Min. capital (% of income per capita) Dealing with Licenses Rank -Procedures (number) -Time (days) -Cost (% of income per capita) Employing Workers Rank -Difficulty of Hiring Index (0-1 00) -Rigidity of Hours Index (0-1 00) -Difficulty of Firing Index (0-100) -Rigidity of Employment Index (0-1 00) -Firing costs (weeks of wages)

Registering Property Rank -Procedures (number) -Time (days) -Cost (% of property value) Getting Credit Rank -Legal Rights Index (0-10) -Credit Information Index (0-6) -Public registry coverage (% adults) -Private bureau coverage (% adults)

145 10 31

18.8 168.8 158 30 308 137 82 11 60 40 37 13

84 6

197 0.5 28 8 4 0 50

Protecting Investors Rank -Disclosure Index (0-1 0) -Director Liability Index (0-10) -Shareholder Suits Index (0-1 0) -Investor Protection Index (0-10) Paying Taxes Rank -Payments (number) -Time (hours) -Profit tax (%) -Labor tax and contributions (%) -Other taxes (%) -Total tax rate (% profit) Trading Across Borders Rank -Documents for export (number) -Time for export (days) -Cost to export (US$ per container) -Documents for import (number) -Time for import (days) -Cost to import (US$ per container) Enforcing Contracts Rank -Procedures (number) -Time (days) -Cost (% of debt) Closing a Business Rank -Time (years) -Cost (% of estate) -Recovery rate (cents on the dollar)

38 7 2 9 6

142 40

41 8 13

23.5 3.7

40.2 41 5 17

884 5

27 884 68 38

830 12 82 3

20 29.8

63

ANNEX 7. LETTER FROM GOVERNMENT OF THE REPUBLIC OF POLAND

Mr. Robert 5. taelllck President the World Bank

As you may k w , The WerM Bank Offke In WarJaw, roge?htr wHh yow staff In Washtngton, has been worklng extensively with PoLIih gawrnmcnt repnsentat#ws rinn the summer in order tu ntcognDzs and dewlap the mast important area5 of cmwmtion betwmn Poland and the Bank. We have already defined a bl~rnbet 01 Isws where the W o M Bank cauM offer us a comparative advantage of technical ccloperathm. We WC wdpe for Improvement In many of there areas and WE plan to Implement refants with your aWtance. i can assure you that current government is ccrmmRtEd to m a h mry needed c h r t to sped up the proem ob structural reFofm5 being implementing: in Poland. Thus, I wouM like to requesr The International Bank for Reconsbuctbn and Development tD deliver a Paicy Loan, lndudlng associated technical cocpetazion program, in the amount of about EUR 1 billiDn [US0 1.25 billion equivalent). The ban m i d be the firs io an WWl$.agFQ Yerks 61 2.3 loans within a 2-3 p a r programmatic Framework and financidf envelape of about 3 EUR billion (US0 3.fSblllian equlualent).

Poland is one of the few European Union members whkh h a mot graduated from the Workl Bank. Pdand is now appfoadting the end o l EtS transltlon period. We &?auld lldt lwie tnk mornetltum and Strlve to make joint Fffons to strengthen Polish reform$. I'm sure that Paland ao well the Bank wiii benefit from this pragnm of coopeiation. We haw already chained a lot af experience, flnanclal support and technical adstance from the Bank wcr the yean. A number of adjustmqnts ham already been nwde with y w r k i p and we see the need for continued engagement. t he first ban would fwus ~1 the priority r e k m r and policy a d h a recognized during our recent consultations.

Macroemnomi& %ail *nd public finrmo m w p m e n t reform lmprovemenr in the area of public managerrtent wn facilitate a number of budgetary processes, e,g, better EU funds ab5~rption. ?ha main challenges am: [i) ensuring B wntinued gradual redmion In the fiml deficit to help stabllize the economy and meet requlremerrtr krr Euro adoption in a sustainable! way; and (li) improving the qualbry Qf public finance5 through a lowering of the tax burden and increased emphasis bn productive spending. Addressing, these challenges will require actbns in a number of areas: introducing performance-hsed budgeting (PBBJ. consolidating spending unlts and focusiryl on Eeneral actfulties, intduclng an effective MediumTerm Expenditure Framework (MTEF) and further enhancing admmistmtive capacity in the public 5ebar. Progre55 In the areas sutlincd above ha5 to go hand in hand wlfh effort$ to enhance the gewfal adminirlratlvc rap-edty of thr government and public sector.

Employment and pension reform Phi? government recognizes that mobilizing labor supply k crrtkal for sustainable ecowmlC growth, cspcclally on the backgrouhd of popratation aging and the steadily increasing demogmphic dewndeniccy nlio. In additbn, the

contact detZ%a: Mehl Baj, Imtwnatlonal Ueplrrmanc lxresta

*MI a r j @ r o r z l c t . ~ v ~ p tel. 4 22 W 5646 fax. 4 8 22 694% 70

64

Polish economy afready suffers from shortages of skfiled labor. The expensive social security system supports inacttvrty and is financed by high labor taxes. in particular, the availability of generous eatly retirement (and to a lesser extent disability) schemes k fiscally oostfw and results in very low labor force participation of older workers (aged 55-64). FurFher, the low skifls and productivity of a significant fraction of the workforce Is reflected in a low emptoyrnent/popuiation ratio and a high incidence of long-term unemployment among the iesx-educated workers.

Privatization and deragulation Another pillar of the government's reform program is private sector development, including completion of the privatiratlon agenda, In the 1990s and mid-200ds, the successive Polish Governments prkatized a large mass of State-Owned Enterprises (SOEs) through various means including tenders, mass privetisations and other methods. However, there dill remains a small yet not imignificant number of reddual enterprises which are becoming an administrate drain on the State and should rightly be reconstituted as p r h t e sector companies. For some of these, the State is the majority shareholder though some two to three hundred are small enterprises with only minority holdings by the State. As part of its privatization agenda, the Government recently announced a plan to privatlze 740 enterprlses and liquidate or wind down another 350. A small share of enterprlses (e,g, energy sector) wilt not be privatized given the n e d for the Government to first consider strategic needs and choices for the economy in such specialized sectors. Among some of the corpoate governance reforms envisaged is the creation 61 independen€ company boards and management that can turn around companies wirh revenue potential, as well as market-based remuneration for key management staff to dissuade unproductive rent

authorlzations or Interventions required for these deals to move forward. Further, the Government is pursuing an ambitious deregulation program aimed at improving the environment for doing business.

I seeking. Separately, to encourage public/private partnerships, the Government will reduce the Ministerial i

Further reforms are envisaged during the subsequent phases of the programmatic cooperation framework. These include continuation of reforms in the areas abwe as well as envlsaged reforms in other social sectors, notably education and healthcare servlces. The focus of subsequent loans would be defined more precisely during the discussion of these, with due conslderatlon to maintain a focused approach to the policy areas coveted.

I strongly believe that the World Bank can bc supportive for us in all of the above mentioned areas and I am confident that our cooperation would also be valuable to the Bank In its work with other cllents. I hope that in the context of the ongoing global financial turmoil, the Bank would be ready to deliver this regular, man-emergency asdstance as the Polish macroeconomy and financial system are sound.

Mr. Presldent, Since I set store by transparency of this process, please k me copy this corfespondence to Mr. Joaquin Afrnunia, European Commissioner for Economk and Monetary Affairs, Mr. Dominique Straw-Kahn, Managing Director of the International Monetary Fund and Mr. Stawomit Skrrypek President of the National Bank of Poland to keep our key partners well Informed.

Looking forward to hearing From you.

I

Yours sincerely,

- Jan Vincent-Rostowski

2

65

MAP SECTION

Wisla

San

Notec

Warta

Vistula

Odra

Odra

Nysa

Warta

Wis

la

Bug

N

arew

K U J AW S K O -K U J AW S K O -P O M O R S K I EP O M O R S K I E

L Ó D Z K I EL Ó D Z K I E L U B E L S K I EL U B E L S K I E

LUBUSKIELUBUSKIE

MAZOWIECKIEMAZOWIECKIE

OPOLSKIEOPOLSKIE

PODKARPACKIEPODKARPACKIE

P O D L A S K I EP O D L A S K I E

P O M O R S K I EP O M O R S K I E

W I E L K O P O L S K I EW I E L K O P O L S K I E

ZACHODNIOPOMORSKIEZACHODNIOPOMORSKIE

WA R M I N S K O -WA R M I N S K O -M A Z U R S K I EM A Z U R S K I E

SWIETOKRZYSKIESWIETOKRZYSKIESLASKIESLASKIE

DOLNOSLASKIEDOLNOSLASKIE

MALOPOLSKIEMALOPOLSKIE

RadomRadom

KoninKonin

PlockPlock

TorunTorun

KrosnoKrosno

TarnówTarnów

KaliszKaliszLesznoLeszno

LegnicaLegnica

SieradzSieradz

SiedlceSiedlce

SuwalkiSuwalkiKoszalinKoszalin

WloclawekWloclawek

CiechanówCiechanów

TarnobrzegTarnobrzeg

JeleniaJeleniaGóraGóra

Zielona GóraZielona Góra SkierniewiceSkierniewice

PiotrkówPiotrkówTrybunalskiTrybunalski

PilaPila

SlupskSlupsk

ElblagElblag

OstrolecaOstroleca

CzestochowaCzestochowa

Nowy SaczNowy Sacz

LomzaLomza,

BialaBialaPodlaskaPodlaska

ChelmChelm

ZamoscZamosc, ,

PrzemyslPrzemysl,

Bielsko-Bielsko-BialaBiala

WalbrzychWalbrzychOpoleOpole

KrakówKraków

KielceKielce

LublinLublin

RzeszówRzeszów

OlsztynOlsztyn

KatowiceKatowice

SzczecinSzczecin

BydgoszczBydgoszcz BialystokBialystok

GorzówGorzówWielkopolskiWielkopolski

LódzLódz

PoznanPoznan,

WroclawWroclaw

WARSAWWARSAW

RUSSIANRUSSIANFEDERATIONFEDERATION L I T H U A N I AL I T H U A N I A

UKRAINEUKRAINE

CZECH REPUBLICCZECH REPUBLIC

SLOVAK REPUBLICSLOVAK REPUBLIC

BEL

AR

US

BEL

AR

US

GE

RM

AN

YG

ER

MA

NY

To To BerlinBerlin

To To BerlinBerlin

To To BerlinBerlin

To To DresdenDresden

To To PraguePrague

To To PraguePrague

To To BrnoBrno

To To ZvolenZvolen

To To KosiceKosice

To To L'vivL'viv

To To Kovel'Kovel'

To To Kovel'Kovel'

To To VilniusVilnius

To To GusevGusev

To To PinskPinsk

To To BaranavichyBaranavichy

To To NeubrandenburgNeubrandenburg

K U J AW S K O -P O M O R S K I E

L Ó D Z K I E L U B E L S K I E

LUBUSKIE

MAZOWIECKIE

OPOLSKIE

PODKARPACKIE

P O D L A S K I E

P O M O R S K I E

W I E L K O P O L S K I E

ZACHODNIOPOMORSKIE

WA R M I N S K O -M A Z U R S K I E

SWIETOKRZYSKIESLASKIE

DOLNOSLASKIE

MALOPOLSKIE

Radom

Konin

Plock

Torun

Krosno

Tarnów

KaliszLeszno

Gdynia

Legnica

Sieradz

Siedlce

SuwalkiKoszalin

Wloclawek

Ciechanów

Tarnobrzeg

JeleniaGóra

Zielona Góra Skierniewice

PiotrkówTrybunalski

Pila

Slupsk

Elblag

Ostroleca

Czestochowa

Nowy Sacz

Lomza,

BialaPodlaska

Chelm

Zamosc, ,

Przemysl,

Bielsko-Biala

WalbrzychOpole

Kraków

Kielce

Lublin

Rzeszów

Olsztyn

Katowice

Szczecin

Bydgoszcz Bialystok

GorzówWielkopolski

Gdansk´

Lódz

Poznan,

Wroclaw

WARSAW

RUSSIANFEDERATION L I T H U A N I A

UKRAINE

CZECH REPUBLIC

SLOVAK REPUBLIC

BEL

AR

US

GE

RM

AN

Y

Wisla

San

Notec

Warta

Vistula

Odra

Odra

Nysa

Warta

Wis

la

Bug

N

arew

Bal t ic Sea

Gulf ofGdansk

To Stralsund

To Berlin

To Berlin

To Berlin

To Dresden

To Prague

To Prague

To Brno

To Zvolen

To Kosice

To L'viv

To Kovel'

To Kovel'

To Vilnius

To Gusev

To Pinsk

To Baranavichy

To Neubrandenburg

Rysy(2,499 m)

54°N

52°N

50°N 50°N

52°N

54°N

18°E 20°E 22°E 24°E

16°E14°E 18°E 20°E 22°E 24°E

POLAND

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 25 50 75

0 25 50 75 Miles

100 Kilometers

IBRD 33467R

MARCH 2007

POLANDSELECTED CITIES AND TOWNS

PROVINCE (WOJEWÓDZTWO) CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

MAIN RAILROADS

PROVINCE (WOJEWÓDZTWO) BOUNDARIES

INTERNATIONAL BOUNDARIES