Fitch Ratings says in an updated sovereign report that an economic upturn is supporting the ongoing convergence of Poland's income levels with wealthier EU countries. It has also helped reduce external financing risks and improve the government's budgetary position, despite ongoing political risks. These ongoing trends were reflected in Fitch's January 2007 upgrade of Poland's Long-term Foreign Currency Issuer Default Rating (IDR) to 'A-' (A minus) from 'BBB+'.

"Poland's economy is experiencing an upturn following a number of years in which it lagged its regional peers", says David Heslam, Director in Fitch's Emerging Europe Sovereign Group in London. Real GDP growth reached 6.1% in 2006 and Fitch forecasts it to average 5.5% per year between 2007 and 2009, aiding the continued convergence of real income levels with wealthier EU members. Although strong growth is putting some upward pressure on prices, these are moderate and the inflation outlook remains benign. The current account deficit was moderate at 2.3% of GDP in 2006 and deficits of about 2.5%-3.5% up to 2009 should continue to be largely covered by non-debt-creating foreign direct investment (FDI) inflows, as has been the case since 2000. Combined with currency appreciation, these financing trends are likely to continue to mitigate the growth of Poland's external debt ratios.

"The economic upturn has aided a narrowing of the budget deficit, a traditional weakness for Poland's Sovereign Ratings," said Mr. Heslam. The 2006 general government deficit narrowed for the third year in a row to 3.9% of GDP - its lowest since 2000. Fitch expects the general government deficit to stabilise at around 3.5% of GDP in 2007-2009. This should be sufficient to keep the level of general government debt at 48%-49% of GDP, despite the ongoing costs of pension reforms. Over the medium term, the cost of diverting social security contributions to a non-public pension fund contributes approximately 2% of GDP to Poland's general government deficit per year. Over the longer term, pension reforms place Poland's public finances in a stronger position to cope with the costs of an ageing population than those of many EU member states.

Political risk to sovereign creditworthiness has lessened but cannot be discounted in Fitch's view. Despite previous fears and some high-profile conflicts with the financial community and the European Union, the Law and Justice Party (PiS), the largest in the governing coalition, has so far followed a benign economic path. It has also been able to moderate some of the more populist policy objectives of its smaller coalition partners, Self-Defence and the League of Polish Families (LPR). "The populist nature of the PiS's partners and lack of any fundamental shared economic ethos is nevertheless likely to mean that the political landscape will continue to be characterised by periodic intra-coalition conflict and there is the potential for populist spending policies to undermine recent improvements in the financial position of the government," said Mr. Heslam.

Meanwhile, progress with structural and fiscal reforms is likely to be slow and concentrated on plans to reduce the tax burden - a constructive development if balancing savings are found - and the PiS's anti-corruption drive. Euro adoption is unlikely to be a major ambition for the euro-sceptic government, which has promised a referendum on the issue, and is not expected by Fitch until 2012.