Recent tax receipt rises are not a blip and sound growth and a reasonable fiscal stance should support Polish bonds
The 2018 draft budget draft aims at 2.7% of GDP deficit. It assumes a modest reduction of central budget expenditure (by 0.25% of GDP, despite costs of lowering the retirement age) and a significant but justified increase in effective tax rates. In our opinion, the 2018 deficit is likely to surprise positively and not exceed 2.0% of GDP. A strong fiscal stance will continue to support Polish government bonds (POLGBs), countering the effects of the government's controversial political agenda.
The Polish Ministry of Finance has presented a preliminary budget for 2018, but the final version shouldn’t change much. The document looks feasible, but also not very ambitious in terms of improvement in the structural balance. The general government deficit is expected to be 2.7% of GDP, only slightly lower (0.2ppt) than assumed in the 2017 budget bill and 0.2ppt higher than expected in the Convergence Programme (from Aprril 2017). In our opinion, however, there is a good chance for a much better result – a 2018 deficit of c.2% of GDP. The following arguments support our view:
From this perspective, another 10% YoY increase in VAT revenues in 2018 doesn’t seem to be wishful thinking, especially if one bears in mind that there is some space for structural improvement in the effective VAT rates due to lagged effects of the anti-tax evasion measures launched gradually over the last 18 months. Even if VAT disappoints, excise might come to the rescue.
Excise revenue estimates were conservative and a positive surprise is likely.
The 2018 budget seems to be most optimistic with regard to labour taxation. Revenues from PIT (personal income tax) are expected to grow by nearly 9% YoY and Social Security contributions by 6% YoY. From 4Q17 the retirement age for men and women will be lowered from 66 and 61 to 65 and 60. The cost of this is expected to be PLN10bn in 2018 and the government expects to cover this mainly through higher effective tax rates - something which might prove difficult and poses the biggest risk for the budget. However, unemployment is at a record low and the resulting wage pressure may indeed push up PIT revenues and social security contributions. Moreover, Poland benefits from high Ukrainian worker migration – these workers are increasingly covered by a standard employment contract with income taxes and social contributions. All in all, the expectations of the 2018 budget from labour taxation include some risk but aren’t without justification.
Summing up, we are optimistic with regard to the 2018 budget. Even though at this point of the business cycle one would wish for a lower deficit or even a surplus, the fiscal stance of the government is stable and the deficit target for 2018 of 2.7% of GDP is not only feasible but, we believe, also susceptible to a significant positive surprise. We expect the deficit to reach c.2.0% of GDP. A strong fiscal stance is not new and has supported POLGBs for some time already, not only because it allows a lower supply of Polish debt. It also encourages new more risk-averse entities to participate in the market. We expect that this effect will last for at least 2018.