OREANDA-NEWS. Fitch Ratings has affirmed Poland's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'A-' and 'A', respectively. The Outlooks are Stable. The issue ratings on Poland's senior unsecured Foreign - and Local-Currency bonds have also been affirmed at 'A-' and 'A', respectively. The Country Ceiling has been affirmed at 'AA-' and the Short-Term Foreign-Currency IDR at 'F2'

KEY RATING DRIVERS

Poland's 'A-' rating reflects its solid macro fundamentals, government debt close to its rating peers median and improving external finances from a weak starting point. Strong GDP growth in recent years has supported an increase in GDP per capita, which remains low relative to rating peers. Reduced predictability in economic policy since the October 2015 political transition increases downside risks to Fitch's economic and fiscal forecasts.

During its first eight months in power, the Law and Justice (PiS) government has implemented unorthodox measures, including taxes on banks and some fiscal relaxation, despite high GDP growth. Measures that could significantly affect financial and fiscal stability, including a scheme to convert foreign currency mortgages, are under discussion. Changes at the constitutional tribunal have led to a stand-off with the European Commission. These developments could affect Poland's attractiveness as a place to do business.

However, Fitch notes that some of the most controversial measures on PiS's agenda during the electoral campaign have been avoided. An initial proposal to convert all FX mortgages was withdrawn following an estimate of its highly detrimental cost to the banks (PLN67bn or 3.6% of GDP).The renewal of the central bank's Monetary Policy Committee, with members chosen by PiS-controlled bodies, has not led to a change in the conduct of monetary policy. The government has committed to comply with the European Union's 3% of GDP deficit criteria.

After implementing its programme to increase child benefit (family 500+, 0.9% of GDP in 2016), the agency expects that the government will moderate other electoral promises of fiscal largesse to remain EU compliant. Fitch expects the government deficit at 2.8% of GDP in 2016 and 3.0% in 2017 as the fall in 2016 one-off revenue is partially offset by stronger tax revenues reflecting improved economic conditions and some improvement in VAT compliance. The agency expects gradual fiscal tightening thereafter and a government deficit of 2.9% in 2018.

Government debt was 51.3% of GDP at end-2015 (vs. 43.9% for the 'A' median). Fitch expects it will peak at 53.2% by 2018 and remain around 53% of GDP in the medium term assuming some fiscal tightening from 2018, GDP growth converging towards 3% and a pick-up in inflation towards the 2.5% central bank's target. Failure to consolidate public finances and lower-than-expected GDP growth are the key upside risks to the debt trajectory.

Fitch expects real GDP will grow 3.2% in 2016 and 3.3% in 2017 and 2018, after 3.6% in 2015, primarily driven by private consumption thanks to a strong labour market (unemployment was down at 6.3% in May vs. 7.5% a year ago) and the increase in governments' transfers to families. Potential lower than expected external demand is a key risk, especially after the Brexit vote. 6% of Poland's exports go to the UK and 75% to the rest of the EU. Private sector investment could be affected by post-Brexit referendum uncertainty and adverse policy developments.

The banking system is well capitalised, liquid and profitable. Banks' 2016 profits are affected by the new tax on assets, which is expected to raise PLN4.4bn (equivalent to 0.2% of GDP). The main risk to the sector is a potential scheme to convert CHF mortgage loans (7.5% of GDP) into local currency. The government has emphasised that any solution should preserve financial stability. Eventual conversion terms remain highly uncertain. A bill should be submitted to parliament in the summer. A solution that would be too costly to banks would put financial stability at risk.

Poland's external position is on an improving trend. The current account balance was -0.2% of GDP in 2015, much lower than in previous years (3.6% of GDP on average from 2010 to 2015) thanks to improved competitiveness and, more recently, the fall in commodity prices. The combination of a stronger current account and high EU capital inflows have supported net external deleveraging in Poland. Net external debt was 34% of GDP in 2015 (vs. -18.8% for the A peers' median) from 37% in 2012 and Fitch expects it could decline to 30% by 2018. The IMF precautionary line would provide external funding if needed.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Poland a score equivalent to a rating of 'A' on the Long-Term FC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- External finances: -1 notch, to reflect Poland's high Net external Debt (33.5% of GDP in 2015) relative to the 'A' peers' median (-18.8% of GDP).

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Nonetheless, the following risk factors could, individually or collectively, trigger negative rating action:

- Any sign that the relevance of the 3% of GDP EU deficit criteria weakens as a fiscal anchor, or failure to tighten fiscal policy in order to stabilise debt-GDP-ratio in the medium term.

- An FX mortgage conversion scheme that would put financial stability at risk.

- Changes in economic policy and/or worse than expected impact of the Brexit referendum that would affect macro stability and the outlook for GDP growth.

The following risk factors could individually or collectively, trigger positive rating action:

- Continued high GDP growth that supports income convergence towards the 'A' category median.

- Continued reduction in external debt ratio supported by stronger current account balances and capital inflows.

KEY ASSUMPTIONS

Fitch assumes that economies in the eurozone, Poland's main economic partners, will grow 1.6% in 2017, from 1.5% in 2015.

Fitch assumes the eventual scheme to convert FX mortgage loans will be designed so that it will not materially affect macro stability or the health of the banking sector.