OREANDA-NEWS. Fitch Ratings has affirmed Poland's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'A-' and 'A' respectively. The issue ratings on Poland's senior unsecured foreign and local currency bonds are also affirmed at 'A-' and 'A' respectively. The Outlooks on the Long-term IDRs are Stable. The Country Ceiling is affirmed at 'AA-' and the Short-term foreign currency IDR at 'F2'.

The ratings are supported by strong economic fundamentals, including a credible macroeconomic framework. Membership to the EU underpins political stability and institutional strength. Government debt (49% of GDP in 2014) is in line with peers' median (49%) and its fiscal deficit is narrowing. The ratings are constrained by high levels of external debt and refinancing needs. GDP per capita is lower than peers' median.

KEY RATING DRIVERS

Poland's IDRs reflect the following key rating drivers:-

In 2014, real GDP grew 3.3%, up from 1.7% in 2013, supported by domestic demand in the context of high job creation (unemployment rate down at 8% at end-2014 from 10% a year ago), low inflation (0.1% on average in 2014) and easing monetary policy. Fitch expects real GDP will continue to grow at around 3% per year in 2015 and 2016 as domestic demand continues to expand, a new EU fund cycle (EUR105.8bn or 26% of 2014 GDP) for 2014-2020 starts and as European economies (75% of exports, 25% to Germany) gradually improve.

Fitch expects the general government deficit will narrow to 2.8% of GDP in 2015, from 3.2% in 2014, and remain below the 3% threshold in the medium-term, allowing Poland to exit from the European Union Excessive Deficit Procedure. Fiscal tightening is driven by accelerating GDP growth, increased tax compliance and VAT receipts and by the Stabilising Expenditure Rule to cap growth in government spending.

Fitch expects gross general government debt to remain stable at 49% of GDP up to 2016, consistent with narrowing budget deficits. A one-off transfer of pension funds' assets to the social security fund contributed to a marked decline in debt relative to 2013 (56% of GDP). This development is rating-neutral as unfunded future pension liabilities have increased by an equal amount. The transfer also led to an increase in the share of non-residents and FX in the central government debt, to 58% and 35%, respectively, in 2014 from 52% and 30% in 2013. Authorities aim to bring it back to previous level in the medium-term.

Fitch expects the current account deficit to gradually widen to 2.3% of GDP up to 2016 from 1.7% of GDP in 2014 as strong domestic demand supports growth in imports. Falling oil prices will contribute to an improvement of 1% of GDP in the trade balance. Net external debt is set to slowly decline to 34% of GDP up till 2016 (from 38% in 2013) but to remain high relative to 'A' peers' median (-11.9% of GDP in 2014). Poland has renewed its flexible credit line with the IMF (USD23bn or 4.3% of GDP) in January 2015 and will continue to treat it as a precautionary buffer against financial market volatility.

The recent removal of the euro/Swiss franc (CHF) exchange rate ceiling and, consequently, the depreciation in the Polish zloty (PLN -13% against the CHF) highlighted the exposure of households to the PLN/CHF rate. About 37% of total mortgages, or 9% of GDP, are CHF-denominated. Part of the negative impact will be offset by lower interest rates on CHF loans and potential support from banks to affected customers. Assuming no further depreciation in the PLN, the negative impact on households' consumption will be limited.

The PLN/CHF depreciation also affected Polish banks through margin calls (related to currency swaps to fund CHF loans) and an increase in risk-weighted assets. Measures adopted by banks to soften the impact of the weaker PLN, such as lower currency spreads related to FX mortgages and lengthening of debt maturities, could weaken their performance in 2015. Polish banks are generally strong, well-capitalised and liquid, which will help absorb the shock. In 3Q14, the core tier 1 capital ratio for Polish banks was 13.7% on average and the loan-to-deposit ratio was 105%. Fitch expects a potential rise in non-performing loans should be manageable, assuming no further material depreciation in the currency.

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 positive rating action:
- A more marked reduction in external debt ratios
-Sustained convergence of incomes towards EU and 'A' category medians
-Greater confidence that a track record of low budget deficit is being established
The following risk factors that could individually or collectively, trigger negative rating action:
- A pronounced fiscal loosening that endangers the achievement of medium-term budget deficit and debt reduction targets
- Prolonged weak economic performance, resulting either from external or from domestic shocks that halts income convergence or endangers the stability of public finances

KEY ASSUMPTIONS
Fitch assumes that fiscal policy will be conducted in line with the goal of exiting the EU's Excessive Deficit Procedure by the 2015 deadline and, subsequently, by the Stabilising
Expenditure Rule.

Fitch assumes Poland's main economic partners in the eurozone will benefit from a gradual economic recovery with eurozone real GDP growing 1.5% by 2016, up from 0.9% in 2014. Our base case is for the eurozone to avoid prolonged deflation.