Jan Cienski in Warsaw -

Poland's draft budget for 2012 aims to finally bring the budget deficit below the EU's requirement of 3% of GDP. But with reports emerging on May 9 that the budget deficit likely hit PLN21.5bn-22.0bn in the January-April period, or 53.5-54.7% of the annual plan for 2011, the size of the problem shows how hard that ambitious goal will be to reach.

The goal is for the deficit to hit 2.9% of GDP in 2012, down from an expected 5.6% this year, and 7.9% in 2010. "We have embarked on a path of consolidation. Tightening and saving so as to reach safe levels of deficit and public debt for Poland," Donald Tusk, the prime minister, said as the budget project was announced earlier in May.

However, Poland's government, which faces a parliamentary election later this year, has been unwilling to take the political risks in embarking on economic reforms of the type seen in countries that were hard hit by the crisis like the three Baltic states. Its most radical step was a controversial move to partially undo earlier pension reforms, shifting some of the money flowing into private pension funds back into the state system, which lessens budgetary pressure. Other steps include a temporary increase in the VAT, as well as restrictions on the growth of discretionary spending. "This is a breakthrough budget when it comes to the realisation of our goal, which is the liquidation of the overly large budget deficit," Jacek Rostowski, the finance minister, said when announcing the planned budget.

However, other issues like the separate and expensive (but politically very popular) pension programme for farmers, as well as reducing the stifling level of bureaucracy have made little progress. And that makes analysts sceptical that Warsaw will hit its budgetary targets. "In terms of fiscal deficits, Poland is now the worst positioned among the major economies in developing Europe - even after this year's pension changes," says Nicholas Spiro of Spiro Sovereign Strategy. "It is paying a price for having pursued accommodative policies prior to and during the financial crisis. While this may have cushioned the downturn, it has led to a significant deterioration in the country's public finances at a time where there remains little appetite for meaningful expenditure reform and non-resident holdings of public debt are growing, making Poland more vulnerable to an adverse shift in market sentiment."

The International Monetary Fund is also dubious. While praising Poland's fiscal consolidation so far, its own estimates find that next year's deficit will come to 3.6% of GDP. The IMF recommends that Poland tighten its spending by an additional 1% of GDP.

Markets have also been less than impressed. The zloty has continued to flounder against the euro despite an unexpected rate hike by the central bank, which brought the benchmark interest rate to 4.25%.

Stronger measures

A stronger zloty coupled with robust GDP growth are key for Tusk's political fortunes. The rising deficit has pushed public debt to within a hair of 55% of GDP, which, if breached, imposes painful legal requirements to bring spending under control. As much of Poland's debt is in euros, a weak zloty increases the danger of passing that threshold.

Tusk's finance minister is under immense pressure to bring spending under control without stalling the economy. One measure, that has aroused the ire of mayors across the country, will limit the ability of local governments to incur debt, as a way of keeping public debt from rising too high. However, as a result dozens of projects such as improving local roads and building new sewerage plants are endangered, which could affect unemployment and economic growth.

Ryszard Petru, head of strategy for PKO BP, Poland's largest bank, says that the budget has been prepared with an eye towards the upcoming elections to ensure as little political turmoil as possible while Tusk tries for an unprecedented second term as prime minister. "This is a survival budget," he says. "It's a budget which does not bring in any essential reforms to the Polish economy, and is based on the idea that the Polish economy will only continue to grow."

The danger, Petru says, is that if the optimistic assumptions, which call for steep increases in the tax take as well as GDP growth in 2012 of 4% do not pan out, the fiscal projections will be unrealistic. "The fundamental problem is that, with any kind of an economic slowdown there will be a repeat of what happened during the last crisis, namely that revenues will fall and spending will rise, increasing the deficit and the debt," he says.