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Cablegate: Eu Ends Excessive Deficit Procedure

VZCZCXRO6372
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHWR #0828 1961321
ZNR UUUUU ZZH
R 141321Z JUL 08
FM AMEMBASSY WARSAW
TO RUEHC/SECSTATE WASHDC 6753
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHKW/AMCONSUL KRAKOW 2130

UNCLAS WARSAW 000828

SIPDIS
SENSITIVE

STATE FOR EUR/NCE, EUR/ERA
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS, JKIMBALL, MWILSON
TREASURY FOR MGAERTNER

E.O. 12958: N/A
TAGS: ECON EFIN PREL PGOV PL
SUBJECT: EU Ends Excessive Deficit Procedure

1. (U) Summary: On July 8, EU Finance Ministers formally ended a
four-year old excessive deficit procedure (EDP) regarding Poland.
This lifts a cloud over some EU subsidies, brings Poland closer to
Euro adoption, and gives the Polish government more breathing room
for decisions on aid programs and debt forgiveness, including debt
owed by Iraq. In May, the European Commission (EC) recommended
ending the EDP, after concluding that Poland's general government
budget deficit had been brought below the EU limit of three percent
of GDP "in a sustainable and credible manner". End summary.

2. (U) Article 104 of the European Community Treaty obliges
EU-member countries to avoid excessive deficits. The Maastrict
Treaty limits the general government budget deficit to three percent
of GDP. When Poland joined the EU, its general government deficit
exceeded four percent of GDP. Consequently, on July 5, 2004 the EC
initiated the EDP with respect to Poland and five other countries.
At the time, the Polish government asserted the EC had relied upon
"invalid" data.

3. (U) The Polish government viewed the EDP as unfair punishment for
introducing structural reforms, such as changes to the pension
system, and had been pushing to end the EDP for years. In 2006,
Poland claimed that its general government deficit had fallen to 2.2
percent of GDP. However, the EC concluded then that the improvement
in the budget situation was a temporary phenomenon, resulting from
counting open pension fund contributions as part of government
revenue. Eurostat, the EU's statistical agency, forced Poland to
stop using that accounting method in July 2007. Discontinuing the
practice pushed the official deficit back above three percent.

4. (U) Starting in the second quarter of 2007, high GDP growth led
to improving Polish public finances, as economic growth translated
into higher inflows from corporate and value-added taxes. The EC
noted that the 2007 deficit was just two percent of GDP. In fact,
in the first four months of 2008, Poland recorded a budget surplus,
although in May the budget slipped back into deficit. The EC stated
that the deficit is likely to increase to 2.5% of GDP in 2008, but
felt the EDP could be ended given a favorable outlook for stability
in Poland's public finances.

5. (U) The Finance Minister's decision removes a cloud over some
funding Poland received from the EU, and clears away an obstacle to
Poland's applying for membership in the European Monetary Union.
However, many commentators believe provisions of the Polish
constitution, such as those regarding the central bank, should be
amended before Poland enters the Exchange Rate Mechanism (ERM II), a
precursor to Euro adoption. Amending the constitution would require
support from Euro-skeptics in the opposition PiS party. The current
market expectation for Euro adoption is 2012-2013 at the soonest.

6. (SBU) Comment: While the end of the EDP is good news for
Poland, several structural problems still present serious challenges
to Polish public finances. Chief among these are early retirement
and healthcare costs. Due to the many incentives to retire, only 54
percent of Poland's potentially active labor force is employed,
compared to about 70 percent in the EU as a whole. Meanwhile the
farming sector is exempt from contributing equally with other Poles
to social insurance schemes. The result is proportionately more
retirees in Poland than in other EU countries and a smaller revenue
base from which to draw taxes. As growth slows, addressing these
issues will become even more pressing. End comment.

QUANRUD

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