Poland Faces New EU Warning on Deficit-Cutting Moves (Update2)

Feb. 2 (Bloomberg) -- Poland faces a new showdown with the European Union after failing to cut government spending enough to bring its budget deficit under the EU limit this year, according to a draft EU ruling.

The European Commission, the EU's executive body, will tell Poland next week that ``additional measures, especially on the expenditure side,'' are needed to bring its deficit below 3 percent of gross domestic product by a 2007 deadline, according to the ruling, which will be released Feb. 7. Poland wanted until 2009 to narrow its deficit to the EU limit.

A separate ruling warns Hungary that slower-than-expected growth after 2008 may hurt that country's deficit-cutting plans. The two draft reports were obtained by Bloomberg News.

Poland, the largest of the 10 mainly eastern European countries that joined the EU in 2004, has flouted deficit rules since its accession. The country is expected to stay above the limit through 2008 after an EU ruling to take effect this year bans the government from classifying payments to private pension funds as state revenue. Poland estimates the accounting-rule change will add 1.9 percentage points to the budget shortfall.

The commission ruling will say the ``action taken so far does not appear adequate and the planned measures appear insufficient'' to bring Poland's deficit into line with EU rules by the deadline, according to the draft. The Polish government does not agree.

`Too Darkly'

``I've heard that the commission thinks our economic forecasts are too optimistic,'' Polish Finance Minister Zyta Gilowska said at a press conference in Warsaw today. ``But I think it is painting Polish reality too darkly.''

The Polish zloty declined against the dollar after the report of the draft ruling and was trading at 3.008 at 4:25 p.m. in Warsaw, compared with 2.997 yesterday. The yield on the benchmark five-year bond rose 4.3 basis points to 4.923, while the price fell to 97.43 as of 3:20 p.m. in Warsaw.

Polish Central Bank Deputy Governor Krzysztof Rybinski urged the government on Jan. 17 to cut the fiscal deficit and improve banking supervision and labor-market flexibility in order to adopt the euro. Poland is the only one of the 2004 EU entrants not to have set any date for euro adoption.

Poland's Deficit

Poland's deficit was 3.9 percent of GDP in 2006, and will be 3.4 percent in 2007 and 3.1 percent in 2008 if revenue from pension funds are excluded, according to the draft.

The Polish government has predicted the budget deficit will be lower after economic growth soared to the fastest rate in 9 years in 2006. The economy will expand as fast as 5.7 percent this year and will grow in the coming years at about 5 percent a year, the central bank said yesterday.

Economists including former central bank Governor Leszek Balcerowicz have said Poland should use its expanding economy to cut budget spending, while the government has pledged to increase expenditure on groups such as farmers, teachers and families this year.

The commission will warn Hungary that while its deficit- reduction plan ``appears to be broadly plausible'' through 2008, there is a risk of economic growth being slower than forecast in later years, according to the draft ruling on that country. Such a slowdown may make it more difficult for the government to meet its target of cutting the shortfall to 3.2 percent of GDP by 2009.

`Worse Than Targeted'

``The budgetary outcomes could be worse than targeted in the program, especially from 2008,'' according to the draft. ``Lower-than-projected GDP growth in the outer years could lead to a higher deficit.''

Prime Minister Ferenc Gyurcsany's government raised taxes and cut subsidies to reduce the EU's widest budget deficit from about 10 percent of GDP last year. Hungary's plan to reach 3.2 percent by 2009 counts on the economy growing 4.1 percent that year, after 2.2 percent this year and 2.6 percent in 2008.

The EU also will warn that the risk of spending overruns remains after Hungary missed its deficit targets every year since 2001, while the government has to do more to overhaul its economy to prevent deficits growing again after 2008.

The government needs to ``rigorously implement the 2007 budget and take adequate action to ensure the correction of the excessive deficit by 2009, if necessary through additional measures,'' according to the draft. Hungary must ``improve budgetary control by enhancing fiscal rules.''

In addition to the reports on Poland and Hungary, the commission on Feb. 7 also will issue rulings on Finland, Luxembourg, Malta and Ireland.

Source:By Meera Louis and Katya Andrusz, bloomberg.com