OREANDA-NEWS. Poland's preliminary state budget for 2017 relies on optimistic tax revenue assumptions to achieve its general government deficit target, Fitch Ratings says. Although we think that EU deficit criteria remains a strong anchor for fiscal policy, the budget highlights fiscal downside risks.

The preliminary budget approved by the Polish government on 25 August projects a general government deficit of 2.9% of GDP, up from an expected 2.6% in 2016. As the one-off revenues from very large central bank profits and the sale of mobile licences worth 0.9% of GDP in 2016 fade and the cost of the flagship 'family 500+' policy rises (to 1.2% of GDP in 2017 from 0.9% in 2016), the budget expects an 8.9% nominal increase in tax revenues to fill the gap.

We believe the assumptions on tax revenues are too optimistic. GDP growth is likely to be lower than forecast by the government, affecting tax revenues relative to the budget's baseline. Despite a downward revision relative to the government's previous forecast, the macroeconomic assumptions in the budget remain slightly stronger than Fitch's forecasts. The government forecasts real GDP growth at 3.4% in 2016 and 3.6% in 2017, versus Fitch's 3.2% and 3.5%, respectively.

Higher VAT income is the main driver of the projected growth in tax revenues. Some increase in VAT compliance is likely given the currently very large VAT gap (amongst the highest in the EU, at 25% of the theoretical collection) and the government's focus on reducing it. However, the 10.9% hike in VAT income expected in the budget seems unrealistic, as it is more than twice the expected increase in nominal consumption.

We expect a slightly higher deficit than the government forecasts, at 3.0% of GDP in 2017 (after 2.8% in 2016). Fitch believes the EU Stability and Growth Pact's (SGP) 3% of GDP deficit limit remains a strong anchor for fiscal policy in Poland, and would expect some policy adjustments if revenue growth disappoints. Poland exited the Excessive Deficit Procedure (EDP) in 2015 and reopening it would damage fiscal policy credibility. It could potentially result in financial sanctions via reduced disbursements of EU funds, a key driver of Poland's economic development since its accession to the EU in 2004.

A commitment to the SGP deficit target is also reflected in Fitch's expectation of some gradual medium-term fiscal tightening (we forecast a deficit at 2.9% in 2018) consistent with stabilisation in the debt-to-GDP ratio at around 53% of GDP. Nevertheless, potential changes in fiscal policy to fulfil electoral promises still constitute risks to the public finances.

Fitch affirmed Poland's sovereign rating at 'A-' with a Stable Outlook on 15 July 2016. In our latest rating assessment, we said that any sign that the 3% of GDP EU criteria was weakening as a fiscal anchor, or failure to tighten fiscal policy to stabilise the debt-GDP-ratio in the medium term, would be negative for the rating. Our next scheduled sovereign rating review is due in January 2017.