FILE PHOTO: Polish Finance Minister Andrzej Domanski speaks during a Reuters interview at the 2025 annual IMF/World Bank Spring Meetings in Washington, D.C., U.S., April 24, 2025. REUTERS/Ken Cedeno/File Photo

By Karol Badohal

WARSAW (Reuters) -The Polish government raised its 2025 deficit forecast on Thursday and projected only a modest fall next year as high defence, welfare and debt servicing spending hamper efforts to rein in the budget shortfall.

The draft budget for 2026 is under close scrutiny as Poland struggles to limit state expenditure in a political climate that has become increasingly volatile due to a feud between the president and prime minister.

Finance Minister Andrzej Domanski said this year's deficit would come in at 6.9% of GDP, before falling to 6.5% in 2026. The government's initial 2025 deficit target was 5.5%.

Analysts in a Reuters poll had expected the 2025 deficit to come in at 6.4% of economic output, down from 2024's 6.6%.

Benchmark 10-year Polish bond yields were over 6 basis points higher at 1635 GMT.

"It seems to me that the market expected some kind of fiscal consolidation year on year, but this consolidation is only the result of some kind of shift in the deficit, an increase to this year, which is why next year's deficit is lower as a percentage of GDP," a Warsaw-based dealer said.

"And next year, it seems that borrowing needs are growing by 40% year over year. That's a lot. I'm not saying it won't sell, but it's really not what the market expected."

SOLID GROWTH

The government expects the Polish economy to keep growing.

"Economic growth is accelerating, and we expect GDP growth to increase by 3.4% this year," Domanski said.

"... economic growth next year will reach 3.5%, and CPI inflation will average 3.0% annually, with a projected wage increase of 6.4%. This means that the real value of Poles' wages will increase significantly."

Poland's new conservative President Karol Nawrocki has said he would not agree to tax increases that would affect "ordinary Poles" and called for the government to tighten tax collection.

Domanski said that security was a priority for the government, hence a record 200 billion zlotys, or 4.8% of GDP, allocated for defence.

Referring to Russia's war in neighbouring Ukraine, Prime Minister Donald Tusk earlier told the government budget meeting that "we can't defend the Polish border with a small deficit".

"This war (in Ukraine) is happening and will continue... which is why we don't hesitate, and we will continue to arm Poland and prepare the Polish state for every eventuality," he said.

($1 = 3.6405 zlotys)

(Reporting by Karol Badohal, Alan Charlish, Pawel Florkiewicz, Anna Wlodarczak-Semczuk. Editing by Helen Popper and Mark Potter)