Country Report Czech Republic
Reflecting close business cycle synchronicity with the euro area and fiscal consolidation at home, the Czech economy contracted by 1.2% last year. The local banking sector remained profitable and well-capitalized, while ongoing fiscal prudence should limit public debt to about 50% of GDP.
Strengths and weaknesses
- Track record of prudent macroeconomic management
Conservative macroeconomic, fiscal and monetary policies brought with them moderate private and public debt levels and contributed to the absence of distortive macroeconomic imbalances. The negative net international investment position mainly reflects non-debt foreign direct investment.
- A solid and profitable financial sector
The largely foreign-owned banking sector is completely financed by local deposits, highly profitable and well-capitalized, while non-performing loans remain at acceptable levels.
- Considerable dependence on exports to the EU
The Czech economy is very open and strongly integrated into EU manufacturing supply chains, particularly in the auto sector, which exposes it to external demand shocks.
- Unstable government
The current Czech government does not have a stable parliamentary majority following the break-up of one of the coalition partners. In combination with poor approval ratings, this could lead to the delayed introduction of anticipated reforms.
1. Protracted recession
The Czech economy slipped back into recession last year, contracting by 1.2% following two years of modest growth in the aftermath of the 2008/2009 global economic crisis. The decline was mainly driven by domestic demand, which was negatively affected by fiscal consolidation measures, weak real wage growth and rising precautionary savings. Net external demand constituted the sole source of economic growth last year, even as both export and import growth cooled markedly. The Czech unemployment rate remained stable at 6.8% in 2012, as companies seem to hoard labor, but it will likely increase in the event of a worsening economic outlook. Economic growth is expected to stagnate this year, as domestic demand will likely remain depressed by low confidence levels and rising savings due to the introduction of a new funded pension pillar, while investments and government consumption are projected to continue to contract.
Economic growth in 2014 is expected to come in at a weak 1.3%, but the risks to the outlook for 2013 and 2014 are tilted to the downside and heavily dependent on economic developments in the euro area. If deemed necessary, the Czech central bank would likely resort to foreign exchange interventions to boost growth, as its policy rate (0.05%) cannot be cut any more.
2. Low approval ratings for the current fragile government ahead of 'super election year 2014'
Ahead of 'super election year 2014', when various polls (including parliamentary elections) are due, the popularity of prime minister Peter Nečas' ODS party has plummeted, while support for the center-left ČSSD and centrist coalition partner TOP09 is rising. Public disapproval with the current strict austerity program, as well as corruption scandals, and lacking cabinet cohesion seem to drive this trend. Consequently, boosting economic growth has become an important topic for most parties, but a major deviation from the current prudent fiscal policy course is unlikely.
3. Public debt on the rise, but the structural deficit improved
The Czech Republic's weak economic performance since the 2008/2009 global economic downturn has left its marks on the country's once very solid fiscal position, as public debt is projected to increase from 29% of GDP in 2008 to almost 50% of GDP in 2014. Yet, thanks to strong commitment to fiscal discipline, structural consolidation measures of about 4.5% of GDP since 2010 resulted in a stronger underlying fiscal position compared to the pre-crisis situation and avoided even stronger public debt increases. Moreover, a structural balance rule and a debt brake have been introduced to strengthen rules-based budgeting procedures. Following a budget deficit of 3.1% of GDP in 2011, last year's budget deficit stood at 5.2% of GDP, which was partly due to one-off expenses related to Church compensation payments (1.5% of GDP) and withheld EU funds (0.3% of GDP). At the same time, the structural budget deficit improved from 3.1% to 2.4% of GDP. Due to new consolidation measures, this year's budget deficit is expected to come in at about 3% of GDP.
4. Banking sectors remains highly profitable and proves its resilience
The Czech banking sector managed to grow last year, even as private and public consumption, as well as investment contracted. Moreover, given a return on equity of 21%, it posted the best profitability in the Central- and Eastern European region. In spite of the challenging economic environment, the sector-wide non-performing loan ratio stabilized at about 6% last year, while the sector's capital adequacy ratio rose to 16.4% in 3Q2012. Thanks to its loan-to-deposit ratio of 75%, it remained independent of parent bank funding and maintained its external creditor position. In order to address the risk of capital outflows to support ailing Western parent banks, the Czech central bank tightened its monitoring standards for exposures to parent banks.
The Czech Republic ranks among the wealthiest and most developed of the former communist countries in Central- and Eastern Europe, as nominal GDP per capita at PPP amounted to USD 26,079 last year. Yet, given a nominal GDP of about USD 200bn, it belongs to the smaller economies of the European Union. Reflecting the Czech Republic’s high level of human development, the social situation in the country is quite stable.
Industrial production constitutes an economic mainstay of the Czech economy. It generates about 40% of national income, whereby automobile production (about 8% of GDP) holds a prominent position. Thanks to its central geographic location in between Austria, Germany, Poland and Slovakia, the local manufacturing sector is strongly integrated into its neighbors’ supply chains, as short distances make just-in-time production possible. The strong integration brings with it close business cycle synchronicity with neighboring countries. Besides manufacturing, tourism constitutes an important sector in the Czech Republic, as the country’s various spas and historic city centers attract about 9 million tourists each year. The Czech Republic’s well-capitalized and highly profitable banking sector is largely foreign-owned and focuses on credit provision to the local economy.
The Czech Republic is currently governed by a center-right coalition government under the leadership of prime minister Peter Nečas. Besides his own ODS party, the coalition also comprises the liberal TOP09 party of foreign secretary Karel Schwarzenberg and the Liberal Democrats. The current government does not have a parliamentary majority, which at times delays policy implementation. The next parliamentary elections are scheduled for 2014.