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Country Report Czech Republic

Country Report

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The Czech Republic’s economy is heading for a relatively broad-based recovery, after it emerged from an 18-month recession last year. On the political front, early elections following a major corruption scandal yielded a less eurosceptical cabinet. 

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.

(-) History of unstable governments

Recurrent cabinet crises and early elections have been a common feature of the young Czech democracy so far. While the impact on the overall direction of policies has been limited, the relative instability of Czech governments can delay policy formulation and implementation. 

Key developments

1. The Czech economy emerges from a protracted recession

Following an 18-month contraction that was driven by weak external demand in the euro area and strict fiscal consolidation at home, rising exports pulled the Czech economy out of recession in the second quarter of 2013. Since growth remained positive in the following quarters, as public consumption also started to support growth, the contraction of the Czech economy in 2013 as a whole was limited to 0.9%. Going forward, a broadening and strengthening of the so far mainly export-driven recovery is expected, as domestic demand will benefit from the likely relaxation of fiscal policies by the new Czech government. Consequently, economic growth is expected to come in at roughly 2.2% this year, before strengthening to about 2.7% in 2015, as domestic demand gradually replaces exports as the main growth driver. Even though private consumption stagnated last year, recent retail sales data and strengthening confidence indicators point to rising household consumption growth that should be supported by rising real wages on the back of low inflation and an improving employment outlook. Meanwhile, the recovery of gross fixed investment, which started in the fourth quarter of 2013, will likely continue, as strengthening corporate credit demand, rising business confidence and growing industrial production should boost corporate investments. Public investments should benefit from plans for increased infrastructure spending and several EU-funded investment projects. The risks to the outlook are relatively limited. While weaker exports could slow down investment growth and hurt private consumption via a weaker labour market, the Czech Republic’s currently beneficial fiscal position should provide the cabinet with some policy space to support domestic demand, if needed.

Figure 1: Economic growth set to strengthen
Figure 1: Economic growth set to strengthenSource: European Commision
Figure 2: A changing political landscape
Figure 2: A changing political landscapeSource: Volby.cz

2. A major political crisis puts the Czech democracy to the test

The Czech Republic underwent a major political crisis last year following the collapse of the previous cabinet amid a corruption scandal. The crisis was initially triggered by the arrest in June 2013 of Jana Nagyova, the personal assistant of then-Prime Minister Petr Nečas, based on charges of bribing members of parliament to ensure their support for the prime minister’s austerity policies, as well as allegations that Ms Nagyova had asked the secret service to spy on the prime minister’s then-wife. Following Mr Nečas’s resignation over this matter, President Miloš Zeman, feeling emboldened by the fact that he is the first popularly elected president, took matters into his own hands and installed a technocrat cabinet, even as several factions in parliament claimed that they could form a new cabinet with sufficient parliamentary support. As President Zeman’s caretaker cabinet subsequently lost its confidence vote, early elections were held in late October, which brought the Czech Republic’s government crisis to an end and heralded a major change in the country’s political landscape. While former Prime Minister Nečas’s ODS lost its once dominant position in Czech politics, the newcomer anti-corruption pro-business ANO 2011 party of Czech billionaire Andrej Babiš has since become the Czech Republic’s most popular party. Even though the crisis put the Czech political system to the test, the way in which it was handled may point to a major step forward in the development of the country’s young democracy. The fact that anti-corruption investigations directed against the prime minister’s office could be concluded without interference of the executive points to improvements in the fight against corruption. Moreover, the anti-corruption ANO 2011 party’s s popularity sent a clear message to Czech politicians that voters demand meaningful progress in this struggle, while the party’s participation in the current government may lead to the appointment of new public officials that are not affiliated with the old political elite. Meanwhile, the parliament’s clear rejection of the president’s caretaker government illustrated the Czech legislative’s aversion to a return to semi-democratic forms of government.

3. Early elections yield a less Eurosceptic government

Following the major defeat of former Prime Minister Nečas’s ODS at the early elections in October, a new coalition government comprising the Social Democrat ČSSD, the anti-corruption ANO 2011, and the Christian-Democrat KDU-ČSL took office in January 2014. The new cabinet’s policy agenda reflects the preferences of the two largest parties involved. While the ČSSD pushes for increased public spending on infrastructure and welfare, the pro-business ANO 2011 strives to improve the business climate, reinforce the fight against corruption and boost the efficiency and transparency of public administration. Moreover, the cabinet intends to adopt a less euro-sceptic policy approach than its predecessor. Prime Minister Sobotka (ČSSD) announced that his government would put the Czech Republic on track for euro accession in 2020, while finance minister Babiš stressed the importance of stronger Czech involvement in European affairs, even as he does not see euro introduction as a policy priority. Still, the cabinet’s recent ratification of the EU’s Fiscal Compact, on which the Czech Republic and the United Kingdom had opted out so far, illustrates renewed commitment to common EU policies. While the cabinet stands a good chance of serving out its full four-year term, risks remain that possible inter-party conflicts regarding issues like taxation or internal tensions within the newcomer ANO 2011 party could lead to an early coalition break-up.

Factsheet of Czech Republic
Factsheet of Czech RepublicSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

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 25,991 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. While the Czech Republic’s business climate compares relatively well with neighbouring peers, corruption remains a point of concern. Industrial production constitutes the 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 neighbours’ supply chains, as short distances make just-in-time production possible. The strong integration brings with it close business cycle synchronicity with these countries. Besides manufacturing, tourism constitutes an important sector, as the Czech Republic’s various spas and historic city centres attract about 9 million tourists each year. Its largely foreign-owned banking sector is well-capitalized and highly profitable. Since January 2014, the Czech Republic is governed by a centre-left coalition government under the leadership of prime minister Bohuslav Sobotka. Besides his own Social Democrat ČSSD party, the coalition also comprises the anti-corruption ANO 2011 party of business tycoon turned finance minister Andrej Babiš and the Christian-Democrat KDU- ČSL. The cabinet benefits from a large parliamentary majority and strong popular support, but given a tendency for early elections it remains to be seen whether the cabinet succeeds in completing its legislative term. The Czech Republic’s external relations are stable and benefit from EU and NATO membership, whereby co-operation with Austria, Germany and Slovakia is particularly close.

Economic indicators of Czech Republic
Economic indicators of Czech RepublicSource: EIU
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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 64053

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