GDP expected to contract in Czech Republic

After a 0.6% year-on-year increase in Q4 of 2011, the economy contracted 0.7% in Q1 of 2012. GDP is expected to shrink 0.8% this year and forecast to rebound modestly in 2013.

Madrid - 10-set-2012

The political situation in Czech Republic is currently uncertain. The ruling coalition lost its majority and now has to rely on a number of independent members of parliament that have split from other parties. The government’s resignation and a call for new elections could happen before the end of the current term in 2014.

After a 0.6% year-on-year increase in Q4 of 2011, the economy contracted 0.7% in Q1 of 2012. GDP is expected to shrink 0.8% this year and forecast to rebound modestly in 2013.

The current weak economic performance is partly the result of austerity measures, including tax increases and public sector cuts, that have diminished the purchasing power and confidence of both households and businesses.

Private consumption is expected to decrease 2.4% year-on-year in 2012, while lower government spending will also have a negative effect on growth this year and in 2013. While industrial production growth will slow down to 2% this year [6.5% in 2011], investments will rebound slightly by 0.7%, after yearly decreases in the 2009-2011 period.

At the same time, low demand from EU trading partners has affected exports. The Czech Republic has one of the highest export-to-GDP ratios in the EU, making it especially vulnerable to trade losses. After a robust year-on-year increase of around 11% in 2011, exports growth is forecast to slow down to 4.8% in 2012 and 1.4% in 2013, as Eurozone growth will shrink 0.4% this year and 0.1% in 2013.

Budget deficit targets will probably be met

Government debt has increased significantly over the last couple of years: from 28% of GDP in 2007 to 42% of GDP this year. The budget deficits increased to nearly 6% of GDP in 2009 and 4.8% of GDP in 2010.

In order to push the budget deficit below 3% of GDP next year, the government has implemented a range of austerity measures, including VAT and income tax increases and public spending cuts that will be worth EUR 2.5 billion in 2013. The official target of a 2013 deficit below the 3% threshold is likely to be met, as the expected deficit for this year is only a little above 3%, thanks to earlier austerity measures.

Additional austerity measures are under discussion in parliament. However, together with endemic corruption scandals, the 2012 tax increases and spending cuts have already sparked public mass protests, and it is uncertain whether all the proposed austerity measures will be accepted.

Public finances are in good shape

Despite the sharp increase during the last couple of years, government debt is still at a manageable level and, at 48% of GDP, the foreign debt level is also modest. Overall public finances are in reasonably good shape: a fact that is reflected in the relatively low yields on government bonds. Its good liquidity and solvency are shielding the Czech Republic from potential external funding problems.

Interest cut to a record low

While inflation has been modest in recent years [1.9% in 2011], it has risen since the beginning of 2012 because of the VAT increase. After peaking at 3.8% in March 2012, it has begun to drop - to 3.2% in May, but increased again in June [to 3.5% year-on-year]. However, consumer prices are expected to decrease in the coming months and to reach normal levels in 2013 [forecast: 2.2%] when the effects of the VAT rise will fade.

Due to lower inflation expectations - and to support both domestic and foreign demand in the current difficult economic environment - at the end of June 2012 the Czech Central Bank lowered the repo interest rate by 25 basis points to a record low of 0.50%.

Small current account deficit

The current account is showing a small deficit of 2.5% of GDP this year and is forecast to remain more or less at the same level in 2013. Lower exports, due to weaker demand across Europe, are offset by a similar decrease in demand for imports.

Some exchange rate fluctuations

After a high in mid-2008, the koruna exchange rate fell by around 10% against the euro. However, this was more a reflection of weakened market sentiment towards the whole Eastern European region than a negative perception of the Czech Republic itself. Since then, tensions have abated, although the exchange rate against the euro has fluctuated somewhat over the past twelve months. Despite some vulnerability to global market sentiments, we do not expect the koruna to fall victim to extreme volatility.

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