Czech Republic: Staff Report for the 2002 Article IV Consultation Supplementary Information

This 2002 Article IV Consultations highlights that following a period of inaction on the structural front and a protracted recession, economic growth in the Czech Republic has picked up. Underlying this performance have been supportive macroeconomic policies, large foreign direct investment, and steady progress with structural reform. However, enterprise restructuring has led to rising structural unemployment and large regional disparities in unemployment rates. Sizable losses were accumulated by banks, which had to be transferred to the government to allow the banks to be sold to strategic investors, adding to medium-term fiscal pressures.

Abstract

This 2002 Article IV Consultations highlights that following a period of inaction on the structural front and a protracted recession, economic growth in the Czech Republic has picked up. Underlying this performance have been supportive macroeconomic policies, large foreign direct investment, and steady progress with structural reform. However, enterprise restructuring has led to rising structural unemployment and large regional disparities in unemployment rates. Sizable losses were accumulated by banks, which had to be transferred to the government to allow the banks to be sold to strategic investors, adding to medium-term fiscal pressures.

1. This supplement contains information on recent economic and policy developments in the Czech Republic that became available since the circulation of the staff report for the Article IV consultation (SM/02/215). This information does not alter the general thrust of the staff appraisal.

I. Macroeconomic Developments

2. Economic growth continued in the first quarter of 2002, though at a slightly slower pace. GDP expanded by 2.5 percent (year-on-year) in the first quarter, down marginally from 2.7 percent in the fourth quarter of 2001 (see text chart). Fixed investment and household consumption continued to grow strongly (by 8.1 percent and 3.3 percent, respectively). However, weak demand in trading partners contributed to a further slowdown in Czech exports (to 3.1 percent, down sharply from a 2001 average of 12.3 percent), but import growth also softened (to 3.1 percent), helping to cushion the effect on GDP growth.

Figure 1.
Figure 1.

Czech Republic: Developments in GDP, 2000–02

Citation: IMF Staff Country Reports 2002, 167; 10.5089/9781451810059.002.A002

Sources: Czech Statistical Office; and Fund staff calculations.

3. Higher-frequency indicators reveal a somewhat mixed picture of economic activity during the second quarter. Industrial production expanded by 5.1 percent in the 12 months to May, implying only a marginal slowdown from earlier in the year, while the unemployment rate remained about stable in June at 8.7 percent. On the other hand, the trade deficit widened sharply in May, despite favorable terms of trade movements. Export growth (measured in euro terms) was significantly weaker (3.8 percent, year-on-year) compared with almost 10 percent for the first five months of the year, while import growth declined only slightly. Imports of cars were particularly strong in May, consistent with an increase in demand caused by an exchange-rate-induced drop in domestic prices.

4. Reflecting the stronger koruna-euro exchange rate and the weakening U.S. dollar, inflation continued on its downward path in June. Consumer prices increased by 1.2 percent in the year to June, down sharply from 2.5 percent in the previous month and approaching the historical low set in September 1999. The strengthening koruna helped push down prices of foreign goods and services, including fuels, vacations abroad, and some food items. Deflation at the level of producer prices intensified in June, with prices dropping at the faster pace of 0.8 percent (year-on-year).

5. The koruna strengthened further in early July, hitting new highs against the euro, and then retreated some (see text chart). Market reports suggest that developments in Poland and Hungary, which led to temporary weakening of the zloty and forint, respectively, may have played a role in fueling additional inflows into koruna assets. Strong warnings by the Czech National Bank (CNB) about the strength of the currency and an announcement that the CNB is “ready to employ its monetary policy instruments” are thought to have contributed to the retreat. However, even after the retreat, the exchange rate is still considerably higher than its level a month ago.

uA02fig01

CZK/Euro Rate 1/

Citation: IMF Staff Country Reports 2002, 167; 10.5089/9781451810059.002.A002

Source: Czech National Bank.1/ Upward movement denotes appreciation.

6. In view of the further strengthening of the koruna, the staff has updated its macroeconomic forecast for 2002, as shown in the revised PIN table (attached). 1 Conditioned on no further movement of the exchange rate, GDP growth is now expected to reach only 2.9 percent this year, compared with the earlier projection of 3.2 percent, reflecting a smaller growth contribution from the external sector. In addition, the external current account deficit is projected to widen some for the year as a whole, notwithstanding the better-than-expected first quarter outcome. The stronger koruna is also expected to push inflation further below the CNB’s target band over the next 12–18 months.

II. Policy Developments

7. The new coalition government formed by the CSSD and the two-party Coalition agreed on a broad policy agenda for their term in office. They agreed that accession to the EU at the earliest possible date (if endorsed by a successful referendum of the Czech people) is among the priorities of the new government. They also affirmed their intention to: further develop the welfare state; fight corruption and economic crime; make changes to the pension system (without, however, specifying any measures that would significantly improve future balances); devolve more spending powers to regions and municipalities; and consolidate public finances at a gradual pace (see below).

8. The agreement sets the start of fiscal consolidation in 2005, with a goal to bringing down the general government deficit to not more than 4.9–5.4 percent of GDP on an ESA95 basis by 2006, above the 3 percent criterion needed to join the euro. This might imply a further widening of the deficit in the next two years, from an anticipated 6.6 percent of GDP on an ESA95 basis in 2002. Underpinning the deficit reduction would be revenue and expenditure measures to be spelled out in a four-year fiscal plan to be formulated and approved by end-2002, though the agreement has set some general principles, such as keeping the tax-to-GDP ratio at around its 2000 level. The new Finance Minister Sobotka has reportedly said that the Czech Republic should not rush to meet the Maastricht deficit criterion to avoid causing social instability, and could join the euro sometime before 2010.

Czech Republic: Selected Economic and Financial Indicators, 1997–2002

article image
Sources: Czech authorities; and Fund staff estimates and projections.

Staff projections.

General government operations and debt; central government guarantees. Revenues and expenditures exclude privatization receipts. For 2002, budget numbers.

Includes a CZK 33 billion government guarantee not included in official reported statistics. From 2001, includes CZK 155.7 billion of government guarantees to CKA.

Adjusted to account for removal of KoB’s banking license in September 2001, exchange rate effects on foreign-currency-denominated loans, loan write-offs, and transfer of IPB loans to CKA.

Inflows for direct investment (equity capital and reinvested earnings) and equity securities. Includes privatization-related FDI.

1

In addition to recent movements in the koruna-euro exchange rate, the updated projections take into account first quarter GDP and current account data, as well as revised assumptions about the global economic environment, which imply weaker import demand by Czech trading partners and a more depreciated U.S. dollar relative to the euro.

Czech Republic: Staff Report for the 2002 Article IV Consultation
Author: International Monetary Fund