Czech Republic: Risk Assessment
Country Risk Rating
Business Climate Rating
- Central geographic location at the heart of industrial Europe
- Tightly integrated in the international, especially German, production chain
- Preferential destination for foreign direct investments in Central Europe
- Significant industrial potential
- Robust public accounts and banking system
- Low reliance on external energy
- Small, very open economy: exports account for 84% of GDP
- Very dependent on European demand: 63% of exports are to the Eurozone, one third to Germany
- Automotive occupy large share of the economy
- Lack of rapid transport links with the rest of Europe
- Ageing population and shortage of skilled labor
Dynamic Activity Despite and Economic Slowdown
Following the outstanding performance of 2017 associated with the recovery of investment, growth in 2018 is expected to settle at a level in line with potential but will remain hampered by the shortage of a local workforce due to low unemployment (2.7% in October 2017). Private investment will continue to be the second most important contributor to growth, after private consumption, because of the high capacity utilization ratio. Construction will continue to benefit from the return to normal of European structural finance, but will be hampered by the residential property downturn. This will suffer from more expensive credit linked to the central bank’s monetary policy tightening. Automotive – which accounts for 28% of industrial production, 20% of exports of goods, and 10% of GDP – is expected to continue to prosper. This is because automotive exports will benefit from strong German consumption and performance, as well as the positive trend on the European market on which they greatly rely. Nonetheless, export momentum will be dampened by the appreciation of the koruna, reducing export competitiveness and trade’s contribution to growth. Inflationary tensions will start to put pressure on household consumption. Nevertheless, household consumption will continue to be underpinned by robust employment figures and wages, as well as by the gradual appreciation of the krona, enabling a reduction in the cost of imported goods.
Excellent Fiscal Position and Satisfactory External Accounts
Despite some easing, the new government’s fiscal policy is expected to remain cautious, helping keep the public accounts in equilibrium in 2018. Infrastructure spending will increase due to the necessity of using European funds awarded under the 2014-2020 program, on pain of seeing the level reduced in future. Moreover, massive fiscal reforms are planned by the new government, which wants to take advantage of the strong increase in revenues generated by the lively pace of activity to finance the reforms without worsening the budget position. The reforms include a cut in VAT in the hospitality sector (from 21% to 15%), a reduction in employer contributions, as well as cuts to income and corporation tax. The reform program will also be financed by cuts to current spending, allowing budget equilibrium to be maintained and debt reduction to continue. Despite the influx of foreign capital attracted by prospects for an appreciation of the koruna, 80% of the debt is still held by local investors. This success explains why 86% is denominated in koruna and issued at negative yields on short maturities.
The trade balance shows a structural surplus (5.6% of GDP in 2016) thanks to close integration in the European, especially German, production chain and for automotive. Engineering, household appliances and electrical equipment will also make a positive contribution. Nevertheless, the slight appreciation of the koruna, as well as robust domestic demand, will limit the trade surplus. Services also show a surplus (2.3%) thanks to tourism. The substantial income deficit (6.1%) is explained by the substantial FDI stock. This results in a small current account surplus, which could be jeopardized by a drop in the trade surplus, even if the potential for deterioration seems fairly limited. Moreover, external debt (74% of GDP) presents a low risk, as it mostly consists of intragroup liabilities, loans linked to FDIs, short-term commercial loans, and deposits by foreign banks with their local subsidiaries (87% of bank assets), which are by nature fairly fixed.
Formation of a Minority Government, Weakened by Allegations Concerning the New Prime Minister
The ANO 2011 (center-right) movement led by Andrej Babis, won the October 2017 elections by a large margin, obtaining 30% of the votes cast and 78 out 200 seats in parliament. Nevertheless, the traditional parties have refused to enter into a coalition with this party whose leader has been charged with the fraudulent use of European funds. The traditional parties received a historically low share of the votes, for example the Social Democratic Party (CSSD), to which the outgoing Prime Minister belongs, was relegated to sixth place with only 7% of the votes. Conversely, the rival parties have made significant progress with the Czech Pirate Party (10.8%) and the extreme-right Freedom and Direct Democracy Party (10.6%) able to profit from distrust of migrants and Euroscepticism. With nine parties represented, the fragmented parliament makes it difficult to form a majority government. Therefore, Andrej Babis will lead a minority government and will have his work cut out to win the parliamentary vote of confidence. He could win the vote if the far-right and far-left parties, which have given him their tacit support at the price of major concessions, were to abstain. If he fails, another less controversial member of his party could take over in order to reassure the traditional parties.