Czechia: 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
- Preferred destination for FDI in Central Europe
- Significant industrial potential
- Robust public accounts and banking system
- Small, open economy: exports account for 80% of GDP
- Dependent on European demand: 65% of exports are to the eurozone, one third to Germany
- Automotive sector occupies a large share of the economy
- Lack of rapid transport links with the rest of Europe
- Ageing population and shortage of skilled labor
Dynamic economic activity
The Czech economy is expected to keep a fair rate of growth in 2019. As in previous years, the economic activity is strongly supported by growing household consumption, which benefits from increased consumer confidence thanks to growing wages and decreasing unemployment. The jobless rate remains at the lowest level in the EU, reaching 2.3% in September 2018. Whereas the situation on the labor market is positive for households, companies are concerned: the talent pool is limited and the number of job vacancies has soared to the highest level in the EU. Facing labor cost increases, further strong wage pressures, and higher input prices, companies’ profitability has barely increased. The Czech labor market will still be challenging for businesses in the coming years, especially as the supply of labor will suffer from aging population. Private investment continues its recovery and remains the second-most important contributor to growth because of the high capacity utilization ratio and the surge of public investments supported by EU funds. Despite this, investments are likely to be less robust in 2019 than in 2018, mostly due to moderating public investment.
Since August 2017, the Czech central bank has been gradually raising its interest rates, further worsening the tensions on the koruna that have been in force since the bank decided to abandon the cap on koruna/euro exchange rate in April 2017. This had led to the domestic currency’s appreciation, although this was not amplified by recent interest rate hikes. Nevertheless, higher rates temper inflationary pressures. Inflation in 2019 is likely to exceed the Czech National Bank’s target of 2%, but drop below it the following year.
As a small open economy, Czechia is highly dependent on the external sector. The automotive sector – which accounts for 28% of industrial production, 20% of exports of goods and 10% of GDP – is expected to grow fairly. Western European demand is crucial in this regard, but the inclusion of Czech companies in global production chains (not only in the automotive sector) makes them vulnerable to weaker global trade dynamics.
Solid fiscal position and trade balance surplus
Despite some easing, the government's fiscal policy remains cautious, helping keep the public accounts to similar levels as last year and still generating a budget surplus. The increase of public wages and higher indexation of pensions are expected to be compensated by rising revenues, thanks in part to the improved tax collectability. Public debt will remain on its alleviating path.
The trade balance shows a structural surplus (5.0% of GDP in 2017) thanks to close integration in the European – especially German and automotive – production chain. However, the previous appreciation of the koruna, as well as robust domestic demand, limits the trade surplus. Moreover, weaker external demand will contribute to slowing the growth of exports. At the same time, imports are likely to record lower dynamics in line with moderating investments, which have relatively high import content.
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 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, with the Social Democratic Party (CSSD), to which the outgoing Prime Minister belongs, relegated to sixth place (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%), who were able to profit from distrust of migrants and Euroscepticism. With nine parties represented, the fragmented Parliament made it impossible to form a majority government. The government won confidence votes in July 2018 and again in November 2018. The Communist party supported the minority coalition between Ano and the CSSD. Although the Communists remain outside the government, their deal with Mr. Babis brought them the closest they have been to power since 1989.