Recovery shaken by supply chain disruptions

Although the Czech economy rebounded from the pandemic-induced doldrums amid eased restrictions and the economic recovery, the growth pace was insufficient to return fully to the pre-pandemic level in 2021. The latter should be reached in the middle of 2022. While strict restrictions in force in late 2020 delayed the recovery, supply chain disruptions became a crucial drag on growth in 2021. This factor will also be perceived in 2022 but diminish closer to year-end. The automotive industry and the activity in the German economy drive the manufacturing sector. Both factors remain crucial for Czechia. Exports to Germany reach nearly one-third of the total. The automotive industry generates over 9% of total gross value added, accounts for over 8% of full employment, and above 26% of exports. The surge in demand for vehicles has been countered by a shortage of semiconductors, which forced the reduction in the automotive sector’s output. Gradually, exports should improve, but robust imports will impact foreign trade’s contribution to GDP growth. Indeed, household spending is expected to remain vivid thanks to increased disposable income, the fall in the savings rate, and a favorable situation in the labor market. Despite the pandemic, the unemployment rate increased marginally and remained the lowest in the European Union. However, labor shortages are again substantial, and the lack of materials has also become an essential obstacle for companies. Rising costs of inputs and higher consumer demand have driven inflationary pressures. Despite several interest rate hikes (by 350 basis points in total in 2021), inflation is expected to remain high due to increased regulated energy prices from 2022 and companies transferring higher production costs to final consumers.

Companies will increase fixed asset investments, while the EU will boost public investments in 2022 and in the following years. Czechia’s recovery and resilience plan enables the disbursement of EUR 7 billion (3.1% of GDP) in grants under the Recovery and Resilience Facility (RRF).

Fiscal consolidation

The budget balance will improve in 2022 thanks to the withdrawal of pandemic support measures. However, some of them, including the decrease in personal income tax, will still affect budget revenues. The recovery of private consumption and higher wages have already led to increases in indirect taxes and social security contributions. Expenditures will be driven by investments, especially those co-financed by ‘traditional’ EU funds, as well as from the Recovery and Resilience Facility (RRF). The public debt remains moderate, although it has increased during the pandemic due to higher financing needs. Indeed, since 2019, the general government debt is expected to rise by almost half by 2022.

The current account balance will remain slightly negative, as supply chain disruptions will still affect Czech foreign trade, especially in the first half of 2022. After that, it should start improving. However, due to solid demand and higher income repatriated by foreign firms, increased imports will prevent the deficit from turning into a surplus. The Czech economy is highly open, with various companies participating in global value chains. EU capital transfers and stable projected foreign direct investment inflows will comfortably support the current account balance.

New government

A five-party coalition won the latest parliamentary elections held in October 2021. The conservative Civic Democratic Party (ODS) leads the section with other parties in the Together alliance (the Christian and Democratic Union-Czechoslovak People’s Party (KDU-CSL) and Top 09), as well as the progressive Pirate Party and the centrist Mayors. The coalition controls 108 of the 200 seats in the Chamber of Deputies (the lower house of parliament). The opposition consists of previously ruling Andrej Babis’ party ANO (72 seats) and the radical-right Freedom and Direct Democracy (SPD, 20 seats). Petr Fiala, the leader of ODS, was appointed prime minister by the president of the Czech Republic, Milos Zeman, at the end of November 2021. In December 2021, the new Czech government took office. However, its appointment was delayed by several weeks owing to President Zeman’s ill health. The government has declared several general priorities. It plans to balance the budget by cutting government welfare expenditures rather than increasing taxes. It also aims to spend more on research and development, digitalization, and infrastructure projects (primarily highways and high-speed railways). The Czech security policy will be more pro-Western, with higher defense spending and a more hawkish stance towards Russia and China. The most urgent issues include managing the pandemic and the fiscal budget.