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: 64% of exports are to the Eurozone, one-third to Germany
- High foreign intermediate inputs in exports and low contribution of services to locally value-added in exports
- Automotive sector occupies a large share of the economy
- Lack of rapid transport links with the rest of Europe
- Aging population and shortage of skilled labor
Growth gradually losing momentum
The Czech economy is strongly linked to external demand with exports at almost 80% of GDP. Unsurprisingly, its GDP growth follows the global trend and country’s crucial export market, i.e. Germany. Therefore, growth has been decelerating since 2017. Czechia has been one of the CEE countries that first started to experience the Eurozone slowdown. In 2020, GDP growth will weaken only slightly but will remain at a level below regional peers. The economic activity continues to be driven by household consumption, which benefits from a favorable labor market, further wage growth and robust consumer confidence. The unemployment rate remains at the lowest level in the EU, reaching 2.1% in September 2019. While 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.
Fixed asset investments, especially those in equipment, suffer from muted growth of industrial production. Indeed, the latter lost its momentum in mid-2018 and delivers weak dynamics since then. In the first nine months of 2019, industrial production increased by 0.3% compared to the same period of the previous year. Considering the gloomy sentiment expressed by manufacturing businesses, a surge of investments is unlikely. The weakness of investments and concerns over exports have been a result of slower demand from the main Western European trade partners, weaker global demand through the country’s inclusion in various supply chains and delayed adoptions of new emission standards by car producers. In the production approach, the Czech economy is driven by manufacturing of vehicles. Considering also supplying industries, the automotive sector generates more than 9% of total gross value added and accounts for over 8% of the total employment, and above 26% of exports. Despite the challenges of the external situation, net exports are expected to positively contribute to GDP growth, as weaker investments and production will make imports growth slower.
Since August 2017, the Czech central bank has been gradually raising its interest rates, with the last move made in May 2019. The Czech National Bank seems to be more sensitive to a rising inflation than peers’ central banks. However, it is expected that Czech National Bank’s inflation target will be again slightly exceeded in 2020.
Solid fiscal position
The fiscal policy is likely to be used as a pro-growth stimulus when facing weaker economic activity. Czechia will record a budget deficit this year. Although expected to reach a low level, it will nevertheless reverse a previous trend of budget surpluses. Indeed, a budget surplus in 2019 was the fourth consecutive when revenues were higher than expenditures. Public wages, pensions and subsidies already made expenditures grow last year and are to increase again this year. Furthermore, in the final year of the current EU structural funds program, robust public investments will partly require domestic financing. Revenues will benefit from an increase in excise duties for alcohol and tobacco products, and the introduction of a new digital services tax for large corporations.
At the end of the first half of 2019, the current account surplus was 0.7% of GDP and the goods and services surplus reached 6.3% of GDP. The financial account recorded an outflow of funds due to assets rising faster than liabilities. Despite the growing interest rate differential with the Eurozone, the Czech koruna has not been appreciating in nominal terms versus the euro. It is expected to remain stable.
ANO survives no-confidence votes but protests put pressure
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 of 200 seats in parliament. Nevertheless, the traditional parties refused to enter into a coalition with this party, of which the leader has been charged with 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). The recent cabinet consists of the coalition between ANO and the CSSD (which is supported by the Communist party). In late 2019, a series of demonstrations were held across the country, sparked by the sudden replacement of the justice minister, days after police recommended Andrej Babis be charged with EU subsidies fraud. With further social discontent, early elections are possible before the regular ones scheduled for October 2021