Unlike some of its Eastern European neighbors, the Czech Republic has shunned joining the eurozone and has surprised many with its stable and healthy levels of economic growth. However, progress is still needed on business transparency.
Visitors to Prague soon realize that the city’s most ubiquitous figure—whose cheery, bibulous image decorates T-shirts and beer mugs just about everywhere—is someone who never existed. The figure is taken from the novel Good Soldier Švejk, created by author Jaroslav Hašek and set during the First World War, when Bohemia was part of the Hapsburg Empire. The main character is famous for his passive resistance to authority but also for his ability to succeed effortlessly, while more purposeful colleagues fall by the wayside.
The Czech Republic shares similar attributes. Successive presidents and prime ministers have done their best to hold the European Union (EU) at bay. Eurozone membership is on the back burner (neighboring Slovakia, by contrast, has been a eurozone member since 2009): It is opposed in principle by the ODS, the main right-wing opposition party, and is not part of the current coalition government’s program. Miroslav Singer, the governor of the Czech National Bank, recently admitted that adoption of the euro wouldn’t be under serious consideration until 2020 at the earliest.
Little wonder: Following the Greek crisis, opinion polls have found that more than 60% of Czechs are opposed to joining the euro; a recent Eurobarometer poll found, moreover, that Czechs mistrust the EU generally more than any other member nation, including the UK.
Governed by a three-party center-left coalition since January 2014—headed by prime minister Bohuslav Sobotka—the Czech Republic has also bucked the current European trend for right-of-center governments. The Czech Republic—which left the European Bank for Reconstruction and Development years ago on the grounds it was no longer a transition economy—has done pretty well. After a few bumpy years post 20082009, GDP has been on a steadily rising trend, coming in at 2% in 2014 and 4.3% to 4.5% in 2015. That makes it arguably the best developing economy in Europe this year.
“The Czech economy has been one of the brightest spots in the emerging market world—and no one really saw it coming,” says William Jackson, senior emerging markets economist at Capital Economics, a London-based consultancy. “The best news is, there are no real nasties on the horizon, provided the eurozone continues its gradual recovery. There are no reasons why the Czechs cannot continue going from strength to strength.”
Commerzbank says GDP has long-term potential to grow at an annual 2.7%, only a little below the Czech National Bank (CNB) estimate of 3%. Living standards have been slowly converging with the rest of the EU, with per capita income ($26,740, in 2013) just above that of Portugal at $26,170, at around 80% of the EU average, slightly down on pre-crisis levels. “Those countries where you monitor political events to judge their impact on the economy, on policymaking or on the manufacturing or banking sectors—well, this isn’t one of them,” says Tatha Ghose, senior emerging markets economist at Commerzbank. Prudence has been something of a byword for successive Czech governments. Gross general government debt is 41% to 42.5% of GDP, one of the lowest levels in the EU and well below the eurozone average of 92%. It is expected to approach 40% by the end of 2017.
The Czech economy has
been one of the brightest
spots in the emerging market world—and no one really saw it coming.
William Jackson, Capital Economics
STABLE COALITION
The truth is that the country, which 26 years ago gave birth to the Velvet Revolution and ended 45 years of Communist misrule in dramatic style, has become almost boring—but in a good way. Even during the volatile era of 20122014, when headlines carried news of corruption charges and vicious political infighting, culminating in the collapse of the center-right government of Petr Necas and six months of turbulence, continuity was the order of the day. Economic and financial normality were aided by broad agreement between the main political parties over policy and economic priorities, while January 2015 saw a bill passed to depoliticize the civil service amid hopes this would curb the graft and favoritism that has plagued public administration and reinforced widespread local cynicism about politicians.
Since January 2014 the Czech Republic has enjoyed political stability, despite president Miloš Zeman’s having a rocky relationship with Sobotka—both are from the Czech Social Democratic Party (SSD).The coalition government also comprises members of the ANO, a populist party headed by the country’s second-wealthiest man, Andrej Babiš. As Finance minister, he is seen by some as the most powerful man in government, although critics have identified major conflicts of interest: Babiš has substantial media interests and owns, among other companies, Agrofert, a substantial agribusiness and chemical company that employs some 35,000 people. So far though, despite verbal antagonism, his relationship with the SSD has worked. “There is generally good accountability, [in addition to] strong institutions and proper checks and balances: Other emerging economies should take note,” observes Ghose.
Growth has been generally broad-based with strong domestic demand boosted by very low real interest rates (0.05%), steady lending from stable and well-capitalized banks, and a dynamic export sector (particularly in manufacturing, reflecting close industrial links with Germany, notably in car manufacturing: Škoda, now a subsidiary of Volkswagen, accounts for some 20% of exports).
However, 2015’s high growth rate also reflected the use of the final tranches of EU structural funds from 20072013 (some €27 billion, or $29 billion, in total), as well as initial funding disbursed under the subsequent 20142020 package. Fund absorption is now one of the highest in emerging Europe. Analysts warn that this situation cannot last. “The current government has been very effective in presenting projects that qualify for EU funding, but once disbursements start in earnest under the new cycle, this will be much slower; approval tends to take longer and be tougher,” says Arnaud Louis, a director in the sovereigns group at Fitch Ratings.
SEEKING CONVERGENCE
Louis says the Czech Republic, burdened like many other European nations with an aging population, runs the risk of reverting to growth rates of 1.5% to 2% after 2016. These levels of growth would be fine for an advanced economy like France or Holland, but not for a former Communist country still trying to converge with its EU partners after years of state-run mismanagement coupled with post-Lehman Brothers fallout.
Foreign direct investment is respectable, with some €89 billion invested since the collapse of Communism. Last year Hyundai Mobis was one of the many companies to invest, cementing the Czech Republic’s reputation as a car-manufacturing hub. But total new FDI—just under €6 billion—suggests a slowing trend, with greenfield projects few and far between. However, the webpage of CzechInvest, the state body that promotes the Czech Republic as an investment destination, includes as major priority sectors nanotechnology and advanced materials, high-tech mechanical engineering, aerospace and electronics and electrical engineering.
“In essence the country needs a new growth model to enable it to converge in per capita income terms, in productivity terms and with its business environment,” Louis says.
A recent IMF report on the Czech Republic suggests that the Czechs’ focus is on making their business environment more transparent (including making state tenders more open) and improving the governance of state bodies. It identifies infrastructure, particularly roads and motorways, as a serious bottleneck.
“Labor market reforms should aim at increasing participation among women with children and low-skilled workers, while greater emphasis should be placed on mitigating skills mismatches,” the IMF report stated. “Priority should also be given to promoting research and innovation, enhancing apprenticeship programs, simplifying tax compliance and other administrative procedures,” the report concluded.
The European Commission says tax evasion needs to be tackled and collection made simpler and less costly for individuals as well as authorities, adding that the government has dragged its feet on other much-needed laws. “There is a lack of transparency and a long duration in the procedures for obtaining building and land use permits, which has held back public investment,” the EC states.
“Public procurement transparency is also a concern,” it adds, noting that the awarding of public contracts is not published in a centralized database.
The need for a more open business environment is reflected in the Czech Republic’s ranking in Transparency International’s Corruption Perceptions Index (2014). It is 53rd out of 175, well below the Baltic states, Poland and Hungary.
The government and the Czech central bank, the CNB, have done their best to support export competitiveness by maintaining a fixed-peg exchange rate against the euro of 27 Czech korunas, first set in 2013. Since then, the CNB has had to intervene to prevent the koruna’s appreciating on numerous occasions, which has led many to suggest the policy should be abandoned.
“CNB foreign exchange reserves have been rising directly as a result of this policy, which has led many local politicians to attack the peg: The Czechs are lucky their currency isn’t traded more widely, or there might be major speculative attacks against it,” says Commerzbank’s Ghose.
So as 2016 gets under way, the mood within this prosperous Mittel-European country is something that the Good Soldier Švejk would recognize: It has done pretty well without trying too hard and has comfortably maintained its place among the better-developed countries of Central Europe. However, if it is to realize its dreams of catching up with the rest of Europe, it will need to try a little harder.
GFmag.com Data Summary: Czech Republic
Central Bank: Czech National Bank |
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|---|---|---|---|
|
International Reserves |
$54.5 billion |
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Gross Domestic Product (GDP) |
$205.3 billion |
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|
Real GDP Growth |
2012 |
2013 |
2014 |
|
GDP Per Capita—Current Prices |
$19,526.40 |
||
|
GDP—Composition By Sector* |
agriculture: |
industry: |
services: |
|
Inflation |
2012 |
2013 |
2014 |
|
Public Debt (general government |
2012 |
2013 |
2014* |
|
Government Bond Ratings (foreign currency) |
Standard & Poor’s |
Moody’s |
Moody’s Outlook |
|
FDI Inflows |
2012 |
2013 |
2014 |
* Estimates
Source: GFMag.com Country Economic Reports
