20 May 2013

IMF: Czech Republic —2013 Article IV Consultation Concluding Statement

IMF says that a further slowdown in the euro area would exacerbate the situation, creating the risk of lower growth in the long run. Short-term macro-economic policies should therefore be geared towards supporting the economy and not creating additional drag.

The mission's key recommendations are:

• Keep fiscal policy neutral until the economic recovery gains strength. Adopt a simple and easy-to-monitor structural fiscal balance rule to provide a medium-term fiscal anchor
• Maintain the accommodative monetary stance for an extended period.
• In a severe adverse scenario where deflationary pressures mount, use fiscal policy to support the economy and deploy unconventional monetary policy tools, notably foreign exchange intervention.
• Use proactive bank supervision to ensure continued adequate capital and liquidity buffers to preserve financial stability.
• Strengthen policies to enhance investment in both physical and human capital, improve the business environment, and increase labour participation in order to boost potential growth.

The Czech economy remains in recession. The economy has shown remarkable stability in the recent volatile economic environment, benefiting from strong policy frameworks and sound fundamentals. However, the export-led recovery observed in 2010-11 subsided as euro area import demand slowed, and growth has noticeably underperformed trade partners and peers since the middle of 2011, mainly because of weaker domestic consumption and investment. Weak private consumption was particularly prominent, driven initially by lower real disposable income, and subsequently also by an increased tendency towards precautionary savings.

Risks are mainly to the downside and include further deterioration of euro area growth and permanent scars to potential growth. If growth prospects for the euro area worsen, it would discourage sentiment even more and delay the recovery of the already policy-constrained Czech economy. With recent disappointing export performance, the economy is at the risk of being dragged deeper into recession. Also, the current poor growth performance, if protracted, runs the risk of translating itself into a long-term decline in potential growth due to lower investment.

With a budget deficit projected at 2.8 per cent of GDP in 2013, the Czech Republic should be able to exit the Excessive Deficit Procedure. The structural consolidation of around 4.5 per cent of GDP over 2010-2013 has resulted in a stronger fiscal position than before the crisis. Thus, fiscal over-performance this year, particularly at the expense of lower capital spending, should be avoided. In addition, further pro-cyclical fiscal tightening in the event of weaker than expected economic activity should also be avoided by allowing automatic stabilisers to operate fully.

Over the next few years, until the economic recovery gains strength, a neutral fiscal stance would be appropriate. This neutral stance could be followed by a moderate, gradual consolidation after 2015 with the aim of achieving the structural balance target incorporated in the new fiscal framework. In a severe adverse scenario, fiscal policy should play an active role through temporary and targeted measures. In such an environment and with monetary policy interest rates already at the zero lower bound, fiscal policy would be more effective than under normal circumstances in providing needed support to domestic demand.

The structural balance rule and debt brake being considered for the new fiscal framework would enhance the transparency and predictability of fiscal policy and reduce pro-cyclicality. The framework’s effectiveness and credibility would be enhanced if its design and adoption is rooted in broad consensus. The final version of the framework would benefit from ensuring independence of the fiscal council and adopting a structural target that strikes the right balance between long-term sustainability considerations and short- and medium-term demand concerns.

The Czech financial system has proved resilient to the effects of the global crisis and a weak domestic economy. Czech banks, largely owned by euro area banking groups, are highly profitable and self-financed with a low system-wide loan to deposit ratio. Profitability is likely to moderate somewhat from the record level achieved in 2012, as margins come under pressure from competition and impairments that would moderately increase due to weak economic activity. The main risk for the Czech banking system is a protracted or deeper recession that would harm asset quality.

Full press release

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