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A potential intensification of the sovereign debt crisis in Europe would negatively affect the economy through the trade channel. In addition, the close financial integration with the euro area entails a clear spillover risk via banking and financial markets channels. However, strong fundamentals in the Czech Republic, including a manageable level of public debt, a comfortable external position and a resilient financial system, limit the vulnerability against these risks.
Against this background, policies should aim at maintaining macro-economic and financial stability, safeguarding fiscal sustainability, and enhancing the growth potential. The mission’s key recommendations are the following:
Given the current manageable level of public debt and sound institutional capacity in the Czech Republic, consideration could be given to a structural fiscal balance rule for the general government, augmented with a debt brake. Such a rule would ensure fiscal sustainability while avoiding unwarranted procyclicality, and would be consistent with the new EU fiscal framework. Other types of rules currently under consideration may achieve the same broad objectives. However, it is essential for any rule to have an appropriately wide coverage, provide clear guidance to the annual budgeting process, and be consistent with supranational rules. An independent fiscal council would foster an effective implementation of the fiscal rule.
The Czech financial system has proved resilient to the effects of the global crisis, but spillover risks remain elevated. Despite slow GDP growth at home and financial strains abroad, the performance of banks is very good, with strong capitalisation, solid profits, and ample liquidity. This resilience, which has been confirmed by the FSAP stress tests, reflects to a large extent a relatively conservative structure of bank balance sheets (particularly low loan-to-deposit ratios) and relatively low indebtedness of the corporate and household sectors. Nevertheless, the financial system is facing a number of risks, particularly related to the macro-economic and financial developments in the euro area, where the parents of the major Czech banks are based. Importantly, the situation of Czech banks is different from those in most other European host countries, as the Czech subsidiaries are typically net creditors vis-à-vis their parents.
The mission is encouraged by the authorities’ efforts to strengthen the financial stability policy framework. In particular, the mission welcomes Czech National Bank’s (CNB) efforts to improve bank reporting requirements and to intensify monitoring of transactions between parents and subsidiaries. Actions to implement many of the recommendations of the recent FSAP mission are already underway. The limit on banks’ exposures to parent groups is planned to be reduced from 100 per cent to 50 per cent of bank capital. Legal amendments aimed at broadening the mandate of the CNB and regulating the activities of credit unions are under preparation. Work is also on going to strengthen the macro-prudential policy framework and stress testing. It would be important to implement other FSAP recommendations, particularly in the areas of bank supervision and crisis management.