Country Report Czech Republic September 2009

Outlook for 2009-10

• As the Civic Democratic Party (ODS) and the Czech Social Democratic Party (CSSD) are level in opinion polls, the composition of the government following the election depends on which smaller parties gain representation.
• Our baseline forecast is that the CSSD will form a government with informal support from the far-left Communist Party of Bohemia and Moravia (KSCM), but there is still a chance of a grand CSSD-ODS coalition.
• Both scenarios imply a continuation of earlier patterns of patchy and incremental reforms, and the first also implies a minority (or weak majority)? government.
• The outlook for the euro zone economy in 2009-10 is poor. Based on this, and on falling consumer and business confidence, the Czech economy is forecast to contract by 3.5% in 2009. A modest recovery is expected in 2010.
• The Czech National Bank (CNB, the central bank) lowered its main policy rate to 1.25% in the year to August 2009. There is an outside chance of a further rate cut if the real economy continues to perform poorly.
• Inflation in 2008 was driven by increases in regulated prices and indirect taxes, but it is expected to fall sharply in 2009, as a result of lower import prices and weak domestic demand.
• We forecast that the current-account deficit will average 1.8% of GDP in? 2009-10.

Monthly review

• The current caretaker administration had been pressing for significant cuts in government spending in the 2010 budget, in order to keep the deficit below 5% of GDP in 2010 and to cap the central state budget at Kc170bn (US$8.9bn).
• However, it eventually agreed to present to parliament a baseline central state budget draft that targets a deficit of Kc230bn, based on current legislation (linked to the anti-crisis package) and minor expenditure cuts.
• An alternative fiscal scenario will also be presented for 2010, which will require structural reforms and tax increases, to keep the budget deficit from exceeding 5% of GDP and the central state budget deficit capped at Kc160bn.
• According to flash estimates, the economy contracted by 4.9% year on year in the second quarter on a seasonally and working-day-adjusted basis, compared with a 3.3% contraction in the first quarter.
• The main Czech blue-chip companies, including banks, have generated solid profits in the first half of the year, despite the recession.