Czech Republic Business Forecast Report

A Sharp Contraction But Safe From Crisis The Czech economy will undergo a painful recession in 2009, as export demand and foreign capital inflows from the eurozone dry up. Taking account of the Q109 GDP growth figure (-3.4% year-onyear

[y-o-y]), an array of leading indicator data and a recent downgrade to our full-year German real GDP growth forecast to -5.8%, we have cut our 2009 Czech growth forecast to -3.1% from

-2.1%. That said, we maintain our core view that the economy is relatively well-placed to weather the global economic downturn as a result of its stable banking system, FDI-heavy financial account, and low national debt. We believe that the country is at little risk of a systemic economic crisis, and expect it to benefit fully from the global recovery, with positive growth of 1.1% and 3.2% forecast for 2010 and 2011 respectively. However, we caution that key risks remain in the political sphere. The collapse of the minority Civic Democrat-led coalition in March and its subsequent replacement by an interim technocratic administration does not bode well for long-term structural-economic reform, although the new cabinet will at least provide a reasonable level of policy making continuity.

Following the decision by the Czech Constitutional Court to veto a planned early election for October 9-10, a revised proposal for a November 6-7 poll was shot down by the leftist Czech Social Democratic Party (CSSD) and the far-left Communist Party of Bohemia and Moravia (KDU-CSL), on September 15. This in turn has forced the interim caretaker cabinet, comprised of professionals without affiliations with political parties, to take on a new role. Indeed, having previously proposed tough fiscal austerity measures to stabilise the public finances, and paving the way for a new government to implement the much needed reforms, the technocratic cabinet must now assume the responsibility of pushing new legislation through parliament. While this bodes well for short-term fiscal stability, it also means that more far reaching reforms will be put on the backburner for now.

What is more, we caution that the CSSD may be adopting a more populist stance to shore up its support base, which could severely delay the passing of new legislation.

The recession that will run throughout 2009 and into 2010 in the Czech Republic will put severe strain on all aspects of the economy. We forecast the fiscal deficit to soar to 5.3% of GDP in 2009 and 5.6% in 2010 from 0.9% in 2008, as tax revenues collapse and social spending demands rise. The balance of payments will come under similar strain, as FDI inflows from the recessionhit eurozone fall, and this reduction of the financial account surplus will force a correction in the current account, lowering the deficit to 1.1% of GDP in 2009 from 3.0% in 2008. We also expect fundamental pressures on the Czech koruna to remain weighted to the downside, and forecast renewed depreciation towards CZK30.00/EUR by end-2009.

The Czech business environment is one of the best in emerging Europe, thanks to comparatively low corruption, a friendly tax regime, effective judicial process, and full integration with both EU markets and regulatory standards. Moreover, the country benefits from a high skill base, particularly in advanced manufacturing sectors, coupled with wages that are below the EU average. That said, we caution that a key drag on business in 2009 and into 2010 will be the global contraction of credit, and the subsequent difficulty that firms will face in accessing credit to pursue investment projects and meet cyclical costs.