Czech Republic Business Forecast Report Q1 2008

Vaclav Klaus Likely Re-Elected President In 2008 Key issues for the Czech Republic in 2008 include the impact of slowing eurozone growth, which may reduce the demand for Czech exports in the medium term. In addition, restricted credit availability as a result of the ongoing fallout in the US subprime mortgage market, may hit consumer spending, with associated impacts on economic growth. Despite the potential risks, we believe that economic growth will still remain strong in 2008, largely on the back of robust consumer demand and continued high investment. Other important issues concern the presidential election in 2008, as well as negotiations over the location of the US radar base, which will likely dominate the political sphere. In addition, the Czech Republic is due to take over the EU presidency in 2009, which may raise government spending in 2008, as well as potentially diverting attention from further economic reform.

The Civic Democrat (ODS) party has nominated the current president, Vaclav Klaus, to re-elect in the next presidential election in 2008. Although the ODS holds the largest number of seats in the Chamber of Deputies, it will still require the cooperation of the greens (which remains uncertain) to ensure that President Klaus is re-elected. The re-nomination of Klaus as president comes amid growing tension among the government parties, which may weaken the coalition. Principal concerns include the stirrings within the minority Green party, which threaten to overshadow more pressing concerns of government unity, as well as the proposed US radar base, which may divide political leaders within the coalition.

The trade balance for October recorded a surplus of US$448mn, expanding significantly from the US$172mn surplus since the same period last year. This owes to the faster pace of growth for exports over imports in August, with the former experiencing growth of 32.6% y-o-y and the latter 30.2% y-o-y. The ongoing improvement in the trade balance owes largely to the strength of external demand which has seen the export sector flourish. The Czech Republic mainly exports to the EU, which accounts for 71% of the total. Herein lies a significant risk to the trade balance, since our forecast for slowing economic growth in the eurozone next year will likely hit demand for Czech exports.

Heightened inflationary pressures resulting from the surge in food prices following the summer drought are likely to largely subside by H108. However, structural factors such as the continued reduction in unemployment, will ensure that price pressures remain in play over the medium term.

Indeed, according to data published by the Labour and Social Affairs Ministry, the unemployment rate fell to 6.3% in Q307, a reduction of 1.6pp since Q306. We forecast unemployment to reduce further to 6.1% by end-2008, from our end-2007 projection of 6.5%. The continued tightening of the labour market will see the unemployment rate likely reach 5.7% by 2011.