Czech Republic

Investment recovery will drive pick-up in growth

Country Rating A1

Strengths

  • EU membership and good international relations 
  • High income economy with fairly strong underlying macroeconomic fundamentals
  • Solid monetary policy 
  • Favorable public finances
  • Manageable external debt burden
  • Sound banking sector that has proven resilient to adverse shocks
  • Favourable business environment

Weaknesses

  • History of fragile coalition governments, resulting in often ineffective policymaking and slow reform progress
  • High export dependence and unfavourable export structure

 

Economic Overview

 

Growth set to regain momentum

The Czech economy lost momentum in 2016, with real GDP growth decelerating to +2.4%, down from +4.5% in 2015. Fixed investment was the main driver of the slowdown, contracting by -3.5%, mainly due to base effects (+9% in 2015) and a much lower level of EU funds absorption. Otherwise, growth was broad-based. Both private and public consumption eased slightly but remained robust, increasing by +2.9% and +1.5%, respectively. Inventories added +0.5pp to overall 2016 growth. External trade activity moderated in 2016, with exports expanding by +4.3% (+7.7% in 2015) and imports by +3.2% (+8.2% in 2015). As a result, net exports added +1.1pp to 2016 growth (+0.1pp in 2015).

 

In Q1 2017, unadjusted real GDP rose by +3.9% y/y (calendar-adjusted by +1.3% q/q and +2.9% y/y), driven evenly by both domestic and external demand. Fixed investment is on course of a gradual recovery as EU co-financed investment activity should rise under the 2014-2020 programming period. We expect GDP growth to pick up to +3% in 2017, before slightly easing to +2.8% in 2018.

Strong macroeconomic fundamentals

After three years of near-deflation, inflation is back on track, reaching 2% at end-2016 and averaging 2.3% y/y in January-April 2017. We expect it to remain within the 2%±1pp inflation target range of the Czech National Bank (CNB; the central bank) until end-2018. As a consequence, the CNB removed the exchange rate floor of EUR1:CZK27, which it had imposed in 2013 to fend off deflation, in April 2017. Following the lifting of the cap, currency volatility has slightly increased but at about +2% at the time of writing, the CZK appreciation against the EUR has been far from disorderly. Volatility is likely to continue in the short term. In the medium term, we expect a gradual strengthening of the CZK to a new equilibrium rate. In any event, expect the CNB to be prepared to mitigate potential excessive exchange rate fluctuations, if needed. 

 

Public finances are favorable. The fiscal balance shifted to a surplus of +0.6% of GDP in 2016 and is forecast to be near-balanced in 2017-2018. Public debt has fallen to a moderate 37% of GDP.

The external position is comfortable as well. The current account posted a surplus of +1.1% of GDP in 2016 and should remain in surplus in 2017-2018. Gross external debt is elevated in relation to GDP (75% in 2016) but moderate in relation to export earn¬ings (93%) and the debt-service ratio is forecast at just 15% in 2017. Foreign exchange reserves have surged to EUR124bn in April 2017, sufficient to cover 11 months of imports or, in other terms, all external debt payments falling due in 2017.