- Hans Weber
- October 28, 2024
Czech Republic’s Economy Faces Modest Growth Amidst Export Dependency: Key Insights Revealed
GDP: USD290.9bn (World ranking 47)
Population: 10.5mn (World ranking 87)
Form of state: Parliamentary Republic
Head of government: Petr Fiala (Prime Minister)
Next elections: 2025, Legislative (Senate)
Strengths
- EU membership and good international relations
- High income economy with fairly strong underlying macroeconomic fundamentals
- Favorable public finances
- Manageable external debt burden
- Sound banking sector that has proven resilient to adverse shocks
- Favorable business environment
Weaknesses
- History of fragile coalition governments
- Often ineffective policymaking and slow reform progress
- High export and import dependencies
- Unfavorable export structure
Economic overview
Modest growth and continued gradual disinflation in 2024
The Czech Republic (Czechia) has been a decent performer among emerging economies. However, a strong dependence on exports (accounting for around 80% of GDP), in particular on automotive shipments, causes above-average cyclical fluctuations in growth. Moreover, a high dependence on global supply chains and energy imports has made the Czech economy very vulnerable in the recent global context of supply disruptions and higher energy prices.
Real GDP expanded by an average of +2.5% over the past 20 years and by +3.9% over the five years prior to the Covid-19 pandemic. As a consequence of its dependence on exports and supply chains, the Czech economy was hit harder by the global Covid-19 crisis than others (-5.5% in 2020) despite strong economic policy support. And after a moderate recovery in 2021 (+3.6% growth), economic activity slowed down markedly in 2022-2023 as a result of the consequences of the war in Ukraine, notably the subsequent EU sanctions on Russia and soaring energy prices. The Czech economy has been mostly in recession since mid-2022. Full-year real GDP still posted moderate growth of +2.4% in 2022 but is estimated to have contracted in 2023. Looking ahead, we expect modest growth of around +1% in 2024, followed by +2.5% or so in 2025.
Inflationary pressures will decline but not disappear in 2024.Consumer price inflation rose into double-digit territory in early 2022 amid surging energy and food prices. After peaking at 18% y/y in September 2022, it fell back steadily to 6.9% y/y at end-2023 on the back of a partial correction of the earlier rise in energy prices as well as higher interest rates. The Czech National Bank (CNB, the central bank) raised its key policy interest rate by a cumulative 675bps to 7.00% from June 2021 to June 2022. Thereafter, the rate was kept unchanged until December 2023 when CNB kicked off an easing cycle by a 25bps cut. We forecast inflation to remain elevated for some time and to not fall back to the CNB’s 2% ±1pp target band before 2025. We expect the CNB to continue gradual monetary easing in 2024.
Public and external finances are improving
Czechia’s public finances have deteriorated in recent years but will remain manageable over the next two years. The Czech government posted large annual fiscal deficits of more than -5% of GDP in 2020-2021, as a result of a huge fiscal stimulus program in order to mitigate the impact of the Covid-19 crisis on the economy. The annual shortfalls have narrowed but remained large in 2022-2023, around -3.5% of GDP on average, as the government implemented new fiscal support measures to mitigate the impact of the energy crisis and the economic downturn on households and industry. Meanwhile, the government has decided to embark on a fiscal-consolidation program from 2024 onwards. Hence, we forecast annual fiscal deficits of less than -3% of GDP in the next two years. Financing these deficits will be manageable even though yields on Eurobonds have increased over the past years. Moreover, the government is eligible for substantial EU funding and can also access local markets. As a result of several years of elevated fiscal deficits, total public debt rose from a low of 30% of GDP in 2019 to 44% currently. It is forecast to remain around that ratio in the next few years, but this is still fairly low compared to peers.
Czechia’s external position is on track towards rebalancing after a significant deterioration in 2022 triggered by rapidly increasing energy import costs since H2 2021. After seven successive years of surpluses, the current account balance moved into a deficit of -2.8% of GDP in 2021, which widened to -6.1% in 2022. However, the external shortfall returned to a small surplus of around +1% of GDP in 2023, mainly as a result of the partial correction of the earlier increase in energy prices and the curtailing effect of faltering domestic demand on imports. We forecast continued, albeit smaller annual current account surpluses in 2024-2025, as imports will recover somewhat. On another positive note, net foreign direct investment (FDI) inflows have recovered from modest levels in 2021-2022 and net portfolio inflows have also been positive again since June 2023 (on a rolling 12-month basis), after two years of significant net outflows. Altogether, this rebalancing also helped to halt the downtrend in the CNB’s foreign exchange (FX) reserves, which had dropped from a peak of EUR160bn in April 2022 to a temporary low of EUR127bn a year later. Reserves still covered a comfortable seven months of imports at the end of 2023, but that rate is down from a peak of 12 months in early 2020. In other terms, reserves cover all external debt payments falling due in the next 12 months. In short, Czechia’s external finances are still adequate and appear to regain some of the strength which they had lost in 2021-2022.
Strong business environment and low political risk
The Czech business environment is well above average. The World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are generally business-friendly, though a certain level of corruption is still perceived as present. The Heritage Foundation’s Index of Economic Freedom survey for 2023 assigns Czechia rank 21 out of more than 180 economies, reflecting strong scores with regard to property rights, judicial effectiveness, tax burden, trade freedom, investment freedom and financial freedom. Meanwhile, our proprietary Environmental Sustainability Index puts Czechia at rank 59 out of 210 economies, reflecting strengths in energy use and CO2 emissions per GDP, water stress and general vulnerability to climate change. However, there are still weaknesses in renewable electricity output and the recycling rate.
Overall systemic political risk is relatively low. Czechia is a well-established democracy and has good international relations, reflected in its EU, NATO and OECD membership. Fragile coalition governments have often resulted in ineffective policymaking and slow reform progress. Yet, broad policy continuation has been the rule after past government changes, whether early or on schedule.
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