## cr18187

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---

### 1. Demand and supply pressures; recent macro developments
- Real GDP growth accelerated in the second half of 2017, reaching 4.4 percent y/y.
- Unemployment rate fell to a record low of 2.3 percent in April 2018, even with increased participation.
- Macro policies tightened moderately: the Czech National Bank (CNB) increased the policy rate and tightened macroprudential settings further.
- Overall budget surplus improved by 0.9 percent of GDP in 2017; staff estimates that fiscal policy will ease in 2018 and, in particular, 2019.
- Growth was broad based: services overtook manufacturing in H2 2017; private consumption supported by real wage growth of 4 percent and employment growth of 1.6 percent in 2017.
- Household and national savings rates: about 11 and 25 percent of GDP, respectively.
- Nominal wage inflation averaged 8½ percent in Q1 2018; headline and core inflation fell in Q1 but are now close to the target; imported inflation has been negative.
- Current account posted a surplus in 2017. REER appreciated by 8 percentage points from April 2017 to April 2018.
- NIIP: -26 percent of GDP; NIIP less official reserves: -89 percent of GDP (with most of it FDI and stable).
- Staff assessment: external position in 2017 stronger than warranted by medium-term fundamentals; EBA CA model assessment of a 7 percent undervaluation.
- Fiscal position comfortable: staff projects overall and structural budget surpluses of 1.6 and 1.0 percent of GDP for this year; debt estimated to have fallen to 35 percent of GDP in 2017.

### 2. Supply constraints and labor market pressures
- Working age population fell by 7 percent from 2009 to 2017; increased participation partly compensated.
- Firms report hiring problems; more than one vacancy per unemployed person.
- Capacity utilization is high; labor shortages are a major constraint on growth.
- Employment gains expected to slow considerably going forward, even as wage growth remains strong.
- Staff estimates potential growth at 2½ percent; with declining employment growth, labor productivity must increase to 2¾ percent from the historical average of 2½ percent.
- Projections assume overall participation rate (16–64) and hours worked stay largely unchanged and no substantial increase in inward migration occurs.

### 3. Housing market, credit, and financial vulnerabilities
- Real estate lending accelerated; many households borrow at high multiples of incomes.
- Overall credit growth remains in line with nominal GDP growth; household indebtedness not high by international standards, but persistently high mortgage lending growth coupled with high household leverage could pose a risk to financial stability.
- Aggregate household debt-to-income (DTI) ratio has not increased further over the year given strong disposable income growth, but many households continue to borrow at high loan-to-income multiples.
- Share of new housing loans with LTV above 80 percent remains high.
- 14 percent of new housing loans feature loan-to-income multiples above 8.

### 4. Outlook, projections, and macro assumptions
- Staff projects real GDP growth of 3.7 percent in 2018, gradually falling to 2.5 percent by 2023.
- Near-term domestic momentum supportive: consumer and business confidence, durable goods demand, and production equipment demand.
- Monetary conditions follow CNB forecast: only one policy rate increase in 2018, with more rapid tightening in 2019 and beyond.
- Some fiscal stimulus expected in 2018 and 2019.
- Euro area GDP growth projected to reach 2.5 percent this year; euro area inflation projected to remain subdued and ECB policy assumed accommodative.
- Investment assumed to accelerate in 2018 to compensate for labor shortages; net exports expected to contribute negatively to growth.
- CPI inflation expected to increase in 2018 and remain slightly above target in 2019 as declining margins slow and labor costs are passed on; exchange rate appreciation expected to continue but at a lower rate.

### 5. Risks and vulnerabilities (incl. Risk Assessment Matrix summary)
- Risks tilted to the downside: external shocks, domestic vulnerabilities, political uncertainty.
- Key risk elements:
  - External: decline in global trade; concentrated auto production integration with Germany; increased protectionism.
  - Domestic: rapid mortgage lending growth and high household leverage could threaten financial stability.
  - Inflation: uncertain whether wage-driven domestic inflation or imported disinflationary pressures dominate; risks to domestic inflation on the upside if productivity and firms’ markups do not absorb wage increases.
  - Financial turbulence could raise long-term interest rates and exchange rate volatility.
  - Political uncertainty could delay structural reforms; fiscal policy could become strongly procyclical if proposed public spending and tax changes are implemented.
- RAM highlights (selected):
  - "Weaker-than-expected global growth": Likelihood: High; Expected Impact: High; Policy Response: support domestic demand and diversify trade.
  - "Financial conditions" (tighter global conditions): Likelihood: High; Expected Impact: Low/Medium; Policy Response: maintain accommodative monetary conditions.
  - "Financial stability risks from rapid growth in lending, especially to real estate": Likelihood: Medium; Expected Impact: Medium; Policy Response: borrower-based macroprudential measures and better granular data.

### 6. Monetary policy, FX reserves, and CNB stance
- CNB moved to gradually normalize monetary conditions; repo rate raised to 0.75 percent.
- FX interventions have ceased.
- Nominal effective exchange rate appreciated by 8 percent from exiting the floor through April 2018; some depreciation against the euro and most other currencies since then.
- CNB expected one additional rate hike in 2018 and a series of increases in 2019.
- Assessment: gradual normalization appropriate; CNB should communicate readiness to raise rates earlier if needed.
- CNB adopted new FX reserves management strategy:
  - FX reserves increased to 62 percent of 2017 GDP during the koruna floor period.
  - CNB not planning to sell the reserves.
  - FX reserves tranched: core currently 45 percent of FX reserves invested in short-term, highly-liquid assets; remainder invested in longer-term investments including shares and mortgage-backed securities.
- Authorities’ view: favor gradual normalization, avoid undue appreciation, seek binding powers for borrower-based tools, emphasize need for loan-by-loan data access.

### 7. Macroprudential and supervisory policy recommendations
- CNB measures taken:
  - 2017 non-binding recommendations: Q2 included a 90 percent LTV cap on individual loans and a 15 percent cap on share of new loans with LTV 80–90 percent.
  - June 2017: CNB recommended banks pay extra attention to DTI and DSTI ratios.
  - Reported lending standards tightened; share of new mortgage loans with LTVs above 90 percent declined.
- Policy recommendations:
  - CNB should be given binding powers over maximum LTV, DTI, and DSTI ratios as soon as possible.
  - In absence of binding powers, CNB should immediately issue recommendations over DTI and DSTI to reinforce LTV recommendations.
  - If borrower-based tools not implemented, consider "supply side" measures (e.g., risk weight add-ons or minimum risk weights for property exposures) though substantial increases likely required.
  - Better data needed: comprehensive household loan data and commercial real estate transaction data for monitoring risks.
  - Macroprudential measures should be supported by fiscal and structural policies addressing housing supply constraints (planning and zoning laws), streamlining building permits, and tax environment factors that add to housing demand.

### 8. Financial sector soundness, stress tests, and risks
- Banking sector capital above required levels:
  - Regulatory capital ratio in 2017: Q4 was 18 percent; required ratio 14.8 percent (Pillar 1 capital 8 percent; additional Pillar 2 capital 1.9 percent; systemic risk buffer 1.9 percent; countercyclical capital buffer 0.5 percent; capital conservation buffer 2.5 percent).
- Leverage ratio decreased due to sharp increase in central bank reserves and government bonds holdings; tier 1 capital continued to increase.
- Liquidity and funding:
  - Share of liquid assets relatively high; banks funded largely by deposits.
  - Loan-to-deposit ratio: 78 percent in 2017: Q4.
  - Net interest margins remain relatively high.
- Credit risk:
  - Nonperforming loans for NFCs and households continued to decline; default rates falling.
- Other risks:
  - FX loans: share of foreign currency bank loans stands at 20 percent; stock significant though recent FX lending growth plunged to zero.
  - Non-resident deposits increased significantly in early 2017; ultimate source mostly unknown; customer due diligence (CDD) should be supervised effectively.
- Stress tests: CNB stress tests indicate sector resilient overall, but vulnerabilities would increase with higher real estate exposures and falling risk weights.

### 9. Fiscal performance, projections, and recommendations
- 2017 outperformance:
  - Overall balance estimated at 1.6 percent of GDP in 2017.
  - Primary surplus: 2.2 percent of GDP in 2017.
  - Public debt declined to 35 percent of GDP in 2017.
- Medium-term staff projections (most likely policies):
  - Overall balance: 1.6 percent of GDP in 2018, then gradually easing to about 1 percent of GDP.
  - Structural balance: projected surplus but lower than previously (2018: 1.0; 2019: 0.6).
  - Projection includes expected increase in state employee compensation, not other recently-proposed tax/spending changes.
- Fiscal projection table (selected rows, percent of GDP):
  - Net lending/borrowing (overall balance): 2017: 1.6; 2018: 1.6; 2019: 1.2; 2020: 0.9; 2021: 1.0; 2022: 1.0; 2023: 1.0
  - Primary balance: 2017: 2.2; 2018: 2.3; 2019: 1.8; 2020: 1.5; 2021: 1.6; 2022: 1.5; 2023: 1.5
  - Structural balance: 2017: 1.2; 2018: 1.0; 2019: 0.6; 2020: 0.6; 2021: 0.8; 2022: 0.9; 2023: 1.0
  - Public debt: 2017: 34.6; 2018: 32.8; 2019: 31.3; 2020: 30.4; 2021: 28.0; 2022: 25.9; 2023: 23.9
- Long-term fiscal risks:
  - Healthcare costs projected to increase 2 percentage points of GDP by 2050, to 9 percent of GDP.
  - Pensions spending projected to increase ¾ of a percentage point, to 9 percent of GDP in 2050.
  - Combined effect implies public debt would start increasing from around 2030, passing 45 percent by 2050.
- Staff policy recommendations (fiscal and structural):
  - Increase health spending efficiency: use performance indicators; strengthen primary care gate-keeping; re-introduce co-payments.
  - Establish automatic link between statutory retirement age and life expectancy (current statutory retirement age ~63 years, increasing but capped at 65 years in 2030 under current rules).
  - Reduce disincentives for women as second earners (e.g., non-working spouse benefit); redirect savings to public childcare.
  - Move toward recurrent, value-based property taxation; consider tax-deferral system; eliminate mortgage interest deductibility on a steady schedule.
  - Establish unified long-horizon infrastructure plan and accelerate investment absorption.
  - Redesign grant/tax concession criteria to improve returns and spread technology beyond large manufacturing firms.
  - Continue extending debt maturities while minimizing costs; extend debt management strategy horizon beyond 3 years.
  - Fully implement the fiscal framework adopted last year; make the fiscal council fully operational soon and add the fiscal law to the constitution.

### 10. Productivity, structural constraints, and policy recommendations
- Productivity findings:
  - Productivity of better-performing firms increasing; productivity in the lower tail stalled.
  - Lower-tail firms tend to be smaller, younger, and more leveraged.
  - Weak productivity not primarily caused by sclerotic older firms or credit access problems.
  - Regulatory and planning complexity, administrative burdens, and inconsistent enforcement are significant problems.
- Structural impediments:
  - Complex regulatory environment across central, regional, and municipal governments.
  - Inconsistent application of regulations.
  - Tax incentives and subsidies structure can distort incentives.
  - Infrastructure quality worse than other advanced European economies.
- Government roles:
  - Single plan for public infrastructure coordinated across government recommended.
  - Enhance life-long learning framework; ensure equal access across regions.
  - Increase processing and auditing capacity; digitalize government services and create shared e-binders for planning applications.
- Authorities’ recent measures:
  - Amendment to the Building Act to simplify conditions for starting construction and accelerate permits.
  - National Investment Plan expected by end of June.
  - Education funding changes and vocational training reform.
  - Measures to aid child care: increase child-related tax deductions; one week of paternity leave; guaranteed nursery placement for children aged four and older.
  - Extension of electronic procurement to improve efficiency.
- Staff appraisal:
  - Economy doing very well but supply constraints are binding; more measures needed to insure against financial vulnerabilities.
  - Best macroprudential response: limits on DTI and DSTI ratios to complement LTV limits.
  - Macroprudential tools do not replace need for strong microprudential supervision or supply-side reforms.
  - Fiscal policy should avoid procyclicality; carefully target education and infrastructure spending to avoid adding to demand pressures.

### 11. Authorities’ views and agreed outlook (selected)
- Authorities expect growth close to 4 percent this year and 3½ percent in 2019; tighter labor market will constrain supply but they are more optimistic about productivity gains from investment.
- CNB expects inflation to undershoot the 2 percent target this year and converge to target at the monetary policy horizon; expects the koruna to appreciate further.
- Monetary policy: repo rate raised to 0.75 percent; FX interventions ceased; one additional rate hike expected in 2018 per CNB.
- Macroprudential: CNB seeks binding powers over LTV, DTI, DSTI; announced Recommendation on retail loans secured by residential property:
  - Recommended individual LTV limit: 90 percent.
  - Recommended aggregate cap on new loans with LTV 80–90 percent: 15 percent.
  - New upper limit on DTI: 9 (effective October 2018).
  - New upper limit on DSTI: 45 percent (effective October 2018).
  - CNB continues to seek binding statutory powers.
- CNB increased countercyclical capital buffer (CCyB) rate to 1.50 percent, effective July 1, 2019; effective CCyB starting July 2018 will be the third highest in Europe.
- Authorities: banks highly resilient; Tier 1 capital ratio increased by 0.8 percentage point to 18.5 percent in 2017.

### 12. Implementation status of 2017 Article IV recommendations (selected)
- Monetary recommendation (gradual policy rate increases; avoid FX interventions): Implemented. Repo rate raised to 0.75 percent; no FX interventions since floor removed.
- Macroprudential recommendation (make LTV, DTI, DSTI restrictions binding): Not implemented. Legislation voted down in Parliament.
- Fiscal recommendation (increase public investment; unified infrastructure plan): In progress. Public investment increased in Q4 2017; National Investment Plan expected to be finalized by end of June.
- Structural recommendations (boost participation and invest in human/physical capital): In progress. Implemented measures include increased tax deductions for children, weekly paternity leave, guaranteed nursery placement for 4‑year olds, education funding changes, vocational training reform, and amendment to the Building Act to simplify construction starts and permit proceedings.

### 13. Selected macro and financial indicators (2013–23, selected series)
- Real GDP (expenditure): -0.5; 2.7; 5.3; 2.6; 4.4; 3.7; 3.2; 2.5; 2.5; 2.5; 2.5
- Employment (annual change): 1.0; 0.8; 1.4; 1.9; 1.6; 0.9; -0.7; -0.6; -0.6; -0.3; -0.3
- Unemployment rate (in percent): 6.9; 6.1; 5.0; 3.9; 2.9; 2.5; 3.0; 3.2; 3.5; 3.5; 3.5
- Consumer prices (average): 1.4; 0.3; 0.3; 0.7; 2.4; 2.3; 2.3; 2.0; 2.0; 2.0; 2.0
- General government debt (percent of GDP, Table 1): 44.9; 42.2; 40.0; 36.8; 34.6; 33.1; 31.7; 30.8; 28.5; 26.3; 24.3
- Gross international reserves (billions of euros): 40.8; 44.9; 59.2; 81.3; 123.4; 123.3; 122.6; 122.2; 121.9; 121.6; 121.1
- NIIP (2017): -26 percent of GDP; NIIP excluding FX reserves: -89 percent of GDP.
- Banking sector indicators (selected):
  - Regulatory capital to risk-weighted assets: 15.3; 15.0; 15.6; 16.5; 17.0; 17.6; 17.7; 18.1
  - Regulatory Tier 1 capital to risk-weighted assets: 13.9; 13.9; 15.2; 16.2; 16.5; 17.1; 17.1; 17.5
  - Nonperforming loans to total gross loans (memo): 5.4; 5.2; 5.2; 5.2; 5.6; 5.5; 4.6; 3.7

### 14. Female labor force participation and childcare policy
- Female labor force participation: 69.7 percent; relatively high and growing since 2008.
- Formal childcare for children under age 3: extremely low; in contrast, 97 percent of five-year olds and 90.5percent of four-year olds are in formal childcare (vast majority public).
- Policy obligations and timelines:
  - Since September 2017, public childcare centers obliged to accept any four-year old in corresponding area.
  - Obligation extended to all three-year old children starting in September 2018 and all two-year old children starting in September 2020.
- Authorities will study staff analysis of tax impediments to greater female participation but remain unconvinced that significant infrastructure barriers exist.
- Social preferences: strong preference for long maternity leave combined with generous parental allowance available up to four years of child’s age.
- Gender pay gap: identified as a major issue; authorities analyzing causes and intend to propose measures to reduce it.

*International Monetary Fund staff compilation from "cr18187".*

### 1. Demand and Supply Pressures in the Housing Market ________________________________________ 17

### 1. Demand and Supply Pressures in the Housing Market ________________________________________ 17

### Recent developments
- GDP growth accelerated in the second half of 2017, reaching 4.4 percent y/y.  
- The unemployment rate fell to a record low of 2.3 percent in April 2018, even with increased participation.  
- Macro policies have tightened moderately: the Czech National Bank (CNB) has increased the policy rate and tightened macroprudential settings further.  
- The overall budget surplus improved by 0.9 percent of GDP in 2017; staff estimates that fiscal policy will ease in 2018 and, in particular, 2019.  
- Growth has been broad based: all sectors contributed positively, with services overtaking manufacturing in the second half of the year. Private consumption was strong, supported by real wage growth of 4 percent and employment growth of 1.6 percent in 2017. Investment—particularly private domestic capital formation—picked up in the second half of the year.  
- Household and national savings rates remain stable, at about 11 and 25 percent of GDP, respectively.  
- Inflation has so far been moderate: nominal wage inflation averaged 8½ percent in the first quarter of the year. Headline and core inflation fell in the first quarter but are now close to the target. Imported inflation has been negative.  
- The current account posted a surplus in 2017. The REER appreciated by 8 percentage points from April 2017 to April 2018. The NIIP remains comfortable at -26 percent of GDP; NIIP less official reserves is -89 percent of GDP (with most of it FDI and stable). Staff assesses the external position in 2017 to have been stronger than warranted by medium-term fundamentals, with an EBA CA model assessment of a 7 percent undervaluation (Annex I).  
- The fiscal position is comfortable: staff projects overall and structural budget surpluses of 1.6 and 1.0 percent of GDP for this year; debt is estimated to have fallen to 35 percent of GDP in 2017.  
- A new government had not yet been formed at the time of reporting; administration continues under the terms of the 2018 budget.

### Supply constraints and labor market pressures
- Supply is hitting limits: the working age population fell by 7 percent from 2009 to 2017. A significant increase in the participation rate has partly compensated for the decline.  
- Firms report hiring problems, especially for appropriately skilled workers; there is more than one vacancy per unemployed person.  
- Capacity utilization is high; labor shortages have become a major constraint on growth.  
- Employment gains are expected to slow considerably going forward, even as wage growth remains strong.

### Housing market and financial vulnerabilities
- Real estate lending has accelerated; many households continue to borrow at high multiples of incomes, associated with buoyant housing markets.  
- Overall credit growth remains in line with nominal GDP growth and household indebtedness is not high by international standards, but persistently high mortgage lending growth coupled with high household leverage could pose a risk to financial stability.

### Outlook, projections, and macroeconomic assumptions
- Staff projects real GDP growth of 3.7 percent in 2018, gradually falling to 2.5 percent by 2023.  
- Near-term domestic momentum is strong: consumer and business confidence, durable goods demand, and production equipment demand are supportive.  
- Monetary conditions follow the CNB forecast of only one policy rate increase in 2018, with more rapid tightening in 2019 and beyond. Some fiscal stimulus is expected in 2018 and 2019.  
- The external environment is supportive: euro area GDP growth—an important export market—is projected to reach 2.5 percent this year. Euro area inflation is projected to remain subdued and ECB policy is assumed accommodative.  
- Investment is assumed to accelerate in 2018 as firms attempt to compensate for labor shortages; despite supportive external demand, net exports are expected to contribute negatively to growth as import intensity of domestic demand increases.  
- CPI inflation is expected to increase in 2018 and remain slightly above target in 2019 as declining margins slow and increases in labor costs are passed on to domestic inflation; exchange rate appreciation is expected to continue but at a lower rate.

### Longer-term growth and productivity requirements
- Staff estimates potential growth at 2½ percent. Given declining employment growth, this implies labor productivity growth must increase to 2¾ percent from the historical average of 2½ percent—implying an acceleration in TFP growth given an already-high capital stock.  
- Projections assume the overall participation rate (16–64) and hours worked stay largely unchanged and that no substantial increase in inward migration occurs.

### Risks and vulnerabilities
- Risks are tilted to the downside and include external shocks, domestic vulnerabilities, and political uncertainty:  
  - Near-term growth could be stronger if domestic demand surprises on the upside (e.g., faster absorption of EU funds); potential growth could be lower if the recent pick-up in labor productivity is not sustained.  
  - The inflation outlook is uncertain: outcomes depend on whether domestic inflationary pressures (wage-driven) or imported disinflationary pressures (exchange-rate/import-price effects) dominate. Risks to domestic inflation are on the upside if productivity and firms’ markups do not absorb wage increases.  
  - A decline in global trade is a major risk for this small, externally dependent economy, especially given high concentration in auto production and integration with Germany’s production chain (vulnerability to indirect spillovers, e.g., increased protectionism). Rapid wage growth without productivity gains could erode price competitiveness. Increased financial turbulence could raise long-term interest rates and exchange rate volatility.  
  - Persistently high mortgage lending growth and high household leverage could threaten financial stability.  
  - Political uncertainty could delay structural reforms; fiscal policy could become strongly procyclical if proposed public spending and tax changes are implemented.

_International Monetary Fund staff compilation from "1. Demand and Supply Pressures in the Housing Market" (chapter content provided)._

### 11.      The authorities broadly agreed on the outlook and the balance of risks. The authorities

### 11.      The authorities broadly agreed on the outlook and the balance of risks. The authorities

### Outlook and balance of risks
- Authorities expect growth to be close to 4 percent this year and 3½ percent in 2019, driven mainly by strong domestic demand.
- Authorities agreed that a tighter labor market would constrain supply; they were more optimistic about productivity growth, which would be boosted by investment.
- The CNB expects inflation to undershoot the 2 percent target this year and converge to the target at the monetary policy horizon.
- The CNB expects the koruna, though currently at equilibrium, to appreciate further.
- Key sources of uncertainty: the exchange rate and wage growth.
- Authorities were concerned with external risks related to external demand, such as from increased protectionism.

### Monetary policy
- The CNB has moved to gradually normalize monetary conditions; the repo rate has been raised to 0.75 percent.
- FX interventions have ceased.
- The nominal effective exchange rate has appreciated by 8 percent from the exiting the floor through to April 2018; there has been some depreciation against the euro and most other currencies since then.
- One additional rate hike is expected this year. The CNB’s May 2018 inflation forecast was adjusted downwards, and on this basis the CNB projects one more rate increase in 2018, followed by a series of increases in 2019.
- Assessment: Given uncertainty about inflation, the CNB’s gradual approach to normalizing policy is appropriate; the CNB should continue to communicate readiness to raise rates earlier than currently projected if needed to fulfil its mandate.
- The CNB has adopted a new FX reserves management strategy:
  - FX reserves increased to 62 percent of 2017 GDP during the period of the koruna floor.
  - The CNB is not planning to sell the reserves.
  - FX reserves are tranched: a core, currently 45 percent of FX reserves, will be invested in short-term and highly-liquid assets; the remainder will be invested in longer-term investments with higher expected returns, including shares and mortgage-backed securities.
  - This approach is appropriate so long as liquidity, market, and other risks are contained.
- Authorities’ view: CNB favors continued gradual normalization, seeking to avoid undue appreciation that would pressure the tradeables sector. CNB assesses risks to the inflation forecast and interest rate path as broadly balanced, noting uncertainties about the transmission of labor costs and import prices to CPI.

### Macroprudential policy
- Credit developments:
  - Bank lending to residents eased to 4 percent (y/y) in April.
  - Loans to resident non-financial corporations grew by 1½ percent.
  - Loans to households increased by 7½ percent.
  - Mortgage loans to households increased by 9½ percent, off the recent peak in mid-2017 of 10½ percent, but nonetheless outpacing nominal income growth.
  - Consumer credit also grew relatively strongly.
- Household leverage and housing market indicators:
  - The aggregate household debt-to-income (DTI) ratio has not increased further over the year, given the strong growth of disposable income, but many households continue to borrow at high loan-to-income multiples.
  - The share of new housing loans with loan-to-value ratios above 80 percent remains high.
  - 14 percent of new housing loans feature loan-to-income multiples above 8.
- CNB measures taken:
  - New, non-binding recommendations implemented in 2017: Q2 included a 90 percent LTV cap on individual loans and a 15 percent cap on the share of new loans originated with LTV ratios between 80 and 90 percent.
  - In June 2017, the CNB recommended that banks pay extra attention to debt-to-income and debt-service-to-income ratios.
  - Reported lending standards have tightened and the share of new household mortgage loans with LTVs above 90 percent has declined.
- Policy recommendations and needs:
  - Additional measures are needed to insure against household financial vulnerabilities.
  - The CNB should be given binding powers over maximum LTV, DTI, and Debt-Service-To-Income (DSTI) ratios as soon as possible.
  - In the absence of legislation granting binding powers, the CNB should immediately issue recommendations over DTI and DSTI ratios to reinforce those over LTVs.
  - If borrower-based tools are not implemented, additional "supply side" measures could be considered (e.g., risk weight add-ons or minimum risk weights for property exposures), but these would only indirectly address high household leverage and a substantial increase would likely be required to make a meaningful difference given capital ratios are above regulatory requirements.
  - Better data are needed for monitoring risks: to accurately assess risks and ensure compliance with DTI and DSTI measures, the CNB needs access to comprehensive household loan data; better data on commercial real estate transactions would also be helpful.
  - Macroprudential measures should be supported by fiscal and structural policies addressing housing supply constraints (planning and zoning laws), streamlining building permits, and tax environment factors that add to housing demand.
- Authorities’ view: CNB seeks additional borrower-based tools, prefers binding powers over LTV, DTI, and DSTI ratios, is open to issuing recommendations before being granted binding powers, emphasizes importance of access to detailed loan-by-loan data, and does not favor changing risk weights due to burdensome procedures but notes discretion under Pillar II.

### Financial policy and banking system risks
- Banking system position:
  - The banking sector maintains capital above required levels.
  - As of 2017: Q4, the regulatory capital ratio was 18 percent, compared with a required ratio of 14.8 percent (Pillar 1 capital 8 percent; additional Pillar 2 capital 1.9 percent; systemic risk buffer 1.9 percent; countercyclical capital buffer 0.5 percent; capital conservation buffer 2.5 percent).
  - Average risk weights for banks using the IRB approach have been declining somewhat but are not especially low.
  - The leverage ratio decreased over the previous year mostly because of a sharp increase in holdings of central bank reserves and government bonds; tier 1 capital itself continued to increase.
  - The share of liquid assets remains relatively high and banks are funded largely by deposits.
  - The loan-to-deposit ratio was 78 percent in 2017: Q4.
  - Net interest margins remain relatively high.
- Credit risk:
  - Nonperforming loans for NFCs and households have continued to decline; default rates are falling for both NFCs and households.
- Main risks identified:
  - Growing real estate market exposures could increase risks to the banking system, especially if the share of real estate loans in total loans increases further and risk weights fall.
  - Demand for commercial real estate has been strong, though lending to developers has not increased significantly as many developers are equity financed.
- Other risks:
  - FX loans:
    - The share of foreign currency bank loans stands at 20 percent.
    - FX loans present a risk to unhedged firms that do not invoice in euros or lack euros; recent FX lending growth has plunged to zero but the stock remains significant.
    - Much recent FX lending may have been driven by expectations of koruna appreciation once the floor was removed.
    - Intrusive supervision is needed to monitor FX lending risks.
  - Non-resident inflows:
    - Non-residents’ holdings of commercial bank deposits increased significantly in early 2017 and have since remained largely unchanged.
    - Risks include a sudden withdrawal of foreign-sourced deposits, though such an event would likely be manageable.
    - The ultimate source of the inflows is mostly unknown; non-resident deposits, including from parent banks, should be subject to adequate customer due diligence (CDD) requirements, which should be effectively supervised. Under international standards, the ultimate responsibility for CDD measures remains with the domestic bank even if reliance on a parent bank is permitted.
- Stress tests: Recent CNB stress tests indicate the banking sector is resilient overall, but vulnerabilities would increase with higher real estate exposures and falling risk weights.

*Source: CZECH REPUBLIC — INTERNATIONAL MONETARY FUND (cr18187).*

### 29.      The CNB has appropriately tightened its prudential stance. The CNB has increased the

### 29.      The CNB has appropriately tightened its prudential stance. The CNB has increased the

### Prudential stance and macroprudential measures
- The CNB increased the capital buffer for three systemically-important banks effective from January 2017.
- The countercyclical capital buffer schedule:
  - current level: 0.5 percent
  - increase to 1 percent in July 2018
  - increase to 1.25 percent in January 2019

### Supervisory data and monitoring
- Better access to granular data is needed to support supervision:
  - real estate data
  - individual loans
  - household debt
- The supervisor should continue to monitor:
  - foreign currency exposures
  - nonresident exposures

### Bank Recovery and Resolution Directive (BRRD) implementation
- A Resolution Fund has been set up.
- A “single point of entry” approach has been agreed by the CNB and Single Resolution Board (SRB) for three banking groups.
- Decisions on MREL have been made at the consolidated level, including deadlines, but:
  - exact composition with respect to types of instruments, subordination, and cross-holdings is not yet clear
  - decisions over “internal” MREL will follow, pending SRB policy

### Authorities’ views on the financial sector
- Authorities consider the banking system robust and generally operating with low risk.
- Real estate exposures are recognized as one of the risks to credit institutions.
- FX lending is judged consistent with natural hedging strategies by firms to manage cashflow.
- Foreign deposits were largely sourced from parent banks prior to the exit from the FX commitment; parent banks are responsible for AML Know Your Customer rules in that context.
- AML/CFT implementation:
  - The Czech Republic has been implementing measures in line with FATF recommendations and EU legislation.
  - From April 2018, supervision is fully in line with the Joint Guidelines on Risk-based Approach to AML/CFT Supervision issued in November 2016.

### Fiscal performance in 2017 and short-term outlook
- 2017 outperformance:
  - Overall balance estimated at 1.6 percent of GDP in 2017 (Convergence Programme projection: 0.4 percent of GDP).
  - Drivers: reduced social benefit outlays; improvements in social security contributions, personal income tax revenues, and VAT collections.
  - Primary surplus: 2.2 percent of GDP in 2017.
  - Public debt declined to 35 percent of GDP in 2017.
- Medium-term projections (staff judgment of most likely policies):
  - Overall balance: 1.6 percent of GDP in 2018 (same as 2017), then gradually easing to about 1 percent of GDP.
  - Structural balance: surplus projected but lower than previously, implying fiscal stimulus of 0.1 percent of GDP in 2018 and 0.5 percent of GDP in 2019.
  - Staff note: projection includes expected-but-as-yet-not-approved increase in state employee compensation, but does not include other recently-proposed tax and spending changes.

### Fiscal projection table (percent of GDP) — selected rows
- Net lending/borrowing (overall balance): 2017: 1.6; 2018: 1.6; 2019: 1.2; 2020: 0.9; 2021: 1.0; 2022: 1.0; 2023: 1.0
- Primary balance: 2017: 2.2; 2018: 2.3; 2019: 1.8; 2020: 1.5; 2021: 1.6; 2022: 1.5; 2023: 1.5
- Structural balance: 2017: 1.2; 2018: 1.0; 2019: 0.6; 2020: 0.6; 2021: 0.8; 2022: 0.9; 2023: 1.0
- Structural balance excl revenues from EU: 2017: 0.6; 2018: 0.0; 2019: -0.4; 2020: -0.5; 2021: 0.0; 2022: 0.1; 2023: 0.2
- Public debt: 2017: 34.6; 2018: 32.8; 2019: 31.3; 2020: 30.4; 2021: 28.0; 2022: 25.9; 2023: 23.9

### Long-term fiscal risks and projections
- Staff projects general government gross debt to decline to about 33 percent in 2018 and to around 24 percent of GDP by 2023 (Annex IV).
- Long-term pressures from aging:
  - Healthcare costs projected to increase 2 percentage points of GDP by 2050, to 9 percent of GDP.
  - Pensions spending projected to increase ¾ of a percentage point, to 9 percent of GDP in 2050.
  - Combined effect implies public debt would start increasing from around 2030, passing 45 percent by 2050.
- Baseline assumptions for long-term scenario:
  - steady decline in GDP growth to 1 percent in 2040 from 2 percent in 2023
  - nominal interest rate equal to the 2023 forward rate on 10-year CZE bonds
  - inflation at the 2 percent target

### Fiscal policy challenges and timing
- Key challenges:
  - Avoiding procyclicality amid an economy running above capacity.
  - Addressing medium- and long-term spending challenges from demographics.
  - Setting incentives to raise employment and productivity.
- Specific timing concern:
  - If proposed tax changes were implemented later this year, estimated fiscal stimulus would amount to about 1 percent of GDP in 2019.

### Staff policy recommendations (fiscal and structural)
- Healthcare and retirement-age measures:
  - Increase health spending efficiency: use performance indicators; strengthen primary care gate-keeping; re-introduce co-payments to deter overconsumption.
  - Establish an automatic link between statutory retirement age and life expectancy (current statutory retirement age ~63 years, increasing but capped at 65 years in 2030 under current rules).
- Comprehensive review of taxes and spending to improve incentives and resource use:
  - Labor taxes: reduce disincentives for women as second earners (e.g., non-working spouse benefit) to increase female labor force participation; redirect savings to public childcare; prioritize gains from tax administration toward lowering social security contributions to reduce the labor tax wedge.
  - Property taxes: move toward recurrent, value-based property taxation rather than transaction taxes; consider a tax-deferral system where tax obligations accrue to a deferred-tax asset liquidated at point of sale; eliminate mortgage interest deductibility on a steady and predictable schedule.
  - Public infrastructure: establish a unified and transparent long-horizon infrastructure plan; accelerate investment absorption with fewer regulatory changes and increased processing capacity.
  - Investment support: redesign criteria for grants and tax concessions to improve returns and spread technology and best practices beyond large manufacturing firms.
- Debt management:
  - Continue extending maturities while minimizing costs for acceptable risk; extend strategy time horizon beyond current 3 years.
- Fiscal framework:
  - Fully implement the fiscal framework adopted last year to strengthen accountability and transparency; make the fiscal council fully operational soon and add the fiscal law to the constitution.

### Authorities’ views on fiscal policy
- Authorities view policies as appropriate and expect surpluses to be maintained.
- They see little potential to reduce social security taxation given revenue importance.
- They consider the effective VAT rate to be high and justify reduced rates for some items.
- They do not believe mortgage interest deductibility plays a major role in house purchase decisions.
- Municipalities have flexibility to raise more property tax revenue if needed.
- Grants are directed to underdeveloped regions and to boost employment; support for SMEs exists through lending guarantees.
- Debt maturities are increasing but constrained by weak demand for longer-term CZK-denominated assets.

### Structural policies and labor market challenges
- Main structural challenge: boost capacity amid adverse demographic changes.
- Labor market observations:
  - Overall female labor participation in line with peers, but younger women have relatively low participation.
  - Lack of childcare facilities and tax disincentives cited as causes for low participation of younger women; associated with a relatively high gender pay gap.
  - Participation of older workers has substantially increased but remains below top EU levels for those aged 60+.
- Staff findings on demographic and labor supply scenarios:
  - Under existing policies, staff projects the labor force to decline by 5 percent by 2030 and 21 percent by 2050.
  - Policies to increase participation of women and older workers and linking retirement age to life expectancy would reduce the fall in the labor force to 2 percent by 2030 and 14 percent by 2050.
  - A more ambitious scenario—raising participation rates to EU country maxima and retirement age to 67—could increase the labor force by 2030, but it would fall thereafter.

*International Monetary Fund staff summary based on the provided chapter content.*

### 45.      To boost productivity, policymakers

### 45.      To boost productivity, policymakers

### Productivity findings and firm-level patterns
- Staff analysis shows that the productivity of better-performing firms is increasing healthily, but productivity in the lower tail of firms has stalled.
- Firms in the lower tail tend to be smaller, younger, and more leveraged.
- These findings are corroborated by discussions with industry groups—unlike in some European economies, weak productivity does not appear to be caused by sclerotic older firms or by problems with access to credit.
- Survey indicators suggest regulatory and planning complexity, administrative burdens, and inconsistent enforcement are significant problems. (Selected Issues Paper: Labor Productivity)

### Factors presenting difficulties for smaller and younger firms
- Complex regulatory environment with multiple layers across central, regional, and municipal governments.
- Inconsistent application of regulations.
- Structure of tax incentives and subsidies that can distort incentives.
- Specific Doing Business and regulatory indicators cited (World Bank "Doing Business" Indicators; Orbis, IMF staff estimates; World Bank and OECD indices referenced in figures).

### Government roles: infrastructure and lifelong learning
- Infrastructure quality is assessed to be worse than in other advanced European economies. A single plan for public infrastructure, coordinated across all branches of government, would be an important contribution.
- Participation in adult learning is at the OECD average, but the framework for life-long learning should be enhanced further, given the demands of an aging workforce that will be retiring later in life.
- It is important to ensure equal access to adult learning across regions and the coordination of schemes across government.
- The National Institute for Education formulates policies on life-long learning, separate from ministries of Education, Trade and Industry, and Regional Development.

### Improving government efficiency and e-government
- Staff recommends measures to increase processing and auditing capacity, to reduce holdups in public administration.
- Increasing digitalization of government services could help address fragmentation in public administration.
- Example: initiatives to bundle all information concerning planning applications into a single “e-binder” shared across agencies, facilitating parallel processing and speeding up the planning process, reducing pressures on supply, especially in the real estate market.
- Such “e-government” initiatives are encouraged more broadly.

### Authorities’ views and recent measures
- Authorities agreed with the importance of boosting capacity and pointed to several recently-implemented measures:
  - A new amendment to the Building Act simplifies the conditions for starting construction and accelerates building permit proceedings.
  - A National Investment Plan is expected by the end of June.
  - Education funding has been changed to improve the quality of regional education.
  - Vocational training reform aims to increase coordination with businesses and improving the skills matching.
  - New measures to aid child care include an increase in child-related tax deductions, introduction of one week of paternity leave, and a guaranteed placement in nursery schools for children aged four and older.
  - The efficiency of public administration would be helped by the extension of electronic procurement.

### Demographics and labor force implications
- The Czech Republic currently has the advantage of a younger population than Western European peers, with a higher share of those of prime working age, but demographics are projected to worsen in some scenarios.
- Old-age Dependency Ratio (65+/(20-64)): Levels
  - Czech Republic: 30.5, 32.5, 37.1, 44.2, 51.3, 54.9, 56.5, 59.4
  - (Table header corresponds to 2015, 2020, 2025, 2030, 2035, 2040, 2045, 2050)
- A significant increase in participation has so far compensated for the fall in working age population; the largest contribution to the active population has come from older workers while participation of the young has declined.
- Female labor force participation has increased in recent years and is close to the EU average, but the employment rate is particularly low for mothers with children under 3 years old and formal childcare for children under the age of 3 is among the lowest in the EU.
- Labor productivity growth has lagged peers; non-ICT capital deepening was the major source of labor productivity growth. Manufacturing had the highest productivity growth since 1996, but its share in employment has declined.

### Staff appraisal and policy recommendations
- The economy has been doing very well, but supply constraints are biting; working age population is shrinking and aging, and old-age dependency ratios are set to increase sharply.
- The real exchange rate appears to remain undervalued, and likely to appreciate over the medium term; projected gradual monetary tightening should help address this.
- The gradual approach to normalizing monetary conditions should continue, with the CNB communicating readiness to raise rates earlier than currently projected if needed.
- More measures are needed to insure against financial vulnerabilities: some households are highly leveraged. The best response would be limits on DTI and DSTI ratios, to complement those already in place on LTV ratios.
- Macroprudential tools do not remove the need for strong microprudential supervision, nor can they fix underlying problems caused by insufficient supply and tax policies that boost demand for real estate.
- Fiscal policy should avoid procyclicality, address long-run spending issues, and set incentives for the best use of resources. Proposals such as extra spending on education and infrastructure could boost productivity, but care is needed that they do not add to pressure the economy is already experiencing to meet demand.
- Taxes and spending should be reviewed, particularly grants and tax concessions, tax expenditures that can affect incentives to work, property taxation, and the proposed changes to personal income tax and VAT.
- Structural policies to facilitate higher productivity: a single plan for public infrastructure, an enhanced framework for life-long learning, and easier planning processes would be important contributions.

*IMF staff report (excerpt): "To boost productivity, policymakers" (content unit cr18187).*

### 55.      It is recommended that the next Article IV consultation be held on the standard

### 55.      It is recommended that the next Article IV consultation be held on the standard

### Recommendation on Article IV consultation
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

### Key macroeconomic indicators (selected figures from Tables 1–4, 2013–23)
- Real GDP (expenditure): -0.5; 2.7; 5.3; 2.6; 4.4; 3.7; 3.2; 2.5; 2.5; 2.5; 2.5
- Domestic demand: -0.6; 3.4; 5.9; 1.5; 3.7; 4.0; 3.7; 3.1; 3.1; 3.1; 3.1
- Investment (percent of GDP): 25.1; 25.1; 26.5; 25.0; 25.2; 25.7; 25.7; 25.9; 26.0; 26.2; 26.4
- Gross national savings (percent of GDP): 24.1; 26.1; 28.2; 27.9; 27.5; 26.7; 26.3; 26.2; 26.0; 25.8; 25.5
- Employment (annual change): 1.0; 0.8; 1.4; 1.9; 1.6; 0.9; -0.7; -0.6; -0.6; -0.3; -0.3
- Unemployment rate (in percent): 6.9; 6.1; 5.0; 3.9; 2.9; 2.5; 3.0; 3.2; 3.5; 3.5; 3.5
- Consumer prices (average): 1.4; 0.3; 0.3; 0.7; 2.4; 2.3; 2.3; 2.0; 2.0; 2.0; 2.0
- Broad money (M3) end-of-year percent change (selected years): 5.8; 5.9; 8.0; 6.5; 10.4
- Private sector credit (end-of-year percent change, selected years): 3.7; 3.6; 6.5; 7.8; 5.9
- General government revenue (percent of GDP): 41.4; 40.3; 41.1; 40.2; 40.4; 41.5; 41.7; 41.7; 41.6; 41.6; 41.6
- General government expenditure (percent of GDP): 42.6; 42.4; 41.7; 39.4; 38.8; 40.0; 40.6; 40.8; 40.6; 40.6; 40.6
- Net lending / Overall balance (percent of GDP): -1.2; -2.1; -0.6; 0.7; 1.6; 1.5; 1.1; 0.8; 1.0; 1.0; 1.0
- Primary balance (percent of GDP): -0.2; -1.0; 0.3; 1.5; 2.2; 2.2; 1.7; 1.5; 1.6; 1.6; 1.5
- General government debt (percent of GDP, Table 1): 44.9; 42.2; 40.0; 36.8; 34.6; 33.1; 31.7; 30.8; 28.5; 26.3; 24.3
- Trade balance (goods and services, percent of GDP): 5.8; 6.4; 5.8; 7.4; 7.2; 5.6; 5.2; 4.9; 4.6; 4.1; 3.5
- Current account balance (percent of GDP, Table 1): -0.5; 0.2; 0.2; 1.6; 1.1; -0.2; -0.5; -0.7; -1.0; -1.4; -1.9
- Gross international reserves (billions of euros): 40.8; 44.9; 59.2; 81.3; 123.4; 123.3; 122.6; 122.2; 121.9; 121.6; 121.1
- Gross official reserves (months of current year's imports): 4.5; 4.1; 5.6; 7.7; 10.8; 9.7; 8.5; 7.8; 7.2; 6.6; 6.1
- External debt, percent of GDP: 63.2; 68.0; 68.5; 73.3; 90.5; 80.5; 71.8; 67.4; 63.7; 60.8; 58.3
- Nominal GDP (USD billions): 209.4; 207.8; 186.8; 195.3; 213.7; 250.9; 276.9; 295.8; 314.4; 333.0; 351.5
- Population (millions): 10.5; 10.5; 10.5; 10.6; 10.6; 10.6; 10.6; 10.6; 10.6; 10.6; 10.7
- GDP per capita (USD, selected values): 19,913; 19,769; 17,729; 18,506; 20,201; 23,690; 26,106; 27,860; 29,571; 31,288; 33,000
- Output gap (percent of potential output): -4.3; -3.0; -0.1; -0.2; 1.2; 1.5; 1.6; 1.2; 0.7; 0.4; 0.2

### Balance of payments and capital flows (selected figures, Table 2)
- Current account balance (percent of GDP): -0.5; 0.2; 0.2; 1.6; 1.1; -0.2; -0.5; -0.7; -1.0; -1.4; -1.9
- Trade balance (percent of GDP): 4.1; 5.1; 4.1; 5.1; 4.8; 3.4; 3.1; 2.8; 2.6; 2.2; 1.7
- Exports (percent of GDP): 65.4; 70.5; 68.6; 66.9; 66.8; 65.4; 64.9; 64.5; 64.4; 63.8; 63.1
- Imports (percent of GDP): 61.4; 65.4; 64.5; 61.7; 62.1; 62.0; 61.8; 61.6; 61.8; 61.7; 61.4
- Factor income (net, percent of GDP): -6.1; -6.0; -5.5; -5.3; -5.2; -5.1; -5.1; -5.0; -5.0; -4.9; -4.9
- Financial account (change in stocks, + = increase, percent of GDP): 1.7; 1.5; 3.8; 2.4; 2.3; 1.0; 0.4; 0.1; -0.2; -0.4; -0.8
- Direct investment, net (percent of GDP): 0.2; -1.9; 1.1; -3.9; -2.7; -1.7; -1.7; -1.7; -1.6; -1.6; -1.6
- Reserve assets (percent of GDP, change in stocks): 4.6; 1.7; 7.6; 11.8; 24.7; -0.9; -1.5; -1.4; -1.3; -1.3; -1.3

### General government operations and fiscal metrics (Table 3, selected)
- Revenue (percent of GDP): 41.4; 40.3; 41.1; 40.2; 40.4; 41.4; 41.5; 41.5; 41.5; 41.5; 41.5
- Taxes (percent of GDP): 19.9; 19.1; 19.5; 19.9; 20.2; 20.3; 20.4; 20.3; 20.3; 20.3; 20.3
- Social contributions (percent of GDP): 14.8; 14.6; 14.4; 14.7; 15.0; 15.7; 15.9; 15.9; 15.9; 15.9; 15.9
- Expenditure (percent of GDP): 42.6; 42.4; 41.7; 39.4; 38.8; 39.8; 40.4; 40.6; 40.5; 40.5; 40.5
- Compensation of employees (percent of GDP): 8.9; 8.8; 8.7; 8.8; 9.1; 9.4; 9.8; 9.9; 10.0; 10.0; 10.0
- Interest (percent of GDP): 1.3; 1.3; 1.1; 0.9; 0.7; 0.8; 0.7; 0.7; 0.7; 0.7; 0.6
- Net acquisition of nonfinancial assets (percent of GDP): 3.7; 4.1; 5.1; 3.3; 3.3; 3.7; 3.7; 3.7; 3.7; 3.7; 3.7
- Gross Operating Balance (percent of GDP): 2.5; 2.2; 4.5; 0.7; 4.9; 5.3; 4.9; 4.6; 4.7; 4.7; 4.7
- Net lending/borrowing (overall balance, percent of GDP): -1.2; -2.1; -0.6; 0.7; 1.6; 1.6; 1.2; 0.9; 1.0; 1.0; 1.0
- General government debt (memorandum, percent of GDP in Table 3): 44.9; 42.2; 40.0; 36.8; 34.6; 32.8; 31.3; 30.4; 28.0; 25.9; 23.9

### Financial soundness indicators (selected, Table 5)
- Regulatory capital to risk-weighted assets: 15.3; 15.0; 15.6; 16.5; 17.0; 17.6; 17.7; 18.1
- Regulatory Tier 1 capital to risk-weighted assets: 13.9; 13.9; 15.2; 16.2; 16.5; 17.1; 17.1; 17.5
- Return on assets: 1.3; 1.2; 1.4; 1.2; 1.2; 1.2; 1.2; 1.1
- Nonperforming loans to total gross loans (memo): 5.4; 5.2; 5.2; 5.2; 5.6; 5.5; 4.6; 3.7
- Liquid assets to total assets: 29.4; 29.9; 32.6; 33.8; 30.5; 31.5; 29.1; 20.4
- Liquid assets to short-term liabilities: 71.1; 72.2; 71.4; 67.4; 64.9; 61.7; 53.8; 39.8

### External sector assessment — main findings and policy implications (Annex I)
- Staff assessment (2017): The external position in 2017 was stronger than the level consistent with medium-term fundamentals and desirable policies.
- REER and CA model results:
  - CPI-based REER appreciated by 7 percent in 2017; ULC-based measure appreciated by 7.5 percent in 2017.
  - EBA Current Account (CA) model indicates a 7 percent undervaluation — the actual CA exceeds the norm by 3.2 percent of GDP. Staff places the most weight on the CA model.
  - External Sustainability analysis: REER close to equilibrium; CA gap: -0.4 percent of GDP; corresponding REER gap: +1 percent.
  - REER model indicates REER index and level overvaluation of +11 percent and +12.4 percent respectively; staff finds this result problematic given large residuals and inconsistency with other indicators.
- Staff summary metrics (2017):
  - Staff estimates the CA gap in 2017 to have been 3 percent of GDP.
  - Staff estimates the REER to have been undervalued by 7 percent.
- Exchange rate, reserves, and capital flows:
  - Inflows in run up to removal of koruna floor were largely retained, channeled into government bonds and commercial bank deposits, associated with a large increase in central bank reserve assets.
  - Since the exit, some non-resident investors have left the government bond market; other investment recorded additional small inflows.
  - NIIP has slightly declined since the exit to -26 percent of GDP, of which 62 percentage points are official reserves. NIIP excluding FX reserves is -89 percent of GDP, comprised of -55 percent of GDP from FDI and -19 percent of GDP from other investment.
  - Foreign exchange reserves are substantial; cumulative increase during the koruna floor period with a significant jump before April 2017. As a share of GDP reserves have been declining since the FX floor exit. CNB does not regard balance sheet revaluation losses as a threat to independence.
- Policy implication:
  - Continued but gradual monetary policy tightening consistent with equilibrium real exchange rate appreciation is appropriate.
  - The current policy mix, which relies more on monetary tightening rather than fiscal tightening, is consistent with unwinding the estimated undervaluation.
- Medium-term outlook on REER:
  - Some REER appreciation is likely over the medium term if Czech national income converges to the European mean and if concentration in manufacturing does not increase.
  - Mechanisms cited:
    - Balassa-Samuelson: higher productivity in tradeables with wage equalization drives up the real exchange rate.
    - Demand-side: higher incomes increase relative demand for non-tradeable services, driving up the real exchange rate.

*Sources: Czech National Bank; Czech Statistical Office; Ministry of Finance; Haver Analytics; IMF staff estimates and projections.*

### Annex II. Risk Assessment Matrix

### Annex II. Risk Assessment Matrix

### External Risks
- Retreat from cross-border integration.
  - Likelihood: Medium
  - Time Horizon: Short to medium term
  - Expected Impact: Medium — Damage to global supply chains that benefit the Czech economy
  - Policy Response: A temporary easing bias would be appropriate.

- Policy and geopolitical uncertainties.
  - Description: Two-sided risks to U.S. growth with uncertainties about the positive short-term impact of the tax bill on growth and the extent of potential medium-term adjustment to offset its fiscal costs; uncertainty associated with negotiating post-Brexit arrangements and NAFTA and associated market fragmentation risks; and evolving political processes, including elections in several large economies, weigh on the whole on global growth.
  - Likelihood: Medium
  - Time Horizon: Short to medium term
  - Expected Impact: Medium — Border closures and restrictions on the free movement of goods, services, and labor weigh on trade.
  - Policy Response: Maintaining accommodative monetary conditions, while loosening fiscal stance.

- Weaker-than-expected global growth.
  - Components:
    - Structurally weak growth in key advanced economies: Low productivity growth (U.S., euro area and Japan), high debt, and failure to fully address crisis legacies by undertaking structural reforms amidst persistently low inflation (euro area and Japan) undermine medium-term growth.
    - Significant China slowdown and its spillovers: Ongoing efforts to “de-risk” the financial system are welcome, but too fast an adjustment and improper sequencing may adversely affect near-term growth (low likelihood). Over the medium term, overly ambitious growth targets and over reliance on credit stimulus and investment lead to unsustainable policies, reducing fiscal space and increasing financial imbalances. A sharp adjustment would weaken domestic demand, with adverse international spillovers, including a pullback in capital flows to EMs (medium likelihood).
  - Likelihood: High (overall); Low to medium for China downside
  - Time Horizon: Medium term; Short to medium term for China
  - Expected Impact: High — As a small open economy, Czech Republic growth is highly dependent on export growth, especially to Germany and the euro area. On the upside, stronger-than-expected demand from trading partners would have a positive impact on growth.
  - Policy Response: Medium — External demand would wane, weighing on Czech Republic’s exports and growth. Policies supporting domestic demand, as well as diversifying trade partners and specialization could help cushion the impact on the economy.

- Financial conditions.
  - Components:
    - Tighter global financial conditions: Continued monetary policy normalization and stretched valuations could lead to abrupt increases in interest rates, tightening conditions, higher debt service and refinancing risks, and capital account pressures.
    - Further pressure on traditional bank business models: Legacy problems and potential competition from non-banks curb bank profitability; loss of confidence could increase risk of distress at major banks with knock-on effects. Migration of activities outside traditional banking (fintech) raises monitoring challenges.
  - Likelihood: High for tighter conditions; Medium for bank-model pressure
  - Time Horizon: Short to medium term for tighter conditions; Medium term for bank-model pressure
  - Expected Impact: Low/Medium — The banking system is well capitalized, with stable funding. Recent stress tests by the CNB indicate that the banking sector is resilient overall, but risks would increase if the share of real estate loans in total loans were to increase further and risk weights were to fall. Czech banks are funded mainly from deposits. Net interest margins, though slightly lower than previously, remain high, and returns are relatively high.
  - Policy Response: Maintaining accommodative monetary conditions would buffer shocks.

- Lower energy prices (weakening OPEC/Russia cohesion and/or recovery of oil production in Africa).
  - Likelihood: Low
  - Time Horizon: Short to medium term
  - Expected Impact: Medium — Household real incomes would be boosted and lower production costs would support growth. Lower import prices would temporarily lower inflation away from the target.
  - Policy Response: Consistent monetary framework emphasizing the priority of the inflation objective.

### Domestic Risks
- Financial stability risks arising from rapid growth in lending, especially to real estate.
  - Likelihood: Medium
  - Time Horizon: Short to medium term
  - Expected Impact: Medium — Some households appear overextended and vulnerable to house price, interest rate, or income shocks.
  - Policy Response:
    - Powers of direction for borrower-based macroprudential measures are needed to strengthen the demand-side tools to implement macroprudential policy.
    - Access to more granular data on real estate, individual loans, and household debt would help back supervision.
    - Structural and fiscal policies should help reduce distortions.

- Inflationary pressures different than expected.
  - Likelihood: Medium
  - Time Horizon: Short term
  - Expected Impact: Medium — The inflation outlook is particularly uncertain, as the outcome will depend on which of domestic inflationary and imported disinflationary pressures dominate.
  - Policy Response: Altered monetary stance.

- Uncertainty about near-term and potential growth.
  - Likelihood: Medium
  - Time Horizon: Short and long term
  - Expected Impact: Medium — Declining working age population means that sustaining robust GDP growth requires acceleration in productivity growth. Firms might substitute more than anticipated toward capital to address labor shortages.
  - Policy Response: Fiscal and structural policies could reduce distortions and boost the capacity of the economy.

- Political uncertainty.
  - Likelihood: Medium
  - Time Horizon: Short term
  - Expected Impact: Low — The domestic political situation remains in flux, potentially delaying structural reforms.
  - Policy Response: Maintain sound macroeconomic policies during transition.

- RAM methodological note:
  - The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).
  - The relative likelihood is the staff’s subjective assessment: “low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent.
  - The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.
  - “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

*Source: Annex II. Risk Assessment Matrix — Czech Republic, IMF staff.*

### Annex VI. Implementation of the 2017 Article IV

### Annex VI. Implementation of the 2017 Article IV

### Key recommendations and implementation status
- Monetary
  - Recommendation: Make policy rate increases gradual and guided by the data; avoid FX interventions.
  - Status: Implemented. The CNB has moved to gradually normalize monetary conditions. The repo rate has been raised to 0.75 percent. There have been no FX interventions since the currency floor was removed.
- Macroprudential
  - Recommendation: Make LTV, DTI, and DSTI restrictions binding.
  - Status: Not implemented. Legislation providing powers over the LTV, DTI and DSTI was voted down in the Parliament.
- Fiscal
  - Recommendation: Increase public investment spending, establish a unified and transparent infrastructure plan.
  - Status: In progress. Public investment increased in the last quarter of 2017 and is projected to accelerate this year, mainly due to increased absorption of EU funds. A National Investment Plan is expected to be finalized by the end of June.
  - Recommendation: Improve the debt management framework.
  - Status: In progress. The debt management office has started to increase the maturities.
- Structural
  - Recommendation: Boost potential growth by increasing labor market participation of certain population groups, and enhancing investment in human and physical capital.
  - Status: In progress. Measures implemented include:
    - increase in tax deductions concerning children and child allowances;
    - introduction of weekly paternity leave;
    - guaranteed placement in nursery schools for children aged 4 and above;
    - changes in education funding to improve quality of regional education;
    - vocational training reform to increase coordination with businesses and improve skills matching;
    - amendment to the Building Act simplifying conditions for starting construction and accelerating building permit proceedings.

### Fund relations and financial positions
- Membership Status: Joined 01/01/1993; Article VIII.
- General Resources Account (SDR Million / Percent of Quota)
  - Quota: 2,180.20 / 100.00
  - IMF’s Holding of Currency (Holding Rate): 1,879.77 / 86.22
  - Reserve Tranche Position: 300.43 / 13.78
- SDR Department (SDR Million / Percent of Quota)
  - Net Cumulative Allocation: 780.20 / 100.00
  - Holdings: 457.00 / 58.57
- Outstanding Purchases and Loans: None
- Financial Arrangements (Amount Approval Date Expiration Date Approved Drawn; Type: Stand-By)
  - Stand-By: March 17, 1993 — March 16, 1994; (SDR Million) Approved 177.00 / Drawn 70.00
- Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): Charges/Interest
  - 2018: 2.09
  - 2019: 2.86
  - 2020: 2.86
  - 2021: 2.86
  - 2022: 2.86
  - Total (row header shown as Total): 2.09 / 2.86 / 2.86 / 2.86 / 2.86 (as above)

### Exchange rate arrangement and CNB policy actions
- Currency: Czech koruna; de jure arrangement: floating.
- Historical policy actions:
  - November 7, 2013: CNB announced it would (if needed) intervene to weaken koruna to bring exchange rate close to CZK 27.
  - Effective April 6, 2017: CNB removed its 3-year cap on the koruna; de facto arrangement reclassified to floating from stabilized, effective April 6, 2017.
- CNB communication:
  - February 2018: CNB resumed publishing the EUR/CZK exchange rate forecast consistent with its inflation forecast.
- Repo rate: raised to 0.75 percent (see Monetary implementation above).
- No FX interventions since the currency floor was removed.

### Statistical and data issues
- Assessment of Data Adequacy for Surveillance: Data provision is adequate for surveillance.
- National Accounts:
  - CSO compiles annual and quarterly national accounts on ESA2010 basis.
  - Annual Supply-Use Tables (SUT) by 88 types of economic activities and 88 products.
  - Share of non-observed economy in GDP varied from seven to eight percent.
- Price Statistics:
  - CSO compiles monthly CPI using weighting structure based on 2014 expenditure data.
  - Monthly HICP disseminated according to European regulations.
  - Producer price index released monthly covering manufacturing, construction, agriculture, and select business services.
  - Monthly import and export price indexes compiled from establishments engaged in export/import activities.
- Government Finance Statistics:
  - Fiscal data in the GFSM 2014 framework reported through the Eurostat convergence project with the IMF.
  - Annual and quarterly fiscal data compiled on ESA2010 basis by the CSO, including non-financial accounts, financial accounts, and financial balance sheets.
  - Government transactions recorded on an accrual basis.
- Monetary and Financial Statistics:
  - Monthly MFS data sent to STA by ECB and based on standardized report forms (SRFs).
  - MFS covers central bank (CNB) and other depository corporations; data from other financial corporations not currently compiled.
  - CNB reports financial soundness indicators for Deposit Takers quarterly to STA.
- External sector statistics:
  - CNB compiles and disseminates balance of payments and international investment position statistics in line with BPM6.
  - CNB derives BOP financial account transactions from changes in position data adjusted by exchange rate, price, and other changes.
  - CNB monthly disseminates the data template on International Reserves and Foreign Currency Liquidity.
  - Participation in CDIS and CPIS; quarterly external debt statistics reported to QEDS.
- Data Standards and Quality:
  - The Czech Republic adheres to the SDDS Plus since April 2016.
  - Data ROSC published on July 1, 2000.

### Table of Common Indicators Required for Surveillance (as of June 6, 2018) — selected entries
- Exchange Rates: Date of Latest Observation: current | Date Received: current | Frequency of Data: D | Frequency of Reporting: D | Frequency of Publication: D
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities:
  - Date of Latest Observation: Apr. 2018 | Date Received: May 2018 | Frequency of Data: D | Frequency of Reporting: M | Frequency of Publication: M
- Reserve/Base Money: Apr. 2018 | May 2018 | M | M | M
- Broad Money: Apr. 2018 | May 2018 | M | M | M
- Central Bank Balance Sheet: May 2018 | May 2018 | M | M | M
- Consolidated Balance Sheet of the Banking System: Mar. 2018 | Apr. 2018 | M | M | M
- Interest Rates: Current | Current | D | D | D
- Consumer Price Index: Apr. 2018 | May 2018 | M | M | M
- Revenue, Expenditure, Balance and Composition of Financing – General Government: 2017 Q4 | May 2018 | Q | Q | Q
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Mar 2018 | Apr. 2018 | M | M | M
- Stocks of Central Government and Central Government-Guaranteed Debt: 2017 Q4 | May 2018 | Q | Q | Q
- External Current Account Balance: Mar. 2018 | May 2018 | M | M | M
- Exports and Imports of Goods and Services: Mar. 2018 | May 2018 | M | M | M
- GDP/GNP: 2018 Q1 | May 2018 | Q | Q | Q
- Gross External Debt: 2017 Q4 | Mar. 2018 | Q | Q | Q
- International Investment Position: 2017 Q4 | Mar. 2018 | Q | Q | Q

### Statement by the Czech authorities (Michaela Erbenova and Ondra Stradal), June 22, 2018 — key points
- Economic performance
  - Uninterrupted growth since late 2013; pace peaked above annualized 5 percent in the fourth quarter of 2017.
  - Growth expected to gradually decelerate but remain well above 3 percent this year and next.
  - Unemployment rate: 2.3 percent (lowest in the EU and among OECD countries).
  - Inflation rate: very close to CNB’s target of 2 percent.
  - Budget surplus achieved in both 2016 and 2017.
  - Public debt: below 35 percent of GDP; projected below 30 percent of GDP by 2021.
- Exchange rate and monetary policy
  - November 2013: CNB introduced koruna floor at EUR/CZK 27.00.
  - April 6, 2017: CNB discontinued the commitment; exit judged timely.
  - Post-exit exchange rate appreciation to approximately 25.30 in Q1 2018 with low volatility; moderate correction in April and May due to external factors.
  - February 2018: CNB resumed publishing EUR/CZK exchange rate forecast consistent with inflation forecast.
  - Annual inflation: 2.2 percent in May.
  - CNB prefers tightening via interest rate channel rather than exchange rate.
- Financial sector and macroprudential policy
  - Banks highly resilient; stress tests in Financial Stability Report (June 12, 2018) support resilience.
  - Tier 1 capital ratio increased by 0.8 percentage point to 18.5 percent in 2017.
  - CNB increased countercyclical capital buffer (CCyB) rate to 1.50 percent, effective July 1, 2019. This is the fourth increase over the past two years; starting July 2018 the effective CCyB will be the third highest in Europe.
  - Foreign currency loans viewed as not a serious risk; extended solely to corporate sector and used as natural hedge by exporters.
  - Real estate risks acknowledged: transaction housing prices grew fastest in EU for most of 2017; average year-on-year growth of apartment prices almost 16 percent in the individual quarters of 2017.
  - Household debt-to-gross disposable income ratio: slightly over 60 percent (well below EU average).
  - CNB Recommendation on retail loans secured by residential property:
    - Recommended individual LTV limit: 90 percent.
    - Recommended aggregate cap on volume of new loans with LTV between 80 and 90 percent: 15 percent.
    - New upper limit on DTI: 9 (effective October 2018).
    - New upper limit on DSTI: 45 percent (effective October 2018).
    - CNB continues to seek binding statutory powers for upper LTV, DTI and DSTI limits.
- Fiscal developments and policy
  - October 2017 elections produced a more fragmented Parliament; minority/acting government in place after January 2018 vote of no confidence.
  - Regular budget proposed by previous government approved in December 2017 and is being implemented.
  - Budget surplus in 2017: 1.6 percent of GDP (highest in Czech history).
  - VAT revenues increased by 9.5 percent, exceeding nominal household consumption dynamics by 3 percentage points; helped by new VAT reporting and electronic registration of sales introduced since 2016.
  - Government pursuing comprehensive reverse charge mechanism to reduce VAT evasion.
  - Direct tax revenues grew by almost 8 percent; personal income tax collection up by 11.4 percent.
  - Budget outlook assumes surpluses in the next three years.
  - Room for targeted expenditure increases: increased funding for regional education; plans to continue raising wages of doctors, nurses, and other public health care employees.
  - Measures to improve cost-effectiveness in health care: computerization, new technologies assessment, stocktaking of hi-tech equipment purchases.
  - Fiscal institutions: 2017 first year applying new fiscal rule for determining maximum central government expenditure; national Budget Council set up and members elected in January 2018; Budgetary Forecast Committee to assess realism of forecasts.
- Structural agenda and labor market
  - Czech Republic on track or reached most Europe 2020 targets; more action needed on energy efficiency and R&D spending.
  - Total labor participation rate: 76.7 percent; staff highlight room to improve participation of young women and older workers.

*Source: Annex VI. Implementation of the 2017 Article IV (cr18187).*

### 69.7 percent, is already relatively high—in some age cohorts at the EU maxima—and has been

### cr18187 - 69.7 percent, is already relatively high—in some age cohorts at the EU maxima—and has been

### Female labor force participation and childcare infrastructure
- 69.7 percent, is already relatively high—in some age cohorts at the EU maxima—and has been growing since 2008.
- The extremely low formal childcare for children under the age of three, highlighted by staff in Figure 12, is a mirror image of that.
- In contrast, 97 percent of five-year old children and 90.5percent of four-year old children are in formal childcare, the vast majority of which is public.
- Maternal employment is at or above the EU average for mothers of children older than three years.

### Policy measures, obligations, and timelines
- Since September 2017, public childcare centers are obliged to accept any four-year old child living in the corresponding area.
- This obligation will be extended to all three-year old children starting in September 2018 and all two-year old children starting in September 2020.
- The authorities will study staff’s analysis of tax impediments to greater female labor force participation, but remain to be convinced that significant infrastructure barriers exist to increase the participation of some cohorts.
- There is a strong social preference in the Czech Republic for long maternity leave combined with a generous state social support system, including a parental allowance which can be drawn up to four years of child’s age.

### Gender pay gap
- The large gender pay gap is in contrast a major issue for the Czech Republic.
- The authorities currently analyze its causes in conjunction with the social partners and intend to propose measures to reduce it.

*Source: IMF staff report (cr18187).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18187.pdf_