## 1czeea2022001

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### A Solid Economic Position Entering the Pandemic
- Pre-pandemic strengths:
  - Inflation: 2.8 percent in 2019.
  - Public debt: low at 30 percent of GDP.
  - Unemployment and growth: steady upswing since 2014; solid GDP growth and declining unemployment.
- Pandemic impact:
  - Real GDP: declined by 5.8 percent in 2020.
  - Headline fiscal deficit: 5.6 percent of GDP in 2020.
  - Unemployment: peaked at 3.3 percent in 2021:Q1.
  - Compensation of employees growth: 1.4 percent in 2020 (7.8 percent in 2019).
- Health and vaccination:
  - Vaccination: 58.4 percent (6.2 million) with two doses as of November 19, 2021; above 75 percent coverage for ages 50 and older.
  - State of emergency ended on April 11, 2021; cases increased again in November 2021.
- External position:
  - Current account surplus: 3.6 percent of GDP in 2020.
  - Exchange rate: depreciated by 10 percent relative to the Euro in March 2020, recovered to pre-pandemic levels by May 2021.

*Source: IMF staff report — "1. A Solid Economic Position Entering the Pandemic" (Czech Republic).*

### Near-term Growth Outlook and Inflation
- Baseline projections:
  - Real GDP (expenditure): 2021: 2.9; 2022: 3.6.
  - Staff projects economic activity to rebound to 2.9 percent in 2021 and 3.6 percent in 2022.
  - Output gap will become slightly positive entering 2022 and is expected to close in the medium term.
- Inflation path and drivers:
  - Inflation averaged 3.2 percent in 2020.
  - Inflation highs: 6.6 and 5.8 percent in October 2021.
  - Staff projects inflation to remain elevated through 2021 and early 2022, then gradually converge to the CNB’s target range by early 2023.
  - Drivers: tight labor and housing markets, imputed rents, GVC disruptions, rising food and fuel prices, unit labor costs and wage inflation, import price rebound.
- Monetary policy assumptions:
  - Staff’s baseline assumes the CNB raises rates to 3.5 percent in early 2022.
  - CNB actions during 2021 (pre-baseline): two 25bp hikes in July and August, a 75bp hike in October, and a 125bp hike in November to 2.75 percent from 0.25 percent at the beginning of 2021.
  - CNB policy rate: lowered by cumulative 200 bps to 0.25 percent in spring 2020; subsequently raised (see above) and further increased in December to 3.75 percent (statement notes a December increase by 100 basis points to 3.75 percent).
  - Staff estimates a neutral rate of 2–3 percent; given trends, a higher policy rate than this range is appropriate.
- Staff recommendation:
  - Support tightening stance to counteract inflation pressures and prevent inflation expectations from becoming untethered; future policy should respond primarily to movements in core inflation and inflation expectations.

### Macrofinancial Vulnerabilities and Housing Market
- House prices and valuations:
  - House price growth: accelerated to a record high of 14½ percent year-over-year in 2021:Q2.
  - CNB estimates property prices to be overvalued by 25 percent on average (as of mid-2021).
  - Cumulative property price growth of about 54 percent in the five years prior to 2021.
- Household indebtedness and mortgage risks:
  - Aggregate household indebtedness: increased by 2½ percentage points to 34 percent of GDP during 2020.
  - Financing guarantees offered: about 15½ percent of GDP (uptake one-tenth of available balance).
  - Share of loans with DTI ratios:
    - Above eight: increased from about 17 percent at end-2019 to about 27 percent in February 2020.
    - Above nine: increased from about 3¼ percent to about 14 percent.
  - DSTI ratios:
    - Above 45 percent: increased from about five to 17¾ percent.
    - Above 50 percent: increased from about three to 8 percent.
  - Large proportion of mortgages with fixation periods up to five years increases exposure to interest rate shocks.
- Macroprudential responses:
  - CNB released CCyB to 0.5 percent from 1.75 percent in 2020; later decisions raised CCyB:
    - CCyB buffer rate was increased to 2 percent (on November 25, 2021) effective January 2023.
  - Mortgage recommendations relaxed in 2020 (LTV to 90 percent; DSTI to 50 percent; DTI recommendation removed) and later tightened in November 2021 (effective April 2022): DTI (8.5), DSTI (45 percent), LTV (80 percent); limits for applicants under 36: DTI (9.5), DSTI (50 percent), LTV (90 percent).
  - Staff welcomes November 2021 tightening and recommends tight prudential tools, coordinated housing supply and tax policies, proper calibration for lower risk groups, clear communication, and close monitoring with potential for further tightening.

### Fiscal Developments, Policy Recommendations, and Debt Outlook
- Fiscal outcomes and projections:
  - Headline deficit: 5.6 percent of GDP in 2020.
  - Fiscal support announced as of end-October 2021: about 25 percent of 2020 GDP.
  - Above-the-line measures: CZK 533.0 bn, 9.4 percent of 2020 GDP (uptake CZK 430.4 bn, 7.6 percent of 2020 GDP).
  - Fiscal impulse: almost 4½ percent of potential GDP in 2020; 2 percent in 2021.
  - Staff estimates the budget deficit widened to 7¼ percent of GDP in 2021 from 5.6 percent in 2020.
  - General government debt projected to increase by 5¾ percentage points to 43½ percent of GDP at end-2021.
  - Staff projects headline deficit of 2½ percent of GDP in 2026 and a primary deficit of 1¾ percent under a path with yearly structural balance improvement of ½ percentage point; public debt projected to increase to 49 percent of GDP by 2026.
- Personal income tax (PIT) change:
  - Beginning 2021, PIT rate for employees lowered to 15 percent from an effective 20.1 percent; basic tax deduction raised by CZK 3,000 (from CZK 24,840) in 2021 and again in 2022.
  - The measure is non-targeted and lowers revenue by about 2 percentage points of GDP beyond 2021 (staff notes no phasing out plans announced).
- Public Debt Sustainability Analysis (DSA) highlights:
  - Public debt: 37¾ percent of GDP in 2020; about 41½ percent of GDP in 2021:Q2.
  - Projected to rise to 49 percent of GDP by 2026 under the baseline.
  - Debt-to-GDP ratio does not stabilize by 2026 under the baseline.
  - Effective interest rate path shown: 2.5, 2.3, 2.2, 2.1, 2.1, 2.1 (2019–2026 entries shown).
  - Gross financing needs projected to be 9½ percent of GDP at the end of the projection period.
- Stress tests and key shocks:
  - Growth shock (1 standard deviation, 3.3 percentage point decline in real GDP growth in 2022–2023) raises public debt by almost 12 percentage points to 56 percent of GDP and gross financing needs to 15.2 percent of GDP by 2023; debt reaches 58 percent of GDP in 2026 under this shock.
  - Interest rate shock (nominal rate increases by 385 basis points) raises debt to 52 percent of GDP by 2026.
- Fiscal policy recommendations:
  - Carefully scale back fiscal support in the short term, remaining flexible and state-contingent.
  - Reverse broad-based and non-targeted support measures in the 2022 budget to arrest growing debt and replenish buffers.
  - Unless more growth-friendly revenue measures are feasible, reverse the PIT relaxation and reintroduce the real estate transfer tax (4 percent on acquirer); these measures alone would yield over 2 percent of GDP going forward, lifting the primary balance above the debt-stabilizing level of -1.1 percent of GDP as early as 2023.
  - Use resulting savings to boost growth-enhancing and green investments.
  - Re-link retirement age to life expectancy and consider net revenue increases from consumption, carbon, and valuation-based real estate taxes for long-term sustainability.

### Monetary Policy, Financial Sector, and AML/CFT
- Monetary policy stance and actions:
  - CNB lowered the policy rate in three steps in spring 2020 by a cumulative 200 bps to 0.25 percent and later increased rates across 2021 and December (to 3.75 percent noted in statements).
  - CNB increased frequency of repo operations and broadened eligible collateral instruments; introduced extraordinary lending facility.
- Banking sector soundness and vulnerabilities:
  - Banking sector accounts for almost 80 percent of financial sector assets.
  - Regulatory capital to risk weighted assets: 2021-Q2: 22.5 (percent); Regulatory Tier 1: 2021-Q2: 21.8 (percent).
  - Non-performing loans to total gross loans: 2021-Q2: 2.9 (percent).
  - Return on assets: 2021-Q2: 0.8 (percent); Return on equity: 2021-Q2: 10.9 (percent).
  - Liquid assets to total assets: 2021-Q2: 29.5 (percent).
  - Customer deposits to total non-interbank loans: 2021-Q2: 144.8 (percent).
  - FX loans to total loans and FX liabilities to total liabilities: 2021-Q2: 0.00 (percent).
  - Banks remained well capitalized, profitable, and liquid; profits in 2020 dropped by nearly half y-o-y.
  - Risk weights have been declining; concentration in residential mortgages increased.
- Macroprudential and supervisory measures:
  - CNB released CCyB to 0.5 percent from 1.75 percent in 2020; later increased CCyB and decided on 2 percent effective January 2023.
  - Reintroduced and tightened borrower-based limits in November 2021.
  - Recommendation: phase out support measures under close monitoring; proceed gradually with easing dividend payout restrictions (up to 15 percent of 2019 and 2020 profits allowed); continue increases in CCyB with appropriate phase-in; monitor NPLs and cross-border linkages; improve risk measurement and use credit registry and macroprudential stress tests.
- AML/CFT and governance actions:
  - Substantial progress made aligning AML/CFT framework with 5th EU AML Directive and FATF Standards.
  - Beneficial ownership registry established; covers more than 90 percent of legal entities.
  - Authorities enhancing monitoring of cross-border flows, PEP measures, and implementation of AML/CFT measures; support for bank-issued ID to improve CDD and remote onboarding.

### Climate Mitigation, Green Transition, and Recovery Funding
- Emissions and energy mix:
  - Total GHG emissions since 1990 dropped by about one third.
  - Per-capita CO2 emissions: about 10 tons of CO2 per capita (2018), EU average around 8.5.
  - Energy generation accounted for 76 percent of total GHG emissions in 2018.
  - Coal production: 46 million tonnes annually; coal accounts for about one third of total energy supply and for 64 percent of fossil fuel emissions in 2018.
- Targets and investment needs:
  - Target: net GHG reduction of likely 55 percent by 2030.
  - Estimated investment needed: CZK 500 billion (10 percent GDP) over the next decade (McKinsey, 2020).
  - National Recovery Plan (RRF): envisages CZK 199.9bn in spending, of which CZK 172bn will be funded by EU grants; 45 percent earmarked for physical infrastructure and green transition; 14 percent for digital transformation.
- Carbon pricing and policy instruments:
  - No explicit carbon tax currently; fuel excise taxes and road taxes amount to approximately 2 percent of GDP.
  - IMF staff model: carbon price of USD 75 per ton would cut emissions 26 percent below baseline in 2030 but be 32 ppts short of pledged NDC reduction; to meet pledged NDC, carbon price higher than USD 200 would be necessary.
  - Complementary instruments recommended: feebates, rebates, R&D incentives, recycling revenues to protect vulnerable households and lower distortionary taxes.
- Quantified illustrative fuel price impacts under USD 75 per ton carbon price (weighted by consumption):
  - Gasoline: baseline US$ per liter 1.48 → 1.67; % change 12.90%
  - Diesel: baseline US$ per liter 1.47 → 1.68; % change 14.80%
  - LPG: baseline US$ per liter 0.34 → 0.78; % change 131.00%
  - Kerosene: baseline US$ per liter 0.85 → 1.07; % change 26.00%
  - Oil: baseline US$ per barrel 70.65 → 104.31; % change 47.60%
  - Coal: baseline US$ per GJ 2.49 → 9.59; % change 299.50%
  - Natural gas: baseline US$ per GJ 14.98 → 18.99; % change 26.80%
  - Electricity: baseline US$ per kwh 0.11 → 0.16; % change 40.40%

### Labor Market, Skills, and Structural Reforms
- Labor market status and training gaps:
  - Employment rate (age 20–64) at end-2019: 80 percent.
  - Activity rate: 82 percent.
  - Unemployment before COVID: 2 percent.
  - Adult training: high enterprise participation and coverage but older workers, low-skilled workers, and unemployed remain underserved.
- Childcare and female participation:
  - Employment rate of mothers with young children is 30 percent below that of men.
  - Unmet demand for childcare: 14,000 children below 3 years of age (2017/2018); more than 33,000 nursery school applications rejected.
- Digitalization, automation, and projections:
  - Share of students graduating in ICT subjects: around 4 percent.
  - Estimates of automation risk: between 40 percent and 70 percent of current jobs at risk of being fully or partly automated in next decades.
  - McKinsey (2018) estimate: equivalent of 1.1 million jobs will be automated by 2030 in a middle adoption scenario.
  - Heterogeneous agent model: a 20 percent drop in relative price of capital goods → GDP rises by 6½ percent over the long term; unskilled worker income rises by 6½ percent (about 2 ppt less than medium- and high-skilled workers). A 10 percent increase in elasticity of substitution (automation) → GDP 18 percent higher vs baseline.
- Policy recommendations:
  - Target adult training to low-skilled, older workers, and unemployed; expand childcare and early childhood education; make education more inclusive and increase spending on ALMPs.
  - Improve insolvency procedures, simplify business regulatory framework, foster SME access to equity finance, encourage R&D through incentives, and strengthen governance/anti-corruption measures.
  - Use recovery funds to boost productivity, green and ICT investments; estimate CZK 500 billion needed over next decade to meet 2030 targets.

### External Sector, Reserves, and Key Projections
- External assessment and projections:
  - Staff assesses external position in 2021 as broadly in line with fundamentals and policy settings.
  - Net international investment position (NIIP), 2021: -10.5 percent of GDP.
  - Current account: 2021 projection: -0.2 percent of GDP; 2022–2026: 0.8 each year (staff projections).
  - REER gaps: staff REER gap (CA gap model): 0.7 percent; REER index/model gaps: 21.3 percent and 24.6 percent respectively.
- Reserves and FX:
  - Gross international reserves increased to 149 billion US dollars (68 percent of GDP) in 2020.
  - Allocation of 2.09 billion SDRs—1.1 percent of GDP or 0.2 months of imports—in August 2021 will be held as foreign reserves.
  - Reserves assessed as over 10 months of imported goods and services and sufficient to insulate against external shocks.
  - Czech koruna floated freely; no FX interventions since April 2017.
- Selected macro projections (annual percent change unless stated):
  - Real GDP: 2021: 2.9; 2022: 3.6; 2023: 4.4; 2024: 3.5; 2025: 3.1; 2026: 2.5.
  - Inflation (CPI): 2021: 3.6; 2022: 5.6; 2023: 2.3; 2024: 2.0; 2025: 2.0; 2026: 2.0.
  - Unemployment rate (average): 2021: 2.9; 2022: 2.5; 2023–2026: 2.3.
  - Investment (percent of GDP) (level): 2021: 28.9; 2022: 25.3; 2023: 25.8; 2024: 26.2; 2025: 26.5; 2026: 26.7.
  - General government debt (percent of GDP): 2021: 43.5; 2022: 45.0; 2023: 46.6; 2024: 48.0; 2025: 48.6; 2026: 49.1.
  - Nominal GDP (billions of Koruny): 2021: 6,059; 2022: 6,534; 2023: 6,942; 2024: 7,306; 2025: 7,680; 2026: 8,026.

### GVC Disruptions, Industrial Production, and Scenarios
- Industrial context:
  - Industrial production accounts for 30–35 percent of total GDP.
  - Industrial production rose above pre-pandemic values in early 2021 but stalled by mid-2021.
  - Equipment shortages and microchip supply constraints drove recent stalls; automotive sector particularly affected.
- Scenario outcomes:
  - Baseline: GVC recovery by mid-2022.
  - Slower GVC recovery: disruptions ease by Q3 2023 rather than Q4 2022; lower output growth of 0.6 percent in 2022 and higher output growth of 0.3 percent in 2023 relative to baseline.
  - Broader disruption: non-automotive industrial production hit similarly in Q4 2021, recovers linearly by Q4 2022; envisages lower output growth of 0.6 percent in 2021 and 0.2 percent in 2022 followed by higher output growth of 1.0 percent in 2023 relative to baseline.
- Risks and implications:
  - Continued or prolonged GVC disruptions would delay recovery (to early-to-mid 2023 under slower scenario).
  - Spillovers from automotive to other sectors could produce a stronger drop in end-2021/early-2022 output with stronger recovery in 2023.

*Source: IMF staff report — "1. A Solid Economic Position Entering the Pandemic" (Czech Republic).*

### 1. A Solid Economic Position Entering the Pandemic _____________________________________________ 4

### 1. A Solid Economic Position Entering the Pandemic

### Context and recent developments
- The Czech Republic entered the crisis on a solid economic footing after a steady upswing since 2014: solid GDP growth, declining unemployment, inflation below the CNB’s 3 percent upper bound (2.8 percent in 2019), and public debt at a low of 30 percent of GDP.
- Real GDP declined by 5.8 percent in 2020.
- The headline fiscal deficit was 5.6 percent of GDP in 2020.

### COVID-19 developments and health indicators
- State of emergency ended on April 11, 2021; cases increased again in November 2021.
- Vaccination: 58.4 percent (6.2 million) of the population, and above 75 percent of older citizens (50 and older), had received two doses as of November 19, 2021.
- The Czech Republic experienced a comparatively high COVID-19 death toll (chart data as of Nov 26, 2021).

### Economic impact and recent growth dynamics
- Growth turned negative in 2021:Q1 due to continued lockdowns; domestic demand sharply rebounded in 2021:H1, growing at an average pace of 4 percent driven by pent-up demand.
- Investment growth was strong in 2021:H1 as firms rebuilt inventories.
- Durable and service consumption growth began to recover in 2021; GFCF also recovered in 2021.
- Q2:2021 value added recovery driven by sectors most affected by lockdowns.

### Labor market and capacity
- Unemployment peaked at 3.3 percent in 2021:Q1.
- Growth of compensation of employees declined to 1.4 percent in 2020 from 7.8 percent in 2019, and began to rebound in 2021 as the economy reopened.
- Capacity utilization dropped sharply during lockdowns but has since overtaken its initial value.
- Vacancy rates declined gradually consistent with pre-pandemic trends; labor force participation remained stable; long-term unemployment rose slightly.

### Inflation developments
- Inflation averaged 3.2 percent in 2020 (above CNB tolerance band).
- Core and headline inflation continued rising through 2021, reaching highs of 6.6 and 5.8 percent in October 2021, driven by:
  - rising core inflation from a tight labor market and imputed rents,
  - global value chain (GVC) disruptions,
  - rising food and fuel prices.
- Imputed rent was already a large contributor to inflation and is expected to increase further.
- Unit labor costs and wage inflation contributed to higher labor costs; import prices rebounded.

### External position and current account
- Current account posted a large surplus of 3.6 percent of GDP in 2020, largely due to an extraordinarily low primary income deficit caused by falling bank profits and lower dividend payments.
- Staff assesses the external position in 2021 as broadly in line with fundamentals and policy settings, noting considerable uncertainty.
- The exchange rate depreciated by 10 percent relative to the Euro in March 2020 but recovered to pre-pandemic levels by May 2021 and remained stable thereafter.
- The NIIP is at a comfortable level; external debt remained stable nominally.

### Policy response: fiscal, monetary, and macrofinancial measures
- Fiscal support:
  - Announced measures as of end-October 2021 were about 25 percent of 2020 GDP.
  - Above-the-line measures totaled CZK 533.0 bn, 9.4 percent of 2020 GDP (uptake CZK 430.4 bn, 7.6 percent of 2020 GDP).
  - Measures included wage compensation schemes, compensatory transfers to small businesses and the self-employed, a lump-sum payment for pensioners, care allowance packages, increased health insurance payments for persons covered by the state, a PIT regime change embedding a broad rate cut by about 5 percentage points, cancellation of the property sales tax, and sizeable financing guarantees to the private sector of about 15½ percent of GDP (uptake about one-tenth of available balance).
  - The fiscal impulse amounted to almost 4½ percent of potential GDP in 2020 and 2 percent in 2021.
- Monetary policy:
  - The CNB lowered the policy rate in three steps in spring 2020 by a cumulative 200 bps to 0.25 percent.
  - The CNB increased the frequency of repo operations and broadened eligible collateral instruments.
- Macrofinancial policy:
  - The CNB introduced an extraordinary lending facility and released the countercyclical capital buffer (CCyB) to 0.5 percent from previously 1.75 percent to provide additional lending and loss-absorbing capacity.
  - Mortgage market recommendations were relaxed effective April 1, 2020: maximum recommended LTV increased from 80 to 90 percent, DSTI increased from 45 to 50 percent (eventually abolished on June 18, 2020), and the DTI recommendation (previously set at 9) was removed.
  - In line with ESRB guidelines, the CNB called on banks in 2020 to refrain from making dividend payouts.

### Key statistics and policy-relevant figures (preserved exactly)
- Inflation: 2.8 percent in 2019; averaged 3.2 percent in 2020; highs of 6.6 and 5.8 percent in October 2021.
- Real GDP: declined by 5.8 percent in 2020.
- Unemployment: peaked at 3.3 percent in 2021:Q1.
- Compensation of employees growth: 1.4 percent in 2020 (7.8 percent in 2019).
- Vaccination: 58.4 percent (6.2 million) with two doses as of November 19, 2021; above 75 percent coverage for ages 50 and older.
- Fiscal support announced as of end-October 2021: about 25 percent of 2020 GDP.
- Financing guarantees offered: about 15½ percent of GDP (uptake one-tenth of available balance).
- Headline deficit: 5.6 percent of GDP in 2020.
- Fiscal impulse: almost 4½ percent of potential GDP in 2020; 2 percent in 2021.
- CNB policy rate: lowered by cumulative 200 bps to 0.25 percent in spring 2020.
- Countercyclical capital buffer (CCyB): released to 0.5 percent from 1.75 percent.
- Above-the-line measures: CZK 533.0 bn, 9.4 percent of 2020 GDP (uptake CZK 430.4 bn, 7.6 percent of 2020 GDP).
- Current account surplus: 3.6 percent of GDP in 2020.

*Source: IMF staff report — "1. A Solid Economic Position Entering the Pandemic" (Czech Republic).*

### 6.      Growth in the near term is projected to rebound, even if less than earlier projected

### 6.      Growth in the near term is projected to rebound, even if less than earlier projected

### Near-term growth outlook
- Baseline projections:
  - Economic activity to rebound to 2.9 percent in 2021 and 3.6 percent in 2022.
  - Output gap will become slightly positive entering 2022 and is expected to close in the medium term.
- Drivers:
  - Pandemic subsides and vaccination rollout continues.
  - GVC disruptions, which weighed on the initial recovery, are expected to ease (Annex VIII).
  - Private consumption is projected to increase; public consumption tapers off as support measures are withdrawn.
  - Net exports are expected to recover throughout 2022 as GVC disruptions are resolved, supported by strong demand in the automotive sector and recovery of trading partners.
  - Unemployment expected to remain low and wage growth to return to pre-pandemic rates.

### Inflation and monetary policy
- Inflation path and drivers:
  - Inflation projected to remain elevated throughout 2021 and early 2022, then gradually converge to the CNB’s target range by early 2023.
  - Near-term inflationary pressures driven by domestic factors—tight labor and housing markets—and foreign drivers—supply chain disruptions and high energy prices.
- Policy assumptions and actions:
  - Staff’s baseline assumes the CNB raises rates to 3.5 percent in early 2022.
  - The CNB began normalizing policy in H2 2021: two 25bp hikes in July and August, a 75bp hike in October, and a 125bp hike in November to 2.75 percent from 0.25 percent at the beginning of 2021.
  - Based on a Taylor-type rule, staff estimates a neutral rate of 2–3 percent consistent with the CNB’s 2 percent inflation target; given recent trends, a higher policy rate than this range is appropriate.
- Staff view:
  - Staff supports the tightening stance to counteract inflation pressures and prevent inflation expectations from becoming untethered.
  - Future policy should respond primarily to movements in core inflation and inflation expectations while carefully considering risks from raising rates too quickly.

### Risks and scenarios
- Downside risks (tilted to the downside amid high uncertainty):
  - Continued virus risk, including emergence of the Omicron variant.
  - Longer-than-expected surges in energy prices or prolonged disruptions to GVCs could hinder recovery and increase inflationary pressures, risking de-anchored inflation expectations.
  - Disorderly reallocation leaving pandemic-affected sectors behind poses a near-to-medium term downside risk (Annex IV).
- Upside/mitigating factor:
  - A strong appreciation of the koruna due to larger-than-expected capital inflows may ease inflationary pressures.
- Policy trade-offs:
  - Excessive tightening could exacerbate downside risks from strict lockdowns, higher energy prices, or prolonged GVC disruptions and destabilize asset prices and financial markets.
  - Delayed tightening risks inflation expectations becoming untethered, wage spirals, and second-round inflation effects.

### Macrofinancial vulnerabilities and housing market
- Property prices and valuations:
  - House price growth accelerated to a record high of 14½ percent year-over-year in 2021:Q2.
  - The CNB estimates property prices to be overvalued by 25 percent on average (as of mid-2021).
  - Cumulative property price growth of about 54 percent in the five years prior to 2021.
- Household indebtedness and credit:
  - Aggregate household indebtedness increased robustly by 2½ percentage points to 34 percent of GDP during 2020.
  - Fast increases in property prices, loosening credit standards, and macroprudential easing during the pandemic resulted in households/lenders taking larger and riskier mortgages.
  - The share of loans with DTI ratios of above eight increased from about 17 percent at end-2019 to about 27 percent in February 2020; those with DTI above nine increased from about 3¼ percent to about 14 percent.
  - DSTI ratios of above 45 percent increased from about five to 17¾ percent and those above 50 from about three to 8 percent.
  - Large proportion of mortgages with fixation periods up to five years increases exposure to interest rate shocks.
- Macroprudential response:
  - Staff welcomes the CNB’s November 2021 decision (effective April 2022) to tighten limits on mortgage loan ratios to: DTI (8.5), DSTI (45 percent), LTV (80 percent).
  - Limits for applicants under the age of 36: DTI (9.5), DSTI (50 percent), LTV (90 percent).
  - Recommendation: tight prudential tools, coordinated housing supply and tax policies, proper calibration for lower risk groups (first-time buyers and low-levered households), clear communication, and close monitoring with potential for further tightening.

### Fiscal developments and policy
- 2021 fiscal outturn and drivers:
  - Staff estimates the budget deficit widened to 7¼ percent of GDP in 2021 from 5.6 percent in 2020.
  - Expanded fiscal policy measures accounted for almost 4 percent of GDP by end-October 2021.
  - General government debt projected to increase by 5¾ percentage points to 43½ percent of GDP at end-2021.
- Personal income tax (PIT) regime change:
  - Beginning 2021, PIT rate for employees lowered to 15 percent from an effective 20.1 percent; basic tax deduction raised by CZK 3,000 (from CZK 24,840) in 2021 and again in 2022.
  - The measure is non-targeted and no phasing out plans announced, lowering revenue by about 2 percentage points of GDP beyond 2021.
- 2022 and medium-term projections:
  - The 2022 budget envisages a deficit reduction; staff forecasts the 2022 budget deficit to reach 4.4 percent of GDP.
  - MoF’s Fiscal Outlook envisages yearly improvement of the structural balance of ½ percentage point.
  - Based on this path, staff projects a headline deficit of 2½ percent of GDP in 2026 and a primary deficit of 1¾ percent.
  - Public debt projected to increase to 49 percent of GDP by 2026—about 6 percentage points below the national debt brake threshold (Annex V).
- Policy recommendations:
  - Carefully scale back fiscal support in the short term, remaining flexible and state-contingent given uncertainty.
  - Reverse broad-based and non-targeted support measures in the 2022 budget to arrest growing debt and replenish buffers.
  - Unless more growth-friendly revenue measures are feasible, reverse the PIT relaxation and reintroduce the real estate transfer tax (applied to the acquirer at a rate of 4 percent); these measures alone would yield over 2 percent of GDP going forward, lifting the primary balance above the debt-stabilizing level of -1.1 percent of GDP as early as 2023.
  - Use resulting savings to boost growth-enhancing and green investments.
- Long-term sustainability:
  - Pension system sustainability challenged by demographic pressures; Fiscal Council projects public debt to reach 180 percent by 2050, and almost 330 percent by 2070 in its baseline scenario.
  - Re-linking retirement age to life expectancy recommended but insufficient alone; net revenue increases needed.
  - Suggested revenue sources that promote growth and sustainability: consumption, carbon, and valuation-based real estate taxes.

### Recovery and resilience funding
- National Recovery Plan (RRF):
  - Envisages CZK 199.9bn in spending, of which CZK 172bn will be funded by EU grants.
  - 45 percent of funds earmarked for physical infrastructure and green transition; 14 percent for digital transformation.
  - Recommendation: focus on key priority projects with high impact and ensure timely and efficient implementation.

_International Monetary Fund_

### 26.      Pre-existing housing supply shortages

### 26.      Pre-existing housing supply shortages

### Housing supply and construction activity
- Pre-existing housing supply shortages persisted throughout the pandemic, partly reinforced by temporary pauses in construction activity.
- A new construction law aimed at simplifying the construction code and the permitting process through creation of a one-stop-shop for construction companies was adopted in July, 2021, but implementation of some of its provisions will take until 2023.
- The impact on the number of granted residential building permits has been limited so far.

### Tax policy and housing-related taxation
- Revenues from property taxes are low in comparison to other countries and will further fall after the recent cancellation of the property transaction tax.
- Real estate property taxation should be based on current market valuations and not on floor space.
- The recent reduction of the maximum deductible amount of mortgage interest from CZK 300,000 to CZK 150,000 per year starting in 2021 is welcome, but this benefit could be eliminated completely as in other countries.

### Macroprudential framework and CNB powers
- Staff welcomes the recent reform of the macroprudential framework that provides the CNB with the legal powers to implement macroprudential policy.
- In July 2021, the CNB was given powers to make macroprudential limits legally binding, consistent with international best practice.
- Authorities acknowledged risks from the heated property market and stand ready to tighten macroprudential policies as needed.
- On the basis of new statutory powers, the CNB Bank Board decided on November 25, 2021 to reintroduce limits on DTI and DSTI ratios and to tighten the LTV limit.

### Financial sector vulnerabilities and supervisory recommendations
- Banks remain well capitalized, profitable, and liquid, though in a challenging environment.
  - The banking sector accounts for almost 80 percent of financial sector assets.
  - Capitalization remained comfortably above regulatory minima throughout the pandemic as capital surpluses reached historical highs.
  - In 2020, profits, while remaining positive, dropped by nearly half y-o-y on the back of higher provisioning and lower net-interest income.
  - Liquidity coverage ratio (LCR) reached all-time highs.
- But vulnerabilities remain:
  - Very loose financial conditions, increasing asset prices—particularly residential real estate prices—and prospects for a rapid recovery provide ground for risk buildup.
  - The banking system has continued to become more concentrated in residential mortgages.
  - Risk weights have been declining on the back of positive market developments and support programs for households and corporates.
  - A sudden correction of real estate prices or a shock to household incomes could jeopardize regulatory capital buffers with potential spillovers to financial stability.
  - By end-2020—after the statutory loan moratorium ended—banks assessed credit quality to have deteriorated, leading to higher provisioning amid increased impairment charges. While impairment charges remain low, they are likely to eventually increase further once support policies are unwound.
  - Close regional financial system interlinkages expose the Czech banking system to potential regional spillover vulnerabilities.
- Policy and supervisory recommendations:
  - Phasing out of policy measures to support the financial system should continue, albeit under close monitoring to ensure adequate functioning of markets as risks unwind.
  - Easing of limits on banks’ dividend payouts should proceed gradually; up to 15 percent of 2019 and 2020 profits are allowed to be distributed.
  - As the economy recovers, increases in the CCyB should continue with appropriate phase-in periods.
  - Close monitoring of non-performing loans and cross-border linkages should continue as policy support is reduced.
  - Improvements in risk measurement across the cycle and for individual exposures should be considered:
    - If credit is identified as fueling overheating-prone sectors, risk weights for individual exposures could be considered to ensure capital buffers remain consistent with higher-risk sectors.
    - Leverage information of individuals and corporates; enhance a fully risk-based prudential framework so provisioning and capital buffers remain consistent with higher risks and risk measurement is forward looking.
    - Combine the proposed framework with macroprudential stress tests to quantify spillovers (losses) due to contagion across Czech and foreign financial entities with strong links and to improve calibration of macroprudential tools.
  - The credit registry can be used to develop risk measurement models to estimate probabilities of default and loss-given-default parameters at the individual debtor level to estimate expected and unexpected losses and provisioning and capital requirements at the individual exposure level.
- Notable policy action:
  - The CCyB buffer rate was increased to 2 percent (on November 25, 2021) effective January 2023.

### Authorities’ views on financial stability and AML/CFT
- Authorities assess the financial system as stable but vigilantly monitor risks.
- They acknowledged risks from increasing impairments due to prolonged GVC disruptions and rising inflation, which is pushing up costs for corporate and household sectors.
- Authorities consider it essential that credit institutions continue to be well equipped to cover expected and unexpected credit losses through adequate provisioning and capital.
- Authorities are making efforts to monitor foreign financial flows and improve the AML/CFT framework:
  - Monitoring cross-border financial flows, including following up with banks on information about sources of foreign funds and country of origin to support risk-based supervision.
  - Continue to enhance implementation of AML/CFT measures related to politically-exposed-persons.
  - Track and analyze data on non-resident and beneficial owners of real estate assets to aid monitoring and supervision of the sector for ML/TF risks.
  - Practical efforts include enhanced risk-based supervision driven by data gathering and analysis, use of SWIFT data to enhance monitoring of cross-border flows, support for a bank-issued ID project to increase quality of CDD data and security of remote on-boarding, and a registration regime for real-estate agents.

### Structural policies briefly related to housing and labor markets
- As the crisis hit, the “Antivirus” package supported labor markets through job retention schemes and other policies. The program was phased out by end-May 2021 but targeted support for those affected by mandatory quarantine was kept.
- Going forward, job-retention schemes should increase financial contributions from employers to improve incentives for self-selection.
- Spending on Active Labor Market Policies (ALMP) should be increased to improve job matching and boost effective labor supply and participation by enhancing training and reskilling.
- Efforts to have vocational and educational programs guided by current and future labor market demand, trends, and skill needs are welcome and should continue.

*Source: 1czeea2022001 - 26.      Pre-existing housing supply shortages*

### 39.      The recovery offers an opportunity to address pre-COVID legacies and build forward

### The recovery offers an opportunity to address pre-COVID legacies and build forward

### Summary and context
- The recovery is seen as an opportunity to boost productivity growth and investment, including in green and ICT sectors, building on the Innovation Strategy and the National Investment Plan.
- Staff highlights the need to expedite investments in the transport and energy sectors, education, and digitalization.

### Investment and productivity priorities
- Priorities for expedited investment:
  - Transport (railways, highways, waterways, etc.)
  - Energy
  - Education-science-research
  - Digitalization
- National Investment Plan 2020-2050 allocations (as presented):
  - Transport: 79%
  - Energy: 5%
  - Regional development: 4%
  - Agriculture: 2%
  - Public administration: 2%
  - Healthcare: 2%
  - Water management: 2%
  - Digitalization: 1%
  - Environment: 1%
  - Culture: 1%
  - Education-science-research: 1%

- Measures to incentivize investment and raise productivity:
  - Ensure an adequate supply of human capital in high productivity sectors, including Knowledge-Intensive-Sectors (KIS), by enabling the provision of technical and digital skills.
  - Capitalize on SMEs’ potential through well-targeted R&D grants, tax incentives and better access to equity finance.
    - Staff recommends developing standards for information disclosure, reviewing regulation for pension funds and providing incentives for institutional investors to ensure adequate resources for investment vehicles targeting SMEs.
  - Simplify the business regulatory framework—address obstacles to starting a business, resolving commercial disputes, and obtaining construction permits.
    - Staff welcomes progress on the planned overhaul of construction permit legislation.
  - Improve insolvency procedures to minimize barriers to corporate restructuring, speed up the asset recovery process and spur capital reallocation as insolvency cases are likely to rise.

### Labor market, inclusion, and Active Labor Market Policies (ALMP)
- Staff recommends stepping up Active Labor Market Policies to better support the unemployed with job matching, while enhancing training and reskilling programs focused on technical and digital skills, including for the employed.
- Policies to bring mothers with young children back into the labor force should continue, including expansion of childcare and increased flexibility on the use of parental leave.
- The authorities plan to enhance ALMPs with specific focus on disadvantaged groups.

### Governance and anti-corruption
- Strengthen governance and address corruption by:
  - Implementing the anti-corruption strategy.
  - Systematically monitoring asset declarations to improve government spending efficiency, boost growth, and enhance attractiveness for FDI.
  - Ensuring transparency and accountability of COVID-19 related spending, including publication of the beneficial owners of awarded procurement contracts.
- Foreign Direct Investments Screening Act—implemented on May 1, 2021—provides structure for cooperation and information sharing with other EU countries; staff recommends FDI restrictions on national security grounds be used sparingly and judiciously.
- On foreign bribery and enforcement:
  - The Czech Republic has taken steps to strengthen detection framework, but further efforts are needed to improve enforcement.
  - Staff’s assessment is based on OECD WGB Phase 4 Report (June 2017) and Written Follow-Up Report (June 2019).
  - Key concerns: lack of prioritized enforcement, insufficient measures to ensure independence of prosecutors, and need for better protection of whistleblowers.
  - Recommendations include enhanced use of AML/CFT measures and increased resources for complex money laundering prosecutions as per the 2018 MONEYVAL AML/CFT assessment and follow-up reports.

### Green transformation and climate policy
- Target: a net greenhouse gas emissions (GHG) reduction of likely 55 percent by 2030.
- Historical progress: total GHG emissions dropped by about 30 percent since 1990, but the country remains among the top European polluters and highly dependent on coal.
- Transition requirements:
  - Reduce coal consumption, accelerate clean energy sources, and increase efficiency in heating systems.
  - Adopt a comprehensive strategy including a higher carbon pricing score reinforced by broader incentives—feebates, rebates, R&D incentives—and recycling of revenues to support the economy in a balanced manner.
- Electricity generation transition plans and trade-offs:
  - Fossil fuels share planned to decline from 50 percent in 2016 to 11–21 percent in 2040.
  - Nuclear share planned to increase from 29 percent in 2016 to 46–58 percent in 2040.
  - Alternative technologies include renewables and possibly fossil generation with carbon capture and storage; trade-offs include higher costs, unstable supply and geopolitical considerations.
  - Nuclear expansion should be accompanied by strong regulation to minimize risks (accidents, radioactive waste leakage, etc.).
- Investment needs:
  - Estimated investment of CZK 500 billion (10 percent GDP) over the next decade (McKinsey, 2020) are needed to meet the 2030 targets.
  - RRF and other structural EU funds are expected to contribute significantly; broader incentives to attract complementary private investment should be designed.
  - Prompt definition of the tax framework for green investment, including the level and base of carbon taxation, would provide clarity for private investment.

### Fiscal, monetary, macroprudential staff appraisal and recommendations
- Outlook and external position:
  - Following a strong policy response to the virus, the outlook is for a rebound in activity but uncertainty remains elevated with risks tilted to the downside.
  - Staff assesses the external position in 2021 to be broadly in line with fundamentals and desirable policy settings.
- Monetary policy:
  - Staff supports the monetary policy stance and the CNB’s stance of raising the policy rate to counteract inflation pressures and prevent inflation expectations from becoming untethered.
  - Further policy action should respond primarily to movements in core inflation due to domestic pressures and inflation expectations, while weighing risks of raising rates too quickly against risks from overshooting inflation.
  - Simultaneous fiscal consolidation and tightening of macroprudential regulation should be factored into the overall policy mix.
- Fiscal policy:
  - Fiscal policy should aim at unwinding untargeted policy support to replenish policy buffers and support the transformation to the post-pandemic economy.
  - Top priorities include reversal of the relaxation in the personal income tax regime and reintroduction of the real estate transfer tax.
  - Long-run debt sustainability pressures from demographic shifts require re-linking the retirement age to life expectancy and further increases in net revenue from less-distortionary taxes such as consumption and real-estate taxes.
- Macroprudential and housing:
  - Macroprudential tools should continue to be fine tuned to address household vulnerabilities.
  - Record growth in property prices, amid loosening credit standards and macroprudential policy during the pandemic, resulted in households taking larger and riskier mortgages.
  - Housing market developments should be monitored closely to assess need for further tightening.
  - Real estate property taxation should be based on current market valuations; construction code and permitting process should be further simplified.
- Banking sector:
  - The banking system is comfortably capitalized, liquid and still profitable but has become more concentrated in residential mortgages amid declining risk weights.
  - A fully risk-based prudential framework should be enhanced to ensure adequate provisioning and capital buffers consistent with higher risks in overheating-prone sectors.

### Authorities’ views
- Authorities agreed that high productivity and investment are crucial for sustained income growth.
- A comprehensive strategy for SMEs’ competitiveness has been approved.
- Plans to enhance ALMPs are ongoing with specific focus on disadvantaged groups.
- Children groups (childcare) are being expanded and parental leave flexibility increased.
- Ongoing work on a multicriteria point system for immigration.
- Plans are in place, supported by EU structural and RRF funds, to advance the green and digital transition.

*International Monetary Fund — Staff Report excerpt*

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

### 1czeea2022001 - 53.      It is recommended that the next Article IV consultation be held on the standard

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

### Structural issues (Figure 22)
- The quality of public infrastructure can be improved.
- The labor market is moving to high-skilled workers.
- Female labor force participation is at the EU average but could be improved, particularly for younger and older women.
- Demographic shifts will impose spending pressures while the population is aging rapidly.
- Note: Data as of 2019.

### Macroeconomic outlook and key projections (Selected)
- Real GDP (expenditure): 2021: 2.9; 2022: 3.6; 2023: 4.4; 2024: 3.5; 2025: 3.1; 2026: 2.5 (annual percent change).
- Inflation (CPI, percent): 2021: 3.6; 2022: 5.6; 2023: 2.3; 2024: 2.0; 2025: 2.0; 2026: 2.0 (annual percent change).
- Unemployment rate (average, in percent): 2021: 2.9; 2022: 2.5; 2023: 2.3; 2024: 2.3; 2025: 2.3; 2026: 2.3.
- Output gap (percent of potential output): 2021: 0.0; 2022: 0.3; 2023: 0.2; 2024: 0.1; 2025: 0.0; 2026: 0.0.
- Potential growth: 2021: (2.3)1.9; 2022: 3.3; 2023: 4.6; 2024: 3.6; 2025: 3.3; 2026: 2.5.
- Investment (percent of GDP) (level): 2021: 28.9; 2022: 25.3; 2023: 25.8; 2024: 26.2; 2025: 26.5; 2026: 26.7.
- Gross national savings (percent of GDP): 2021: 28.4; 2022: 25.9; 2023: 26.4; 2024: 26.8; 2025: 27.1; 2026: 27.2.

### Public finances (Selected projections and indicators)
- General government revenue (percent of GDP): 2021: 40.2; 2022: 40.3; 2023: 40.3; 2024: 39.8; 2025: 39.5; 2026: 39.4.
- General government expenditure (percent of GDP): 2021: 47.2; 2022: 47.4; 2023: 44.6; 2024: 44.3; 2025: 42.5; 2026: 41.9.
- Net lending / Overall balance (percent of GDP): 2021: -7.2; 2022: -4.4; 2023: -3.9; 2024: -3.5; 2025: -3.0; 2026: -2.5.
- Primary balance (percent of GDP): 2021: -6.5; 2022: -3.6; 2023: -3.2; 2024: -2.7; 2025: -2.2; 2026: -1.8.
- Structural balance (percent of potential GDP): 2021: -7.2; 2022: -4.5; 2023: -4.0; 2024: -3.5; 2025: -3.0; 2026: -2.5.
- General government debt (percent of GDP): 2021: 43.5; 2022: 45.0; 2023: 46.6; 2024: 48.0; 2025: 48.6; 2026: 49.1.
- Nominal GDP (billions of Koruny): 2021: 6,059; 2022: 6,534; 2023: 6,942; 2024: 7,306; 2025: 7,680; 2026: 8,026.

### External sector — levels, projections, and assessment
- Net international investment position (NIIP), 2021: -10.5 percent of GDP.
- Gross Assets, 2021: 135 percent of GDP.
- Reserve Assets, 2021: 63 percent of GDP.
- Gross Liabilities, 2021: 145 percent of GDP.
- Debt Liabilities, 2021: 28 percent of GDP.
- Current account (percent of GDP): 2021 projection: -0.2; 2022–2026: 0.8 each year (staff projections).
- External assessment (Annex I):
  - Overall Assessment: The external position in 2021 was broadly in line with fundamentals and desirable policy settings.
  - Estimated CA gap: -0.3 percent of GDP, with a range of -1.3 to 0.7 percent of GDP.
  - REER gap: 0.7 (±2) percent (staff assessment).
  - The CA is projected to be -0.2 percent of GDP in 2021 reflecting a decline in the trade balance and recovery in the primary income balance towards pre-pandemic levels; in the medium term CA is expected to return to a small surplus as trade normalizes and profits recover.
- External adjustments and model details (2021):
  - Proj. CA: -0.2 (percent of GDP).
  - Cyclically Adjusted CA: 0.5.
  - EBA CA Norm: -0.4.
  - EBA CA Gap: 0.9.
  - COVID-19 Adjustments (total): -1.24 percent of GDP, resulting in Staff CA Gap: -0.3 percent of GDP.
  - Specific COVID adjustments: decline in primary income balance: –2.04 percent of GDP; contraction in tourism net exports: +0.24 percent of GDP; change in consumption composition: +0.04 percent of GDP; increase in imports of medical equipment: +0.52 percent of GDP.
- REER model divergences:
  - Staff REER gap (CA gap model): 0.7 percent.
  - REER index model gap: 21.3 percent.
  - REER level model gap: 24.6 percent.
- Capital and financial accounts (selected):
  - Capital account: 2020: 1.3 percent of GDP (up from 0.4 percent in 2019).
  - Financial account: 2020: 4.3 percent of GDP (up from 0.1 percent in 2019).
  - Driver: 2020 increase in financial account driven by a sharp decline in FDI liabilities, specifically equity and investment funds.
  - Assessment: Risks related to capital flows are assessed to be small.
- FX intervention and reserves:
  - Gross international reserves increased to 149 billion US dollars (68 percent of GDP) in 2020.
  - Allocation of 2.09 billion SDRs—1.1 percent of GDP or 0.2 months of imports—in August 2021 will be held as foreign reserves.
  - Czech koruna has floated freely and there have been no FX interventions since April 2017, including in 2021.
  - Assessment: Reserves are over 10 months of imported goods and services and are assessed to be sufficient to insulate against external shocks and disorderly market conditions.

### Financial sector indicators (selected FSIs, latest values)
- Regulatory capital to risk weighted assets: 2021-Q2: 22.5 (percent).
- Regulatory Tier 1 capital to risk-weighted assets: 2021-Q2: 21.8 (percent).
- Non-performing loans to total gross loans: 2021-Q2: 2.9 (percent).
- Return on assets: 2021-Q2: 0.8 (percent).
- Return on equity: 2021-Q2: 10.9 (percent).
- Liquid assets to total assets: 2021-Q2: 29.5 (percent).
- Customer deposits to total non-interbank loans: 2021-Q2: 144.8 (percent).
- FX loans to total loans and FX liabilities to total liabilities: 2021-Q2: 0.00 (percent).

### Policy implications and potential responses (from External Sector Assessment)
- Overall: The external position in 2021 was broadly in line with fundamentals and desirable policy settings, accounting for transitory pandemic-related factors.
- Potential Policy Responses: If the CA gap becomes positive in the future, the authorities could consider implementing structural policies aimed at raising investment to help reduce the surplus.
- Staff suggests that pandemic-related transitory factors be adjusted for in assessing the CA gap (see COVID-19 Adjustments above).

*Source: IMF staff estimates and projections, Czech National Bank, Czech Statistical Office, Ministry of Finance, and associated tables and annexes contained in the provided content.*

### Annex II. Climate Mitigation in the Czech Republic

### Annex II. Climate Mitigation in the Czech Republic

### Stock Taking of Emissions Trends
- Total greenhouse gas (GHG) emissions since 1990 dropped by about one third, more than the EU average.
- Per-capita CO2 emissions: about 10 tons of CO2 per capita compared to the EU average around 8.5 in 2018.
- Energy generation accounted for 76 percent of total GHG emissions in 2018; industrial processes 13 percent; agricultural sources 7 percent; waste 4 percent.
- By sector (CO2, 2018): power generation 51 percent; industry and construction 22 percent; transportation 19 percent; (residential) buildings 8 percent.
- Emission intensity of output declined and in 2018 was broadly in line with CESEE peers, but a gap with the EU remains due to lower efficiency in the power sector, a large share of industry in GDP, and higher emission intensity in transport.
- Energy mix and fuel shares:
  - Coal production: 46 million tonnes annually; Czech Republic is the third largest coal producer in Europe.
  - Coal accounts for about one third of the country’s total energy supply (down from more than 60 percent in 1990) and for 64 percent of fossil fuel emissions in 2018.
  - 2019 energy sources: oil 22 percent; nuclear 18 percent; natural gas 16 percent; biofuel and waste 10 percent; rest from renewables.
  - Share of renewables in energy consumption broadly flat; electricity sector’s renewables share about 20 pps below the EU average.
- Historical and projected trends:
  - IMF staff BAU projection: fossil fuel CO2 emissions will increase about 11 percent between 2018 and 2030.
  - Projected decline in share of coal and other fossil fuels in gross electricity production: from 50 percent in 2016 to 11–21 percent in 2040 (National Energy and Climate Plan projections).
  - Nuclear share projected to increase from 29 percent to 46–58 percent in the same period.

### Strong Policy Initiative and Multi‑Pronged Strategy to Meet Climate Goals
- National targets and required transformation:
  - Targets imply a reduction of net greenhouse gas emissions by likely 55 percent by 2030 (EU 2030 ambition under the European Green Deal and European Climate Law).
  - Old lignite-fueled power plants should be retired; co-generation plants converted to gas, biomass or waste; coal-fired heat generation decommissioned.
  - Alternative technologies during transition: renewables, fossil generation with carbon capture and storage; nuclear expansion requires strong regulation.
- Carbon pricing and fiscal instruments:
  - No explicit carbon tax currently; fuel excise taxes and road taxes amount to approximately 2 percent of GDP (in line with EU average).
  - In 2018, only 30 percent of all emissions were priced at a level that equals or exceeds EUR 60 per tonne of CO2.
  - IMF staff model projection: a carbon price of USD 75 per ton would cut emissions 26 percent below baseline levels in 2030—this is 32 ppts short of the pledged emissions reduction in the NDC. To meet the pledged NDC target, a carbon price higher than USD 200 would be necessary.
  - Trade-offs: higher carbon prices risk political infeasibility and public backlash due to non-negligible price increases for various fuels.
- Complementary instruments recommended:
  - Reinforced carbon pricing complemented by feebates, rebates, R&D incentives, and use of carbon pricing revenues to support the economy in a balanced manner.
  - Feebates recommended for high-emission sectors such as transportation and agriculture.
  - Expansion and tightening of the EU ETS (covers about 60 percent of Czechia’s total GHG emissions from 350 installations) and extension to currently exempt sectors are options under consideration.
  - Well-targeted subsidies to support uptake of renewable energy sources while controlling budget costs.
  - R&D investments and transparent regulation to reward innovators, tackle monopolies, and support efficient energy networks.

### Sectoral Policies and Technical Measures
- Electrification and transport:
  - Petrol is the most widely used fuel: 64 percent of passenger cars.
  - Share of electric vehicles is below 1 percent.
  - Authorities plan gradual increase of alternative propulsion and fuels in road transport, development of charging/filling infrastructure, further electrification of railways, and modal shift of freight from road to rail/water.
- Buildings and district heating:
  - About 60 percent of households are connected to district-wide heating systems.
  - National Action Plan for Energy Efficiency (NAPEE) measures include improving insulation and installing heat control systems.
- Forestry and land use:
  - Bark beetle outbreak reduced potential for Czech forests to be a carbon sink; managing the outbreak, promoting rebound in total volume of forests’ living biomass, and swift reforestation are critical.
- Waste management:
  - Methane capture increased in last ten years: biogas stations located in approximately 33 percent of landfills, capturing up to 15 percent of generated methane; waste-sector GHGs stabilized.
  - Policies aim to reduce waste produced, minimize biodegradable waste to landfills, and expand separate collection systems.

### Distributional, Competitiveness, and Investment Implications
- Distributional impacts and revenue recycling:
  - A carbon tax around USD 44 per ton of CO2 is estimated to impose a burden of about 3 percent of consumption on the average household in 2025 (estimate assumes no behavioral or structural changes).
  - Carbon tax revenues could be higher by up to 2 percent of GDP than under the baseline in 2030.
  - Revenue recycling can protect vulnerable households via targeted compensation and offset regressivity; revenues can be used to decrease distortionary taxes (e.g., on labor) to maximize economic efficiency.
  - Dedicated policies needed for coal mining regions and workers in the coal-fired energy sector (estimated at over 21,000 workers) to ensure a socially fair transition.
- Competitiveness and leakage:
  - Concerns for energy‑intensive, trade‑exposed (EITE) industries and carbon leakage risks.
  - EU options under development include border carbon adjustment (BCA) mechanisms; authorities should engage in international fora and be aware of dispute/retaliation risks.
- Investment needs and financing:
  - Estimated investment needed: CZK 500 billion (10 percent GDP) over the next decade to meet 2030 targets (McKinsey, 2020).
  - NextGenEU / Recovery and Resilience Plan expected contribution: about EUR 3 billion to support green projects; should be complemented by incentives to attract private investment.

### Quantified Energy Price Effects under Carbon Pricing Scenarios
- IMF staff illustrative fuel price impacts for a carbon price of USD 75 per ton (weighted by consumption):
  - Gasoline: baseline US$ per liter 1.48 → 1.67; % change 12.90%
  - Diesel: baseline US$ per liter 1.47 → 1.68; % change 14.80%
  - LPG: baseline US$ per liter 0.34 → 0.78; % change 131.00%
  - Kerosene: baseline US$ per liter 0.85 → 1.07; % change 26.00%
  - Oil: baseline US$ per barrel 70.65 → 104.31; % change 47.60%
  - Coal: baseline US$ per gigajoule (GJ) 2.49 → 9.59; % change 299.50%
  - Natural gas: baseline US$ per gigajoule (GJ) 14.98 → 18.99; % change 26.80%
  - Electricity: baseline US$ per kwh 0.11 → 0.16; % change 40.40%

*Source: IMF staff summary of Annex II. Climate Mitigation in the Czech Republic*

### 4.      Adult training should be better targeted to low-skilled and older workers. The Czech

### 4.      Adult training should be better targeted to low-skilled and older workers. The Czech Republic has high enterprise participation and high employee coverage rates in vocational training

### Labor market overview and key statistics
- Employment rate (age 20–64) at end-2019: 80 percent, 6 pps above the EU average.
- Activity rate: 82 percent, EU average: 79 percent.
- Unemployment rate before COVID crisis: 2 percent (lowest in the EU).
- Part-time and temporary employment were low; share of discouraged workers was low.

### Adult training, coverage gaps, and target groups
- Enterprise participation and employee coverage in vocational training are high, but:
  - Older workers, low-skilled workers, and the unemployed remain at the margins of training programs.
- Policy objective: direct training policies to these categories to bring them back into the labor force, especially in sectors with largest needs for reskilling and upskilling.

### Childcare, parental leave, and female labor force participation
- Employment rate of mothers with young children is 30 percent below that of men.
- Gender gap in labor income remains high.
- Parental leave and child cash benefits discourage Czech women from resuming work after childbirth:
  - One parent (almost exclusively the mother) can stay at home receiving a parental allowance until the child reaches three years of age without losing reintegration rights at their employer.
  - Paternity leave introduced in 2018 to encourage fathers' early childcare engagement.
- Childcare supply constraints (2017/2018):
  - Estimated unmet demand for childcare of 14,000 children below 3 years of age.
  - More than 33,000 applications for admission to nursery schools were rejected (close to one-fifth of all applications).

### Education system, skills mismatch, and sectoral skill needs
- Share of workers in occupations that differ from their studies: 38 percent.
- In 2019, almost 80 percent of firms looking to hire specialists in the ICT field reported major difficulties with recruitment.
- Estimated demand growth for skills (Western European benchmarks, McKinsey 2018):
  - Technological capabilities: around 50 percent growth in demand.
  - Social and emotional skills: around 20 percent growth in demand.
- Share of students graduating in ICT subjects: around 4 percent (below EU average).
- Funding for education: among the lowest in the OECD.
- Teacher shortages reported in English, physics, and ICT.
- Gender in ICT: in 2017 about 10 percent of 16–24 years-old software programmers are women, compared to about 40 percent in France.

### Digitalization, automation, and AI — opportunities and risks
- The country is in an early stage of a digital-industrial revolution; digitalization can reignite productivity growth given near-full employment, above-average hours worked, and high capital intensity.
- Potential benefits:
  - Allow employees to focus on value-adding activities and reduce administrative time.
  - Automation can mitigate inadequate labor supply in sectors with highest job vacancy rates.
  - Technology can improve operating efficiency and boost revenues through digital channels.
- Automation risks, especially for low-skilled workers:
  - Various estimates: between 40 percent and 70 percent of current jobs in the country at risk of being fully or partly automated in the next decades.
  - Manufacturing and automotive share in the economy increases automation risk (production workers and machine operators have higher automation potential).

### Projections and modelled impacts of automation
- Czech government 2018 study:
  - Current AI technologies could substitute 50 percent of the skills demand in 11 percent of professions.
  - Over 30 years, automation could replace more than 50 percent of skills in most current professions, totaling around 3.4 million employees.
- McKinsey (2018) estimate:
  - Equivalent of 1.1 million jobs will be automated by 2030 in a middle technology adoption scenario.
- Regional effects:
  - Highest negative impact in the Ústecký and Karlovarský regions.
  - Largest benefits likely around Prague and Brno (clusters for digitalization and innovation).
- Heterogeneous agent general equilibrium model (calibrated to Czech economy; Lizarazo et al. 2017) simulations:
  - Assuming a 20 percent drop in the relative price of capital goods (machinery and equipment): GDP rises by 6½ percent over the long term compared to the baseline.
  - Distributional effects across skills: income of unskilled workers increases by 6½ percent, about 2 ppt less than for medium- and high-skilled workers.
  - Simulating a 10 percent increase in the elasticity of substitution between capital and labor (automation scenario) produces a larger GDP impulse: 18 percent higher compared to baseline; benefits for low-skilled workers are materially smaller relative to medium- and high-skilled workers.

### Policy recommendations and structural reforms to support productivity and inclusive outcomes
- Target adult training to low-skilled, older workers, and unemployed to facilitate re-entry and reskilling for growing sectors.
- Expand provision of childcare and early childhood education to bring mothers back into the labor force.
- Make the education system more inclusive, promote technical skills, and expand graduate student numbers; improve attractiveness and supply of teaching in key subjects (English, physics, ICT).
- Increase spending on active labor market policies (ALMP) and focus on reskilling programs; provide high-quality labor market information on current and future demand and earnings potential.
- Use the recovery to boost productivity growth and investments, including in green and ICT:
  - Estimated investment needed to meet 2030 targets: CZK 500 billion (10 percent GDP) over the next decade.
  - RRF allocation: 42 percent of the EUR 7 billion total allocation destined to support green projects.
  - Complement public funds with incentives to attract private investment and a prompt definition of the tax framework for green investment, including carbon taxation level and base.
- Additional measures to raise productivity and investment:
  - Nurture high productivity sectors, including Knowledge-Intensive-Sectors (KIS), by ensuring adequate supply of technical and digital skills.
  - Improve access to equity finance for domestic start-ups and SMEs; develop capital markets and venture capital availability.
  - Simplify business regulatory framework: address weaknesses in starting a business, resolving commercial disputes, and obtaining construction permits.
  - Improve insolvency procedures to speed asset recovery and support corporate restructuring.
  - Support R&D for domestic SMEs through well-targeted R&D deductions and tax incentives.
  - Strengthen governance and address corruption to improve government spending efficiency and attractiveness for FDI.

### Risk Assessment highlights (select points)
- Medium likelihood: global resurgence of COVID-19 pandemic — impact: High. Policy response: adjust fiscal spending composition, adopt credible fiscal consolidation plan, monitor fiscal and financial sector risks.
- Medium/Low likelihood: de-anchoring of U.S. inflation expectations leading to higher yields — impact: Medium/Low. Policy response: expand macroprudential toolkit, monitor financial sector risks, adjust fiscal spending to better target support.
- Medium likelihood: disorderly structural transformations with impeded reallocation — impact: Medium. Policy response: pursue structural reforms in education, labor market, business climate, infrastructure, and insolvency framework while safeguarding fiscal sustainability.
- Medium likelihood: sharp correction in housing prices — impact: High/Medium. Policy response: vigilant financial surveillance, discourage housing debt build-up, tighten macroprudential measures.
- Low likelihood: continued domestic inflationary pressures un-anchoring expectations — impact: Medium. Policy response: tighten monetary stance in a forward-looking, data-dependent manner.

*International Monetary Fund — Czech Republic (chapter content).*

### Annex V. Public Debt Sustainability Analysis

### Annex V. Public Debt Sustainability Analysis

### Summary of recent developments and medium-term outlook
- Public debt increased to 37¾ percent of GDP in 2020 and further to about 41½ percent of GDP in 2021:Q2.
- Public debt is projected to rise to 49 percent of GDP by 2026 under the baseline.
- The debt-to-GDP ratio does not stabilize by 2026 under the baseline.
- A negative shock to real GDP growth is identified as the main risk to the projections.

### Baseline assumptions and realism of projections
- Fiscal stance and balances:
  - The fiscal stance loosens to a structural balance of -7.2 percent of GDP in 2021.
  - Over the medium term the structural balance is assumed to improve by ½ percent of GDP per year, reaching -2½ percent (structural and headline) by 2026.
  - Primary deficit trajectory (from DSA table): primary deficit contributions drive debt increases with cumulative primary deficit contribution of 20.0 (cumulative row in figure table).
- Growth and inflation:
  - Real GDP growth: 2.9 percent in 2021 (baseline projection).
  - Inflation (GDP deflator): 3.6 percent in 2021, converging to the 2 percent target by 2023.
- Interest and financing:
  - Effective interest rate path (figure): 2.5, 2.3, 2.2, 2.1, 2.1, 2.1 (2019–2026 entries shown).
  - Gross financing needs projected to be 9½ percent of GDP at the end of the projection period.
- Debt dynamics:
  - Staff projects a steady increase in the debt-to-GDP ratio from 37¾ percent in 2020 to 49 percent in 2026 as the primary deficit exceeds the debt-stabilizing primary balance of -1.1 percent over the projection horizon.
  - Automatic debt dynamics (interest rate/growth differential contribution) shown in table: 0.1, -1.4, 1.1, -1.4, -2.2, -1.7, -1.4, -1.4, -1.1 (2019–2026).

### Shock and stress test results
- Growth shock:
  - A 1 standard deviation shock to real GDP growth (3.3 percentage point decline) hitting in 2022 and 2023 causes:
    - Public debt to rise by almost 12 percentage points to 56 percent of GDP and gross financing needs to increase to 15.2 percent of GDP by 2023.
    - Thereafter debt follows a trajectory parallel to the baseline, reaching 58 percent of GDP in 2026; gross financing needs are higher by 1½ percent of GDP than under the baseline by 2026.
  - Calibration note: shock calibrated using historical real GDP growth data from 2011–20; every percentage point decline in real GDP growth assumed to reduce inflation by 0.25 percentage points while non-interest revenues and non-interest expenditures are assumed constant.
- Interest rate shock:
  - An interest rate shock in which the nominal rate increases by 385 basis points (the difference between the maximum real interest rate over the last 10 years and the average real interest rate over the projection period) accelerates the increase in debt moderately to 52 percent of GDP by 2026.
- Other scenario results (from DSA figures and tables):
  - Historical-scenario and alternative-scenario panels show varying outcomes under constant primary balance or historical averages, with Gross Nominal Public Debt and Public Gross Financing Needs plotted through 2026 (figures indicate rising debt and financing needs under adverse scenarios).

### External debt sustainability highlights (Table 1 and figures)
- Baseline external debt-to-GDP and flows:
  - Baseline external debt: 68.1 (2016), rising through the series to 65.8 (2026) in table header (row labeled "1Baseline: External debt" with year entries).
  - Change in external debt (row 2): varied by year (e.g., 0.6, 4.9, 15.4, -7.0, -4.9, -2.9 ...).
  - Identified external debt-creating flows (row 3): series including 8.2, -8.7, ... and projection values.
- Key macroeconomic assumptions underlying baseline (selected entries):
  - Real GDP growth (percent): 2.9, 3.6, 4.4, 3.5, 3.1, 2.5, 2.5 (for 2021–2026 entries listed).
  - GDP deflator in US dollars (change in percent): 4.0, 3.4, 2.8, 2.9, 2.8, 2.8 (projection entries).
  - Current account balance, excluding interest payments: 0.3 (2021), -0.3 (2022), 1.7 (2023) and then 0.8, 0.8, 0.8, 0.8 (subsequent projection entries as shown).
- External vulnerabilities and bound tests:
  - Bound tests (Figure 3) display external debt under shocks (interest rate shock, current account shock, combined shocks, real depreciation) with baseline external debt shown at 66 percent of GDP in figures and higher peaks under combined and depreciation shocks (e.g., up to 99 in real depreciation shock panel).

### Key analytical findings and policy-relevant implications (drawn from DSA results)
- Under baseline assumptions of gradual structural consolidation (½ percent of GDP per year) and improving growth, public debt still rises materially to about 49 percent of GDP by 2026 and does not stabilize by 2026.
- A growth shock is the most consequential risk: a 1 standard deviation fall in real GDP growth can raise the debt ratio by nearly 12 percentage points within two years and materially increase gross financing needs (to 15.2 percent of GDP by 2023).
- The DSA indicates comparatively lower sensitivity to an interest rate shock relative to the growth shock; a large nominal rate rise of 385 basis points raises debt to 52 percent by 2026.
- Gross financing needs reaching around 9½ percent of GDP under the baseline, and substantially higher under adverse scenarios, imply financing pressures under shocks and highlight the importance of rebuilding fiscal buffers and contingency planning.

*Source: IMF staff.*

### 3. GVC disruptions have led to a stalling of industrial production growth in mid-2021.

### 3. GVC disruptions have led to a stalling of industrial production growth in mid-2021.

### Industrial production and GVC disruptions
- Industrial production accounts for 30–35 percent of total GDP.
- Output growth and industrial production growth tend to be highly correlated.
- Industrial production rose above pre-pandemic values in early 2021 but has since stalled.
- Microchip production has been further delayed by an abnormally cold winter season in Texas and fires in South-East Asian causing additional shutdowns of factories.
- Equipment shortages have overtaken lack of demand as the main reported factor limiting production (lack of demand peaked at the height of the pandemic lockdown measures).
- Industrial goods orders over the first half of 2021 increased by 20 percent more than industrial production.

### Automotive sector impacts and spillovers
- GVC-related disruption in the automotive sector led to a sharp decline in automotive industrial production.
- The automotive sector has been hit especially hard and has erased the gains made in other major manufacturing sectors.
- The automotive sector experienced a sharp decline in production due to issues obtaining the microchips necessary to complete vehicles.
- Other sectors have fared relatively well and have not dipped below pre-pandemic production levels to date; this could change if other sectors experience similar GVC disruptions.

### Input-output linkages and domestic transmission
- The automotive sector is a key consumer of intermediate goods produced in other domestic sectors.
- Recent closures and slowdowns in automotive production resulted in lower input purchases from other sectors, limiting short-term recovery of non-automotive industrial production to pre-pandemic levels.
- There is a downside risk that further disruptions to automotive GVCs could lead to closures of, otherwise viable, supplying firms due to increased financial instability.
- The automotive industry is not an important supplier to other sectors in the Czech economy (aside from retail and wholesale trade of motor vehicles), limiting the extent that current disruptions to vehicle completion will cause bottlenecks in other sectors.

### Scenarios and projected paths for recovery
- Baseline scenario: recovery in the GVCs by mid-2022.
- Slower GVC recovery scenario:
  - Assumes GVC disruptions ease by Q3 2023 rather than Q4 2022 in the baseline.
  - Envisages lower output growth of 0.6 percent in 2022 and higher output growth of 0.3 percent in 2023 relative to the baseline scenario.
- Broader disruption (GVC spillovers to other sectors) scenario:
  - Assumes non-automotive industrial production is hit by a similarly sized shock, adjusted for relative variation in industrial production, as the automotive sector in Q4 2021 and then recovers linearly by Q4 2022.
  - Envisages lower output growth of 0.6 percent in 2021 and 0.2 percent in 2022 followed by higher output growth of 1.0 percent in 2023 relative to the baseline.
- Alternative paths assume industrial production accounts for around one-third of total output and recovers to the pre-pandemic level by the end of the shock.

### Key risks and implications
- Continued or prolonged GVC disruptions would delay the economy’s recovery (to early-to-mid 2023 in the slower recovery scenario).
- Spillovers from the automotive sector to other sectors could produce a much stronger drop in output in end-2021 and early 2022, with a comparatively stronger recovery in 2023.
- Short-term limitations on non-automotive recovery stem from reduced input demand due to automotive slowdowns; persistent shocks could induce firm closures and broader financial instability.

*Source: 1czeea2022001 - 3. GVC disruptions have led to a stalling of industrial production growth in mid-2021.*

### 3.      On the back of persistently high inflation, the CNB undertook another

### 3.      On the back of persistently high inflation, the CNB undertook another

### Covid-19 policy response and latest economic developments
- Czech Republic entered the pandemic with strong fiscal, monetary, and macro-prudential policy buffers and deployed substantial direct and indirect fiscal support to households and firms.
- CNB measures during the pandemic:
  - Decreased the two-week repo rate and increased frequency of repo operations.
  - Released the countercyclical capital buffer (CCyB) in line with its counter-cyclical objective.
  - Relaxed or discontinued borrower-based macroprudential tools (LTV, DTI, DSTI) to remove constraints to credit growth amid rapid decline in economic activity.
- Economic outlook and projections:
  - Growth driven mainly by domestic demand; net exports contribution substantially negative.
  - Supply chain disruptions expected to weigh on growth in 2022 and government fiscal support withdrawal expected to dampen activity.
  - CNB autumn growth projections: 1.9 percent in 2021 and 3.5 percent in 2022.
  - Headline inflation projected to reach 7 percent at the beginning of 2022; gradual return to 2 percent expected in 2023.
  - Staff and authorities broadly aligned on medium-term return of inflation to target.

### Fiscal policies and public finances
- Pandemic fiscal impact and near-term outlook:
  - Expansionary fiscal policy expected to lead to a deficit of 7.2 percent of GDP and a rise in debt to 43.3 percent of GDP in 2021.
  - Authorities estimate overall deficit of 4.4 percent of GDP and debt rising to 46.2 percent of GDP in 2022 as pandemic-related measures no longer affect the balance.
- Consolidation strategy and fiscal framework:
  - Incoming government committed to returning to a balanced fiscal stance; 2022 expected to be first year of public finance consolidation since pandemic onset.
  - Structural balance projected to improve by 0.5 pp to 4.8 percent of GDP, compared to 5.3 percent of GDP in 2021.
  - Priority to scale down public expenditures, consider staffing reductions and organizational simplification in public sector.
  - Authorities prefer discontinuing non-systemic tax exemptions over increasing personal income tax or reintroducing real estate transfer tax.
  - Commitment to reinforce fiscal rules: meeting Maastricht criteria and anchoring Act on Fiscal Responsibility Rules into constitutional framework.
  - Ministry of Finance published a preliminary Funding and Debt Management Strategy for 2022 covering the provisional budget period.

### Monetary policy
- CNB recent actions and stance:
  - CNB increased the policy rate in December by 100 basis points to 3.75 percent and signaled further increases as needed.
  - In 2020 CNB reduced the interest rate three times in response to the pandemic; five interest hikes followed in 2021 as inflation rose above the 2 percent target, with the last increase in December (after staff report cut-off).
  - Monetary policy pass-through to loans and deposits functioning well, but inflationary pressures persisted.
  - Inflation further accelerated to 6.6 percent in December 2021.
- Authorities’ outlook and rationale for tightening:
  - Current inflation trend driven by extraordinary acceleration of imputed rents, stronger-than-expected domestic demand, and higher growth of foreign prices.
  - CNB expects inflation reversal later in 2022 and envisages additional monetary policy tightening going forward.
  - Foreign producer price inflation expected to ease as global supply chains disruptions dissipate; high fuel price growth expected to fade as global oil prices stabilize.
  - Appreciation of the koruna against the euro expected to exert downward pressure on domestic prices.
  - Inflation expected to fall close to the 2 percent target in early 2023 (over the monetary policy horizon).

### Labor market
- Labor market developments and projections:
  - Labor market coped relatively well due to fiscal support but is getting increasingly overheated.
  - Wage growth expected to rise in early 2022 with demand recovery, minimum wage increase, and inflation pass-through to wages.
  - Decline in total employment halted.
  - Authorities project unemployment at 3 percent in 2021 and 2.7 in 2022.

### Pension system and demographics
- Demographic challenge and reform plans:
  - Eurostat population projection (2019) expects a decline in the population of the Czech Republic by almost 4.5 percent in the long term.
  - Parametric reforms suggested (broadly in line with staff recommendations): link retirement age to life expectancy, adjust pension indexation to inflation, or increase contributions to the funded pillar.
  - Government committed to present a thorough pension system reform by end-2023 based on fairness and sustainability while maintaining private pension savings.

### Financial sector policies and macroprudential measures
- CCyB and capital measures:
  - At pandemic onset CNB gradually lowered CCyB from 1.75 percent to 0.5 percent in 2020.
  - CNB increased CCyB rate three times in 2021; in November 2021 adopted decision to increase CCyB to 2 percent, taking effect in January 2023.
  - Given strong capitalization, increasing CCyB not expected to negatively affect lending to the real economy.
  - Bank profitability improved in 2021, supporting capital positions.
- Borrower-based macroprudential tightening:
  - LTV, DTI, DSTI limits tightened in November 2021 to contain rising real estate market overheating and household credit expansion.
  - Authorities note residential mortgage expansion and house price growth partly reflect households’ strategy to protect income from inflation; additional underlying factors should be considered.
- Risk weights, provisioning, and supervision:
  - Decline in banking sector risk weights partly attributable to CRR II regulatory changes including SME supporting factor reducing capital requirements for SME exposures.
  - CNB regularly verifies banks’ model approaches and assumptions on risk weights.
  - Deterioration of credit portfolio quality after loan moratorium expiration was marginal, leading to partial release of provisions in 2021.
  - CNB proactively communicates provisioning expectations to banks and external auditors.
- Contagion and dividend policy:
  - Authorities consider interlinkages and contagion risks limited due to local funding for local lending and financing of domestic sovereign entities.
  - CNB conducts supervision on individual and sub-consolidated bases; capital held on these bases.
  - CNB eased conditions for dividend payouts and will assess profit distribution proposals within standard supervisory process.

### AML/CFT and governance
- AML/CFT framework improvements:
  - Substantial progress made on AML/CFT framework via legislative amendments and supervisory developments; framework aligned with 5th EU AML Directive and FATF Standards.
  - AML/CFT supervision follows a risk-based, data-driven approach, improving private sector compliance.
  - CNB and Financial Analytical Office strengthened monitoring of cross-border financial flows, including use of SWIFT data.
  - Support for banking-issued ID project to improve customer due diligence and remote onboarding security.
- Politically exposed persons (PEP) measures:
  - Regulation and implementation of PEP-related AML/CFT measures in line with international and European standards; private sector applies PEP measures thoroughly.
  - Authorities note publishing assets of local PEPs does not fall under AML/CFT standards; therefore prefer positioning staff recommendation regarding PEPs in a governance/corruption context rather than as an AML/CFT shortcoming.
- Beneficial ownership registry:
  - Registry established through transposition of 4th and 5th EU AML Directives; partly public, free of charge, covers more than 90 percent of legal entities.

### Structural reform agenda and investment
- Labor market reforms and participation:
  - Priorities include increasing labor participation of elderly, disabled, foreign workers, and families with young children while ensuring work-life balance.
  - Commitments to enhance life-long learning via cooperation among state, employer associations, and trade unions; review systems to integrate disabled people into society and labor market.
  - Foreign workers constitute around 12 percent of the total workforce; authorities intend to ease work permit acquisition, including a Multicriterial Points-Based System and digitalization of work permit application.
- Investment, R&D, and SME support:
  - Authorities committed to implementing Innovation Strategy and National Investment Plan; utilize EU Recovery and Resilience Facility (RRF) funds alongside other EU structural funds and national resources.
  - Priority to stimulate private investment in R&D by incentivizing reinvestment of profits in R&D and supporting commercialization of academic R&D via SME collaboration.
  - Authorities will draw on the Strategy to Support SMEs in the Czech Republic, developed for the period 2021–2027.
- Governance, anti-corruption, and legal reforms:
  - Authorities advancing governance and anti-corruption measures postponed due to elections.
  - Steps taken to detect and prosecute foreign bribery in high-risk sectors (financial, gambling, real estate).
  - Government pledged to finalize review of Act on Public Prosecutor’s Office for transparent appointment and dismissal rules for prosecutors.
  - Committed to adopt delayed whistleblower protection legislation accompanied by a public awareness campaign.
- Green transition and climate policy:
  - Green transition constrained by economy structure, high costs, and redistributive consequences, but government pledged progress.
  - Authorities to introduce a new Climate Protection Policy (CPP) reflecting EU 2030 goals and to draft guidelines for climate neutrality by 2050 at the latest.
  - High emissions concentrated in power generation; CPP to be drafted in parallel with updated State Energy Policy for government discussion in 2023.

*Statement by Mr. Daniel Palotai, Executive Director for Czech Republic and Mr. Lukas Marek, Senior Advisor to the Executive Director, January 24, 2022; January 14, 2022 note on CNB policy rate increase included.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1czeea2022001.pdf_