## 1czeea2023001

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### Inflation Expectations — Context and recent developments
- Russia’s war in Ukraine: undermined growth, increased living costs, and clouded the economic outlook.
- Energy supply and vulnerabilities:
  - Czechia sourced virtually all of its gas from Russia; gas storage is fully filled; LNG access secured; idle coal facilities can be reactivated; vulnerabilities to further increases in energy prices remain.
- GDP and labor market:
  - GDP: contracted by 5½ percent in 2020; rebounded to 3½ percent in 2021. Growth in the first three quarters of 2022 averaged around 0.3 percent q-o-q.
  - Unemployment rate around 2½ percent in 2022:Q2.
- Real incomes and inflation:
  - Real incomes have fallen in 2022 due to inflationary pressures and relatively subdued nominal wage growth.
  - CNB policy rate increased to 7 percent.
  - Headline and core inflation rose from about 2½ and 3½ percent respectively at end-2020, to peaks of 18 percent and 14.7 percent respectively y-o-y in September 2022.
  - Core inflation remained at 14.6 percent in October 2022; headline inflation receded to about 15.1 percent in October 2022.
  - Decrease in CPI inflation by almost 3 percentage points in October 2022 mainly reflects a drop in administered price inflation.
- Inflation expectations:
  - Indicators increased but appear broadly anchored (36-month financial sector expectations stable; inverted government bond yield curve).

### Outlook and risks for growth and inflation
- Growth projections:
  - Growth projected to slow to 2.5 percent in 2022.
  - Growth projected to turn negative to around -0.5 percent in 2023.
  - Rebound expected from 2024; growth projected to pick up by end 2024 driven mainly by consumption and exports.
- Inflation projections and drivers:
  - Inflation projected to remain elevated in the near term but converge to the CNB’s target range during 2024, barring additional shocks.
  - Near-term inflationary pressures driven by domestic factors (imputed rents and input costs) and external factors (GVC disruptions and high commodity prices).
- Main downside risks:
  - Further increases in energy and commodity prices.
  - Disorderly house price correction causing financial disruptions.
  - Risk of inflation expectations becoming untethered or wage-price spirals in a tight labor market.
  - Depreciation pressures on the koruna if interest rate differentials narrow.
- Upside/alternative risk:
  - A deeper recession or significant fall in global demand could reduce domestic or external inflationary pressures.

### Policy discussions and recommendations (inflation, macroprudential, fiscal)
- Monetary policy:
  - Staff recommends further tightening of monetary policy in the short term to ensure fulfillment of the inflation target over the medium term and reduce the risk of inflation expectations becoming untethered.
  - Priority given to decisively quelling inflation; actions should be data dependent.
- Fiscal policy:
  - Targeted and temporary fiscal support to alleviate the cost-of-living crisis while avoiding adding to inflationary pressures.
  - Unwinding previously-adopted untargeted support measures can enhance policy space.
  - Recommendation to reinstate the PIT regime and the property transfer tax to pre-pandemic levels as soon as conditions allow; implementing these measures would yield over 2 percent of GDP going forward and lift the primary balance above its debt-stabilizing level of - 0.5 percent of GDP as early as 2024.
- Macroprudential policy:
  - Pause in tightening macroprudential policies recommended; macroprudential measures should be calibrated to market developments and the monetary policy stance.
  - Close monitoring of financial sector risks and debt-servicing, especially if further interest rate increases materialize.

### CNB policy actions and Board views
- Policy rate:
  - CNB tightened the policy rate from 0.5 percent in June 2021 to 7 percent (current value at time of report).
  - At the policy meeting on November 3, 2022, the CNB Board kept the policy rate unchanged citing rates dampening domestic demand and slowing loan growth.
- FX interventions:
  - CNB increased FX interventions since May 2022 to prevent excessive koruna fluctuations and announced continuation.
- Board views:
  - Some Board members favor further short-term rate increases to guard against de-anchoring of expectations.
  - Other Board members view current interest rate level as sufficiently restrictive and attributable external shocks as largely outside domestic policy control; they prefer waiting for further data.
- Staff analysis (Annex XI):
  - Further short-term interest rate tightening would steer inflation to the target sooner, allowing an earlier reduction of the policy rate.

### Fiscal measures (2022–2023) — main items and assessments
- Energy-price-related measures (CZK billion and percent of GDP):
  - Energy-price-related measures: 71.8 (1.0 percent of GDP) in 2022; 115.2 (1.6 percent of GDP) in 2023.
  - Power price cap for households and SMEs: 0.0 (0.0 percent of GDP) in 2022; 83.0 (1.1 percent of GDP) in 2023.
  - Energy saving tariff for households: 18.5 (0.3 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - Power subsidy for large businesses: 30.0 (0.4 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - One-off allowance for families with children: 7.8 (0.1 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - Reduction of excise tax on petrol and diesel by CZK 1.50/l: 6.7 (0.1 percent of GDP) in 2022; 9.6 (0.1 percent of GDP) in 2023.
  - Waiver of the renewable energy surcharge: 4.6 (0.1 percent of GDP) in 2022; 18.4 (0.2 percent of GDP) in 2023.
  - Cancellation of road tax for cars up to 12t: 4.2 (0.1 percent of GDP) in 2022; 4.2 (0.1 percent of GDP) in 2023.
- Other measures (CZK billion and percent of GDP):
  - Other measures total: 66.1 (1.0 percent of GDP) in 2022; 82.2 (1.2 percent of GDP) in 2023.
  - Support for Ukrainian refugees: 15.2 (0.2 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - Mandatory extraordinary pension hikes due to high inflation: 28.0 (0.4 percent of GDP) in 2022; 59.0 (0.9 percent of GDP) in 2023.
  - Discretionary pension hike: 10.6 (0.2 percent of GDP) in 2022; 10.9 (0.2 percent of GDP) in 2023.
  - Second increase in the basic income tax deduction: 12.3 (0.2 percent of GDP) in 2022; 12.3 (0.2 percent of GDP) in 2023.
  - Pension increase of CZK 500 per month for each child raised: 0.0 (0.0 percent of GDP) in 2022; 18.4 (0.3 percent of GDP) in 2023.
  - Increase in the turnover limit for VAT registration from CZK 1 to 2 million: 0.0 (0.0 percent of GDP) in 2022; 10.0 (0.1 percent of GDP) in 2023.
- Selected specifics:
  - Electricity price cap: CZK 5/kWh (CZK 6.05/kWh incl. VAT) for households, government entities and SMEs; caps apply January 2023-end 2023.
  - Gas price cap: CZK 2.5/kWh (CZK 3.025/kWh incl. VAT) for households and SMEs with consumption below 630MWh; caps apply January 2023-end 2023.
  - One-off allowance to households’ energy bills: CZK 3,500 or CZK 2,000 depending on tariff in 2022.
  - Waived renewable energy surcharge: CZK 599/MWh; applies Oct 2022–Dec 2023.
  - Discretionary pension hike (permanent): pensions increased by CZK 300.
  - One-off allowance for families with children: CZK 5,000 per child under 18 for households with annual gross income up to CZK 1 million.
- Staff assessment of measures:
  - Prefers targeted, temporary expenditure-side measures (lump sum cash transfers to the most vulnerable) that preserve price signals to incentivize energy savings.
  - Views waivers, excise cuts, and broad price caps as not targeted and blunt incentives for energy saving.
  - Energy subsidies for large firms should be better designed (link relief to past usage or provide lump-sum support).

### Windfall tax
- Design: levied on profits of banks and energy production and distribution companies in 2023–2025 exceeding average profits plus 20 percent during 2019–2021.
- Rate: 60 percent.
- Revenue estimate: expected to yield about CZK 150 billion (close to 2¼ percent of 2022 GDP) in 2023–2025.
- Staff assessment: acceptable as strictly temporary and imposed only on excess profits, but may undermine tax certainty and investment; second-best to a permanent excess profit tax with clear rules.

### Fiscal stance and consolidation
- General government deficit declined to 5.1 percent of GDP in 2021 versus 7.2 percent envisaged in the November 2021 Fiscal Outlook.
- Debt at end-2021 was 42 percent of GDP—12 percentage points higher than in 2019.
- Headline and structural fiscal balances in 2022 estimated to have improved by about ¾ and 1 percent, respectively; general government debt estimated to have remained constant at about 42 percent of GDP.
- Recommendation: unwinding untargeted support measures to enhance policy space; reinstate PIT and property transfer tax to pre-pandemic levels when feasible.

### Selected macroeconomic projections and key statistics (highlights)
- Real GDP (expenditure, 2019–2027): 3.0, -5.5, 3.5, 2.5, -0.5, 2.5, 3.4, 2.8, 2.5
- Consumer prices (average, 2019–2027): 2.8, 3.2, 3.8, 16.0, 9.3, 2.5, 2.0, 2.0, 2.0
- Unemployment rate (average, percent, 2019–2027): 2.0, 2.5, 2.8, 2.5, 3.1, 2.5, 2.3, 2.3, 2.3
- General government debt (percent of GDP, 2019–2027): 30.0, 37.7, 42.0, 41.8, 43.7, 44.1, 44.2, 44.9, 45.9
- Current account balance (percent of GDP, 2019–2027): 0.3, 2.0, -0.8, -4.0, -0.9, 1.2, 2.3, 2.5, 2.5
- Gross international reserves (billions of euros, 2019–2027): 133.4, 135.4, 153.3, 151.3, 160.3, 169.3, 178.3, 186.3, 192.3
- Nominal GDP (USD billions, 2019–2027): 252.5, 246.0, 281.8, 293.0, 309.0, 325.8, 339.0, 346.8, 350.6
- Population (millions, 2019–2027): 10.6, 10.7, 10.5, 10.5, 10.5, 10.6, 10.6, 10.6, 10.5

### Financial sector, macroprudential stance, and risks
- Banking sector resilience (end-2021 highlights):
  - Capital ratio in banking sector: 23.3 percent at end-2021 including a 9 percent surplus beyond the required level.
  - Liquidity coverage ratio: 183 percent at end-2021.
  - Net stable funding ratio: 200 percent for the average bank at end-2021.
  - Non-performing loans ratio reverted to pre-pandemic levels at end-2022:Q1.
- Vulnerabilities and monitoring:
  - Concentration of lending for real-estate purchases close to 63 percent of total loans to the non-financial private sector at end-2021.
  - Average mortgage size rose close to 75 percent over the past five years to above CZK 3 million in 2021:H2.
  - CNB retightened borrower-based measures effective 1 April 2022: DTI (8.5), DSTI (45 percent), LTV (80 percent); limits for applicants under age 36: DTI (9.5), DSTI (50 percent), LTV (90 percent).
  - Shares of newly extended loans with elevated LTV and DTI ratios have come down; share with elevated DSTI ratios continues to increase.
  - CCyB schedule: "The CCyB becomes effective at 1.5 percent in October 2022, 2 percent in January 2023, and 2.5 percent in April 2023."
- Staff recommendations:
  - Enhance models to improve measurement of risk at the individual exposure level using credit-registry information.
  - Combine modeling with macroprudential stress tests to quantify potential losses and improve calibration of tools.
  - Close monitoring of debt-servicing capacity given retightened borrower-based measures and potential further interest-rate increases.

### Anti–money laundering / Countering the financing of terrorism (AML/CFT)
- Recommendations:
  - Continue implementing AML/CFT measures to mitigate laundering of foreign proceeds of corruption.
  - Increase resources for complex money laundering prosecutions.
  - Enhance supervision of designated non-professional businesses and professions, per MONEYVAL recommendations.
  - Monitor impact of EU and other sanctions on the Czech financial system, including prevention of sanctions evasion.

### Structural policies — labor shortages, migration, productivity, and green/digital transition
- Labor and migration:
  - Employment gaps sizable for low-skilled, foreign, young, and old workers and mothers with young children; employment gap for mothers with young children is "about 30 percent."
  - As of end-October the Czech Republic was hosting about 456,000 refugees (4.3 pct of pop).
  - Recommendations: improve technical and digital education, increase ALMP spending, facilitate migration and integration of Ukrainian refugees, support flexible work arrangements.
- Productivity and innovation:
  - Private support for business R&D was comparatively lower versus OECD peers in 2022.
  - RRF implementation critical for digital transition and green investments.
- Green transition:
  - GHG emissions reduced by about 43 percent in 2020 relative to 1990.
  - Fit-for-55 targets: GHG reduction of 55 percent by 2030 and climate neutrality by 2050.
  - Ministry of Environment (2022) estimates decarbonization investment needs through 2030: around EUR 41 billion under current policies; up to EUR 61.5 billion under Fit for 55.
  - RRP: about EUR 7.1 billion of grants or 3 percent of GDP over 2021–2026; RRP energy efficiency allocation EUR 1.4 billion.
  - Policy priorities: follow through on coal phase-out by 2033, diversify energy sources, scale up renewables and energy efficiency, accompany nuclear expansion with strong regulation, define tax framework for green investment.

### Pension spending and sustainability
- Projected pension spending:
  - Czechia among countries with highest expected increase: about 3.8 percentage points to 11.8 percent of GDP by 2060 (EC’s Aging Report, 2021).
  - Pension spending expected to remain around 8.8 percent of GDP until 2030, increase to 11.8 percent by 2060, then decline to 10.9 percent in 2070.
- Demographics:
  - Elderly population increased by about 47 percent between 2000 and 2019; old-age dependency ratio expected to rise from 33 percent in 2019 to 59 percent in 2060.
  - Statutory retirement age will reach 65 years in 2030; raising retirement age to 67 beyond 2030 would boost employment by about 3 percent (OECD, 2020).
- Policy options:
  - Increasing retirement age beyond 2030 and linking it to life expectancy to stabilize pension spending.
  - Indexing pensions to inflation only could reduce spending (by 0.9 percentage point of GDP at the peak in 2059 per OECD (2020)).
  - Broaden fiscal revenues via growth-friendly tax reforms (property taxes, environment taxes) and improve tax compliance.
  - Boost labor force participation via ALMPs, vocational training, and migrant integration.

### Debt dynamics and sensitivity
- Baseline nominal gross public debt (selected years):
  - 2021: 37.9
  - 2022: 42.0
  - 2023: 41.8
  - 2024: 43.7
  - 2025: 44.1
  - 2026: 44.2
  - 2027: 44.9
  - 2028: 45.9–46.6
- Interest rate shock:
  - An interest rate shock with the real rate increasing by 346 basis points accelerates debt increase moderately to 48 percent of GDP by 2028.
- Public gross financing needs (percent of GDP, selected years):
  - 2021: 6.9
  - 2022: 9.5
  - 2023: 8.1
  - 2024: 7.7
  - 2028: 8.0–9.5
- Automatic debt dynamics (annual contributions, percent of GDP, 2021–2028):
  - 2021: -0.2; 2022: -1.6; 2023: -3.7; 2024: -2.0; 2025: -1.1; 2026: -1.1; 2027: -0.5; 2028: -0.2; Cumulative (2021–2028): -5.2

### External sector assessment and exposures
- External position:
  - Overall assessment: The external position in 2022 was broadly in line with fundamentals and desirable policy settings.
  - Estimated CA gap: 0.6 percent of GDP (range 1 to -1 percent of GDP).
  - REER gap (staff assessment): 4 percent (±1.8) percent.
- Trade and energy exposures:
  - Exports to Russia and Ukraine in 2021: 1.9 percent and 0.7 percent of total exports, respectively.
  - Imports from Russia and Ukraine in 2021: 4.2 percent of total imports; increased to close to 6.2 percent in January–July 2022.
  - Crude petroleum and natural gas account for almost 60 percent of goods imports.
  - Gas represents about a fifth of the domestic energy mix.
- Reserves and FX:
  - Gross international reserves increased to US$178 billion (60 percent of GDP) in 2021.
  - Reserves equivalent to approximately 9 months of imported goods and services in 2022.
  - CNB intervened through the first nine months of 2022 and may continue to intervene if warranted.

### Downside scenario (Annex VIII) — assumptions and quantified impacts
- Adverse shocks if war escalates:
  - Global wholesale energy prices increase by a further 30 percent.
  - Financial conditions tighten (corporate risk premia increase by 80–100 bps; sovereign risk premia increase by about 200 bps).
  - Euro Area economic activity falls by up to 1.5 percentage points.
- Quantified outcomes (Adverse vs Baseline):
  - GDP Growth:
    - Baseline 2023: -0.5; 2024: 2.5.
    - Adverse 2023: -3.6; 2024: -0.2.
    - Difference in 2023: -3.1 percentage points; in 2024: -2.7 percentage points.
  - CPI Inflation:
    - Baseline 2023: 9.3; 2024: 2.5.
    - Adverse 2023: 10.7; 2024: 3.2.
    - Difference in 2023: 1.4 percentage points; in 2024: 0.7 percentage points.
- Policy implication: adverse scenario would require policy to remain agile and data dependent.

### Model of expectations and scenario analysis (Annex XI and model summary)
- Workhorse model: small open economy semi-structural New Keynesian variant with wage and price Phillips curves, IS curve, UIP condition, and policy reaction function.
- Expectations formation:
  - Rational Expectations (RE) vs Adaptive Learning (AL) specification where agents use an AR(2) forecasting equation with time-varying coefficients updated via a Kalman filter.
  - Empirical findings: greater backward-looking behavior in Czechia versus the USA; sum of AR coefficients in household forecasting equation almost 0.7 in Czechia versus less than 0.3 in the USA.
- Policy scenario (starting 2022:Q4) — common assumptions:
  - Cost-push shock lifts actual inflation to observed 2022:Q3 level with half-life 6.5 quarters; no new shocks thereafter.
- Two policy paths and key quarter-by-quarter outcomes (selected series):
  - Stable rates scenario:
    - CPI YOY: 22:IV = 18.4 percent; 23:IV = 4.6 percent; 24:IV = 2.6 percent.
    - Policy Rate (2W repo): peaks at 6.7 percent in 2023:Q1; eases to 3.9 percent by 2024:Q4.
    - Output gap (selected): 22:IV = −7.4; 23:IV = −5.1; 24:IV = −1.5.
  - Further hiking (optimal policy with weight on output gap = zero):
    - CPI YOY: 22:IV = 18.3 percent; 23:IV = 3.9 percent; 24:IV = 1.9 percent.
    - Policy Rate: peaks at 9.8/9.7 percent (quarter series give 22:IV = 9.8; 23:I = 9.7); eases to 3.2 percent by 2024:Q4.
    - Output gap (selected): 22:IV = −7.9; 23:IV = −6.0; 24:IV = −1.7.
    - Comparative outcome: by end-2024, inflation is lower by 0.7 percent in the further hiking scenario versus stable rates; terminal interest rate is lower under further hiking.
- Interpretation:
  - Adaptive expectations prolong inflationary episodes via feedback from outcomes to expectations.
  - More aggressive initial tightening lowers inflation faster, shortens period of elevated inflation, updates learning coefficients (households place less weight on past inflation), but causes a deeper initial output gap.

*Source: IMF staff report content unit 1czeea2023001.*

### 1. Inflation Expectations  __________________________________________________________________________ 5

### 1. Inflation Expectations

### Context and recent developments
- Russia’s war in Ukraine has undermined growth, increased living costs, and clouded the economic outlook.
- Czechia sourced virtually all of its gas from Russia; physical gas disruptions are unlikely this winter as gas storage is fully filled, access to liquified natural gas (LNG) sources was secured, and idle coal facilities can be reactivated. Vulnerabilities to further increases in energy prices remain.
- GDP: contracted by 5½ percent in 2020; rebounded to 3½ percent in 2021. Growth in the first three quarters of 2022 averaged around 0.3 percent q-o-q.
- Labor market: unemployment rate around 2½ percent in 2022:Q2—one of the lowest in Europe.
- Real incomes have fallen in 2022 due to inflationary pressures and relatively subdued nominal wage growth.
- CNB increased the policy rate to 7 percent to combat high and rising inflation.
- Headline and core inflation rose from about 2½ and 3½ percent respectively at end-2020, to peaks of 18 percent and 14.7 percent respectively y-o-y in September 2022.
- Core inflation remained at 14.6 percent in October 2022; headline inflation receded to about 15.1 percent in October 2022.
- Decrease in CPI inflation by almost 3 percentage points in October 2022 mainly reflects a drop in administered price inflation.
- Indicators of inflation expectations have increased but appear broadly anchored (36-month financial sector expectations stable; inverted government bond yield curve).

### Fiscal and external backdrop
- General government deficit declined to 5.1 percent of GDP in 2021 versus 7.2 percent envisaged in the November 2021 Fiscal Outlook.
- Revenues declined as a share of GDP in 2021, largely driven by lower income tax receipts from the permanently revised personal income tax (PIT) regime.
- Debt at end-2021 was 42 percent of GDP—12 percentage points higher than in 2019.
- Headline and structural fiscal balances in 2022 estimated to have improved by about ¾ and 1 percent, respectively; general government debt estimated to have remained constant at about 42 percent of GDP.
- Current account: turned into a deficit of close to 1 percent of GDP in 2021 after seven years of surplus; assessed broadly in line with fundamentals and desirable policy settings in 2022.

### Outlook and risks for growth and inflation
- Growth projections:
  - Growth projected to slow to 2.5 percent in 2022.
  - Growth projected to turn negative to around -0.5 percent in 2023.
  - Rebound expected from 2024; growth projected to pick up by end 2024 driven mainly by consumption and exports.
- Inflation projections:
  - Inflation projected to remain elevated in the near term but converge to the CNB’s target range during 2024, barring additional shocks.
  - Near-term inflationary pressures driven by domestic factors (imputed rents and input costs) and external factors (GVC disruptions and high commodity prices).
- Key downside risks:
  - Further increases in energy and commodity prices could worsen outcomes for growth and inflation.
  - Disorderly house price correction could cause financial disruptions, impair balance sheets, and suppress aggregate demand.
  - Risk of inflation expectations becoming untethered or wage-price spirals forming is high given already high inflation and a still tight labor market.
  - Depreciation pressures on the koruna could arise if interest rate differentials narrow.
- Upside/alternative risk:
  - A deeper recession or significant fall in global demand could reduce domestic or external inflationary pressures.

### Policy discussions and recommendations
- Overall emphasis: fight high inflation while helping the most vulnerable cope with the cost-of-living crisis and contain housing market risk-taking.
- Staff recommends:
  - Further tightening of monetary policy in the short term to ensure fulfillment of the inflation target over the medium term and reduce the risk of inflation expectations becoming untethered.
  - Pause in tightening macroprudential policies, with fiscal and macroprudential policy otherwise remaining broadly appropriate.
  - Place greater weight on minimizing the risk of inflation expectations becoming untethered; priority given to decisively quelling inflation.
  - Actions should be data dependent, primarily to keep inflation expectations tethered and avoid wage-inflation spirals.
  - Targeted and temporary fiscal support to alleviate the cost-of-living crisis while avoiding adding to inflationary pressures.
  - Unwinding previously-adopted untargeted support measures can enhance policy space to support the vulnerable if needed.
  - Close monitoring of financial sector risks and debt-servicing, especially if further increases in interest rates materialize.
  - Macroprudential measures should be calibrated to market developments and the monetary policy stance to balance adequate risk-taking and the banking system’s ability to finance viable debtors.
- Under an adverse scenario:
  - CNB needs to balance reducing inflation with shielding economic growth; policy action should be data dependent.
  - Policy calibration should aim to keep inflation expectations tethered and avoid costly wage-price spirals.

### CNB policy actions and stance
- CNB tightened the policy rate from 0.5 percent in June 2021 to 7 percent (current value at time of report).
- At the policy meeting on November 3, 2022, the CNB Board kept the policy rate unchanged, citing rates dampening domestic demand and slowing loan growth.
- CNB has increased FX interventions since May 2022 to prevent excessive fluctuations of the koruna and announced it will continue to do so.
- Staff analysis (Annex XI) indicates further short-term interest rate tightening would steer inflation to the target sooner, allowing an earlier reduction of the policy rate.

*Source: 1. Inflation Expectations (IMF Country Report chapter).*

### 15.      The CNB confirmed its commitment to fighting inflation until it is under control;

### 15.      The CNB confirmed its commitment to fighting inflation until it is under control;

### Monetary policy: CNB stance and Board views
- The CNB confirmed its commitment to fighting inflation until it is under control; differences of opinion remain on the shape of the tightening cycle.
- Some Board members: give higher weight to the risk of inflation expectations becoming de-anchored and therefore raise the policy rate further in the short term.
- Other Board members: consider the current interest rate level is having a sufficiently restrictive effect on domestic demand and that current inflation pressures are largely due to strong external price shocks outside the control of domestic monetary policy; they do not consider further increases to the policy rate necessary at this conjuncture.
- The CNB Board indicated it will wait for further data to assess if further tightening might be needed.

### Fiscal policy: stance and overall assessment
- The current fiscal stance is assessed as appropriately contractionary but should remain flexible given the uncertain outlook.
- Headline deficit: projected to decrease by about ¾ percentage points to 4¼ percent of GDP in 2022 and then to remain at the same level in 2023.
- Cyclically adjusted terms: fiscal stance is mildly contractionary in both years (2022 due to expiring pandemic-related measures; 2023 as the output gap turns negative).
- Rationale: contractionary stance called for by above-target inflation and a tight labor market; it will avoid compounding inflationary pressures by adding to aggregate demand.
- Recommendation: pace of consolidation should be reassessed in the event of severe shocks.

### Fiscal measures in 2022 and 2023: main items (as presented)
- Energy-price-related measures (CZK billion and percent of GDP shown in the source table):
  - Energy-price-related measures: 71.8 (1.0 percent of GDP) in 2022; 115.2 (1.6 percent of GDP) in 2023.
  - Power price cap for households and SMEs: 0.0 (0.0 percent of GDP) in 2022; 83.0 (1.1 percent of GDP) in 2023.
  - Energy saving tariff for households: 18.5 (0.3 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - Power subsidy for large businesses: 30.0 (0.4 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - One-off allowance for families with children: 7.8 (0.1 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - Reduction of excise tax on petrol and diesel by CZK 1.50/l: 6.7 (0.1 percent of GDP) in 2022; 9.6 (0.1 percent of GDP) in 2023.
  - Waiver of the renewable energy surcharge: 4.6 (0.1 percent of GDP) in 2022; 18.4 (0.2 percent of GDP) in 2023.
  - Cancellation of road tax for cars up to 12t: 4.2 (0.1 percent of GDP) in 2022; 4.2 (0.1 percent of GDP) in 2023.
- Other measures (CZK billion and percent of GDP from the table):
  - Other measures total: 66.1 (1.0 percent of GDP) in 2022; 82.2 (1.2 percent of GDP) in 2023.
  - Support for Ukrainian refugees: 15.2 (0.2 percent of GDP) in 2022; 0.0 (0.0 percent of GDP) in 2023.
  - Mandatory extraordinary pension hikes due to high inflation: 28.0 (0.4 percent of GDP) in 2022; 59.0 (0.9 percent of GDP) in 2023.
  - Discretionary pension hike: 10.6 (0.2 percent of GDP) in 2022; 10.9 (0.2 percent of GDP) in 2023.
  - Second increase in the basic income tax deduction: 12.3 (0.2 percent of GDP) in 2022; 12.3 (0.2 percent of GDP) in 2023.
  - Pension increase of CZK 500 per month for each child raised: 0.0 (0.0 percent of GDP) in 2022; 18.4 (0.3 percent of GDP) in 2023.
  - Increase in the turnover limit for VAT registration from CZK 1 to 2 million: 0.0 (0.0 percent of GDP) in 2022; 10.0 (0.1 percent of GDP) in 2023.
- Table methodology: ESA 2010; Source: Ministry of Finance.

### Details on main fiscal measures (selected specifics)
- Power and gas price caps:
  - Electricity price cap at CZK 5/kWh (CZK 6.05/kWh incl. VAT) for households, government entities and SMEs irrespective of energy consumption.
  - For SMEs using high and very high voltage levels or with consumption between 630-4200MWh, the cap applies only to 80 percent of the highest consumption in the last five years.
  - Gas price cap at CZK 2.5/kWh (CZK 3.025/kWh incl. VAT) for households (all consumption) and SMEs with consumption below 630MWh.
  - Caps apply January 2023-end 2023.
- Energy package and waiver:
  - One-off allowance to households’ energy bills of CZK 3,500 or CZK 2,000 depending on the type of electricity tariff in 2022.
  - Waived renewable energy surcharge is CZK 599/MWh. It applies Oct 2022–Dec 2023.
- Energy subsidy for large businesses (for 2022 costs):
  - All large firms, excluding those benefiting from capped power and gas prices or affected by upcoming windfall tax, are eligible.
  - Energy costs exceeding 200 percent of 2021 costs are eligible.
  - Subsidy limited to 50 to 70 (specific sectors) percent of eligible costs up to CZK 200 million for energy intensive firms and 30 percent of eligible costs up to CZK 45 million for all other large firms.
  - Energy intensive firms must be incurring operating losses to be eligible; the subsidy can cover up to 80 percent of the operating loss.
- Discretionary pension hike (permanent): Pensions were increased by CZK 300.
- Extraordinary mandatory pension hikes (permanent): pension indexation automatic increases if consumer prices since the last indexation have increased by more than 5 percent.
- Second increase in basic income tax deduction (PIT regime change adopted in 2020): Beginning 2021, the PIT rate for employees was lowered to 15 percent from an effective 20.1 percent, while the basic tax deduction was raised by CZK 3,000 (from CZK 24,840) in 2021 and again in 2022.
- One-off allowance for families with children: CZK 5,000 per child under 18 for a household with an annual gross income of up to CZK 1 million.

### Staff analysis and policy recommendations on support measures
- Support for households and firms amidst the cost-of-living crisis is justified, but measures that are targeted, temporary, and preserve price signals to incentivize energy savings are preferable.
- Preferred approach: well-targeted, temporary expenditure-side measures utilizing existing social safety nets such as lump sum cash transfers to the most vulnerable households rather than reducing taxes on energy or measures that suppress price signals.
- Rationale: allowing prices to pass through to consumers incentivizes energy-conserving behavior and energy efficiency investments.
- Assessment of specific measures:
  - One-off lump-sum allowance applied to households’ energy bills, and the allowance for families with children subject to income caps, preserve price signals and incentives to conserve energy and are therefore welcome.
  - Waivers of the renewable energy surcharge and excise and road taxes, and the energy price caps for households and SMEs, are not targeted and blunt incentives for further energy saving.
  - Energy subsidies for large firms could be better designed by linking relief to past energy usage or offering lump-sum support to avoid lowering the effective price of current consumption; alternatively, subsidize energy consumption below a minimum necessary level while market prices apply above that level.

### Fiscal consolidation, unwinding untargeted measures, and revenue options
- Recommendation: unwinding previously-adopted, untargeted support measures can enhance policy space to extend further support to the vulnerable and help address long-term debt sustainability.
- Specific recommendation: reinstate the PIT regime as well as the property transfer tax to pre-pandemic levels as soon as conditions allow.
- Quantified impact: Implementing these measures would yield over 2 percent of GDP going forward, lifting the primary balance above its debt-stabilizing level of - 0.5 percent of GDP as early as 2024.
- If immediate tax increases are not feasible: reintroduction could be undertaken in phases, increase progressivity of the PIT and step up transfers for the vulnerable; remaining savings would replenish fiscal buffers, improving policy space and stabilizing debt.
- Unwinding untargeted measures would further improve the policy mix in fighting inflation.

### Windfall tax: design, revenue, and assessment
- Design: levied on profits of banks and energy production and distribution companies in 2023–2025 exceeding average profits plus 20 percent during 2019–2021.
- Rate: 60 percent.
- Revenue estimate: expected to yield about CZK 150 billion (close to 2¼ percent of 2022 GDP) in 2023–2025.
- Staff assessment: acceptable given current circumstances because it is strictly temporary and imposed only on excess profits, allowing producers to recover operating costs and keep a portion of excess profits.
- Caveat: may undermine tax certainty, weaken the investment climate and discourage future investment due to its ad-hoc nature; second-best to a permanent excess profit tax that determines clear rules under which excess profits can be taxed.

### Authorities’ views on fiscal measures
- Authorities confirmed commitment to provide support against the cost-of-living crisis in a fiscally prudent way and noted international energy prices have already been allowed to pass through to domestic prices substantially.
- Authorities agree that temporary and fully-targeted measures are first-best, but argue the energy price caps are set at a high level and therefore strongly incentivize consumers to conserve energy.
- Authorities view the windfall tax, including for banks, as a fair way of redistributing benefits generated as a consequence of external shocks.
- Authorities argued that reversing the PIT regime is difficult as it requires changing laws and would be counterproductive in the current economic environment.

### Real estate markets and macroprudential policy
- Finding: continued strong house price growth increased residential property price overvaluation and stretched affordability, intensifying vulnerabilities.
- CNB estimate: overvaluation of apartment prices of 40 percent in mid-2022 (over 15 percentage points higher than at end-2019).
- Household indebtedness: average household indebtedness in Czechia is low compared to the rest of Europe, but lower-income households and those who purchased in overvalued areas or at the maximum of their budget are particularly vulnerable.
- Mortgage size: average mortgage size rose close to 75 percent over the past five years to above CZK 3 million in 2021:H2.
- Macroprudential measures:
  - Retightening of borrower-based measures is welcome; limits reintroduced effective 1 April 2022: DTI (8.5), DSTI (45 percent), LTV (80 percent).
  - Limits for applicants under age 36: DTI (9.5), DSTI (50 percent), LTV (90 percent).
  - Subsequent outcomes: shares of newly extended loans with elevated LTV and DTI ratios have come down; share with elevated DSTI ratios continues to increase, reflecting rapidly rising interest rates in monthly mortgage payments.
  - Recommendation: close monitoring of debt-servicing capacity; conditional on market developments and risk-taking behavior, further loosening or tightening of macroprudential measures may be needed.

### Housing taxation, supply, and structural recommendations
- Recommendations to alleviate price and affordability pressures:
  - Step up fiscal revenues from recurring property taxation (currently among the lowest in Europe).
  - Base property taxes on market valuations instead of floor space.
  - Eliminate mortgage interest deductibility (as in other advanced economies) because it incentivizes larger housing purchases and higher indebtedness, pushing up prices.
  - These tax changes would also strengthen fiscal buffers.
- Supply-side: implementation of some provisions of the new construction law will take until 2023; efforts to improve the permitting process should continue as the new construction law has had a limited impact on granted building permits so far.

### Financial sector policies and risks
- Overall assessment: banking sector broadly resilient at end-2021:
  - Capital ratio in banking sector: 23.3 percent at end-2021 including a 9 percent surplus beyond the required level.
  - Liquidity coverage ratio: 183 percent at end-2021 (above the 100 percent minimum).
  - Net stable funding ratio: 200 percent for the average bank at end-2021.
  - Non-performing loans ratio reverted to pre-pandemic levels at end-2022:Q1.
  - Staff welcomes lifting of restrictions on dividend distributions in September 2021.
- Pockets of vulnerability and monitoring needs:
  - Concentration of lending for real-estate purchases reached close to 63 percent of total loans to the non-financial private sector at end-2021, increasing about 3½ percentage points over the past five years.
  - Persistently declining risk weights for banks using internal risk-based modeling approaches.
  - A sudden correction of real estate prices or a shock to household incomes could have a system-wide impact on regulatory capital buffers with spillovers to financial stability.
  - CNB stress tests indicate banks have sufficient capital to absorb shocks under a severe adverse scenario, but lending to the private sector would be curtailed with spillovers to aggregate demand.
  - Regional interlinkages expose the Czech financial system to potential spillovers; despite negligible direct exposures to Ukraine and Russia, the war in Ukraine may impact global financial sentiment and conditions negatively.
  - Share of stage 2 loans marginally increased in 2022:Q1; the share of stage 2 loans increased by 2 percentage points to 16.3 percent for non-financial corporations (source note).
  - Bank lending survey shows expectations of rising credit losses.
- Authorities’ view: monitoring households’ mortgage repayment capacity closely; acknowledge increased repayment risk from rapid interest rate rises but assess risks for financial stability as still limited; stand ready to adjust macroprudential stance as needed.

*Source: IMF staff report (Czech Republic), chapter content provided in the supplied PDF excerpt.*

### 0.4 percentage points to 9.2 percent for households in 2022:Q1.

### 1czeea2023001 - 0.4 percentage points to 9.2 percent for households in 2022:Q1.

### Financial sector developments and macroprudential stance
- Capital adequacy ratios are described as "solid" and capital surpluses remained high.
- Non-performing loans decreased while the coverage ratio increased.
- Banks’ profitability rebounded in 2021 from the year before.
- System liquidity coverage has improved. Loan-to-deposit ratios have remained broadly stable.
- Czech banks increasingly preserve additional liquidity via 2-week securities repurchase agreements (repo) with the Czech National Bank; these repo loans are not included in the definition of liquid assets referenced in the report and explain the fall in the liquid-assets ratio in 2017 and 2018.
- Macroprudential action:
  - The CNB retightened the countercyclical capital buffer (CCyB) rate.
  - CCyB schedule: "The CCyB becomes effective at 1.5 percent in October 2022, 2 percent in January 2023, and 2.5 percent in April 2023."
- Staff recommendations:
  - Further enhance models to improve measurement of risk at the individual exposure level, leveraging credit-registry information to estimate default and loss-given-default parameters at the individual debtor level.
  - Combine the proposed modeling framework with macroprudential stress tests to quantify potential losses due to contagion across Czech and foreign financial entities and to improve calibration of macroprudential tools.
- Monitoring:
  - Close monitoring of debt-servicing capacity is warranted given retightened borrower-based measures and potential further interest-rate increases or continued increases in cost of living.

### Anti–money laundering / Countering the financing of terrorism (AML/CFT)
- Effective implementation of the AML/CFT framework is key to mitigate existing and emerging ML/TF risks, including facilitation of transnational corruption.
- Building on recent legal improvements for suspicious transaction reporting and sanctions, staff recommends:
  - Continue implementing AML/CFT measures to mitigate laundering of foreign proceeds of corruption.
  - Increase resources for complex money laundering prosecutions.
  - Enhance supervision of designated non-professional businesses and professions, per MONEYVAL recommendations.
  - Continue monitoring the impact on the Czech financial system of EU and other sanctions against third countries, including prevention of regulatory and reputational impact from sanctions evasion.
- Contextual notes:
  - The Czech Republic's 2021 AIV SR covered staff's assessment of authorities’ efforts to combat the supply-side of transnational corruption.
  - "Czechia joined sanctions imposed on Russia in response to its invasion of Ukraine."

### Authorities’ views on financial stability
- Authorities view the financial system as stable.
- They acknowledge that risks from residential property lending have increased somewhat but are still relatively low and that banks have adequate buffers to withstand potential shocks to property prices.
- Authorities have taken measures to improve:
  - Accuracy of beneficial ownership data.
  - Reporting of suspicious transactions related to PEPs.
  - Supervision of real-estate agents.
  - Implementation of Russia-related sanctions.

### Structural policies — labor shortages, reallocation, and migration
- Employment gaps remain sizable for low-skilled, foreign, young, and old workers and mothers with young children.
  - The employment gap for mothers with young children is "about 30 percent."
- Policy recommendations to improve employment and labor reallocation:
  - Improve education in technical and digital skills and provide accessible and flexible vocational training.
  - Provide adequate resources to the National Pedagogical Institute to sustain education and curricula reforms.
  - Continue using the registry of professional qualifications to facilitate learning and job mobility.
  - Increase use of flexible and part-time work arrangements.
  - Build on childcare and early childhood education improvements; target more flexible parental allowances and enhanced job-sharing opportunities.
  - Increase spending on Active Labor Market Policies (ALMPs), including reskilling and vocational training, to facilitate participation, job matching, and cross-sectoral reallocation.
  - Link retirement age to life expectancy to boost labor market participation; "Raising the retirement age to 67 beyond 2030 would boost employment by about 3 percent" (OECD, 2020).
- Migration and refugee integration:
  - Further facilitate inflow of migrants and effectively integrate Ukrainian refugees to alleviate labor shortages.
  - The "Key and Research Staff" and "Highly Qualified Employee" programs have been increasingly successful; sustain efforts to increase quotas and accessibility and diversify source countries.
  - For Ukrainian refugees, prioritize language training, childcare, job search support, and ease of qualification recognition to accelerate integration and reduce skill downgrading.
  - Contextual statistic: "As of end-October the Czech Republic was hosting about 456,000 refugees (4.3 pct of pop)."

### Productivity, innovation, and the green/digital transition
- Limited progress in enhancing productivity calls for scaling up investment and timely implementation of the Innovation Strategy and National Development Plan.
- Recovery and Resilience Facility (RRF) implementation is critical to enhance the digital transition via new digital education curricula, digitalization of businesses, high-capacity digital infrastructure, cyber-security, and public administration digitalization.
- Private investment:
  - Czechia’s support for business R&D was comparatively lower versus OECD peers in 2022, indicating room to further incentivize investments in digital and green transitions and the transition to EV production.
  - Targeted support to young and dynamic firms, and improved SMEs access to venture capital and equity financing, can spur innovation and technology adoption.
  - Streamline business regulatory framework and simplify the construction permitting process to improve the ease of doing business.
- Green transformation:
  - Policies to encourage investment in renewables and enhance energy efficiency should be prioritized in line with the Fit for 55 package and the REPowerEU plan.
  - Given energy security concerns, delaying the phase-out of coal facilities could be an option in the short term, but priority should remain on increasing renewables and energy efficiency.
  - RRP-supported green investments are key, particularly energy efficiency and sustainability measures in building and transport sectors.

### Pension system sustainability
- Demographic pressures:
  - Czechia’s population is among the most rapidly aging in Central and Eastern Europe, putting pressure on pension-system sustainability.
  - Fiscal council estimate: under current policies, public debt could breach the brake threshold (55 percent of GDP) by 2028 and reach 296 percent of GDP by 2072.
- Policy recommendations for sustainability:
  - Link the retirement age to life expectancy to automatically adjust retirement age.
  - Complement with net revenue increases (e.g., via growth-friendly tax reforms such as raising environmental and property taxes and enhancing compliance).
  - Consider indexing pensions to inflation only instead of inflation and wage developments (OECD, 2020).
  - Increase labor force participation to support pension sustainability.

### Staff appraisal — outlook and policy priorities
- Outlook:
  - The recovery from the pandemic is being hindered by the fallout from Russia’s war in Ukraine, likely turning 2023 into a recession year. Uncertainty is very high with risks to economic activity tilted to the downside and those for inflation to the upside.
- Monetary policy:
  - Staff recommends further hikes to the policy rate in the short term to above the current level of the policy rate, prioritizing decisively quelling inflation to avoid unanchored inflation expectations that would require significantly higher tightening later.
- Fiscal policy:
  - The contractionary fiscal stance is appropriate amid high inflation and low unemployment.
  - Previously-adopted untargeted support measures should be unwound to enhance policy space; support for households and firms should be targeted, temporary, and preserve price signals.
  - Reinstatement of the PIT regime and the property transfer tax to pre-pandemic levels is advised as soon as conditions allow; if infeasible now, consider phased reintroduction with increased PIT progressivity and stepped-up transfers for the vulnerable.
  - The windfall tax can offset the cost of energy relief measures but its ad-hoc nature could disincentivize investment by undermining tax certainty.
- Macroprudential and regulatory:
  - The retightening of borrower-based measures is welcome; monitor debt-servicing capacity closely.
  - Further loosening or tightening of macroprudential measures may be needed conditional on market developments and risk-taking behavior.
  - Improve risk measurement across the cycle and at the individual exposure level; leverage CNB model developments and credit-registry data.
- Structural priorities reiterated:
  - Enhance labor supply and integration of migrants and Ukrainian refugees.
  - Increase spending on ALMPs, reskilling, and vocational training.
  - Implement RRP to build digital skills and support the green transition.
  - Streamline business regulatory framework and simplify construction permitting.
  - Link retirement age to life expectancy to strengthen long-term fiscal sustainability.
- External sector assessment:
  - Indicates an external position in 2022 that was broadly in line with fundamentals and desirable policy settings.

*Source: IMF staff report content from 1czeea2023001.*

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

### 1czeea2023001 - 46.      It is recommended that the next Article IV consultation be held on the standard 12-

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

### Selected Economic Indicators (highlights from Table 1, 2019–27)
- Real GDP (expenditure): 3.0, -5.5, 3.5, 2.5, -0.5, 2.5, 3.4, 2.8, 2.5 (2019–2027)
- Domestic demand: 3.2, -5.6, 7.8, 3.1, -4.4, 1.2, 3.2, 2.6, 2.5 (2019–2027)
- Investment: 4.5, -9.3, 19.0, 11.5, -10.2, -4.0, 4.5, 3.5, 3.0 (2019–2027)
- Consumer prices (average): 2.8, 3.2, 3.8, 16.0, 9.3, 2.5, 2.0, 2.0, 2.0 (2019–2027)
- Unemployment rate (average, in percent): 2.0, 2.5, 2.8, 2.5, 3.1, 2.5, 2.3, 2.3, 2.3 (2019–2027)
- General government revenue (percent of GDP): 41.3, 41.5, 41.4, 41.7, 42.9, 41.5, 40.8, 40.7, 40.7 (2019–2027)
- General government expenditure (percent of GDP): 41.1, 47.2, 46.5, 46.0, 47.2, 44.2, 43.2, 43.2, 43.2 (2019–2027)
- Net lending / Overall balance (percent of GDP): 0.3, -5.8, -5.1, -4.3, -4.3, -2.7, -2.5, -2.5, -2.5 (2019–2027)
- General government debt (percent of GDP): 30.0, 37.7, 42.0, 41.8, 43.7, 44.1, 44.2, 44.9, 45.9 (2019–2027)
- Trade balance (goods and services, percent of GDP): 6.0, 6.7, 3.0, -1.9, 2.4, 4.4, 5.5, 5.8, 5.4 (2019–2027)
- Current account balance (percent of GDP): 0.3, 2.0, -0.8, -4.0, -0.9, 1.2, 2.3, 2.5, 2.5 (2019–2027)
- Gross international reserves (billions of euros): 133.4, 135.4, 153.3, 151.3, 160.3, 169.3, 178.3, 186.3, 192.3 (2019–2027)
- Nominal GDP (USD billions): 252.5, 246.0, 281.8, 293.0, 309.0, 325.8, 339.0, 346.8, 350.6 (2019–2027)
- Population (millions): 10.6, 10.7, 10.5, 10.5, 10.5, 10.6, 10.6, 10.6, 10.5 (2019–2027)

### Balance of Payments (highlights from Table 2, 2019–27)
- Current Account Balance (percent of GDP): 0.3, 2.0, -0.8, -4.0, -0.9, 1.2, 2.3, 2.5, 2.5 (2019–2027)
- Trade balance (goods, percent of GDP): 4.1, 4.9, 1.2, -2.8, 0.9, 2.6, 3.6, 3.8, 3.5 (2019–2027)
- Exports (percent of GDP): 61.8, 59.4, 62.2, 61.3, 60.7, 62.3, 61.3, 60.9, 60.7 (2019–2027)
- Imports (percent of GDP): 57.7, 54.4, 60.9, 64.1, 59.8, 59.7, 57.7, 57.1, 57.2 (2019–2027)
- Factor income (net, percent of GDP): -5.0, -4.2, -3.3, -1.6, -2.9, -2.7, -2.7, -3.4, -3.5 (2019–2027)
- Financial Account (change in stocks, + = increase, percent of GDP): 0.1, 2.9, 0.2, -4.4, 0.2, 2.1, 3.0, 2.8, 2.8 (2019–2027)
- Gross official reserves (billions of euros): 133.4, 135.4, 153.3, 151.3, 160.3, 169.3, 178.3, 186.3, 192.3 (2019–2027)
- External debt (percent of GDP): 76.5, 76.4, 75.5, 68.9, 66.6, 64.5, 61.3, 58.8, 56.2 (2019–2027)

### General Government Operations (highlights from Table 3, 2019–27)
- Revenue (percent of GDP): 41.3, 41.5, 41.4, 41.7, 42.9, 41.5, 40.8, 40.7, 40.7 (2019–2027)
- Taxes (percent of GDP): 20.3, 19.9, 19.2, 19.2, 20.1, 19.8, 19.3, 19.3, 19.4 (2019–2027)
- Social contributions (percent of GDP): 15.5, 15.9, 16.6, 16.2, 16.0, 15.9, 15.9, 15.9, 15.9 (2019–2027)
- Expenditure (percent of GDP): 41.1, 47.2, 46.5, 46.0, 47.2, 44.2, 43.2, 43.2, 43.2 (2019–2027)
- Net Acquisition of Nonfinancial Assets (percent of GDP): 4.4, 4.8, 4.7, 4.8, 5.3, 4.4, 4.0, 4.0, 4.0 (2019–2027)
- Gross Operating Balance: 4.7, -0.9, -0.4, 0.6, 1.0, 1.7, 1.5, 1.5, 1.5 (2019–2027)
- Net Lending/Borrowing (overall balance, percent of GDP): 0.3, -5.8, -5.1, -4.3, -4.3, -2.7, -2.5, -2.5, -2.5 (2019–2027)
- Nominal GDP (billions of Koruny): 5,791; 5,709; 6,108; 6,874; 7,411; 7,842; 8,319; 8,713; 9,066 (2019–2027)

### Macroeconomic Framework (Table 4 highlights)
- Real GDP (annual percent change): 3.0, -5.5, 3.5, 2.5, -0.5, 2.5, 3.4, 2.8, 2.5 (2019–2027)
- Inflation (CPI, percent): 2.8, 3.2, 3.8, 16.0, 9.3, 2.5, 2.0, 2.0, 2.0 (2019–2027)
- Unemployment (percent of labor force): 2.0, 2.5, 2.8, 2.5, 3.1, 2.5, 2.3, 2.3, 2.3 (2019–2027)
- Gross domestic savings (percent of GDP): 27.9, 28.1, 29.3, 29.6, 28.2, 28.0, 29.0, 29.2, 29.5 (2019–2027)
- Current account balance (percent of GDP): 0.3, 2.0, -0.8, -4.0, -0.9, 1.2, 2.3, 2.5, 2.5 (2019–2027)

### Financial Soundness Indicators (selected, Table 5)
- Regulatory capital to risk-weighted assets: 17.6, 17.7, 18.1, 18.3, 19.7, 22.1, 21.2, 20.3 (2015–2022Q1)
- Nonperforming loans to total gross loans: 5.4, 4.5, 3.7, 3.1, 1.7, 1.9, 1.7, 1.6 (2015–2022Q1)
- Return on assets: 1.5, 1.5, 1.4, 1.3, 1.4, 0.7, 1.1, 1.2 (2015–2022Q1)
- Customer deposits to total (noninterbank) loans: 120.9, 121.9, 128.3, 128.2, 72.8, 82.3, 83.7, 90.6 (2015–2022Q1)

### External Sector Assessment (Annex I)
- Overall assessment: The external position in 2022 was broadly in line with fundamentals and desirable policy settings.
- Estimated CA gap: 0.6 percent of GDP, with a range of 1 to -1 percent of GDP.
- REER gap (staff assessment): 4 percent (±1.8) percent; REER index model gap: 30.6 percent; REER level model gap: 1.6 percent.
- NIIP and external positions (2022 projections, percent of GDP):
  - NIIP: -15
  - Gross Assets: 131
  - Res. Assets: 60
  - Gross Liab.: 146
  - Debt Liab.: 68
- Current account trajectory:
  - Projection for 2022 CA: -4.0 percent of GDP (reflecting sharp decline in trade balance from temporary supply chain disruptions)
  - EBA model outputs for 2022: Cycl. Adj. CA = -2.4; EBA CA norm = -0.5; EBA CA gap = -1.9; Staff adjustments: Prim. inc. Adj. = -1.8; Trade bal. Adj. = 4.3; Staff CA Gap result = 0.6 (% GDP)
- FX intervention and reserves:
  - Gross international reserves increased to US$178 billion (60 percent of GDP) in 2021.
  - Reserves equivalent to approximately 9 months of imported goods and services in 2022.
  - CNB intervened through the first nine months of 2022 and may continue to intervene if warranted.

### Capital and Financial Accounts
- Financial account: Declined to 0.2 percent of GDP in 2021 from 2.9 percent of GDP in 2020; expected to turn negative in 2022 driven by net portfolio outflows, then turn positive over the medium-term.
- Assessment: Risks related to capital flows are assessed to be relatively small.

### Restoring Long-term Sustainability of the Pension System (Annex II — key findings and options)
- Main finding: Ageing is expected to substantially weigh on pension expenditures and deteriorate sustainability beyond 2030; delinking of retirement age from life expectancy gains and permanent fiscal measures passed in 2020 have worsened public finance sustainability.
- Required actions (summary of policy options):
  - Increasing the statutory retirement age beyond 2030 would be required to restore long-term sustainability, though it would only moderately ease rising pension expenditures.
  - Additional measures to consider: indexation to inflation; reforming the tax system to increase the pension system’s financial resources; boosting labour supply.
- Demographic and labour market projections:
  - Elderly population expected to increase by more than 50 percent over 2019–2060.
  - Working-age population expected to decline by about 18 percent over the long run, implying old-age dependency ratio increase from 33 percent in 2019 to 59 percent in 2060.
  - Generations born in the 2000s expected to bear the greatest burden of long-term unsustainable pensions.
  - Statutory retirement age (SRA) will reach 65 years in 2030; a 2017 legislative change set maximum retirement age at 65 beyond 2030 with mechanism for regular re-assessments; no modifications introduced during 2019 assessment round.
  - Working-age population (19 to retirement age) expected to remain relatively stable until 2030, slowly decline until 2040, and accelerate to reach a level 18 percent below the 2019 level in 2060.
- Distributional/demographic note: The elderly population increase is expected to be larger for men than for women (about 65 percent vs 40 percent).

*Source: IMF staff estimates, projections, and text as presented in the Czech Republic staff report content unit 1czeea2023001.*

### 3.      Pension spending is projected to increase

### 3.      Pension spending is projected to increase

### Projected pension spending trajectory
- Pension spending is projected to increase by more than in the average EU countries.
- Czechia is among the countries with the highest expected increase by about 3.8 percentage points to 11.8 percent of GDP 2060 (EC’s Aging Report, 2021).
- Pension spending is expected to remain stable around 8.8 percent of GDP until 2030—contained by the increase in the retirement age—, increase progressively to peak at 11.8 percent of GDP in 2060.
- Thereafter, pension is expected to decline to 10.9 percent in 2070, reflecting the big cohorts born in the 1970s leaving the pension system and to lesser extent a decline in the average validated contribution periods OECD (2020).
- Same magnitude of pension increase was found in CFC (2022) and OECD (2020).
- The stable dynamics of pension spending through 2030 offer a window to progressively reform the pension system.

### Demographic context and measures of dependency
- The large increase in the elderly population, by about 47 percent between 2000 and 2019, only induced an 18 percent increase in the population at or beyond the statutory retirement age.
- The old-age dependency ratio is the ratio of the population at and over the retirement age to the working-age population.

### Financing structure and constraints
- The financing of the pension system mostly relies on wage-based social contributions from the government budget.
- The spending pressure from ageing is compounded by the limited financing sources of the pension system, which relies more on social security contributions than many EU countries (both contributory and non-contributory benefits).
- VAT revenues are above the EU average, but revenues on goods and services are closer to the EU average, suggesting comparatively fewer excise duties (possibly on fuels and environmentally related taxes).
- Room to increase social security contribution rates in Czechia is limited by the tax wedge, which remains comparatively high in the EU.
- As wages converge towards EU averages, a higher level of wage taxation could impede labour market performance by incentivizing firms to substitute labour for capital (OECD 2020).

### Pension reform options and their projected impacts
- Increasing the retirement age beyond 2030:
  - Would help moderate rising pension spending beyond 2030 by reducing the number of age cohorts in retirement and augmenting the labour force.
  - OECD (2020) found that increasing the statutory retirement age to 67 after 2030 would stabilize pension spending until 2040 and induce a lower and earlier peak than in the baseline (by 1.1 percentage points of GDP lower in 2050 by 0.6 percentage points and 2059).
  - Would improve adequacy by inducing a higher pension replacement rate (by 3 percentage points over the projection period).
  - Would increase revenues as more people contribute and for longer.
  - Although linking the retirement age after 2030 in line with life expectancy gains boosts growth and reduce financing needs, additional measures would be needed to close the financing gap of the pension system (CFC 2022).
- Indexing pensions with inflation:
  - Indexing pensions to inflation only would reduce spending while preserving the purchasing power of retirees, at the cost of raising the income gap between retirees and workers.
  - OECD (2020) suggests such indexation could reduce pension spending (by 0.9 percentage point of GDP at the peak in 2059), comparable to the reduction achieved by increasing the retirement age beyond 2030.

### Rebalancing financing sources and fiscal options
- The sustainability of the pension system hinges on rebalancing financing sources and increasing budget transfers.
- Non-contributory components, in particular family benefits, weigh on pension expenditures financed through wage contributions.
- Increasing fiscal resources for the pension system could be facilitated by greater tax revenue.
- VAT increases are judged less efficient as they would depress consumption and investment via higher cost of capital.
- OECD (2020) simulations indicate increasing profits and corporate income taxes would have fewer negative impacts on GDP and employment than increasing social contributions and VAT.
- Other less growth-detrimental options include property taxes, environment taxes, and improvements in tax compliance.

### Expanding the working-age population and labour supply measures
- Increasing labour force participation will raise potential GDP and alleviate the weight of pension expenditures over time.
- Structural shifts from digitalization, automation, and the transition to the EV industry require a holistic policy framework to contain displacement risks affecting participation and employment.
- Short- and medium-term policies should focus on skill upgrading and adequate training to adapt to new skill demands; vocational education should be further developed to address skill mismatches.
- Labour supply could be further enhanced by:
  - Supporting flexible and part-time work arrangements for young people and elderly workers.
  - Further strengthening labour market integration of women with young children and vulnerable groups such as Roma people or people with disabilities.
  - Sustaining recent gains in migration while facilitating the integration of refugees.

*Source: Excerpt from IMF staff report chapter on Czech Republic pension projections and policy discussion.*

### 4.      Despite the recent significant increases in public debt, its trajectory is still relatively

### 1czeea2023001 - 4.      Despite the recent significant increases in public debt, its trajectory is still relatively

### Debt dynamics and sensitivity to interest rate shock
- An interest rate shock in which the real rate increases by 346 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 only moderately to 48 percent of GDP by 2028.
- Change in gross public sector debt (cumulative projection 2021–2028): 4.8 (percent of GDP).
- Identified debt-creating flows (2021–2028 cumulative): 4.9 (percent of GDP).
- Residual, including asset changes (cumulative 2021–2028): 0.0 (percent of GDP).

### Baseline scenario — key fiscal and macro indicators (selected annual values as shown)
- Nominal gross public debt:
  - 2021: 37.9
  - 2022: 42.0
  - 2023: 41.8
  - 2024: 43.7
  - 2025: 44.1
  - 2026: 44.2
  - 2027: 44.9
  - 2028: 45.9–46.6 (table shows 45.9 and 46.6 entries)
- Public gross financing needs (percent of GDP):
  - 2021: 6.9
  - 2022: 9.5
  - 2023: 8.1
  - 2024: 7.7
  - 2025: 6.8
  - 2026: 7.2
  - 2027: 8.0
  - 2028: 8.0–9.5 (table shows 8.0 and 9.5 entries)
- Real GDP growth (in percent):
  - 2021: 1.7
  - 2022: 3.5
  - 2023: 2.5
  - 2024: -0.5
  - 2025: 2.5
  - 2026: 3.4
  - 2027: 2.8
  - 2028: 2.5
- Inflation (GDP deflator, in percent):
  - 2021: 2.2
  - 2022: 3.4
  - 2023: 9.7
  - 2024: 8.4
  - 2025: 3.2
  - 2026: 2.6
  - 2027: 1.8
  - 2028: 1.5–1.7 (table shows 1.5 and 1.7 entries)
- Effective interest rate (in percent; interest payments divided by debt stock at end of previous year):
  - 2021: 2.7
  - 2022: 2.1
  - 2023: 2.1
  - 2024: 2.8
  - 2025: 3.3
  - 2026: 3.5
  - 2027: 3.6
  - 2028: 3.5–3.3 (table shows 3.5 and 3.3)
- Primary deficit (annual):
  - 2021: 0.3
  - 2022: 4.5
  - 2023: 3.6
  - 2024: 3.4
  - 2025: 1.5
  - 2026: 1.3
  - 2027: 1.3
  - 2028: 1.3
- Primary (noninterest) revenue and grants (percent of GDP):
  - 2021: 40.8
  - 2022: 41.3
  - 2023: 41.6
  - 2024: 42.7
  - 2025: 41.4
  - 2026: 40.6
  - 2027: 40.6
  - 2028: 40.6
  - Cumulative (2021–2028): 246.4
- Primary (noninterest) expenditure (percent of GDP):
  - 2021: 41.2
  - 2022: 45.8
  - 2023: 45.2
  - 2024: 46.1
  - 2025: 42.9
  - 2026: 41.9
  - 2027: 41.9
  - 2028: 41.9
  - Cumulative (2021–2028): 256.5

### Contributions to automatic debt dynamics and interest-growth differentials
- Automatic debt dynamics (annual contributions, percent of GDP):
  - 2021: -0.2
  - 2022: -1.6
  - 2023: -3.7
  - 2024: -2.0
  - 2025: -1.1
  - 2026: -1.1
  - 2027: -0.5
  - 2028: -0.2
  - Cumulative (2021–2028): -5.2
- Interest rate/growth differential (same series as automatic dynamics; cumulative -5.2)
- Real interest rate contribution (annual):
  - 2021: 0.2
  - 2022: -0.5
  - 2023: -2.9
  - 2024: -2.2
  - 2025: 0.0
  - 2026: 0.3
  - 2027: 0.7
  - 2028: 0.9
  - Cumulative (2021–2028): 0.7–0.4 (table shows cumulative 0.4 in one line)
- Real GDP growth contribution (annual):
  - 2021: -0.6
  - 2022: -1.2
  - 2023: -0.9
  - 2024: 0.2
  - 2025: -1.0
  - 2026: -1.4
  - 2027: -1.2
  - 2028: -1.1
  - Cumulative (2021–2028): -5.6

### Composition of public debt and financing needs
- Composition by maturity (gross nominal public debt, percent of GDP) shows increasing share of medium and long-term debt relative to short-term in projections through 2028 (figures shown in charts).
- By currency (percent of GDP): local currency-denominated and foreign currency-denominated shares plotted for 2021–2028 (charts in source).

### Alternative scenarios and stress tests (selected findings)
- Historical scenario, constant primary balance scenario, and other alternative scenarios are presented with differing assumptions for:
  - Real GDP growth (examples shown: Baseline 2023: -0.8; Historical 2023: -0.8; Constant Primary Balance 2023: -0.8).
  - Inflation (examples shown: 2023: 8.4).
  - Primary balance (examples shown: Baseline 2023: -3.4; Historical 2024 onward: -0.8; Constant Primary Balance: -3.4 each year).
  - Effective interest rate examples: Baseline 2024: 3.3; Historical 2024: 3.4; Constant Primary Balance 2024: 3.6.
- External debt DSA bound tests:
  - Baseline external debt around 56 percent of GDP in figures shown.
  - Interest rate shock, growth shock, current account shock, combined shock, and a 30 percent real depreciation shock are illustrated with resulting external debt paths (charts show scenario averages and historical boxes).
  - Some scenario averages shown in boxes: Baseline: 0.0; Scenario: 0.0; Historical: 0.0 (for certain variables); Baseline: 2.2; Scenario: 0.6; Historical: 1.7 (other variables); Baseline: 1.5; Scenario: 0.8; Historical: 0.3 (growth shock examples).

### External debt and external financing metrics (Table 1 highlights)
- External debt (percent of GDP):
  - 2017: 88.4
  - 2018: 81.4
  - 2019: 76.5
  - 2020: 76.4
  - 2021: 75.5
  - 2022: 68.9
  - 2023: 66.6
  - 2024: 64.4
  - 2025: 61.3
  - 2026: 58.8
  - 2027: 56.2
  - Debt-stabilizing non-interest current account: -1.4
- Change in external debt (annual, percent of GDP):
  - 2017: 15.4
  - 2018: -7.0
  - 2019: -4.9
  - 2020: -0.1
  - 2021: -0.8
  - 2022: -7.5
  - 2023: -2.3
  - 2024: -2.1
  - 2025: -3.2
  - 2026: -2.5
  - 2027: -2.6
  - 2028: 0.0 (projection)
- Identified external debt-creating flows (2017–2027 series; cumulative and components shown).
- External debt-to-exports ratio (in percent):
  - 2017: 111.9
  - 2018: 105.8
  - 2019: 103.6
  - 2020: 109.2
  - 2021: 104.0
  - 2022: 94.6
  - 2023: 92.4
  - 2024: 87.1
  - 2025: 84.2
  - 2026: 81.3
  - 2027: 78.1
- Gross external financing need (in billions of US dollars; percent of GDP series shown in table and charts):
  - 2017: 66.8 (30.6 percent of GDP)
  - 2018: 109.3 (43.9 percent of GDP)
  - 2019: 118.8 (47.0 percent of GDP)
  - 2020: 106.1 (43.0 percent of GDP)
  - 2021: 0.0 (note: table shows 0.0 entry for 2021)
  - 2022: 115.8
  - 2023: 122.2
  - 2024: 117.6
  - 2025: 116.1
  - 2026: 114.0
  - 2027: 111.5

### Authorities’ response to past IMF policy recommendations (Annex V — selected actions)
- Monetary:
  - Recommendation: Given high uncertainty about inflation and the external environment, policy action should remain data-driven and carefully weigh trade-offs in hiking too fast.
  - Action: The CNB undertook a last increase of 125 bps in June 2022 to 7 percent, reflecting a steady tightening cycle that has led to a 675 bp increase since May 2020.
- Macroprudential:
  - Recommendation: Macroprudential limits should be given some time to have effect but might need to be tightened further.
  - Action: Macroprudential tools have been tightened adequately.
- Fiscal:
  - Recommendation: While fiscal consolidation is warranted in the short term, fiscal policy should remain flexible given economic uncertainty.
  - Action: The fiscal stance is adequately slightly contractionary while fiscal policy continues to support the vulnerable.
- Structural:
  - Recommendation: Increasing labor supply and enhancing the employment prospects of disadvantaged groups; incentivize investment and raise productivity; strategy based on enhanced carbon pricing and broader incentives.
  - Action: Improvements delayed during the pandemic; some progress made in attracting skilled labor and boosting AMLP spending; inefficient building permitting process remains a key bottleneck.

### Enhancing the green transition (Annex VI — findings, costs, and policy priorities)
- Progress and targets:
  - GHG emissions were reduced by about 43 percent in 2020 relative to 1990.
  - Fit-for-55 targets: greenhouse gas emissions (GHG) reduction of 55 percent by 2030 and climate neutrality by 2050.
  - Commitment: phase out coal by 2033.
- Investment needs and financing gaps:
  - Ministry of Environment (2022) estimates total investment costs of decarbonization through 2030:
    - Around EUR 41 billion (17.2 percent of 2021 GDP) under current policies.
    - Up to EUR 61.5 billion on average under the “Fit for 55” scenario.
  - Authorities estimate funding sources: RRF and other structural EU funds totaling EUR 41 billion by 2030; revenues from the EU ETS about EUR 27.1 billion (11.3 percent of 2021 GDP) by 2030 in the baseline scenario and twice higher if the Fit for 55 implemented.
  - Renovation needs: around EUR 17 billion (EC 2022) for building renovations; RRP energy efficiency allocation EUR 1.4 billion.
  - RRP allocations: EUR 335 million to reforestation investments; construction of 270MW of photovoltaic power for companies (noted as modest fraction).
- Energy mix and renewables:
  - Planned decline in share of fossil fuels in electricity production from 50 percent in 2016 to 11–21 percent in 2040.
  - Nuclear contribution planned to increase from 29 percent to 46–58 percent by 2040.
  - Czechia’s 2030 goal for renewables: 22 percent (noted as below recently proposed Renewable Energy Directive level of 31 percent).
- Coal phase-out and regional impacts:
  - Coal regions (e.g., Ústí and Karlovy Vary) face higher unemployment and poverty; Operational Programme Just Transition allocation of EUR 1.6 billion for business start-ups, SMEs, up-skilling and retraining.
  - Just Transition Fund complemented by the Modernization Fund.
- Forests, LULUCF, and nature-based solutions:
  - Net emissions from land use, land change and forestry (LULUCF) increased by 329 percent to 13 565 kt CO2 eq. in 2019.
  - Large-scale reforms in forest management practices and RRP-supported nature-based solutions needed to reach LULUCF net removal levels achieved before 2015.
- Policy recommendations and priorities:
  - Follow through on commitment to phase out coal by 2033 while addressing socio-economic impacts with Just Transition measures.
  - Diversify energy sources and invest in efficiency and renewable sources to enhance energy security.
  - Scale up investments in renewables (solar, wind, geothermal, renewable hydrogen, sustainable bio-methane) beyond RRP financing.
  - Accompany nuclear expansion with strong regulation to minimize risks.
  - Define tax framework for green investment, including carbon taxation, to provide clarity for private investment.
  - Scale up building renovation programs, prioritize renovations for buildings connected to coal-based district heating.
  - Promote modal shift to rail and public transport; invest in electrified rail and charging infrastructure to improve electric vehicle adoption.

*Source: IMF staff.*

### References

### 1czeea2023001 - References

### References
- European Commission, 2022, “2022 European Semester: Country Report– Czechia,” European Semester Spring package, 2022.
- European Commission, 2021, “Analysis of the National Long-term Renovation Strategies”, Commission Staff Working Document.
- International monetary Fund, 2020, “Mitigating Climate—Growth and Distribution-Friendly Strategies Could be Helpful”, World Economic Outlook, October 2020 Chapter 3.

### Annex VII. Czechia’s Resilience and Recovery Plan (RRP)
- Purpose:
  - Reforms to address bottlenecks to lasting and sustainable growth.
  - Investments to enhance low-carbon and climate-resilient economy, digital transformation, and public administration quality.
  - Social cohesion measures: increase availability and quality of healthcare, tackle inequalities in education, invest in pre-school facilities.
- Scale and timing:
  - RRP: about EUR 7.1 billion of grants or 3 percent of GDP over 2021–2026.
  - Pre-financing payment: €915 million (13 percent of the RRF allocation) disbursed September 2021.
  - Czechia submitted request for first disbursement (EUR 928 million) after fulfilling 37 milestones/targets.
  - For 2023, Czechia must fulfil 35 milestones related to the 2nd and the 3rd payment request.
  - Planned CZK 30.5 billion RRF spending in the 2022 Fiscal Outlook (CZK 14.2 billion allocated to capital spending); CZK 21 billion (of which CZK 13.2 billion capital spending) disbursed as of October 2022 — implying an absorption rate of about 69 percent as of October 2022.
  - Macroeconomic impact of the RRF estimated at about 0.8–1.2 percent increase in GDP by 2026 (EC 2022).
  - Revisions in 2023 expected to reflect REPowerEU and estimated cost increases of around 20 percent of the basis year level (2020).
- Green transition (around 20 percent of the plan):
  - Energy efficiency: €1.4 billion for large-scale renovation programs (residential and public buildings).
  - Renewable energy: €480 million for investments in renewable energy sources for businesses and households.
  - Sustainable mobility: €1.1 billion for low-emission vehicles (public and business), railway infrastructure, electric charging stations, cycling pathways.
  - Circular economy: €141 million for recycling infrastructure, circular solutions, and water savings in businesses.
  - Reform of forestry management to increase sustainability.
- Digital objectives:
  - 42 percent and 22 percent of the plan’s total envelope allocated to climate objectives and digital objectives, respectively.
  - Digital skills and education: €585 million for digital equipment for schools, teacher training, new university programs, upskilling and reskilling courses.
  - Digital transformation and cyber-security of public administration, justice system, and health care: €585 million.
  - Digital transformation of businesses, digital innovation hubs, high-capacity networks, and 5G networks: €650 million.
- Economic and social resilience:
  - Business environment improvements: €222 million (access to finance, construction licensing, anti-corruption, public-private research cooperation).
  - Equal access to education: €393 million (affordable pre-school care, support for disadvantaged schools, tutoring).
  - Healthcare resilience: €823 million (new hospitals and long-term care facilities, medical equipment, strengthen cancer screening, roll out e-Health).

### Annex VIII. Downside Scenario
- Scenario framework:
  - Channels: commodities (energy price increases → input costs, higher consumer prices, reduced real incomes → lower private consumption), trade (lower external demand, notably Germany and Euro Area → reduced exports), labor mismatch (tight labor markets and worse matching), financial conditions (tightening global financial conditions → domestic spillovers).
  - Assumptions calibrated to Czechia and consistent with WEO Scenario Box 1.3 (October 2022).
- Adverse shocks assumed if war escalates:
  - Global wholesale energy prices increase by a further 30 percent.
  - Financial conditions tighten further (consistent with WEO: corporate risk premia increase by 80–100 bps and sovereign risk premia increase by about 200 bps).
  - Labor market tightness and mismatches exacerbated.
  - Euro Area economic activity falls by up to 1.5 percentage points.
- Impacts:
  - Commodities and trade channels: high energy prices and reduced external demand → higher domestic costs, inflation, lower purchasing power; pass-through of oil and gas to CPI implies higher inflation even with endogenous monetary tightening.
  - Financial and labor channels: sharp tightening of global financial conditions → higher borrowing costs, equity market volatility; tighter labor markets → adverse effects on activity.
- Quantified outcomes (Adverse vs Baseline):
  - GDP Growth: Baseline 2023: -0.5; 2024: 2.5. Adverse 2023: -3.6; 2024: -0.2. Difference in 2023: -3.1 percentage points; in 2024: -2.7 percentage points.
  - CPI Inflation: Baseline 2023: 9.3; 2024: 2.5. Adverse 2023: 10.7; 2024: 3.2. Difference in 2023: 1.4 percentage points; in 2024: 0.7 percentage points.
  - Near-term outcome: implies negative growth in the near term under the adverse scenario.
  - Policy implication: scenario could be worse and will require policy to remain agile and data dependent.

### Annex IX. Czechia’s Exposure to Russia and Ukraine
- Trade exposures:
  - Exports to Russia and Ukraine in 2021: 1.9 percent and 0.7 percent of total exports, respectively.
  - Imports from Russia and Ukraine in 2021: 4.2 percent of total imports (predominantly from Russia); increased to close to 6.2 percent of total in January–July 2022 reflecting higher energy prices.
  - Structure of goods imports (percent of total): Crude petroleum and natural gas 59.26, Metal ores 11.90, Basic metals 8.16, Chemicals and chemical products 7.97, Motor vehicles, trailers and semi-trailers 2.74.
  - About 90 percent of Czech exports are to the Euro Area; Germany accounts for 31 percent of exports.
- Energy vulnerability:
  - Crude petroleum and natural gas account for almost 60 percent of goods imports, largely due to natural gas.
  - Czechia sourced virtually all of its gas from Russia until the war started.
  - Gas represents about a fifth of the domestic energy mix.
  - Current gas supplies and ability to reactivate idled coal facilities provide a buffer, but economy remains vulnerable to availability and additional price increases in energy and fuel.
  - Risks: higher inflationary pressures, potential wage-price spiral in a tight labor market, erosion of real wages and purchasing power, depressed investment.
- Sanctions and supply chains:
  - Additional sanctions and uncertainties could further impact trade and supply chains, affecting activities indirectly linked to imports from Russia and Ukraine (e.g., car manufacturing).
- Services trade:
  - Services exports to Russia: 1.3 percent of total services exports; services imports from Russia: about 4 percent (mostly travel).
  - Tourist arrivals from Russia and Ukraine typically less than 2 percent; share increased in 2022 to about 2.5 percent due to Ukrainian refugees.
- Refugee flows:
  - As of mid-November 2022: Ukrainian refugees in Czechia totaled about 300,000 or about 3 percent of the population.
  - This number expected to increase through the winter as some of roughly 160,000 refugees who returned to Ukraine over the summer come back to Czechia.
  - Risks: increased pressure on fiscal balances, public services, institutional capacity.
  - Opportunities: with adequate management and integration (childcare, language training, employment services), refugees could help ease labor market shortages.
- Financial sector and investment exposures:
  - Czech National Bank: banks’ direct exposures to Russia and Ukraine were negligible at end-2021.
  - Indirect spillovers risk: war may impact financial sentiment and conditions, with potential credit and market risk implications; sharp tightening could precipitate disorderly correction in housing sector affecting bank and household balance sheets.
  - Direct investments in Russia: EUR 310 million (0.7 percent of total FDI stock at end-2020); in Ukraine: EUR 164 million (0.4 percent).
  - Russian FDI in Czechia: EUR 948 million (0.6 percent); Ukrainian investment in Czechia: EUR 139 million (0.1 percent).
  - Combined Russian and Ukrainian portfolio investment in Czechia: about 0.1 percent of total investment as of end-December 2021.
- Labor market:
  - Considerable resilience through pandemic and war so far.
  - Prolonged conflict, diminished GDP growth, and significant refugee increases could raise unemployment.
- Aggregate impact estimate:
  - The war in Ukraine is estimated to have led to a 1 ½ percentage point decline in baseline GDP growth and a 7 percentage point increase in average baseline CPI inflation in 2022 relative to the pre-war baseline scenario.

### Annex X. Financial Conditions in Czechia
- Financial Conditions Index (FCI):
  - Constructed to characterize ease of financing (prices and quantities).
  - Shows significant tightening starting in early 2022 and projected to continue into 2023.
  - Tightening is simultaneous across European countries with smaller dispersion across euro area countries in 2022 than previous contraction episodes.
- Sectoral dynamics:
  - FCIs across all three sectors in Czechia exhibit tightening.
  - Unlike past episodes, government sector is not counteracting tightening; simultaneous credit contraction across balance sheets expected to negatively impact medium-term macroeconomic outcomes.
- Drivers of tightening (Figure 2 highlights):
  - Policy stance:
    - CNB policy rate increased from 0.25 percent in June 2021 to its current value of 7 percent.
    - Policy stance measured through central bank policy rates, shadow rates, and money supply indicates considerable tightening.
  - Price of risk:
    - Increased volatility, market and credit risk across asset markets contributed to FCI tightening.
  - Credit availability:
    - Tightening began in 2022:Q1 and 2022:Q2; expected to accelerate as policy rate increases pass-through to credit rates and new mortgage origination sharply declines.
  - Funding constraints:
    - Banks’ willingness to lend has contributed to tightening; recent bank surveys suggest further tightening in coming quarters.
- Note on methodology:
  - FCI targets growth in overall level of liabilities for each sector, aggregating price and quantity indicators via a Partial Least Square regression.

### Annex XI. Large Cost Push Shocks and Adaptive Expectations
- Context:
  - Concern that, amid high and accelerating inflation, expectation formation might become more backward looking.
  - Literature explores deviations from rational expectations (RE), allowing transition from near-RE to backward-looking expectation formation.
- Model description:
  - Agents form expectations based on a simple statistical model and update beliefs via a learning mechanism as new data arrive.
  - Expectations modeled as adaptive learning (AL) in the presented framework.

*Italic: Source: 1czeea2023001 - References (PDF chapter/section).*

### 2. The  workhorse  model  used  here  is  a  small  open  economy  semi-structural  model

### 2. The workhorse model used here is a small open economy semi-structural model

### Model structure and equilibrium equations
- Variant of Galí, Smets, and Wouters (2012) and Berg and others (2006); standard New Keynesian model including wage and price Phillips curves (PC).
- Equilibrium (linearized) equations for each country:
  - IS Curve:
    - y_t = α_y^y y_{t-1} + α_y^y y_{t+1} + γ(π_{t+1} − r_t) + φ_z z_t + s_{y t}
  - Demand shock process:
    - s_{y t} = ρ_ε s_{y t−1} + ε_{y t}
  - Price Phillips Curve (Price PC):
    - π_t = α_π^π π_{t−1} + α_π^π π_{t+1} + k_π w_t + λ_z z_t + ε_{π t}
  - Nominal wage definition:
    - π_{w t} = w_t − w_{t−1} + π_t
  - Wage Phillips Curve (Wage PC):
    - π_{w t} = −α_w^y w_{t−1} + α_w^y π_{w t+1} + K_w y_t + ε_{w t}
  - Policy reaction function:
    - r_t = ρ_r r_{t−1} + (1−ρ_r)(ρ_π π_{t+1} + ρ_y y_t) + ε_{r t}
  - UIP condition:
    - z_t = E_t[z_{t+1}] − (r_t − π_t) − (r_t^y − π_t^y) + ε_{z t}
- Variable definitions:
  - y: output gap (measure of slack)
  - π: quarter-on-quarter, annualized core inflation rate
  - r: nominal monetary policy interest rate
  - w: composition-constant real wage gap (real wage deviations from labor productivity growth)
  - π_w: real wage inflation
  - z: koruna bilateral real exchange rate with respect to the US dollar (Kč / USD)

### Expectations formation: Rational Expectations (RE) vs. Adaptive Learning (AL)
- Full credibility RE model:
  - E_t[x_{t+1}] = x_{t+1} if ε_{t+1} = 0 (model-consistent expectations).
- AL model specification:
  - Agents' expectations follow an AR(2) forecasting equation that achieves best out-of-sample forecast performance:
    - E_t[x_{t+1}] = α_t + β_{t}^1 x_t + β_{t}^2 x_{t−1}
  - Coefficients (α_t, β_t^1, β_t^2) vary over time depending on forecast accuracy.
  - Learning algorithm: agents use a Kalman filter (Slobodyan and Wouters 2012a; 2012b).
    - B_{t|t} = B_{t|t−1} + P_{t|t−1} X_{t−1} [Σ_t + X'_{t−1} P_{t|t−1} X_{t−1}]^{−1} * (forecast errors)
    - B_{t|t} stacks all AR(2) coefficients; P_{t|t−1} is the covariance matrix; Σ_t is the variance-covariance matrix of AR(2) residuals.

### Estimation, data, and variables used
- Estimation method: Bayesian.
- Sample period: 2000:Q1 to 2019:Q4 for Czechia and the USA.
- Variables included:
  - Output gap (as estimated by the IMF team)
  - Real wage gap
  - Annualized quarterly price inflation deviation from target
  - Policy rate
- Real wage: use composition-constant real wage calculated by Howard, Rich, and Tracy (2022) for the USA because the model lacks workforce composition structure.

### Empirical findings: inflation expectations and learning
- Estimates indicate greater backward-looking behavior in Czechia versus the USA:
  - Sum of the two AR coefficients in the household forecasting equation: almost 0.7 in Czechia compared to less than 0.3 in the USA.
- Coefficient stability:
  - Coefficient reflecting mean expected inflation was close to zero over the ten years before the pandemic (households expected inflation at the central bank target).
  - Pandemic period: stability challenged as observed inflation outcomes rose above target in both economies.
- Implication:
  - Because Czechia's expectations respond more to past inflation outcomes, there is feedback from inflation to inflation expectations that keeps inflation higher for longer for all shocks in the model (illustrated for an inflation shock).

### Monetary policy: channels and optimal policy formulation
- Three channels for central bank to influence inflation in the AL model:
  1. Standard direct channel: tighter policy cools demand → lowers output gap → lowers inflation.
  2. Expectations channel (outcomes to forecasting equation): lowering current inflation reduces next period expectations.
  3. Learning channel (coefficients in forecasting equation): observing less inflation than expected leads households to update how past inflation matters for future inflation.
- Optimal monetary policy path (interest rate path {i_t} for t = 1 to ∞) defined to minimize welfare function:
  - Σ_{t=j}^∞ β^t (0.9(i_t − i_{t−1}) + (y_t − 0)^2 + (π*_t − 0)^2)
  - Assumptions:
    - Equal weights for output gap (y_t) and inflation deviations from target (π*_t).
    - Role for interest rate smoothing (0.9 weight on i_t − i_{t−1}).
    - Central bank assumed to have full knowledge of current shocks, all future shocks, and how actions impact expectations.

### Scenario analysis and conditional forecasts (starting 2022:Q4)
- Common assumptions for scenarios:
  - First simulation period: 2022:Q4.
  - Czechia faces an unexpected cost-push shock that takes actual inflation to observed 2022:Q3 level and with a half-life of 6.5 quarters.
  - No new shocks from 2022:Q3 onwards.
  - Output shock unwinds according to estimated AR(1) process.
- Stable rates scenario (policy follows estimated behavior; described as "stable rates"):
  - Year-on-year CPI inflation:
    - 2022:Q4 = 18.4 percent
    - 2023:Q4 = 4.6 percent
    - 2024:Q4 = 2.6 percent
  - Policy rate path (2W repo / policy rate):
    - Peaks at 6.7 percent in 2023:Q1
    - Eases to 3.9 percent by end-2024 (2024:Q4)
  - Output gap:
    - Slowly closes and reaches a mild negative level by end-2024
    - Quarter values (from Table 1, stable rates output gap): 22:IV = −7.4; 23:I = −5.2; 23:II = −4.6; 23:III = −5.2; 23:IV = −5.1; 24:I = −3.8; 24:II = −2.7; 24:III = −1.8; 24:IV = −1.5

- Further hiking scenario (optimal policy with weight on output gap = zero)
  - CPI YOY:
    - 2022:Q4 = 18.3 percent
    - 2023:Q4 = 3.9 percent
    - 2024:Q4 = 1.9 percent
    - Quarter series (from Table 1, further hikes CPI YOY): 22:IV = 18.3; 23:I = 14.7; 23:II = 9.9; 23:III = 6.5; 23:IV = 3.9; 24:I = 2.3; 24:II = 1.6; 24:III = 1.7; 24:IV = 1.9
  - Policy rate path:
    - Peaks at 9.7 percent in 2022:Q4 (text says 9.7 percent in 2022:Q4)
    - Eases to 3.2 percent by end-2024 (2024:Q4)
    - Quarter series (from Table 1, further hikes policy rate): 22:IV = 9.8; 23:I = 9.7; 23:II = 9.2; 23:III = 8.4; 23:IV = 7.4; 24:I = 6.0; 24:II = 4.8; 24:III = 3.6; 24:IV = 3.2
  - Output gap:
    - Bottoms in 2022:Q4 then closes rapidly as inflation falls
    - Quarter values (from Table 1, optimal policy output gap): 22:IV = −7.9; 23:I = −5.9; 23:II = −5.4; 23:III = −6.1; 23:IV = −6.0; 24:I = −4.6; 24:II = −3.4; 24:III = −2.4; 24:IV = −1.7
  - Comparative outcomes:
    - By end-2024, inflation is lower by 0.7 percent in the further hiking scenario compared to the stable rates scenario.
    - Terminal interest rate is lower in the further hiking scenario compared to the stable rates scenario.
    - Further hiking affects inflation expectations both by lowering inflation outcomes and by influencing households' learning (coefficients), bringing expectations back to target sooner than under stable rates.

### Key numeric outcomes (selected series, quarter-by-quarter from Table 1)
- CPI YOY (stable rates): 22:IV = 18.4; 23:I = 15.0; 23:II = 10.3; 23:III = 7.2; 23:IV = 4.6; 24:I = 3.1; 24:II = 2.5; 24:III = 2.5; 24:IV = 2.6
- CPI YOY (further hikes): 22:IV = 18.3; 23:I = 14.7; 23:II = 9.9; 23:III = 6.5; 23:IV = 3.9; 24:I = 2.3; 24:II = 1.6; 24:III = 1.7; 24:IV = 1.9
- Output Gap (stable rates): 22:IV = −7.4; 23:I = −5.2; 23:II = −4.6; 23:III = −5.2; 23:IV = −5.1; 24:I = −3.8; 24:II = −2.7; 24:III = −1.8; 24:IV = −1.5
- Output Gap (optimal policy / further hikes): 22:IV = −7.9; 23:I = −5.9; 23:II = −5.4; 23:III = −6.1; 23:IV = −6.0; 24:I = −4.6; 24:II = −3.4; 24:III = −2.4; 24:IV = −1.7
- Policy Rate (Stable Rates): 22:IV = 6.7; 23:I = 6.7; 23:II = 6.2; 23:III = 6.1; 23:IV = 5.5; 24:I = 4.5; 24:II = 4.1; 24:III = 3.9
- Policy Rate (Further Hikes Scenario): 22:IV = 9.8; 23:I = 9.7; 23:II = 9.2; 23:III = 8.4; 23:IV = 7.4; 24:I = 6.0; 24:II = 4.8; 24:III = 3.6; 24:IV = 3.2

### Interpretation and policy implications
- Adaptive expectations (learning) prolong inflationary episodes even in the absence of new shocks because inflation outcomes feed back into expectations via backward-looking forecasting rules.
- A more aggressive initial policy tightening (further hiking scenario) lowers inflation faster and shortens the period of elevated inflation by:
  - Directly reducing inflation through demand suppression.
  - Reducing future inflation expectations via realized lower inflation outcomes.
  - Altering learning coefficients so households place less weight on past inflation, moving expectations back to target sooner.
- Trade-offs:
  - Further hiking implies a deeper initial output gap deterioration (output gap bottoms lower in 2022:Q4) but permits faster return of inflation to target and earlier policy easing, resulting in a lower terminal policy rate by end-2024 than under stable rates.

*Source: IMF staff calculations and model estimates as presented in the informational annex.*

### 2011. ROSCs on: banking supervision; data dissemination; fiscal transparency; securities

### 2011. ROSCs on: banking supervision; data dissemination; fiscal transparency; securities market; and transparency of monetary and financial policies

### Technical assistance (last mission)
- FAD — June/July 1999 — Medium-term fiscal framework
- MCM — February/June 1999 — Integrated financial sector supervision (with WB)
- RES — June/August 2000 — Inflation targeting (financed by MFD)
- STA — November 2006 — GFSM 2001 implementation

### Assessment of data adequacy for surveillance — Key findings
- General: Data provision is adequate for surveillance.
- National Accounts:
  - The Czech Statistical Office (CSO) compiles and disseminates annual and quarterly national accounts on ESA2010 basis.
  - The CSO compiles annual Supply-Use Tables (SUT) by 88 types of economic activities and 88 products, but there is room for improvements.
  - Discrepancies between GDP estimates based on the production method and the expenditure method are subsumed under changes in inventories, which sometimes significantly changes the first estimates of inventories obtained directly from the surveys.
- Price Statistics:
  - The CSO compiles and disseminates a monthly consumer price index (CPI) using a weighting structure based on expenditure data from 2016.
  - A monthly Harmonized Index of Consumer Prices (HICP) is disseminated according to European regulations.
  - The producer price index is released monthly with coverage including manufacturing, construction, agriculture, and select business services (business to business only).
  - The CSO compiles and releases monthly import and export price indexes based on data collected directly from establishments engaged in export and/or import activities.
- External Sector Statistics:
  - The CNB compiles and disseminates balance of payments and international investment position statistics in line with BPM6 and in accordance with legal requirements of the ECB and Eurostat.
  - CNB generally derives balance of payments financial account transactions from changes in position data adjusted by exchange rate, price, and other changes.
  - The CNB monthly disseminates the data template on International Reserves and Foreign Currency Liquidity.
  - Czechia participates in the CDIS and the CPIS and reports quarterly external debt statistics to the World Bank’s QEDS database.
- Government Finance Statistics:
  - Fiscal data in the GFSM 2014 framework is reported through the Eurostat convergence project with the IMF.
  - Annual and quarterly fiscal data are compiled on ESA2010 basis by the CSO, including non-financial accounts, financial accounts, and financial balance sheets.
  - Government transactions are recorded on an accrual basis.
- Monetary and Financial Statistics:
  - Monthly MFS data is sent to STA by ECB and is based on standardized report forms (SRFs).
  - MFS data covers the central bank (CNB) and the other depository corporations; data from the other financial corporations are currently not compiled.
  - Czechia reports data on some basic series and indicators of the Financial Access Survey (FAS), including the two indicators adopted by the UN to monitor Target 8.10.1 of the SDGs.

### Data standards and quality
- Czechia has adhered to the SDDS Plus since April 2016.
- Data ROSC was published on July 1, 2000.

### Selected macroeconomic projections and key statistics (annual percent change or percent of GDP, as presented)
- Real GDP (expenditure): 2019 3.0, 2020 -5.5, 2021 3.5, 2022 2.5, 2023 -0.5, 2024 2.5, 2025 3.4, 2026 2.8, 2027 2.5
- Domestic demand: 2019 3.2, 2020 -5.6, 2021 7.8, 2022 3.1, 2023 -4.4, 2024 1.2, 2025 3.2, 2026 2.6, 2027 2.5
- Investment: 2019 4.5, 2020 -9.3, 2021 19.0, 2022 11.5, 2023 -10.2, 2024 -4.0, 2025 4.5, 2026 3.5, 2027 3.0
- Exports: 2019 1.5, 2020 -8.0, 2021 6.9, 2022 5.1, 2023 4.7, 2024 6.4, 2025 2.9, 2026 2.8, 2027 2.6
- Imports: 2019 1.5, 2020 -8.2, 2021 13.3, 2022 4.4, 2023 1.1, 2024 5.2, 2025 2.6, 2026 2.6, 2027 2.6
- Output gap (percent of potential output): 2019 2.8, 2020 -0.6, 2021 1.0, 2022 0.5, 2023 -1.0, 2024 -0.4, 2025 0.0, 2026 0.0, 2027 0.0
- Potential growth: 2019 2.2, 2020 -2.2, 2021 1.9, 2022 3.0, 2023 0.7, 2024 2.0, 2025 3.0, 2026 2.8, 2027 2.5
- Unemployment rate (average, in percent): 2019 2.0, 2020 2.5, 2021 2.8, 2022 2.5, 2023 3.1, 2024 2.5, 2025 2.3, 2026 2.3, 2027 2.3
- Consumer prices (average): 2019 2.8, 2020 3.2, 2021 3.8, 2022 16.0, 2023 9.3, 2024 2.5, 2025 2.0, 2026 2.0, 2027 2.0
- General government revenue (percent of GDP): 2019 41.3, 2020 41.5, 2021 41.4, 2022 41.7, 2023 42.9, 2024 41.5, 2025 40.8, 2026 40.7, 2027 40.7
- General government expenditure (percent of GDP): 2019 41.1, 2020 47.2, 2021 46.5, 2022 46.0, 2023 47.2, 2024 44.2, 2025 43.2, 2026 43.2, 2027 43.2
- Net lending / Overall balance (percent of GDP): 2019 0.3, 2020 -5.8, 2021 -5.1, 2022 -4.3, 2023 -4.3, 2024 -2.7, 2025 -2.5, 2026 -2.5, 2027 -2.5
- General government debt (percent of GDP): 2019 30.0, 2020 37.7, 2021 42.0, 2022 41.8, 2023 43.7, 2024 44.1, 2025 44.2, 2026 44.9, 2027 45.9
- Trade balance (goods and services, percent of GDP): 2019 6.0, 2020 6.7, 2021 3.0, 2022 -1.9, 2023 2.4, 2024 4.4, 2025 5.5, 2026 5.8, 2027 5.4
- Current account balance (percent of GDP): 2019 0.3, 2020 2.0, 2021 -0.8, 2022 -4.0, 2023 -0.9, 2024 1.2, 2025 2.3, 2026 2.5, 2027 2.5
- Gross international reserves (billions of euros): 2019 133.4, 2020 135.4, 2021 153.3, 2022 151.3, 2023 160.3, 2024 169.3, 2025 178.3, 2026 186.3, 2027 192.3
- Gross external debt (percent of GDP): 2019 76.5, 2020 76.4, 2021 75.5, 2022 68.9, 2023 66.6, 2024 64.5, 2025 61.3, 2026 58.8, 2027 56.2

### Balance of payments (selected items, percent of GDP)
- Current Account Balance: 2019 0.3, 2020 2.0, 2021 -0.8, 2022 -4.0, 2023 -0.9, 2024 1.2, 2025 2.3, 2026 2.5, 2027 2.5
- Exports (percent of GDP): 2019 61.8, 2020 59.4, 2021 62.1, 2022 61.3, 2023 60.7, 2024 62.3, 2025 61.3, 2026 60.9, 2027 60.7
- Imports (percent of GDP): 2019 57.7, 2020 54.4, 2021 60.9, 2022 64.1, 2023 59.8, 2024 59.7, 2025 57.7, 2026 57.1, 2027 57.2
- Financial Account (change in stocks, + = increase): 2019 0.1, 2020 2.9, 2021 0.2, 2022 -4.4, 2023 0.2, 2024 2.1, 2025 3.0, 2026 2.8, 2027 2.8
- Reserve assets (percent of GDP): 2019 1.9, 2020 0.8, 2021 4.8, 2022 -0.7, 2023 3.0, 2024 2.8, 2025 2.6, 2026 2.2, 2027 1.6

### External debt sustainability (high-level)
- Baseline external debt (percent of GDP): 2017 88.4, 2018 81.4, 2019 76.5, 2020 76.4, 2021 75.5, 2022 68.9, 2023 66.6, 2024 64.5, 2025 61.3, 2026 58.8, 2027 56.2
- External debt-to-exports ratio (in percent): 2017 111.9, 2018 105.8, 2019 103.6, 2020 109.2, 2021 104.0, 2022 94.6, 2023 92.4, 2024 87.1, 2025 84.2, 2026 81.3, 2027 78.1

### Figures and scenario notes
- External Debt Sustainability: bound tests include interest rate shock, current account shock, growth shock, combined shock, and a real depreciation shock (one-time real depreciation of 30 percent occurs in 2021).
- Shaded areas in figures represent actual data; individual shocks are permanent one-half standard deviation shocks. Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance in some scenarios.

*Prepared by European Department — Supplementary information to staff report for the 2022 Article IV Consultation (updates as of January 6, 2023).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1czeea2023001.pdf_