## 1czeea2024001 - 2025. The ongoing disinflation reflects the diminishing impact of price shocks from commodity

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### Disinflation and inflation outlook
- Ongoing disinflation reflects the diminishing impact of price shocks from commodity prices and a substantial decrease in domestic demand pressures.
- Falling core inflation primarily reflects the dampening effect of the tight monetary policy stance.
- Continued drops in commodity prices (food and fuel) are expected to support a fall in administered price inflation.
- Inflation is projected to meet its target by early 2025.
- Underlying inflation momentum (3-month seasonally adjusted annualized inflation rate excluding administrative prices) recorded at 2.4 percent in October 2023.
- Twelve-month headline and core inflation decreased from peaks of 18.0 percent and 14.7 percent (September and October 2022) to 8.5 percent and 4.2 percent in October 2023; headline inflation reached 6.5 percent in September 2023 (lowest since 2022, statistical base effect noted).

### Risks to growth and inflation
- Overall risk tilt:
  - Risks to the growth outlook are tilted to the downside.
  - Risks to inflation are tilted to the upside.
- Downside risks to activity:
  - Spillovers from a weaker global outlook.
  - A possible renewed surge in global energy prices.
  - New supply chain disruptions.
  - An increase in geopolitical tensions and potential broader geo-economic fragmentation.
  - Heightened global financial volatility impacting pricing and availability of financing.
- Upside risks to inflation:
  - Inflation expectations becoming untethered amid high inflation, tight labor market, and elevated but declining saving rate.
  - Strong wage growth and failure of profit margins to compress rapidly, causing stronger repricing of goods and services.
  - New global energy or commodity price shocks or reversal of expected administered price declines.
  - Abrupt return of household saving rate to near long-term average levels boosting consumption.
  - A falling differential in policy rates vis-a-vis major central banks or geopolitical shifts exerting depreciation pressure on the koruna.
- Alternative scenarios and policy responses are discussed (Annex VII referenced).

### Executive Board assessment and recommended policy stance
- Board observations:
  - Commended authorities for maintaining macroeconomic and financial stability and welcomed expected economic recovery in 2024.
  - Emphasized maintaining a prudent macroeconomic policy mix to ensure price stability and implementing structural reforms for green and digital transformation.
- Monetary policy guidance:
  - Maintaining a tight monetary policy stance remains appropriate to ensure inflation returns to target in a timely manner.
  - Central bank should adopt a cautious, data-driven approach to potential further rate cuts.
- Fiscal policy guidance:
  - Welcomed authorities’ commitment to fiscal prudence and emphasized flexibility given uncertainty.
  - If current conditions persist, Directors broadly concurred that further fiscal consolidation is needed to support disinflation efforts and reach the medium-term objective in the Fiscal Responsibility Act by 2028.
  - Further consolidation could help build fiscal buffers in the face of aging pressures and support economic transformation while protecting the most vulnerable.
  - Welcomed commitment to pension system reforms.
- Financial sector and macroprudential stance:
  - Banks described as well-capitalized, liquid, and profitable with strong asset quality.
  - Macroprudential settings broadly adequate but vigilance needed for pockets of vulnerabilities (housing market, foreign currency corporate loans, cyber security).
  - Some Directors saw no immediate need to reactivate debt- and debt-service-to-income ratios at this stage.
  - Encouraged improvements in risk-based supervision and continued efforts to strengthen safeguards against AML/CFT risks.

### Staff key messages and policy recommendations (KEY ISSUES)
- Context summary:
  - Growth slowed significantly after Russia’s invasion of Ukraine; growth expected to pick up in 2024 led by consumption and fixed investment as inflation fades and real income recovers—supported by net exports.
  - Over the medium term, GDP not expected to reach levels consistent with its pre-pandemic trend.
  - Inflation peaked in 2022 and is projected to meet its target by early 2025.
  - Risks: tilted to the downside for activity and to the upside for inflation.
- Policy priorities:
  - Reducing inflation to target, restoring fiscal space, maintaining macro-financial stability, and boosting potential growth to offset structural headwinds.
- Specific recommendations:
  - Monetary Policy:
    - Keep the policy stance sufficiently tight for some time to ensure inflation returns to target in a timely manner and reduce risk of an upward shift in inflation expectations.
    - Adopt a flexible, data-driven approach to policy setting given high uncertainty.
    - Maintain nominal policy rate broadly unchanged through early 2024 to consolidate disinflation; lower cautiously thereafter.
  - Fiscal Policy:
    - The approved consolidation for 2024 will help disinflation; automatic stabilizers should function fully.
    - Preserve and enhance policy space to address future shocks, support economic transformation and ensure long-term debt sustainability despite a low debt-to-GDP ratio.
    - Identify additional consolidation measures to reach MTO (structural balance of -0.75 percent of GDP) by 2028.
  - Macrofinancial Policies:
    - Current CCyB and LTV levels seem appropriate given diminished real estate risks.
    - Reactivating DTI and DSTI limits would be advisable to manage potential systemic risks.
    - Closely monitor risks from increasing share of euro-denominated bank loans.
  - Structural Policies:
    - Facilitate labor and capital reallocation, boost digitalization and productivity, and accelerate the green transformation to address population aging and the global shift away from fossil fuels.

### Key statistics and projections (selected)
- Real GDP (expenditure): -5.5 (2020); 3.5 (2021); 2.4 (2022); -0.4 (2023); 1.2 (2024); 2.5 (2025); 2.7 (2026); 2.6 (2027); 2.5 (2028)
- Consumer prices (average): 3.2 (2020); 3.8 (2021); 15.1 (2022); 10.6 (2023); 2.8 (2024); 2.0 (2025); 2.0 (2026); 2.0 (2027); 2.0 (2028)
- Consumer prices (end-of-period): 2.3 (2020); 6.6 (2021); 15.8 (2022); 7.4 (2023); 2.9 (2024); 2.0 (2025); 2.0 (2026); 2.0 (2027); 2.0 (2028)
- Unemployment rate (average, in percent): 2.4 (2020); 2.7 (2021); 2.1 (2022); 2.7 (2023); 2.6 (2024); 2.5 (2025); 2.4 (2026); 2.4 (2027); 2.4 (2028)
- General government debt (percent of GDP): 37.7 (2020); 42.0 (2021); 44.2 (2022); 44.2 (2023); 44.3 (2024); 44.2 (2025); 44.0 (2026); 43.6 (2027); 42.5 (2028)
- Current account balance (percent of GDP): 2.0 (2020); -2.8 (2021); -6.1 (2022); -0.9 (2023); -0.2 (2024); 0.3 (2025); 1.0 (2026); 1.5 (2027); 2.0 (2028)
- Gross international reserves (billions of euros): 135.4 (2020); 153.3 (2021); 131.3 (2022); 140.3 (2023); 149.3 (2024); 158.3 (2025); 166.3 (2026); 172.3 (2027); 176.9 (2028)
- Nominal GDP (USD billions): 246.0 (2020); 281.8 (2021); 290.5 (2022); 335.5 (2023); 350.4 (2024); 368.4 (2025); 385.1 (2026); 400.1 (2027); 416.8 (2028)
- Real GDP per capita: -5.6 (2020); 5.4 (2021); -0.6 (2022); -2.0 (2023); 0.4 (2024); 2.8 (2025); 3.0 (2026); 2.9 (2027); 2.8 (2028)
- GDP per capita (USD thousands): 22.98 (2020); 26.79 (2021); 26.83 (2022); 30.50 (2023); 31.61 (2024); 33.33 (2025); 34.94 (2026); 36.42 (2027); 38.06 (2028)

### Structural challenges and policy imperatives
- Long-standing structural issues coincide with global shifts: climate transition and mitigation, and an aging population.
- Decarbonization and EU trends (carbon pricing, electric vehicles, phasing out fossil fuel–based power) require major capital and labor reallocation.
- Investment needs by 2050 estimated at about CZK 3.5 trillion, of which about CZK 1–1.2 trillion are identified from public support including EU funds.
- Decarbonization targets and energy mix:
  - Phase out coal by 2033.
  - Raise share of renewables to 30 percent by 2030 (up from close to 18 percent in 2021).
  - Increase nuclear power to 33 percent by 2040 (up from 15 percent in 2016).
  - Expected emissions reductions: in sectors covered by EU ETS, reduce emissions by 63 percent in 2030 compared to 1990; in non-ETS sectors, expected reduction is 32 percent in 2030 (target 26 percent).
- Policies to encourage private investment: carbon pricing under ETS1 and ETS2 (starting 2027), regulatory guidance (ban on fossil-fuel vehicle registration within next decade, building energy-efficiency requirements), targeted subsidies, feebates, faster depreciation for cleaner machinery.

### Labor market, ALMPs, and technological innovation
- Labor market and wages:
  - Unemployment rate picked up slightly to 2.8 percent in 2023: Q3 but remains low by historical standards.
  - NAIRU estimated at about 3.9 percent in 2022.
  - About 100,000 Ukrainian workers estimated absorbed (around 2 percent of labor force).
  - Nominal wages increased but lagged inflation; real wages fell by about 10.7 percent from end 2019 to 2022: Q2; real wages in 2023: Q1 remained about 3 percent below end-2019 level.
- Active Labor Market Policies (ALMPs) recommendations:
  - Increase investments in reskilling, vocational training, lifelong learning and job search assistance.
  - Support the Labor Market Prediction Project (KOMPAS) and the Database of Retraining and Further Education Courses.
  - Improve vocational education, childcare provision, flexible work arrangements, and integrate refugees via language training, childcare and job support.
  - Extend initial work permits to five years and grant immediate temporary residence and work rights to accompanying family members; continue developing immigration point-based system.
- Technological innovation and R&D:
  - Accelerate Innovation Strategy and National Development Plan measures.
  - Provide targeted incentives for R&D, improve access to venture capital and equity financing, and simplify construction permitting.

### Financial sector resilience, macroprudential policy, and AML/CFT
- Macroprudential recalibration:
  - CCyB raised by 200 basis points between June 2022 and April 2023 to 250 basis points; partially released by 50 basis points between July and September 2023.
  - Loan-to-Value (LTV) upper limits kept unchanged.
  - Debt-Service-to-Income (DSTI) and Debt-to-Income (DTI) limits removed in June and November 2023 respectively; DSTI deactivated again in July 2023; DTI deactivation effective in early 2024.
- Staff assessment and recommendations:
  - Current CCyB level assessed as appropriate; staff cautioned against further reductions.
  - Recommend reactivating DTI and DSTI and recalibrating borrower-based measures (prefer legislative changes over repeated deactivation/reactivation).
- Banking sector indicators:
  - Regulatory capital to risk-weighted assets: 2016 17.7; 2017 18.1; 2018 18.3; 2019 19.7; 2020 22.1; 2021 21.2; 2022 20.3; 2023Q2 20.5.
  - Nonperforming loans to total gross loans: 2016 4.5; 2017 3.7; 2018 3.1; 2019 1.7; 2020 1.9; 2021 1.7; 2022 1.5; 2023Q2 1.2.
  - Return on assets: 2016 1.5; 2017 1.4; 2018 1.3; 2019 1.4; 2020 0.7; 2021 1.1; 2022 1.3; 2023Q2 1.4.
- Pockets of vulnerability to monitor:
  - Euroization of corporate loans (share of foreign currency loans to corporations increased to about 50 percent of total corporate loan portfolio).
  - Increased direct and indirect exposure to the treasury since the pandemic.
  - Real estate exposures: risks have diminished but require monitoring for loan quality and potential future nonperforming loans.
  - Cyber risk and vulnerabilities in NBFI (NBFI about 20 percent of financial sector).
- AML/CFT and corruption:
  - Continue enhancing detection and enforcement, obtain beneficial ownership information on real estate, increase STR reporting by real-estate intermediaries, and adopt measures to improve prosecution of foreign bribery offences.
  - Whistleblower Protection Act came into force in August 2023.

### External sector, reserves, and FX policy
- Current account developments:
  - CA deficit narrowed to 3.9 percent of GDP at end-July 2023 (12-month rolling basis); CA deficit projected to reach -0.9 percent of GDP by end-2023 in staff table.
  - Staff assesses external position in 2023 broadly in line with fundamentals after adjustments for temporary supply chain disruptions.
- Reserves and FX:
  - Gross international reserves fell by EUR22 billion to EUR131 billion in 2022 (reflecting CNB FX intervention sales); reserves about 8 months of imports in 2022 and remain between 3 and 4 times the IMF reserve adequacy metric.
  - CNB did not intervene in FX to affect exchange rate between October 2022 and November 2023; resumed sales of part of income on international reserves in August 2023 with mandate to minimize exchange rate impact.
  - CPI-based real exchange rate appreciated by about 25 percent since April 2017 exit from koruna floor.
- External assessment:
  - Staff CA Gap for 2023: 0.9 percent of GDP after adjustments (Proj. CA -0.9; Cycl. Adj. CA -0.8; EBA CA Norm -0.8; EBA CA Gap 0.0; Prim. inc. Adj. -0.6; Trade bal. Adj. 1.6; Staff CA Gap 0.9).

### Fiscal policy details and consolidation measures
- Draft 2024 budget targets an overall general government fiscal deficit of 2.2 percent of GDP in 2024 (down from 3.6 percent budget target for 2023).
- State budget deficit target for 2024: CZK 252bn (3.3 percent of GDP) compared to CZK 295bn in 2023 budget (4.0 percent of GDP).
- Staff projects cyclically adjusted fiscal deficit to contract by 1.3 percent of potential GDP.
- Medium-term baseline envisages debt-to-GDP ratio of 42.5 percent and structural balance of -0.8 percent of potential GDP by 2028 (consistent with MTO of -0.75 percent of GDP).
- Key fiscal consolidation measures (presented as table entries):
  - Total expected gain (loss): 114.0 1.5 24.0 0.3
  - Selected revenue items: Value added tax: 65.0 0.8 8.0 0.1; Excise tax: 5.7 0.1 3.2 0.0; Gambling tax: 1.1 0.0 0.0 0.0; Real estate tax: 10.0 0.1 0.6 0.0; Corporate income tax: 21.9 0.3 0.0 0.0; Personal income tax: 8.2 0.1 0.3 0.0; Social security contributions: 21.5 0.3 3.0 0.0; Other: -0.7 0.0 0.1 0.0
  - Selected expenditure items: Expenditure total: 49.0 0.6 16.0 0.2; Public sector wages: 12.0 0.2 -0.1 0.0; Savings in interest costs due to a lower deficit: 0.0 0.0 4.5 0.1; Reduction of national subsidies: 31.6 0.4 8.7 0.1; Other: 4.9 0.1 2.6 0.0
- Specific revenue measures in consolidation package: increase in corporate income tax rate, re-introduction of employee sickness insurance contribution at 0.6 percent, VAT streamlining, increases in excises, increase in real estate tax, modest PIT increase for high-income households.
- Staff recommendations:
  - Ensure PIT and real estate related taxes recover pre-pandemic tax revenue as a percent of GDP (would yield above 1.5 percent of GDP).
  - Advance pension reform, including linking retirement age to life expectancy.

### Risk Assessment Matrix (RAM) — key risks and recommended responses
- Conjunctural risks with staff likelihood/impact assessments include:
  - Intensification of regional conflict(s): Likelihood High; Impact on Czechia High. Recommended: diversify trade, accelerate investments in energy efficiency and renewables, develop contingency plans.
  - Commodity price volatility: Likelihood High; Impact High. Recommended: participate in European policy responses; diversify energy and food supply; incentivize domestic production.
  - Abrupt global slowdown or recession: Likelihood Medium; Impact Medium. Recommended: forward-looking data-driven monetary policy; diversify supply; participate in European responses.
  - Monetary policy miscalibration, systemic financial instability, sovereign debt distress, social discontent: various Likelihood Medium; Impact Medium. Recommended: monitor and manage risks; fine-tune macroprudential toolkit; target support to vulnerable populations.
- Structural risks include deepening geoeconomic fragmentation (High likelihood, High impact), cyberthreats (Medium likelihood, High impact), extreme climate events and disorderly energy transition (Medium likelihood, Medium impact). Recommended responses include targeted fiscal assistance for security-related sectors, enhanced cyber preparedness, and accelerated climate adaptation implementation.

### Medium- and long-term risk assessment and scenarios
- Medium-term risk signal: Low (fanchart risk score low).
- Probability of debt non-stabilization: 28.30.2 (percent) as presented.
- Final assessment: Prob. of missed crisis, 2023-2028, if stress not predicted: 9.1 pct; Prob. of false alarms, 2023-2028, if stress predicted: 58.0 pct.
- Climate stress scenarios:
  - Climate Change Adaptation: GFN-to-GDP ratio increases above 10 percent long-term; public debt-to-GDP above 45 percent.
  - Climate Change Mitigation: GFN-to-GDP ratio increases above 10 percent long-term; public debt-to-GDP above 55 percent.

### Resilience and Recovery Plan (RRP) and RRF impacts
- RRP size about €9.2 billion of grants and loans (3 percent of GDP) over 2021–2026.
- RRF estimated macroeconomic impact: about 1.2 percent increase in GDP by 2026.
- RRP allocations (selected):
  - Energy efficiency: €1.6 billion.
  - Renewable energy investments: €907 million.
  - Modernization/digitalization of electricity distribution: €316 million.
  - Sustainable mobility: €1.2 billion.
  - Circular economy: €121 million.
  - Forestry management: €335 million.
- RRF digital and social investments:
  - Digital curricula and upskilling: €585 million.
  - Digital transformation and cyber-security of public administration, justice, health: €790 million.
  - Digital transformation of businesses, digital innovation hubs, 5G: €662 million.
  - University infrastructure: €368 million.
  - Education access measures: €451 million.
  - Healthcare resilience: €823 million.
  - Affordable housing construction: €358 million.
  - REPowerEU support: €681 million grant plus Brexit Adjustment Reserve €55 million.

### Timing and procedural note
- It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

*Prepared by IMF staff; staff report for the 2023 Article IV consultation (discussions took place in Prague during November 7–21, 2023).*

### 2025. The ongoing disinflation reflects the diminishing impact of price shocks from commodity

### 1czeea2024001 - 2025. The ongoing disinflation reflects the diminishing impact of price shocks from commodity

### Disinflation and inflation outlook
- Ongoing disinflation reflects the diminishing impact of price shocks from commodity prices and a substantial decrease in domestic demand pressures.
- Falling core inflation primarily reflects the dampening effect of the tight monetary policy stance.
- Continued drops in commodity prices (food and fuel) are expected to support a fall in administered price inflation.
- Inflation is projected to meet its target by early 2025.

### Risks to growth and inflation
- Risks to the growth outlook are tilted to the downside; risks to inflation are tilted to the upside.
- Downside risks to activity:
  - Spillovers from a weaker global outlook.
  - A possible renewed surge in global energy prices.
  - New supply chain disruptions.
  - An increase in geopolitical tensions and potential broader geo-economic fragmentation.
  - Heightened global financial volatility due to stress in global financial markets, negatively impacting pricing and availability of financing.
- Upside risks to inflation:
  - Inflation expectations becoming untethered—against the backdrop of high inflation, a tight labor market and the currently elevated but declining saving rate.
  - Strong wage growth and a failure of profit margins to compress rapidly in an environment of recovering growth, resulting in stronger repricing of goods and services.
  - New global energy or commodity price shocks or a reversal of the expected increase in administered prices that could reverse the downward inflation momentum.
  - An abrupt return of the household saving rate to near long-term average levels boosting household consumption and heightening demand-driven inflationary pressures.
  - A falling differential in policy rates vis-a-vis major central banks or geopolitical shifts in regional sentiment could exert depreciation pressure on the koruna and add to inflationary pressures.

### Executive Board assessment and policy stance
- Executive Directors commended authorities for maintaining macroeconomic and financial stability and welcomed the expected economic recovery in 2024.
- Directors emphasized maintaining a prudent macroeconomic policy mix to ensure price stability and implementing structural reforms to facilitate the green and digital transformation.
- Monetary policy:
  - Directors agreed that maintaining a tight monetary policy stance remains appropriate to ensure inflation returns to target in a timely manner.
  - The central bank should adopt a cautious, data-driven approach to potential further rate cuts.
- Fiscal policy:
  - Directors welcomed the authorities’ commitment to fiscal prudence and emphasized the need to remain flexible given the uncertain outlook.
  - If current conditions persist, Directors broadly concurred that further fiscal consolidation is needed to support disinflation efforts and reach the medium-term objective in the Fiscal Responsibility Act by 2028.
  - Further consolidation could help build fiscal buffers in the face of aging pressures and support economic transformation.
  - Directors emphasized the importance of protecting the most vulnerable and welcomed commitment to pension system reforms.
- Financial sector and macroprudential policy:
  - Directors welcomed the resilience of the financial sector: banks are described as well-capitalized, liquid, and profitable while asset quality remains strong.
  - Macroprudential settings are broadly adequate but vigilance is needed as pockets of vulnerabilities warrant close monitoring, including in the housing market, foreign currency corporate loans, and cyber security.
  - A number of Directors found no immediate need to reactivate debt- and debt-service to income ratios at this stage.
  - Directors welcomed improvements in risk-based supervision and encouraged further progress.
  - Efforts to strengthen safeguards against AML/CFT risks should be continued.
- Structural policies:
  - Addressing structural challenges from demographic dynamics and the global energy transition is critical to maintain sustainable growth.
  - Structural reform policies should facilitate reallocation of labor and capital and advance technological innovation to support economic transformation toward a greener and more digitalized economy.
  - Directors welcomed the authorities’ decarbonization strategy and noted the need for continued efforts to meet climate targets.

### Staff key messages and policy recommendations (KEY ISSUES)
- Context summary:
  - Growth slowed considerably following Russia’s invasion of Ukraine due to disruptions in global value chains, significant increases in energy and commodity prices, erosion in real wages, and a necessary tightening in monetary policy.
  - Growth is expected to pick up in 2024 led by consumption and fixed investment as inflation fades and real income recovers—supported by net exports.
  - Over the medium term, GDP is not expected to reach levels consistent with its pre-pandemic trend.
  - Inflation peaked in 2022 and is projected to meet its target by early 2025. Risks are tilted to the downside for activity and to the upside for inflation.
- Policy priorities:
  - Reducing inflation to target, restoring fiscal space, and maintaining macro-financial stability, while remaining nimble given high uncertainty.
  - Boosting potential growth to offset structural headwinds.
- Specific recommendations:
  - Monetary Policy: Keep the policy stance sufficiently tight for some time to ensure inflation returns to target in a timely manner and reduce the risk of an upward shift in inflation expectations. Adopt a flexible approach to policy setting given high uncertainty.
  - Fiscal Policy: The approved consolidation for 2024 will help disinflation. Automatic stabilizers should function fully. Preserve and enhance policy space to address future shocks, support economic transformation and help ensure long-term debt sustainability despite a low debt to GDP ratio.
  - Macrofinancial Policies: Current levels of the countercyclical capital buffer and loan-to-value ratios seem appropriate given diminished real estate risks. Reactivating limits on debt-to-income and debt-service-to-income ratios would be advisable to help manage potential systemic risks. Closely monitor risks from an increasing share of euro-denominated bank loans.
  - Structural Policies: Aid labor and capital reallocation, boost digitalization and productivity, and accelerate the green transformation to address structural changes including population aging and the global shift away from fossil-fuel based power.

### Key statistics and projections (selected from Czech Republic: Selected Economic Indicators, 2020–28)
- Real GDP (expenditure): -5.5 (2020); 3.5 (2021); 2.4 (2022); -0.4 (2023); 1.2 (2024); 2.5 (2025); 2.7 (2026); 2.6 (2027); 2.5 (2028)
- Domestic demand: -5.6 (2020); 8.2 (2021); 2.6 (2022); -3.7 (2023); 0.6 (2024); 2.3 (2025); 2.6 (2026); 2.6 (2027); 2.7 (2028)
- Investment: -9.3 (2020); 20.4 (2021); 8.8 (2022); -8.2 (2023); -2.7 (2024); 2.1 (2025); 2.5 (2026); 2.7 (2027); 3.0 (2028)
- Exports: -8.0 (2020); 6.8 (2021); 7.2 (2022); 2.7 (2023); 2.5 (2024); 5.0 (2025); 5.1 (2026); 5.2 (2027); 5.4 (2028)
- Consumer prices (average): 3.2 (2020); 3.8 (2021); 15.1 (2022); 10.6 (2023); 2.8 (2024); 2.0 (2025); 2.0 (2026); 2.0 (2027); 2.0 (2028)
- Consumer prices (end-of-period): 2.3 (2020); 6.6 (2021); 15.8 (2022); 7.4 (2023); 2.9 (2024); 2.0 (2025); 2.0 (2026); 2.0 (2027); 2.0 (2028)
- Unemployment rate (average, in percent): 2.4 (2020); 2.7 (2021); 2.1 (2022); 2.7 (2023); 2.6 (2024); 2.5 (2025); 2.4 (2026); 2.4 (2027); 2.4 (2028)
- General government revenue (percent of GDP): 41.5 (2020); 41.4 (2021); 41.4 (2022); 42.6 (2023); 41.9 (2024); 41.6 (2025); 41.5 (2026); 41.5 (2027); 41.4 (2028)
- General government expenditure (percent of GDP): 47.2 (2020); 46.5 (2021); 44.6 (2022); 46.2 (2023); 44.1 (2024); 43.3 (2025); 43.0 (2026); 42.6 (2027); 42.2 (2028)
- Net lending / Overall balance (percent of GDP): -5.8 (2020); -5.1 (2021); -3.2 (2022); -3.6 (2023); -2.2 (2024); -1.7 (2025); -1.5 (2026); -1.2 (2027); -0.8 (2028)
- General government debt (percent of GDP): 37.7 (2020); 42.0 (2021); 44.2 (2022); 44.2 (2023); 44.3 (2024); 44.2 (2025); 44.0 (2026); 43.6 (2027); 42.5 (2028)
- Current account balance (percent of GDP): 2.0 (2020); -2.8 (2021); -6.1 (2022); -0.9 (2023); -0.2 (2024); 0.3 (2025); 1.0 (2026); 1.5 (2027); 2.0 (2028)
- Gross international reserves (billions of euros): 135.4 (2020); 153.3 (2021); 131.3 (2022); 140.3 (2023); 149.3 (2024); 158.3 (2025); 166.3 (2026); 172.3 (2027); 176.9 (2028)
- Nominal GDP (USD billions): 246.0 (2020); 281.8 (2021); 290.5 (2022); 335.5 (2023); 350.4 (2024); 368.4 (2025); 385.1 (2026); 400.1 (2027); 416.8 (2028)
- Population (millions): 10.7 (2020); 10.5 (2021); 10.8 (2022); 11.0 (2023); 11.1 (2024); 11.1 (2025); 11.0 (2026); 11.0 (2027); 11.0 (2028)
- Real GDP per capita: -5.6 (2020); 5.4 (2021); -0.6 (2022); -2.0 (2023); 0.4 (2024); 2.8 (2025); 3.0 (2026); 2.9 (2027); 2.8 (2028)
- GDP per capita (USD thousands): 22.98 (2020); 26.79 (2021); 26.83 (2022); 30.50 (2023); 31.61 (2024); 33.33 (2025); 34.94 (2026); 36.42 (2027); 38.06 (2028)

*Prepared by IMF staff; staff report for the 2023 Article IV consultation (discussions took place in Prague during November 7–21, 2023).*

### 3.      Policy action is needed to secure a successful transformation of the economy amidst

### 3.      Policy action is needed to secure a successful transformation of the economy amidst structural shifts

### Structural challenges and policy imperatives
- Long-standing issues intertwine with global structural shifts: climate transition and mitigation challenges, and an aging population.
- Decarbonization trends (carbon pricing, electric vehicles, phasing out fossil fuel–based power within the EU) require major capital and labor reallocation and significant investments.
- With an aging population weighing on labor supply and fiscal balances, urgent structural reforms are essential to:
  - direct resources towards higher value-added sectors to maintain living standards;
  - support the digital and green transformation of the economy.

### Recent developments (growth and demand)
- Real GDP growth in 2023 is estimated to have declined to -0.4 percent, mainly reflecting a decline in household consumption amid a significant fall in real wages, deteriorating consumer sentiment, and heightened uncertainty.
- Household consumption fell by 0.8 percent of GDP in 2022 and is projected to fall by around 3.2 percent of GDP in 2023.
- Fixed investment fell during late 2022 and early 2023 due to high interest rates and is projected to remain weak in 2023.
- Inventories built up in 2022 are being reversed as supply disruptions fade.
- Strong export growth together with subdued import growth (due to the downturn in domestic demand) led to strong net exports that helped contain the slowdown.

### Labor market and wages
- Unemployment rate picked up slightly to 2.8 percent in 2023: Q3 but remains low by historical standards and is among the lowest in Europe.
- NAIRU is estimated to have been about 3.9 percent in 2022.
- It is estimated that about 100,000 Ukrainian workers were absorbed in Czechia’s labor market (around 2 percent of the labor force).
- Nominal wages increased broadly across sectors but lagged behind inflation, resulting in a sharp fall in real wages.
  - Real wages fell by about 10.7 percent from end 2019 to 2022: Q2.
  - Despite recovery, real wages in 2023: Q1 remained about 3 percent below their level relative to end 2019.
- Labor force participation has increased slightly over time and remained stable since the pandemic.
- Vacancy rates have declined gradually since 2019, though vacancies in some sectors remain relatively high compared to other European countries.

### Monetary policy and inflation
- The CNB has maintained the policy rate at 7 percent since June 2022.
- Twelve-month headline and core inflation decreased from peaks of 18.0 percent and 14.7 percent in September 2022 and October 2022 respectively, to 8.5 percent and 4.2 percent in October 2023.
- Underlying inflation momentum (3-month seasonally adjusted annualized inflation rate excluding administrative prices) has been declining, with the October reading at 2.4 percent.
- Inflation expectations in October 2023:
  - around 2.8 percent for 12 months ahead for financial markets;
  - 6.6 percent for nonfinancial firms in Q3 2023.
- The inverted yield curve on government bonds suggests financial markets expect further disinflation.
- The headline inflation rate reached its lowest point since 2022 at 6.5 percent in September 2023 (statistical base effect noted).

### Fiscal developments
- General government fiscal deficit ended at 3.2 percent of GDP in 2022, lower than the 2021 deficit of 5.1 percent.
- The fiscal impulse in 2022 was -2.0 percent of potential GDP as the cyclically adjusted balance was reduced from -5.4 to -3.4 percent of potential GDP against a decrease of the output gap of about 0.4 percent of potential output.
- Debt at end-2022 was 44.2 percent of GDP—14.1 percentage points higher than in 2019.
- The GG budgeted deficit of 3.6 percent of GDP for 2023 is likely to be met.
- The cyclically adjusted balance is projected to remain unchanged in 2023 at around –3.4 percent of potential output, 2.6 percentage points weaker than its pre-pandemic level.
- Debt over GDP at end 2023 is projected to remain around 44.2 percent.
- For the state budget, the January–October outturn ended up at 2.9 percent of GDP deficit, lower than budgeted for the same period by 0.4 percent of GDP.
- The utility company (CEZ) dividend payout reached a record CZK 54bn (0.7 percent of GDP).

### Housing market and household credit
- Nominal growth rate in housing prices has turned mildly negative and indicators of overvaluation have declined.
- Real value of apartment prices in Prague is 4 percent below pre-pandemic levels; prices remain above pre-2020 levels outside the capital.
- In real terms new mortgages and other loans for household purchase are 39 percent below the pandemic level but have started to recover in the current year.
- Ratio of household debt to disposable income returned to pre-pandemic levels during 2022.
- About 80 percent of existing mortgages are above one-year maturities.
- Nonperforming loans for households have continued to decline and are significantly lower than for nonfinancial corporations.
- Euroization of corporate loans has increased, raising credit risks, but CNB stress tests suggest the unhedged portion does not raise systemic stability concerns.

### Financial sector resilience
- Financial system remains well capitalized, liquid, and profitable compared to peers.
  - Capital ratio in the banking sector is well above the regulatory requirement; Tier 1 ratio is relatively high by European standards.
  - Liquidity measures are strong (share of liquid assets and liquidity coverage ratio comfortably above the 100 percent minimum).
  - Net stable funding ratio is solid, reflecting reliance on domestic deposits.
  - Bank profitability and return on equity fare well relative to peers.
- Corporate sector: leverage and interest burden increased, but profitability improved on average and corporate defaults remained subdued.
- Interest coverage ratio declined but remains at a comfortable level.
- Probability of default has increased, yet corporate loan defaults have remained contained and the number of registered joint-stock firms has increased.

### External position
- Current account (CA) deficit narrowed to 3.9 percent of GDP at end-July 2023 (measured on a 12-month rolling basis).
- CA deficit projected to continue narrowing, reaching a deficit of 0.9 percent of GDP by end-2023.
- Goods trade surplus has been the primary contributor to CA improvement as inventories built during supply disruptions are lowered and finished products exported.
- Staff assesses the external position in 2023 to be broadly in line with fundamentals and desirable policy settings (after adjustment for temporary supply chain disruptions).
- External debt is moderate and assessed to be sustainable.

### Outlook and risks
- Growth is projected to increase to about 1.2 percent in 2024, driven by recovery of consumption and fixed investment as inflation declines and real wages recover.
- Private investment expected to pick up as external demand recovers; overall aggregate investment dampened by subdued public investment due to gradual phase-in of EU investment and structural funds (2021-2027).
- Labor market projected to marginally tighten in 2024 with unemployment decreasing to about 2.6 percent.
- Wage growth projected to decline gradually as real wages catch up toward labor productivity; staff projects recovery in real wages and real unit labor costs to be matched by a compression in profit shares back to pre-energy-shock levels.
- Inflation is projected to meet the CNB’s target by early-2025 as commodity price shocks diminish and domestic demand pressures fall.
  - Continued drops in food and fuel prices are expected (WEO October 2023).
  - An annual increase of about 6 percent in administered prices is expected in January 2024, mainly due to re-introduction of fees for transmission and renewable energy defined in the fiscal consolidation package.
- Risks to the growth outlook are tilted to the downside, including:
  - spillovers from a weaker global outlook;
  - possible renewed surge in global energy prices;
  - new supply chain disruptions;
  - increase in geopolitical tensions and broader geo-economic fragmentation;
  - heightened global financial volatility affecting financing costs and availability;
  - (low probability) disorderly house price correction that could impair banks’ and households’ balance sheets and markedly tighten financial conditions.
- Financial stability risks appear contained amid strong buffers and profitability of the banking sector, though vulnerabilities exist.

*Source: IMF country report chapter content.*

### 16.      Risks to inflation are tilted to the upside. These relate to inflation expectations becoming

### 16. Risks to inflation are tilted to the upside. These relate to inflation expectations becoming

### Inflation risks and scenarios
- Inflation expectations have been decreasing but remain above the inflation target.
- Upside risks to inflation include:
  - Inflation expectations becoming untethered in the context of high inflation, a tight labor market, and the currently elevated but declining saving rate.
  - Strong wage growth coupled with a failure of profit margins to compress rapidly in an environment of recovering growth, resulting in stronger repricing of goods and services.
  - New global energy or commodity price shocks.
  - An expected increase in administered prices reversing the downward inflation momentum.
  - An abrupt return of the household saving rate to near long-term average levels boosting household consumption and demand-driven inflationary pressures.
  - A falling differential in policy rates vis-a-vis major central banks or geopolitical shifts in regional sentiment exerting depreciation pressure on the koruna and adding to inflationary pressures.
- Downside risks include a slower recovery than expected in the baseline or an unexpected significant fall in global demand, which could accelerate convergence of inflation to the target.
- An alternative downside scenario based on these risks illustrates likely policy responses (Annex VII).

### Authorities’ views (overview)
- Authorities broadly agreed with staff’s assessment of the outlook and risks.
- Authorities envisage:
  - The economy contracting in 2023 and growth gradually strengthening in 2024 to about 2.5–3 percent in 2025.
  - Headline inflation is expected to fall substantially in early 2024.
- Authorities agree key risks include a weaker global outlook, a renewed surge in global energy prices, and an increase in geopolitical tensions—tilted to the downside for growth and to the upside for inflation.
- As part of the fiscal consolidation package, the government will withdraw subsidies towards renewables and electricity transmission at the start of 2024; the resulting higher corporate energy costs could be reflected in higher repricing in January.

### Monetary policy
- The CNB has kept the policy rate at 7 percent.
- The CNB regarded the current settings as appropriate for inflation to return to the inflation target by early-2025.
- Staff concurs with the CNB’s call for caution with regard to easing monetary policy and supports keeping rates at the current level for longer than implied by the baseline scenario of the CNB’s current forecast.
- Exchange rate note: Recently the koruna weakened against the Euro, but as of October 2023 remained 1.2 percent above its level one year ago.
- CNB policy history and scenarios:
  - The CNB began increasing its policy rates in June 2021, starting at 0.25 percent, and reaching 7 percent by June 2022.
  - CNB risk scenario: assumes a stronger increase in the inflation momentum following the adjustment of administered prices in January (expected to amount to 10 percent in the month) with an impact of 1 percentage point on annual inflation rate; under this risk scenario the policy rate should be kept at the current level for longer until the end of 2024: Q1.
  - CNB decisions will be based on forecasts and newly available data, including persistence of the disinflationary trend, labor market pressures, and domestic and external demand.
- Staff recommendations:
  - Maintain a tight monetary policy stance until there is firm evidence that inflation is on course to converge to target.
  - Erring on the side of overtightening would be less costly than underestimating persistence of inflation and delivering too little tightening.
  - Given heightened profit shares, ongoing recovery in real wages can be absorbed by firms without adding significant upward pressure on prices, but this requires aggregate demand to remain contained.
  - Maintain a tight stance by keeping the nominal policy rate broadly unchanged through early 2024 to consolidate disinflation and provide insurance against de-anchoring of inflation expectations.
  - Thereafter, lower the nominal policy interest rate cautiously and gradually, with pace accelerated if inflation expectations align faster to the target than envisaged.
  - Adopt a data-driven, meeting-by-meeting approach to determine the interest rate path.
- Views on minimum reserve requirement (MRR):
  - Staff highlights risks of raising the unremunerated MRR from the current level.
  - CNB stopped remunerating the mandatory minimum reserve requirements (2 percent of the deposit reserve base) effective October 2023.
  - Concerns: unremunerated MRR may impede banks’ capital accumulation, restrict credit provision, weigh on macro-financial stability, and reduce predictability of monetary policy transmission.
- Monetary stance estimates:
  - Staff estimates the monetary policy stance at about 2.6 in October 2023.
  - Staff estimates the real neutral rate at 1.5 percent.
  - Taylor Rule estimations: rates lower than 7 percent since May 2023 with rates increasing steadily to about 2 percent by end 2024; the estimation for October 2023 is around 6.4 percent.
- Foreign exchange policy:
  - A flexible exchange rate arrangement has served Czechia well as a shock absorber and in transmission of monetary policy.
  - The central bank has not conducted foreign exchange market operations to affect the exchange rate since October 2022, but resumed sales of part of the income on international reserves in August 2023 with the mandate to execute transactions with minimal impact on the exchange rate.
  - The CPI-based real exchange rate has appreciated by about 25 percent since 2019; other real exchange rate indicators show smaller appreciation.
  - Staff supports limited CNB presence in the foreign exchange market this year.

### Fiscal policy
- Draft 2024 budget aims at consolidation:
  - Targets an overall general government fiscal deficit of 2.2 percent of GDP in 2024, down from the 2023 budget target of 3.6 percent.
  - Consolidation based on streamlining government operations, cuts to the public sector wage bill, removal of subsidies for business entities, and increases of taxes including corporate income tax rate, excise taxes on alcohol, tobacco, and gambling.
  - Streamlining of VAT structure and re-introduction of employee sickness insurance contribution at the rate of 0.6 percent.
- Specific fiscal figures and comparisons:
  - State budget deficit target for 2024: CZK 252bn (3.3 percent of GDP) compared to a deficit target of CZK 295bn in the 2023 budget (4.0 percent of GDP).
- Staff assessment:
  - In cyclically adjusted terms, staff projects the fiscal deficit to contract by 1.3 percent of potential GDP.
  - Contractionary stance appropriate to support disinflation efforts, with the output gap set to nearly close in 2024.
  - Staff assesses there is substantial fiscal space.
- Medium-term fiscal framework:
  - Staff’s baseline envisages a debt-to-GDP ratio of 42.5 percent and a structural balance of -0.8 percent of potential GDP by 2028, consistent with the MTO—a structural balance of -0.75 percent of GDP.
  - Reaching the -0.75 percent of GDP MTO would require identifying additional consolidation measures to reduce the structural deficit by ½ a percentage point of GDP in 2027–28.
- Fiscal risks and medium/long-term pressures:
  - Spending pressures will increase to facilitate economic transformation toward a green digital economy and address population aging.
  - Structural transformation will require reforms, investments, social safety net support, adaptation of public sector infrastructure, ALMP, and education reforms.
  - Aging population will give rise to a pension funding gap in the long-term; actuarial deficit calls for higher general government structural balances than currently targeted MTO and an additional buffer against future shocks and fiscal risks.

### Policy recommendations and measures
- Fiscal measures recommended by staff:
  - As the recovery takes hold, ensure that the PIT and real estate related taxes deliver pre-pandemic tax revenue as a percentage of GDP. This would yield above 1.5 percent of GDP.
  - Further advance pension reform, complementing recent regulatory reforms with additional reforms to improve long-term sustainability, including linking retirement age to life expectancy.
- Authorities’ stance:
  - Concurred with need for further fiscal consolidation over the medium-term.
  - Noted fiscal effort is frontloaded in 2024–25 and additional measures will be needed to reach the MTO by 2028.
  - Agreed long-term pressures from aging require further pension reforms and additional public spending to facilitate green digital transformation.
  - Argued making changes to the PIT regime to recover pre-pandemic tax revenues would be politically challenging.

### Key fiscal consolidation measures (table summary as presented)
- Total expected gain (loss): 114.0 1.5 24.0 0.3
- Selected revenue items (as presented):
  - Value added tax: 65.0 0.8 8.0 0.1
  - Excise tax: 5.7 0.1 3.2 0.0
  - Gambling tax: 1.1 0.0 0.0 0.0
  - Real estate tax: 10.0 0.1 0.6 0.0
  - Corporate income tax: 21.9 0.3 0.0 0.0
  - Personal income tax: 8.2 0.1 0.3 0.0
  - Social security contributions: 21.5 0.3 3.0 0.0
  - Other: -0.7 0.0 0.1 0.0
- Selected expenditure items (as presented):
  - Expenditure total: 49.0 0.6 16.0 0.2
  - Public sector wages: 12.0 0.2 -0.1 0.0
  - Savings in interest costs due to a lower deficit: 0.0 0.0 4.5 0.1
  - Reduction of national subsidies: 31.6 0.4 8.7 0.1
  - Other: 4.9 0.1 2.6 0.0

*Source: 1czeea2024001 - 16.      Risks to inflation are tilted to the upside.*

### 30.      Macroprudential policy has been recalibrated. Between June 2022 and April 2023, the

### Macroprudential policy has been recalibrated.

### Recalibration of macroprudential tools
- Between June 2022 and April 2023, the CNB raised the Countercyclical Capital Buffer (CCyB) by 200 basis points—to a maximum level of 250 basis points.
- Between July and September 2023, the CNB released the CCyB by 50 basis points in two steps, partly because financial conditions were tighter than envisaged when the increases were announced.
- The net increase in the CCyB did not lead to higher capital levels but reduced the surplus over regulatory requirements.
- The CNB kept the upper limits of Loan-to-Value (LTV) unchanged.
- The CNB removed the Debt-Service-to-Income (DSTI) and the Debt-to-Income (DTI) limits in June and November 2023, respectively; the deactivation of the DTI limits will be effective in early 2024.
- The debt-service-to-income ratio was deactivated again in July 2023.

### Staff assessment and recommendations
- Staff assessed the current level of the CCyB as appropriate and cautioned against further reductions.
- Rationale and evidence cited by staff:
  - Monetary policy tightening, together with deployment of macroprudential instruments, helped arrest and later reverse the expansionary phase of the cycle.
  - CNB’s estimates and the recent evolution of new real mortgage loans suggest the cycle would be well below historical average levels.
  - Financial conditions (FCs) have become tight; staff’s analysis of FCs is consistent with these views.
  - Reduction in real estate market risks suggests capital requirements need not be as high as had been envisaged a year ago.
  - Even with recent relaxation, at 200 basis points, the CCyB requirements in the Czech Republic are among the three highest in Europe.
  - Remaining uncertainty in the outlook suggests caution in further reductions in the CCyB.
- Staff recommendation on borrower-based measures:
  - The loan-to-value limits remain appropriate.
  - The debt-to-income and debt-service-to-income limits should be reactivated.
  - With the reintroduction of borrower-based measures, the distribution of mortgage borrowers in banks’ balance sheets moved toward lower levels of risk.
  - Deactivating the upper DSTI limit allows banks to provide potentially riskier loans from a DSTI perspective; deactivating the DTI adds another dimension to borrower risk.
  - Staff recommends reinstating these instruments and, going forward, recalibrating and improving their design, including by legislative changes, rather than repeated deactivation and reactivation.

### Authorities’ views on macroprudential stance
- Authorities highlighted that risks to financial sector stability have declined.
- With the financial cycle well below its median level and subdued new credit activity, the macroprudential policy stance could be prudently relaxed.
- Authorities noted that although the CCyB has been relaxed from its peaks, it remained among the highest in Europe.
- They argued that temporary deactivation of the DSTI and DTI would not lead to substantial systemic risk given:
  - Low levels of new credit activity,
  - The backstop of the remaining LTV,
  - Prudent credit allocation by banks supported by risk-based capital requirements.

### Banking sector resilience and pockets of vulnerability
- Staff assesses the banking sector is broadly resilient:
  - Financial sector indicators point to a well-capitalized, liquid, and profitable banking system compared to European peers.
  - Asset quality remains strong as measured by the declining trend in nonperforming loans, though evolution of loans in stage II needs close monitoring.
  - Improvements in supervisory risk measurement for sectoral/individual exposures are welcomed; further progress is important.
- Pockets of vulnerability requiring close monitoring:
  - Euroization of corporate loans:
    - The share of the stock of foreign currency loans to corporations has increased to about 50 percent of the total corporate loan portfolio despite real exchange appreciation.
    - Banks’ derivative asset and liability positions have increased; foreign currency exposures in percent of capital remain contained.
    - The ability of corporate borrowers to repay in the context of an exchange rate realignment, and counterparties’ ability to honor derivative obligations, need periodic assessment.
    - Stress tests suggest these risks are not systemically important but warrant close monitoring of credit, exchange rate, and counterparty risks.
  - Increased direct exposure to the treasury since the pandemic remains contained, but indirect exposure rose through households and corporates.
    - Financial net worth of households and firms improved significantly since the pandemic; the general government and central bank net worth deteriorated.
    - Maintaining household and corporate balance-sheet strength ultimately depends on the treasury’s ability to honor obligations and maintain low sovereign risk.
  - Real estate exposures:
    - Risks from real estate exposures have diminished but require continued monitoring for loan quality evolution and possible future nonperforming loans.
  - Cyber risk:
    - Preparation for contingent cyberattacks to the financial sector is warranted.
  - Non-bank financial institutions (NBFI):
    - CNB stress tests indicate vulnerabilities in the NBFI, commercial and residential real estate sectors are contained and do not give rise to financial stability risks.
    - The NBFI remains relatively small, accounting for about 20 percent of the financial sector.

### AML/CFT, corruption, and cross-border illicit financial flows
- Continued efforts are needed to safeguard financial and real-estate sectors from money laundering risks and cross-border illicit financial flows.
- Recommended actions:
  - Use analysis of financial flows data to enhance understanding of cross-border risks.
  - Obtain information on beneficial ownership of Czech real-estate.
  - Address regulatory gaps related to financial intermediaries.
  - Increase STR reporting by real-estate intermediaries.
  - Continue efforts to reduce transnational aspects of corruption.
- Authorities’ observations:
  - Financial system remains sound; capital and liquidity buffers are comfortable; banks are profitable and nonperforming loans contained.
  - Risks in housing markets have declined; households’ gross disposable incomes recovered relative to housing prices and should absorb repricing of fixed interest-rate mortgages.
  - On AML/CFT, authorities indicated they obtain transactional data from banks for understanding cross-border risks.
- Box 1 findings on transnational aspects of corruption:
  - Foreign bribery risks are relatively contained but further efforts are needed.
  - None of the 500 largest multinational enterprises (MNEs) is headquartered in Czech Republic and the scale of foreign direct investment is relatively not significant.
  - Czech Republic has taken steps to enhance detection of foreign bribery and published guidance on corporate liability; the Whistleblower Protection Act came into force in August 2023.
  - Authorities are advised to adopt further measures to promote effective investigation, prosecution, and sanctions of foreign bribery offences, including legislation to ensure protection of prosecutorial independence from improper political influence.
  - Laundering of foreign proceeds of corruption risks are relatively limited but safeguards and enforcement need enhancement, particularly in the real estate sector.
  - Specific statistics on suspicious transactions reports involving foreign politically exposed persons and convictions for laundering of foreign proceeds of corruption should be maintained to ascertain AML/CFT effectiveness.

### Structural policies and the green transition
- Challenges:
  - Global structural shifts and an aging population.
  - Highly energy-intensive economy with a coal-intensive energy mix, producing substantial decarbonization and industrial transformation challenges.
  - Aging population expected to reduce labor supply and increase pension deficits, putting pressure on fiscal balances.
- Decarbonization strategy goals:
  - Phase out coal by 2033.
  - Increase shares of renewables and nuclear energy.
  - Raise the share of renewable energy (mainly photovoltaics and wind energy, with contribution of biofuels and biomass) to 30 percent by 2030 (up from close to 18 percent in 2021).
  - Increase nuclear power to 33 percent by 2040 (up from 15 percent in 2016).
  - Expected emissions reductions: in sectors covered by EU ETS, Czechia is expected to reduce emissions by 63 percent in 2030 compared to the 1990 level; in non-ETS sectors, expected reduction is 32 percent in 2030 compared to its target of 26 percent.
- Investment needs and financing:
  - Investment needs by 2050 are estimated at about CZK 3.5 trillion, of which about CZK 1–1.2 trillion are identified from public support including EU funds.
  - Public support includes funding from: Cohesion Funds, Recovery and Resilience Plan (Annex VI), ETS1 and ETS2 revenues, Modernization Fund, Social Climate Fund, and Loan from EIB-SFDI.
- Policies to encourage private investment:
  - Carbon prices under EU’s Emissions Trading System (ETS)1 and ETS2 (starting in 2027) will tilt relative prices toward greener energy sources.
  - Regulatory guidance includes banning the registration of fossil-fuel vehicles within the next decade and setting building requirements for energy efficiency.
  - Staff-recommended additional incentives may include:
    - Use of feebates in the agriculture sector (and other sectors not covered under the European Trading Systems).
    - Targeted subsidies for R&D investment.
    - Faster rates of depreciation of machinery and equipment that use fossil fuels if replaced by those that use clean fuels.
- Structural reform recommendations for capital reallocation and private investment:
  - Streamline regulations related to business establishment and insolvency to promote corporate restructuring and improve capital reallocation.
  - Simplify construction permits to enhance ease of doing business.
  - Improve SME access to alternative funding sources, in particular venture capital and equity financing.

*Source: INTERNATIONAL MONETARY FUND (Czech Republic).*

### 41.      To facilitate the labor reallocation, active labor market policies (ALMPs) could play a

### 1czeea2024001 - 41.      To facilitate the labor reallocation, active labor market policies (ALMPs) could play a

### Active Labor Market Policies and Training
- Training and lifelong learning are crucial to aid workers’ transition to growing sectors of the economy.
- Policymakers should proactively facilitate engagement, effective job matching, and the cross-sectional reallocation of workers through increased investments in ALMPs, which encompass reskilling and vocational training initiatives.
- Staff welcomes the government’s Labor Market Prediction Project (KOMPAS) designed to identify mismatches between labor demand and supply and provide job search assistance.
- Modernized vocational education can develop specific skills and raise the economy’s adaptability to structural change.
- Other ALMPs like job search assistance could help match jobseekers with opportunities.
- The government’s Database of Retraining and Further Education Courses is important to support upskilling and reskilling.
- Sustaining key education and curricula reforms requires adequate resources.

### Labor Force Participation and Integration
- Policy recommendations to improve labor force participation and alleviate labor shortages:
  - Stepping up policies to enhance employment prospects for disadvantaged groups; employment gaps persist for low-skilled, foreign, and young workers, and mothers with young children (Figure 16).
  - Staff welcomes the Job Integration Program (effective 2024).
  - Improving vocational training and education in technical and digital skills remains essential.
  - Continued efforts to integrate women with young children should build on recent improvements in childcare provision and early childhood education, and target more flexible use of parental allowances and enhanced opportunities for job searching.
  - A greater use of flexible and part-time work arrangements would also help to enhance participation.
- Continuing efforts to effectively integrate refugees and facilitate the inflow of migrants:
  - Continue provision of language training, childcare, and job search support for refugees.
  - The recently developed “pathways to work” program to support provision of skills to high-school immigrant children is welcome.
  - Extending initial work permits to five years and granting immediate temporary residence and work rights to accompanying family members are recommended.
  - “Key and Research Staff” and “Highly Qualified Employee” programs have successfully attracted qualified employees.
  - Efforts to develop an immigration point-based system should continue.

### Technological Innovation and R&D
- Structural reforms should support technological innovation.
- Incentives for R&D could boost productivity and create high value-added sectors (Figure 17).
- Providing targeted support to emerging and innovative firms encourages technological advancement and innovation.
- Implementation of the Innovation Strategy and National Development Plan is important to foster technical and digital competencies essential for high productivity sectors, particularly in Knowledge Intensive Sectors.
- Planned reforms under the Recovery and Resilience Facility to:
  - provide digital equipment to schools,
  - revise the IT curriculum,
  - expand life-long learning in digital technologies, and
  - implement the new digital governance structure
  should be accelerated.

### Macroeconomic Context and Policy Recommendations
- Authorities’ views:
  - Authorities recognized structural changes requiring reallocation of capital and labor, and advancing technological innovation.
  - They reiterated commitment to phasing out coal by 2033 and scaling up investment into renewable and low emissions energy sources.
  - Incentives through the EU funds and cash grants are expected to encourage the private sector to step up green investment.
  - Authorities highlighted ongoing structural reforms, with a focus on training and reskilling, to increase labor force participation and reduce labor shortages.
- Staff appraisal and macro recommendations:
  - Czechia’s economy is estimated to have contracted in 2023 but a gradual recovery is expected in 2024.
  - In 2024, growth is projected to pick up, mainly driven by a recovery of consumption and fixed investment, as inflation continues to decline and real wages recover.
  - Tight monetary policy has helped sharply reduce the inflation momentum, but additional effort is needed to consolidate the disinflation process.
    - Staff recommends keeping the policy stance tight for some time to ensure inflation returns to target in a timely manner and to reduce the risk of an upward shift in inflation expectations.
    - High uncertainty calls for a flexible approach to policy setting.
  - The approved fiscal consolidation for 2024 will aid disinflation efforts.
    - The consolidation package is consistent with the path envisaged in the FRA to reach the MTO of a -0.75 percent of GDP structural balance by 2028.
    - Reaching the MTO would entail identifying additional consolidation measures to reduce the structural deficit by ½ a percentage point (as stipulated in the FRA) in 2027–28.
    - Staff assesses there is substantial fiscal space; despite a low debt-to -GDP ratio, further consolidation will be crucial to build buffers for future shocks and support economic transformation.
    - In the event of adverse risks, it would be advisable to let automatic stabilizers operate freely; in case of a major shock, targeted fiscal support might be needed.
  - Financial sector:
    - Staff assesses the banking sector to be broadly resilient and macroprudential policy settings broadly adequate.
    - At 2 percent, the CCyB setting is adequate.
    - Borrower-based measures (LTV, DTI, and DSTI) have contributed to responsible lending practices and manage systemic risk.
    - Staff recommends reinstating DTI and DSTI, and going forward, recalibrating and improving their design, including by legislative changes, rather than their deactivation and reactivation.
- Structural transformation and long-term pressures:
  - Policies should support reallocation of labor and capital towards a greener economy.
  - Czechia must manage decarbonization and structural transformation of industries, including transition from internal combustion engine production to electric vehicles and automation trends.
  - Aging population is envisaged to reduce labor supply and increase pension deficits in the long-term, putting pressure on fiscal balances.

### Key statistics and facts (as stated)
- Setting up a company could take up to 25 days, one of the longest times in the EU.
- Job Integration Program effective 2024.
- Phase out of coal by 2033.
- MTO of a -0.75 percent of GDP structural balance by 2028.
- Reduce the structural deficit by ½ a percentage point in 2027–28.
- CCyB setting: 2 percent.
- Reference to employment gaps and ALMP spending figures appear in Figure 16 and R&D per inhabitant figures in Figure 17 (charts referenced in text).

*https://www.imf.org/-/media/files/publications/cr/2024/english/1czeea2024001.pdf*

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

### 1czeea2024001 - 50.      It is recommended that the next Article IV consultation be held on the standard 12- month cycle.

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

### Key macroeconomic projections and indicators (selected)
- Real GDP (expenditure): 2020 -5.5; 2021 3.5; 2022 2.4; 2023 -0.4; 2024 1.2; 2025 2.5; 2026 2.7; 2027 2.6; 2028 2.5 (annual percent change).
- Domestic demand: 2020 -5.6; 2021 8.2; 2022 2.6; 2023 -3.7; 2024 0.6; 2025 2.3; 2026 2.6; 2027 2.6; 2028 2.7.
- Investment (percent of GDP): 2020 26.5; 2021 26.0; 2022 26.8; 2023 25.9; 2024 26.2; 2025 25.6; 2026 25.5; 2027 25.6; 2028 25.7.
- Gross national savings (percent of GDP): 2020 28.1; 2021 27.5; 2022 26.0; 2023 28.1; 2024 27.0; 2025 27.0; 2026 27.4; 2027 28.0; 2028 28.6.
- Output gap (percent of potential output): 2020 -0.6; 2021 0.8; 2022 0.4; 2023 -0.5; 2024 -0.3; 2025 0.0; 2026 0.5; 2027 0.1; 2028 0.0.
- Potential growth: 2020 2.2; 2021 2.1; 2022 2.8; 2023 0.5; 2024 1.0; 2025 2.2; 2026 2.2; 2027 2.9; 2028 2.6.
- Unemployment rate (average, in percent): 2020 2.4; 2021 2.7; 2022 2.1; 2023 2.7; 2024 2.6; 2025 2.5; 2026 2.4; 2027 2.4; 2028 2.4.
- Consumer prices (average): 2020 3.2; 2021 3.8; 2022 15.1; 2023 10.6; 2024 2.8; 2025 2.0; 2026 2.0; 2027 2.0; 2028 2.0.
- Ten-year government bond (year average): 2020 1.1; 2021 1.9; 2022 4.2; 2023 1.2; 2024 1.7; 2025 1.7; 2026 1.7; 2027 1.7; 2028 1.7.

### Public finance projections and balances
- General government revenue (percent of GDP): 2020 41.5; 2021 41.4; 2022 41.4; 2023 42.6; 2024 41.9; 2025 41.6; 2026 41.5; 2027 41.5; 2028 41.4.
- General government expenditure (percent of GDP): 2020 47.2; 2021 46.5; 2022 44.6; 2023 46.2; 2024 44.1; 2025 43.3; 2026 43.0; 2027 42.6; 2028 42.2.
- Net lending / Overall balance (percent of GDP): 2020 -5.8; 2021 -5.1; 2022 -3.2; 2023 -3.6; 2024 -2.2; 2025 -1.7; 2026 -1.5; 2027 -1.2; 2028 -0.8.
- Primary balance (percent of GDP): 2020 -5.2; 2021 -4.5; 2022 -2.7; 2023 -2.8; 2024 -1.2; 2025 -0.7; 2026 -0.5; 2027 -0.2; 2028 0.2.
- Structural balance (percent of potential GDP): 2020 -5.5; 2021 -5.4; 2022 -3.4; 2023 -3.4; 2024 -2.1; 2025 -1.8; 2026 -1.8; 2027 -1.3; 2028 -0.8.
- General government debt (percent of GDP): 2020 37.7; 2021 42.0; 2022 44.2; 2023 44.2; 2024 44.3; 2025 44.2; 2026 44.0; 2027 43.6; 2028 42.5.

### Balance of payments and external sector projections
- Trade balance (goods and services, percent of GDP): 2020 6.7; 2021 2.8; 2022 -0.1; 2023 3.5; 2024 3.9; 2025 4.9; 2026 5.0; 2027 5.0; 2028 5.0.
- Current account balance (percent of GDP): 2020 2.0; 2021 -2.8; 2022 -6.1; 2023 -0.9; 2024 -0.2; 2025 0.3; 2026 1.0; 2027 1.5; 2028 2.0.
- Exports (percent of GDP): 2020 59.4; 2021 62.4; 2022 63.3; 2023 57.5; 2024 56.4; 2025 57.2; 2026 57.8; 2027 59.0; 2028 60.1.
- Imports (percent of GDP): 2020 54.4; 2021 61.2; 2022 64.8; 2023 54.8; 2024 53.8; 2025 53.8; 2026 54.5; 2027 55.8; 2028 57.1.
- Gross international reserves (billions of euros): 2020 135.4; 2021 153.3; 2022 131.3; 2023 140.3; 2024 149.3; 2025 158.3; 2026 166.3; 2027 172.3; 2028 176.9.
- Reserves in months of imports (selected entries): 2020 11.9; 2021 11.0; 2022 7.6; 2023 8.4; 2024 8.8; 2025 8.9; 2026 8.8; 2027 8.5; 2028 8.2.
- Financial account (change in stocks, + = increase, percent of GDP): 2020 2.9; 2021 -0.1; 2022 -5.5; 2023 0.4; 2024 1.0; 2025 1.7; 2026 2.4; 2027 3.0; 2028 3.5.
- Gross official reserves (2023 est, percent of GDP and items in External Sector Assessment): NIIP: -21 (% GDP); Gross Assets: 108 (% GDP); Res.Assets: 42 (% GDP); Gross Liab.: 129 (% GDP); Debt Liab.: 64 (% GDP).

### External sector assessment: main findings and adjustments
- Overall assessment for 2023: the forecasted external position for 2023 is broadly in line with fundamentals and desirable policy settings.
- Estimated CA gap for 2023: -0.8 percent of GDP, with a range of 1 to -1 percent of GDP.
- REER gap estimate: 1 percent (±1.8) percent indicating the exchange rate was broadly in line with fundamentals and desirable policy settings.
- NIIP trajectory: deteriorated to about -20 percent of GDP in 2022 from about -14 percent in 2021; through mid-2023 improved to -17 percent of GDP; external debt about 62 percent of annual GDP (over the last 4 quarters).
- Assessment: current NIIP and projected path do not imply risks to external sustainability.
- Current account background: CA turned negative in late 2021 and worsened in 2022 due to supply disruptions and surging energy prices; started to improve through mid-2023 and expected to end 2023 in a small surplus; medium-term CA expected to remain in surplus as GVC issues resolve.

- Specific adjustments applied in staff assessment for 2023:
  - An adjustment of -0.6 percent of GDP to the cyclically adjusted CA balance to account for half of the change in the primary income balance to -3.9 percent of GDP (vs. a 5-year pre-pandemic average of -5.1 percent of GDP).
  - An adjustment of 1.6 percent of GDP to reflect half of the decline in the trade balance to 3.5 percent of GDP (vs. a pre-pandemic 5-year average of 6.6 percent of GDP).
  - Resulting staff CA Gap table entries for 2023: 2023 Proj. CA: -0.9; Cycl. Adj. CA: -0.8; EBA CA Norm: -0.8; EBA CA Gap: 0.0; Prim. inc. Adj.: -0.6; Trade bal. Adj.: 1.6; Staff CA Gap: 0.9 (all entries in percent of GDP).

### Real exchange rate assessment
- Background: CPI-based REER appreciated by about 25 percent since April 2017 exit from koruna floor.
- Staff assessment under CA gap model: REER gap 1.6 percent, within tolerance range of -5 to 5 percent (broadly in line with fundamentals).
- Other EBA/REER models:
  - Index REER gap estimated at 43 percent.
  - REER level model suggests a 17 percent gap relative to fundamentals.
- Interpretation: larger gaps from REER models largely reflect residuals and factors outside those REER models.

### Capital and financial accounts, and reserves policy
- Financial account: declined to -5.5 percent of GDP in 2022 from -0.1 percent of GDP in 2021; falls in net FDI, other investment and reserve assets; increase in net portfolio assets abroad linked to large nonresident portfolio outflows.
- 2023 projection: financial account roughly in balance and projected to turn positive over the medium-term.
- Assessment: risks related to capital flows assessed to be relatively small.
- FX intervention and reserves:
  - Gross international reserves fell by EUR22 billion to EUR131 billion in 2022, reflecting about EUR26 billion in FX intervention sales by the Czech National Bank (registered as a 4.5 percent of GDP decline in reserve assets in the BoP).
  - CNB did not intervene in the FX market to affect the exchange rate between October 2022 and November 2023; resumed program in August 2023 of sales of part of its income on international reserves with mandate to execute transactions with minimal exchange rate impact.
  - Reserves assessed as sufficient: equivalent to approximately 8 months of imported goods and services in 2022 and expected to increase slightly in 2023; reserves remain between 3 and 4 times above the IMF’s reserve adequacy metric.

### Financial sector and monetary indicators (selected)
- Broad money (M3) year-on-year growth and levels: broad money (end of year, percent change) 2020 10.0; 2021 6.8; 2022 6.1; 2023 8.5; 2024 4.9; 2025 4.8; 2026 4.3; 2027 4.3; 2028 4.6.
- Private sector credit (end of year, percent change): 2020 3.6; 2021 8.9; 2022 5.0; 2023 4.5; 2024 4.0; 2025 3.5; 2026 3.5; 2027 3.5; 2028 3.5.
- Financial soundness indicators (selected, percent):
  - Regulatory capital to risk-weighted assets: 2016 17.7; 2017 18.1; 2018 18.3; 2019 19.7; 2020 22.1; 2021 21.2; 2022 20.3; 2023Q2 20.5.
  - Nonperforming loans to total gross loans: 2016 4.5; 2017 3.7; 2018 3.1; 2019 1.7; 2020 1.9; 2021 1.7; 2022 1.5; 2023Q2 1.2.
  - Return on assets: 2016 1.5; 2017 1.4; 2018 1.3; 2019 1.4; 2020 0.7; 2021 1.1; 2022 1.3; 2023Q2 1.4.

### Potential policy responses and staff suggestions
- External sector: no contribution from policies to the CA gap for 2023; if the CA gap widens indicating an imbalance, authorities could consider implementing structural policies to reduce it.
- FX policy: CNB resumed limited sales of part of income on international reserves with mandate to minimize exchange rate impact; reserves judged sufficient to insulate against external shocks.
- Structural and fiscal policy implications:
  - Structural balance trajectory shows gradual narrowing of deficits: structural balance from -5.5 (2020) to -0.8 (2028) percent of potential GDP, supporting gradual fiscal consolidation over the medium term.
  - If external or domestic imbalances emerge, policy responses would include structural reforms to address competitiveness and external adjustments.

*Source: IMF staff estimates, projections, and assessments as presented in the Czech Republic country report tables and Annex I: External Sector Assessment.*

### Annex II. Risk Assessment Matrix

### Annex II. Risk Assessment Matrix

### Conjunctural Risks

- Intensification of regional conflict(s).
  - Likelihood: High
  - Impact on Czechia: High
  - Impact summary: "The war in Ukraine or other regional conflicts increase likelihood of trade and supply chain disruptions, higher inflation, and confidence shocks"
  - Recommended Policy Response:
    - "Diversify trade, particularly imports of energy. Develop contingency plans."
    - "Accelerate investments in energy efficient and renewable sources of energy, and in critical energy infrastructure such as the as the Poland – Czechia gas pipeline being revamped."

- Commodity price volatility.
  - Likelihood: High
  - Impact on Czechia: High
  - Impact summary: "Supply disruption will cause high and volatile food and energy prices in the region."
  - Recommended Policy Response:
    - "Keep participating in European policy responses. Diversify energy and food supply."
    - "Incentivize domestic production of food and renewable energy."

- Abrupt global slowdown or recession.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "Given its integration in GVCs, Czechia’s inflation and economic activities would be significantly affected by recession in Europe and recurrent energy crises and supply disruptions."
  - Scenario components described in source:
    - U.S.: "Amid tight labor markets and/or commodity price shocks, inflation remains elevated, prompting the Fed to keep rates higher for longer and resulting in more abrupt financial, housing and commercial real estate market correction, and “hard landing”."
    - Europe: "Intensifying fallout from the war in Ukraine, recurrent energy crisis and supply disruptions, and monetary tightening exacerbate economic downturns, and housing and commercial real estate market corrections."
    - China: "Sharper-than-expected slowdown in the property sector, unexpected fiscal tightening due to local government financing stress and decline in investment, and/or rising geopolitical tensions disrupt economic activity."
  - Recommended Policy Response:
    - "Keep participating in European policy responses. Monetary policy stance should be forward-looking, and data driven. Diversify energy and food supply. Incentivize domestic production of food and renewable energy."

- Monetary policy miscalibration.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "Czechia faces the same monetary policy miscalibration risks. Combatting inflation and maintaining inflation expectation anchored are still policy priorities."
  - Recommended Policy Response:
    - "Keep monetary policy sufficiently tight until there are clear signs of inflation rates and expectations stabilizing around target rates."

- Systemic financial instability.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "Czechia would be relatively insulted given the high reliance on domestic financing in both public and private sectors."
  - Recommended Policy Response:
    - "Closely monitor and manage financial sector risks."
    - "Enhance the resilience of household and financial sectors by fine-tuning the macroprudential toolkit as needed."

- Sovereign debt distress.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "Czechia would be less exploded to these shocks because of its high dependence on domestic financing in both public and private sectors, along with its relatively low debt level."
  - Recommended Policy Response:
    - "Vigilantly monitor and manage financial sector risks."
    - "Strengthen the resilience of household and financial sectors by adjusting the macroprudential toolkit as required."

- Social discontent.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "High and volatile food and energy prices, and lower real income in the region could increase the risks of social unrest."
  - Recommended Policy Response:
    - "Continue to engage in European policy responses, diversity energy and food sources, encourage domestic production of food and renewable energy, and direct support measures towards vulnerable populations."

### Structural Risks

- Deepening geoeconomic fragmentation.
  - Likelihood: High
  - Impact on Czechia: High
  - Impact summary: "Geopolitical tensions between Europe and Russia have escalated due to support for Ukraine and could potentially intensify further if the war in worsens, leading to broader regional consequences."
  - Recommended Policy Response:
    - "Allocate further targeted fiscal assistance with focus on critical security-related sector. And continue to enforce AML/CFT frameworks to protect the financial sector."

- Cyberthreats.
  - Likelihood: Medium
  - Impact on Czechia: High
  - Impact summary: "Given the ongoing geopolitical tensions with Russia and recent cyber-attacks, there are risks of additional cyber threats."
  - Recommended Policy Response:
    - "Enhance preparedness for cyberattacks through extensive risk monitoring in cooperation with private and public sector stakeholders."

- Extreme climate events.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "Czechia’s strategy on climate adaptation to Change identifies industry and energy as the main sectors subject to climate change risks and emphasis on connectivity across sectors."
  - Recommended Policy Response:
    - "Accelerate the implementation the National Action Plan on Adaptation which established a robust scheme to build and enhance the energy sector’s climate resilience."

- Disorderly energy transition.
  - Likelihood: Medium
  - Impact on Czechia: Medium
  - Impact summary: "Industry and energy are the main sectors identified as the main sectors subject to climate change risks, especially given the connectivity across sectors."
  - Recommended Policy Response:
    - "Continue implementing the National Action Plan on Adaptation to build and enhance the energy sector’s climate resilience."

### Note on the Risk Assessment Matrix (RAM)

- "The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. The conjunctural shocks and scenarios highlight risks that may materialize over a shorter horizon (between 12 to 18 months) given the current baseline. Structural risks are those that are likely to remain salient over a longer horizon."

*Source: IMF staff (Annex II. Risk Assessment Matrix).*

### 2024. Therefore, the growth projection is higher than the levels implied by the fiscal multipliers in 2024-25.

### 1czeea2024001 - 2024. Therefore, the growth projection is higher than the levels implied by the fiscal multipliers in 2024-25.

### Medium-Term Risk Assessment
- Risk signal: Low (fanchart risk score is low, given the relatively wide fanchart and probability of debt not stabilizing).
- Debt fanchart module:
  - Fanchart width34.20.5 (percent of GDP)
  - Probability of debt non-stabilizaiton (percent) 28.30.2
  - Terminal debt-to-GDP x11.50.2
  - Debt fanchart index (DFI)1.0
- Gross Financing Needs (GFN) module:
  - Average baseline GFN6.52.2 (percent of GDP)
  - Initial Banks' claims on the gen. govt (pct bank assets)13.44.3
  - Chg. In banks' claims in stress (pct banks' assets)2.70.9
  - GFN financeability index (GFI)7.4
  - Risk signal: Low
- Medium-term index: 0.20.50.1 / 0.10.50.1 (presented in fanchart visuals)
- Final assessment:
  - Prob. of missed crisis, 2023-2028, if stress not predicted: 9.1 pct.
  - Prob. of false alarms, 2023-2028, if stress predicted: 58.0 pct.
- Commentary: Gross financing needs are manageable and staff assesses that the banking sector is broadly resilient, well capitalized, liquid, and profitable. It is expected that the banking sector will have ample borrowing space with vulnerabilities easing as the monetary stance is relaxed.

### Long-Term Risk Assessment and Scenario Results
- Baseline dynamics:
  - Staff's baseline scenario (Baseline with t+5) shows both GFN- and public debt-to-GDP ratios declining over the long-term as Czechia converges to steady-state growth.
- Alternative scenarios:
  - Baseline with t+5 and DSPB scenario: stabilization of long-term GFN and public debt ratios at higher levels than staff's baseline.
  - Medium-term extrapolation with debt stabilizing primary balance: presented as an alternative projection.
- Custom scenario (Table / Figure summary):
  - Variable 2028 / 2032 to 2036 average / Custom Scenario
  - Real GDP growth 2.5% / 2.5% / 2.5%
  - Primary Balance-to-GDP ratio 0.2% / -1.3% / -0.9%
  - Real depreciation -1.6% / -2.0% / -1.9%
  - Inflation (GDP deflator) 2.0% / 2.1% / 2.1%
  - Commentary: Custom scenario shows an increase in long-term GFN and public debt ratios at higher levels than staff's baseline, because a smaller primary surplus is assumed than is required by the projected steady-state.
- Climate stress scenarios:
  - Climate Change Adaptation:
    - Under stress scenarios, the GFN-to-GDP ratio will increase above 10 percent in the long-term and public debt-to-GDP will increase above 45 percent.
  - Climate Change Mitigation:
    - Under stress scenarios, the GFN-to-GDP ratio will increase above 10 percent in the long-term and public debt-to-GDP will increase above 55 percent.
  - Commentary: Both adaptation and mitigation raise long-term GFN-to-GDP and public debt-to-GDP ratios relative to the baseline.

### External Debt Sustainability and Stress Tests
- Baseline external debt path (selected entries from table):
  - Baseline: External debt 76.5 76.4 76.3 67.0 63.5 64.1 63.4 61.7 59.1 55.5 52.9 -3.4
  - Change in external debt -4.9 -0.1 -0.1 -9.3 -3.5 0.6 -0.8 -1.6 -2.6 -3.6 -2.6
  - Identified external debt-creating flows (4+8+9) -3.8 -2.6 -7.4 -5.8 -0.2 -1.7 -3.1 -3.8 -4.2 -4.5 -4.5
  - Current account deficit, excluding interest payments -0.3 -2.0 2.8 6.1 0.9 0.2 -0.3 -1.0 -1.5 -2.0 -2.0
  - Exports 73.9 69.9 73.0 74.9 68.6 67.8 68.8 69.8 71.2 72.8 74.5
  - Imports 67.9 63.2 70.1 75.1 65.1 63.8 63.9 64.7 66.3 67.9 69.5
  - Net non-debt creating capital inflows (negative) -2.3 -2.7 -0.4 -2.5 -1.3 -1.2 -1.2 -1.2 -1.1 -1.0 -1.1
  - Automatic debt dynamics 1/ -1.1 2.0 -9.7 -9.4 0.2 -0.7 -1.6 -1.6 -1.5 -1.4 -1.3
  - Residual, incl. change in gross foreign assets (2-3) 3/ -1.1 2.5 7.3 -3.6 -3.3 2.3 2.3 2.2 1.6 0.9 1.9
- External debt ratios and financing needs:
  - External debt-to-exports ratio (in percent) 103.6 109.2 104.6 89.4 92.6 94.6 92.2 88.5 83.0 76.3 71.1
  - Gross external financing need (in billions of US dollars) 4/ 118.8 106.1 111.9 121.9 117.9 126.6 131.6 134.2 134.4 131.2 127.9
  - in percent of GDP 47.0 43.1 39.7 42.0 (further entries in table)
- Key macroeconomic assumptions (selected):
  - Real GDP growth (in percent) 3.0 -5.5 3.6 2.3 2.2 3.1 -0.4 1.2 2.5 2.7 2.6 2.5 2.5
  - GDP deflator in US dollars (change in percent) -1.6 3.1 10.6 11.5 2.5 8.0 9.0 3.7 2.2 1.6 1.7 2.0 2.0
  - Growth of exports (US dollar terms, in percent) -2.6 -7.8 19.5 5.9 3.6 9.4 5.7 3.2 6.7 6.0 6.1 6.5 7.0
  - Growth of imports (US dollar terms, in percent) -3.0 -9.3 27.1 10.4 4.5 11.6 0.2 2.4 5.2 5.9 6.4 6.7 7.2
- Bound and shock tests (figures summarized):
  - Interest rate shock, current account shock, growth shock, combined shock, and 30% real depreciation scenarios are presented visually; baseline averages shown (e.g., Baseline: 53, Historical: 61 in selected box indicators).
  - Notes: Individual shocks are permanent one-half standard deviation shocks; permanent 1/4 standard deviation shocks also applied to real interest rate, growth rate, and current account balance; one-time real depreciation of 30 percent occurs in 2021 in the historical scenario.

### Resilience and Recovery Plan (RRP) — Implementation and Expected Impacts
- Overall:
  - The RRP contains reforms and investments to address bottlenecks to lasting and sustainable growth, accelerate the transition towards a low-carbon and climate-resilient economy, maximize digital transformation benefits, and improve public administration quality, while fostering social cohesion and resilience in healthcare, education, and pre-school facilities.
- Funding and implementation status:
  - RRP size: about €9.2 billion of grants and loans or 3 percent of GDP over 2021–2026.
  - The RRP was kick-started in September 2021 with the disbursement of the pre-financing payment (€915 million, 13 percent of the Recovery and Resilience Facility (RRF) allocation).
  - In March 2023, Czechia received the first disbursement (€928 million), after satisfactory fulfilment of all 37 milestones and targets (EC, 2023a).
  - The related 37 milestones and targets cover reforms of school curricula to promote digital literacy and digital skills, eHealth, the country's audit and control system, the law on the registration of beneficial owners, investments for reconstruction of three railway bridges, 45 safer railway level crossings and digital tools for education (EC, 2023b).
  - The macroeconomic impact of the RRF is estimated at about 1.2 percent increase in GDP by 2026 (EC, 2022).
- RRF support for the green transition (key measures and amounts):
  - (i) energy efficiency (€1. 6    billion) for financing large-scale renovation programs to increase energy efficiency of residential and public buildings;
  - (ii) investments in renewable energy sources for businesses and households (€907 million);
  - (iii) financing the modernization and digitalization of electricity distribution grids (€316 million);
  - (iv) investments in sustainable mobility (€1.2   billion), including low-emission vehicles for the business sector, improving railway infrastructure, and promoting electric charging stations and cycling pathways;
  - (v) investment in the circular economy (€121 million), including recycling infrastructure and support for circular economy solutions and water savings in businesses;
  - (vi) investment in forestry management (€335 million) to increase sustainability of Czech forests.
- REPowerEU measures:
  - REPowerEU measures include 15 reforms and 9   investments, supported by a grant of €681 million.
  - Key reforms: facilitate the Renovation Wave by supporting/ advising households, businesses and public sector entities in building renovations; streamline and accelerate permitting for renewables; simplify linking of renewables to grids; provide support to energy communities.
  - Key investments: modernization and digitalization of the electricity grid; develop new photovoltaic energy sources; electrify railways; support purchase of electric or hydrogen vehicles and cargo e-bikes by private companies; promote green skills and sustainability in universities.

*Source: IMF staff estimates and projections (Czech Republic country report content unit).*

### 4.      The RRF will help facilitate the digital transformation by improving digital

### 4.      The RRF will help facilitate the digital transformation by improving digital

### RRF support for digital transformation and education
- The RRF will support revamping digital curricula in education, providing digital equipment and training to schools, incorporating new university programs in fast-growing digital fields, and upskilling and reskilling courses for citizens (€585 million).
- Planned investments include:
  - Digital transformation and cyber-security of public administration, the justice system and health care (€790 million).
  - Digital transformation of businesses, digital innovation hubs, high-capacity networks, and 5G networks (€662 million).
  - Construction of university infrastructure (€368 million).

### RRP measures to boost economic and social resilience
- The plan envisages measures to improve the business environment (€222 million), with focus on:
  - Access to finance for companies.
  - Construction licensing procedures.
  - Anti-corruption measures.
  - Cooperation between public and private research.
- Education access and support measures (€451 million), notably:
  - Increasing access to affordable pre-school care.
  - Reinforced support for disadvantaged children.
  - Additional tutoring for children at risk of failure.
- Healthcare resilience investments (€823 million), including:
  - Building new hospitals and long-term care facilities.
  - Acquiring new medical equipment.
  - Strengthening cancer screening programs.
  - Rolling out e-Health.
- Investments for new construction of affordable housing (€358 million).
- Czechia’s Brexit Adjustment Reserve of €55 million is expected to be added to the grant of €681 million to finance the REPowerEU measures.

### Downside scenario: shock channels and impacts
- Adverse scenario assumptions include:
  - Intensification of Russia’s war in Ukraine and other regional conflicts.
  - Possibility of a sudden global economic slowdown or recession.
  - Fluctuations in commodity prices.
  - Misalignment in monetary policies.
  - Systemic financial instability, including sharp shifts in real interest rates, risk premiums, and asset repricing in some countries.
- Four main channels through which shocks affect the economy:
  - Commodities channel: rising energy prices increase input costs and, with higher food and energy prices for households, elevate consumer price inflation, reduce real incomes, and weigh on private consumption and investment.
  - Trade channel: decreased external demand from major trading partners reduces Czechia’s exports.
  - Labor mismatch channel: tight labor markets and reduced efficiency in matching workers to suitable job opportunities.
  - Financial conditions channel: tightening of global financial conditions affects domestic financial markets, results in stock market losses, and potentially impacts economic activity.

### Contingent policy responses and calibration
- Fiscal policy:
  - Can play a counter-cyclical role.
  - If adverse shocks put the economy in deep recession (such as during the pandemic), the consolidation path could be slowed down—with clear communication of the reasons, and a plan to return to the medium-term-objective (MTO) target and to ensure medium-to -long-term debt sustainability.
  - It is essential to devise targeted aid without stoking inflation.
- Monetary policy:
  - Action would need to be data driven.
  - CNB should stand ready to further tighten monetary policy if the inflationary effect of the shock (exchange rate) can be expected to dominate potential disinflationary effects (output, financial stability), impeding efforts to move inflation towards target.
  - If growth decelerates substantially or inflationary pressures subside faster in a sustained manner, monetary policy can respond with a more accommodative stance.
- Financial sector policies:
  - Must ensure adequate incentives for appropriate risk-taking while maintaining the banking system’s ability to finance viable debtors and keep adequate buffers.
  - Calibration of prudential policies should account for sector specific developments.
  - Close monitoring of financial sector risks and debt-servicing would be warranted, especially if further increases in interest rates materialized or increases in prices further limited the ability to service debt.

### Selected statistical and governance context (highlights)
- Last Article IV Consultation concluded on January 20, 2023 (IMF Country Report No. 23/31).
- The Czech koruna was created on February 8, 1993; the de jure exchange rate arrangement is free floating and the de facto exchange rate arrangement is floating.
- As of October 31, 2023:
  - Quota: 2,180.20 SDR Million (100.00 percent).
  - Fund Holdings of Currency: 1,590.00 SDR Million (72.93 percent).
  - Reserve Position: 590.20 SDR Million (27.07 percent).
- Projected payments to the Fund (Forthcoming, SDR Million): Charges/Interest of 3.26 (2023), 13.29 (2024), 13.28 (2025), 13.29 (2026), 13.29 (2027); Total 3.26 (2023), 13.29 (2024), 13.28 (2025), 13.29 (2026), 13.29 (2027).
- Data dissemination and standards:
  - The Czech Republic has adhered to the SDDS Plus since April 2016.
  - National accounts compiled on ESA2010 basis; consumer price index (CPI) compiled monthly with weighting structure based on average expenditure data from 2019–2022.
  - CNB compiles balance of payments and international investment position statistics in line with BPM6.
- Statement by the Staff Representative (January 22, 2024) highlights:
  - GDP growth for Q3 revised downward to -0.6 percent from -0.5 percent (y/y).
  - The state budget fiscal deficit ended at CZK 288.5bn (about 3.9 percent of GDP), lower than the 2023 annual budget deficit target of CZK 295bn (about 4.0 percent of GDP).
  - In December, twelve-month headline and core inflation decreased to 6.9 and 3.6 percent, respectively, from 7.3 and [text truncated in source].

*Source: IMF staff report excerpts from the Czech Republic staff report and informational annex.*

### 3.9 percent in November, respectively. The one-year-ahead financial markets inflation

### 1czeea2024001 - 3.9 percent in November, respectively. The one-year-ahead financial markets inflation

### Recent developments and outlook
- GDP declined by 0.4 percent in 2023 according to the estimates.
- Inflation was at 10.7 percent for the year 2023 as a whole.
- The economy was still impacted by receding external inflationary pressures and domestic demand pressures.
- Drivers of subdued economic activity in 2023:
  - Lower household consumption due to tight monetary policy, deteriorated real purchasing power, and an increased savings rate.
  - Decreasing additions to inventories returning to normal after supply chain disruptions subsided.
- Labor market: authorities estimate the economy is currently below its potential, but the labor market remains somewhat tight.
- Projections:
  - Economy projected to return to positive growth in 2024 at 1.2 percent.
  - Inflation expected to decline from 2.6 percent in 2024 to the central bank’s 2 percent target in early 2025.
- Contributors to 2024 growth: recovery in household consumption supported by a persistently strong labor market, restored real purchasing power, and gradual return of the savings rate to normal.
- Offsetting factors for inflation from increased household consumption: decreasing profit margins of producers.
- Fiscal consolidation package: will complement the still tight monetary policy and reduce inflationary pressures with a slightly dampening effect on economic activity.
- Risks:
  - Downside risks to economic growth: uncertainty about domestic wage growth and development of external demand.
  - Upside risks to inflation: inflation expectations becoming unanchored and impact of changes in indirect taxes.

### Monetary policy
- CNB policy actions and history:
  - In the first half of 2020, CNB reduced the key monetary policy rate three times to 0.25 percent in response to the pandemic-induced shock.
  - Between June 2021 and June 2022, CNB increased interest rates nine times, bringing the key monetary policy rate to 7 percent.
  - Inflation peaked at 18.0 percent in September 2022.
  - Inflation fell to 6.9 percent in December 2023 (actually to 4.2 percent if adjusted by a statistical base effect stemming from an administratively driven temporary drop in electricity prices in the last three months of 2022).
- Recent adjustments:
  - CNB started to lower key policy rates later and to a smaller extent than the baseline scenario of its Autumn 2023 forecast.
  - Projections consistent with CNB’s Autumn 2023 forecast imply a decline in interest rates by approximately 0.5 pp from the fourth quarter of 2023 onwards.
  - Bank Board kept rates unchanged in November 2023 given risk of elevated inflation expectations.
  - In December 2023 (after the cut-off date of the staff report), the Bank Board decided to lower the monetary policy rates by 0.25 percent, i.e., less than implied by the baseline scenario.
- Forward guidance and stance:
  - CNB stands ready to adjust the pace of interest rate reduction as necessary to safeguard price stability.
  - Bank Board sees inflationary risks and considers it necessary to persist with a tight monetary policy stance and approach potential further rate cuts with caution.
  - Bank Board expects the interest rate path in coming quarters to be higher than in the baseline scenario of the last forecast.
  - Interest rate reduction process can be paused or terminated at any time at levels that are still restrictive if inflation does not decrease in line with the forecast.
- Staff recommendation: staff supports the data-driven, meeting-by-meeting approach to determine the interest rate path given significant uncertainty surrounding commodity prices, wages, profits and inflation.

### Fiscal policy
- Pre-2020 context: Czech Republic had one of the lowest public debt-to-GDP ratios in the EU and public budget surpluses.
- Since 2020, general government deficits exceeded the EU Stability and Growth Pact benchmark of 3 percent of GDP.
- Deficit developments:
  - In 2020 and 2021, general government deficit exceeded 5 percent of GDP.
  - Fallen to 3.2 percent of GDP in 2022.
  - In 2023, government ran a deficit of CZK 288.5 billion, which was CZK 71.9 billion lower than in 2022 and more favorable than the approved plan.
- Debt criteria: Czech Republic continues to meet the EU Maastricht criterion of 60 percent of GDP for general government debt and the national debt rule.
- Fiscal space: shrinking significantly given additional demands from energy self-sufficiency, population ageing, and transition to a low-carbon economy.
- Government commitments and measures:
  - Committed to significant steps to improve fiscal sustainability in medium and long term; fiscal sustainability is one of highest priorities.
  - Extensive legislative consolidation package legislated by Parliament in December 2023; one-off measures related to high energy prices ended at start of 2024 while consolidation package enters into force.
  - Consolidation package includes an amendment to the national balance rule implying a return to the medium-term budgetary objective at least three years faster than previously anticipated.
  - Pension system: several changes put forward in 2023 making up first part of reform; second part of revision in preparation.
  - Government does not intend to ensure fiscal sustainability by reducing public investment.
- Fiscal Outlook forecast:
  - Gradual reduction of the general government deficit to 1.5 percent of GDP in 2026.
  - Fiscal balance should fall below the Maastricht criterion and the Stability and Growth Pact reference value for excessive deficits already in 2024.
- Key elements of consolidation package:
  - Expenditure side: revision and suspension of costly but untargeted subsidies; tightening payment of unemployment benefits; reduction in central government operational expenditures and public salary costs.
  - Revenue side:
    - Increase in corporate income tax by 2 pp to 21 percent.
    - Reintroduction of the sickness insurance rate for employees.
    - Increase in the real estate tax to approximately 180 percent.
    - Increase in taxation of “vices” (alcohol and tobacco products, gambling).
    - Modest increase in personal income tax for high-income households.
    - Simplification of VAT system, consolidating the two reduced rates into one at 12 percent.
- Timing: package timed in a period of renewed economic recovery to support implementation of consolidation measures.

### Financial policies
- Counter cyclical buffer (CCyB):
  - CNB increased CCyB to the maximum during last expansion.
  - In first half of 2020, CNB lowered CCyB three times from 2 percent to 0.5 percent.
  - Rapid change in financial cycle: CNB increased CCyB three times up to 2 percent over 2021.
  - In March 2022, CCyB increased to maximum rate of 2.5 percent.
  - In 2023, CNB partially released CCyB: lowered from 2.5 percent to 2.25 percent in June and to 2 percent in September 2023.
  - CNB estimates current rate is sufficient to cover additional capital needed to cover unexpected cyclical credit losses and growth in risk weights from adverse developments.
  - Projections consistent with CNB’s Autumn 2023 forecast suggest only a gradual rebound of the financial cycle.
  - Asynchronous CCyB developments compared to other EU countries are explained by different monetary policy timing, previous exuberant cyclical risks, and previous increase to maximum rate.
- Borrower-based measures (BBMs):
  - CNB used recommendations to limit LTV, DTI, and DSTI back in 2015 and 2016.
  - During 2020, CNB eased LTV limits and lifted DTI and DSTI limits in response to the pandemic.
  - As housing and mortgage markets overheated, CNB tightened or reintroduced LTV, DTI and DSTI limits in November 2021 using new legally binding powers.
  - In 2023, with slowdown in cyclical risks:
    - DSTI limits deactivated in June 2023.
    - DTI limits discontinued in November 2023.
    - LTV limits were kept in place.
  - Rationale: mortgage lending to households remained subdued in 2023; house prices declined for first time in years; contribution to systemic risks from new loan production was declining.
  - Ex-post assessment: no major increase in demand for new mortgage loans with high LTV or DTI after DSTI limits lifted.
  - Simulations indicated small difference between default rates and credit losses if other BBMs were deactivated.
  - Projections forecast only a gradual recovery of the mortgage market without potential for systemic risk build-up.
  - Authorities’ view: where new mortgage provision does not contribute to systemic risk build-up, difference between structural and cyclical use of BBMs is insignificant; existing legal condition linking BBM use to identification of systemic risks is not considered sufficient reason for revising the law.
- Corporate foreign currency loans:
  - Share of euro loans in total outstanding domestic banks’ loans to non-financial corporations was close to 50 percent in Q3 2023.
  - For total loans to domestic corporations (including loans from foreign banks and intercompany loans), the figure was even higher.
  - CNB strengthened supervision of foreign currency corporate loans.
  - Risks can be hedged via derivatives or foreign currency revenues, but vulnerabilities can be exacerbated by drops in foreign currency income or downturns in external demand.
  - CNB analysis: additional burden on corporations would not be systemically important per se, but could exacerbate other adverse conditions.
  - CNB stands ready to set a general or sectoral systemic risk buffer if needed to strengthen banking sector resilience.

### Structural reform agenda
- Authorities prioritize addressing carbon dependence and population ageing as risks to long-term prosperity.
- Challenges:
  - Czech industry is strongly energy-intensive and use of fossil fuels in the energy sector is above the EU average, implying potentially higher costs for transitioning to climate neutrality.
  - Ageing population strains sustainability of pension and health care systems despite positive net migration and increasing statutory retirement age.
  - Labor shortages persist; unemployment rate in 2023 remained the lowest in the EU despite subdued economic activity.
- Government reform progress and initiatives:
  - National Development Plan 2023 actions: support green transition (incentives for private investment, support to small and medium-sized enterprises), reduce labor supply-demand mismatches, increase labor force participation (job integration program for disadvantaged persons and support to families with children), and digital transformation.
  - Implementation of the Innovation Strategy aimed to foster change toward higher value-added and less labor-intensive businesses without harming competitiveness.
  - Second part of pension system revision is currently in preparation.

*Statement by Mr. Daniel Palotai, Executive Director for Czech Republic and Ms. Hana Hejlova, Senior Advisor to Executive Director; January 22, 2024*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1czeea2024001.pdf_