## _cr1183

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### Executive summary
- The Czech economy "has weathered the global crisis relatively well, with the recovery underway since mid-2009."
- GDP grew by 2.3 percent in 2010.
- The government formed in mid-2010 outlined a medium-term policy agenda anchored in fiscal consolidation; the deficit was an estimated 4.9 percent of GDP in 2010 (target 5.3 percent of GDP).
- CNB maintained the two-week repo interest rate at the record low level of 0.75 percent after cumulative cuts of 325 basis points between August 2008 and May 2010.
- Banking system is "virtually foreign-owned" and stable; no institution required government support or intervention.
- Credit growth "dropped virtually to zero"; interbank and corporate credit plummeted.
- External debt increased to around 48 percent of GDP, with short-term debt accounting for one quarter.
- Interest cost savings of 0.5 percent of GDP relative to the budgeted amount were achieved through fiscal efforts, interest savings, and the improving economy.
- Recovery drivers: net exports (linked to Germany), inventory rebuilding, and an upturn in private consumption.

### Short-term risks, outlook, and forecast comparisons
- Risks to the short-term outlook are tilted downward:
  - Downside risks: possible sovereign debt distress in the euro area periphery spreading to core Europe; lack of progress on medium-term consolidation in major advanced economies; high commodity prices.
  - Upside possibility: faster improvement in labor market conditions boosting private consumption.
- Staff projections and authorities’ views:
  - IMF staff projects GDP growth of 1.7 percent in 2011; output reaching its pre-crisis level by year-end 2011.
  - Ministry of Finance projects GDP growth of 2.2 percent in 2011.
  - CNB overall growth forecast similar to staff’s assessment.
- Comparison of macroeconomic forecasts (percent):
  - IMF: 1.7 (2011), 2.9 (2012), 2.0 (2011), 2.0 (2012)
  - OECD (November): 2.8 (2011), 3.2 (2012), 1.9 (2011), 1.7 (2012)
  - EC (November): 2.3 (2011), 3.1 (2012), 2.1 (2011), 2.2 (2012)
  - CNB (February): 1.6 (2011), 3.0 (2012), 2.0 (2011), 2.1 (2012)
  - MOF (January): 2.2 (2011), 2.7 (2012), 2.3 (2011), 2.4 (2012)
  - Consensus (February): 2.2 (2011), 3.0 (2012), 2.2 (2011), 2.4 (2012)
- Output gap: negative output gap is forecast to narrow only marginally in 2011; output gap expected to close around 2014.
- Medium-term growth: GDP growth projected to reach around 3 percent beyond 2011.
- Income per capita and productivity are about 1/3 below the average of the EU-15.

### Fiscal challenges, 2011 budget, and medium-term consolidation
- Fiscal position and objectives:
  - Public debt rose by one third since end-2008.
  - Demographic pressures: aging-related fiscal costs projected to increase to almost one-quarter of GDP by 2060.
  - Government medium-term objectives: reduce the general government deficit below the SGP limit of 3 percent in 2013; balance the general government budget by 2016.
- 2011 budget and staff assessment:
  - Staff estimate: general government fiscal deficit will fall by about 1 percentage point of GDP to 3.7 percent of GDP in 2011.
  - Authorities’ deficit target: 4.6 percent of GDP (higher due to conservative interest rate assumptions, lower nominal GDP projections, and worse expected outturn for 2010 at time of budget preparation).
  - Constitutional Court ruling: emergency-approved consolidation measures for 2011 (0.6 percent of GDP) conflict with law; government has until end-2011 to hold another vote.
  - Staff estimate the 2011 budget’s frontloaded adjustment at 1.2 percent of GDP with a limited negative growth impact (0.4 percentage points of GDP in staff estimates).
  - Recommendation: if government fails to secure the necessary vote, identify compensating consolidation measures.
- Staff view on instruments (relative efficiency and impact):
  - Rationalizing entitlements and the generous welfare state is unavoidable for durable fiscal adjustment.
  - More efficient, lower-GDP-impact instruments: reducing general transfers; reducing government consumption; raising VAT revenues (e.g., eliminating the preferential rate); real estate taxes.
  - Less efficient/higher-cost instruments: reducing government investment or increasing payroll taxes.
  - Streamline public institutions and positions to lower wage bill without reducing government wages.
  - Strengthen means-testing to improve targeting of social benefits.

### Pension and health-care reform (EAG and staff assessments)
- Coalition and EAG proposals:
  - Changes to the PAYG; introduction of a voluntary second fully-funded defined contribution pillar; higher VAT rates; unifying VAT rate at 19 percent (EAG proposal).
- EAG second-pillar design:
  - Mandatory participation for those under 40 at launch.
  - Financed by carving out 3 percentage points of pension insurance contributions.
  - Administered by the state; funds managed by asset manager of members’ choice; benefits as life-long annuity.
- Staff assessment of pension proposals:
  - Proposed parametric changes insufficient to close PAYG long-term deficit; gradual rise in retirement age past 65 would cover about 4/5 of the PAYG long-term deficit.
  - Staff recommend further parametric changes, including lower weight on wages in pension-indexation formula, and accelerating increase in retirement age — set it to 65 years in 2020 is recommended.
  - Introduction of a voluntary second pillar will create transition deficits and may erode PAYG balance; voluntary nature likely limits size but long-run pressure may rise if high-wage earners opt out.
  - Some proposed changes would immediately worsen PAYG finances: reduction of assessment ceiling from 6 to 4 times the average wage; proposed voluntary redirection of 1 percentage point of social security contributions by employees to support pensions of their parents.
  - Staff support unification of VAT rates to cover transition costs associated with the second pillar: preferential VAT rate raised to 14 percent in 2012; in 2013 VAT rates to be unified at 17.5 percent (top rate currently at 20 percent).
  - Emphasis: VAT increase needs calibration to cover all pension-reform related costs, including compensation of socially vulnerable groups, to avoid pension-reform induced public debt accumulation.
  - Scope to improve third voluntary pillar: reform regulatory framework to facilitate more diversified asset allocation.

### Fiscal numerical projections (selected figures, percent of GDP)
- Revenues: 40.8 (2010), 41.0 (2011), 40.8 (2012), 40.6 (2013), 40.6 (2014), 40.6 (2015), 40.6 (2016)
- Expenditures: 45.7 (2010), 44.7 (2011), 44.4 (2012), 44.0 (2013), 44.0 (2014), 44.0 (2015), 44.1 (2016)
- Interest Expenditures: 1.2 (2010), 1.4 (2011), 1.7 (2012), 1.9 (2013), 2.0 (2014), 2.1 (2015), 2.1 (2016)
- Overall Balance: -4.9 (2010), -3.7 (2011), -3.6 (2012), -3.5 (2013), -3.4 (2014), -3.5 (2015), -3.5 (2016)
- Structural Balance: -2.8 (2010), -1.6 (2011), -1.7 (2012), -1.6 (2013), -1.6 (2014), -1.7 (2015), -1.7 (2016)
- Primary Budget Balance: -3.7 (2010), -2.4 (2011), -1.9 (2012), -1.6 (2013), -1.4 (2014), -1.4 (2015), -1.4 (2016)
- General Government Debt: 39.6 (2010), 41.7 (2011), 43.4 (2012), 44.5 (2013), 45.6 (2014), 46.5 (2015), 47.6 (2016)

### Monetary policy guidance
- Staff view:
  - Low-interest-rate policy remains appropriate given sizeable negative output gap and ongoing fiscal consolidation.
  - CNB inflation forecast: headline inflation expected to fluctuate close to the 2 percent target.
  - Inflation risks broadly balanced: fiscal consolidation and exchange rate appreciation on downside; rising world commodity and food prices on upside.
  - Recommendation: gradual interest rate increase should begin once the output gap starts to close significantly; a rise in inflation expectations or a faster reduction in labor market slack would require earlier tightening.
  - Markets expect an interest rate hike around mid-year.
  - If significant capital inflows occur and real exchange rate is broadly in line with fundamentals with adequate reserves, appropriate response would be to allow the koruna to appreciate further and—if needed—lower policy interest rates.

### Financial sector stability, structure, and key statistics
- Banking system resilience and ownership:
  - System stable throughout crisis; no bailouts.
  - Foreign banks hold 97 percent of system assets.
  - Three main foreign players own about one half of banking system assets (Erste—Česká spořitelna; KBC—ČSOB; Société Générale—Komerční Banka).
- Credit and asset quality:
  - Credit growth: about 25 percent peak in late 2007 → virtually zero in early 2010 → 2½ percent in October 2010.
  - Credit to private sector stabilized at about 60 percent of GDP.
  - NPLs: about 6½ percent of gross loans by September 2010.
  - NPLs for unsecured consumer loans and credit to non-financial firms: 9 percent (half of it already classified as loss).
  - Mortgages: represent 40 percent of total credit; aggregate Loan to Value for mortgage loans: 42.6 (2005), 41.2 (2006), 45.9 (2007), 46.3 (2008), 56.6 (2009), 55.9 (Sep-10).
- Liquidity and capital:
  - Tier 1 share of own resources: about 85 percent.
  - Liquid assets: about 1/3 of bank balance sheets; liquid assets cover 3/4 of short-term liabilities.
  - Capital adequacy ratios: CAR 15.6 (Sep-10); Regulatory Capital to Risk-Weighted Assets: 11.9 (2005), 11.4 (2006), 11.5 (2007), 12.3 (2008), 14.1 (2009), 15.6 (Sep-10).
  - Return on Assets: 1.4 (2005), 1.2 (2006), 1.3 (2007), 1.2 (2008), 1.5 (2009), 1.4 (Sep-10).
- Funding:
  - Resident retail deposits in local currency account for bulk of liabilities and were broadly unchanged throughout 2010.
  - Reliance on short-term wholesale funding is low.
  - Banks have net external credit position vis-à-vis non-residents.
- Insurance and pension sectors:
  - Insurance: 14 sampled companies account for 90 percent of sector assets; Solvency II implied capital requirement increase: 1½ times.
  - Pension funds: shareholder’s equity recovered from about 1½ percent of assets in mid-2009 to 5½ percent in mid-2010; portfolios under management increased by 12 percent in H1 2010; portfolio composition: around 80 percent bonds, 10 percent bank deposits, 5 percent shares and units.
  - Recommendation: revise pension fund regulations on guaranteed non-negative yearly returns to allow more suitable investment policies.

### Stress tests, supervisory issues, and recommended safeguards
- Stress test conclusions:
  - CNB stress tests indicate banking system can absorb severe adverse shocks without threatening financial stability.
  - Banks’ capital buffers adequate to absorb credit and market losses associated with severe but plausible macroeconomic and financial environments.
  - Direct exposures to euro-area periphery sovereigns not material; banks appear prepared to absorb related losses.
  - CNB reassessed and recalibrated stress test models in 2009; reassessment indicated models erred on conservative side (bank losses overestimated).
- Stress-test outputs (selected figures):
  - Selected variables (2011/2012 values shown): GDP: 2.7 1.6 2.8 -3.3 2.8 -3.3; Exchange rate: 24.6 24 24.6 27.1 24.6 27.1; Inflation: 1.3 2.1 1.3 2.1 1.3 2.1; Unemployment: 9.4 9.9 9.5 11.5 9.5 11.5; Nominal wage growth: 2.9 4.6 2.2 0.5 2.2 0.5; Credit growth: 5.6 7.6 6.3 3.9 6.3 3.9.
  - Estimated Impact / Change in Capital Ratios (p.p.): Estimated Impact: -35 -85 -85; Change in Capital Ratios (p.p.): -0.45 -5.4 -7.2.
  - Average Losses for 2011–12 (CZK billion): 0 0.45 0.77.
  - Estimated Capital Needs (percent of GDP): 0 0 0.
- Cross-border and parent-bank risks:
  - Main risks: further worsening of credit quality under adverse scenario; potential contagion from foreign parent banks.
  - CNB assessment: deterioration of credit quality is slowing; share of NPLs unlikely to reach double digits; intra-group contagion minimized by standalone position of Czech subsidiaries.
  - Staff assessment: risks from parent banks abroad are receding but not ruled out due to challenging EU operating environment and sizeable gross intra-group exposures.
  - Recommendation: continued close monitoring and cross-border supervisory cooperation; ensure prudent profit repatriation to protect capital cushions; incorporate explicit differentiation of exposures vis-à-vis related companies in models.
- Financial safety net and resolution tools:
  - 2009 amendment to the Act on Banks strengthened CNB oversight over liquidity and special powers to impose temporary across-the-board restrictions.
  - Menu of bank-resolution tools widened, including enabling bridge banks and purchase and assumption powers.
  - Payment period for insured deposits cut to twenty days starting in June 2011 (in line with EC directives).
  - Staff suggestion: improve coordination and exchange of information between CNB and deposit insurance agency; involve deposit insurer in war games; consider allowing use of deposit insurance funds for least-cost resolution (authorities did not share this view).
  - Supervisory colleges: CNB participation for seven banking groups involving five home supervisors deemed critical.

### External sector and balance of payments (selected figures)
- Trade and current account (percent of GDP):
  - Trade balance (goods and services): 3.4 (2006), 4.8 (2007), 4.7 (2008), 5.7 (2009), 4.6 (2010), 5.7 (2011), 6.3 (2012)
  - Current account balance: -2.5 (2006), -3.3 (2007), -0.6 (2008), -1.1 (2009), -2.4 (2010), -1.8 (2011), -1.2 (2012)
- Exports and imports (percent of GDP):
  - Exports: 95.1 (2006), 122.7 (2007), 146.2 (2008), 112.6 (2009), 125.8 (2010), 132.7 (2011), 133.6 (2012)
  - Imports: 92.3 (2006), 116.8 (2007), 139.9 (2008), 103.1 (2009), 115.3 (2010), 117.8 (2011), 117.1 (2012)
- External debt and reserves:
  - External debt, percent of GDP: 40.1 (2006), 43.6 (2007), 38.5 (2008), 45.5 (2009), 47.4 (2010), 45.8 (2011), 43.7 (2012)
  - Gross official reserves (US$ billion): 31.5 (2006), 34.9 (2007), 37.0 (2008), 41.6 (2009), 43.7 (2010), 46.2 (2011), 48.7 (2012)
  - Reserve cover (months of imports): 3.6 (2006), 3.2 (2007), 2.8 (2008), 4.1 (2009), 3.8 (2010), 3.9 (2011), 4.1 (2012)
- REER misalignment estimates (2010):
  - Macroeconomic Balance Approach -7%
  - External Sustainability Approach -10%
  - Equilibrium Real Exchange Rate Approach 11%
  - Overall Assessment (Fall 2010) About 0%
  - Overall Assessment (Spring 2010) About 0%

### Public debt sustainability, scenarios, and stress tests
- Baseline public sector debt (percent of GDP): 29.4 (2006), 29.0 (2007), 30.0 (2008), 35.4 (2009), 39.6 (2010), 41.7 (2011), 43.4 (2012), 44.5 (2013), 45.6 (2014), 46.5 (2015), 47.6 (2016)
- Gross financing need (percent of GDP): 7.6 (2006), 5.1 (2007), 6.7 (2008), 10.4 (2009), 9.5 (2010), 8.0 (2011), 8.7 (2012), 8.5 (2013), 8.4 (2014), 8.4 (2015), 8.4 (2016)
  - In US$ billions: 10.8 (2006), 8.9 (2007), 14.6 (2008), 19.8 (2009), 18.3 (2010), 16.8 (2011), 19.8 (2012), 21.1 (2013), 22.7 (2014), 24.6 (2015), 26.8 (2016)
- Stress-test and scenario outcomes:
  - Scenario with key variables at historical averages yields public debt path: 41.7; 44.4; 46.8; 49.2; 51.6; 53.9 (years unspecified in excerpt).
  - No policy change scenario (constant primary balance) yields public debt path: 41.7; 43.8; 45.7; 47.6; 49.6; 51.5 (2011–2016 implied).
- Baseline macro and fiscal assumptions (selected):
  - Real GDP growth: 6.8 (2006), 6.1 (2007), 2.5 (2008), -4.1 (2009), 2.3 (2010), 1.7 (2011), 2.9 (2012), rising to 3.2 by 2016.
  - Average nominal interest rate on public debt (percent): 4.0 (2006), 4.2 (2007), 3.9 (2008), 4.3 (2009), 3.4 (2010), 3.6 (2011), 4.2 (2012), 4.5 (2013), 4.7 (2014), 4.8 (2015), 4.8 (2016)
  - Primary deficit (percent of GDP): 1.5 (2006), -0.5 (2007), 1.6 (2008), 4.5 (2009), 3.7 (2010), 2.4 (2011), 1.9 (2012)

### Data, surveillance, and Fund relations (selected)
- Membership: Joined 1/01/1993; Article VIII.
- Quota and SDRs (SDR Million):
  - Quota: 819.30 (100.0 percent)
  - Fund holdings of currency: 603.98 (73.72 percent)
  - Reserve position in Fund: 215.33 (26.28 percent)
  - Net cumulative allocation (SDR Department): 780.20 (100.00 percent); Holdings: 794.89 (101.88 percent)
- Exchange rate and reserves:
  - Exchange rate (as of January 31, 2011): CZK 17.696 per U.S. dollar.
  - De facto regime: free float.
  - CNB has not engaged in direct interventions in foreign exchange market since 2002.
- Surveillance and consultations:
  - Last Article IV consultation concluded February 22, 2010; staff report and PIN published March 4, 2010.
  - Executive Board assessment (2011 Article IV): staff projection GDP growth 1.7 percent in 2011; output reaching pre-crisis level by year-end 2011; medium-term growth around 3 percent beyond 2011; public debt about 40 percent of GDP in 2010.
- Selected indicators (2006–12 highlights):
  - Real GDP (change in percent): 6.8 (2006), 6.1 (2007), 2.5 (2008), -4.1 (2009), 2.3 (2010), 1.7 (2011), 2.9 (2012)
  - Unemployment rate (percent): 7.1 (2006), 5.3 (2007), 4.4 (2008), 6.7 (2009), 7.3 (2010), 7.1 (2011), 6.9 (2012)
  - General government debt: 29.4 (2006), 29.0 (2007), 30.0 (2008), 35.4 (2009), 39.6 (2010), 41.7 (2011), 43.4 (2012)
  - Broad money (M3, percent change): 12.9 (2006), 16.1 (2007), 13.7 (2008), 0.2 (2009), 1.2 (2010)
  - Private sector credit (percent change, eop): 20.5 (2006), 26.6 (2007), 16.1 (2008), 0.8 (2009), 3.0 (2010)

### Staff recommendations and appraisal — policy priorities
- Fiscal policy:
  - Define additional fiscal consolidation measures beyond 2011, including pension, health care, and social benefits reforms, to support medium-term fiscal targets and preserve market credibility.
  - Continue implementation of medium-term consolidation plans to halt rise in public debt and balance general government budget by 2016.
- Monetary policy:
  - Maintain accommodative monetary policy until the negative output gap narrows considerably, unless a spike in inflation expectations, a substantial widening of interest rate differential against other advanced countries, or a rapid reduction in labor market slack necessitate earlier action.
- Structural reforms:
  - Pursue productivity-enhancing structural reforms: increase labor participation and labor market flexibility; enhance efficiency of higher education, R&D, and the public sector; improve business climate to attract FDI.
- Financial sector surveillance:
  - Continue to monitor banking sector risks from potential further deterioration of credit portfolios and from foreign parent banks; maintain cross-border supervisory cooperation and prudent profit repatriation practices.
- Implementation note:
  - A broad-based consensus is necessary for full and successful implementation and durability of pension and entitlement reforms.

*Source: IMF staff report content unit _cr1183.*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Background and recent developments
- The Czech economy "has weathered the global crisis relatively well, with the recovery underway since mid-2009."
- The government formed in mid-2010 "outlined a comprehensive medium-term policy agenda anchored in fiscal consolidation, which has already yielded credibility gains."
- Monetary policy remains supportive; inflation pressures "were fairly subdued until the recent surge in commodity prices," and "the banking sector is stable."
- GDP grew by 2.3 percent in 2010.
- The Czech National Bank (CNB) "has maintained the two-week repo interest rate at the record low level of 0.75 percent," after cumulative cuts of 325 basis points between August 2008 and May 2010.
- The banking system is "virtually foreign-owned" and "has been stable throughout the crisis." No institution required government support or intervention.
- Credit growth "dropped virtually to zero," with interbank and corporate credit plummeting.
- External debt increased to around 48 percent of GDP, with short-term debt accounting for one quarter.
- Fiscal consolidation commenced in 2010; the deficit was an estimated 4.9 percent of GDP in 2010 compared to the target of 5.3 percent of GDP.
- Fiscal efforts, interest savings, and the improving economy produced interest cost savings of 0.5 percent of GDP relative to the budgeted amount.
- The recovery has been supported by external demand and accommodative monetary policy; net exports led the recovery, followed by inventory rebuilding and an upturn in private consumption.

### Key challenges and risks
- "With large structural deficits and population aging, public debt is on a rising trend."
- Monetary policy faces a trade-off: "climbing world commodity prices" versus "the still nascent recovery."
- Sustaining robust productivity and GDP growth in the long run "requires significant policy efforts" and comprehensive structural reforms.
- Risks to the banking sector include "further deterioration of credit portfolios and from foreign parent banks."
- The recovery is expected to slow in line with developments in the euro area; the negative output gap is forecast to narrow only marginally in 2011.

### Macroeconomic outlook (staff projections and authorities’ views)
- Staff projects GDP growth of 1.7 percent in 2011, with output reaching its pre-crisis level by year-end.
- The Ministry of Finance projects GDP growth of 2.2 percent in 2011.
- Growth drivers: "Net exports—closely linked to growth performance in the main trading partner Germany—and fixed investment are expected to drive growth, while consumption expansion should be modest given slow improvements in unemployment and fiscal consolidation."
- The CNB’s overall growth forecast is similar to staff’s assessment.

### Policy recommendations
- Fiscal policy
  - "Defining additional fiscal consolidation measures beyond 2011—including through pension, health care, and social benefits reforms—to support the government’s medium-term fiscal targets and preserve market credibility."
  - Continue implementation of the government's medium-term consolidation plans to halt the rise in public debt and balance the general government budget by 2016 (as set out in the government's Policy Statement from August 2010).
- Monetary policy
  - "Maintaining accommodative monetary policy until the negative output gap narrows considerably, unless a spike in inflation expectations, a substantial widening of the interest rate differential against other advanced countries, or a rapid reduction in labor market slack necessitate earlier action."
- Structural reforms
  - "Pursuing productivity-enhancing structural reforms to buttress growth."
  - Reform agendas highlighted include pension, health care, and social benefits reforms.
- Financial sector surveillance
  - "Continuing to monitor risks for the banking sector that may arise from further deterioration of credit portfolios and from foreign parent banks."

### Staff mission and authorities’ response
- "The authorities broadly agreed with staff’s assessment of the economic situation and the key policy recommendations."
- The staff team comprising Ms. Murgašová (head), Messrs. Tchaidze and Vázquez (all EUR), and Mr. Klyuev (RES) visited Prague during February 9–21, 2011.
- Mr. Kiekens (Executive Director) and Mr. Kollár (Advisor to the Executive Director) joined the discussions.
- The mission met with Minister of Finance Kalousek, Czech National Bank Governor Singer, other senior officials, as well as representatives of the Parliament, financial and business sectors, academia, and trade unions.

*IMF staff Executive Summary (source document: _cr1183 - EXECUTIVE SUMMARY).*

### 12.      Risks to the short-term outlook are tilted downward. Downside risks arise from the

### _cr1183 - 12.      Risks to the short-term outlook are tilted downward. Downside risks arise from the

### Short-term risks and forecast comparisons
- Risks to the short-term outlook are tilted downward. Downside risks arise from the possibility of sovereign debt distress in the euro area periphery spreading to core Europe and the lack of progress in formulating medium-term fiscal consolidation plans in major advanced economies. This would lead to lower growth in the euro area and in the Czech Republic. High commodity prices present another downside risk. On the upside, faster improvement in labor market conditions could boost private consumption.
- Comparison of Macroeconomic Forecasts (percent) — selected entries:
  - IMF: 1.7 (2011), 2.9 (2012), 2.0 (2011), 2.0 (2012)
  - OECD (November): 2.8 (2011), 3.2 (2012), 1.9 (2011), 1.7 (2012)
  - EC (November): 2.3 (2011), 3.1 (2012), 2.1 (2011), 2.2 (2012)
  - CNB (February): 1.6 (2011), 3.0 (2012), 2.0 (2011), 2.1 (2012)
  - MOF (January): 2.2 (2011), 2.7 (2012), 2.3 (2011), 2.4 (2012)
  - Consensus (February): 2.2 (2011), 3.0 (2012), 2.2 (2011), 2.4 (2012)
- Output is forecast to reach its pre-crisis level by end-2011.

### Medium-term growth prospects and potential
- GDP growth is projected to reach around 3 percent beyond 2011 and output gap is forecast to close around 2014.
- Income per capita and productivity are about 1/3 below the average of the EU-15, implying scope to accelerate growth further.
- Structural reform priorities identified to raise growth:
  - increasing labor participation and labor market flexibility;
  - enhancing efficiency of higher education, R&D, and the public sector;
  - improving the business climate to attract foreign direct investment.

### Fiscal challenges and targets
- The Czech Republic entered the crisis with a structural deficit and a high share of entitlement expenditures; public debt has risen by one third since end-2008.
- Demographic pressures: aging-related fiscal costs projected to increase to almost one-quarter of GDP by 2060.
- Government medium-term fiscal objectives:
  - reduce the general government deficit below the SGP limit of 3 percent in 2013;
  - balance the general government budget by 2016.
- Staff support these objectives as helping reverse the rising trend of debt.

### 2011 budget, consolidation measures, and staff assessment
- The 2011 budget implies significant fiscal consolidation; staff view the largely expenditure-based adjustment as appropriate but note across-the-board cuts may not be efficiency-improving.
- Staff estimate: general government fiscal deficit will fall by about 1 percentage point of GDP to 3.7 percent of GDP in 2011.
- Authorities’ deficit target: 4.6 percent of GDP (higher due to conservative interest rate assumptions, lower nominal GDP projections, and worse expected outturn for 2010 at time of budget preparation).
- Constitutional Court ruling: the procedure of legislative emergency used to approve some consolidation measures for 2011 (0.6 percent of GDP) is in conflict with existing law; government has until end-2011 to hold another vote to keep the legislation in place.
- Staff estimate the 2011 budget’s frontloaded adjustment at 1.2 percent of GDP and that the negative impact on growth in 2011 is likely to be limited (0.4 percentage points of GDP in staff estimates—Appendix III).
- If the government fails to secure the necessary vote to maintain the emergency-approved measures, staff recommend identifying a set of compensating consolidation measures.

### Need for medium-term consolidation strategy and recommended instruments
- Staff urged specification and early implementation of a credible medium-term consolidation package; additional measures beyond 2011 budget need to be implemented.
- Staff research indicates a credible consolidation strategy decreases the output cost of fiscal tightening.
- Staff recommendations on instruments (relative efficiency and impact):
  - Rationalizing entitlements and the generous welfare state is unavoidable for durable fiscal adjustment.
  - Reducing general transfers, reducing government consumption, raising VAT revenues (e.g., eliminating the preferential rate), and real estate taxes are more efficient and have lower negative impact on GDP than reducing government investment or increasing payroll taxes.
  - Streamlining public institutions and positions to lower the overall wage bill without reducing government wages.
  - Strengthening means-testing to improve targeting of social benefits, yield savings, and enhance work incentives.

### Pension and health-care reform plans (Box 1)
- Coalition partners agreed on key elements: changes to the PAYG, introduction of a voluntary second fully-funded defined contribution pillar, and higher VAT rates.
- Staff assessment of pension proposals:
  - The proposed parametric changes will be insufficient to close the PAYG long-term deficit; the plan to continue gradually raising the retirement age past 65 years would cover about 4/5 of the PAYG long-term deficit.
  - Staff recommend further parametric changes, including a lower weight on wages in the pension-indexation formula, and accelerating the increase in the retirement age — setting it to 65 years in 2020 is recommended.
  - Introduction of a voluntary second pillar will erode the PAYG balance by creating transition deficits; voluntary nature likely limits their size, but long-run pressure on PAYG may rise as high-wage earners opt out.
  - Other proposed changes would immediately worsen PAYG finances: reduction of the assessment ceiling from 6 to 4 times the average wage and proposed voluntary redirection of 1 percentage point of social security contributions by employees to support pensions of their parents would worsen PAYG deficits.
  - Staff support unification of VAT rates to cover transition costs associated with the second pillar: preferential VAT rate raised to 14 percent in 2012, and in 2013 VAT rates to be unified at 17.5 percent (top rate currently at 20 percent).
  - Staff emphasize VAT increase needs calibration to cover all pension-reform related costs, including compensation of socially vulnerable groups, to avoid pension-reform induced public debt accumulation.
  - Scope to improve functioning of existing third voluntary pension pillar: reform regulatory framework to facilitate more diversified asset allocation to promote savings.

### Fiscal stance and numerical projections (selected figures)
- Fiscal Stance of the General Government with Unchanged Policies after 2011, ESA-95, 2010-16 (percent of GDP) — selected rows:
  - Revenues: 40.8 (2010), 41.0 (2011), 40.8 (2012), 40.6 (2013), 40.6 (2014), 40.6 (2015), 40.6 (2016)
  - Expenditures: 45.7 (2010), 44.7 (2011), 44.4 (2012), 44.0 (2013), 44.0 (2014), 44.0 (2015), 44.1 (2016)
  - o/w Interest Expenditures: 1.2 (2010), 1.4 (2011), 1.7 (2012), 1.9 (2013), 2.0 (2014), 2.1 (2015), 2.1 (2016)
  - Overall Balance: -4.9 (2010), -3.7 (2011), -3.6 (2012), -3.5 (2013), -3.4 (2014), -3.5 (2015), -3.5 (2016)
  - Structural Balance 1/: -2.8 (2010), -1.6 (2011), -1.7 (2012), -1.6 (2013), -1.6 (2014), -1.7 (2015), -1.7 (2016)
  - Primary Budget Balance: -3.7 (2010), -2.4 (2011), -1.9 (2012), -1.6 (2013), -1.4 (2014), -1.4 (2015), -1.4 (2016)
  - General Government Debt: 39.6 (2010), 41.7 (2011), 43.4 (2012), 44.5 (2013), 45.6 (2014), 46.5 (2015), 47.6 (2016)

### Reinforcing fiscal institutions
- Authorities plan to strengthen fiscal rules, introduce an act on budgetary discipline and responsibility, and create a National Budget Council.
- Staff support these efforts; they emphasize the need for the Council’s autonomy to provide useful independent evaluation of fiscal policies. Authorities expressed concerns about the costs of an independent Council.

### Monetary policy guidance
- Staff: low-interest-rate policy remains appropriate given a sizeable negative output gap and ongoing fiscal consolidation.
- CNB inflation forecast: headline inflation expected to fluctuate close to the 2 percent target.
- Staff view inflation risks as broadly balanced: fiscal consolidation and exchange rate appreciation on the downside; rising world commodity and food prices on the upside.
- Recommendation: a gradual interest rate increase should begin once the output gap starts to close significantly; a rise in inflation expectations or a faster reduction in labor-market slack would require earlier tightening.
- Markets expect an interest rate hike around mid-year.
- In the event of significant capital inflows, with the real exchange rate broadly in line with fundamentals and an adequate amount of reserves, the appropriate policy response would be to allow the koruna to appreciate further, and—if needed—lower policy interest rates.

### Financial sector stability
- Banks’ financial soundness and liquidity indicators are generally robust.
  - Liquidity is comfortable and structurally sound, funding coming mainly from domestic retail deposits.
  - CNB started gradual withdrawal of liquidity-support measures: eliminated the three-month repo facility by end-2010, and extended the two-week repo facility until at least end-2011.
  - Capital adequacy ratios have strengthened on the back of retained earnings; credit quality has deteriorated and put pressure on profitability, which nonetheless remained positive.
  - Prior to dividend payments CNB performs thorough evaluation to ensure capital and liquidity relocation across borders does not impair domestic subsidiaries.
- Comparator Bank Financial Indicators, Sep-2010 (In Percent) — selected entries:
  - Czech Rep.: Non-Performing Loans 6.6, Provisions to NPLs 55.0, Return on Assets 1.4, Capital to Assets 6.6, CAR 15.5
  - Euro Area (unweighted average): Non-Performing Loans 6.6, Provisions to NPLs 53.0, Return on Assets 0.3, Capital to Assets 6.8, CAR 14.7
- Stock of FX Reserves and Reserve Adequacy Metric (RAM): reserves and RAM shown as adequate.

*Source: Czech Statistical Office and IMF staff estimates and forecasts.*

### 24.      The CNB and staff agreed that the main risks for the banks stem from possible

### The CNB and staff agreed that the main risks for the banks stem from possible further worsening of credit quality under an adverse scenario and potential contagion from foreign parent banks

### Risks to banks and supervisory assessment
- Main risks:
  - Possible further worsening of credit quality under an adverse scenario.
  - Potential contagion from foreign parent banks (reputational and financial contagion).
- CNB assessment:
  - Credit quality deterioration is slowing down in line with the macroeconomic recovery.
  - The share of NPLs in total loans is unlikely to reach double digits.
  - Credit to construction, transport, and energy sectors required attention.
  - Intra-group contagion was minimized by the standalone financial position of the Czech subsidiaries, anchored in their domestic retail orientation and their high capital and liquidity buffers.
- Staff assessment:
  - Risks from parent banks abroad are receding but cannot be entirely ruled out because:
    - The operating environment in the EU remains challenging.
    - Some parent bank groups have large exposures to sovereign euro area periphery bonds.
    - Gross intra-group exposures are sizeable.
  - Other risks (liquidity and market risks) were deemed to be relatively less important.
- Recommendation/observation:
  - Continued close monitoring and cross-border supervisory co-operation is required.

### Stress test results and implications
- CNB’s stress tests indicate:
  - The banking system is well prepared to absorb losses of severe adverse shocks without threatening financial stability.
  - Models include assessment of concentration risk in credit portfolios in line with previous staff suggestions.
  - Banks’ capital buffers are adequate to absorb credit and market losses associated with severe but plausible macroeconomic and financial environments, without threatening macro-financial stability.
  - Banks seem well prepared to absorb credit and market losses stemming from a possible sovereign debt crisis in the euro area periphery as their direct exposures were not material.
- Highlighted need:
  - Ensure prudent profit repatriation to protect the capital cushions of domestic banks.
- Staff suggestion and CNB concurrence:
  - Incorporate an explicit differentiation of exposures vis-à-vis related companies in the models to assess potential for intra-group contagion.
- Reference to data and models:
  - The stress test results are reported by CNB and IMF staff calculations (figures and tables in text).
  - Note: "The CNB reassessed and recalibrated its battery of stress test models in 2009. The assessment indicated that the models erred on the conservative side (i.e., bank losses were overestimated)."

### Selected variables and stress-test outputs (as presented)
- Selected Variables (2011/2012 values as listed):
  - GDP: 2.7 1.6 2.8 -3.3 2.8 -3.3
  - Exchange rate: 24.6 24 24.6 27.1 24.6 27.1
  - Inflation: 1.3 2.1 1.3 2.1 1.3 2.1
  - Unemployment: 9.4 9.9 9.5 11.5 9.5 11.5
  - Nominal wage growth: 2.9 4.6 2.2 0.5 2.2 0.5
  - Effective GDP growth in euro area: 2.9 23.2 -0.5 3.2 -0.5
  - Credit growth: 5.6 7.6 6.3 3.9 6.3 3.9
- Estimated Impact / Change in Capital Ratios (p.p.):
  - Estimated Impact: -35 -85 -85
  - Change in Capital Ratios (p.p.): -0.45 -5.4 -7.2
  - Average Losses for 2011–12 (CZK billion): 0 0.45 0.77
  - Estimated Capital Needs (percent of GDP): 0 0 0
- Sources cited in the tables/figures:
  - "Source: CNB and IMF staff calculations."
  - "Source: CNB."

### Building societies and sectoral reform
- Problem:
  - Existing regulations limit building societies to issuance of fixed-rate deposits and providing housing loans, creating significant maturity and duration mismatches and associated interest and liquidity risks.
- Policy action:
  - Reduction of subsidies to depositors of building societies is a step towards reforming the sector.
  - Authorities plan a phased introduction of regulatory changes to:
    - Establish a more level playing field among building societies and commercial banks.
    - Increase efficiency in the provision of the financial service.
    - Release scarce public resources that are needed elsewhere.
- Risks during transition:
  - Need to remain vigilant about risks associated with the stability of deposits of building societies during the transition.

### International regulatory initiatives and domestic impact
- Assessment:
  - The impact of ongoing international regulatory initiatives on the domestic banking system is deemed to be low.
  - Banks seem well prepared to undergo a phased implementation of proposed changes to the liquidity and capital regimes (full impact assessment pending).
- Authorities’ preferences:
  - Prefer incorporating changes into the supervisory review process (as opposed to introduction of hard ratios under pillar 1) to allow increased flexibility.
  - Need to align EC regulations and Basel III proposals to the largest extent possible.
  - Urged careful calibration of regulatory parameters to avoid unwarranted adverse effects on financial intermediation.
  - Supported calculation and disclosure of capital buffers at the level of individual legal entities to protect financial soundness of bank subsidiaries.
  - Saw merit in maintaining flexibility to resolve problem banks at the level of national authorities, cautioning against excessive empowering of home supervisors at the expense of host supervisors.

### Financial safety net, resolution tools, and supervision
- Strengthening measures:
  - CNB established a separate department in charge of macro-financial stability.
  - 2009 amendment to the Act on Banks strengthened CNB’s oversight authority over banks’ liquidity, including special powers to impose temporary across-the-board restrictions on bank activities (covering foreign bank branches) in situations jeopardizing financial stability.
  - Menu of bank-resolution tools widened, including enabling creation of publicly-owned bridge banks and entrusting appointed administrators with powers to carry out purchase and assumption operations.
  - In line with EC directives, the payment period for insured deposits will be cut to twenty days starting in June 2011.
  - Level of bank contributions and the coverage limit were increased in 2010.
- Staff recommendations and observations:
  - Room to improve coordination and exchange of information between the CNB and the deposit insurance agency, including involvement of the latter in war games (acknowledged by authorities).
  - Staff saw merit in allowing use of deposit insurance funds to support bank resolution under a least-cost principle, which was not shared by the authorities.
- Supervisory framework:
  - Prudential and supervisory frameworks are robust.
  - Incipient work of supervisory colleges is critical for effective supervision.
  - CNB participation in supervisory colleges for seven banking groups (involving five home supervisors) is critical to ensure adequate, comprehensive assessment of banks’ risk profiles.
  - Authorities positively assessed the work but noted it is too early to assess effectiveness of some activities.

### Staff appraisal: macro policy priorities and conclusions
- Economic outlook and challenges:
  - The Czech economy has rebounded from the downturn owing to its strong fundamentals and the global recovery, but faces policy challenges:
    - Large structural deficits together with demographic trends are creating fiscal pressures; under unchanged policies would imply a rising public debt burden.
    - Climbing world commodity prices complicate monetary policy amid nascent recovery and low core inflation.
    - Sustaining robust productivity and GDP growth will require significant policy efforts.
- Monetary policy advice:
  - An accommodative monetary policy remains appropriate in the presence of a large negative output gap and fiscal consolidation.
  - Appreciation of the koruna and the sizeable output gap are likely to offset effects of rising commodity prices.
  - A gradual increase in policy interest rates should commence once the output gap starts closing at a significant pace, though a rise in inflation expectations or rapid improvement in labor markets would warrant earlier action.
  - Interest rate differentials against other advanced economies need consideration to avoid sharp changes in capital flows.
- Fiscal and structural reform advice:
  - Wide-ranging structural reforms are needed to buttress growth, focusing on:
    - Increasing labor participation and labor market flexibility.
    - Enhancing efficiency in higher education, R&D, and the public sector.
    - Further improving the business climate.
  - 2011 budget is a welcome further step towards consolidation; largely expenditure-based focus is adequate and should limit negative impact on growth given the openness of the economy.
  - Medium-term fiscal targets are appropriate, but additional reforms need specification and rapid implementation.
    - Balancing the budget by 2016 would reverse the rising trend of public debt.
    - Efforts should focus primarily on reducing the high level of entitlement spending and rationalizing the generous welfare state.
    - Pension reform should ensure long-term sustainability of the PAYG finances and introduce a second pillar without additional accumulation of debt.
    - A broad-based consensus will be necessary for full and successful implementation and durability of these reforms.
- Overall banking-sector conclusion:
  - The banking sector is stable and well supervised, though possible risks (further worsening of credit portfolios and potential contagion from parent banks) warrant close monitoring.

*Source: CNB and IMF staff calculations.*

### 36.      It is recommended that the Article IV consultations with the Czech Republic

### 36.      It is recommended that the Article IV consultations with the Czech Republic

### Short-term indicators of real activity
- Confidence indicators improved (Consumer Confidence Index; Business Confidence Index).
- Economic activity indicators improved: Foreign Industrial New Orders; Retail Trade Volume; Manufacturing Production; Construction Output (3-month moving average shown).
- Capacity utilization and unemployment:
  - Capacity Utilization series shown (2003q1–2010q3).
  - Unemployment Rate, Registered (Ministry of Labour) and Harmonized (Eurostat) shown (percent).
- Labor market:
  - Employment growth and vacancies growth (year-on-year percent change) displayed; reduction in employment and vacancies moderated.
- Inflation and credit:
  - PPI, CPI, Core CPI (year-on-year percent change) shown; headline CPI and PPI inflation picked up, core inflation remains low.
  - Business loans and HH loans (year-on-year percent change) show credit growth rates subdued.
- Summary bullets from figures:
  - "Confidence indicators have improved..."
  - "... and so has economic activity."
  - "While headline CPI and PPI inflation picked up, core inflation remains low."
  - "The credit growth rates are subdued."
  - "Spare capacity and unemployment have declined."

### Financial markets
- Equity and property markets:
  - Stock markets index (January 3, 2007=100) for Germany, USA, Czech Rep., Hungary, Poland shown (2007–2011); equity market remains subdued.
  - Real property prices index (2005Q1=100) for Czech, US, Spain, UK, Hungary, Poland (2003–2010); housing prices gradually decline.
- Yield curve and issuance:
  - Yield curves shown for dates: 6/30/2008; 9/30/2008; 3/18/2009; 12/31/2009; 2/28/2011 — "The yield curve steepened and shifted downward."
  - Corporate (Non-Financial) and Financial sector external bond issuance, 2003–10 (Millions of US dollars) shown; financial entities continued to issue bonds in foreign currency, and so did public entities.
- Exchange rates:
  - Spot Exchange Rate, CZK/US$ and CZK/Euro series (Jan-09 to Jan-11) show movements per market sentiments.
- Summary bullets:
  - "Equity market remains subdued ..."
  - "...while housing prices gradually decline."
  - "The yield curve steepened and shifted downward."
  - "Exchange rates move according to market sentiments."
  - "Financial entities continued to issue bonds in foreign currency..."
  - "... and so did public entities."

### External sector
- Current account and components (4 rolling quarters, percent of GDP; BOP based on "border" methodology):
  - Goods, Services, Income, Current Transfers, Current Account series (2004q1–2010q3).
  - "Current account deficit widened."
- Export profitability:
  - Export margin and Relative profitability of exports series show "Export profitability improved."
- Financial account and external debt:
  - Financial Account components: FDI and Equity, Debt net, Derivatives net, Other net (4 rolling quarters, percent of GDP).
  - External debt, percent of GDP (2001–2010) with breakdown: Government & CNB, Banks Short Term; Banks Long Term; Others Short Term; Others Long Term; Total; Short Term.
  - "Capital flows resumed, but their composition changed."
  - "External debt rose on account of increasing public debt."
- Exchange rate and REER assessments:
  - NEER (Jan. 2007=100), REER-CPI (Jan. 2007=100), CZK/Euro (right scale, inverted) series (Jan-2007–Jan-2011).
  - "Koruna has been following the appreciating trend... but remains broadly in line with fundamentals."
  - Estimates of REER Misalignment, 2010:
    - Macroeconomic Balance Approach -7%
    - External Sustainability Approach -10%
    - Equilibrium Real Exchange Rate Approach 11%
    - Overall Assessment (Fall 2010) About 0%
    - Overall Assessment (Spring 2010) About 0%

### Fiscal developments and prospects
- Fiscal position and debt:
  - Fiscal Position, percent of GDP (2008; 2010) and General government debt comparisons across Czech Republic, Slovak Republic, Hungary, Poland, Germany, Euro area.
  - "The debt level is still relatively low... despite somewhat erratic fiscal policy."
- Cyclically-adjusted primary balance (percent of potential GDP, 2003–2010) shown.
- CDS spreads (basis points) Jan-10 to Jan-11 distribution shown.
- Debt and projections:
  - General Government Debt, Unchanged Policies percent of GDP projected 2008–2016.
  - "Timely start of consolidation helped maintain credibility... and lower the interest bill."
  - "Public debt will continues rising."
- Fiscal balance, unchanged policies (percent of GDP) 2008–2016: "With unchanged policies, deficits will remain elevated ..."
- 10-Year Government Bond Yields (Percent) shown for selected countries (2007–2010).

### Evolution of bank credit
- Credit growth by selected categories (percent) Jan-06–Jan-10:
  - Non-Financial Corporations; Financial Corporations; Households — credit growth dropped substantially.
- Credit growth by currencies (percent) Jan-06–Jan-10:
  - Total Loans in Local Currency; Total Loans in Foreign Currency; Total Loans in euro — decline particularly in foreign currency.
- Short-term credit to NFCs and Households, Percent of corresponding portfolios Jan-06–Jan-10 — short-term maturities declined.
- Composition of loan portfolios, Percent of Total Loans Jan-06–Jan-10:
  - NFCs, Financial Corporations, General Government, Households, Non-residents — composition reshaped.
- Summary bullets:
  - "Credit growth has dropped substantially......particularly in foreign currency,"
  - "...and on short-term maturities..."
  - "...reshaping the composition of credit portfolios."

### Selected financial indicators (banking sector)
- Central bank balances and interbank spreads:
  - Commercial bank balances vis-a-vis the Central Bank (percent of assets) Jan-06–Jan-11: Deposits with Central Bank; Liabilities with Central Bank — liquidity assistance from the CNB is not material.
  - Interbank Bid-Offer Spreads (percentage points) Jan-05–Jan-11 for 1 Day, 30 Days, 90 Days, 1 Year — interbank spreads remain high.
- Lending spreads:
  - Evolution of Lending Spreads on Commercial Loans (percentage points) Jan-05–Jan-11 for Loans < 30 Mil Kr and > 30 Mil Kr — lending spreads on commercial credit are dropping.
  - Lending Spreads on Household Loans (percentage points) Jan-05–Jan-11: Consumer Credit (left-hand scale), Mortgage Credit (right-hand scale) — lending spreads on mortgage credit are dropping.
- Summary bullets:
  - "Liquidity assistance from the CNB is not material..."
  - "...but interbank spreads remain high."
  - "Lending spreads on commercial credit are dropping..."
  - "...as are lending spreads on mortgage credit."

### Public debt sustainability: bound tests and scenarios
- Public debt in percent of GDP (2006–2016) baseline and shocks (figures summarized):
  - Baseline public debt shown as 48 (in figure boxes representing average projections).
  - Individual permanent one-half standard deviation shocks applied: Growth shock, Primary balance (PB) shock, Interest-rate shock; combined shock; contingent liabilities shock; real depreciation (one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occurring in 2010).
  - Historical average and baseline comparisons shown (Historical 54; Baseline 48; etc. across scenarios).
- Key summary values from box notes:
  - Baseline: Primary balance -1.6
  - No policy change scenario (constant primary balance): Scenario: -2.5; Historical: -3.1
  - Baseline: Real GDP growth 3.0; Scenario: 1.4; Historical: 3.2
  - Baseline: Primary balance 2.5; Scenario: 3.3; Historical: 2.3
- Gross financing need under baseline (right scale) plotted.
- Summary bullets:
  - Bound tests illustrate debt dynamics under shocks (growth, PB, interest-rate, combined, contingent liabilities, real depreciation).
  - Scenario outcomes and averages shown for each stress test.

### Selected economic indicators, 2006–12 (Table 1 highlights)
- Real economy (change in percent):
  - Real GDP: 2006 6.8; 2007 6.1; 2008 2.5; 2009 -4.1; 2010 2.3; 2011 1.7; 2012 2.9.
  - Domestic demand: 5.4; 5.2; 1.2; -3.7; 1.1; 1.0; 2.2.
  - CPI (year average): 1.8; 2.5; 2.9; 6.3; 1.0; 1.6; 2.0.
  - PPI (year average): 1.5; 4.1; 4.5; -3.1; 1.3; ...; ...
  - Unemployment rate (percent): 7.1; 5.3; 4.4; 6.7; 7.3; 7.1; 6.9.
- Public finance (percent of GDP):
  - General government revenue: 41.1; 41.8; 40.2; 40.2; 40.8; 41.0; 40.8.
  - General government expenditure: 43.7; 42.5; 42.9; 45.9; 45.7; 44.7; 44.4.
  - Net lending / Overall balance: -2.6; -0.7; -2.7; -5.8; -4.9; -3.7; -3.6.
  - General government debt: 29.4; 29.0; 30.0; 35.4; 39.6; 41.7; 43.4.
- Money and credit (end of year, percent change):
  - Broad money (M3): 12.9; 16.1; 13.7; 0.2; 1.2; ...; ...
  - Private sector credit (percent change, eop): 20.5; 26.6; 16.1; 0.8; 3.0; ...; ...
- Balance of payments (percent of GDP):
  - Trade balance (goods and services)1/: 3.4; 4.8; 4.7; 5.7; 4.6; 5.7; 6.3.
  - Current account balance: -2.5; -3.3; -0.6; -1.1; -2.4; -1.8; -1.2.
  - Gross international reserves (US$ billion): 31.5; 34.9; 37.0; 41.6; 43.7; 46.2; 48.7.
  - Reserve cover (months of imports): 3.6; 3.2; 2.8; 4.1; 3.8; 3.9; 4.1.
- Exchange rate indices:
  - Nominal effective exchange rate (index, 2000=100): 105.2; 108.1; 121.6; 116.3; 118.7; n.a.; n.a.
  - Real effective exchange rate (CPI-based; 2000=100): 105.6; 108.8; 125.5; 120.4; 122.1; n.a.; n.a.

### Balance of payments, 2006–12 (Table 2 highlights)
- Current account and trade:
  - Current account balance (percent of GDP): 2006 -3.6; 2007 -5.7; 2008 -1.3; 2009 -2.1; 2010 -4.7; 2011 -3.7; 2012 -2.7.
  - Trade Balance 1/: 2.8; 5.9; 6.3; 9.5; 10.5; 14.9; 16.5.
  - Exports (percent of GDP): 95.1; 122.7; 146.2; 112.6; 125.8; 132.7; 133.6.
  - Imports (percent of GDP): 92.3; 116.8; 139.9; 103.1; 115.3; 117.8; 117.1.
- Services and income:
  - Nonfactor Services 1/: 2.0; 2.4; 3.9; 1.3; -1.8; -3.0; -2.1.
  - Factor Income (net): -7.5; -12.7; -10.5; -12.2; -13.4; -14.7; -15.8.
- Capital and financial accounts:
  - Capital account: 0.4; 1.0; 1.8; 2.1; 1.8; 2.0; 2.0.
  - Financial account: 4.1; 5.5; 1.2; 2.3; 7.4; 1.6; 0.6.
  - Direct investment, net: 4.0; 9.0; 2.3; 1.4; 5.0; 2.2; 1.7.
  - Portfolio investment, net: -1.1; -2.7; 0.0; 6.0; 8.1; 4.4; 4.4.
- External debt and reserves:
  - Gross official reserves (US$ billion): 31.5; 34.9; 37.0; 41.6; 43.7; 46.2; 48.7.
  - External debt, percent of GDP: 40.1; 43.6; 38.5; 45.5; 47.4; 45.8; 43.7.
- Memorandum:
  - Current account, percent of GDP: -2.5; -3.3; -0.6; -1.1; -2.4; -1.8; -1.2.
  - Trade balance, percent of GDP: 2.0; 3.4; 2.9; 5.0; 5.5; 7.1; 7.3.
  - Foreign direct investment, net, percent of GDP: 2.8; 5.1; 1.0; 0.7; 2.6; 1.1; 0.8.
  - Gross official reserves in months of current year's imports: 3.6; 3.2; 2.8; 4.1; 3.8; 3.9; 4.1.

### Consolidated general government budget, 2006–12 (Table 3 highlights, ESA-95 basis)
- Revenues and expenditure (percent of GDP):
  - Total revenue: 41.4 (2005); 41.1 (2006); 41.8 (2007); 40.2 (2008); 40.2 (2009); 40.8 (2010); 41.0 (2011); 40.8 (2012).
  - Total expenditure: 45.0; 43.7; 42.5; 42.9; 45.9; 45.7; 44.7; 44.4.
- Major components (selected):
  - Personal income tax: 4.6; 4.2; 4.3; 3.7; 3.6; 3.7; 4.0; 3.8.
  - Corporate income tax: 4.5; 4.8; 5.0; 4.2; 3.6; 3.6; 3.6; 3.6.
  - Social contributions: 16.2; 16.3; 16.3; 16.2; 15.4; 15.6; 15.6; 15.6.
  - Interest: 1.2; 1.1; 1.1; 1.1; 1.3; 1.2; 1.4; 1.7.
- Net lending and financing:
  - Net lending: -3.6; -2.6; -0.7; -2.7; -5.8; -4.9; -3.7; -3.6.
  - Financing: 3.6; 2.6; 0.7; 2.7; 5.8; 4.9; 3.7; 3.6.
- Memorandum:
  - General government debt: 29.7; 29.4; 29.0; 30.0; 35.4; 39.6; 41.7; 43.4.
  - Primary balance: -2.4; -1.5; 0.5; -1.6; -4.5; -3.7; -2.4; -1.9.
  - Cyclically adjusted balance 4/: -3.5; -2.7; -1.2; -3.1; -4.2; -3.8; -2.8; -3.0.
  - Output gap 4/: -0.2; 0.2; 1.6; 1.3; -4.1; -3.0; -2.7; -1.6.

### Medium-term macroeconomic scenario, 2005–16 (Table 4 highlights)
- Real sector (change, percent):
  - Real GDP (2005–2016): 6.3; 6.8; 6.1; 2.5; -4.1; 2.3; 1.7; 2.9; 2.9; 3.0; 3.1; 3.2.
  - Private consumption, public consumption, investment, exports, imports, contributions of net exports and inventories provided.
- CPI inflation and GDP deflator:
  - CPI inflation series (2005–2016): 1.8; 2.5; 2.9; 6.3; 1.0; 1.6; 2.0; 2.0; 2.0; 2.0; 2.0; 2.0.
  - GDP deflator series (2005–2016) include negative and positive values (e.g., 2009 -1.1; 2010 2.6).
- Unemployment (percent of labor force):
  - 2005 7.9; 2006 7.1; 2007 5.3; 2008 4.4; 2009 6.7; 2010 7.3; 2011 7.1; 2012 6.9; 2013 6.5; 2014 6.5; 2015 6.5; 2016 6.5.
- Public finances (percent of GDP):
  - Revenues and expenditures series (2005–2016) indicate net lending and cyclically-adjusted deficits; general government debt rising to 47.6 by 2016 under baseline.
- Balance of payments projections:
  - Current account balance, trade balance, services balance, net factor income, capital and financial account balances projected through 2016.
  - Change in reserves (- increase) projected (2007 -0.1; 2008 -0.5; 2009 -0.5; 2010 -1.6; 2011 -1.1; 2012 -1.2; etc.).

### Selected bank financial soundness indicators, 2005–Sep-2010 (Table 5 highlights)
- Solvency:
  - Regulatory Capital to Risk-Weighted Assets: 11.9 (2005); 11.4 (2006); 11.5 (2007); 12.3 (2008); 14.1 (2009); 15.6 (Sep-10).
  - Tier 1 Capital Adequacy: 11.3; 10.0; 10.3; 11.7; 12.7; 14.2.
  - Leverage Ratio 1/: 13.4; 13.5; 14.6; 13.8; 12.8; 12.5.
- Profitability:
  - Return on Assets: 1.4; 1.2; 1.3; 1.2; 1.5; 1.4.
  - Return on Equity: 25.3; 22.5; 24.4; 21.7; 25.8; 23.1.
- Liquidity:
  - Liquid Assets to Total Assets: 32.8; 30.4; 24.0; 23.1; 25.3; 28.1.
  - Liquid Assets to Deposits: 50.5; 45.5; 36.5; 36.5; 38.0; 41.3.
  - Loans to Deposits: 60.8; 67.7; 73.8; 79.1; 75.5; 73.0.
- Asset quality:
  - Sectoral breakdown of loans (percent): Non-financial Corporations 44.6; 44.9; 41.7; 40.9; 37.2; 36.3. Households 32.2; 35.0; 37.5; 38.9; 42.7; 44.3.
  - Non-Performing Loans to Gross Loans: 3.9; 3.7; 2.8; 3.3; 5.4; 6.6.
  - Loan Loss Provisions to Non-Performing Loans: 64.5; 61.3; 70.2; 67.4; 56.9; 55.0.
  - Aggregate Loan to Value for Mortgage Loans: 42.6; 41.2; 45.9; 46.3; 56.6; 55.9.
- Memorandum items:
  - Financial Sector Assets to GDP: 127.0; 127.5; 136.9; 144.3; 149.5; ...
  - Banking Sector Assets to GDP: 99.0; 97.8; 106.1; 109.6; 112.9; ...

### Financial indicators of non-financial corporations and households, 2005–Sep-2010 (Table 6 highlights)
- Non-Bank Financial Corporations:
  - Share in Financial Sector Assets: 25.9; 26.7; 25.8; 25.0; 22.8; ...
  - Total Premiums to GDP: 3.9; 3.8; 3.8; 3.8; 4.0; 4.2.
  - Return on Equity of Insurance Companies and Pension Funds and other indicators listed.
- Non-Financial Corporations:
  - Return on Equity: 9.2; 10.2; 11.2; 9.4; 8.8; ...
  - Debt to Total Liabilities: 44.7; 45.7; 47.1; 47.3; 46.8; ...
  - Debt to GDP: 44.0; 43.2; 42.2; 46.1; 45.8; 45.8.
  - Loans from Czech Banks to GDP: 17.6; 19.7; 21.0; 23.0; 21.6; 21.2.
  - Average 12M Default Rate of Corporations: 1.5; 1.7; 2.1; 3.5; 6.5; 5.6.
- Households:
  - Debt to gross disposable income: 34.0; 40.3; 48.1; 52.1; 54.3; ...
  - Debt to financial assets: 22.9; 26.3; 30.6; 33.4; 36.6; 33.3.
  - Debt to GDP: 17.6; 20.4; 24.5; 27.5; 29.7; 30.3.
  - Loans from Czech Banks to GDP: 12.7; 15.4; 18.9; 21.9; 24.8; 25.9.
  - Average 12M Default Rate of Households (2010 preliminary): 3.3; 4.8; 5.0 for recent periods.
- Real estate market memorandum:
  - Growth in Residential Property Prices 2/: 5.98; 10.50; 18.30; 8.90; -8.00; ...
  - Growth of Apartment Prices 3/: 0.2; 13.4; 23.2; 19.6; -8.8; -3.3.
  - Apartment Price to Average Annual Wages and Apartment Prices to Rent series provided.

### Public sector debt sustainability framework, 2006–16 (Table 7 highlights)
- Baseline public sector debt (percent of GDP): 29.4 (2006); 29.0 (2007); 30.0 (2008); 35.4 (2009); 39.6 (2010); 41.7 (2011); 43.4 (2012); 44.5 (2013); 45.6 (2014); 46.5 (2015); 47.6 (2016).
- Foreign-currency denominated share (percent): 3.4; 3.2; 2.6; 4.2; 5.7; 6.3; 6.6; 6.8; 7.0; 7.2; 7.3.
- Change in public sector debt (percent of GDP): -0.2; -0.5; 1.0; 5.4; 4.2; 2.1; 1.7; 1.2; 1.0; 1.0; 1.0.
- Identified debt-creating flows (4+7+12): -1.7; -2.9; 3.3; 5.5; 4.0; 1.8; 1.6; 1.5; 1.1; 1.0; 1.0.
- Primary deficit (percent of GDP): 1.5; -0.5; 1.6; 4.5; 3.7; 2.4; 1.9; 1.6; 1.4; 1.4; 1.4.
- Automatic debt dynamics contribution: -1.4; -1.9; 0.1; 1.6; 1.0; -0.3; -0.3; -0.3; -0.2; -0.2; -0.2.
- Gross financing need 6/ (percent of GDP): 7.6; 5.1; 6.7; 10.4; 9.5; 8.0; 8.7; 8.5; 8.4; 8.4; 8.4.
  - In billions of U.S. dollars: 10.8; 8.9; 14.6; 19.8; 18.3; 16.8; 19.8; 21.1; 22.7; 24.6; 26.8.
- Scenarios:
  - Scenario with key variables at their historical averages 7/ yields public debt path: 41.7; 44.4; 46.8; 49.2; 51.6; 53.9.
  - Scenario with no policy change (constant primary balance) in 2011-2016 yields: 41.7; 43.8; 45.7; 47.6; 49.6; 51.5.
- Key macro and fiscal assumptions underlying baseline:
  - Real GDP growth (percent): 2006 6.8; 2007 6.1; 2008 2.5; 2009 -4.1; 2010 2.3; 2011 1.7; 2012 2.9; thereafter up to 3.2 by 2016.
  - Average nominal interest rate on public debt (percent) 8/: 4.0; 4.2; 3.9; 4.3; 3.4; 3.6; 4.2; 4.5; 4.7; 4.8; 4.8.
  - Average real interest rate (nominal rate minus change in GDP deflator, percent): 2.9; 0.8; 2.0; 1.7; 4.5; 1.0; 2.1; 2.3; 2.5; 2.8; 2.8.
  - Inflation rate (GDP deflator, percent): 1.1; 3.4; 1.8; 2.5; -1.1; 2.6; 2.1; 2.2; 2.1; 2.0; 2.0.
  - Growth of real primary spending (deflated by GDP deflator, percent): 3.9; 3.0; 3.6; 2.3; 2.0; -0.9; 1.5; 1.5; 2.5; 3.0; 3.3.
  - Primary deficit (percent of GDP) as above.

*IMF staff report content unit _cr1183 - 36.*

### Appendix I. Resilience of the Czech Financial Sector

### Appendix I. Resilience of the Czech Financial Sector

### Banking system — stability and structure
- The banking system has been stable throughout the global financial crisis; no institution had to be intervened or bailed out.
- Resilience drivers:
  - Conservative, inward retail orientation of domestic banks.
  - Prevalence of lending in domestic currency.
  - Strong liquidity and funding profiles.
  - Provision of emergency liquidity by the ECB and support to troubled parent banks by their home governments helped shield Czech subsidiaries from induced financial distress.
- Ownership and market share:
  - Foreign banks continue holding 97 percent of system assets.
  - The three main foreign players own about a half of banking system assets (Erste—Česká spořitelna, KBC—ČSOB, Société Générale—Komerční Banka).
- Credit dynamics:
  - Credit growth dropped from about 25 percent peak in late 2007 to virtually zero in early 2010, before recovering to 2½ percent in October 2010.
  - Credit to the private sector stabilized at about 60 percent of GDP.
  - End of rapid credit growth creates vulnerability as loan vintages mature during downturns.
- Credit composition and trends:
  - Credit to households accounts for over half of total stock of credit and remained relatively robust, particularly mortgages.
  - Interbank credit was severely curtailed.
  - Credit to non-financial firms plummeted due to weak loan demand and tightening credit standards.
  - Bank intermediation spreads widened at the peak of the crisis and have been slowly normalizing, particularly for commercial and mortgage lending.
  - Drop in lending rates did not fully transmit the monetary policy easing.

### Banking system — asset quality, liquidity, and capital
- Non-performing loans (NPLs):
  - NPLs increased to about 6½ percent of gross loans by September 2010.
  - NPLs vary substantially among groups of banks and credit types.
  - Across credit types:
    - Unsecured consumer loans and credit to non-financial firms have higher NPLs at 9 percent (half of it already classified as loss).
    - Mortgages represent 40 percent of total credit and have shown better credit quality due to conservative loan-to-value ratios, moderate household debt, and relatively resilient house prices.
- Deposits and liquidity:
  - Resident retail deposits in local currency account for the bulk of bank liabilities and were broadly unchanged throughout 2010.
  - Authorities stepped up liquidity monitoring and strengthened emergency liquidity facilities; some banks called upon these mainly at the peak of turmoil.
  - Normalization of liquidity conditions allowed gradual withdrawal of liquidity support measures.
- Financial soundness indicators:
  - Capital adequacy ratios increased due to retained earnings; all banks display solvency ratios above 10 percent.
  - Tier 1 components account for about 85 percent of banks’ own resources.
  - Liquid assets account for about 1/3 of bank balance sheets and cover 3/4 of short-term liabilities.
  - Retail deposits fully cover the non-interbank loan portfolio.
  - Reliance on short-term wholesale funding is low.
  - The banking system has a net external credit position vis-à-vis non-residents, including foreign credit institutions.
  - Despite increasing loan-loss provisions, banks’ profits remained positive, helped by one-off gains from securities sales.

### Parent banks and cross-border considerations
- Financial situation of parent banks abroad:
  - Gradually improving but underlying fragilities persist.
  - Parent banks’ solvency has not fully recovered due to weak macroeconomic environment in core Europe and market perceptions of sovereign risk in the EU periphery.
  - Parent banks that relied on government assistance have stabilized and continue implementing EC-approved restructuring plans (run-down of non-core businesses and financial deleveraging).
  - Some subsidiaries have been repatriating profits after CNB evaluation ensuring cross-border capital and liquidity moves do not impair domestic subsidiaries.

### Non-bank financial sector — insurance
- Insurance industry:
  - Stable and well prepared to transit into Solvency II framework.
  - Insurance premiums and total assets have resumed gradual increase.
  - Unrealized losses from marked-to-market portfolios have been partially reversed.
  - Authorization to apply amortized-cost valuation to a large proportion of government bond portfolios held to maturity provided further relief.
  - Preparations for Solvency II implementation scheduled to start in 2013 continue as planned.
  - Impact assessments indicate all 14 sampled insurance companies (accounting for 90 percent of insurance sector’s assets) are well positioned to transit into the new regime, entailing a 1½ times increase in current capital requirements.

### Non-bank financial sector — pension funds
- Pension funds recovery:
  - Marked-to-market valuation losses have been fully reversed alongside rebound in financial markets.
  - Shareholder’s equity recovered from about 1½ percent of assets in mid-2009 to 5½ percent in mid-2010.
  - Total value of portfolios under management increased by 12 percent in the first half of 2010 (valuation gains and strong net contributions).
  - Portfolio composition remained conservative: around 80 percent in bonds (mainly domestic sovereign), 10 percent in bank deposits, and 5 percent in shares and units.
- Policy recommendation:
  - Revise pension fund regulations on guaranteed non-negative yearly returns to allow investment policies more commensurate with long-term horizons, which could help promote private savings.

### Key statistics (selected from text and tables)
- Credit growth: about 25 percent peak in late 2007 → virtually zero in early 2010 → 2½ percent in October 2010.
- Credit to private sector: about 60 percent of GDP.
- NPLs: about 6½ percent of gross loans by September 2010.
- NPLs for unsecured consumer loans and credit to non-financial firms: 9 percent (half already classified as loss).
- Mortgages share of total credit: 40 percent.
- Foreign banks’ share of system assets: 97 percent.
- Tier 1 share of own resources: about 85 percent.
- Liquid assets share of balance sheets: about 1/3.
- Liquid assets cover of short-term liabilities: 3/4.
- Insurance sector sample: 14 companies covering 90 percent of sector assets; Solvency II implied capital requirement increase: 1½ times.
- Pension funds: shareholder’s equity 1½ percent of assets in mid-2009 → 5½ percent in mid-2010; portfolios under management increased by 12 percent in H1 2010.
- Deposits in foreign currency and non-resident deposit dynamics (selected table entries preserved in narrative context): resident retail deposits broadly unchanged in 2010.

*Source: _cr1183 - Appendix I. Resilience of the Czech Financial Sector*

### Appendix IV. Pension System Reform Options—Expert Advisory Group Proposal

### Appendix IV. Pension System Reform Options—Expert Advisory Group Proposal

### Current system and fiscal outlook
- The Czech pension system currently has two pillars: a mandatory, state-run universal defined-benefit PAYG (first pillar) and a voluntary private subsidized supplement (third pillar).
- The PAYG scheme is financed by social security contributions.
- The PAYG pillar is projected to run deficits on the order of half a percent of GDP over the next decade.
- Owing to impending demographic changes, PAYG deficits are expected to surge around 2030 and reach a new plateau of 4 percent of GDP by 2055.
- The supplementary scheme enjoys a high participation rate but has a rather small size in terms of accumulated assets; participants appear focused on maximizing state contributions rather than building up savings for retirement.

### Expert Advisory Group (EAG) reform package — overview
- The EAG recommended a package of reforms combining:
  - Measures to contain PAYG deficits.
  - Introduction of a fully-funded, defined-contribution second pillar.
  - A partial substitution of VAT for payroll taxes as a source of PAYG financing.
- Under the EAG’s projections, the proposed changes will bring the PAYG pillar into balance by around 2075 (i.e., once the transition is over).

### Second-pillar design (fully-funded, defined-contribution)
- The second pillar would be relatively small and would supplement rather than replace the PAYG pillar, which would remain the mainstay of the Czech pension system.
- Participation rules:
  - Participation in the second pillar would be mandatory for those under 40 at the time the scheme is launched.
- Financing:
  - The second pillar would be financed by carving out 3 percentage points of the pension insurance contributions for the second pillar.
- Administration and benefits:
  - The scheme would be administered by the state, but the funds would be managed by an asset manager of members’ choice.
  - Benefits would be paid out upon retirement in the form of life-long annuity.

### Parametric changes to improve PAYG sustainability
- Unifying retirement ages for men and women by 2035.
- Increasing the retirement age by 2 months per year henceforth.
- Linking growth in pension benefits to CPI inflation.
  - Current indexing (existing policy) is: indexed to 2/3 CPI inflation plus 1/3 of nominal wage growth, with the government having discretion to grant increases above, but not below those suggested by the formula.
- Abolishing life-long widow or widower payments for new pensioners.

### Fiscal and tax measures
- The EAG proposed reducing social security contributions from 28 to 23 percent.
- The EAG proposed unifying the VAT rate at 19 percent.
- The change was meant to be broadly revenue-neutral and aimed at increasing the efficiency of the economy.

*Source: Expert Advisory Group.*

### Appendix I. Czech Republic: Fund Relations

### Appendix I. Czech Republic: Fund Relations

### I. Membership status and Fund financial position
- Membership: Joined 1/01/1993; Article VIII.
- General Resources Account (SDR Million):
  - Quota: 819.30 (100.0 percent)
  - Fund holdings of currency: 603.98 (73.72 percent)
  - Reserve position in Fund: 215.33 (26.28 percent)
  - Lending to the Fund: 89.50
- SDR Department (SDR Million):
  - Net cumulative allocation: 780.20 (100.00 percent)
  - Holdings: 794.89 (101.88 percent)
- Outstanding purchases and loans: None.
- Financial arrangements:
  - Stand-by: Approval Date 3/17/1993; Expiration Date 3/16/1994; Approved (SDR Million) 177.00; Drawn (SDR Million) 70.00.
- Projected payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Charges/Interest: 2011 0.01; 2012 0.01; 2013 0.01; 2014 0.01; 2015 0.01.
  - Principal: Forthcoming (no numeric principal amounts specified).
  - Total: 2011 0.01; 2012 0.01; 2013 0.01; 2014 0.01; 2015 0.01.

### II. Exchange rate arrangement and external position
- Currency: Czech koruna (created February 8, 1993).
- Historical regime:
  - May 3, 1993 to May 27, 1997: pegged to a basket — deutsche mark (65 percent) and U.S. dollar (35 percent).
  - February 28, 1996: exchange rate band widened from ±0.5 percent to ±7.5 percent around the central rate.
  - May 27, 1997: managed floating introduced.
- De facto regime: Classified as a free float in the Annual Report on Exchange Arrangements and Exchange Restrictions.
- CNB interventions: Since 2002, CNB has not engaged in direct interventions in the foreign exchange market.
- Factors affecting international reserves: off-market purchases of large privatization receipts and EU transfers and the sales of the accumulated interest.
- Exchange rate (as of January 31, 2011): CZK 17.696 per U.S. dollar.
- Article VIII: Czech Republic has accepted the obligations of Article VIII and maintains an exchange system free of restrictions on payments and transfers for current international transactions.
- Exchange restrictions: Maintained for security reasons, based on UN Security Council Resolutions and Council of the European Union Regulations; notified to the Fund per Executive Board Decision No. 144-(52/51).

### III. Surveillance, consultations, and Executive Board assessment
- Last Article IV consultation concluded: February 22, 2010. Staff report and PIN published: March 4, 2010.
- FSAP and ROSCs:
  - FSAP carried out in late 2000/early 2001.
  - Financial System Stability Assessment considered by Executive Board on July 16, 2001.
  - ROSCs published July 1, 2000 on: banking supervision; data dissemination; fiscal transparency; securities market; transparency of monetary and financial policies.
- Executive Board (2011 Article IV consultation; PIN No. 11/45, April 7, 2011) — key points and staff projections:
  - Background: Economy recovered owing to strong fundamentals and global recovery. Overall GDP grew by 2.3 percent in 2010.
  - Staff projection: GDP growth of 1.7 percent in 2011; output reaching pre-crisis level by year-end 2011.
  - Medium-term growth: Expected to reach around 3 percent beyond 2011; output gap forecast to close around 2014.
  - Fiscal outcomes: 2010 deficit estimated at 4.9 percent of GDP (from 5.8 percent in 2009); general government debt about 40 percent of GDP.
  - Inflation and monetary policy: Headline CPI largely below 2 percent since mid-2010; recent pressures from regulated prices, indirect tax hikes, and global commodity prices; CNB maintained policy interest rates at record low levels.
  - Banking sector: Virtually foreign-owned; liquidity comfortable; capital adequacy strengthened; main risks from credit quality under adverse scenarios and potential contagion from foreign parent banks; CNB stress tests indicate system can absorb severe shocks without threatening financial stability.
- Executive Directors’ assessment — summary of endorsed staff appraisal:
  - Challenges: Large structural deficits, demographic trends creating fiscal pressures; rising world commodity prices complicate monetary policy; need for significant policy efforts to sustain productivity and GDP growth.
  - Monetary policy guidance: Accommodative policy remains appropriate given large negative output gap and fiscal consolidation. Gradual increase in policy interest rates should commence once output gap starts closing significantly; earlier action warranted if inflation expectations rise or labor markets improve rapidly. Interest rate differentials with other advanced economies should be considered to avoid sharp capital flow changes.
  - Structural reforms needed: Increase labor participation and labor market flexibility; enhance efficiency in higher education, research and development, and the public sector; improve the business climate.
  - Fiscal policy: 2011 budget is a further step toward consolidation; medium-term target to balance the budget by 2016 is appropriate to reverse rising public debt. Additional reforms needed to reduce entitlement spending, rationalize the welfare state, and ensure pension reform sustainability with a second pillar introduced without additional accumulation of debt. Broad-based consensus required for implementation.
  - Financial sector monitoring: Banking sector stable and well supervised, but close monitoring and cross-border supervisory cooperation remain necessary.

### IV. Selected economic indicators (2006–12; as reported)
- Real economy (change in percent):
  - Real GDP: 2006 6.8; 2007 6.1; 2008 2.5; 2009 -4.1; 2010 2.3; 2011 (Staff Proj.) 1.7; 2012 2.9.
  - Domestic demand: 2006 5.4; 2007 5.2; 2008 1.2; 2009 -3.7; 2010 2.6; 2011 1.0; 2012 2.2.
  - CPI (year average): 2006 2.5; 2007 2.9; 2008 6.3; 2009 1.0; 2010 1.6; 2011 2.0; 2012 2.0.
  - PPI (year average): 2006 1.5; 2007 4.1; 2008 4.5; 2009 -3.1; 2010 1.3.
  - Unemployment rate (in percent): 2006 7.1; 2007 5.3; 2008 4.4; 2009 6.7; 2010 7.3; 2011 7.1; 2012 6.9.
- Savings and investment (percent of GDP):
  - Gross national savings: 2006 24.3; 2007 23.7; 2008 24.7; 2009 20.6; 2010 19.9; 2011 20.7; 2012 20.9.
  - Gross domestic investments: 2006 26.8; 2007 27.0; 2008 25.3; 2009 21.7; 2010 22.3; 2011 22.4; 2012 22.1.
- Public finance (percent of GDP):
  - General government revenue: 2006 41.1; 2007 41.8; 2008 40.2; 2009 40.2; 2010 40.8; 2011 41.0; 2012 40.8.
  - General government expenditure: 2006 43.7; 2007 42.5; 2008 42.9; 2009 45.9; 2010 45.7; 2011 44.7; 2012 44.4.
  - Net lending / Overall balance: 2006 -2.6; 2007 -0.7; 2008 -2.7; 2009 -5.8; 2010 -4.9; 2011 -3.7; 2012 -3.6.
  - General government debt: 2006 29.4; 2007 29.0; 2008 30.0; 2009 35.4; 2010 39.6; 2011 41.7; 2012 43.4.
- Money and credit (end of year, percent change):
  - Broad money (M3): 2006 12.9; 2007 16.1; 2008 13.7; 2009 0.2; 2010 1.2.
  - Private sector credit (percent change, eop): 2006 20.5; 2007 26.6; 2008 16.1; 2009 0.8; 2010 3.0.
- Interest rates (in percent, year average):
  - Three-month interbank rate: 2006 2.3; 2007 3.1; 2008 4.0; 2009 2.2; 2010 1.3.
  - Ten-year government bond: 2006 3.8; 2007 4.3; 2008 4.6; 2009 4.7; 2010 3.7.
- Balance of payments (percent of GDP):
  - Trade balance (goods and services): 2006 3.4; 2007 4.8; 2008 4.7; 2009 5.7; 2010 4.6; 2011 5.7; 2012 6.3.
  - Current account balance: 2006 -2.5; 2007 -3.3; 2008 -0.6; 2009 -1.1; 2010 -2.4; 2011 -1.8; 2012 -1.2.
- Reserves and exchange rates:
  - Gross international reserves (US$ billion): 2006 31.5; 2007 34.9; 2008 37.0; 2009 41.6; 2010 43.7; 2011 46.2; 2012 48.7.
  - Reserve cover (in months of imports of goods and services): 2006 3.6; 2007 3.2; 2008 2.8; 2009 4.1; 2010 3.8; 2011 3.9; 2012 4.1.
  - Nominal effective exchange rate (index, 2000=100): 2006 105.2; 2007 108.1; 2008 121.6; 2009 116.3; 2010 118.7.
  - Real effective exchange rate (index, CPI-based; 2000=100): 2006 105.6; 2007 108.8; 2008 125.5; 2009 120.4; 2010 122.1.

### V. Statistical issues, data dissemination, and data adequacy
- Data dissemination: Czech Republic subscribed to the Special Data Dissemination Standard in April 1998; metadata and annual observance reports for 2006-9 are posted on the Fund’s Dissemination Standards Bulletin Board.
- Timeliness and frequency (selected):
  - Exchange rates and interest rates: reported daily with no lag.
  - Gross and net international reserves: monthly with a one-week lag; also on a 10-day basis (with CNB’s balance sheet) with a one-week lag.
  - Consumer prices, reserve money, broad money, borrowing and lending interest rates, central government fiscal accounts, and foreign trade: monthly with a lag of between one and four weeks.
  - Final monetary survey data: lag of about one month.
  - GDP and balance of payments: quarterly with a lag of two to three months; main components of balance of payments also available monthly since 2003.
  - Annual Government Finance Statistics Yearbook: covers all operations of general government including extrabudgetary funds excluded from monthly data; annual data timely.
  - Monthly fiscal data in IFS: cover state budget accounts with two- to three-month lag.
- Data quality and remaining deficiencies:
  - National accounts: Value added in the small-scale private sector likely underestimated; significant unrecorded activity stems from tax evasion. Large discrepancies between production and expenditure-based GDP estimates are subsumed under change in stocks. Quarterly estimates subject to bias from nonresponse and lumping; large quarter-to-quarter swings hamper business cycle analysis.
  - External trade statistics: Revisions brought practices close to EU standards; weakness remains in unavailability of fixed base price indices for exports and imports (indices presented on basis of same month of previous year).
  - Monetary statistics: Generally adequate for policy purposes; large variations in interbank clearing account float, especially year-end, require caution. In 2002 CNB implemented ECB framework for collecting, compiling, and reporting monetary data; IFS monetary accounts based on ECB framework and harmonized with CNB publications.
  - Fiscal statistics: Annual fiscal data on ESA-95 basis prepared by Czech Statistical Office. Quarterly non-financial accounts compiled; quarterly financial accounts being prepared. ESA-95 differs from national fiscal targeting methodology in institutional coverage and inclusion of financial transactions and accrual items. Ministry of Finance participated in Fund’s pilot project to transition to GFSM 2001 methodologies.

### VI. Technical assistance and capacity building (1991–2010)
- Technical assistance provided by IMF departments (high-level summary of timing and purpose):
  - FAD (Dec. 1991–Sept. 1993; multiple missions through June–July 1999): Regular visits and follow-up visits on VAT administration; public financial management; medium-term fiscal framework.
  - MCM (February 1992; June 1992; July 1992; Dec. 1992 and Feb. 1993; Nov. 1993; Apr. 1994; Jan. 1995; May 1995; May 1996; Apr. 1997; Feb.–June 1999; June 1999): Monetary management and research, foreign exchange operations, banking supervision, monetary research, long-term resident expert assignment in banking supervision, bond issuance and monetary management, data management, foreign exchange laws (jointly with LEG), banking system reform, monetary research––inflation targeting, integrated financial sector supervision (with WB).
  - RES (September 1999; June–August 2000; February–March 2005): Inflation targeting (financed by MFD).
  - STA (May 1993; Feb. 1994; Apr. 1994; Nov. 1994; Jan.–Feb. 1999; May 2002; Feb. 2003; Nov. 2006): Money and banking statistics; balance of payments; government finance; monetary and financial statistics; implementing GFSM 2001; GFSM 2001 Pilot Project.

*Appendix I. Czech Republic: Fund Relations (As of January 31, 2011) and accompanying material from the Czech Republic Article IV consultation documents.*

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