## Statement by Willy Kiekens, Executive Director and Jiri Jonáš, Advisor for the Czech Republic — July 26, 2000

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**Canonical URL:** [Statement by Willy Kiekens, Executive Director and Jiri Jonáš, Advisor for the Czech Republic — July 26, 2000](https://www.imf.org/-/media/websites/imf/imported-publications/external/np/a4pilot/2000/_stm0096.pdf)

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### Recent Developments
- After three consecutive years of negative growth, the Czech economy appears to be recovering, with renewed strengthening of activity.
- External demand initially drove the recovery, notably strong growth in the euro area, the Czech Republic's most important export market.
- Signs of rising domestic demand:
  - Retail sales increased by 8.4 percent in real terms in May.
  - First quarter national account data show fixed investment growing by 2.2 percent.
  - Construction activity is gradually beginning to recover.
- Labor market:
  - Recovery appears to have arrested the growth of unemployment for the time being.
  - Earlier projections expecting unemployment "significantly higher than 10 percent by the end of this year" are now seen as too pessimistic.
  - Continued enterprise restructuring will nonetheless cause labor shedding and could push unemployment higher.
- Inflation developments:
  - Headline CPI rose from a low of 1 percent in June 1999 to reach 4.1 percent in June 2000.
  - Net inflation rose from -0.6 percent to 2.6 percent over the same period.
  - Producer prices grew faster, influenced by higher oil prices.
- External accounts and capital flows:
  - Domestic demand recovery combined with higher imported oil prices has weakened trade and current account balances.
  - Export growth remains robust despite koruna appreciation, supported by Western European demand, enterprise restructuring, and growing inflows of FDI.
  - Expectation of some widening of the current account deficit this year is not judged a cause for concern given expected large inflows of FDI and potential short-term capital outflows driven by low interest rates on koruna deposits.

### Structural Reforms
- Banking sector weaknesses:
  - Contributing factors included difficulties in bank supervision and regulation amid growing financial intermediation, delays in bank privatization, credit used to finance acquisition of nonfinancial companies during voucher privatization, and less than arm's length relations between banks and corporate clients.
  - A high level of monetization and debt early in transition left banks with large savings to allocate, but incentive structures failed to prevent bad loan problems.
  - The 1997 recession and tighter financial conditions exposed these latent problems.
- Bank privatization and resolution actions:
  - Authorities moved to privatize four large state-owned banks by selling to strong foreign investors.
  - Two banks, the CSOB and CS, are already sold.
  - Sale of the largest bank, the KB, is in process and "will likely be completed early next year."
  - Problems at IPB (purchased by Nomura Securities in 1998) culminated in auditors' findings of serious capital inadequacy by end-June; authorities imposed forced administration, wrote equity value down to zero, and resold IPB as a going concern to CSOB to avoid disruptive closure and create stronger ownership.
- Nonfinancial sector restructuring:
  - Authorities are addressing problems of several large enterprises, some still state-owned, through financial and operational restructuring prior to sales to private investors.
  - Objective is to restructure debt burdens, streamline operations, and make firms durably viable under market conditions, guided by economic considerations and insulated from political pressure.

### Fiscal Policy
- Banking sector restructuring affected public finances, but low public debt and prior prudent fiscal policies provided a cushion sufficient to absorb banking-sector restructuring costs without serious financial destabilization.
- Authorities and IMF staff agree structural fiscal problems remain and require urgent resolution to prevent public debt from swelling to levels that threaten financial stability.
- Authorities' fiscal measures and intentions:
  - Improving fiscal transparency and accountability.
  - Imposing new budgetary rules in 2001.
  - Creation of two new extrabudgetary funds intended as temporary vehicles to direct one-time privatization receipts to investment projects with high social value, despite staff concerns that such funds may undermine transparency.
- Political motivation:
  - Strong urgency across the political spectrum to achieve early European Union membership provides discipline for economic policy, especially fiscal policy.
  - Broad awareness that the present social security system is unsustainable and requires a thorough overhaul to ensure long-term viability, though current political constellation may complicate fundamental reforms.

### Monetary Policy and Central Bank Autonomy
- Debate over whether monetary policy in 1998–1999 was too tight; with hindsight, staff judged monetary easing was too slow, though this was not obvious ex ante.
- The CNB chose to "lock in" lower inflation while remaining supportive of recovery:
  - End-2000 inflation target likely to be somewhat undershot.
  - CNB announced a 2-4 percent net inflation target for 2001; the government has publicly endorsed this inflation target.
- Policy stance:
  - Strengthening recovery and pick-up in headline and core inflation persuaded the CNB to refrain from further cuts in interest rates; current interest rates are considered adequately supportive of recovery.
  - CNB and staff view recent acceleration of inflation as mainly due to external factors; domestic inflation pressures remain low.
- Exchange rate considerations:
  - Authorities are concerned about recent koruna strength but note that rapid recovery in Western Europe, productivity-enhancing restructurings, and strong FDI inflows mean some appreciation may not unduly harm competitiveness.
  - Projected large FDI inflows suggest upward pressure on the koruna is likely to continue; authorities are monitoring developments and ready to take measures to prevent excessive appreciation that could undermine the nascent recovery.
- CNB legal changes and accountability:
  - Parliament amended the CNB Law to align with EU norms and address perceived accountability gaps; some proposed changes were removed in final reading but the amendment still introduces significant modifications.
  - While not directly attacking CNB independence in conducting monetary policy, the amendment could provide an opening for political pressures on the CNB.
  - The amendment still requires Senate approval before becoming effective.

*Source: Statement by Willy Kiekens, Executive Director and Jiri Jonáš, Advisor for the Czech Republic — July 26, 2000 (document _stm0096).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-publications/external/np/a4pilot/2000/_stm0096.pdf_