Czech Republic-2013 Article IV Consultation Concluding Statement
IMF News, May 20, 2013
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- Published: May 20, 2013
Key recommendations and policy stance
- Keep fiscal policy neutral until the economic recovery gains strength.
- Adopt a simple and easy-to-monitor structural fiscal balance rule to provide a medium-term fiscal anchor.
- Maintain the accommodative monetary stance for an extended period.
- In a severe adverse scenario where deflationary pressures mount:
- Use fiscal policy to support the economy.
- Deploy unconventional monetary policy tools, notably foreign exchange intervention.
- Use proactive bank supervision to ensure continued adequate capital and liquidity buffers to preserve financial stability.
- Strengthen policies to enhance investment in both physical and human capital, improve the business environment, and increase labor participation to boost potential growth.
Macroeconomic outlook and risks
- The Czech Republic's economic fundamentals are strong, but the economy is in the midst of a prolonged recession because of the euro area slump and weak domestic demand.
- Recent performance and drivers:
- Export-led recovery of 2010-11 subsided as euro area import demand slowed.
- Growth has underperformed trade partners and peers since mid-2011 mainly because of weaker domestic consumption and investment.
- Weak private consumption driven by lower real disposable income and increased precautionary savings.
- Near-term projection:
- Economic activity expected to be weak in 2013 and recover gradually thereafter.
- Prospects are for a prolonged period of modest growth with the output gap closing only gradually.
- Risks (mainly downside):
- Further deterioration of euro area growth could deepen recession and delay recovery.
- Protracted poor growth performance risks permanent scars to potential growth through lower investment.
Public finances
- Budget and consolidation:
- Budget deficit projected at 2.8 percent of GDP in 2013; the country should be able to exit the Excessive Deficit Procedure.
- Structural consolidation of around 4.5 percent of GDP over 2010-2013.
- Policy guidance:
- Avoid fiscal over-performance this year, particularly at the expense of lower capital spending.
- Allow automatic stabilizers to fully operate; avoid further pro-cyclical fiscal tightening if activity is weaker than expected.
- Maintain a neutral fiscal stance until recovery gains strength; consider moderate, gradual consolidation after 2015 aiming for the structural balance target in the new fiscal framework.
- In a severe adverse scenario, fiscal policy should play an active role through temporary and targeted measures; fiscal policy would be more effective with monetary policy constrained by the zero lower bound.
- Fiscal framework design:
- Structural balance rule and debt brake under consideration would enhance transparency and reduce pro-cyclicality.
- Effectiveness and credibility would be enhanced by broad consensus, independence of the fiscal council, and a structural target balancing long-term sustainability and short- and medium-term demand concerns.
Monetary policy
- Policy rate and inflation:
- Policy interest rate cut by 70 basis points to 0.05 percent between June and November 2012.
- Inflation declined below the 2 percent target level starting from January 2013.
- Inflation projected to remain at around 1¾ percent through 2014; risks to inflation are to the downside.
- Policy interest rates have reached the zero lower bound.
- Additional tools:
- If persistent and large undershooting of the inflation target is in prospect, the CNB should employ additional tools.
- The CNB's statement that additional monetary easing within the context of inflation targeting would come from foreign exchange (FX) interventions is viewed as appropriate.
- FX interventions are assessed as an effective and appropriate tool to address deflationary risks in a small open economy with relatively high pass through.
- Operational aspects of interventions should pay due regard to transparency to help shape market expectations and ease exit from the policy.
- The mission assesses the exchange rate to be in line with the fundamentals; FX interventions should not target a certain exchange rate level.
Financial stability
- System resilience and risks:
- The Czech financial system has proved resilient to the global crisis and a weak domestic economy.
- Czech banks are largely owned by euro area banking groups, are highly profitable and self-financed with a low system-wide loan to deposit ratio.
- Profitability likely to moderate from the record level in 2012 as margins come under pressure and impairments moderately increase due to weak activity.
- Main risk is a protracted or deeper recession harming asset quality.
- Existing capital and liquidity buffers are expected to keep the system resilient, per CNB regular stress tests.
- Supervisory and regulatory priorities:
- Supervision should proactively ensure provisions are adequate and buffers remain strong if economic weakening continues.
- Adopt the draft proposal on the regulation of credit unions given higher-than-average risks in that segment.
- Continue implementing FSAP Update recommendations (December 2011) including lowering regulatory limits on exposures to parent banks, strengthening cooperation between the Ministry of Finance and the CNB, and increasing the role of the CNB’s macroprudential policies.
- If not entering the Single Supervisory Mechanism now, strengthen home-host supervisor cooperation and prepare for a more integrated European financial policy framework.
- Bank resolution and deposit insurance improvements should follow recent European-wide initiatives and be implemented in due course.
Structural reforms to boost potential growth
- Investment and business environment:
- Enhancing private investment and especially FDI is critical for future growth and moving up the value chain.
- Reduce uncertainty by improving the legal framework and minimizing administrative costs for formation, restructuring and liquidation of firms to improve the business environment.
- Human capital and labor market:
- A highly capable and skilled workforce is essential to attract knowledge-intensive industries; education reforms would support this objective.
- Higher labor participation will enhance potential growth; active labor market policies providing information, counseling and retraining help avoid permanent negative impacts from higher long-term unemployment.
- Although overall labor participation is above the OECD average, participation is low for some segments such as women with young children; targeted policies such as public support for childcare can be effective.
Czech Republic-2013 Article IV Consultation Concluding Statement