Czech Republic -- Concluding Statement of October 2001 IMF Staff Visit
IMF News, October 30, 2001
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- Published: October 30, 2001
Mission overview
- Date: October 30, 2001
- Purpose: Describes the preliminary findings of IMF staff at the conclusion of the October 2001 staff visit to the Czech Republic, undertaken as part of regular consultations and staff reviews of economic developments.
- Central medium-term challenge identified: further enhance the momentum of growth and reduce the income gap with the European Union (EU), while preserving disinflation gains and protecting the external balance.
- Near-term complication: uncertainty regarding the depth of the global slowdown following the events of September 11 and prospects of large inflows of foreign capital.
Current macroeconomic conditions and prospects
- Recent performance:
- Growth accelerated in the first half of 2001, supported by strong investment demand and a rebound in household consumption.
- Construction remained particularly strong, benefiting from FDI in greenfield projects.
- Growth forecasts and assumptions:
- GDP growth forecast for 2001: around 3.3 percent (based on a slowdown in the second half of the year).
- If EU economies begin to recover in the second half of 2002, projected growth for 2002: around 3.5 percent.
- Inflation outlook:
- Headline inflation expected to decline to around 4 percent by the end of 2002, comfortably within the Czech National Bank's (CNB) target range.
- Recent sharp increases in food prices (May–July) attributed to temporary effects, now unwinding.
- Weak external demand (particularly Germany) and prospects of large FDI are expected to moderate domestic inflation and put upward pressure on the koruna, directly lowering prices of tradable goods.
- Imported oil prices expected to tend to suppress inflation in the future.
- External sector:
- Current account deficit expected to widen to more than 5 percent of GDP in 2001, and could reach a similar order of magnitude in 2002.
- Sizeable FDI inflows, including those related to privatization, likely to provide ample financing for the deficit, but their impact on the koruna poses a major policy challenge.
Macroeconomic policy assessment and recommendations
- Overall prescription:
- Advocated policy mix: more prudent fiscal policy combined with a more accommodative monetary policy (making the overall macroeconomic policy stance broadly neutral).
- Rationale:
- More prudent fiscal policy: contributes to medium-term fiscal consolidation and helps keep the external current account deficit in check amid weakening external demand.
- More accommodative monetary policy (within inflation-targeting constraints): helps the domestic economy weather the global downturn and tends to attenuate koruna appreciation.
- Fiscal policy assessment:
- General government deficit, as defined for aggregate demand impact, is projected to increase by about 1 percent of GDP in 2001, and slightly less than 1 percent of GDP in 2002 according to the government's budget proposal.
- The 2002 budget contains no significant fiscal reform measures needed to improve sustainability of public finances over the medium term.
- The budget document and the Pre-Accession Economic Program identify large fiscal deficits as the principal medium-term risk and characterize Czech demographics as a "time bomb" requiring pension reform beyond the recent changes.
- IMF staff view: puzzling that the government does not attempt fundamental fiscal reforms now; responsibility appears to shift to the next government.
- Monetary policy assessment:
- The CNB slightly tightened policy in July (raised its key policy rate) due to concerns about spillovers from cost to demand pressures, closing output gap, and expansionary fiscal stance.
- Since then, the balance of risks shifted: concern about spillover has subsided, reducing the likelihood of overshooting the inflation target toward end-2002 and beyond.
- Continued appreciation of the koruna is effectively tightening monetary conditions.
- IMF staff recommendation: strong case for the CNB to return to a more accommodative policy stance, but room for easing is constrained by the expansionary fiscal policy next year.
- Koruna appreciation and privatization-related inflows:
- IMF staff view previously: koruna appreciation broadly consistent with fundamentals and competitiveness not undermined.
- Current concern: continuing appreciation led to the CNB's intervention "last Thursday for the first time since March 2000."
- Key considerations and recommended approach:
- Many pending privatization deals are domestic utility companies whose positive impact on external competitiveness is small; if market assesses this correctly, converting proceeds would not lead to a large lasting appreciation.
- Given the size of the Czech foreign exchange market, major conversions can have disruptive short-term effects; thus policy should aim to seal off a large part (if not all) of privatization-related inflows from the market.
- Under the advocated precautionary policy, proceeds would be held by the government without conversion and/or converted to koruna funds through bilateral transactions with the CNB.
- If part of privatization proceeds must be channeled through the market, they should be done gradually over time.
- A case-by-case, non-firm approach to handling proceeds would introduce uncertainty and could become a source of speculation.
- Recommendation: a clear joint statement by the government and the CNB, specifying the rules for dealing with privatization proceeds, to dispel uncertainty.
- Footnote clarification:
- Privatization receipts, proceeds from the sale of UMTS licenses, and expected repayment of Russian debt are excluded from the revenue side of the budget because, unlike taxes, they do not result in a decline in the domestic private sector's disposable income.
- Grants to transformation institutions to cover bank restructuring costs are excluded from the expenditure side, since they neither generate government demand for goods or services nor influence private sector income.
Structural policy issues
- Banking sector:
- Completion of banking sector privatization with the sale of Komercni banka has created the foundation for an efficient and competitive banking system.
- Provided legal and regulatory framework is further strengthened (including bankruptcy law), banks should resume lending to the private sector and foster sustainable medium-term growth.
- Clean-up of banks' balance sheets has saddled the Czech Consolidation Agency (CKA) with a large volume of non-performing assets, set to grow with the transfer of bad assets of the old IPB.
- Disposal priorities and principles for CKA:
- Dispose of bad assets rapidly and efficiently; bad assets do not get better over time.
- The pool sale in early 2001, despite low yield, was successful because it combined speed, transparency, and an arms-length transaction.
- Future sales should ensure speed, transparency, and arms-length terms.
- CKA should strictly limit involvement in enterprise restructuring, leaving restructuring to the private sector.
- Privatization process and regulation:
- Government moving rapidly on an ambitious privatization program.
- IMF staff support privatization where private ownership demonstrably improves efficiency, but emphasize:
- The post-privatization regulatory framework must be clear.
- The privatization process must be guided by the public sector and marked by transparency and clarity.
International Monetary Fund — Czech Republic: Concluding Statement (Preliminary), October 30, 2001