Czech Republic--2008 Article IV Consultation, Concluding Statement of IMF Mission
IMF News, November 24, 2008
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Bibliographic details
- Published: November 24, 2008
Mission overview and context
- Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
- November 24, 2008, Prague.
- Key cross-cutting observation: strong fundamentals helped the Czech economy weather the global financial crisis during the past year, but clear signs of spillover from the global crisis have begun to appear and the authorities need to be ready with speedy policy responses to preserve financial stability and mitigate the risk of a hard landing.
Growth outlook and risks
- Recent performance:
- Growth moderating to about 4 percent in 2008, reflecting a slowdown in domestic demand.
- Following three years of exceptionally rapid expansion, the economy is set to slow sharply next year amid a gathering recession abroad and tightening credit at home.
- Projections:
- Projected sharp slowdown in 2009 to around 1½ percent.
- Household consumption expected to grow only modestly.
- Key downside risks:
- Possible credit crunch that could hold back spending by corporations and households.
- A deeper-than-projected recession in the eurozone.
- Shrinking demand from the euro area, and Germany in particular, will sharply curtail export growth and direct investment inflows.
- Offsetting factors:
- Stimulus from the new automobile plant and rising inflows of EU funds.
- Plummeting confidence and rising unemployment likely to overshadow the favorable impact of declining inflation on real disposable incomes.
Monetary policy, inflation, and exchange rate
- Recent monetary actions:
- The Czech National Bank (CNB) was the first central bank in Europe to reverse the tightening policy cycle in August 2008.
- In early November, the CNB acted aggressively to cut the policy rate by 75 basis points, exceeding market expectations.
- Inflation and outlook:
- A strong koruna helped keep inflation pressures in check despite a sharp rise in the prices of food, fuel and utilities, and sustained demand pressures.
- With inflation likely to fall below the CNB's target of 3 percent amid a sharp slowdown, scope exists for further easing.
- Headline inflation expected to decline to 2½ percent in 2009.
- Importance of CNB communication: ensure expectations are well anchored to the new target of 2 percent from January 2010.
- Exchange rate and competitiveness:
- The effective exchange rate of the koruna, adjusted for either relative consumer prices or unit labor costs, appreciated significantly in the first half of 2008, but has weakened recently.
- Despite sharp real appreciation, the external position has remained strong; the trade balance is in surplus and the modest current account deficit is expected to be comfortably financed by direct investment inflows.
- Model-based approaches support the view that the koruna is broadly in line with fundamentals and consistent with external stability.
- Recent koruna depreciation is beginning to offset the adverse impact from the earlier appreciation on profit margins.
Financial sector conditions and vulnerabilities
- Integration and exposures:
- Domestic financial markets and institutions have come under increasing pressure due to global financial turmoil and high foreign ownership of the banking sector.
- Exposure to sub-prime securities by Czech banks appears to be low; involvement in structured financial products appears low.
- Off-balance sheet amounts are high relative to on-balance sheet totals and need to be monitored closely.
- Spreads facing parent banks of major Czech subsidiaries have widened; the proportion of short-term loans from parent banks may be rising.
- Policy implications:
- Authorities need to take measures to maintain confidence in the financial system and ensure its stability.
Measures to support market functioning and supervision
- Market functioning recommendations:
- Interbank market:
- The range of instruments acceptable as collateral could be widened. At present, only government bonds are accepted for the CNB's new repurchase facilities for liquidity provision. If this proves insufficient, steps to mitigate perceptions of rising counterparty risks may be necessary.
- Bond market:
- The government could ensure greater transparency by, for example, adhering to the announced size of bond issuances, to enable accurate pricing by dealers. Issuances should also take into account the need for developing the local market.
- Supervisory and crisis-preparedness recommendations:
- The supervisory authorities will soon be putting in place a framework for systemic assessment to help review the potential effects of a crisis. Since any decision to intervene would likely be discretionary, a consistent approach needs to be established among the relevant authorities from the outset.
- The Czech Republic has adopted the Basel II framework. The supervisory authority should put in place the modalities for the application of Pillar II as soon as possible, to ensure that banks remain well-capitalized.
- The CNB has supervisory tools in place to preserve the continuity of access to key banking functions in systemically important banks. These measures should be continually enhanced, and where discretion is required, supervisory response should be prompt.
- The features of the Deposit Insurance Fund could be calibrated to ensure transparency and credibility. The level of deposit insurance has been increased to cover 100 percent of deposits up to €50,000 in line with the EU agreement. In the context of the pending revision of the relevant legislation, clarifying the capacity and features of the scheme would help maintain confidence.
- Domestic crisis management arrangements between the CNB and the Ministry of Finance have been established and tested. More formal arrangements between the authorities and the private sector should be considered.
- Cross-border bank linkages are very important for the Czech Republic, a major host country to subsidiaries of Western European banks. Proactive collaboration with financial authorities and governments in home countries is essential.
Fiscal position, near-term stance, and policy advice
- Recent fiscal strength:
- The structural fiscal balance improved significantly in 2007.
- Authorities committed to the deficit objective of 1 percent of GDP (on ESA-95 basis) by 2012 through saving these up-front fiscal gains and adhering to the nominal expenditure ceilings.
- Early savings have helped create a cushion for a cyclical margin to stay within the Stability and Growth Pact threshold deficit of 3 percent of GDP.
- Savings have also helped support the government's liquidity position, relieving financing pressures in a tight financial market.
- Near-term fiscal outlook and projections:
- General government deficit close to 1½ percent of GDP in 2008, resulting in a small stimulus.
- Government plans a budget deficit of 1.6 percent of GDP for 2009, with cuts in corporate income tax and social security contribution rates largely offset by tightening of the wage bill and social transfers.
- Staff project a deficit of around of 2½ percent of GDP in 2009, reflecting mainly revenue shortfalls from slower growth; this would imply a neutral fiscal stance.
- Policy recommendations:
- Fiscal policy should aim at supporting growth, but be mindful of potential financing constraints and medium term fiscal goals.
- Automatic stabilizers should be allowed to operate fully.
- Scope for discretionary fiscal stimulus may exist if the outlook for growth worsens further, given low government debt and limited domestic and external imbalances. Any discretionary measure needs to be temporary and well targeted to vulnerable social groups.
- Faster implementation of EU-funded projects and bringing forward planned infrastructure spending could help boost demand while safeguarding the longer-run fiscal position.
Medium-term structural reform agenda
- Objectives:
- Restore momentum of reforms to address long-term challenges and ensure high growth.
- Create fiscal space to cope with the demographic transition through greater efficiency in public spending.
- Suggested measures:
- Introduction of user fees in the health sector and plans to modernize the tax administration are welcome.
- Forthcoming regulatory reforms should encourage private pension savings and pave the way for the development of a funded system.
- Recent parametric pension reforms should help reduce fiscal pressures and increase labor force participation.
- Considerable scope exists for improving incentives to work through reforms of the labor market and the tax-benefit system.
- The beneficial effects of such structural reforms would reinforce each other, promoting economic stability and sustained growth.
International Monetary Fund. Concluding Statement of IMF Mission, November 24, 2008.