Czech Republic: Staff Concluding Statement of the 2021 Article IV Mission
IMF News, November 23, 2021
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- Published: November 23, 2021
Overview
- The Czech Republic entered the pandemic on a strong economic footing and utilized its ample policy space built over time to successfully address the crisis.
- Swift utilization of an extensive set of fiscal, monetary, and macroprudential policies cushioned the impact of the shock and helped protect people, jobs and businesses.
- The labor market withstood the impact of the pandemic relatively well, but long-term pressures continue.
- Inflation remained marginally above the tolerance band in 2020 but increased substantially in late 2021.
- Macrofinancial vulnerabilities persist as house price growth has reached record highs amid significant risk-taking by households.
- Given the ongoing resurgence of COVID-19 cases in Europe, the recovery could be impeded by further waves of infections.
- Policy guidance: commensurate with the recovery, policy support should be cautiously reduced, while ensuring policy coordination to avoid cliff effects; support should be pivoted to rein in increasing inflation, rebuild policy space, address macrofinancial imbalances, and build forward better.
Key Policy Recommendations
- Monetary policy: Amid high inflation and increasing domestic price pressures, staff supports the monetary policy stance. Going forward, in light of the current significant uncertainty, policy action should carefully weigh risks from raising rates too quickly, possibly jeopardizing the economic recovery versus those from hiking too slowly and risking inflation expectations becoming untethered.
- Fiscal policy: Carefully scaling back fiscal support measures in the short term is appropriate, but fiscal policy should remain flexible given the uncertain outlook, while facilitating reallocation and providing a bridge to the economy of the future.
- Macrofinancial: Tightening macroprudential tools in coordination with balancing tax incentives and improving housing supply are warranted to address increasing household risk-taking and restrain fast-rising property prices.
- Green transformation: A strategy based on enhanced carbon pricing, reinforced by broader incentives across sectors is recommended. The Recovery and Resilience Facility provides an opportunity to finance mitigation and productivity-enhancing investments to accelerate the transformation.
Outlook and Risks
- Growth projections:
- Output growth is projected to rebound to 2.6 and 3.5 percent in 2021 and 2022 respectively.
- Sources of near-term demand:
- Pent-up demand is expected to continue to boost private consumption.
- Public consumption tapers off as support measures are withdrawn.
- Unemployment is expected to remain low and wage growth to return to pre-pandemic rates.
- Net exports are expected to recover as supply chain issues resolve by mid-2022, supported by strong foreign demand.
- Inflation outlook:
- Inflation is projected to remain elevated into 2022 driven by domestic pressures—heating labor and housing markets—and foreign drivers—supply chain disruptions and high energy prices.
- Inflation is forecasted to converge to the policy target by early 2023 amid the rise in policy rates and ebbing of current inflation pressures.
- Downside risks:
- Ongoing resurgence of COVID-19 cases could impede the recovery.
- Further tightening in the labor market could deter a swift economic rebound.
- Longer-than-expected surges in energy prices or prolonged disruptions to global supply chains could continue hindering the recovery and further increasing inflationary pressures, imperiling inflation expectations from becoming de-anchored.
- A housing price correction could ignite adverse feedback loops and weigh on banks’ balance sheets.
Monetary Policy
- Staff supports the monetary policy stance.
- Rationale:
- Persistent labor and housing market pressures are significantly contributing to high and rising inflation.
- The CNB’s stance of raising the policy rate is appropriate to counteract inflation pressures and prevent inflation expectations from becoming untethered.
- Risks of policy action:
- Raising rates too quickly could exacerbate downside risks from pandemic waves, energy price spikes, or supply-chain disruptions, and may destabilize asset prices and financial markets.
- Delaying policy action risks inflation expectations becoming untethered, wage-price spirals developing, and second-round inflation pressures spreading.
- Recommendation: policy action should carefully consider these trade-offs given significant uncertainty.
Fiscal Policy
- Short-term stance:
- Carefully scaling back fiscal support measures in the short term is appropriate, but fiscal policy should remain flexible given the uncertain outlook.
- Fiscal space and consolidation:
- The Czech Republic entered the pandemic with substantial fiscal space, which allowed deployment of sizeable fiscal policy measures.
- Despite the resulting increase in public debt, its level as a share of GDP is still among the lowest in the EU.
- Fiscal consolidation should proceed in a state-contingent and well-communicated manner as the recovery is entrenched to ensure that fiscal space remains available.
- 2022 budget guidance:
- Barring setbacks, remaining broad-based and non-targeted support measures should be reversed in the 2022 budget to arrest growing debt and replenish fiscal buffers.
- The 2022 budget envisages a deficit reduction as pandemic-related measures are set to expire.
- Unless other—possibly more growth-friendly—revenue-side measures can be implemented, the reversal of the relaxation of the personal income tax regime and the reintroduction of the real estate transfer tax should proceed.
- Revenue-side measures could be accompanied by consolidation on the expenditure side to facilitate earlier reduction of public debt than under the currently-implied trajectory.
- Long-term sustainability:
- Addressing public debt sustainability pressures in the long term will be paramount.
- The sustainability of the pension system in the long run is challenged by demographic pressures, which will start to become increasingly binding at the turn of the decade.
- Recommendations: re-link the retirement age to adjust automatically to life expectancy; generate more revenue from less-distortionary taxes, such as consumption and real estate taxes, which would also help reduce pressures in the housing market.
Macroprudential and Financial Sector Policies
- Rationale:
- Increasing risk-taking by lenders amid high and rapidly-rising property prices warrant tightening macroprudential tools and deploying housing supply and tax policies.
- Recommended measures:
- Tighten DTI, DSTI and LTV limits to pre-pandemic levels as a start, with close monitoring to determine if subsequent action is needed.
- Clearly communicate macroprudential policy actions and continue adequate coordination of the overall policy mix to ensure smooth stabilization.
- Calibrate macroprudential tools for lower risk groups, such as first-time home buyers, to safeguard access to financing.
- Relax supply constraints by ensuring proper implementation and further simplification of the construction permitting process.
- Increase property taxation, including through valuation consistent with market prices, and further reduce mortgage interest deductibility to help curve demand.
- Financial sector condition:
- In 2020, capitalization and liquidity in the banking sector reached historical highs.
- Profitability, while remaining positive, dropped by nearly half.
- The banking system has continued to become more concentrated in residential mortgages amid declining risk weights for mortgage lending.
- A sudden correction of housing prices or a shock to household incomes could have a system-wide impact jeopardizing financial stability.
- Impairment charges, albeit remaining low, are likely to increase further as support policies are fully unwound.
- The high degree of foreign ownership in the Czech banking sector warrants close monitoring of developments in home countries of parent institutions.
- Prudential framework actions:
- Leverage information in the mortgage database and the credit registry to enhance a fully risk-based prudential framework.
- Ensure adequate provisioning and capital buffers consistent with higher risks in overheating-prone sectors and ensure risk measurement is forward looking.
- Continue close monitoring of non-performing loans and cross-border linkages as policy support is reduced.
- Maintain guidance on dividend payouts as needed to protect capital buffers.
- Continue improvements to the AML/CFT framework and monitoring of foreign financial flows in line with previous recommendations.
Labor Market Policies
- Shift support as recovery advances:
- Commensurate with the recovery, policies should continue shifting to targeted support and facilitating reallocation.
- The crisis “Antivirus” package successfully contained the rise in unemployment.
- Job-retention schemes should increase financial contributions from employers to improve incentives for self-selection of participating companies.
- Active Labor Market Policies:
- Step up job matching, training, and reskilling programs, including for the employed.
- Continue efforts to have vocational and educational programs guided by information on current and future labor market demand.
- Inclusion and labor supply:
- Lifelong learning schemes are welcome to enhance workers’ technical and digital skills, given exposure of a high proportion of low-skilled jobs to automation.
- To support employment of mothers with young children: continue expanding childcare services, provide flexibility on the use of parental allowances, and enhance opportunities for job sharing.
- Policies to attract foreign workers and streamline administrative processes for employment and residency permits—including a multicriteria points-based system—can reduce labor market tightness.
- Reinstating a mechanism linking the retirement age to life expectancy is recommended.
Investment and Productivity
- Opportunity to build forward better by increasing productivity growth and investment.
- Policy focuses:
- Ensure workers are equipped with technical and digital skills, and encourage broad-based innovation, building on the Innovation Strategy and the National Investment Plan.
- For SMEs: use well-targeted R&D grants, tax incentives and better access to equity finance.
- Develop standards for information disclosure, review regulation for pension funds, and provide incentives for institutional investors to ensure adequate resources for investment vehicles targeting SMEs.
- Improve implementation of insolvency procedures to minimize barriers to corporate restructuring, spur capital reallocation and improve recovery rates in the wake of the crisis.
Closing
- The IMF team thanks the Czech authorities and other counterparts for their accommodative flexibility, warm hospitality and high-quality discussions.
Mission Concluding Statement, November 23, 2021 — IMF Communications Department