Monday, December 24, 2007

Merry Xmas and A Happy New Year

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.

Credit crunch, did someone use the expression credit crunch?

Wednesday, December 19, 2007

Czech National Bank Leaves Interest Rates Unchanged

The Czech National Bank left its benchmark interest rate unchanged today as risks to its inflation forecast were judged to remain ``roughly balanced.'' Monetary Policy Board members voted 5-2 to keep the two-week repurchase rate at 3.5 percent, following an increase last month, central bank Governor Zdenek Tuma informed a crowded press conference in Prague today. Two policy makers voted to lift the rate to 3.75 percent.

The Czech Republic's inflation rate reached a six-year high of 5 percent in November, breaching the upper end of the central bank's target range as well as its 3.9 percent forecast for that month. The effect on price growth may be countered by the koruna's 10 percent gain against the euro since July and the possibility of an economic slowdown in the euro-sharing countries.

The board is still ``convinced that faster-than-expected inflation is caused by one-time influences,'' Tuma said. Also, ``there's an impact of the koruna appreciation, with the stronger exchange rate pushing down import prices.''

The currency gains help combat inflation by cutting the price of imports but it also restricts growth by limiting export growth since it makes Czech goods more expensive abroad. The koruna reached a record high on Dec. 10, advancing 5.2 percent against the euro and 14.9 percent against the dollar so far this year.

While the board assessed risks to inflation as ``significant'' in both directions, Tuma said he personally thinks risks are skewed to the upside. That makes a rate increase ``more likely'' than a cut as the next move, he said.

Still, ``should the koruna keep appreciating at a similar pace -- even though I don't find it likely -- it is possible to imagine a different monetary policy reaction,'' Tuma said. He said last month it is unclear whether the next move will be an increase or cut.

Inflationary pressures are mounting in the economy, which is heading for growth of more than 6 percent for a third year. Labor unions may become more successful in seeking higher wages after the unemployment rate reached a record-low of 5.6 percent in November.

Inflation is accelerating much faster than expected, which may drive January's rate to between 5 percent and 6 percent, Tuma said. Still, price growth is spurred by indirect tax increases, rising utility costs and food - factors that are beyond the central bank's reach, and the impact of these factors should fade away soon, Tuma said.

Inflation is being capped by the stronger-than-anticipated koruna and an outlook that growth in the euro-area economy may decelerate more than predicted, the central bank said.

The October ``forecast's main scenario continues to count on a gradual increase in interest rates to ward off a spillover of an inflationary shock to inflation expectations,'' he said. ``A higher risk of the spill-over'' could ``make it problematic to approach our target for 2008 and 2009, let alone for 2010.''

Food costs in the past two months may already have reflected the planned Jan. 1 increase in one of the value-added tax rates, a higher excise tax on cigarettes and introduction of an environmental tax, which could lead to a smaller-than- forecast pickup of consumer prices in January, Tuma said.

Central bankers may raise borrowing costs as early as at their next meeting on Feb 7, but meanwhile Czech borrowing costs remain the lowest among the European Union countries even after four increases this year.

The central bank has also decided to cut the number of its monetary policy meetings to eight from 12, starting next year, with the first session scheduled in February. It will also begin releasing individual votes by the board members and its outlook for rates.

Tuesday, December 11, 2007

Czech Industrial Output October 2007

Czech industrial output grew at an 8.4% rate year-on-year in October, up from 1.2% in September and beating market expectations of 6.0%, mainly due to higher car and electronics production, data released this week by the Czech statistical office (CSU) showed. The figure confirmed consensus expectations for a small rebound in industry after lower-than-expected growth in the previous two months.

Car production jumped 20.3 pct in October, while electronics production grew 15.3 pct. The stats office also said the value of new industrial orders grew 20.5 pct year-on-year, with the bulk of orders coming from foreign buyers.

October construction output also grew 3.5 pct year-on-year, versus a 1.8 pct contraction in September, data which was released separately showed. In addition the planning and building control authorities granted 11 217 building permits, which was down by 18.6% year-on-year. The approximate value of permitted constructions increased by 9.9% year-on-year and reached CZK 32.8 billion.

Monday, December 10, 2007

Czech Inflation November 2007

According to the Czech Statistics Office, the consumer price level in November increased by 0.9% when compared with October. The fast growth in food prices obviously had a strong upward effect on the consumer price level, but there may be more here. The year-on-year rise in consumer prices accelerated to 5.0% in November from 4.0% in October, which is the highest year-on-year price growth since August 2001.

The 0.9% month-on-month increase in the consumer price level had a lot to do with the rise in the ‘food and non-alcoholic beverages‘ component, and the 4.0% increase here was the highest month-on-month price jump in this category since January 1993. The price increase was recorded for majority of kinds of food. The main upward pressure came from the rise in prices of bread and cereals by 11.3%, of which prices of rolls and baguettes rose by 24.6% and prices of bread by 16.2%. Prices of eggs, milk, cheese and other dairy products increased by 12.6%, 2.5%, 7.9% and 3.5%, respectively. Prices of oils and fats rose by 9.4%, of which edible oils by 17.5%, vegetable fats by 9.7% and butter by 6.0%. Prices of vegetables grown for fruit were up by 6.7%. Prices of chocolate and chocolate-based products rose by 4.8%, confectionery without chocolate by 3.2% and confectionery products by 4.5%. Prices of some ingredients, coffee, tea, cocoa and other non-alcoholic beverages went up, too.

The price growth in the 'transport' component was influenced by the increase in prices of automotive fuel by 2.9%, in which prices of diesel oil rose by 6.0% and liquefied petroleum gas (LPG) by 6.2%. Oil prices hit a record high since the beginning of a statistical price monitoring (1969).

But extending beyond the details of the increases, this rise is significant since it means that the Czech central bank may need to continue raising interest rates, following a string of four increases already this year, and indeed central bank Deputy Governor Miroslav Singer has been hinting at just this possibility. The Ceska Narodni Banka's seven-member board last lifted the two- week repurchase rate by a quarter of a percentage point to 3.5% on November 29.

The Central Bank last month raised its two-week repurchase rate by a quarter of a percentage point to 3.5 percent, but at the time of taking this decision policy makers - who target inflation at 3 percent plus or minus a percentage point - had been forecasting November inflation to come in at 3.9 percent. The next meeting of the monetary policy board is on Dec. 19.

Singer is quoted as saying that the "sensitivities" in the bank forecast to the actual inflation registered and to the exchange rate "are more or less known, so the December debate will be substantive". ``What is evident is that the level of restriction will have to be higher, but it's not evident'' how the central bank will ``achieve that'' with interest rates and the exchange rate.

And the problem is no mean one, since it is not clear at this point whether additional increases in the interest rate will serve to slow inflation, or attract more funds which may even cause it to accelerate. A combination of rising rates and a rising koruna make the Czech Republic and ideal "haven" for those playing the currency markets, and in the process (and of course to the extent that the US Federal Reserve and others lower interest rates) the koruna may be about to make the rapid turnaround from being a "carry" currency, to a carried one. Indeed the koruna has been the world's best-performing currency in the second half 2007 and has risen by 10 percent against the euro since July. The currency could, in theory, keep on rising, with significant consequences from the Republic's trade balance in the medium term. Some signs of the creeping issue arriving are to be found in the October trade statistics, since the Czech trade surplus dropped to 8.6 billion koruna, compared with 13.9 billion koruna in September and 3.8 billion koruna a year ago. That is the rate of increase in the balance is slowing, and the balance could at some point turn negative. This is a very worrying prospect, since the Czech Republic had been the most solid one in the whole EU10 group.

And the issue also has broader importance, since the rise in the koruna must to some extent have limited price growth in the short term. That is without the appreciation in the koruna things would have been worse on the inflation front, and this must be taken into consideration when evaluating the consequences of any possible "unwind" at a later date. In the words of Miroslav Singer "the exchange rate is undoubtedly significantly stronger than foreseen by the October forecast, and is much higher than the koruna's trend appreciation,''

Also according to Singer, the last central bank inflation report was "undoubtedly a signal that the level of restriction that we considered adequate" to tame prices may "prove to be insufficient" and "The resulting trajectory'' of interest rates "at this point is not clear'' In this report the Czech national bank forecast that the inflation rate might rise to as much as 6 percent next year, fueled in part by one-time increases in indirect taxes. Also a growing shortage of labor may lead to demands for higher wages and prevent inflation slowing toward the bank's 3 percent target as the impact of the tax increases and rising food and oil prices wanes.

Now the Czech economy grew at an annual 6 % rate in Q3/07, with this growth being principally driven by increases in domestic demand and a continuing strong export performance. Household demand is estimated to be likely to grow at around 6% this year, and investment at around 19%, while government demand is only forecast to grow at around a 1% annual rate.

Now , if we look at the chart below (which was prepared by a staff economist at the Czech National Bank), according to central bank estimates GDP is currently growing at roughly 1 % above its non-inflationary potential, while overall monetary conditions remain broadly neutral. That is to say, inflation is not exclusively a food and fuel price story.

What all this means is that the Czech economy is now moving into tricky territory, with what is known as the output gap - which is really a rule of thumb measure of how fast an economy can grow without producing inflation, since the "gap" in question is a general measure of spare capacity - having turned negative around the end of 2005. So basically the Czech economy is now dependent on inward flows to maintain stability, of funds, and in particular of FDI, to pay for the current account deficit, and inward migration flows of workers to meet the growing labour supply needs.

Labour Shortages?

The lowest unemployment rate in 10 years and a record number of vacant jobs, created by economic growth of more than 6 percent for nine quarters, are increasing chances of demands for rising salaries to be met. Czech real wages rose at the same 5% pace in the third quarter as the preceding three months.

The average gross monthly annual growth, adjusted for inflation, rose 5 percent, while the average nominal wage grew 7.6 percent to 21,470 koruna, led by strong wages pressure in the private sector.

Among private businesses, the monthly salary grew be 7.6 percent, to 21,612 koruna, while salaries for state employee advanced 7.5 percent in the July- September period from a year earlier, to 20,952 koruna. That translates into a 4.9 percent real increase. The largest Czech trade union is now calling for an average 8 percent salary increase next year to cushion workers against measures in the pipeline like increases in value-added tax and cuts in social spending, which will are both likely to undermine purchasing power. The November inflation data will only add more grist to their mill.

The relative position of labour has improved steadily as unemployment falls to decade lows month after month and businesses increasingly have difficulty finding people to hire. Indeed Czech Central Bank Governor Zdenek Tuma has been quite explicit in saying he expects a shortage of labor to fuel wage growth, and hence drive inflation up even more.

"The tension on the labor market is relatively significant'" and `"pressures on wage growth can be expected" told a conference in Prague back in October.

Czechia has one big advantage over many of its East European neighbours in that it has had a positive policy of encouraging migrant workers in place for some time now, and the number of foreigners in the Czech Republic has been rising steadily. Indeed over 34,000 foreigners went to live in the Czech Republic in the first six months of this year, and this compares with 25,000 in the second half of 2006, according to data fromthe Czech Statistical Office.

Data from the Czech police indicate that there were a total of 356,014 foreigners living in the Czech Republic in the first half of this year, compared to 321,456 at the end of 2006. This means that about 34,600 foreigners have arrived in the Czech Republic to stay permanently or temporarily over the past six months. The number of non-nationals living and working in the Czech Republic is still very low when compared with Western European averages, but the figure is rising, and the change in the country's evolution in this sense is very significant. While at the end of 2005 foreigners accounted for 2.5 percent of the Czech Republic's population, by mid 2007 this share had risen to 3.5 percent.

The largest group of foreigners staying in the Czech Republic are Ukrainians. In the first half of 2007, there were 115,000 Ukrainians with permanent residence or temporary stay permits, while three years ago there were 70,500. Ukrainians are also the second largest group of employees who come from abroad, although the largest number are over-the-border workers from neighbouring Slovakia (100,000). In the first half of this year, almost 49,000 Ukrainians were working legally in the Czech Republic legally, but to this should be added many thousands more who are undoubtedly working in the country illegally. (Incidentally, it should be noted that this outflow of Ukrainians to countries across Eastern and Western Europe - and in particular of course to Russia - is now producing large pressure inside the Ukraine labour market, with unemployment dropping steadily, inflation hitting 15.4% in November, and wages and salaries rising at 20% plus a year. So there is not a bottomless pit here anywhere).

Ukrainians also form the biggest group of foreigners with residence permits in Slovakia but, compared to the Czech Republic, their number is low. In the first half of this year, only 630 Ukrainians received residence permits in Slovakia. Again this comparison gives us some idea of just how far out in from on the migrant labour flow question the Czech Republic actually is. All of these countries are suffering the corrosive effect of long run low fertility, and if they are to continue to grow at the rate they are doing they will need to find the labour supply from somewhere.

To give us some idea of just how complex all of this is, it is worth noting that the third largest group of non-nationals working in Czechia come from Poland (22,000) a country with its own labour supply problem (following the mass exodus to the UK and Ireland), a country where labour ministry official recently visited India to scour for construction workers, and where as a short term "urgent" measure convicts have even been released from prison to help build the local highways.

And Poland is not the only EU10 country to start looking farther afield to meet the long term needs which arise from its population shortfall, Skoda has now begun to recruit workers from Vietnam for its factories in the Czech Republic as it struggles with the local labour shortage. Long queues outside the Czech consulate in Hanoi have now become an almost daily sight, provoking some controversy (and even allegations of corruption) both in Vietnam and in the Czech Republic.

This is not the first time that workers from Vietnam have moved to the Czech Republic. When the country was under communist rule as Czechoslovakia, Vietnam, also under communist control, and Cuba sent workers in return for arms and heavy engineering goods. Many of these Vietnamese stayed in Czechoslovakia after the overthrow of communism in 1989 and set up small businesses. Now the Vietnamese are the third-largest migrant worker group in the Czech Republic, behind Ukrainians and Slovaks.

Many Czech companies would now be unable to operate without the foreign labour force, according to HVB Bank analyst Pavel Sobisek. The share of foreign workers in the total labour force already exceeds four percent, and the share of value added created by them is around 3 percent, according to Sobisek. In some sectors, like construction and retail, the share is much higher.

Monday, November 19, 2007

The Koruna and the Euro

Two interesting pieces in Bloomberg this morning, both about central bank Governor Zdenek Tuma. First there is this:

The Czech koruna's climb to a record against the euro is ``unsustainable,'' though monetary policy makers must take the currency gains into consideration when setting interest rates, central bank Governor Zdenek Tuma said.

``In the open economy of the Czech Republic, the exchange rate is important and the pass-through on inflation is relatively strong,'' Tuma said in an interview in Cape Town yesterday. ``I always warn against panic regarding exchange-rate developments, but nevertheless this is very strong appreciation'' and ``we cannot ignore it.''

The koruna is the world's best-performing currency against the euro in the past month and has risen 2.6 percent in the period. The currency's surge has prompted policy makers to put off a fourth rate increase this year even after economic growth helped push inflation in October to the highest since 2001.

The koruna was at 26.65 against the euro as of 9:33 a.m. in Prague, unchanged from Nov. 16. It reached a record 26.50 per euro on Nov. 12 and climbed to an all-time high of 18.08 against the dollar on Nov. 15. The koruna has gained 14.4 percent against the dollar this year, helping to counter the effect of record oil prices.


``By definition this pace of appreciation is unsustainable,'' Tuma said on the sidelines of a meeting of central bankers from around the world. ``That is clear.''

The Czech 3.25 percent benchmark rate is the lowest in the European Union. Tuma said the currency's gain was one of the factors that prompted the central bank's seven-member board to keep the rate unchanged at its last meeting on Oct. 25.

The koruna's exchange rate will ``stabilize,'' Tuma said. ``The only question is whether we can expect moderate correction and some stability or just that stability at new levels.''

The central bank predicts a temporary surge in the inflation rate to as high as 5.1 percent in 2008 on one-time increases in indirect taxes and utility costs, surpassing its 3 percent target plus or minus a percentage point. It expects consumer-price growth to slow again in the next 12 months, Tuma said.

and then there is this:

Czech central bank Governor Zdenek Tuma said the country can ``afford'' to keep the koruna even if neighboring countries switch to the euro.

``The Czech economy has been growing between 5 percent and 6 percent in the past few years, this is not a failure,'' Tuma said in an interview in Cape Town yesterday. ``Because of that, I can imagine we can afford to stay outside the euro. I don't think in 1990 we expected people would trust the Czech koruna this much.''

The Czechs last year dropped a plan to adopt the euro in 2010. The country, which is committed under European Union rules to give up the koruna, has yet to set a new date. Slovenia so far is the only one of the eight former communist countries that joined the EU in 2004 to become a member of the euro region.

The Czech government of Mirek Topolanek has introduced tax changes and welfare spending cuts aimed at cutting the budget deficit below 3 percent of gross domestic product starting in 2008, and has pledged to overhaul pension and health-care programs by 2010.

`Economic Shocks'

``The decision in our case is not only to push through important reforms but also to have sufficient maneuvering room for economic shocks,'' the 47-year-old Tuma said.

To apply for the euro, countries must meet thresholds for the budget deficit, debt, inflation and long-term interest rates, and enter the exchange-rate mechanism, a minimum two-year test of currency stability.

``I wouldn't like to enter'' the exchange-rate mechanism, ``a system I don't like, then to fail to'' meet ``one of the criteria and then be trapped in the terms of'' the mechanism,'' Tuma said.

By delaying the euro, the Czechs are hoping to avoid the experience of Lithuania, whose euro bid was rejected last year because inflation was too fast. Slovakia wants to switch currencies in 2009.

Tuma said the country will eventually become a member of the 13-member euro region.

``Nobody is saying we're going to postpone it forever,'' he said. ``This is the dilemma: the more successful the country is, the less important the euro is. We are committed to the euro because it's a part of the treaty and we voted for the EU, including the euro. It's just a question of timing.''

Tuma declined to give a date by which the Czech Republic may be expected to adopt the common European currency, stressing the decision would be a ``political'' one.

Premier Topolanek said on state-run public television yesterday that adopting Europe's single currency in 2012 is ``not realistic'' because the country would have to fulfill all adoption criteria as of 2008, which is not possible without an overhaul of the pension and health-care systems.

Czech central banker Mojmir Hampl told Hospodarske Noviny newspaper today that the economy is not ready to switch currencies, and that fast adoption of the euro would increase inflation.

Friday, November 02, 2007

Employment and Unemployment in the Czech Republic September 2007

The Czech jobless rate fell to what for the Czech Republic in recent times was the unprecedently low level of 6.2% in September (or around 5% if we use the ILO rather than the Czech MLSA methodology). This was the lowest recorded level for the Czech Republic since the new data series was introduced in January 2004, and was the result of the rapid rate of job creation which has accompanied the third consecutive year of substantial economic growth. But the rapid rate of economic growth and job creation which has been taking place in the Czech Republic is at the same time starting to give rise to fears about ensuing labour shortages and a concern that these may lead to the sort of wage-increase driven inflation we are currently seeing in some other parts of the EU10. Indeed Czech Central Bank Governor Zdenek Tuma recently explicitly warned that a shortage of available labor may fuel wage growth, and that this in turn would fuel inflation.

In an attempt to maintain inflation under some sort of control the central bank has already raised interest rates three times so far this year, and only really decided to leave it's two-week repo rate unchanged at 3.25% at the October meeting because it took the view that the administrative fiscal-tightening measures the Czech government has now started to introduce following the fiscal expansionary measures of 2006 - and which will themselves not be bereft of some inflationary consequences, since they involve raising taxes and untility prices - were likely to have an overall restraining effect on demand such that it would be both unnecessary and undesireable to further tighten monetary policy at this point in time. This, and of course the increased external risk which follows from the financial market turmoil of last August.

Despite this consideration, several members of the monetary policy committe did voice their concerns that while demand side inflationary pressures seemed reasonably benign, labor market tightening may become a major factor in the Czech situation, and the non-inflationary effect of real wage increases that the comittee in fact took was conditional on fairly optimistic assumptions regarding labour productivity growth. All-in-all there was an expectation that inflation maywell be driven up towards the upper end of the 4 percent target range sometime early next year.
"The tension on the labor market is relatively significant....pressures on wage growth can be expected...If inflation is low, relatively significant pressures on the labor market can be expected."
Zdenek Tuma, Governor of the Czech National Bank speaking in Prague last month

Increases in regulated prices have pushed headline inflation closer to the 3 percent target in 2006, but the underlying inflationary pressures have remained subdued. Lingering slack in the labor market and inflows of migrant workers kept wage inflation moderate, which, coupled with strong productivity gains, helped contain labor costs. There are no apparent signs of the second-round effects from increases in energy and other regulated prices, which, together with well anchored expectations, underscores the strong credibility of the Czech National Bank (CNB).
IMF, Executive Board Concludes 2006 Article IV Consultation with the Czech Republic, February 28 2007

Czech GDP growth - which has hovered around the 6% mark - has certainly been strong, but not excessively so, in recent years, and the problems which currently exist in the Czech republic are certainly a far cry from the overheating issues which are arising elsewhere in the EU10, and in particular in the Baltics and Bulgaria.

The Czech economy grew at exactly an annual 6 % rate in Q2/07, with this growth being principally pulled by increases in domestic demand. Household demand is estimated to be likely to grow at around 6% this year, and investment at around 19%, while government demand is only forcast to grow at around a 1% annual rate. According to central bank estimates GDP is currently growing at roughly 1 % above its noninflationary potential, while overall monetary conditions remain broadly neutral. What all this means is that the Czech economy is now moving into tricky territory, with what is known as the output gap - which is really a rule of thumb measure of how fast an economy can grow without producing inflation, since the "gap" in question is a general measure of spare capacity - having turned negative around the end of 2005, as can be seen in the chart below which was prepared by a staff economist at the Czech National Bank. So basically the Czech economy is now dependent on flows of funds, and in particular on FDI (to pay for the current account deficit) and on inward migration of workers to meet all the labour supply needs.

Nominal wage growth has accelerated up towards 8 % mark in recent months while nominal uniit labour costs are now growing at around 3 %. This - if you like - is the "productivity gap". What it means is that real wages are no longer in "anti-inflationary" mode, since the ongoing decline in unemployment (which is now evidently below the level which any reasonable estimate of NAIRU ought to give us) means that supply side pressures emmanating from the real economy have become pro-inflationary.

I have commented separately on the fiscal situation in this note, but it is evident that structural reforms in government spending are essential if Czech finances are to achieve longer term sustainability. Even making full allowance for the impact of the new fiscal reform introduced this year, the government deficit is likely to be around 2.5 % of GDP in 2008, which is a strange posture to find in an economy running a negative output gap, ie in an economy which is already expanding at a rate which on many estimates would seem to be above its real capacity. However, it should be stressed that such measures of capacity are only that, estimates. Given the ease and facility of capital and migrant labour flows in todays global economy, a judicious leveraging of such a position can allow an economy to grow at well beyond what might seem to be the normal capacity rate. But this possibility is conditional on simply this, a judicious leveraging of the available resources.

One part of the current fiscal adjustment measures are, however, only temporary in nature, since further tax cuts are already envisioned for 2009. So without further measures, the government deficit will start to increase again in 2009. The previous government record here does not inspire excessive confidence, since fiscal gains which were achieved in 2005 were then relinquished in 2006, when fiscal policy turned expansionary, with the general government deficit having risen to something like 3.75 percent of GDP, reflecting pre-election tax cuts and increases in social transfers for pensions and health care. A large social spending package in the budget for 2007 is expected to raise mandatory spending in the coming years.

The procyclical fiscal stimulus which was implemented in 2006, at a time when the economy was set to register another year of robust growth, was untimely to say the least. In particular, the decision to increase mandatory social spending in the 2007 budget worsened the longer term fiscal position, and an opportunity was lost to consolidate fiscal gains in what were effectively the good times. The authorities have declared, however, an intention to achieve an annual reduction in the structural deficit by 0.25 percent of GDP per annum in their forthcoming Convergence Program.

Nevertheless, weaknesses have emerged in the process of implementing the medium term budgetary framework. The upward revision of the spending limits in the medium term budget during the 2006 and 2007 budget process and the abandonment of the 2005 Convergence Program targets suggests that the fiscal framework needs to be strengthened to increase fiscal discipline in good times. Given the current environment of political uncertainty, the fiscal framework takes on added importance as a disciplining device.
IMF Selected Issues, February, 2007

Certainly the current rate of growth in the Czech Republic - as elsewhere in the EU10 - is creating jobs and reducing unemployment at an unprecedented rate. In Q3 2007, total employment in the Czech Republic grew by 102,800 year-on-year and reached the highest level of employment achieved at any time over the last ten years, according to data from the Czech Statistics Office released at the end of last week. The number of employees rose by 87.3 thousand, and the number of self-employed by 17.5 thousand. The number of unemployed according to ILO methodology was down by 98.3 thousand year-on-year, the number of long-term unemployed dropped by 62.3 thousand. The general unemployment rate fell by 1.9 percentage points to the lowest level since the end of 1997 (5.2%).

The employment rate (the proportion of first (main) jobholders in the number of persons aged 15-64) reached 66.3% and was 0.9 percentage points up year-on-year. The male employment rate grew by 1.3 percentage points to 75.2%, while the employment rate of women grew by 0.5 points to 57.3%.

The seasonally adjusted average number of employed persons increased by 25.5 thousand (+0.5%) quarter-on-quarter.

The average number of unemployed according to the ILO methodology decreased by 17,900 quarter-on-quarter (seasonally adjusted). The number of unemployed fell to only 266,700 (of which 146.900 were women), and this is the lowest level of unemployed which has been registered since the end of 1997. In comparison with Q3 2006, the total number of unemployed decreased by 98,300 and has dropped by more than a quarter year-on-year (26.9%). Generally, unemployment dropped faster among persons in the young and middle productive age. Unemployment dropped more among the female population (by 53,600), especially in the five-year age group 20-24 (by 13,700). The total number of unemployed men fell by 44,700 year-on-year, most of this in the 20-24 age group (by 14,100). A majority of the unemployed (71.1%) are persons either with secondary education without GCSE (the leaving certificate) or with only basic education.

According to the Labour Force Survey results, the general unemployment rate according to the ILO methodology (derived for the 15-64 age group) reached a ten-year minimum of 5.2% in Q3 2007. Compared to Q3 2006 it decreased by 1.9 percentage points.

The different methodology use in the Labour Force Survey is what gives rise to the difference between the general unemployment rate using ILO criteria and the registered unemployment rate by provided by the Ministry of Labour and Social Affairs of the CR (MLSA CR), but it is important to note that the development trend is the same whichever rate you use. The registered unemployment rate by the MLSA CR reached 6.3% in Q3 2007 and decreased by 1.6 percentage points year-on-year.

The regional unemployment rate ranged from 2.3% in the Hl.m.Praha Region and 3.2% in the Jihočeský region to 7.9% in the Karlovarský Region and 9.0% in the Ústecký Region. The drop of unemployment showed itself in all of the regions of the CR, with the greatest declines being registered in areas with high or above average unemployment rates i.e. in the Moravskolslezský, Karlovarský and Ústecký Regions.

Much lower unemploy­ment rates are being recorded for university graduates (2.1%) and persons having full secondary education with GCSE (3.1%). A high unemployment rate continues to be observed among persons with basic education (18.8%) and an above-the-average unemployment rate (5.6%) is still in the large group of persons with secondary education without GCSE including those with vocational education.

Czech inflation accelerated to the fastest in 13 months in September, closing in on the central bank's target and suggesting interest rates may rise again as early as this month. Consumer prices rose an annual 2.8 percent, up from a 2.4 percent in August, according to the Czech statistics office.

Obviously a number of factors are at work in the way the Czech economy is assimilating this drop in numbers of unemployed without stoking inflation, but could one of the important details which "mark the difference" between the Czech Republic and some of its neighbours could be the fact that the Czech Republic far from losing workers on a net-basis through out-migration, has actually been acting as a magnet which attracts inward migrants in significant numbers.

The number of foreigners legally working in the Czech Republic grew by 38,000 at the end of September 2007 in comparison with December 2006, with the total rising to 223,000, and most of the newcomers arriving from either Slovakia (100,000), Ukraine (57,000) or Poland (22,000), according to statistics issued by the Labour and Social Affairs Ministry. Tens of thousands of non-Czech nationals also work in the country illegally, according to numerous estimates.

Lingering slack in the labor market has helped contain wage inflation. Despite strengthening demand for labor, suggested by rising vacancies, wage pressures have remained subdued, as rising inflows of immigrant workers have helped offset the impact of population aging on labor supply. Recent employment gains have been concentrated in industry and private services, including real estate, and do not yet appear broad-based. Unemployment has fallen, but remains around 7 percent, as continued geographical and skill mismatches have kept structural unemployment high.
IMF Selected Issues, February, 2007

Many Czech companies would be unable to operate without the foreign labour force according to HVB Bank analyst Pavel Sobisek. The share of foreign workers in the total labour force already exceeds four percent. The share of value added created by them is around 3 percent, according to Sobisek, while in some sectors, like construction and retail, the share is much higher.

So while some Czechs have left their country to work elsewhere since the turn of the century, the Czech Republic has been more than able to compensate for this by attracting workers from elsewhere. Obviously all of this is not completely problem free, in that wage pressures are nonetheless building up. But the situation is certainly strikingly better than in many other EU 10 countries. So, is there a lesson here for anyone?

Czech September 2007 Trade Surplus

The Czech Republic posted its first trade surplus in three months in September as import growth slowed and exporters stepped up sales after production was reduced during the holiday period.

According to preliminary data from the Czech Statistics Office for September 2007, exports and imports at current prices grew by 11.0% and 7.6% year-on-year respectively. The trade balance achieved a surplus of CZK 14.4 billion, which was an improvement of CZK 7.0 billion year-on-year. This figure was fuelled by a CZK 5.8 billion increase in the trade surplus in machinery and transport equipment and by a CZK 1.9 billion decrease in the trade deficit in mineral fuels, lubricants and related materials.

The surplus was 14.4 billion koruna ($771 million), which compared with a deficit of 600 million koruna in Augustr and a 7.4 billion-koruna surplus a year earlier.

Exports grew at the slowest pace since August 2006, and imports at the slowest pace since April 2006. These figures are influenced by the high base figure of September 2006 when the third highest level for 2006 was recorded. Due to appreciation of the koruna against the euro and in particular against the US dollar, external trade grew faster in euros (exports +14.3%, imports +10.8%) and in US dollars (exports +24.6%, imports +20.8%) than in korunas.

In terms of destination and origin countries, the trade surplus with EU27 states rose by CZK 66.9 billion and trade deficit with non-EU27 states increased by CZK 28.2 billion. The surplus with Slovakia increased (by CZK 22.1 billion), as it did with Germany (by CZK 13.7 billion), the United Kingdom (by CZK 11.3 billion), Poland (by CZK 7.7 billion) and France (by CZK 7.4 billion).

The deficit in trade with the Russian Federation decreased (by CZK 27.0 billion), and the trade balance with Norway improved (by CZK 9.6 billion) turning the deficit into a surplus. The trade deficit with China increased (by CZK 49.5 billion), as it did with the Netherlands (by CZK 10.4 billion), Japan (by CZK 7.1 billion) and Ireland (by CZK 4.6 billion).

The trade balance reached a surplus of CZK 14.4 billion, which was an improvement of CZK 7.0 billion when compared with September 2006. This is the highest September surplus in the history of the Czech Republic and the second highest surplus during 2007.

Czech export-oriented plants often boost production in September following shutdowns during the holiday period and before Christmas imports. The impact of surging oil prices has also been reduced by the koruna's gain against the dollar, thus keeping open the possibility that the full-year surplus will beat the record 43 billion koruna from last year.

Czech Producer Price Index September 2007

In September 2007, according to data from the Czech Statistical Office, and as compared with August 2007, prices of agricultural and industrial producers, construction work and market services grew by 4.3%, 0.1%, 0.5% and 0.9%, respectively.

In comparison to September 2006, prices of agricultural and industrial producers, construction work and market services were higher by 18.1%, 4.0%, 3.8% and 1.6%, respectively.

Agricultural producer prices grew by 4.3% in total. Prices of crop products grew by 5.9%, higher were prices of fruit (+25.1%), cereals (+10.5%) and oil seeds (+9.0%). Prices of potatoes and vegetables fell by 24.6% and 3.3%, respectively. Prices of animal products increased by 2.6% due to higher prices of eggs (+14.7%), poultry (+3.8%), milk (+2.8%) and pigs for slaughter (+1.2%).

Prices of industrial producers increased by 0.1% in September 2007 (-0.1% in August). The most significant increase of prices was recorded in ‘coke, refined petroleum products’ up 2.9% (-3.8% in August). The prices of ‘food products, beverages and tobacco’ were up by 0.7% (+1.2% in August). Prices went down in ‘chemicals, chemical products and man-made fibres’ by 1.0% and in ‘basic metals, fabricated metal products’ by 0.4%.

Construction work prices grew by 0.5%, construction material input prices fell by 0.6%.

Prices of market services in the business sphere grew by 0.9% due to 1.6% price increase in ‘real estate, renting and business services’ (prices of advertising services were up by 11.1%).

The prices charged by industrial producers were up by 4.0% in September 2007 (+3.7% in August). This increase was particularly influenced by higher prices for ‘electrical energy, gas, steam and water” (+7.5%). In addition, the price level for ‘basic metals, fabricated metal products’ was up significantly - by 5.7% (+6.9% in August). Prices for ‘food products, beverages and tobacco’ went up by 4.4% (+4.0% in August). Construction work prices were higher by 3.8% (+3.6% in August), construction material input prices grew by 5.3% (+5.9% in August)

Prices of market services in the business sphere were higher by 1.6% in total (+1.0% in August). Prices of ‘real estate, renting and business services’ (higher prices of advertising services by 6.0%) and ‘freight transport and storage services’ grew by 2.5% and 3.3%, respectively.

Obviously the increase in industrial producer prices is to some extent conditioed by energy prices, but the steady upward movement since the start of the year is unmistakeable.

Thursday, November 01, 2007

Retail Sales August 2007

In August, according to data from the Czech Statistical Office, seasonally adjusted sales in ‘retail trade except of motor vehicles and motorcycles’ increased by 0.3% month-on-month at constant prices. The year-on-year increase was 7.2%, not seasonally adjusted sales 6.9%. The growth of sales of food, beverages and tobacco accelerated to 5.4%, non-food goods on the contrary recorded this year’s lowest increase of 7.9%. Seasonally adjusted sales in hotels and restaurants increased by 0.7% month-on-month in August, not seasonally adjusted sales increased by 1.8% year-on-year.

Seasonally adjusted sales in retail trade (CZ-NACE 52) increased by 0.3% month-on-month at constant prices in August, of which non-food goods by 0.5% while prices of food, beverages and tobacco stagnated. The growth of the trend component by 0.5% followed up on the trend from the previous four months and was 0.1 p.p. lower compared to the average of the last 12 months.

Year-on-year, after seasonal and working day adjustments (August 2007 and 2006 had the same number of working days), sales in retail trade increased by 7.2% at constant prices. Not seasonally adjusted sales grew by 6.9% which was the third lowest growth from the beginning of the year owing most to the sale of non-food goods that this year recorded the smallest increase (7.9%) in August. Conversely, food, beverages and tobacco recorded the second highest growth (5.4%).

Almost 30% contribution to the total growth had non-specialised stores with food, beverages and tobacco predominating and a 23% contribution had specialised stores with other non-food goods. The fastest sale growth occurred in, in terms of share little significant, retail sale via Internet or mail order houses (16.6%). A two digit growth was recorded also in stores with textiles, clothing and footwear and right below 10% ranged the year-on-year sale growth in stores with pharmaceutical and medical goods, cosmetic and toilet articles. (Table 3)

Broken down by size group of enterprises, the biggest growth of sales occurred in enterprises with 50 to 99 employees (+11.1%). Enterprises with 100+ employees reported a growth by 7.9%, with 0 to 19 employees by 5.9% and with 20 to 49 employees by 5.0%.

Wednesday, October 24, 2007

Catch Up Growth and Demographics - Evidence from Eastern Europe

by Claus Vistesen: Copenhagen

Performing a simple series of adept Googling exercises around various sources on the internet you can easily discover that certain species of the lynx are able to travel at speeds of up to 50 kph (31 mph). Wikipedia informs us that the Eurasian lynx, on average, commands a hunting area of between 20-60 square kilometers in which the lynx is able to walk and run about 20 kilometers in one single night. All in all, a pretty rugged and constitutional little thing this lynx.

In this way, and perhaps because, at that particular point in time, the Eastern European Economies looked as if nothing could come in their way of economic prosperity and growth they were paired, by the Economist, with the region's sturdy feline coining the notion of 'Lynx Economies.' Thus, 'that particular point in time' was sometime back in the spring of 2006 where the Economist's (and my own) coverage of the CEE and Baltic economies came in hot on the heels of publications by the World Bank and and the Vienna Institute of Comparative Economic Studies speaking favorably of the future prospects of economic prosperity and thus 'catch-up' growth in the CEE and Baltic Economics.

Yet, merely 1 year and a tad later things seem to have changed quite significantly with respect to the discourse on the economic situation in Eastern Europe. Many of the contributors to this blog has been pitching on the change in discourse but also some of major institutional actors have been flagging the red banner. Not least the World Bank seems to have changed their attitude somewhat with most notably a recent report on the demographics of Eastern Europe entitled From Red to Gray - The Third Transition of Ageing Populations in Eastern Europe and the former Soviet Union as well as a recent writ with specific focus on the macroeconomic risks prevailing in the region. Yet, also the IMF in their latest World Economic Outlook devotes a chapter to the managing of large capital inflows where Eastern European economies also take center stage of the general tone of warning; in essence this note of warning concerning Eastern Europe seems to be the general talk of the day amongst economic analysts and journalists. As such, perhaps even the lynxes roaming the forests and planes of Eastern Europe are beginning to feel that the otherwise catchy notion conjured by journalists at the Economist is becoming something of a stretch according to the reality of the situation. Sure, things are moving fast now but it is what happens next which might finally serve to make the allegory rather unrealistic. In this entry I set out to explicitly investigate an issue which in fact has been treated several times on this blog and perhaps most often in the context of the CEE and Baltic Economies. Simply put and in the form of one simple question;

  • How do changing demographics and more specifically the final and ongoing stages of the demographic transition affect the notion and principle of economic catch up growth and thus economic convergence as it is stipulated by (neo-classical) economic growth theory?

As I have hinted above in the introduction my main subject of analysis on which the general theoretical argument is based is the current and ongoing situation in the CEE and Baltic economies. A lot has been written about this recently not least from the hands of the contributors to this blog (see also above). As a one-stop overview of the concrete issues at hand this recent note by Edward over at Global.Economy.Matters should provide you with suitable ammunition to get you started. In particular, the following three point overview of the current economic situation in Eastern Europe should always be in the back of your mind as we move forward from this point ...

Basically the principal outstanding issues confronting the EU10 countries are threefold:

  • Labour capacity constraints (which are normally a by product of long-term low fertility and large scale recent migration flows) are producing significant wage inflation and strong overheating.
  • A structural dependence on external financing - which is in part a by-product of the effect of low levels of internal saving, and which is another factor which separates the EU 10 from those like India or China who are benefiting from a typical demographic dividend driven catch up, is leading to large current account deficits, and potentially high levels of financial instability.
  • A loss of control over domestic monetary policy due to eurozone convergence processes which - with or without the presence of formal pegs - make gradual downward adjustment in currency values as a alternative to strong wage deflation virtually impossible. This issue is compounded by the likely private "balance sheet consequences" of any sustained downward movement in the domestic currency given the widespread use of mortgages which are not denominated in the local currency.
Traditionally a rigorous economic analysis in the light of the immediate events would focus a lot on point 2 and 3 but in this note we shall look specifically at number 1 and the issues of labour capacity, its constraints, and what it means of the economic growth of less to medium developed countries. Now, the most obvious caveat in this entry is that I really don't have the time at this point to really lay out the whole theoretical framework of economic growth theory and as such the precise slot in which my argument should be inserted within the wider theoretical framework. This will be the topic of a more rigorous article not suited for the blog format. However, I still need to attach some comments to set the scene where I should also immediately note that my previous note here at DM about catch up growth in Eastern Europe serves as a good state of the game post for what comes next.

Apart from my studies of selected pieces of the economic growth literature one of the best overviews of the concept of economic convergence as a function of the theoretical and practical assumptions vested in the growth models is to be found in an article by Norbert Fiess and Marco Fugazza on economic integration in Europe (PDF). As such it is important to note that convergence of GDP per capita levels is not a holy grail within the fields of economic growth theory. Rather, the process of convergence should be seen as an inbuilt consequence of the fact that as economies mature returns to production inputs decrease; that is to say that this discussion essentially revolves around the concept of increasing v. decreasing returns to scale in our economic model. If we think about decreasing returns to scale and introduce the concept of marginal productivity to production inputs we can then see that less developed countries are likely to exhibit higher rates of growth than their more mature counterparts in the sense that their marginal productivity is higher which then leads to a process of convergence. Now, this argument in its most strict sense is usually applied in the context of capital as a production input and coupled with the properties of an open economy and subsequent free flow of production factors this would lead to a rather rapid process of convergence or absolute convergence as the technical term. As regards to labour as a production input is has also been argued that the universal transition from an agricultural to manufacturing over to service (?) based economy produces a mechanism of convergence in the sense that this process implies a move up the value chain and thus that every unit of labour becomes more productive. Of course and even though we are talking about stylised facts here, this is also where the whole debacle begins in the context of my immediate argument because how certain is this process? Also, we need to take into account the distinction between stocks and flows (of labour) which is a crucial issue to consider when talking about ageing economies.

However and it does not take much of an economist to see that empirical facts do not support the idea of absolute convergence or at least it seems as if the process takes much longer to materialize than predicted by the theory. This has lead, among other factors, to a 'new' strand of economic growth models which allows for persistent growth divergence to exist between countries. The crucial aspect to understand here is the mechanism through which persistent divergences can occur. In this way, one of the widest contributions by economist to this thesis has dealt with the possibility that technological processes and thus accumulation of technological advances exhibits increasing returns to scale. The fundamental brilliancy of this notion is that it allows for a model where there is indeed decreasing returns to labour and capital but where different levels of technological effort leads to internal positive feedback mechanisms and thus explains persistent divergences in growth and 'prosperity' across countries.

Ok, I think that I have already said enough at this point and in order to get us back to track one crucial assumption and conceptual idea needs to be pinned down. As such and if we look at the rudimentary description of the economic growth process above it is not wholly unreasonable to argue that the growth process of an economy is somewhat directly related to the process of the demographic transition. Or as Robert Lucas puts it in a widely cited article ...

That is, the industrial revolution is invariably associated with the reduction in fertility known as the demographic transition.

As such, why don't we take a look at Eastern Europe where the economies have experienced, quite as expected by the conventional theory of economic growth, economic dynamics tantamount to catch-up or convergence. Especially the economic data since the expansion from EU15 to EU25/27 and, for some countries, the subsequent anchoring to the Euro has been very impressive indeed. Yet as Edward and I have been at pains (see link above) to explain again and again these countries are not your average emerging markets. This follows from the fact that their demographic structures have been fundamentally distorted due to a collapse of fertility in the beginning of the 1990s which has been aggravated by a persistent net outflow of migrants serving to further speed up the decline in the working and essentially also most productive cohorts. In order to capture this development and in order to frame the current situation the following point I made in a previous note is worthwhile to repeat.

In short, we are dealing with countries where the demographic transition by far, and indeed worryingly, has out paced the traditional economic process of economic convergence.

This is exactly what we are talking about here and apart from going to the heart of the imminent issues in Eastern Europe it also strikes right smack into the concept of economic growth theory and how to deal with the fact that the demographic transition does not occur the way it was originally anticipated. Most emphatically, we can see in the context of the Eastern European countries that the final stages of the transition have arrived far before and quicker than the twists and turns of history allowed for these economies to really get on with business. Yet, the general argument can just as easily be expanded into a discussion of the ageing part of OECD where it is painfully clear at this point that conventional economic theories are wholly incapable of explaining what is likely to happen next. In fact, we could stretch it so far as to say that modern economic growth theory is not able to explain what happens when fertility drops to a level below replacement level and stays there!

In Summary

Even though that a lot words have been written in this entry I am afraid that only superficial contributions have been made to the final answer of the proposed question. This entry principally had one main task, namely to initiate a line of reasoning which ultimately and hopefully can lead to a better understanding of modern economic growth processes in a context of the current demographic profile of many developed and developing economies. Specifically, this entry revolved around the concept of catch-up growth/convergence where the countries in Eastern Europe were suggested as an example to demonstrate how demographics can fundamentally alter the principles by which the economic growth process is likely to conform. In this way, the message is not that modern economic growth theory and growth accounting methods are rendered obsolete in the face of changing demographics but rather that considerable adjustment needs to be made; especially in the context of catch up growth/convergence but also crucially in the context of the notion of a steady state of economic growth. Returning briefly to the real world before we sign off it could seem as if the branding of the lynx economies never was more than a quick and essentially expensive make-up which is set to quickly wear off as we venture on. Specifically, recent signs coming out of the ECB and the European commission suggest that expectations are aligning towards an outlook where the process of convergence effectively risks grinding to a halt. My advice would then be not to exchange the carrot too swiftly into a stick since this would only serve to kick those who are already on the ground.

Tuesday, October 09, 2007

EU Ministers Criticise Czech Government Deficit

Well, I can't help thinking some people have an obsession with fiscal deficits at the moment, I really can't. EU finance and economy ministers, meeting yesterday in Luxembourg, took it upon themselves to criticise the Czech government for their fiscal policy telling them in the process that they must "take effective steps" to cut their budget deficit to bring it into line with European Union rules, and that they must do this no later than next year. In fact they have given the Czech Cabinet until April 9, 2008 to take measures to ensure that next year's fiscal deficit, adjusted for one-time factors, falls below the EU limit of 3 percent of gross domestic product. At the present time the Czech government government projects a fiscal deficit of 3.6 percent of GDP this year, compared with an initial 4 percent target.

Now in the face of ageing societies I am all for structural reforms and fiscal rigour I really am, but I think there is a time and a place for everything, and a sense of proportion is needed here. The Czech economy is, as I tried to have illustrate yesterday, one of the few real relative success stories to be found among the EU 10, and as such there is a real need for balance and for classifying issues in terms of their importance here. (This stance on the Czech Republic seems to parallel recent exchanges over the level pf the current French deficit between Trichet and Sarkozy, exchanges which seem truly out of proportion when you consider the extent of the accumulated debt problem which exists in say Italy or Greece, and well, I would make a similar point about how the Czech Republic. "Overheating", while still an issue, is far less problematic in Czechia than it is in many members of the EU10, and this "detail" would be my personal initial point of departure for assessing the robustness of the Czech economy, and the margin for manoevre the government may or may not have in terms of fiscal deficits).

The Problem Facing the EU10

Basically the principal outstanding issues confronting the EU10 countries are threefold:

1/. Labour capacity constraints (which are normally a by product of long term low fertility and large scale recent migration flows) producing significant wage inflation and strong overheating.

2/. Structural dependence on external financing leading to current large current account deficits.

3/. Loss of control over domestic monetary policy due to eurozone convergence processes which - with or without the presence of formal pegs - make gradual downward adjustment in currency values as a alternative to strong wage deflation virtually impossible. This issue is compounded by the likely private "balance sheet consequences" of any sustained downward movement in the domestic currency given the widespread use of mortgages which are not denominated in the local currency.

Now the worrying part about all three of these is that they are not simply cyclical in character. As such they are not problems which will "self correct" as a result of a recessionary slowdown, whether this be of the "soft-" or "hard-landing" variety. This problem simply is not being taken into account in many of the current pronouncements on the EU10, and certainly is in no way reflected in the current "deficit obsession" which we can see at EU Commission level.

The Immediate Problem

The current controversy has its roots in a decision by the Czech government last September to push through Parliament a set of tax changes and spending cuts that are intended to narrow the fiscal shortfall to 3.2 percent of GDP next year and 2.8 percent of GDP in 2009, an outcome that the Czech finance ministers consider to be "plausible'' in spite of the "considerable uncertainties'' which are linked to the tax overhaul.

The controversy has of course been well served by a 17 percent jump in welfare spending approved before elections last year, and these have, of course, boosted spending even as a record 6.4 percent pace of economic growth in 2006 brought in more tax revenue than expected. The economy is expected to expand 5.9 percent this year, according to the Finance Ministry forecast in the 2008 draft budget.

``In the absence of measures to address the budgetary impact of aging, the debt ratio is likely to increase significantly over the next decades'' from about 30 percent of GDP now, EU finance ministers said, in their statement. I agree completely, but are we not in danger of confusing two issues here, longer term structural issues, and short term budgetary ones?

Certainly, when compared even with many existing eurozone members, the Czech deficit problems can hardly be said to be of the "basket case" variety:

And as the EU finance ministers accept, the debt to GDP ratio - which is currently around 30% - is hardly huge in comparison with some others I could mention.

So the issue here is the need for longer term structural changes - just like in France - and the best way to achieve this may be by presenting the necessary laws and longer term reforms, and not by focusing on short term deficit issues. As I have indicated, there are far more pressing issues on the table all over the place at the present time.

And even when we come to the external balance position, the Czech position is far from being a chronic one. Trade in goods and services is now in balance:

And even the CA deficit, which does need addressing, is not large in comparison with many of the rest in the EU10.

Finally, and as an example of a more balanced view I would draw attention to the fact that the most recent IMF staff report on the Czech Republic had this to say:

Lingering slack in the labor market has helped contain wage inflation. Despite strengthening demand for labor, suggested by rising vacancies, wage pressures have remained subdued, as rising inflows of immigrant workers have helped offset the impact of population aging on labor supply. Recent employment gains have been concentrated in industry and private services, including real estate, and do not yet appear broad-based. Unemployment has fallen, but remains around 7 percent, as continued geographical and skill mismatches have kept structural unemployment high.

and this:

The main concerns center on the erosion of fiscal discipline in 2006-7 and the medium-term fiscal outlook. The expansionary fiscal stance for 2007 is out of place in view of the expected robust growth. The authorities’ medium-term consolidation plans are appropriate, but supporting measures should be identified without delay. A cutback in high mandatory social spending would improve fiscal flexibility and efficiency. The institutional fiscal framework also needs to be strengthened.

Well exactly. So let's just try and keep things in proportion, shall we?

Monday, October 08, 2007

Czech Inflation September 2007

Czech inflation accelerated to the fastest in 13 months in September, closing in on the central bank's target and suggesting interest rates may rise again as early as this month. Consumer prices rose an annual 2.8 percent, up from a 2.4 percent in August, according to the Czech statistics office.

The central bank has been lifting what are the European Union's lowest interest rates for two years now on concern the consumption-driven expansion will foster price growth. Policy makers target inflation one point either side of 3 percent and have signaled borrowing costs will have to rise further because consumer-price increases are forecast to exceed 4 percent next year. The central bank foresees annual price growth of as high as 4.5 percent next year, driven by higher indirect taxes and wages pressure from a rapidly tightening labour market.

The mid-point peak of the so-called monetary-policy inflation, which excludes the effect of one-time changes in indirect taxes that the central bank omits, is projected to jump to 3.7 percent in 2008 from about 1.8 percent in September. Central bankers raised the key two-week repurchase rate in May, July and August, bringing it to 3.25 percent, a level which still significantly below the European Central Bank's current 4 percent refi rate.

The month on month price change was in fact pushed into negative territory - a drop of 0.3% in the index between August and September - by a seasonal drop of costs of travel packages, which were on average 16.1 percent lower last month than in August.

What is most interesting about the Czech situation is how different it is from many of the other EU10 economies. Despite the fact that GDP growth has been strong in recent quarters:

and a brisk, but not exaggerated, pace of growth in retail sales:

With unemployment coming down quite fast:

Wage costs have not gone through the roof, Baltic style, at least not so far they haven't. There are, however, distinct indications in the chart below that wages inflation has accelerated since the start of 2006:

and this has been reflected by a steady uptick in producer prices, although this has started to ease off a little since June.

Obviously a number of factors are at work here, but could one of them be the fact that the Czech Republic far from losing workers on a net basis to out-migration in recent years, has actually been able to attract inward migrants in significant numbers.

So while Czechs have left to work elsewhere in significant numbers since the turn of the century, the Czech Republic has been more than able to compensate for this by attracting workers from elsewhere. Obviously all of this is not completely problem free, in that wage pressures are building up. But the situation is certainly strikingly better than in many other EU 10 countries. Is there a lesson here for anyone?

Friday, September 28, 2007

Czech Central Bank Maintains Interest rate

The Czech central bank kept its benchmark interest rate unchanged at the lowest level in the European Union's lowest level yesterday, after perviously raising it three times this year, citing in justification for the decision the stronger koruna and increased global borrowing costs.

At the close of the meeting, the Board decided to leave the CNB two-week repo rate unchanged at 3.25 %. All six board members present voted in favour of this decision.

Key Czech Economic Indicators

Price indicators:

- annual industrial producer price inflation in August (3.7 %)
- annual agricultural producer price inflation in August (15.6 %)

Leading indicators of growth:

- annual growth in retail sales in July (8.9 %)
- annual growth in industrial production in July (11.5 %)
- annual growth in construction production in July (-1.7 %)

External balance:

- trade balance in July (CZK -0.7 billion)

According the the bank press conference presentation:

The risks of headline inflation forecast are on the upside, risks of monetary-policy relevant inflation forecast are on the contrary on the downside.

Major risks and uncertainties:

- tax changes and faster expected growth of regulated prices
- faster then expected growth of food prices
- drop in market expectations of 1Y Euribor rate
- stronger koruna exchange rate against the euro
- lower August inflation and in particular adjusted inflation excl. fuels
- extent of fiscal restriction in 2008

Bank Governor Zdenek Tuma indicated at the press conference that the bank may reduce its forecast for future interest rates next month. Policy makers have previously said more increases are needed through 2008 to combat the effect of rising domestic demand and excise taxes. The koruna, which rose 2.1 percent against the euro in the past seven weeks, and the rising cost of credit, may have eased that concern.

``The koruna has been stronger than we anticipated in the latest forecast'' in July, Tuma said. ``There is a great question-mark'' over the impact of the global market turbulence on economic growth, inflation and monetary policy, which ``will be a subject to study'' in the next few months.

He also suggested that inflation adjusted for one-time effects is more likely to undershoot July's forecasts than exceed them, even as the headline inflation rate may rise higher than estimated.

The inflation rate rose to 2.4 percent in August from 2.3 percent in July, 0.2 percentage point below the central bank's forecast for that month.

"The monetary-policy inflation is what we react to is below our forecast ....Were we to evaluate that the secondary effects of tax and regulated-price changes..... we feel that will not be too significant, and that could theoretically lead to a somewhat lower interest rate trajectory"

Still, the central bank sees ``upside risks'' to its quarterly inflation forecast from rising taxes and regulated costs as well as from a larger-than-assumed jump in food prices.

The banker also expects an upward ``correction'' of inflation by the end of the year in the order of fractions of a percentage point after the impact of a new methodology on measuring inflation introduced this year led to unexpectedly slow price growth.

A reduced outlook for interest rates in the euro region, being one of the most marked effects of the turmoil on global markets, is also a risk to the bank's inflation prediction, according to the central bank chief.

The government's fiscal policy next year, which will be reflected in the October inflation prediction, may be more restrictive than expected, Tuma said.

The koruna has been the best performing emerging-market currency against the euro in the third quarter, reversing a trend from the first half when it lost 4.1 percent. It was trading at 27.595 to the euro as of 5:06 p.m. in Prague, compared with 27.620 yesterday.

The currency's gains cap inflation by making imports cheaper and undermining export revenue. The koruna is used for so-called carry trades when investors buy higher-yielding assets using loans taken out in currencies with low interest rates. With the recent aversion to risk on global credit markets, investors unwound those trades, buying back the koruna.

Friday, September 07, 2007

Czech Economy Expands Strongly in Q2 2007

The Czech Republic's economy expanded an annual 6 percent rate in the second quarter on the back of strong household spending and investment growth according to data released today by CSU, the Czech statistical office. The growth rate, which has been at 6 percent or over for nine consecutive quarters, compares with a revised 6.4 percent pace in Q1.

The Czech central bank has raised interest rates three times so far this year due to concern about the pace of household consumption growth. Czech household consumption rose 6.5 percent in the second quarter, the second-highest growth rate in nearly four years, compared with 7.2 percent in the first three months of the year. Gross fixed investments rose at an annual 4.2 percent, according to the statistical office, while inventories rose by 44.1 billion koruna from a year earlier. Imports of goods and services, calculated in constant prices, rose 13.9 percent from a year earlier, outpacing exports which recorded 13.8 percent growth.

Government spending fell 1.6 percent in the April-June period.

In the second quarter, retail sales grew an average 7.4 percent, compared with an average 9.4 percent in the first three months of the year.

Real wages grew 4.9 percent in the second quarter, slower than 6.3 percent in the first three months of the year. The unemployment rate in June reached 6.3 percent, the lowest since the data series was started in 2004.

The Finance Ministry estimates growth at 5.8 percent this year and 5 percent in 2008.

Tuesday, August 21, 2007

Czech PM wins fight for tax cut package

From the Financial Times today:

Czech PM wins fight for tax cut package

By Katka Krosnar in Prague

Published: August 22 2007 02:14 | Last updated: August 22 2007 02:14

The Czech parliament on Tuesday approved a public finance reform package that would cut corporate tax to 21 per cent next year.

Under the reforms proposed by the centre-right coalition government of Mirek Topolanek, prime minister, the corporate income tax rate will fall from 24 per cent to 21 per cent next year, then by a further 1 percentage point in 2009 and 2010.

A simplified individual income tax rate of 15 per cent is to be introduced next year, falling to 12.5 per cent in 2009.

The backing for the reform package, albeit by a slim two-vote majority, was a big victory for Mr Topolanek who faced a backlash by rebel MPs from his own Civic Democrats party led by Vlastimil Tlusty, the former finance minister. Mr Tlusty had threatened to vote against the bill, arguing it would make many families worse off.

Mr Topolanek had earlier warned that the ruling coalition would collapse if the package was rejected and the government would be unable to prepare a budget with a deficit of less than 3 per cent of GDP, a key criterion for euro adoption. But some analysts said on Tuesday the reforms did not go far enough to rein in public expenditure as the Czech Republic faces a 3.9 per cent public finance deficit this year.

Under the reforms, social benefits including sick pay, long-term unemployment benefit, one-off new baby payments and child benefit would be cut, while the VAT rate for food and medicine would be raised from 5 per cent to 9 per cent. Fees for consulting doctors would also be introduced.

“The vast majority of steps in this bill are positive and will not worsen the situation for people,” Mr Topolanek insisted on Tuesday.

With GDP growth of 6.4 per cent last year and the finance ministry forecasting 5.8 per cent this year, analysts say now is the time to implement wider-reaching spending cuts.

“These reforms will not dramatically improve the public deficit. There is no reason to cut taxes right now and the government is not tackling the key problem of huge social spending,” said Vadimir Pikora, an analyst with Next Finance.

Ales Michl, an analyst at Raiffeissenbank, said: “These watery reforms lack vision and ambition and do nothing to solve the deficit. The government should be seriously cutting public expenditure particularly in state orders, the health sector and social benefits.”

Pavel Sobisek, an economist at HVB, said that without the reforms euro adoption would be impossible in 2012.

The bill must now be approved by the Senate, where the ruling parties have a majority, and then by President Vaclav Klaus.