Friday, February 15, 2008

Czech GDP Q4 2007

The Czech Republic's economy unexpectedly expanded accelerated in the last quarter of 2007, graowing at the fastest pace in two years, fueled by investment, solid exports and rising employment. Gross domestic product grew at a 7.0 percent annual rate on a seasonally and working day adjusted basis (preliminary data), compared with a revised 6.4 percent in the third quarter, the Czech Statistical Office said today. The Office also announced that the economy grew 6.6 percent in 2007.

The quarterly rate of expansion accelerated from the 1.4% achieved in the third quarter to a full 1.9% in Q4.However it should be noted that the statistics office single out expenditure by health insurance companies, which are classified as part of the general government sector, as contributing to the GDP increase by approximately 0.5 percentage points (ie a good part, if not all, of the acceleration). They suggest that this is probably due to higher demand for health services which remained free till the end of the year and in anticipation of the introduction of medical fees for certain services in 2008. So much of this may well be "one off".

Following the news the koruna had its biggest weekly gain in 5 1/2 years - rising for a fourth succesive week - and at one point was up by as much as 0.7 percent on the day (at 25.080, its highest level ever against the euro), before closing at 25.193 by 4 p.m. in Prague. In the last week it has advanced by 2.4 percent, the fastest rate since June 2002. So far this year the koruna has been the best-performing of the nine European emerging-market currencies, gaining 5.5 percent against the euro.

Household consumption has bolstered the Czech economy's expansion for almost two years now, and is driven by accelerating wage growth, a 30% y-o-y rate of increase in lending and a decade-low jobless rate. The very low number of people now remaining unemployed has given rise to concerns that if the economy should continue to grow as quickly as it is doing currently, then wage-cost driven inflation may get the economy in its grip in the way it has done in other EU10 economies. The average nominal hourly wage in industry rose by 11.3% in December 2007 over December 2006, while the average monthly nominal wage in industry rose by 7.4% in 2007 when compared with 2006.

The extra growth is certainly creating employment, and there were 1.9 percent more people working in the economy during the last quarter of 2007 than there were one year earlier. Still, the statistics office (although it gave no details, for thpse we will have to wait till March) stated that household spending growth slowed in the fourth quarter (retail sales, for which we do now have December figures, rose only at an annual rate of 4.3%), dropping back from the 5.6 percent rate of increase of the previous three months, discouraged perhaps by the 4.4 percent inflation rate experienced over the period.

This change in the structure of Czech GDP growth, with consumer demand accounting for a smaller portion of expansion, and exports and capital investment accounting for more, is fueling central bank optimism that the inflation rate can gradually be clawed back to the mid-point 3 percent target by next year, from the whopping 7.5 percent registered in January.

The bank predicts GDP will grow 4.1 percent this year after an estimated 6.1 percent in 2007, thus being a touch more skeptical than the Finance Ministry who are currently advancing a 4.7 percent growth outlook for this year.

Long Term Structural Problems On The Fiscal Side

There is however still plenty of room for concern about the medium term evolution of the Czech economy. Only last week the European Union reiterated its call for the Czech government to address underlying fiscal pressures linked to the pace of population ageing in the Republic, and stressed that the administration needed to do more to prevent the creation of excessive budget surpluses. The call was made as part of the EU Commission periodic assessment of individual country convergence programmes.

The Czech Republic is by no means the oldest of the EU10 societies, indeed at around 40 the Czech median age is not especially high at this point (even by EU10 standards) - and Slovenia and Bulgaria have higher median ages.

(please click over image for better viewing)

But life expectancy in the Czech Republic is significantly higher than the rest of the group (coming second in this respect only to Slovenia) and hence the weight of pensions expenditure is likely to be greater than in many other states in the region.

As a result of this higher than average EU10 life expectancy, and many years of lowest-low fertility, the Czech population median age is set to rise very rapidly - to around 44 in 2020 - which means that the Czech Republic will soon be older than several West European societies (where there has been higher fertility and more substantial immigration) like France or the UK. And this despite the fact that the Czech Republic has been one of the few EU10 societies to be really proactive on the immigration front in recent years.

The Czech Republic's budget deficit is now within the EU 3 percent of GDP limit, but this is not the Commission's real concern in this report. Rather what are being raised are longer term structural and sustainability questions. The Czech government should "exploit the likely better-than- expected 2007 budgetary outcome to bring the 2008 deficit below the 3 percent of GDP reference value by a larger margin" the EU said in the report since "The Czech Republic remains at high risk with respect to the sustainability of public finances".

Essentially the EU is criticising the Czech Republic for failing to take advantage of the record economic growth to cut spending, overhaul the pension and health-care systems and reduce the deficit so it may be used as a stabilising cushion in the event of an economic slowdown. The Czech Cabinet has responded to the ongoing criticism from the Commission by amending the tax code, cutting welfare spending and imposing health-care fees. But the Commission is far from satisfied, and in particular they have said the following:

The Czech Republic appears to be at high risk with regard to the sustainability of public finances. The initial budgetary position in the programme is not sufficiently high to stabilize the debt ratio over the long-term. The long-term budgetary impact of ageing is well above the EU average, influenced notably by a substantial increase in pension expenditure as a share of GDP as well as a significant increase in health care expenditure. Implementation of structural reform measures notably in the field of pensions and health care aimed at containing the significant increase in age-related expenditures would contribute to reducing risks to the sustainability of public finances. While initial steps have been made to reform the health care system, reform of the pension system still lacks implementation against a definite timetable.
To date the Czech Cabinet has pledged to trim the public deficit to 2.6 percent of GDP in 2009 and to 2.3 percent in 2010, but given the rate of GDP increase, and the rapid rise in the koruna, a strong move in the direction of a budget surplus would seem to be called for.

The Czech administration, which in 2006 abandoned 2010 as the country's euro-adoption date, has pledged to overhaul the welfare, pension and health-care systems in an attempt to ensure that country is in a position to fulfill the EU fiscal rules after it accepts the common currency. One of the problems being faced is that the ruling coalition lacks a sound majority in the Czech Parliament, and has to rely on two former opposition deputies, which makes progress on serious reform an uphill struggle.

But if it remains substantially unamended, the current pensions system will weigh heavily on state finance during the coming years due to the rapidly increasing number of retired people and the shrinking number of potential contributors. The working age population - 15 to 64 - is set to shrink from around 7.25 million now to around 6.4 million in 2025.

While the elderly dependent population - defined as being over 65 - is set to rise from around 1.5 million currently, to around 2.25 million in 2025.

Now the numbers involved here are not excessively large, and the situation can to some extent be eased by immigration, raising participation rates, and raising the retiremnt age beyond 65. But it is important to note that all the countries in the region are facing - to a greater or a lesser extent - the same problem, so it isn't clear where the migrants are to come from, and if they ultimately will arrive from another continent, then this has implications for the cultural model on which these societies have been based to date. Which is not to say that such an outcome is unattainable, but simply that it is not going to be as easy in practice as it perhaps appears to be on paper.

On the pensions side the current problems are threefold: i) the excessive reliance on a PAYGO system, ii) the high level of contrubutions, iii) the low level of the retirement ages. Pension contributions currently total around 30% of employee earnings, of which 7.5 percentage points are paid by employees and 22.5 points by employers. These contribution levels are among the highest in the OECD, and only Hungary, Italy and Slovakia have higher contribution rates.

Following an earlier reform, the retirement age is gradually being increased from 60 to 63 years for men and from a range between 53-57 years to one between 59-63 for women (with the retirement age depending on the number of children they have had) between now and 2013. But such age increases are clearly far from sufficient. As a result the Czech cabinet agreed last Monday to raise the retirement age and lay the basis for wider pension reforms to secure the system's long-term financial stability.

The cabinet sent a bill to parliament which envisages a gradual increase in the retirement age to 65 by 2030 and an extension of the required length of employment. A further proposed step will follow later which involves moving from the current pay-as-you-go scheme to a partially fund-based system where people save for their own pensions. Czech pension payments are expected to reach 306 billion crowns ($17.34 billion) this year, taking up nearly 30 percent of the national budget, and will grow rapidly as the population ages if nothing is done.

Basically the big problem with moving from PAYGO to partially funded schemes is maintaining the payments from the PAYGO system during the transition. As a way of trying to get round this problem the government proposes to set up a fund fed by income from privatisations, with the idea being that the shortfall caused in the old system by the payment diversion into would be made up from the reserve fund. Many Czechs already have private pensions savings, which are supported by government subsidies and tax breaks, but the volume is too low to support them in retirement. The average Czech state pension is 9,111 crowns ($515.9) per month, about 42 percent of the average salary.

Bad Timing or Bad Decisions?

So much for the longer term issues, but the real danger facing the Czech economy at the present time is that a number of faulty short-term decisions, and a certain tardiness in reform coupled with an unhelpful external environment, may well cost the Czech Republic dear in the longer term.

In the first place the recent decision to raise administered prices in January has produced a sharp 2% hike in the annual inflation rate (from 5.4% in December to 7.5%in January). In particular the government raised value-added tax on basic items such as food to 9 percent (up from 5 percent), and introduced a 30 koruna ($1.71) fee for doctor's visits. In total the health service increases added 0.5% to the annual inflation rate. The price of electricity also went up 9.5 percent and natural gas 7.8 percent. State-controlled rents jumped 18.9 percent from their December level.

So the danger is that the application of such measures in an environment where growth is strong, and possibly even above capacity, and the labour market is extremely tight, may simply lead to an ongoing process of second round effects, where wage rises to compenate for inflation (or over and above the inflation rate) simply add more fuel to the underlying inflation dynamic. In order to try and avoid this outcome the central bank will undoubtedly continue raising interest rates. The bank has already raise rates five times since last June - at quarter point intervals (with the last raise being on the 8 February - and the current rate is at 3.75%. The prospect of the bank doing just this, coupled with the comparatively high rate of GDP growth, is already pushing - as we have seen above - the koruna ever onward and upward. If, as now seems likely, the Czech base interest rate should pass an ECB refi rate which was on the way down as the eurozone economy slows, then this upward pressure on the koruna might well accelerate, and the central banks attempts to restrain inflation with conventional monetary policy might well prove thwarted.

Added to this problem of inflation and a rising koruna, is the associated one of the evolution of the Czech trade balance. While the Czech Republic has so far enjoyed a fairly healthy goods trade surplus, this does not come by divine fiat, and changes in relative prices can erode the situation quite rapidly. Exports in December were up 5.2 percent year on year down down substantially from the 20 percent rate in November and the smallest figure in the whole of 2007. For the time being this is simply a seasonal blip, but the whole Czech external trade situation will now need monitoring carefully, and in particular given that the German economy now seems to be slowing, and the Czech economy is inter-locked with Germany (31% of the CRs exports went to Germany in 2007) to a very high degree.

In this context the position of the fiscal deficit of the Czech administration takes on even more importance. As indicated above, the Czech Republic's budget deficit is certainly likely to fall with the EU limit of 3 percent of gross domestic product this year, although the deficit may in fact widen to 2.95 percent of GDP from an estimated 1.9 percent in 2007. The original goal for 2007 was 4 percent of GDP, so the outcome is, in terms of the EU convergence process, not especially bad. But in terms of the current short and medium term macro environment, the projected level of deficit is certainly fraught with risk. Ideally the objective for 2008 should be a budget surplus. This would act as a brake on excessive growth as the koruna rises (since capital funds into the CR in search of yield will definitely increase in the short term) and both the surplus and the newly higher interest rates would provide something of a cushion should further deterioration in the external environment (and especially in Germany) lead the Czech economy to start to slow too rapidly. However, as noted above, the extent of the danger does not seem to be appreciated, and we are still looking at a deficit in the 2 to 3% range. The risk that this may provoke excess inflation which will be hard to eradicate later is real and present, and hence the evolution of the Czech CPI will need to be monitored closely, especially given that January's large base effect is now built in for the whole of 2008. We can only realistically expect inflation to start to come seriously down as we get towards the autumn, and only then if.......

Thursday, February 14, 2008

Czech Industrial Output December 2007

Czech industrial production slowed for a second consecutive month in December as faltering demand in western European countries and a rising koruna curbed Czech exports. Industrial production rose 2.9 percent, compared with an advance of 6.7 percent a month before, bringing the full-year increase to 8.2 percent, the Prague-based Czech Statistical Office said earlier today.

Economic growth in Germany, the No. 1 Czech trading partner, slowed to 0.3 percent in the fourth quarter from 0.7 percent in the third quarter. Expansion of industrial output, which is mostly destined for export, is expected to ease to about 5 percent this year, with the record-strong koruna, scarcity of workforce and rising salaries also contributing to the decline.

Czech December exports were up 5.2 percent on the year, the slowest pace since April 2006.

The average hourly wage jumped 11.3 percent in December. The number of people working in the industry grew 1.2 percent in the last month of 2007. Labour productivity increased 0.5 percent, compared with 5.5 percent in November.

Tuesday, February 12, 2008

Czech Current Account Deficit December 2007

The Czech monthly current-account deficit was the largest since last August in December as an increased number of foreign companies in the Czech Republic repatriated profits.

The monthly shortfall was 20.1 billion koruna ($1.14 billion), compared with a 1.2 billion-koruna deficit in November and a 13.2 billion-koruna gap a year ago, the Prague-based central bank said today.

The Czech current-account balance normally fluctuates according to when foreign investors collect locally earned dividends and profit, which are increasing rapidly as the Czech economy experiences economic growth of around 6 percent for a third consecutive year. With the full-year trade surplus having doubled, it is a good guess that the 2007 current-account deficit will have shrunk to something just under 3% of GDP - 2.8 percent perhaps.

The full-year current-account deficit reached 106.6 billion koruna.

The deficit on the income balance, which includes dividend payouts abroad as well as estimated reinvested earnings by foreigner investors, rose to 24.7 billion koruna in December and to 24.7 billion koruna for the whole of 2007.

The December goods trade surplus was reported as being 1.5 billion koruna, (this compares with a 1.1 billion-koruna surplus estimated by the statistics office last week). The surplus in services trade shrank to 3.7 billion koruna from 5 billion koruna in November, the central bank said.

The financial account for December 2007 showed a surplus of 7 billion koruna. The 12-month figure was 78 billion koruna, and failed to cover the cumulative current-account deficit. The country attracted net foreign direct investment of 18.1 billion koruna in December, a 60 percent increase over November. The central bank estimated reinvested profits at 10.8 billion koruna.

Friday, February 08, 2008

Czech Inflation January 2008

Czech consumer prices jumped a much faster than expected 3.0 percent month on month in January, pushed up to some considerable extent by government tax and health cost increases, putting strong pressure on the central bank to make further increases in a base interest rate that they only raised yesterday.

The Czech Statistical Bureau said on Friday the jump put year-on-year inflation at a nine-year high of 7.5 percent, sending the Koruna up to yet another new record high as currency traders started to bet on future rate rises. The market had expected a 1.9 percent monthly rise and a 6.2 percent annual price rise. The statistical bureau said nearly all of the January rise -- 2.9 percentage points -- could be attributed to the administrative measures.

The government raised value-added tax in January on basic items such as food to 9 percent from 5 percent, and also introduced a fee of 30 crowns ($1.71) for a doctor's visit. The price of electricity advanced 9.5 percent while natural gas was 7.8 percent more expensive. State-controlled rents jumped 18.9 percent from December, the authority said.

New health-care regulatory fees made up 0.5 percentage point to the overall monthly price index while food prices were 2.3 percent higher in the month, led by fruit, vegetables, meat and dairy products.

The inflation data followed a 25 basis point interest rate increase to 3.75 percent on Thursday, which still left rates well below the inflation rate.

The koruna rose to 25.668 per euro as of 1:15 p.m. in Prague from 25.715 before the data was released and from 25.756 in yesterday's late trading.

The ask yield on the government 10-year bond climbed 4 basis points to 4.48 percent. The price fell 0.3, or 30 koruna per 10,000 koruna ($565) face amount, to 100.95, according to Ceska Sporitelna prices. A basis point is 0.01 of a percentage point.

The central bank said in its quarterly forecast published yesterday that it expects inflation to reach 5.3 percent in the fourth quarter of 2008, before it falls to 2.4 percent in the second quarter of 2009 on anticipation that inflation will return to the target next year once temporary costs and administrative shocks start dropping out of the price index later in the year. The key issue now is, of course, the possibility of second round effects in the shape and form of wage rises, and the danger is that a dynamic may be set in motion which will be hard to put a brake on, especially given the tightness in the labour market, the inward movement of funds which will accompany any sustained raising of interest rates, and the availability of cheaper euro denominated currency loans at cheaper rates should the ECB start to head south just as the Czech central bank keeps heading north. In other words what has been a fairly benign win-win situation with interest rates and the Koruna up to now could very easily invert into a lose-lose dynamic.

Thursday, February 07, 2008

Czech Central Bank Raises Main Interest Rate

The Czech central bank raised its main interest rate for a fifth time since May today in a bid to bring the inflation rate down to its 3 percent target by next year. The rate-setting board lifted the two-week repurchase rate a quarter point to 3.75 percent at this year's first session.

The inflation rate climbed to 5.4 percent in December, the highest in more than six year, beating the central bank's prediction for 3.9 percent.

The koruna was trading at 25.623 per euro as of 2:14 p.m. in Prague, compared with 25.582 in yesterday's late trading.

The statistics office may say tomorrow the January inflation rate soared to a nine-year high of 6.5 percent, based on the median estimate of 15 economists. The central bank's October outlook, which will be revised today, put annual price growth at 4.4 percent to 5.8 percent in September and 3.1 percent to 4.5 percent in March 2009.

Czech borrowing rates, which are the highest in six years, are still the lowest in the European Union, trailing the European Central Bank's main lending rate of 4 percent. Futures trading shows investors are betting on the repo rate to peak at 4 percent by June, which would end a 2 1/2-year rate-rise series.

Demand for higher wages from employees who see their buying power eroded from accelerating inflation may thwart the expected drop in the rate back to the central bank's target of 3 percent, plus or minus a percentage point, even after the effect of one-time tax increases and jumping food and oil prices ebbs.

The koruna's almost 12 percent appreciation against the euro since July is helping tame inflation by slashing import prices and weighing on exports. In addition, the economy is seen to grow 4.7 percent this year, after 6.1 percent in 2007, led down by household spending, the Finance Ministry estimated on Jan. 31.

Starting this year, the central bank is reducing the number of monetary-policy sessions to eight from 12. It will also start publishing minutes showing how individual board members voted on rates and will present a non-binding path of future interest rates as suggested by its inflation prediction.

Today, the central bank also decided to increase the discount rate to 2.75 percent and boost the Lombard rate to 4.75 percent. All changes take effect tomorrow.

Wednesday, February 06, 2008

Czech Employment and Unemployment Q4 2007

According to data released last week by the Czech Statistics Office, In Q4 2007, total employment grew by 105.6 thousand year-on-year to reach the highest level achieved in the last eleven years. The number of employees rose by 97.4 thousand and of the self-employed by 10.2 thousand. The number of unemployed - according to ILO methodology - was down by 86.5 thousand year-on-year, while the number of long-term unemployed fell by 62.3 thousand. When compared with Q4 2006, the general unemployment rate in the age group 15-64 decreased by 1.7 percentage points to the lowest level since the end of 1997 (4.9%).


The number of first (main) jobholders in Q4 2007 was 4 967.3 thousand, up by 105.6 thousand more (+2.2%) year-on-year. Employment thus reached it highest level since the start of 1997.

The number of working secondary school graduates with the maturita examination increased significantly (+66.6 thousand), and employed university and higher professional school graduates were also up (+28.1 thousand). This seems to be associated with a rapid growth in the education level of the young Czech population.

The number of employees increased by 97.4 thousand year-on-year to 4 155.1 thousand and their share in total employment was 83.6%. The number of the self-employed including family workers recorded a year-on-year rise of 10.2 thousand to 798.7 thousand and the share of the self-employed sector in total employment slightly decreased compared to Q4 2006 and reached 16.1%.

The growth in total employment largely took place in the secondary sector (industry incl. construction) where the increase of persons in employment (+73.1 thousand) was nearly twice as high as the increase in the entire tertiary sector (all services incl. transport). Employment grew the most in manufacturing (+60.7 thousand); the Czech Republic has the highest percentage of people employed in manufacturing (28.8%) among all the EU countries.

Employment rate

This is the proportion of first (main) jobholders in the total 15-64 age group, and it reached 66.5% in Q4 2007, up by 0.9 percentage points year-on-year. Male and female employment rates grew by 1.3 percentage points to 75.5% and by 0.5 points to 57.4% respectively. The increase of first (main) jobholders was partly offset by a drop in the number of second jobholders (decrease by 13.7 thousand to 83.3 thousand).


The average number of unemployed - using ILO methodology - decreased by 13.6 thousand quarter-on-quarter (seasonally adjusted). The total number of unemployed reached 252.8 thousand (of which 143.6 thousand were females), which was the lowest level since the mid-1997. In comparison to Q4 2006, the total number of the unemployed decreased by 86.5 thousand (-25.5%).

Generally, unemployment dropped more rapidly among persons in the young and middle working age groups. Male unemployment dropped more (by 44.9 thousand), especially in the five-year age group 20-24 (by 10.4 thousand). Female unemployment decreased by 41.6 thousand year-on-year, most in the young age group 20-24 (by 11.6 thousand). A majority of all the unemployed (71.5%) are persons with secondary education without maturita examination and persons with basic education.

The number of persons unemployed for one year or more decreased by 62.3 thousand year-on-year to 122.8 thousand and their percentage is below half of all the unemployed (48.6%). This percentage of the long-term unemployed is still high within the EU. An extraordinarily high percentage of persons out of work for a long time can be found in the group of the unemployed with basic education (65.1% of all unemployed persons with basic education); in the group of unemployed persons with secondary education without maturita examination the percentage is 46.2%. The total number of persons unemployed more than four years decreased by 8.7 thousand to 49.5 thousand (19.6% of the total number of unemployed persons).

Unemployment Rate

The general unemployment rate according to the International Labour Organisation (derived for the age group 15-64) reached a ten-year minimum of 4.9% in Q4 2007. Compared to Q4 2006 it decreased by 1.7 percentage points. The general unemployment rate in the Czech Republic is in the long-term below both the EU25 average and the euro area average.

Czech Republic Foreign Trade December 2007

The Czech Republic posted its first trade deficit in four months in December as demand for Christmas gifts bolstered imports and exporters reduced production during the holiday season. The full-year surplus was however in surplus and the value rose to a record. The deficit of 1.1 billion koruna ($64 million) was the smallest December shortfall ever, and compared with a 11.3 billion-koruna surplus in November and a 3.7 billion-koruna deficit a year ago, the Prague-based statistics office said earlier this week.

The full-year surplus was a record 86.1 billion koruna, and was largely driven by orders for Czech-made vehicles, machines and home equipment from other European Union countries. This has its good side and its bad side, since this EU dependence of course makes the Czech economy vulnerable to any EU wide slowdown like the one we are now entering. The 2007 surplus more than doubled from 39.8 billion koruna a year before, and the koruna rose to a record 25.580 per euro on the news.

Exports in December were up 5.2 percent on the year to 178.3 billion koruna. The value was down some 20 percent from November and the smallest figure last year, seasonally this is not surprising On the whole of 2007 they were up 15 percent on 2006.

The other 26 EU countries bought 14 percent more Czech products in 2007, while local exporters last year shipped 21 percent more goods to neighboring Slovakia.

Imports in December rose at an annual 3.6 percent to 179.4 billion koruna. The whole year goods trade surplus shrank however by 1.9 billion koruna on 2006, largely as a result of rising household spending. Czech imports increased by 13 percent in 2007 when compared with 2006.

So the drop in the trade surplus in December is not surprising given the time of year, but if we look at the year on year rate of increase in both imports and exports (see chart below) we will see that these have been slowing steadily since the summer, and this could be something of a warning signal, especially if conditions deteriorate in the main export destinations.

Bloomberg quote Michal Brozka, an economist at Raiffeisenbank AS in Prague, as saying:

"Besides the strong koruna, Czech exporters will suffer this year from the faltering economies of our main trading partners and from domestic conditions such as higher interest rates and a tightening labor market, which is pushing for higher salaries"

I think this is the main point, especially as the labour market tightens (see my next post) since Czech unemployment is now at its lowest level in more than a decade, causing a dearth of workforce in the economy and threatening to trigger accelerated pay rises.

In addition, due to inflation concerns the central bank is expected to raise its benchmark interest rate to 3.75 percent this week in a fifth increase since May, although it remains to be seen whether in the short term this has the desired effect of cooling the economy, or simply serves to attract more capial inflows and to encourage more Czech citizens to start contracting swiss franc or euro denominated loans as interest rates start to fall elsewhere.