Czech Republic Economy Watch

Eastern European Growth - Coming Rapidly Off The Boil?

2011-08-22T09:30:00.000-07:00

The latest round of EU GDP data, brought to light a reality which many who have been closely following the economies of Eastern Europe already suspected: that the heavily export dependent economies in the region would almost inevitably be dragged down by the rapid slowdown in Europe's principal economic motor, the German economy (see this post for background).

The Czech Republic, Hungary, Slovakia, Bulgaria and Romania all reported slower GDP growth in the second quarter, due in large measure to the disappointing performance of their German neighbour, central Europe’s most important trading partner.

As anticipated on this earlier blog, the Hungarian results were especially weak. Analysts had widely predicted interannual growth of just under 2.5%, but in the end the result came in at 1.5%. Even worse, the economy completely failed to grow in the second three months in the year, since quarter on quarter growth was effectively zero. Thus the increase in industrial activity which accompanied the increased demand for exports was only sufficient to compensate for the drop in internal demand, and this at a time of near record export levels in many European countries. This is doubly worrying since the government, while continuing to reduce the deficit, has appropriated something like 9% of GDP from a one off pension move, paying down debt and, in addition, adding some support to this years spending programme. This factor will not be there to assist growth in the years to come.

This post will examine the growth performance in a number of the region's economies, and attempt to extract some useful conclusions for what we can expect to see in the region in the future.

The Czech Republic Shows Its Weaknesses

Mirroring what just happened in Germany, second quarter GDP growth in the Czech republic slowed from what had been the fastest pace in almost three years achieved in the first three months of the year, to a mere 0.2%, the slowest rate of increase in two years.

While the economy grew 2.4 per cent from a year earlier, compared to 2.8 per cent in the first three months of the year.

Like many economies in the region, the Czech one is now strongly dependent on foreign demand for its products. Exports have surged back up and beyond pre-crisis highs, while industrial output has grown strongly.

What makes the Czech case interesting is that neither the private nor the public sector is heavily indebted - public sector debt was only 41.3% of GDP in 2010, and the country's external debt was only 46.7% of GDP. Nor is the country facing an "investor strike", the central bank policy rate is currently 0.75% , and far from this deterring people from holding the currency, the Koruna has gained nearly 2.4% against the euro so far this year, as compared with a decline of around 10 per cent in the Polish zloty. Indeed some are even talking of the Koruna as a potential safe haven alternative to the Swiss Franc.

The government deficit has been over the EU 3% limit (it stood at 5% of GDP in 2010) and recent government austerity measures to reduce this level have undoubtedly played some part in the slowdown, but this on its own is not enough to fully explain the velocity of the reduction. As I argue in my most recent post on Germany, export driven economies are inherently volatile, and what has happened in the Czech Republic is an almost classic example. But why is the country export dependent? Well, there are probably as many answers offered to this question as there are economists, but my own personal view is that demography is the key. After decades of very low fertility, the country's population is ageing rapidly, and by 2020 the median age will be nearly 45, making the Czech Republic the second oldest nation in the region, after Slovenia.

Many will see no significance in this fact, but from where I am sitting the association is not simply coincidental (see this working paper from Claus Vistesen).

A number of "stylised facts" can be extracted from the Czech example. In the first place, if we look back at the q-o-q GDP chart (the orange/red one), what is most noteworthy is how the rate of quaterly growth since the crisis has fallen to about half its prior level. This, in an economy without major debt problems and with a fairly competitive economy must give us some idea of what the "new normal" looks like. GDP growth is much lower, and likely to remain lower (on average) as far ahead as the eye can see.

In the second place, construction output is down (and falling). This also seems to form part of the brave new world we now live in, at least as far as most of Europe, the US and Japan are concerned. A house is once more becoming something you live in.

And thirdly, as I say, domestic demand is falling steadily, as reflected in retail sales (naturally in the more heavily indebted economies this situation is worse). This weakness in domestic demand is unlikely to be temporary, and those waiting for a turnaround would do better going and waiting for Godot.

This persistent weakness in domestic consumption is all the more striking in the Czech case, given that real GDP is now almost back at pre-crisis levels.

The Czech example is illustrative, since it is one of the best case scenarios, and unfortunately, when we look at the regional neigbours, we find that in general things only get worse.

Romanian Growth Holiday

Romania has struggled far longer than any other CEE economy to emerge from recession, only grew (q-o-q) by 0.1%, following a 0.7% quarterly rate of increase in the first quarter.

Even though there is some discrepancy between the data published by the national statistics office and by Eurostat, it is clear that Romanian GDP is barely up from one year ago.

And indeed is still something like 8.5% below its pre-crisis peak.

This despite the fact that exports have been booming, and are now above the pre-crisis level.

As per the regional pattern, domestic demand has not recovered and retail sales are falling.

Construction is well down, and is unlikely to return to pre-crisis levels.

But Romania and the other countries we are about to look at suffer from an additional problem - the have significant external debt levels, and despite the activation of the so called Vienna initiative they continue to suffer from very tight credit conditions.

Total Romanian government debt is not high (only just over 35% of GDP), but the country does suffer from deficit problems (6.5% of GDP in 2010), while external debt is over 70% of GDP (a lot of this in forex loans to the private sector). The country continues to run a significant current account deficit (4.2% of GDP in 2010):

and inflation has been far higher than is desireable, given that the country cannot easily devalue to restore competitiveness given the external debt exposure.

True, the inflation rate was exacerbated by a 5% VAT rise in July 2010 and the annual rate has now fallen back from 8% in June to 4.9% in July, but I really would question the wisdom of the widespread recourse to VAT rises made by the IMF, since while they do offer a fairly quick short term fix to deficit issues, they only compound growth and external competitiveness problems, in particular in cases where devaluation is not a quick'n easy option.

Bulgaria's Limp-along Economy

The Bulgarian case is not dissimilar to the Romanian one, even though the economy did return to growth in the second quarter of last year. Growth screeched to a virtual halt in the most recent quarter (0.1% q-o-q):

while interannual growth slowed to 1.9% from 3.4% in the first quarter.

Bulgarian GDP has recovered rather more than it has in Romania, but at the end of June it was still more than 7% down from the pre crisis peak level.

The explanation for the weak recovery is the same as elsewhere, with domestic consumption stagnant, and retail sales in tendential decline.

Construction has also slumped significantly.

In addition to the credit crunch which is to be found elsewhere, Bulgaria faces the added difficulty that many banks are Greek owned, and are themselves facing a liquidity stretch at home.

Yet despite the Euro peg the country continues to run a sizeable inflation rate, and competitiveness - as measured by the REER - continues to deteriorate. Thus an export sector which in value added terms is already too small for the job it has to do is facing headwinds which don't exactly encourage expansion.

Hungary Had No Boom, But The "Bust" Continues

Hungary's GDP growth basically stalled in the second quarter (0.0% q-o-q), taking the year-on-year rate down from 2.4% to 1.5% in the first quarter. This is well below consensus expectations (2.5%) and also worse than the central bank forecast of around 2.2%. The pull from net trade evidentally weakened substantially, and in an economy that only has one cylinder to fire on (exports) this makes itself noticed quickly.

Hungarian exports have risen well since early 2009, but in recent months growth in both these and industrial output has tapered off.

Hungarian GDP is still over 8% down from the pre-crisis peak.

Household consumption has not recovered at all, and retail sales continue to fall.

Again, construction activity is trending down.

The Hungarian current account has recovered considerably, and the country now runs a surplus, unfortunately not a large enough one to underpin stable growth.

The stock of CHF private sector loans is equivalent to approximately 20% of GDP, most of it made up of household loans (18% of GDP). Roughly half of these loans are mortgages, and the other half consists of home equity loans. As shown in the chart below (housing loans only, but representative of the whole), most of these loans were contracted in 2005- 08, when the consensus view was that the forint was in a secular appreciation trend versus EUR as well as CHF and Hungarians felt safe about borrowing at much cheaper foreign interest rates. People were focused on the repayment size, and not the capital value movements, rather like people have recently been focusing on public deficit issues, without thinking too much about debt dynamics (until Italy came barging along, that is).

In 2005, the average rate for a home equity loan in CHF was 4.8%, compared to 6.2% in EUR and 17.6% in local currency.The upward surge in the CHF together with increases in interest rates on CHF loans since these were intitially taken out means that the repayments on these mortgages have risen significantly. Morgan Stanley estimate that the average repayment on a CHF mortgage taken out over 2005-07 is up over 50%.

Carrying out some simple back-of-the-envelope calculations they also arrived at the conclusion that servicing this debt at an 8% interest rate costs Hungarians around 2% of GDP every year. Absent the adverse FX shock, servicing costs would have been around 1.4% of GDP. The 0.6% difference can be seen as a kind of growth penalty, hamstringing what would already have been pretty weak domestic consumtion. According to Morgan Stanley calculations, the rise in CHF since 2008 has had the equivalent impact on Hungarian FX borrowers of a 6% rate increase.

And it isn't only householders who are suffering from Forex risk. Hungary's gross external debt is around 135% of GDP. The country has the largest public debt in the region (around 80% of GDP), and although one off measures with the pension system mean that this will fall this year, the upward path may then resume unless the country has a growth revolution. Worse, 45% of public debt is not in Forints (and some of it is even in Swiss Francs), meaning that currency depreciation risk exists. All in all, it is very had to see the country being able to find its way onto a sustainable debt path.

Drifting Towards Export Dependence Too Slowly For Comfort?

The recent enthusiasm we have seen for the East European model has a nasty and worrying precedent, since in the years leading up to the financial crisis those who lauded the merits of the European Union’s newest members were not few in number. They were seen as the high-growth members of the Union who had learnt the costly lessson that big government was to be strenously avoided. Such was the enthusiasm that even the very evident and very substantial current account deficits were considered almost benign. But then, as even, after pride came the fall, as one country after another had financing difficulties and became forced to call in the IMF.

Now countries in the East are cited for their low debt, and capacity to accept sacrifices in avoiding excessive deficits. Two issues stand out as important: the prevalence of unhedged forex debt and the regions unique demographics. Just like in the Euro Area's Southern Periphery the presence of forex borrowing severely limits devaluation as a potential competitiveness restorer, while ageing and declining populations mean that the economies are increasingly export dependent. This means they often have both increased exposure to global slowdowns (or recessions), combined with an external financing dependency when sources of funding may rapidly dry up.

Evidently, societies with young, growing populations can hope that the sheer pace of economic growth will eventually burn down their debt, but societies with shrinking populations, and rapidly rising elderly dependency ratios cannot adopt such a complacent attitude. Older societies are normally lower growth societies, and in addition, with the number of people of working age falling and falling, an ever greater burden falls on an ever smaller labour force. All four countries in our sample are pioneeers in this regard, sounding out the frontiers of a world in constant decline, a world which is ever older.

This post first appeared on my Roubini Global Economonitor Blog "Don't Shoot The Messenger".

From Original Sin To The Eternal Triangle - Lessons From Central Europe

2009-08-14T02:02:00.000-07:00

The non-biblical concept of original sin, as Claus Vistesen notes in this post, when propounded in its standard Obstfeld & Krugman textbook version refers to the situation where many developing economies who are not able to borrow in their own currencies feel forced to denominate large parts of their sovereign and private sector debt in non-domestic currencies in order to attract capital from foreign investors - as evidenced most recently in the countries of Central and Eastern Europe. Well, piling insult upon injury, I'd like to take Claus's point a little further, and do so by drawing on another well tried and tested weapon from the Krugman armoury, the idea of the "eternal triangle".

As is evident, the reality which lies behind the current crisis in the EU10 is complex, and has its origin in a variety of causes. But one key factor has undoubtedly been the decisions the various countries took when thinking about their monetary policy and currency regimes. The case of the legendary euro "peggers" - the three Baltic countries and Bulgaria - has been receiving plenty of media attention on late, and two of the remaining six (Slovenia and Slovakia) are now members of the Eurozone, but what of the other four, Romania, Hungary, Poland and The Czech Republic? What can be learnt from the experience of these countries in the present crisis.

Well, one convenient way of thinking about what just happened could be to use Nobel Economist Paul Krugman’s Eternal Triangle” model (see his summary here), which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.

In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.

The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.

A second problem which stems from this "initial decision" has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.

The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.

So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions - to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to "grin and bear" higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.

Appendix

Here for comparative purposes are charts illustrating the varying degrees of economic contraction, inflation, and interest rates. GDP contraction rates actually present a little problem at the moment, since one of the relevant countries - Poland - still has to report. However Michal Boni, chief adviser to the Prime Minister, told the newspaper Dziennik this week that the economy expanded at an annual rate of between 0.5% and 1% in Q1. So lets take the lower bound as good, it is still an expansion.

The economy in the Czech Republic contracted by an estimated 4.9% year on year in the second quarter.

The Hungarian economy contracted by an estimated 7.4% year on year in Q2.

While the Romanian economy contracted by an estimated 8.8% year on year.

Inflation Rates

Poland's CPI rose by an annual 4.2% in July.

The CPI in the Czech Republic rose by an annual 0.3% in July.

Romania's CPI rose by an annual 5.1% in July.

Polands CPI rose by an annual 5.1% in July.

Interest Rates

The benchmark central bank interest rate in Poland is currently 3.5%.

The benchmark central bank interest rate in the Czech Republic is currently 1.25%.

The benchmark central bank interest rate in Romania is currently 8.5%.

The benchmark central bank interest rate in Hungary is currently 8.5%.

Czech Exports Slide

2009-04-07T14:18:00.000-07:00

Czech external trade was down again in February, with exports and imports falling by 22.2% and 21.5% year-on-year respectively. The trade balance was in surplus (by CZK 8.7 bn), down by CZK 4.3 bn (or around a third) year-on-year. The trade balance was negatively affected by a fall of CZK 5.8 bn in the machinery and transport equipment surplus.

Seasonally adjusted exports were down by 0.9% and imports by 2.9%, month-on-month. Due to the depreciation of the koruna against the two major currencies, external trade decreased at a more rapid pace when measured in euros (exports -30.6%, imports -30.0%) and in US dollars (exports -39.8%, imports -39.3%), although it should be remembered that February 2008 had one working day more than February 2009.

The trade surplus with the other EU member states fell by CZK 4.3 bn while the trade deficit with non-EU countries decreased by CZK 1.9 bn. The trade balance deteriorated with Poland (by CZK 2.4 bn) and the United States (by CZK 1.0 bn) as surplus turned into a deficit. Surplus fell in trade with the United Kingdom (by CZK 1.4 bn), Italy and Romania (both by CZK 1.3 bn), Spain and Sweden (both by CZK 1.1 bn) and Slovakia (by CZK 1.0 bn), and trade deficit with China deepened (by CZK 0.9 bn). Trade balance improved with Germany (surplus up by CZK 6.0 bn as imports dropped more than exports). The trade deficit decreased with Japan (by CZK 1.8 bn), Korea (by CZK 1.7 bn) and the Russian Federation (by CZK 1.4 bn). The trade balance improved with Turkey (by CZK 1.4 bn) as deficit turned into a surplus.

Topolánek's toppling leads to early Czech election

2009-03-31T11:53:00.000-07:00

by Manuel Alvarez-Rivera, Election Resources On The Internet

The Czech Republic will be holding an early general election later this year - nearly a year ahead of schedule - after the center-right coalition government of Prime Minister Mirek Topolánek was brought down last week in a parliamentary no-confidence vote. Topolánek, who submitted his resignation last Thursday but remains as caretaker head of government and leader of the Civic Democratic Party (ODS) - the largest party in the Central European country's bicameral legislature - subsequently reached an agreement with former Prime Minister Jiří Paroubek, the leader of the Czech Social Democratic Party (ČSSD) - the main opposition force - to hold an early poll next October; a specific date remains to be determined.

Prime Minister Topolánek came to office following a closely fought general election in June 2006, which left the Chamber of Deputies - the lower house of the Czech Parliament - evenly split between left- and right-wing parties. However, in early 2007 Topolánek was able to secure a parliamentary majority with the help of two rebel ČSSD deputies, and he went on to survive four no-confidence motions during the course of 2007 and 2008. Nonetheless, his government depended upon a fragile majority, which was finally shattered when four dissident deputies - two from ODS, plus two recently expelled from the Green Party (SZ) - sided with ČSSD and the Communist Party of Bohemia and Moravia (KSČM) to pass by 101-96 a vote of no-confidence.

Coincidentally, the fall of the Czech government came on the same day that Topolánek - who currently holds the European Union's rotating presidency - made headlines around the world when he criticized the economic stimulus program of U.S. President Barack Obama as "the road to hell." While the vote of confidence was triggered by allegations of abuse of state subsidies by a deputy who left ČSSD to support ODS, some opposition deputies voted to bring down Topolánek as a protest against his government's economic policies, which according to them failed to deal effectively with the global financial crisis; although the Czech economy is not in as dire straits as those of other nearby countries (such as Hungary), the Czech Republic is nonetheless forecast to suffer a recession this year.

Opinion polls have ČSSD ahead of ODS; that said, the gap between the two parties appears to be narrowing down. Nonetheless, the Social Democrats are hoping for a repeat of their performance in last October's regional and Senate elections, in which ČSSD captured 23 of 27 Senate mandates up for renewal, depriving ODS of its absolute majority in the upper house of Parliament. Although it has some ex-Communist members, ČSSD is not a post-Communist party; unlike major left-of-center parties in other Eastern European countries, it traces its roots to the Social Democratic Party that was forcibly merged with the Communists in 1948. However, the Czech Social Democrats have to compete on the left with the Communists, who still command a significant following.

The Czech Chamber of Deputies is elected by party-list proportional representation in regional constituencies - Parliamentary Elections in the Czech Republic has a review of the Czech electoral system - and no single party has ever commanded an absolute lower house majority. Moreover, the ongoing presence of a sizable, unreformed Communist Party has greatly complicated the task of forming stable governments in the Czech Republic. While the Social Democrats have called upon Communist support from time to time (as they did for last week's no-confidence vote), neither them nor the parties to their right regard the Communists as suitable coalition partners, largely for historical reasons: save for the short-lived "Prague Spring" of 1968, the Communist Party governed Czechoslovakia - the now-defunct federation of the Czech Republic and Slovakia - in a totalitarian fashion from 1948 to 1989, when the Velvet Revolution put an end to the Communist regime.

As a result, since 1996 the Czech Republic has been ruled either by shaky coalition cabinets, such as those formed from 2002 to 2006 by ČSSD and the four party coalition headed by the Christian and Democratic Union-Czechoslovak People's Party (KDU-ČSL), and from 2007 to the present by ODS, KDU-ČSL and SZ; or by minority governments dependent upon the good will of the opposition, as was the case from 1998 to 2002, when ODS reached an "opposition agreement" with ČSSD under which the Civic Democrats tolerated Milos Zeman's minority Social Democratic government without supporting it.

In fact, Topolánek may have to reach out to the Social Democrats in order to secure Senate passage of the Lisbon Treaty, which would streamline the functioning of the European Union. While Topolánek is in favor of the treaty, many Euroskeptics in ODS remain opposed to it, as is President Vaclav Klaus, the former leader of the Civic Democrats.

At this juncture, it remains unclear what will happen to Prime Minister Topolánek's outgoing government until the election is held. ČSSD leader Paroubek declared that he is willing to tolerate the government until the end of June (when Sweden takes over the EU presidency) if certain conditions are met, but favors the appointment of an interim government of non-party experts after that date. Meanwhile, Topolánek insists on remaining in office, but he and President Klaus - who has the right to appoint the next government - are political enemies, and not surprisingly Klaus is proposing the formation of a new cabinet without further delay. However, Czech governments require majority support in the Chamber of Deputies in order to remain in office, and in light of last week's events it appears rather unlikely that such support would be forthcoming.

Czech Industrial Output Drops By 23.3% In January

2009-03-23T08:57:00.000-07:00

Czech industrial output fell the most in at least 16 years in January, the fourth successive month of contraction. Output was down 23.3 percent following a revised 12.8 percent slump in December. The drop was the highest since Czech Reublic came into existance in January 1993.

The slowdown in the euro region, which is the main market for Czech goods, is really hurting exports, and both the central bank and the Finance Ministry are cutting their 2009 forecasts. Central bank Governor Zdenek Tuma estimates that the economy may contract by as much as 2 percent this year. Others put the size of the contraction much higher:

“The slump of industrial output confirms fears that the economy may contract 3 percent to 4 percent this year,” said Vojtech Benda, senior economist at ING Wholesale Banking in Prague, in a note to clients. “For the central bank, it presents quite a clear argument for another lowering of interest rates, which could be outlined after the Thursday meeting.”

The central bank, which has cut the benchmark repurchase rate to 1.75 percent, meets again this week Most analysts feel they will keep rates unchanged, but as we see above Vojtech Benda is not so sure, and looking at today's data I am inclined to agree with him.

Strong Contraction In Eastern Europe Forecast

According to a study out today by Capital Economics East Europe’s gross domestic product will shrink 6 percent on average this year, with every single economy in the region posting a contraction.

The biggest decline (15 percent) will be in the Baltics. Poland is forecast to contract by 3 percent. The polish decline will be lead by a drop in industrial output that will help push the unemployment rate to close to 15 percent. Falling tax receipts will widen the fiscal gap to 5 percent of GDP, making the goal of euro adoption in 2012 unlikely.

Hungary and Romania, which is negotiating external aid, will both shrink by 7.5 percent. Turkey will also shrink 7.5 percent, while Ukraine’s and Estonia’s output will decline by 10 percent. Bulgaria, expected to shrink 5 percent this year, is likely to follow its neighbor Romania in applying for an IMF loan as a collapse of exports and inward investment will shrink the money supply, forcing the government to drain its fiscal reserves to restore liquidity. Capital Economics argue Bulgaria's reserves will only cover their needs for a further six to 12 months.

Update Czech Central Bank Leaves Interest Rates Unchanged

The Czech central bank left its benchmark interest rate unchanged on concern that a reduction would further weaken the koruna and spark inflation. The Prague-based Ceska Narodni Banka kept the two-week repurchase rate at 1.75 percent. So concerns about the Koruna have won out over growth in the short term.

How Not To Manage Eastern Europe's Financial Crisis (Part 1)

2009-03-04T11:52:00.000-08:00

"Saying that the situation is the same for all central and eastern European states, I don't see that......you cannot compare the dire situation in Hungary with that of other countries."
Angela Merkel, Brussels, Sunday

"Happy families are all alike; every unhappy family is unhappy in its own way"
Tolstoy

In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.
Paul Krugman

Bank regulators from Bulgaria, the Czech Republic, Poland, Romania and Slovakia met today and issued a joint statement, ostensibly to reduce the some of the impact of what they term "alarmist comments" from the Austrian government about how the regional banking system is now in such a precarious state that it requires urgent action at EU level to prevent meltdown. The Austrian government are, of course, concerned about the impact of any meltdown on their own banking system. The result of this "reassuring statement" can be seen in the chart below (10 years, HUF vs Euro).

Within minutes of the joint statement Hungary's currency plummeted to an all-time low against the euro and to a 6.5-yr low versus the US dollar. In fact the HUF rapidly depreciated to 312 per euro from 307.50 before climbing back in later trading to 310. And the reason for this swift reaction? Hungary was not invited to join the statement. As the forint plunged, Hungary 's banking regulator hurriedly signed up to the statement, blaming the original omission on a communications mess-up, but the damage was already done.

“Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region. It is thus important first to distinguish between the EU Member States and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups."

Well this just takes us back to Tolstoy, each of them have their own specific problems, but the underlying reality is that they all face problems, and are vulnerable, each in their own way.

Hungary's economic fundamentals are clearly much weaker than those to be found in the Czech Republic and Poland as things stand, but what about Bulgaria and Romania? And the Czech Republic and Poland are about to have a pretty hard time of it as a result of their export dependence on the West, and Poland has the unwinding of the zloty options scandal still to hit the front pages. So there is plenty of food for thought here before throwing Hungary to the wolves. A default in Hungary could very easily lead to contagion elsewhere, and then the impact in the West is very hard to foresee. We should not be playing round with lighted matches right next to our fireworks stock. "Hey, it's dark in here" and then "boom".

Yesterday it was Latvia's turn, and the cost of protecting against a Latvian default (Latvia is the first European Union member priced at so- called distressed levels) rose to a record following the announcement that the unemployement level rose from 8.3% in December to 9.5% in January, the highest level in nearly nine years. In fact credit-default swaps linked to Latvia increased nine basis points to an all-time high of 1,109 basis points, according to CMA Datavision in London. The cost is above the 1,000 level, breached last week, that investors consider distressed, and is now about 270 basis points above contracts linked to Lithuania, the next-highest EU member.

So two countries are being systematically detached here - Latvia and Hungary - and statements by EU leaders are unwittingly aiding and abetting the process. But we should all remember, after they have eaten Latvia and Hungary for breakfast, the financial markets will undoubtedly chew on other luckless countries over lunch (Romania's Q4 GDP data was out today, and it was a shocker, and S&P have already said they are "closely monitoring" the situation), before perhaps moving on to bigger game for supper.

And we should remember here, no one is too big to fall, and I have already been warning about the gravity of Germany's situation, with a rapidly ageing population, a hefty bank bailout of its own to swallow, and total export dependence for GDP growth. Final data from Markit economics out today showed that Germany's composite PMI fell to 36.3 in February from 38.0 in January. That was the lowest level registered since the series began in January 1998. And it means that the German economy - which is highly interlocked with the whole of Eastern Europe (Austria holds the finance and Germany the industrial exposure) - is certainly contracting more rapidly in the first quarter of this year than it was in the last quarter of 2008, and may well contract in whole year 2009 by something in the order of 5%. So maybe someone over there in Germany should be reading the poem you will see below aloud to "our Angela" right now (Oh, and if you don't speak German, you can find a translation here).

Als die Nazis die Kommunisten holten,
habe ich geschwiegen;
ich war ja kein Kommunist.
Als sie die Sozialdemokraten einsperrten,
habe ich geschwiegen;
ich war ja kein Sozialdemokrat.

Als sie die Gewerkschafter holten,
habe ich nicht protestiert;
ich war ja kein Gewerkschafter.

Als sie die Juden holten,
habe ich geschwiegen;
ich war ja kein Jude.

Als sie mich holten,
gab es keinen mehr, der protestieren konnte.

What Last Weekend's EU Summit Did And Did Not Achieve

2009-03-04T11:50:00.000-08:00

Well reading the press on Monday morning it would have been fairly easy to reach the conclusion that nothing really happened yesterday in Brussels, and that a great opportunity was lost. The latter may finally be true, but the former most certainly is not.

Let's look first at what was not decided on Sunday. The leaders of the 27 member countries in the European Union most certainly did not vote to back a proposal from Hungarian Prime Minister Ferenc Gyurcsany for a 180-billion-euro ($228 billion) aid package for central and eastern Europe. They did not back it because it was not even seriously on the agenda at this point. These people move slowly and we need to talk them throught one step at a time. So what was on the agenda. EU bonds for one, and accelerated euro membership for the East for a second. And once we have the EU bonds firmly in place, then that will be the time to decide how we might use the extra shooting power they will bring us (boosting the ECB balance sheet would be one serious option they should consider, see forthcoming post from me and Claus Vistesen). That is when the emergency blood transfusion Gyurcsany was rooting for might come into play, but on this, as on so many items, the details of how we do what we do as well as the "what we do" will become important, so the moves we do take need to be well thought out, and systematic, they need to get to the roots of the problem, and not simply respond to problems on a piecemeal, reactive basis.

As Paul Krugman puts it "In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral." Amen to that!

But let's look at little bit deeper at what has been decided, or if you prefer, at what has been floated, and may be "decided" at the next meet up. Well for one, we have promised not to be protectionist, and for another, The World Bank, The European Bank for Reconstruction and Development (EBRD) and The European Investment Bank (EIB) have launched a two-year plan to lend up to 24.5 billion euros ($31.2 billion) in Central and Eastern Europe. This sounds a bit like trying to drain an Ocean with a teaspoon, and it is, so predictably the financial markets were not too impressed, expecially when they learned that not much of what was promised was going to be new money (as opposed to theacceleration of existing commitments), and especially when we take this sum and compare it with the likely quantities which are needed to "take the bull by the horms". EBRD President Thomas Mirow (who is more likely to give a low side estimate than a high side one) recentlly told the French newspaper Le Figaro that in his view Eastern European banks could need some $150 billion in recapitalisation and $200 billion in refinancing to stave off the risk of a banking failure in the region. At least.

"(It) sounds like a lot of money, but when (commercial) banks have lent Eastern Europe about 1.7 trillion dollars, 25 billion is peanuts," said Nigel Rendell, emerging markets strategist at Royal Bank of Canada in London. "Ultimately we will have to get a much bigger package and a coordinated response from the IMF, the European Union and maybe the G7."

So let's now move on to the positive side of the balance sheet, since as we know our leaders are a slowish bunch when it comes to grasping what is actually going on here, and an even slower group when it comes to acting on that knowledge once it has been acquired. The biggest plus to come out of last weekend's thrash is most definitely the fact that the idea of accelerating membership of the eurozone for the Eastern countries has now started to gain traction, if with no-one else then at least with Luxembourg Prime Minister (and Finance Minister, he is a busy man) Jean-Claude Juncker, aka "Mr Euro", who was quoted by Reuters on his way into the meeting saying he did not expect any early change to accession criteria for the single currency.

"I don't think we can change the accession criteria to the euro overnight. This is not feasible," Juncker told reporters as he arrived for a summit where non-euro eastern countries are due to call for accession procedures to be accelerated after their local currencies have taken a hammering on markets.

While in the news conference following the meeting he said that there was now a consensus that the two-year stability test required for a currency of a country hoping to join the euro zone should be discussed.

"I can understand that there may be a slight question mark over the condition that one needs to be member of the monetary system (ERM2) for two years, we will discuss this calmly," Juncker told a news conference after a meeting of EU leaders.

So something actually went on during the meeting, even if we are largely left guessing about what. Angela Merkel also left a similar impression that movement was taking place. "There are requests to enter ERM 2 faster," Merkel is quoted as saying. "We can have a look at that."

Now I have already spelt out at some length why I think the Eastern Countries should be offered accelerated membership of the eurozone forthwith (see this post) as has Wolfgang Munchau (in this FT article here).

The Economist, in a relatively sensible leader which I have already referred to, divides the Eastern countries into three groups. Firstly there are those countries that are a long way from joining the EU, such as Ukraine, Turkey and Serbia. As the Economist points out, while it would be foolhardy practically and hard-hearted ethically to simply stand back and watch, European institutions are pretty limited in what they can do apart from offereing some timely financial help or some sound institutional advice, and it is entirely appropriate that the main burden of pulling these countries back from the brink should fall on the International Monetary Fund.

Then there are those East and Central European Countries who are themselves members of the Union, and here it is the EU that must take the leading role. A first group of these is constituted by the Baltic trio (Estonia, Latvia and Lithuania) and Bulgaria, who have currencies which are effectively tied to the euro, either through currency boards, or pegged exchange rates. Simply abandoning these pegs without euro support would both bankrupt the large chunks of their economies that have borrowed in euros and deal a huge psychological blow to public confidence in the whole idea of independent statehood. Yet devalue they must (either via internal deflation, or by an outright breaking of the peg) and either road is what Jimmy Cliff would have called a hard one to travel. As the Economist itself suggests, these countries have suffered the most painful part of being in the euro zone—the inability to devalue and regain competitiveness—without getting the most substantial benefits of participation, so although none of them will meet the Maastricht treaty’s criteria for euro entry any time soon (and since they are tiny - the Baltics have a population of barely 7m, and Bulgaria is hardly bigger), letting them directly adopt the euro ought not to set an unwelcome precedent for others and should certainly not damage confidence in the single currency (any more than it already is, that is).

On the other hand unilateral adoption of the euro is a rather more difficult issue for the third group of countries, those who are EU members, are not in the eurozone and have floating exchange rates: the Czech Republic, Hungary, Poland and Romania. None of these is here and now, tomorrow, ready for the tough discipline of a single currency that rules out any future devaluation, and they are large enough collectively (around 80 million) that their premature entry could expose the euro to more turbulence than it already has on its plate. But so could simply leaving the situation as is, since if these economies enter a sharp contraction (more on this in a coming post) then the loan defaults are only going to present similar problems for the eurozone banking system as their currencies slide. The big vulnerability for Western Europe from the Polish, Hungarian and Romanian economies, arises from the large volume of Euro and CHF denominated debt taken on by firms and households, mainly from foreign-owned banks. As the Economist puts it "what once seemed a canny convergence play now looks like a barmy risk, for both the borrowers and the banks, chiefly Italian and Austrian, that lent to them".

So we now have several EU leaders opening the door for the first time to the possibility of fast-track membership of the eurozone. As we have seen German Chancellor Angela Merkel said after the summit that we "could consider" accelerating the candidacy process, French President Nicolas Sarkozy said that "the debate is open", and Luxembourg Prime Minister Jean-Claude Juncker, who heads the Eurogroup of eurozone finance ministers, said he was willing "to calmly discuss" such a possibility. So the debate is open. When will the next meeting be? On Sunday I hope. A week in all this is a very long time for reflection in this hectic world. We need proposals, and concrete ones for how to move forward here. Especially since at the present time all our attentions seem to be focusing on the East, and there is also the South and the West (the UK and Ireland) to think about. Perhaps our leaders will be able to make time from their crowded agendas for a series of mid-week meetings on this topic.

And while the leaders dither, the markets react, and as Bloomberg reports the dollar surges as everyone seeks a safe haven during the coming storm.

The dollar rose to the highest level since April 2006 against the currencies of six major U.S. trading partners.... and .... The euro dropped to a one-week low against the greenback as European Union leaders vetoed Hungary’s proposal for 180 billion euros ($227 billion) of loans to former communist economies in eastern Europe. The Swedish krona fell to a record versus the euro on speculation the Baltic region’s borrowers may default, and the Hungarian forint and Polish zloty tumbled.

The Hungarian forint led eastern European currencies lower today, falling 3.1 percent to 243.86, while Poland’s zloty lost 3 percent to 3.7796. The forint fell to a 6 1/2-year low of 246.32 on Feb. 17 as Moody’s Investors Service said it may cut the ratings of several banks with units in eastern Europe. The zloty touched 3.9151 the next day, the weakest since May 2004.

EU leaders spurned Hungary’s request for aid at a summit in Brussels yesterday. Growth in Poland, the biggest eastern European economy, will slow to 2 percent, the slackest pace since 2002, the European Commission forecasts.

Let The East Into The Eurozone Now!

2009-02-22T12:24:00.000-08:00

“It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again.”
Robert Zoellick, World Bank president, in an interview with the Financial Times

(Click On Image To View Video)

World Bank president, Robert Zoellick, made a call this week - in an interview with the Financial Times - for a European Union-led and co-ordinated global support programme for the economies of Central and Eastern Europe. I agree wholeheartedly, and even if I have, reluctantly, to accept the point made last week by our Economy & Finance Commissioner Joaquin Almunia that our pockets, though deep, are certainly not bottomless (and thus it is probably beyond our means right now to rescue the non-EU Eastern states), I still feel we should make good on our responsibilities to those who are EU members, and to do so by opening the doors of the Eurozone to those who wish to join. Since this proposal is fairly radical, the justification that follows will be lengthy.

This is not a view I have arrived at lightly, but looking at the extent of the problem we now have before us, a problem which is growing by the day, and taking into account the fact that the origins of the economic crisis in the East must surely rest (at least in part) in the decision to make euro participation a condition for EU membership for these countries (a possibility which was subsequently withdrawn in the critical moment, when the going started to turn rough), and then assessing the risk to the Western European banking system which would be posed by simply sitting back and watching it all happen, I think this move is not only the least damaging of the policies we can now follow, it is the in effect the only viable path left to us if we are to keep the eurozone as an integral entity together.

If this proposal were accepted a new set of membership criteria would need to be drawn up, of course, but the underlying principle would have to be one of offering the certainty of entry as guaranteed forthwith, for those who chose to accept. Rules were made to be broken, and nothing should be so inflexible - not even the Maastricht eurozone membership criteria - that it cannot be ammended as circumstances dictate. And at this point even the undertaking that this - like the long awaited US Stimulus programme - was on the table, would be sufficient to provide immediate, and much needed relief. Flirting with doing nothing here is, in my opinion, flirting with disaster, both in the East and in the West.

Existing Maastricht Criteria

Convergence criteria (also known as the Maastricht criteria) are the criteria for European Union member states to enter the third stage of European Economic and Monetary Union (EMU) and adopt the euro. The four main criteria are based on Article 121(1) of the European Community Treaty. Those member countries who are to adopt the euro need to meet certain criteria.

1. Inflation rate: No more than 1.5 percentage points higher than the three lowest inflation member states of the EU.

2. Government finance:

Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.

Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.

3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devaluated its currency during the period.

4. Long-term interest rates: The nominal long-term interest rate must not be more than two percentage points higher than in the three lowest inflation member states.

The Dimensions Of The Problem

European governments, the European Union and international financial organizations need to act fast on risks stemming form banks’ exposure in the eastern part of the continent to avert an escalation of the credit crisis, Nomura Holdings Inc. said. East European countries are struggling to refinance foreign- currency loans taken out by borrowers during years of prosperity through 2007, when economic growth averaged at more than 5 percent. The International Monetary Fund, which has bailed out Latvia, Hungary, Serbia, Ukraine and Belarus, warned on Jan. 28 that bank losses may widen as “shocks are transmitted between mature and emerging market banking systems.” “Swift action is needed to restore confidence and prevent trouble” to financial and economic stability in the euro region and emerging Europe, said Peter Attard Montalto, an emerging markets economist at Nomura International in London. “Any move should be quick. The situation has begun to decline more rapidly since the end of last year and there is risk that any action may come too late.”
Bloomberg

Robert Zoellick is far from being a lone voice in the wilderness about the current level of risk to the coutries in the East, and indeed precisely those EU banks who have been most active in emerging Europe are now busily trying to convince EU regulators, the European Central Bank and Brussels itself to coordinate new measures to counter the impact of the financial crisis confronting the region. The problem in the East certainly now adds a new dimesion to the problems facing us here in Europe, since West European governments are now being simultaneously hit on a number of fronts, and the situation is become more complicated by the day.

In the first place most West European economies are now either in or near recession, and their domestic banking systems are, to either a greater or a lesser extent, struggling. The West European states are thus, by and large, already feeling stress on their own sovereign borrowing capacities. But, with greater or lesser effectiveness, these countries are still able to increase their debt, even if sometimes the surge in borrowing is very dramatic, as in the case of Ireland, which will see gross debt/GDP shooting up from 24.8% in 2007 to a projected 68.2% in 2010 (EU January 2009 Forecast).

The situation in Eastern Europe is very different, and their economies and credit ratings evidently can't support such dramatic increases in their debt levels. Thus, in the case of those countries with a significant home banking presence, like Latvia's Parex, or Hungary's OTP, the support of external organisations (the IMF, the World Bank, the EU) becomes rapidly necessary when the bank concerned starts to have liquidity problems. But as a result of the consequent bailout the debt to GDP ratio starts to rise in a way which then places even subsequent eurozone membership in jeopardy. Latvia's Debt/GDP is, for example set to rise from around 12% of GDP in 2007 to over 55% in 2010. With a 10% plus GDP contraction already in the works for 2009, it is clear that Latvia's debt to GDP will rise beyond the critical 60% level. Hungary's debt/GDP is already above, and rising. If we don't do something soon, these two countries at least are being launched off towards sovereign default.

But the other half of this particular and peculiar coin turns up again in a rather unexpected way, and that is in the form of those West European banks who have subsidiaries in CEE countries, and who find now themselves faced, not with bailouts, but with ever rising default rates. This difficulty evidently and inevitably then works its way back upstream to the parent bank, and to the home state national debt, as the bank almost inevitably needs to seek support from one West European government, or another (in fact Unicredit, which has difficulty getting money from an already cash-strapped Italian government is talking of applying for support from the Austrian government via its Austrian subsidiary).

Austria is, in fact, a very good case in point here, since, as Finance Minister Josef Proell recently indicated, the country had some 230 billion euros of debt outstanding in Eastern Europe, equivalent to around 70 percent of Austria's GDP. The Austrian daily "Der Standard" have also reported the analysts view that a failure rate of 10 percent in Eastern Europe's debt repayments could lead to serious difficulties for Austria's financial sector. And this is no hypothetical "what if" type problem since the European Bank for Reconstruction and Development (EBRD) has estimated Eastern Europe's bad debts could go over 10 percent and could even reach 20 percent in the course of the current crisis. Underlining the mounting concern in Austria, Proell tried last week to convince EU finance ministers to provide 150 billion euros is support to CEE economies as a first step in trying to contain the growing wave of defaults.

The total quantity of debt outstanding is hard to put a precise number on, but the Bank for International Settlements estimated that, as of last September, more than $1.25 trillion had been leant by eurozone banks, and if you add in U.K., Swedish and Swiss bank liabilities the number rises to $1.45 trillion.

Western Europeean banks have a very important market share in the East, ranging from a low of 65 percent in Poland to almost 100 percent in the Czech Republic. This basically means two things, that the region's businesses and consumers are extraordinarily dependent on uninterrupted capital inflows from the West, and that some West European banking systems are extremely sensitive to rising default rates in the East. Of course the problem goes beyond the EU's borders, and while EU bank market shares in the Community of Independent States is rather less significant than in the EU12, due to the still substantial domestic ownership which exists there, exposure to defaults is not unimportant, especially in Ukraine, Kazakhstan and, of course, in Russia itself. Further, there is South East Europe to think about, and countries like Serbia and Croatia.

Large Banks Take The Initiative

Getting near to desperation, some of the largest banks involved - Italy's UniCredit and Banca Intesa, Austria's Raiffeisen International and Erste Group Bank, France's Societe Generale and Belgium's KBC - have launched a common initiative to try to lobby for an EU wide solution to the problem.

UniCredit is the largest lender in Poland and Bulgaria, while Erste is number one in Romania, Slovakia and the Czech Republic, with KBC occupying the position in Hungary, Intesa in Serbia, and Raiffeisen in Russia and Ukraine. Hungary's OTP Bank, emerging Europe's number 5 lender and the largest one in its home country, does not formally belong to the group. On the other hand OTP is actively looking for support.

OTP Bank Nyrt., Hungary’s biggest bank, said it’s in talks over a “role” for the European Bank for Reconstruction and Development, as it announced a 97 percent drop in fourth-quarter profit and “substantial” job cuts. As well as a possible EBRD involvement, OTP may also seek funds from Hungary’s emergency loan package from the International Monetary Fund, the European Union and the World Bank to “better serve the economy,” Chairman and Chief Executive Officer Sandor Csanyi said at a press conference in Budapest today. “There’s a chance the EBRD will assume a role in OTP, but I must stress that we plan no issue of new shares,” he said. OTP “doesn’t need to be saved,” Csanyi added.

Chancellor Angela Merkel, while expressing support for the bank initiative, has stopped short of offering concrete assistance or suggesting measures beyond those which are already in place.

The president of the European Bank for Reconstruction and Development, Thomas Mirow, wrote in the Financial Times this week the bank proposals "deserve full support as a worsening crisis in emerging Europe will threaten Europe as a whole".

The Austrian government has already announced it is trying to raise support for a general European Union initiative to rescue the region’s banking system. The government has set aside 100 billion euros in cash and guarantees to stabilise its banking sector. Next in line in terms of exposure are Italy ($232 billion), Germany ($230 billion) and France ($175 billion).

Unicredit is publicly rather dismissive of the problem (as can be seen from the slide below which from a presentation they gave earlier this week, please click on image to see better), but Italian investors are far from convinced by their arguments, as witnessed by the fact that their stock has plunged 41 percent this year, and by the fact that they were forced to sell 2.98 billion euros in 50 year bonds this week to shore up their Tier I capital after investors only bought about 4.6 million shares, or 0.48 percent, from their most recent rights offer. UniCredit, which said last month it is considering asking for government assistance, has also been disposing of assets to raise money and it plans to pay shareholders their dividends in yet more shares. Nationalisation of banks to supply credit lines to the private sector is one hypothesis currently being studied by Silvio Berlusconi, according to a Financial Times report this morning.

(Click on image for better viewing)
The Austrian proposal includes funds from the European Investment Bank, the European Central Bank and the EU Cohesion Fund. The Austrian government has offered money of its own and has been urging Germany, France, Italy and Belgium as well as the EU itself to contribute. One feature, however, stands out in all of the proposals which have so far been advanced: they are loan based-support. What Soros calls the "tricky question" of fiscal allocation from Europe's richer member states has not so far been raised, but it will be, since it will have to be.

And of course, Austria's concern is far from being altruistic, as Austria's economy and sovereign debt stability depend on finding a solution. It is hardly surprising to learn that credit-default swaps linked to Austrian government debt soared this week - by 39 basis points to a record 225 - on concern the country will need to bail out the domestic banks itself as they report losses and writedowns linked to eastern European investments. Erste, which said last week that full-year profit probably slumped by almost 26 percent, is in talks with the government to get 2.7 billion euros ($3.4 billion) in state aid. RZB has asked for 1.75 billion euros.

The European Central Bank on the other hand, seems reluctant to extend emergency financial help to crisis-hit countries beyond the 16-country eurozone. The ECB did not have “a mandate to be a regional United Nations agency”, Yves Mersch, governor of Luxembourg’s central bank, recently told the Financial Times. Such comments reveal the level of resistance which exists within the ECB’s 22-strong governing council to the idea of offering financial support to countries outside the zone.

The ECB has so far offered loans to Hungary and Poland, but has attached what some consider to be excessively strong conditions on facilities allowing them to borrow up to 5billion and 10billion euros respectively. Mr Mersch, whose views are thought to be widely shared in the ECB, suggested the central bank was worried about setting precedents if it relaxed its stance on helping individual countries. While some euromembers might favour assisting nearby nations, “we must not forget that other people might be sensitive to different countries”.

Who Bails Out The West European Banks In The East?

Governments and EU officials are struggling to formulate a coherent response to the economic and financial turmoil that has started to engulf the eastern part of the old continent. EurActiv presents a round-up of national situations with contributions from its network. Leaders of EU countries from central and eastern Europe will meet on 1 March ahead of an extraordinary summit on the same day with the bloc's other members, it emerged on Thursday (19 January). Polish Prime Minister Donald Tusk has invited his counterparts from the Czech Republic, Slovakia, Slovenia, Romania, Bulgaria, Lithuania, Latvia and Estonia for the talks to ensure the 27-nation meeting on the financial crisis is not dominated by the interests of Western member states. See full Euractiv article on background.

The EU has so far provided emergency balance-of-payments assistance to two of the East European member states in difficulty - Hungary and Latvia, and EU ministers did agree in December to more than double the funding available for such emergency lending to 25 billion euros ( so far Hungary has been allocated 6.5 billion and Latvia 3.1 billion). It is also quite probable that such lending will now have to be extended to the two newest southeast European members, Romania and Bulgaria, since their ballooning current account deficits and dramatic credit crunches mean that they are steadily getting into more and more difficulty.

The core of the problem is that the East European economies enjoyed strong credit driven booms, which fuelled higher than desireable inflation and lead to strong foreign exchange loan borrowing which simply bloated current account deficits. Now capital flows into emerging Europe have dried up as the global financial crisis has raised investors' risk aversion and prompted them to dump emerging market assets, leaving foreign-owned banks as the only source of loans for companies and consumers.

Italy's UniCredit, the biggest lender in emerging Europe, warned at the end of January that there was a clear risk of the global credit crunch gripping the region. UniCredit board member Erich Hampel stated at a Euromoney conference in Vienna that the bank was committed to fund its subsidiaries in the CEE countries and would continue to lend, but at the same time made absolutely clear that in order to do this his bank would need government support, whether from Austria, or Poland, or Italy itself.

Hampel said Bank Austria would decide during the first quarter whether to tap the Austrian government's banking stability package for fresh equity. " he said. "Our budget is under discussion now and clearly assumes growth in lending and in funding to the East. "

And according to a report from the Austrian central bank the fact that a relatively small number of Western European groups - including three Austrian ones - own most of the banks in Central and Eastern Europe means that there is the risk of a "domino effect", implying the crisis would spread quickly from one country to another. "How capital flows into (emerging Europe) will develop depends on the financial strength of the parent groups and of the sister banks, and on whether the parents are willing and able to fund their subsidiaries," the bank's half-yearly Financial Stability Report said. "The risks to refinancing are increased by the danger of a domino effect, because a large part of the foreign capital in many countries comes from a relatively small number of Western European banks," .

"What we see is that the emerging European economies have lost all sources of funding but banking," said Deborah Revoltella, chief economist for central and eastern Europe of UniCredit, the region's biggest lender. The task to carry whole economies through a downturn comes at a time when parent banks already face a double challenge: a likely sharp rise in loan defaults at their eastern subsidiaries and more difficult and expensive refinancing for themselves. "The international banks cannot solve this situation," Revoltella said. "They can do their part, and it's fundamental that they do their part but we have to take care of the other sources of funding which are missing now."

And it isn't only Austria who is worried, since Greek central bank governor George Provopoulos warned Greek banks only last Tuesday against transferring funds from the country's bank package to the Balkans, where they have invested heavily.

Regional Risks

In our view GDP growth is like to be negative in all CEE countries this year. In those countries least affected by the crisis (i.e. Poland, the Czech Republic, Slovakia and Slovenia) GDP is like to drop at least 2-5%, while those countries worst affected (i.e. the Baltic States, Bulgaria, Romania and Ukraine) are likely to face double digit declines in GDP. In other words, in terms of expected output lost in the region this is as bad as or even worse than the Asian crisis of 1997-98.
Danskebank - CEE: This Looks Like Meltdown

The problem that the EU has in adressing the situation in the Eastern member states is that what we have on our hands is not only a banking crisis, there is also a strong credit crunch at work, one which is now having a severe impact on the real economies in the region. Most of the economies in the region are already in recession, and those that are not soon will be (I have intersperced a number of relevant graphs throughout this post which should give some general impression of what is happening). Thus these countries are all taking multiple hits at one and the same time.

1/ In the first place they have an economic contraction on their hands, in some cases becuase they are struggling with a steep decline of export demand from western Europe, in others because their externally financed credit boom has now come to a sharp and painful end.

2/. Most countries in the region have some form of foreign currency exposure, although at present this is largely household and corporate rather than sovereign. In a number of countries -notably Hungary, Romania, Bulgaria and the Baltics this is particularly onerous since most of the mortgages were taken out in euros or Swiss Francs, and the default risk is now rising as their economies either deflate (internal devaluation) or their currencies fall as part of the regional sell-off. The danger is that as the bailouts are implemented at local level this exposure is steadily transferred over to the sovereign level, creating a dangerous dynamic which can endanger future eurozone membership. States which default will be unlikely candidate members.

3/. These countries are also suffering the impact of significant asset writedowns, as those assets bought at very high prices during the boom - some at up to six times their book value - now have to be written down, further weighing on earnings and weakening financial and corporate balance sheets.

4/ Finally there is significant contagion risk. The comparatively small number of foreign lenders involved has lead IMF economists and the credit ratings agencies alike to repeatedly warn of how the risk that a seemingly isolated incident in one country may rapidly spread right across the region.

"I don't think it's an exaggeration to say that the whole banking sector and financial system (in the region) rests on the response of parent banks," said Neil Shearing, economist at Capital Economics. "If they withdraw funding it's not very difficult to see how there would be a very severe financial crisis sweeping across the region, and the whole region en masse would have to go to the IMF," he said.

Governments in the region have already taken what measures they can. Most increased deposit guarantees from 20,000 to 50,000 euros following the EU October Paris meeting. Lithuania went further and upped the limit to 100,000 euros, while Slovakia, Slovenia and Hungary all now offer unlimited protection. But this begs the question, who guarantees the government guarantees in the event they are called on.

So the problem has now become a very delicate one, since the banks want to maintain their presence in the region even while almost every factor imaginable is working against them. The latest such factor is the threat of credit downgrades for their core business in Western Europe, and Moody’s Investors Service warned only this week that some of Europe’s largest banks may be downgraded because of loans to eastern Europe, a warning which sent Italy's UniCredit to its lowest level in the Milan stock market in 12 years.

Moody’s argues there will be “continuous downward rating pressure” in the region as a result of worsening asset quality and western banks’ reliance on short-term funding. UniCredit’s Bank Austria subsidiary earned almost half its pretax profit from eastern Europe in 2007, Raiffeisen International Bank-Holding almost 80 percent and Austria’s Erste Group Bank more than 60 percent, according to Moody’s.

“The most risky parts of the western European banks’ businesses are in eastern Europe and when you decide to cut risks, you cut back on the most risky assets first,” Lars Christensen, an analyst at Danske Bank A/S in Copenhagen, said by telephone today. “This could add further risk in the region as the economies there may face large current account deficits if funding from western European banks is withdrawn.”

As a result last Tuesday we saw a surge in the cost of protecting bank bonds from default, lead by Raiffeisen International Bank-Holding and UniCredit. Credit-default swaps on Vienna-based Raiffeisen climbed 26 basis points to a record 369 and those for UniCredit soared 23 basis points to an all-time high of 213, according to data from CMA Datavision in London. Credit-default swaps on Erste increased 24.5 to 307, Paris- based Societe Generale rose 6 to 116 and KBC in Brussels was unchanged at 240, according to CMA prices.

The rising cost of insuring against default by a “peripheral” European government is likely to weigh on the euro, according to Merrill Lynch & Co. “This remains an important background negative for the euro,” Steven Pearson, a strategist in London at Merrill Lynch, wrote in a note today. “European banking-sector exposure to Eastern Europe, often via foreign currency lending, is an additional euro negative story that is gaining air-time.” Emerging market central banks may move away from holding European government bonds in their reserves as widening yield spreads between debt of different euro-zone economies makes bonds more difficult to trade, Pearson said.

So Why Would The Euro Help?

Well, in the first place, four of the Eastern economies - Bulgaria, Latvia, Lithuania and Estonia, are effectively stuck, since their currencies are pegged to the Euro. They are in the unenviable position of being stuck between the proverbial rock and the hard place. They are now faced with US depression type economic slumps, and massive internal wage and price deflation all at the same time. Would Euro membership help? Well lets look at what the IMF said in their most recent report on the stand-by loan arrangement for Latvia.

Accelerated adoption of the euro at a depreciated exchange rate would deliver most of the benefits of widening the bands, but with fewer drawbacks. Unlike all other options for changing the exchange rate, the new (euro-entry) parity would not be subject to speculation.

By providing a stable nominal anchor and removing currency risk, euroization would boost confidence and be associated with less of an output decline than other options.Euroization with EU and ECB concurrence would also help address liquidity strains in the banking system. If Latvian banks could access ECB facilities, then those that are both solvent and hold adequate collateral could access sufficient liquidity. The increase in confidence should dampen concerns of resident depositors and also help stem non resident deposit outflows.

However, this policy option would not address solvency concerns and has been ruled out by the European authorities. If combined with a large upfront devaluation, there would be an immediate deterioration in private-sector solvency, which could slow recovery. Privatesector debt restructuring would likely be necessary. Finally, the European Union strongly objects to accelerated euro adoption, as this would be inconsistent with treaty obligations of member governments, so this option is infeasible.

Basically, devaluating the Lat and entering the euro directly was the IMF's preferred option for Latvia, "euroization with EU and ECB concurrence" was the second option, and keeping the peg and implementing massive internal deflation only the third. The problem was that the EU, in its wisdom felt euro adoption "would be inconsistent with treaty obligations of member governments" - as would I suppose bailing out Austria and Ireland be "inconsistent with treaty obligations of member governments under the Maastricht Treaty. Go tell it to the marines, is what I say!

And this is not just Latvia, but four entire countries (little ones, but still countries) that are effectively being thrown to the wolves here.

Downward Pressure On Currencies, Upward Pressure On Interest Rates

Nor is the position of those with floating currencies - Poland, Hungary, the Czech Republic and Romania - much better, since their currencies are now coming under substantial pressure, and as a result defaults are growing, defaults which will only work their way back upstream to the Western Countries whose banks will have to stand the losses.

At the same time, the risk of a sharper, 1997 Asian-style adjustment cannot be excluded, given the similarities between Asia before the eruption of the crisis there in 1997 and the situation in emerging Europe. Beyond any considerations about valuation, the FX market may overreact as it did during the Asian or Russian crises in 1997 & 1998. To halt the downward spiral of currency depreciation, a substantial rise in interest rates combined with a tight fiscal policy under an IMF programme could be necessary.
Murat Toprak & Gaelle Blanchard, Societe Generale

Obviously there is now a sense of urgency here, and the warning signs are everywhere, for those who know how to read them. According to Zbigniew Chlebowski, the chairman for the Polish ruling party’s parliamentary group speaking in an interview earlier this week, the Polish government has been in official talks with the European Central Bank over joining the pre-euro exchange-rate mechanism “for several days.” So consultations are getting to be fast and furious.

And Hungarian, Polish and Czech government debt, which has been among the highest rated in emerging markets, is now being downgraded by bondholders. Investors are currently demanding 20 basis points more yield to own Hungary’s bonds than similar-maturity Brazilian debt, which is rated four levels lower by Moody’s Investors Service, according JPMorgan bond indexes. The risk of Poland defaulting is currently running at about the same as Serbia, ranked six levels lower by Standard & Poor’s, based on credit-default swap prices, while Czech 10-year bonds yield the most compared with German bunds since 2001.

“Everybody is running for the door,” said Lars Christensen, head of emerging-market strategy at Danske Bank A/S in Copenhagen. “The markets have decided the central and eastern European region is the subprime area of Europe.”

The currencies of these currenciies are tumbling on investor concern the region’s economies are among the most vulnerable to the global credit crisis. Poland’s zloty has fallen 35 percent against the euro since August, the forint - which has fallen around 13% since the start of the year, and about 25% since last August -weakened to a record low of 309.71 this week. At the same time the Koruna hit the lowest level since 2005.

(Chart above - Polish Zloty vs Euro)

The zloty has risen - against the previous trend - by 3.2 percent this week, following a decision by the Finance Ministry to enter the market (on Wednesday) and started selling euros from European Union funds for zlotys. Prime Minister Donald Tusk said yesterday the currency must be defended “at any cost.” The Czech central bank stated it regards the buying and selling currencies to manage the koruna as an “exceptional” tool that it’s resisted using since 2002, with the implication that it may not be able to resist much longer, although interest rate hikes (as practised in Hungary) seem to be the more likely approach in the Czech Republic. Such gains as have been obtained for the zloty are likely to be short lived (intervention is a tool of desperation, not of strength, and rarely has any lasting effect) and they can hardly exhaust EU funding they badly need to spend on stimulus type projects in the face of the downturn defending the indefensible, as Russia has been learning to its cost in another context.

“It [currency intervention ]is for us an exceptional tool at our disposal,” Tomas Holub, head of its monetary policy department, said in a telephone interview today. “Of course it’s one of the potential tools, but so far no decision has been taken in this direction.”

After intervention the only real tool left is interest rate policy, and fear of further currency falls is now acting as a serious brake on monetary policy as the pace of economic contraction gathers speed in one country after another. “A lowering of interest rates at the current levels of the exchange rate is completely out of the debate,” Deputy Governor Miroslav Singer told E15 newspaper earlier this week. “The question is whether to raise, and by how much.”

Really the suggestion that all these countries simply traipse off to the IMF (one after the other) in search of help is shameful. There is simply no other word for it, shameful. As Oscar Wilde put it, losing one child may be an accident, but losing all your children, now that has to be negligence! Let them in, and let them in now, before the whole house of cards collapses on top of each and every one of us.

Postcript

This article is the second in a series of five I am in the process of writing on ways forward with Europe's financial and economic crisis.

The first was Why We Need EU Bonds.

Subsequent articles will deal with:

a) The need for Quantitative Easing In The Eurozone
b) What might a new Stability and Growth Pact look like?
c) Why as well as rewriting the banking regulations we also need to do something about Europe's demographic imbalances.

Update: The Danskebank View

With which I wholeheartedly agree.

This week the crisis in the CEE markets has intensified dramatically after the publication of a number of reports putting a negative focus on Western European banks exposure to the overly leveraged CEE economies. The crisis is clearly developing in an explosive fashion and there is a very clear risk of an Asian crisis style meltdown. The economies in the region are already in free fall, and at least one country Ukraine is dangerously close to sovereign default. Rapidly rising concerns have led policy makers across Europe to call for immediate action to avoid a dangerous collapse that potentially could spill into the euro zone. However, policy makers seem very divided on what to do in the current situation.

Earlier this week Lithuanian Prime Minister Andrius Kubilius called for coordinated action from the EU to try to solve the problems in CEE. Later in the week the World Banks president Robert Zoellick echoed Kubilius cry for help.

However, the EU Commission does not seem very excited about a coordinated effort to avoid meltdown. Rather Joaquín Almunia, EU monetary affairs commissioner, this week said that he would prefer a country-by-country approach to crisis management. In our view, a country-by-country approach to crisis management entails a number of risks, as there is a strong potential for contagion from one CEE country to another due to the significant integration in the financial sector across the region. Therefore, we think that there is urgent need for a more coordinated effort to stabilise the situation otherwise this crisis will drag out and uncertainty remain elevated for an extended period.

The Czech Republic Probably Entered Recession At The End Of 2008

2009-02-13T02:33:00.000-08:00

Well as forecast on this blog (see also here), the Czech Republic's economy contracted in the last quarter of 2008. Since the economy is still contracting sharply, we will more than likely now see a second quarter of negative growth, which means the CR is now in recession.

The Czech economy contracted less than expected in the fourth quarter but the outlook for this year remained grim due to collapsing demand in the euro zone slashing Czech exports. The Czech Statistical Bureau said on Friday the central European country's output dropped by 0.6 percent quarter-on-quarter, adjusted for seasonal and calendar effects, the worst number since 1997. Year-on-year, the economy eked out 1.0 percent growth, much better than 0.2 percent expansion forecast in a Reuters poll of analysts but a drop from 4.2 percent growth in the third quarter. "It doesn't really change the outlook going forward," said Raffaella Tenconi, analyst at Wood & Company. "We're looking at -2.0 percent growth for all of 2009, and if anything, there are downside risks to it," she said.

Retail Sales Contract For A Third Month

Inflation adjusted Czech retail sales, excluding cars and car parts, dropped 0.8% year-on-year in December compared to a 3.4% fall in November. Month-on-month, retail sales at constant prices were flat in December, after falling 0.5% in November. Retail sales for food, beverages and tobacco increased 0.9%, while sales for non-food goods dropped 0.5%. This means that sales fell, compared with a year earlier, every month during the fourth quarter.

Industrial Output Slumps

Czech industrial output also declined for a third consecutive month in December, sliding 14.6 percent from December 2007 following a 17.4 percent drop in November. Czech companies are evidently suffering from the slowdown which now affects the whole euro region, which is the main destination for Czech exports.

Czech Republic PMI

In fact Czech industry continued its steep decline in January with the Czech Purchasing Managers' Index falling to dropping below the 50 mark (to 31.5) for the seventh consecutive month. As compared with December (32.7), the PMI was hit by series-record declines in new orders and employment, while deflationary pressure was also evident as both input and output prices continued to fall sharply, according to the report from Markit Economics and ABN Amro. The figure for output rose for the first time since September, to 29.5, indicating a slightly weaker rate of contraction than in December but still the second lowest in the survey's history.

Czech Exports Fall Again In December

Of course, since the Czech economy is at least partially fuelled by foreign trade, the external situation is hardly helfpul, and both exports and imports fell in December - by 13.4% and 8.2% year-on-year, respectively. The drop in exports was the largest December year-on-year fall since 1994. Exports and imports have now been declining for three consecutive months. The trade balance showed a deficit of CZK 11.8 billion, a deterioration of CZK 9.0 billion year-on-year. Over 2008 as a whole, exports were down by 0.7% and imports rose by a minute 0.1%. The annual trade balance had a surplus of CZK 69.4 billion, which was CZK 18.5 billion less than the 2007 one.

Seasonally adjusted exports fell month on month by 7.8% while imports grew by 0.1%.

Price Growth Slows

Czech consumer prices growth slowed in January while unemployment soared more than forecast as companies slashed jobs in the face of the deepening economic crisis. Monthly price growth of 1.5 percent put year-on-year inflation at 2.2 percent, sharply down from 3.6 percent in December. The drop was attributable to base effects and falling fuel and clothing prices, which brought the headline figure to the lowest level since March 2007 according to the Czech Statistical Bureau.

The Czech National Bank (CNB) now forecast that inflation will fall near to zero during the course of this year. The bank is hopeful that by the beginning of 2010, inflation will once more approach their new 2-percent inflation target, but I think the scale of the economic contraction will determine that more than anything.

The month-on-month consumer price increase of 1.5% was mainly the result of a price rise in administratively regulated prices, which were up by 5.8%, while market driven prices only rose by 0.4 %. The growth of regulated prices was largely the result of price increases for 'housing, water, electricity, gas and other fuels'. Electricity increased by 11.6 %, heat and hot water by 3.2 %, water supply and sewerage collection by 8.7 %. Rents increased by 15.3%, and in the case of dwellings with regulated rents by 22.8%. Private sector rents were only up by 1.6%.

Downward pressure on the consumer price level came decreases in clothing (by 3.0 %) and footwear (by 3.7 % ) which were partly the result of winter sales reductions.

Unemployment Rising

Data from the Czech Labour Ministry show that over 45,000 people lost their jobs in January, bringing the unemployment rate up 0.8 percentage points to 6.8 percent, the highest level since April 2007.

The number of vacancies was also down, following a pattern which now goes back over six months, and which is perhaps the clearest indicator we have of the tightening in the labour market.

Czech Central Bank Eases Monetary Policy

The Czech central bank cut its benchmark interest rate for a third consecutive time at the start of the month as lower economic growth gave the reason to do so and declining inflation opened up the possibility . The Ceska Narodni Banka lowered the two-week repurchase rate to 1.75 percent, matching the record low of September 2005, from the previous 2.25 percent.

“The reasons for an aggressive easing of monetary policy are clear,” David Marek, the chief economist at Patria Finance AS in Prague, said in a note. “The Czech economy is apparently already in recession and this year it may flirt with deflation. There’s another lowering of interest rates ahead of us apparently.”

Central Europe's Manufacturing And Consumers In A State Of Shock

2009-02-02T06:28:00.000-08:00

Central Europe's economies continued to contract in January - lead by their manufacturing industries - under the combined weight of a credit crunch and a slump in demand for their exports. My feeling as all three economies - Poland, the Czech Republic and Hungary - are now in recession. Hungary's is clearly the worst case, and events are moving rapidly and negatively there, but the slowdown in the Czech Economy is also very pronounced, and Poland seems finally to be falling into line, following some internal financial chaos back in October. Based on back of the envelope type calculations derived from the PMIs I would say their economies were contracting at the following pace in January.

Q-o-Q Y-o-Y
Hungary -1% -4%

Poland -0.7% -3%

Czech Republic -1% -4%

These are only provisional assessments based on the PMIs and Consumer Confidence Indexes. They will be subject to calibration as we move forward and receive the real data, but all this should give us some general idea of what is happening, something which is badly needed in view of the suddenness of the change.

Hungary PMI

Hungary's manufacturing purchasing manager index (PMI) fell once again to a all-time low of 38.6 in January, down from 40.8 in December, according to the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM) today. Any PMI index figure above 50 indicates expansion while a figure below 50 shows contraction in economic activity. The index hasd been above the critical 50 mark for more than three years before it dropped below (to 42.6) in October last year.

The January figure is the lowest recorded since September 1995 and is a further sharp drop from January. The last time the January index was below 50 was in 2005 (48.5) and then in 1997 (49.1), but these contraction were much softer.

“In view of the current situation we can confidently say that the five month negative record of 1998 will be broken. We are facing the gravest crisis of the manufacturing industry in almost 15 years," the HALPIM said.

GKI Confidence Index

Economic sentiment also plunged in January with the GKI index falling to a record. The overall index fell to minus 39.8, the lowest since measuring began in 1996, from minus 36.7 in December. The sub components for business and consumer confidence also fell to new lows.

The outlook for industrial production and orders led a decline in the business confidence index to minus 30.5 from minus 28.2 in December. The outlook for export orders improved “minimally,”. Fifty-eight percent of exports are sold in the euro region, which is in its worst recession since the single currency began trading a decade ago. Concern about future job losses dragged the consumer confidence index to a record of minus 66.1 from minus 60.8 in December.

Polish PMI

Morale in Poland's industrial sector rose for the first time in almost a year in January, but output growth remained mired firmly in negative territory, according to a purchasing managers' index survey published Monday. The survey of 300 industrial companies prepared by Markit for ABN AMRO showed Polish manufacturing PMI increased to 40.3 in January, from 38.3 in December. This is an improvement, but the contraction is still a strong one.

"Though slightly improved from the exceptionally weak December data, the latest survey findings underline the headwinds confronting Polish manufacturers in January. Output, new orders and employment all contracted sharply and, overall, the first batch of 2009 PMI data point to further aggressive rate cuts by the central bank in the first quarter following greater than expected reductions in the main policy rate in both November and December. Inflation concerns have eased despite the falling zloty, as the PMI showedfurther falls in price pressures in manufacturing." - Trevor Balchin, Economist at Markit Economics

Polish Consumer Confidence

Poles have become much more pessimistic about the outlook for their economy in recent months and the Ipsos Consumer Confidence Index fell by 11 points to 84.17. The assessment of the current economic climate suffered the most serious deterioration.

(Please click over image for better viewing)

The consumer rating of the current economic climate plummeted by 15 points to hit 69.59. This is one of the lowest levels since Poland joined the European Union. Consumers are worried about the future of the Polish economy, and their worries are linked particularly to the situation on the job market. Currently some 52% of Poles expect unemployment figures to rise over the coming 12 months, while only 6% expect them to fall. This is a radical change, particularly when compared with January 2008, when only 13% expected a rise in unemployment and 39% expected a decline.

The deterioration in consumer sentiment was also to be seen in the ratings for willingness to buy, which in January fell by 8 points to 93.88 (the lowest level for 3 years). In particular expectations regarding the material situation of one's own household deteriorated. Ratings of the current situation in regard to buying durables also weakened somewhat. Nevertheless, consumer appetite is far from dead, and there are more people still considering this a good time for buying than those who disagree.

Czech Republic PMI

Czech industry continued its steep decline in January with the Czech Purchasing Managers' Index falling to dropping below the 50 mark (to 31.5) for the seventh consecutive month. As compared with December (32.7), the PMI was hit by series-record declines in new orders and employment, while deflationary pressure was also evident as both input and output prices continued to fall sharply, according to the report from Markit Economics and ABN Amro. The figure for output rose for the first time since September, to 29.5, indicating a slightly weaker rate of contraction than in December but still the second lowest in the survey's history.

Czech Consumer Confidence

In January 2009, the Czech economic sentiment indicator decreased by 3.2 points m-o-m (it was down by 8.6 points down in December). The business confidence indicator fell by 2.8 points and the consumer confidence indicator dropped 4.8 points. Compared to January 2008, the composite confidence indicator balance was down 30.8 points, the confidence of entrepreneurs is 34.7 points down and the confidence of consumers is down by 15 points. Indicators were thus at their lowest levels in almost ten years.

The survey taken among consumers in January indicates that, compared to December, consumers expect for the next twelve months worsening of the overall economic situation and a slight decrease in their own financial standing. In January, the share of respondents expecting a rise in unemployment increased again. The percentage of respondents planning to save money decreased. The consumer confidence indicator decreased by 4.8 points, m-o-m; it is by 15 points down, y-o-y.

How Near Is The Czech Economy To Recession?

2009-01-23T14:22:00.000-08:00

The highly open Czech economy is set to slow down considerably, affected by the deteriorating outlook for its main trading partners. Although GDP growth was still solid in Q3 2008, both exports and imports growth slowed significantly. The global crisis is expected to adversely impact the real economy particularly from the fourth quarter of 2008. Overall, GDP is expected to have grown by 4.2% in 2008 with a strong contribution from the external balance.
EU Commission Forecast January 2009

Analysts and followers of the Czech economy are basically agreed on two things at the moment: that the Czech is slowing (and rapidly), and that the dependence on car exports is a real achilles heal at a time when a generalised credit crunch means that the financing which is needed for people to make car purchases often quite simply isn't there. Beyond this point opinions differ. Some expect the slowdown to end in nothing more than a year of sub par growth, with a bounce-back recovery in H2 2009 (this is the view, for example, of Pasquale Diana at Morgan Stanley). Others take a more pessimistic view - like Danskebank's Lars Christensen - and fear that not only may we see a substantial slowdown (bordering possibly on outright contraction) throughout the whole of 2009. but also that strong deflationary forces are at work, forces which may well lead the Czech National Bank to become one of the first European central banks (hand in hand possibly with the BoE) to get into the tricky area of trying to operate monetary policy near the zero bound. Personally, after a long hard stare at the detailed macro data, I am in the latter camp, and to answer the question I pose in the title of this post, I think the Czech economy is very near to its first quarter of contraction, indeed we may even have seen contraction in Q4 2008. If we didn't it will be a very close call, since the not only has the trade impact been negative, and industrial output dropped like a stone, but domestic consumer demand - as reflected in retail sales - also seems to have been falling.

And the outlook for domestic demand certainly does not look any too positive, if the most recent consumer confidence readings are anything to go by, since these have been falling strongly since the summer, and surely suggest strong weakness in household consumption right across the first half of 2009, at the very least.

Industrial Output Falls Like A Stone

Czech industrial production fell in November at the fastest rate since at least 2000, dropping by 17.4 percent year on year, following a decline of 7.6 percent in October.

This fall is very substantial and it is clear that the Czech authorities urgently need to revise their growth forecasts in the light of this and other recent data, indeed some analysts - Radomir Jac at Generali PPF Asset Management in Prague , for example - are already arguing the drop may well mean the economy already started to contract in the fourth quarter. Others are more cautious. Still, one thing is common across all the analyses, we are talking about cars, cars, and ever less cars.

The collapse in activity across the region in 4Q08 looks truly extraordinary, and was correctly flagged by the PMI surveys, which sank to all-time lows. Trade data and industrial output and, to a lesser extent, retail sales all show a significant loss of momentum towards year-end. Much of this is due to weaker external demand, in particular in the auto sector, which is the region’s most important export. Car sales in the EU have weakened further, and several carmakers have announced a cut in their production plans for 2009. In the Czech Republic, Hyundai said that it plans to move to a four-day workweek and pay workers 70% of their salaries for a period of 1-3 months; Skoda also downgraded its production plans massively for 2009 (from 700k cars to 570k).
Pasquale Diana, Morgan Stanley

The Czech Republic has arguably the most stable economy in central Europe, but at a time when the world is being buffeted by financial crisis, there is no chance it will escape being hit next year. First in the line of fire will be the automotive sector which, with almost 1m cars manufactured this year, is responsible for about 10 per cent of the economy. Almost all are exported to western Europe, where new car sales have plunged in the final months of the year.
Jan Cienski, Financial Times

And the situation is almost sure to get worse, since the Czech Purchasing Managers' Index fell to 32.7 in December, from 37.8 in November, which indicates a very substantial fall in industrial output again in December.

Thus we can expect Q4 industrial output to be a strongly negative factor, and indeed this only marks a steepening of a trend we have been seeing since Q1 2008, if we look at the quarterly chart for movements in manufacturing output below.

Exports Fall And The Trade Balance Deteriorates

The fall in industrial output is basically a reflection of the ongoing deterioration in the CR's performance in external trade, and the drop indemand for exports. The monthly goods trade deficit was CZK 474 million in November, down from the very large CZK3.95 billion deficit registerd in October, but well below the CZK 12 billion surplus clocked up in November 2007.

Exports were down 18% year-on-year in the month compared with a 10.7% fall in October. The statistics office report said the decline in exports was the highest in the entire history of the Czech Republic. Imports declined 13.2% compared with a 5.9% drop in October. Total imports slipped to CZK 195.2 billion from CZK 221.4 billion.

Retail Sales Also Head South

In November, seasonally adjusted retail sales in retail trade (excluding cars) decreased by 0.3% month-on-month (at constant prices) and fell by 0.7%, year-on-year. As far as the automotive sector goes, seasonally adjusted sales were 3.4% down, m-o-m, and 5.1%. Sales were also down 0.7% month on month in October.

Koruna Continues To Fall

With all this negative data it is hardly surprising that the Czech koruna has been weaking significantly of late, and it depreciated again last week, losing as much as 1 percent on Friday alone (hitting 28.255 against the euro at one point, the weakest since July 2007) and 2.1 percent on the week.

Consumer Prices Already Falling

Consumer prices in the Czech Republic were down again in December, and fell by 0.3% when compared with November. Year-on-year consumer prices were up by 3.6 % in December (down from 4.4 % in November), while the whole year average was 6.3 % in 2008.

As is to be expected the month-on-month drop in consumer prices was lead by the fall in automotive fuel - 95 octane petrol hit its lowest level since March 2002, while food and non-alcoholic beverages were mainly down, with pronounced falls in the prices of flour, milk, butter, citrus fruit and sugar (by 6.7 %, 1.7 %, 2.7 %, 8.6 % and 1.9 %, respectively). But prices drop were far more general, and in the health sector, for example, medical products dropped by 0.5 %. Prices of goods in general decreased by 0.5 %, while prices of services increased by 0.1 %.

But what is perhaps more interesting is the way in which the "core" EU HICP index (ie excluding food, alchohol, tobacco and energy) has now been falling since August, and I do not expect to see an increase in this index in 2009, which means we should see negative core inflation in the CR in 2009.

Industrial producer prices are also falling, and were down by an annual 1.5% in November. The most significant price decreases were observed in ‘coke, refined petroleum products’ (-19.0%), ‘basic metals, fabricated metal products’ (-2.1%) and ‘chemicals, chemical products and man-made fibres’ (-3.8%). Prices of ‘food products, beverages and tobacco’ fell by 0.5%.

The big issue now is what will happen to inflation expectations? The strongest defence against the arrival of deflation is the expectation of inflation to come. To date these expectations have held up, but they could well turn negative at some point, and if this were to occur it would have a very significant impact on consumer behaviour (since evidently it is more interesting to delay that whimsical purchase till tomorrow, when the thing will be cheaper). If expectations do turn significantly negative, then it could turn out to be very hard work indeed getting them back into positive territory. Which is why I suspect the CNB will be pretty proactive, possibly more proactive than many are anticipating.

Moving Towards The Zero Bound At The CNB?

The Czech National Bank, whose next policy-setting meeting is scheduled for 5 February, have been cutting their benchmark borrowing rate pretty aggresively since last October, taking it down to 2.25 percent at its last meeting in December.

The drop of industrial output is “really considerable,” central bank board member Robert Holman said on Patria.cz. The bank’s “pessimistic” forecast scenario is starting to be fulfilled, he said.

The latest central bank forecast cut the outlook for 2009 economic growth to 2.9 percent, although the bank had an alternative (pessimistic) scenario which foresaw growth of 0.5 percent this year.

Today’s industrial production numbers and the outlook for inflation to drop to just above 1% in January should make the Czech central bank (CNB) even more dovish. We now expect a cut of at least 75bp at the next CNB board meeting in February. Furthermore, we would not rule out that CNB could be the first European central bank (maybe with the Bank of England) to go to (near) zero per cent interest rates. Therefore, we also recommend buying EUR/CZK at current levels.
Lars Christensen and Stanislava Pravdova, Danskebank

So far, January’s economic data published support our view that the CNB’s Bank Board Members are ready to continue easing, following the 150bp cut in policy rates in 2H08 to 2.25%. However, yesterday’s data have led us to review our previous forecast of a 50bp cut in the CNB’s policy rates, and we now believe a 75-100bp cut is likely to be discussed at the February meeting. Furthermore, we do not exclude the possibility that the CNB’s main policy rate could breach its all-time low (which was 1.75% in 2Q-3Q05) in February.
Jaromir Sindel, CitiGroup Global Markets

I am with Lars Christensen and Jaromir Sindel here, I think the CNB will move, and move pretty decisively to try to block the path to looming price deflation, and I guess a 75 bp cut (and possibly more) is looking very probable, with further cuts following inswift succession. Evidently the key piece of data will be the January manufacturing PMI, and in the short term I expect the PMI and not the actual output data (which obviously come later) to be dictating policy decisions. The statist office releases simply serve to calibrate the PMIs (post hoc) in this type of situation.

So What Is The Outlook For Czech GDP Growth in 2009?

Well, in trying to determine the future path of Czech GDP, the first thing we need to bear in mind - looking at the GDP chart above - is that the economy has been losing momentum since late 2006, that is the "stellar" catch-up growth component has been waning, and for some time. The second thing we need to bear in mind is that this is not necessarily a bad thing, since it means that the CR's economy (unlike many others across the CEE) is certainly not on a boom bust cycle. The slowdown in quarter on quarter growth is also evident in the chart below. In fact in Q3 2008, Czech GDP grew by 1.0% in comparison to Q2 2008 and by 4.7% in comparison to Q3 2007.

What is interesting is that the weaker growth we can see in the chart has been largely a by-product of slowing private consumption growth (see my earlier post here, and this one here), which leaves us with the possibility that the Czech Republic economy - following along the path already charted by Germany, Japan, Italy and Hungary - may now be in the process of becoming an export dependent one. (Perhaps it sounds strange to talk about Italy as export dependent given its very weak growth, but this weak growth is in fact the outcome of continuing very poor export performance, since domestic demand has now been weak for more years than I personally care to remember). In fact final domestic consumption was still up by 2.7% in Q3 2008, and represented a contribution of 1.9 p.p. to GDP growth. Final consumption was particularly influenced by a year on year increase in household expenditure by 2.5% , while government expenditure grew by 3.7%. Fiscal stimulus should hold the government component steady, but I would expect the household one to drop back, and especially as we start to see job losses from the industrial contraction.

Gross capital formation was down by 2.0% on Q3 2007 and had a negative impact of 0.5 p.p. on GDP growth, although gross fixed capital formation taken alone was up by 4.5% y-o-y; in fact investment in transport equipment and in machinery and equipment was the main source of GFCF growth.

As in earlier quarters, external trade in goods and services was the main source of economic growth in Q3 and contributed by 2.8 p.p. to the GDP increase, despite a considerable fall in y-o-y growth rate of exports (from 13.9% in Q2 to 5.0% in Q3). This was the result of the marked fall in import growth (from 9.7% to 1.6%), hence external trade remained the principal source of GDP growth.

Reflecting Citi’s expectations of a recession in the eurozone, we forecast the trade surplus (both of goods and services) to shrink significantly in 2009 from its surplus of CZK108 billion in 2008 (our estimate).Falling commodity prices are likely to have been behind the improvement in the terms of trade in November, which fell in October. We believe this development has the following implications: the improvement in the terms of trade is likely to cause the foreign trade’s first negative contribution to GDP growth after three and half years, and GDP growth is likely to fall quickly to the levels of real gross domestic income, which was 2% YoY in 3Q08 and much lower than that of GDP growth of 4.3%.
Jaromir Sindel, CitiGroup Global Markets

Employment May Weaken

Employment growth, which has been one of the hallmark features of the Czech expansion, continued to grow in the third quarter and was up by 0.4% q-o-q and 1.9% y-o-y. Labour productivity measured by gross value added per employed person was also up (by 2.3% y-o-y). There were 5.327 million Czechs in employment in Q3 2008, 98,000 more than in Q3 2007. However, there is now some evidence that this favourable situation may now be changing.

Certainly, if we look at the chart below, the substantial drop in unemployment in the CR since 2005 is very impressive, and indeed even though the seasonally adjusted EU harmonised rate ticked up from 4.4% in October to 4.5% in November (the last month for which Eurostat have released data) the change is hardly a dramatic one.

However, if we look at the data from the CR's owb labour office, we find a reasonably sharp increase from November to December (unemployment was up by 32,000, compared with a 7,000 rise in December 2007), and if we look at the situation vis a vis vacancies (see chart below), then it is clear that the deterioration in manufacturing conditions is now affecting the labour market, since the number of vacancies advertised has now fallen from the April 2008 peak of 152,300 to December's low of 91,200 (the lowest number in over 2 years, which is all I have data for).

CA Deficit To Deteriorate, While Fiscal Spending May Increase As The Slowdown Accelerates

The CR does run a current account deficit, but it is actually a fairly moderate one in a regional context, although it is liable to increase in 2009. November’s narrower current account deficit reflects the slightly improved trade balance over October and lower dividend outflows from FDI, which dropped to CZK3.5 billion from October’s CZK12.3 billion. The current account financing requirement has been low but the deficit may have reached 2.8% of GDP in 2008 (up from 1.8% in 2007, and above the IMF estimate of 2.2% GDP).

The EU Commission forecast thatgeneral government deficit will be 1.2% of GDP in 2008. This reflects a much-lower than- expected deficit of 1% of GDP in 2007 and the positive fiscal impact of a variety of revenue and expenditure measures. For 2009, they expect the general government deficit to widen somewhat given the pressure on revenues and expenditure which will result from falling activity, rising unemployment and probable fiscal stimulus measures. Overall, they suggest that the general government deficit will widen to 2.5% of GDP in 2009 but should fall back to 2.3% in 2010 - although this surely reflects their benign slowdown scenario whereby a recivery is expected to arrive in H2 2009. The debt-to-GDP ratio is forecast to rise to above 30% in 2010, from 29.4% in 2008.

Conclusion: Central Europe Is All Recession Bound

This is basically the third in a series of posts, where I have looked at the short term outlook for three key central European economies: Poland (here), Hungary (here) and the CR, and the conclusion is that they are all headed into or near to the contraction zone in 2009. Cetainly Hungary is the worst case scenario, and Poland is struggling with a complex set of forex issues, but even the Czech Republic can not expect to escape unscathed.

Previously, as can be see in this chart for the EU Economic Sentiment index, Poland had been faring rather better its Central European neighbours. But the downward movement in Poland is now evident and pronounced, and in fact the contraction may ultimately be sharper than in the CR.

In their January forecast the EU Commission estimated that GDP growth in the Czech Republic would come in at 1.7% in 2009 and then edge up again to 2.3% in 2010. This now seems very much on the high side to me. I expect Czech GDP to be more or less stationary in 2009, with some downside risk to this estimate given the general problem of economic stability in the region and the very serious contraction which is like to take place in the German economy on which the CR is so dependent. I do not expect a resurgence in domestic demand, and the economy will now more than likely become even more export dependent, which leaves us with the omnipresent question, "exports to where"? On the other hand, at the present time we do are not looking at a "boom-bust" scenario, and the CR economy should fare substantially better than many of those around it.

Czech Inflation Slows Again In October

2008-11-10T05:32:00.000-08:00

Czech inflation dropped back again in October, rather more than had been expected by the central bank and most economists, hitting the lowest level this year, pushed down by transport and food prices. The annual rate fell to 6 percent from 6.6 percent in September. Consumer prices remained unchanged month on month.

The central bank, which anticipated an October rate of 6.4 percent, expects inflation to drop to its mid-point target of 3 percent sometime next year. Czech monetary policy makers only a week ago reduced the key interest rate by three-quarters of a point to 2.75 percent, and this was the largest reduction since 2004, as evidence mounts that both inflation and economic growth are cooling rapidly. On the EU HICP methodology, Czech prices peaked in July, and have since been falling. This process now needs closely watching.

Czech Central Bank Slashes Rates As Czech Manufacturing Contracts And Exports Wane

2008-11-06T01:56:00.000-08:00

The Czech central bank slashed its benchmark interest rate more than expected this morning as a growing credit crunch slows down borrowing and a decline in external demand hits exports and industrial output. Manufacturing output in the Czech Republic contracted for the seventh month in a row in October, and the purchasing managers index (PMI) hit an all-time low of 41.2, just above the revised euro zone figure of 41.1, giving us some idea of just how interconnected Czech and Eurozone activity are.

Sharp Rate Reduction

The Prague-based Ceska Narodni Banka reduced the two-week repurchase rate by three-quarters of a percentage point to 2.75 percent, its lowest level since June 2007. The size of the cut is the largest since at least 2004.

The koruna fell to 24.953 per euro immediately after the decision, and this was its lowest level since Oct. 27. It was trading at 24.868 at 12:37 p.m. in Prague, compared with 24.550 late yesterday. The koruna has risen 11 percent against the euro over the last 12 months, and obviously Czech exporters have been feeling the pinch. This was the second time this year the bank has lowered rates (there was a quarter point reduction in August) as economic growth in both the CR and its key trading partners has fallen back rapidly.

Exports Weaken In September

Czech exports exceeded imports by 10.9 billion koruna ($581 million) in September, well short of the 14 billion-koruna surplus many economist had been expecting. On a working day adjusted (but not price corrected) basis exports were down 1.2% year on year in September (the third month of y-o-y decline, there were 3 working days more in September 2008 than there were in September 2007), while imports were up 6.5%.

Without the working day correction exports at current prices grew by 5.1% and imports by 6.8%, year-on-year. Month on month, seasonally adjusted exports were up by 1.8% over August and imports by 9.8%.

Year-on-year, exports and imports at current prices were up by 5.1% and 6.8% respectively. Imports grew faster than exports for the first time since February 2008. External trade turnover amounting to CZK 436.6 billion was the second highest (after April) in this year. September 2008 was by three working days longer than September 2007. Due to appreciation of the koruna external trade grew more rapidly in euros (exports +18.3%, imports +20.3%) and US dollars (exports +22.4%, imports +24.5%) than in korunas.

Flagging Retail Sales

And if we want additional evidence on the domestic slowdown in the Czech Reoublic then we need look no further than August retail sales, which fell the most in six years as inflation damped consumer spending and two fewer working days than a year ago cut shopping hours. Inflation adjusted sales (excluding automotive sales) were down 2.6 percent, compared with a 3.4 percent increase in July, according to data from the Czech Statistical Office earlier this week. Working day adjusted sales were down 0.3 percent.

Weak Czech Manufacturing Forms Part Of A Global Picture

The October manufacturing contraction in the Czech Republic really forms part of a much larger global picture, since recent events in the CEE financial sector have, above all, a global backdrop, one which the current dependence of the Czech economy on exports only serves to highlight.

Manufacturing output fell in October in one country after another, and indeed the latest JP Morgan Global PMI report really does makes for quite depressing reading.

The world manufacturing sector suffered its sharpest contraction in survey history during October, as the ongoing retrenchment of global demand and further deepening of the credit market crisis negatively impacted on the trends in output, new orders and employment. The JPMorgan Global Manufacturing PMI posted 41.0, its lowest reading since data were first compiled in January 1998 and a level below the no-change mark of 50.0 for the fifth month in a row.

Output, total new orders and new export orders all contracted at the fastest rates in the survey history in October. With the exception of India, which again bucked the global trend, all of the national manufacturing surveys posted declines in output and new orders. The impact of the downshift in global market conditions also had a far-reaching effect on international trade volumes. Although new export orders fell at a slower rate than total new business, all of the national manufacturing sectors covered by the survey (including India) saw a reduction in new export orders.

"October manufacturing PMI data reinforce the stark retrenchment that the sector is currently facing, with production, total new business and new export orders all falling at record rates. The latest Output Index reading is consistent with a fall in global IP of almost 8%. The only positive from the surveys was a decline in input prices for the first time since August 2003."
David Hensley, Director of Global Economics Coordination at JPMorgan

Economies across the Eurozone are being affected. In Italy manufacturing activity contracted at the fastest rate in at least 11 years in October according to the latest Markit/ADACI PMI survey out yesterday (Monday). The Markit Purchasing Managers Index fell to 39.7, its lowest since the series began in 1997, down from 44.4 in September. The Italian manufacturing PMI has now not been above the 50 mark separating growth from contraction since February and the latest data showed activity falling at an accelerating pace as demand shrank while jobs were shed at the fastest rate in the history of the survey.

Other recent indicators from Italy have also been far from encouraging, with October business confidence hit its lowest point since September 1993, when the economy seized up after Italy was rocketed out of the European Exchange Rate Mechanism a year earlier.

Germany's manufacturing sector contracted in October at the fastest pace in seven years as incoming orders and output experienced their sharpest declines in more than 12 years. The headline index in the Markit Purchasing Managers Index for what is Europe's biggest economy fell in October to 42.9 from 47.4 the previous month, well below the 50 mark that separates growth from contraction.

The French manufacturing purchasing managers index was revised down to a series low 40.6 in October, down from both the 'flash' estimate of 40.8 and September's 43.0 figure, Markit Economics said in a press release issued on Monday.

Disaggregating the figures, the output component fell to an all-time low of 37.8 from September's 41.7 level, while new orders slipped all the way to a series low of 34.9 for the month, down 2.6 points from September's 37.5 level. Purchase quantities and new export orders also saw some new record lows in October, falling to 33.7 and 38.5 respectively.

Spain's manufacturing sector continued to shrink at a record pace in October - possibly the fastest among all those included in the JPMorgan index - with both output and new orders contracting and employers shedding jobs at a near record pace, according to the latest Markit Economics Purchasing Managers Index published yesterday (Monday). The Markit PMI for Spain dropped to 34.6 in October, the lowest reading registered by any eurozone economy since the series began in February 1998 and down from the already rapid 38.3 point contraction in September. As we can see, according to this indicator Spanish manufacturing has now been weakening steadily since the start of 2006.

Central and Eastern Europe

Apart from the Czech decline, output also contracted elsewhere in the CEE. In Poland the ABN Amro Purchasing Managers Index fell for the sixth month running to 43.7 (down from September's 44.9) a record low and well below the neutral reading of 50, according to Markit Economics. Hungary's manufacturing industry contracted sharply in October, according to the latest PMI reading, which fell 5.2 points to hit 44.7 in October - a historic low, and 0.8 points below the previous worst reading registered in October 1998, according to the latest data from the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM).

As the Eurozone itself contracts, these economies which are heavily dependent for exports to the zone will be buffeted, especially now that forex loans for their domestic housing markets have all but dried up.

US Manufacturing

The US manufacturing PMI dropped back to 38.9 in October from 43.5 in September, indicating a significantly faster rate of decline in manufacturing when comparing October to September. It appears that US manufacturing is experiencing significant demand destruction as a result of recent events. October's reading is the lowest level for the US PMI since September 1982 when it registered 38.8 percent. On the other hand inflationary pressures are evaporating rapidly, and the Prices Index fell to 37, the lowest level since December 2001 when it registered 33.2 percent. Export orders also contracted for the first time in 70 months.

The BRICs

China's PMI dropped to lows not previously seen in October, confirming that the economy of the so-called factory of the world is now decelerating along with everyone else. Two international surveys measuring the PMI independently corroborated the evidence of a cooling Chinese industrial economy.

According to a survey complied by securities firm CLSA, China's PMI fell to 45.2 in October, its third consecutive drop, from 47.7 in September, as new orders and exports, as well as pricing power, were squeezed by the global financial crisis.

"The very sharp fall in the October PMI confirms that China is more integrated into the global economy than ever. Chinese manufacturers are seeing their order books cut, both at home and abroad, as the world economy falls into recession," said Eric Fishwick, CLSA's head of economic research, in a report released Monday. "Costs are falling but so are output prices. The coming 12 months will be difficult ones for manufacturers, China included."

The government-backed China Federation of Logistics purchasing managers' index - published on 1 November - also showed a strong contraction, falling to 44.6 in October, the lowest level since the data began in 2005, from 51.2 in September

Russian manufacturing contracted in October at the slowest pace in over two and a half years as the global financial crisis cut demand, according to the latest reading on VTB Bank Europe's Purchasing Managers' Index, which fell to 46.4 from 49.8 in September. This was the third consecutive month in which Russian industry has been contracting.

Business conditions in the Brazilian manufacturing worsened in October for the first time since June 2006. The headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) posted 45.7, down from 50.4 in September, pointing to a sharp contraction -the fastest in the survey history in fact. The PMI was driven down by accelerated declines in output and new orders, as well as falls in employment and stocks of purchases.

Even in India the seasonally adjusted ABN Amro India Manufacturing Purchasing Managers’ Index dropped steeply in October, falling to a record low of 52.2, down from a reading of 57.3 in September suggesting another sharp deceleration in growth, even if Indian industry managed to keep expanding. The biggest fall was in the new orders sub-index, which dropped to 54.4 in October from 62.6 in September. Perhaps the saving grace in the Indian survey is that most firms said demand remained strong in domestic markets, while it had been international orders which had waned. This can also be seen from the new export orders sub-index, which contracted to 49.7 for the first time in the history of the series. That fits in with the latest data showing that Indian year on year export growth slowed to 10.4% in September. Thus the Indian expansion is still hanging on in there, by its fingernails, but it is hanging on in.

Czech Financial Sector Struggles as Retail Sales Growth Drops Sharply In August

2008-10-18T00:43:00.000-07:00

Central European stocks dropped again on Friday, led by the banks, following the announcement that Goldman Sachs had lowered its economic forecasts for the region and the decision of Fitch Ratings to cut Hungary's foreign- debt rating. The Czech Republic's PX Index slumped 10 percent.

An index of investors' and analysts' expectations for the CEE region over the next six months plunged to minus 51.1 points in October from minus 30.6 in September according to latest the survey from the ZEW Center for European Economic Research and Erste Bank AG.

Goldman reduced the Czech Republic's 2008 growth forecast to 4.3 percent this year from 4.4 percent, while the 2009 outlook was changed to 2.5 percent from 3.8 percent.

Komercni Banka AS, the third-largest Czech bank, fell the most since 1999. OTP Nyrt. slid to its lowest level in almost five years after HSBC Holdings Plc downgraded Hungary's largest bank on concern its loan expansion may slow and credit quality worsen, while Bank Pekao SA, Poland's biggest bank, posted its steepest drop on record.

Komercni lost 530 koruna, or 17 percent, to 2,510 in Prague trading. Erste Bank AG, Austria's biggest publicly traded bank, slid 2.39 euros, or 10 percent, to 21.6 euros in Vienna.

New World Resources NV, the Czech Republic's biggest maker of coking coal for steel producers, plunged 22 percent to 111 koruna, its lowest since debuting on the bourse in May, after U.K. Coal Plc, the nation's biggest miner of the fuel, fell the most ever in London trading after saying full-year output will ``significantly'' miss a previous target because wet weather curbed third-quarter production.

The NTX Index of 30 companies in the region retreated 4.4 percent to 951.42, the lowest in almost four years, even as stocks in western Europe rose after a two-day selloff. The PX Index's drop was the biggest fluctuation among equity markets included in global benchmarks. Hungary's BUX Index fell 2.4 percent, Poland's WIG20 Index lost 6.4 percent and Austria's ATX Index declined 3.3 percent.

Clearly the financial turmoil has now crossed over the CR's doorstep, and is increasingly making its presence felt. In the meantime, and as Goldman note, the real economy is slowing.

Retail Sales Contract In August

The latest piece of evidence we have for this is the fact that Czech August retail sales fell the most in six years as inflation damped consumer spending and two fewer working days than a year ago cut shopping hours. Inflation adjusted sales (excluding automotive sales) were down 2.6 percent, compared with a 3.4 percent increase in July, according to data from the Czech Statistical Office earlier this week. Working day adjusted sales were down 0.3 percent.

If we look at the evolution of retail sales in the above chart the slowdown is evident, now we need to factor in the impact of all the financial turmoil, which is still very much a "work in progress" as far as Eastern Europe is concerned.

Writing History In The Czech Republic

2008-10-12T05:27:00.001-07:00

The Czech Republic's PX Index posted its steepest drop on record on Friday. Erste Group Bank AG, Austria's largest publicly traded lender, and developer Orco Property Group SA sank the most since their shares were listed on the exchange, which had to suspend trading in four of the 14 listed companies during trading hours. "Today has written itself into history," said Miroslav Adamkovic, an equity analyst at Komercni Banka AS in Prague.

Obviously all of this is significant and important, and I will try and write something more substantial as and when time permits.

Czech Industrial Output Down Sharply in August

2008-10-09T03:57:00.000-07:00

Czech industrial production fell the most in six years in August, suggesting that the slowdown in Czech economy is gathering momentum quite fast. Output fell 2.6 percent after rising 6.7 percent in July, acoording to data from the Prague-based statistical office on Thursday. This was the worst result since August 2002, when production plummeted 6.6 percent. The value of industrial new orders decreased by 10.0%, year-on-year.

And it looks very much like there is worse to come with the Markit Economics/ABN Amro Purchasing Manager's Index (PMI) for the Czech manufacturing sector fallinf for the third consecutive month in September, and remaining below the critical 50-point expansion/contraction level for the second consecutive month. The index fell to 46.5 in September, down from a reading of 47.3 in August - marking the lowest level in the survey's 87-month history and a 55.8 reading in July.

The Construction Slump Continues

The constant-price seasonally-adjusted construction output index was down by 0.1% in August, when compared with July. In comparison to August 2007, constant price output dropped by 1.2%. The planning and building control authorities granted 11 762 building permits, up 4.2% more year-on-year. Approximate value of permitted constructions was also up by 2.8% year-on-year and reached CZK 36.2 billion.

Inflation Holds Steady

Consumer price dropped in September when compared with August by 0.2 %. The downward effect on the consumer price level, month-on-month, came from the seasonal price fall in domestic recreational stays and recreational stays abroad (as in previous years at this time) and a further drop in the price of automotive fuel. The year-on-year consumer price growth accelerated to 6.6 % in September (from 6.5 % in August).

The month-on-month consumer price level decrease by 0.2 % owed mainly due to a price reduction in 'recreation and culture', in which prices of package holidays went down by 14.6 %. In the 'transport' section the drop in the price of automotive fuel continued for the third month and was 1.7 % in September. The price of petrol and diesel oil was the lowest in the last five months. In 'food and non-alcoholic beverages' prices of fruit, potatoes and other vegetables were all down (by 7.8 %, 8.8 % and 9.2 %, respectively). Prices of rolls and baguettes dropped by 3.3 %, flour by 5.6 %, eggs by 2.3 % and cheese by 1.4 %. In the 'communications' section, prices decreased by 1.1 % due especially to due to lower prices for mobile roaming services.

In terms of the year-on-year comparison, in September, the increase in consumer prices was 6.6 %, i.e. 0.1 percentage point up on August. An price increases accelerated primarily in 'alcoholic beverages and tobacco', 'recreation and culture' and 'education'. Prices of tobacco products rose by 13.1 % (from 8.9 % in August). In spite of a marked month-on-month drop in prices of package holidays, their prices were 1.5 % up, year-on-year. In the 'education' section the y-o-y growth accelerated almost in all levels of educational services. On the other hand, in 'food and non-alcoholic beverages', the y-o-y growth of prices slowed down mainly due to changes in prices of fruit, which were lower by 2.2 % in September (a 3.7% growth in August). Similarly, prices of unsalted butter dropped to 7.6 % in September, while in August they were 1.4 % up. A slowdown in the growth of prices was recorded primarily for rolls and baguettes to 25.6 % (from 30.1 % in September), flour to 40.5 % (from 61.6 % in August) and cheese to 4.9 % (from 10.5 % in August).

The biggest effect on the price level still came from 'housing, water, electricity, gas and other fuels', where prices of natural gas rose by 27.5 %, electricity by 9.5 %, heat and hot water by 11.1 % and solid fuels by 19.9 %. Net actual rentals rose by 14.7 %, of which for dwellings with regulated rentals by 22.3 %, while for dwellings with market rentals by 3.0 %. In 'transport', prices of automotive fuel were higher by 4.3 % (by 5.2 % in August), which is the lowest y-o-y increase over the last eleven months. The growth of petrol prices ranged from 1.7 % to 3.2 %, while the growth of diesel oil prices was 13.3 %.

The average number of persons employed in industry decreased in August 2008 by 5.7 thousand persons, y-o-y (i.e. -0.5%). Employment decreased most in 'manufacture of textiles and textile products' (-12.5%), 'manufacture of leather and leather products' (-6.9%) and in 'electricity, gas and water supply' (-6.8%). Increases in average number of persons employed were registered in 'manufacture of transport equipment' (+4.8%), 'manufacture of electrical and optical equipment' (+3.2%) and 'manufacture of rubber and plastic products' (+1.9%).

The average hourly wage increased by 13.4% and stood at CZK 172.4.

Czech Central Bank Keeps Interest Rates On Hold

2008-09-25T10:35:00.001-07:00

Well, it seems we now have a rather fascinating situation on our hands, since raising interest rates appears to have just gone out of fashion. Not that the decision of the Czech Central bank to hold interest rates steady today should have come as any great surprise, with oil prices dropping back and the Czech economy visibly slowing (not to mention the fact that Germany - probably the CRs largest single customer - is now sliding into a full blown recession), but what is so impressive about events this week is the way almost all the global central banks are now speaking with one, almost monotonous voice, on the back of the latest bout of financial turmoil in the United States: no rate rises fot the time being.

And thus it was today with the Ceska Narodni Banka whose board voted 4-2 to leave the two-week repurchase rate at 3.5 percent, following in the footsteps of the Polish and Romanian national banks who have also this week left their benchmark interest rates on hold.

Indeed far from raising, the main consideration was whether or not to lower rates again (following last months quarter point reduction), and during the meeting, two board members argued in favour of cutting to 3.25 percent immediately. Following the meeting Governor Zdenek Tuma reiterated that the bank's August forecast assumes further rate cuts:

``In the end, the opinion to hold won out not so much because the fundamental arguments for lowering were doubted, but mostly, precisely because of the respect for the large uncertainties and volatility in a number of factors in recent weeks,''

In part the justification for holding (and even cutting) rates is that inflation is clearly on the wane. The Czech inflation rate fell in August to the lowest so far this year as costs of food and fuel declined, raising the chances that price growth will slow to the central bank's target in early 2009. The annual rate dropped to 6.5 percent from July's 6.9 percent, according to data from the national statistics office earlier this month.

The koruna has now fallen back 3 percent against the euro since the central bank lowered its benchmark rate a quarter of a point on Aug. 7, turning the currency from one of the best performing to the third-worst performer among the 26 emerging market economies in the MSCI index.

Slowing Industrial Output

Czech indutrial output fell in July, by 0.7% on a seasonally and working day adjusted basis when compared with output in May. On an annual basis production was up by 2.2%, but when allowance is made for the 3 extra working days in July 2008 output was only up by 0.6%.

Looking at the above chart we should remember that due to the early timing of easter this year (in March) data everywhere have been a complete hodge podge. If we assume that the March/April reading need averaging out, what we find is that the rate of increase in Czech industrial output has been slowing steadily since last February. This picture is further confirmed by the seasonally adjusted output index, which clearly peaked in February, lurched down in March, rebounded in April and has since steadily headed south. In part this is due to slowing export activity and consumption in Germany, and in part it is due to the high krona, but whichever way you look at it things are slowing significantly.

Construction Output Also Slowing

2008-09-20T14:03:00.000-07:00

In July seasonally adjusted total construction output at constant prices was up by 1.1%, compared with June. In comparison to July 2007, output at constant prices grew by 6.9%. The planning and building control authorities granted 11 055 building permits, i.e. 13.5% more year-on-year than in July 2007. The approximate value of authorised constructions increased by 16.2% year-on-year at non inflation adjusted prices and reached CZK 35.0 billion.

However when adujsted for working days total output rose by 1.8% (July 2008 had three working days more). The fastest growth was recorded in civil engineering, in the areas of new construction, reconstruction and modernisation as well as repair and maintenance. Civil engineering is of course recepient of most of the resources from EU structural funds going to the construction industry.

What we can see from the above monthly chart is that construction activity has gone in waves. We can also see that the latest wave ground to a halt during the spring of 2007. As we can see from the annual index below, construction activity has been rising steadily since 2000. It now remains to be seen for how much longer this sort of pace can be sustained.

Czech Retail Sales Slow Further in July

2008-09-20T12:35:00.000-07:00

Czech retail sales growth slowed further in July, providing more evidence of the steady deceleration in the economy. In fact sales continued to rise year on year simply because there were 3 more working days in July 2008 than in July 2007.

Seasonally adjusted retail sales (excepting the automotive segment) were down by 0.6%month-on-month at constant prices in July. The year-on-year increase was 1.0% (without seasonal and wd adjustment they increased by 3.4%). The biggest contribution to the growth of sales came from the sale of books, newspapers and stationery, other retail sale in specialised stores and sales of furniture, lighting equipment and household articles, electrical appliances, radio and television goods, hardware, paints and glass in specialized stores.

In the automotive segment, seasonally adjusted sales at constant prices were down by 3.9% m-o-m and down by 2.2% y-o-y. Not seasonally adjusted sales grew by 4.0% year on year. Seasonally adjusted sales in hotels and restaurants dropped by 0.6% m-o-m and not seasonally adjusted sales decreased by 3.0% y-o-y. That is, tourism and services generally have been having a hard time of it.

Czech Export Growth Remains Lacklustre In July While Imports Fall

2008-09-04T07:55:00.000-07:00

Exports from the Czech Republicc roseat an annual 3.2 percent in July - reaching 204.1 billion koruna - compared with a 1.7 percent increase in the previous month. Imports totaled 196.8 billion koruna, and were down 0.9 percent on the year after a 1.1 percent drop in June. The fall in imports is a pretty clear reflection of the slowdown in internal demand, although ironically this will initially be reflected in a slight upward movement in GDP as the net external trade contribution rises slightly.

The export performance was all the weaker taking into account the fact that there were three more working days in July compared with the same month last year. The position hasn't been helped by a dramatic decline in European car sales.German car registrations fell an unadjusted 10.4 percent in August, (there were two fewer working days), and this was the third monthly decline this year.

Elsewhere things were much worse. In Ireland, new sales continued downwards in August, with August monthly sales figures down by 41.6 per cent on last year. Spanish car sales fell by 41.3 per cent in August, their sharpest decline this year. Data issued by Spanish industry group Anfac showed a fall in showroom traffic across regions as the economy moved close to a recession. Italy's sales fell for the eighth month in a row, down 26.42 percent to 77,156 units, the biggest monthly drop this year, according to government figures. For the first eight months, sales totalled 1,531,598 units, down 12.04 percent. Car sales in France did better, falling by 7.1 per cent year on year uncorrected, and rising slightly at 2.2 per cent when adjusted for differences in working days.

In general terms the Czech Republic is beginning to feel the twin impact of slowing growth in the 15-member euro region - the country's main trading partner - and the appreciation of the koruna, which rose to a record of 22.877 on July 21, and has further weighed on exporters by making Czech goods more expensive abroad.

Trade Surplus Narrows

The Czech Republic's trade surplus narrowed in July from the previous month. Goods flowing out of the country exceeded imports by 7.2 billion koruna ($421 million), compared with a revised 15.3 billion koruna in June and a 1.6 billion-koruna deficit a year ago.

Czech Real Wage Growth Slows Further In Q2 2008

2008-08-27T01:56:00.000-07:00

Czech real wages grew at the slowest pace in almost 10 years in the second quarter, helping reduce concern that inflation will get stuck above the central bank's target range. The average salary rose by 8%, which meant a rise in real wages of 1.1 percent when adjusted for 6.8 percent inflation, compared with revised growth of 2.6 percent in the first three months, according to data from the Prague-based statistics office last week. The average gross monthly paycheck jumped to 23,182 koruna ($1,387) after a revised 10.2 percent rise in the first quarter.

The central bank, which on Aug. 7 cut its key interest rate for the first time in three years, mentioned strong wage growth one of the factors that could frustrate its aim of reducing the inflation rate to its 3 percent target range next year.

The central bank is watching closely to see whether the current inflation spike, which they expect to wane during 2009, will lead to faster pay increases than justified by productivity gains, providing a second-round impulse to price growth.

The lowest jobless rate in 11 years, a record number of vacancies and tax optimization pushed first-quarter wages up the most in more than 9 years. The government introduced a flat income tax rate on Jan. 1, replacing four progressive rates, leaving most workers with more net pay in their pockets.

Among private businesses, the monthly paycheck was 9.3 percent higher, at 23,692 koruna. When adjusted for inflation, wages grew 2.3 percent, while the salaries of state employees jumped on average 3 percent to 21,344 koruna, translating into a 3.6 percent drop in real terms after the government capped public wage gains to restrain spending.

Czech Economy Continues To Slow In Q2 2008

2008-08-14T04:58:00.001-07:00

The Czech economy expanded at what was effectively the slowest pace in four years in the second quarter of 2008, although it was perhaps just a touch faster than I personally had been expecting. Gross domestic product grew 4.5 percent, compared with a revised 5.1 percent in the previous quarter, slackening for a fourth straight quarter, according to data from the Prague-based statistics office.

Ostensibly the economy continued to maintain the same 0.9% quarter on quarter expansion pace as in the first quarter, but that may be slightly deceptive, since the early calendar position of Easter this year has meant that in most European economies activities from March have been passed through to April without the statistics offices seasonal adjustments being adequately able to capture the effect. So my feeling is that with a better seasonal correction we would find that the economy expanded rather faster in Q1 and rather slower in Q2, but in any even hardly by an earth shattering value.

The only clue we really have while we wait for the detailed breakdown from the statistics office on 10 September is that the trade surplus may well have played a significant part. Exports of goods in current prices rose 4.6 percent in the three-month period ending June 30, down from 5.7 percent in the first quarter, but slowing domestic demand has meant that imports slowed even more rising by only 2.7% year on year in the second quarter. The three-month goods trade surplus shrank to 31.4 billion koruna, compared with 33.025 billion koruna in the first quarter, according to the statistics bureau's Aug. 4 report so really at the end of the day we are all just guessing here.

Czech Producer Prices Rise Again In July While Retail Sales Expand Slightly In June

2008-08-14T04:32:00.000-07:00

Czech industrial producer prices increased by 0.1% m-o-m in July and by 5.2% year on year. Prices went up the most significantly in ‘basic metals, fabricated metal products’ by 1.8%, in ‘chemicals, chemical products and man-made fibers’ by 1.7% and in ‘food products, beverages and tobacco’ by 0.4%, mainly in ‘animal and vegetable oils and fats’ by 2.8%. Prices went down particularly in ‘coke, refined petroleum products’ by 1.6% and in ‘transport equipment’ by 1.3%.

In June 2008, export prices decreased by 1.8%, import prices by 1.2%, month-on-month. Year-on-year, export prices fell by 8.1% and import prices by 5.7%.

Retail Sales

In June, seasonally adjusted retail sales (except automotive) grew by 0.4% month-on-month at constant prices and by 2.7% year-on-year (not seasonally adjusted by 1.4%). The biggest contribution to the growth of sales came from the sale of furniture, lighting equipment and household articles, electrical appliances, radio and television goods, hardware, paints and glass in specialized stores. In the automotive segment, seasonally adjusted sales increased by 1.7%, m-o-m, at constant prices, by 2.9% year-on-year and not seasonally adjusted by 2.6%. SA sales in hotels and restaurants dropped by 0.6%, m-o-m, and NSA sales were 2.7% down, year-on-year.

Czech Inflation Sneaks Upwards Again In July

2008-08-08T06:03:00.000-07:00

Czech inflation accelerated in July for the first time in six months on higher prices for natural gas, cigarettes and holiday packages. The inflation rate climbed to 6.9 percent from June's 6.7 percent, according to data from the Prague-based statistics office earlier today. Month on month, consumer prices rose 0.5 percent following 0.2 percent growth in June.

Ceska Narodni Banka Drops Its Interest Rate

2008-08-07T07:19:00.000-07:00

Now this is news. Monetary policy makers at the Ceska Narodni Banka (the CRs central bank) cut what is the European Union's lowest key interest rate to 3.5 percent at today's meeting. This was the first decrease in more than three years, and was evidently an attempt to counter the koruna's record appreciation in order to try to revive economic growth which is fading rapidly.

Rate setters seem to have decisively switched their focus from the current high levels of inflation to countering the koruna's 13-month rally on concern a high Koruna will continue to have a negative impact on exports, investments and employment. Central Bank Chief Zdenek Tuma warned last month that the koruna's recent advance could cause inflation to undershoot the central bank's 3 percent target next year, justifying the then hypothetical possibility of rate cuts. Since then, the koruna has lost 4.1 percent against the euro.

The central bank lowered its forecast for economic growth for this year to 4.1 percent from the previous 4.7 percent outlook. In 2009, economic growth the bank expect growth to decelerate further - to 3.6 percent - which compares with the 6.6 percent rate achieved in 2007. So the bank is worried that the economy is slowing excessively quickly.

In fact the Czech economy expanded at the slowest pace in more than three years in the first quarter as consumer spending weakened. Gross domestic product rose 5.3 percent, compared with a revised 6.3 percent in the previous quarter. The economy's rate of expansion slowed for a third consecutive quarter after peaking at a record 6.8 percent in Q2 2006.

If we look at the q-o-q chart we can see the slowdown even more closely. Basically the economy hit a quarterly 1.8% in Q1 2007, and since that time it has been slowing to Q1s 0.9% (or an annual rate of 3.6%). Clearly Q2 will be weaker and we could see q-o-q of 0.5%, which mean if the rate of de-celleration continued we might get negative growth in Q4. This would clearly be a soft landing, but it is preoccupying for an emerging economy nonetheless.

The inflation rate increased to 6.9 percent in July from June's 6.7 percent, surpassing the central bank's goal for the 10th consecutive month. The CR now has negative interest rates of some 3.4 percent. That is, monetary conditions in the CR are extremely accommodative.

And wages have been rising much more rapidly than prices in recent months, that is real wages have been rising.

Which is not really surprising, since the labour market has been steadily tightening as the number of unemployed has dropped steadily. Which makes the issue of why consumption has been falling back much more of a mystery. This situation is very different from what we are seeing at present in Bulgaria or Romania, or even Slovakia.

Now it is not hard given the sharp rise in the Koruna to understand why Czech exports slowed significantly on a year on year basis in June. They were up a touch on May, but down on April and February, and were only very slightly up y-o-y. Exports rose an annual 1.7 percent, to 215.8 billion koruna and imports totaled 201.9 billion koruna, a 1.1 percent decline in the year.

But why is consumer demand slowing at this point? This is much harder to understand, yet it is. Why are people not simply borrowing cheap money and building houses and buying cars? Seasonally adjusted retail sales, however, only grew at a very moderate rate in May (up by 0.6% month-on-month and by 2.5% year-on-year).

And the construction boom is long since over, with output actually contracting year on year in May. Indeed the last construction boom seems to have blown out in Q1 2007.

Now this is all frankly rather worrying, and it is doubly worrying for me, because I think I have seen this before in Portugal and in Hungary. The rising Koruna may well choke exports but there is no reason whatsoever why it should be choking domestic demand, indeed quite the contrary. So why is domestic demand so weak, that is the question?

If we look at a longer term chart for year on year household consumption growth, we will see that the last "long wave" of this peaked in Q1 2007. We can expect the performance in Q2 2008 to be even worse, and the question, the quite deep theoretical question really, is why this should be happening?

Now here's a rather similar chart for Hungary. As we can see, Hungary had it last local peak in Q1 2006.

And as we can see, Portugal's last big "wave" ended in Q1 1999. So my question is really, is it possible that the CR is now where Portugal was in Q1 1999 and where Hungary was in Q1 2006? My feeling is that it is possible, and indeed this is where we may well now be. The thing is we need to understand the theory which explains the dynamics behind all this much better. But if it isn't like this, then I don't understand why consumption is now simply fading out.

Basically one thing that these three countries have in common is declining population (or at least in the Portuguese case declining population at the time when consumption blew, as a result of prior EU freedom of movement related out-migration). Declining and ageing population. As we can see in the first chart, the population of the CR has declined in a variety of ways since the late 1980s. It has started to increase again since 2004, but it seems to me the consumption bust was already in the pipeline by that point. What is really, really surprising to me is just how sensitive the whole system is to what appear to be really quite small movements in population size.

Of course it isn't simply the size that matters, it is more the structure, and as we can see from the median age chart below the CR has been ageing quite rapidly for some time now, and will continue to age as we move forward. Having more children and accepting more immigrants (both of which are very advisable) are the only things which will slow all this down.

Of course you won't read about any of this in the economics text books (yet), but the picture is reasonably clear, and it is also perfectly compatible with life cycle savings and consumption model as presented by Franco Modigliani. You simply need to apply it to population rather than simply to individuals.

Where Now for CEE and Baltic Currencies?

2008-08-06T06:14:00.001-07:00

By Claus Vistesen: Copenhagen

Ever since the illusive credit turmoil began sentiment in the market place has been fickle and essentially, like the assets of which it consists, volatile. We started off with an adamant focus on downside risks to growth which then turned into a focus and fear of inflation. Now, as the cyclical data has turned for the worse in Europe and many places in Asia the focus seems to be reverting to growth. Now, I won't go into the whole decoupling v recoupling discussion at this point since I think that this dichotomy is a false one. It never was about de-coupling à la traditionelle but moreso about two interrelated points. The first would be the extent to which the world already has decoupled from the US in the sense that a key group of emerging economies are now set to ascend in economic prowess. The second would be the extent to which the de-coupling thesis always built on a fallacy. The main point would be that the main fault line of slowdown was observed across economies with external deficits; something which, I am sure most will agree, is sure to impact surplus economies too.

Now, that does not completely let the ECB off the hook since by maintaining a focus on inflation it also assumed the role, if only temporary, of the new anchor in a re-wamped version of Bretton Woods II as the Euro ascended to new highs. This bet on global re-balancing was always going to end in tears and in this light the Eurozone could not decouple from the US; that much, I think, is true.

The key issue here however, as I have argued time and time again is represented in two crucial interlocked questions which together form a key structural trend in the global economy. One is what happens when the surplus economies slow down and there is not sufficient demand to pull the economy back up? Demographics and a high median age are key variables to watch in this regard. The second question is the extent to which hitherto deficit nations can turn the boat around and increase savings (i.e. rely more on exports) and what it will mean for global capital flows when they begin this process?

In the context of the CEE economies the themes above are also present. In a recent note I detailed the change in sentiment from growth to inflation and what it might mean for Eastern Europe's economies and their respective currencies. The key situation as I sketched it was one of a dilemma.

On the one hand, the rampant inflation levels suggest that the exchange rate be loosened to allow appreciation and thus pour water on the roaring inflation bonfire. On the other hand however the Baltics, as well as many other CEE countries, are saddled with extensive external deficits financed by consumer and business credit denominated in Euros. It is not difficult to see that this represents a regular vice from which it will be very difficult to escape since as long as the peg remains deflation seems the only painful alternative as a mean of correcting.

(...)

Another point which is specifically tied to Eastern Europe is that if domestic nominal interest rate increase to keep up with inflation rates it will have a strong substitution effects towards Euro denominated loans. This can become a dangerous cocktail should the tide turn against the currencies.

Now that the focus seems to be changing back again it appears to be a good time to revisit the situation

Within this global nexus of what exactly to do with inflation relative to growth, many Eastern European economies has so far opted to go for inflation by raising interest rates. At an initial glance this seems quite reasonable and in many ways the CEE central banks merely latched on to market sentiment and expectations that many emerging economies would seek to use nominal appreciation as a tool to flush out inflation.

Consequently we have seen how both Ukraine and Hungary have chosen to loosen the peg to the Euro as well as other floating currencies in Eastern Europe have seen their yield advantage increase in an attempt to flush out inflation. This has not been without problems though or more specifically it is not clear that an appreciation of the currency is all for the good. Two points here would seem particularly important. One is the simple question of whether in fact an appreciation is deflationary in a world where capital flows, and in particular the hot kind, act strongly on yield. However, another point would be specifically tied to the situation in Eastern Europe. As such, nominal appreciation of the currency also increases the purchasing power which is not what many CEE economies need at the present time as they stand before the task of correcting a rather large external balance. Moreover, rising domestic interest rates will increase and exacerbate the credit channel by which loans denominated in Euros and Swiss francs become more attractive. I have shown this to be true, for example, in the context of Lithuania. The important thing to do note here would what would happen to the servicing of these liabilities should the domestic currencies depreciate.

What happens next then? Or more concretely, even though CEE currencies, in general, have enjoyed a rally on the back of market expectations of nominal appreciation fed by hawkish central banks what happens if and when central banks reverese course?

An initial warning shot across the bow was handed to us as the governor of the Czech central bank mused that he might lower rates come next meeting due to the strenght of the Koruna and the subsequent effect on exports. Also Poland recently opted to abandon the hawkish stance as rates were kept steady. In light of this event Macro Man managed, as ever, to hit the proverbial nail on the head.

There is little more bearish for a currency these days than abandoning the inflation fight in a pursuit of growth; this is particularly the case when the market is heavily positioned the other way.

This is exactly the issue which now confronts many Eastern European economies. What to do as growth visibly tanks at one at the same time as inflation stays high. One thing here would be for the central banks to hold their raising cycle which in itself should ease the pace of appreciation but what if they need to lower rates.

Now the numbers above do not, in themselves tell anything remotely interesting. For one, the difference between the economies are quite big. For example the Czech Republic has been able to gain, with a comparatively low interest rate, currency appreciation which has actually helped the external balance in so far as it has made imports cheaper. Obviously, at this point the benign effect on the trade balance is just as much down to decreasing domestic demand as the value shield of a dear currency. On the other hand, if we consider especially Ukraine, Romania, and Hungary the price has been dearer and the subsequent effect on inflation less pronounced. One could always argue that the situation would have been much worse, but one thing is certain; the ensuing loss of competitiveness has not been compensated for with a decrease in inflation. And one has to wonder whether pushing nominal interest rates ever higher would be a sound solution.

The key here is that these high interest rates carry with them a high lock-in premium which makes it difficult to reduce them without causing substantial pain to the currency. Add to this that as long as interest rates stay in this territory the incentive to borrow in foreign currency remains very appealing. In fact, the incentive structure here is quite disruptive as many of these economies have higher rates on domestic currency deposits and lower rates on foreign credit. This incites consumers and companies to place their deposits in local currency while funding themselves in foreign currency. Finally, there is of course the more standard economics 1-0-1 point that whatever nominal rate is ascribed to a currency and an economy the latter needs to be able to provide the structural demand for which to satisfy the yield. Otherwise you just pour more gasoline on an already raging bonfire.

Obviously, as long as the local currency remains strong and on an upwards march or the trading band is kept in place the show goes on. But the longer this structure lingers the more difficult it will be to break free; and break free they must since I am quite sure that Eurozone membership is off, for the immediate future at least.

Another more hard hitting point would simply be that whatever growth momentum these economies had going into 2008 it is now steadily levelling off. Now, these economies need to rebalance their external accounts at the same time as they labour under the yoke of slowing growth, high interest rates which are difficult to reduce and/or a quasi fixed exchange rate to the Euro. Can you feel the chilling cold of deflation blowing across the Urals? I can.

Basically, the past years' rapid process of nominal convergence will now need to be kicked into reverse, since it is quite obvious that many CEE economies have been riding a blade too tough.

Be Careful Indeed

Last time I massaged this specific topic I summarised by ominously stating that the CEE economies and their central banks should be careful what they wished for in terms of using higher interest rates and subsequent nominal appreciation of their currencies to flush out inflation. The key point was that the effect would likely be limited and only further worsen the imbalances in the economies. And thus, here we are.

Another more subtle point in the context of market reactions would be the boomerang effect which comes from the currency appreciation as interest rates are increased (and the peg/band abandoned) to the subsequent plunge when the economic tide turns. In line with the change in global sentiment towards growth and deflation (see e.g. here) and the fact that other hitherto strong yielders (e.g. the Kiwi and Aussie) are beginning to falter we may be at an inflection point in the whole discourse of upwards movement in CEE currencies. Stephen Jen's recent tour of global FX markets is a fine addition to this argument.

As ever, this is obviously still a dilemma for most of these economies since inflation continues to rage ahead. In Romania for example the PPI rose at its highest pace since 2004. However, as long as the credit tap stays open and as long as the purchasing power is increasing so will the the demands for higher wages stay strong. This is particularly true in the context of the CEE economies as these are in possession of structurally broken population pyramids after two decades worth of lowest low fertility and, in the cast of the latter decade, net outward migration.

The main point I would like to emphasise here is that correction is coming and that it will only become harder the higher the currencies move upwards. In a more general light this correction will not be a small one and it most certainly will not be felt exclusively in Eastern Europe. Basically, the big hidden data point in all of this is the dependence of Germany on CEE imports. So far, this has moved along just nicely but Germany is in for a rude awakening once the link breaks ... and break, I am afraid, it will.

Exports From The Czech Republic Slow Further In June

2008-08-04T03:44:00.000-07:00

Czech exports slowed further on a year on year basis in June. They were up a touch on May, but down on April and February, and were only very slightly up y-o-y. The Czech economy is slowing visibly now, but could we also deduce we are going to see a very slight increase in German exports in June (over May) when the data are released later this week? Are movements in industrial output and exports in the CR now an early indicator for the German economy?

Exports rose an annual 1.7 percent, to 215.8 billion koruna and imports totaled 201.9 billion koruna, a 1.1 percent decline in the year.

The Czech Republic's trade surplus increased in June as weaking internal demand kept a lid on imports. Exports exceeded imports by 13.9 billion koruna ($905 million), compared with a surplus of 9.2 billion koruna in May and 8.1 billion koruna a year ago, according to the Prague-based statistics office earlier today

The koruna has been the world's best-performing currency so far this this year - advancing 17 percent against the euro and was 33 percent stronger against the dollar. The currency's sustained appreciation lowers the chances that the CR will see a rapid rebound in exports as the high value of the currency is now beginning to seriously weigh on exporters.

Czech Retail Sales May 2008

2008-07-23T13:49:00.000-07:00

Seasonally adjusted retail sales rebounded slightly in May, growing by 0.6% month-on-month and by 2.5% year-on-year. Seasonally adjusted car sales increased by 0.7%, m-o-m, at constant prices, by 1.3% year-on-year and unadjusted (NSA) sales dropped by 1.5%. SA sales in hotels and restaurants increased by 0.2%, m-o-m, and NSA sales dropped by 0.3%, year-on-year.

The evidence for a slowdown in the Czech Republic is now really quite extensive.

The biggest contributors to the total sales increase were retail sale of furniture, lighting equipment, household articles, electrical appliances, radio and television goods, hardware, paints and glass in specialised stores and sale of food, beverages and tobacco predominating in non specialized stores. The most rapid growth was recorded for sales from the sale of textiles, clothing, footwear and leather goods and the sale of furniture, lighting equipment and household articles, electrical appliances, radio and television goods, hardware, paints and glass. The biggest drop of sales was recorded for retail sale of food, beverages and tobacco in specialized stores (-5.4%), retail sale of second-hand goods in stores (-3.3%), sale via stalls and markets and other non-store retail sale (-2.7%) and the sale in stores with pharmaceutical and medical goods, cosmetic and toilet articles (-1.3%)

Czech Producer Prices June 2008

2008-07-14T12:11:00.000-07:00

Czech industrial producer price inflation accelerated in June, and a record rally by the koruna failed to eliminate the impact of soaring oil costs. The price of goods leaving factories and mines grew 5.3 percent from a year ago, compared with a 5.2 percent rate in May, the Prague-based statistics office said today. And this despite the koruna's 22 percent annual gain against the euro and 39 percent rise versus the dollar.

Industrial Output Falls Back In May 2008

2008-07-10T04:19:00.000-07:00

Czech seasonally adjusted industrial output was down by 0.7% in May over April 2008. Industrial production was up 3.4%, year-on-year. The value of industrial new orders was down 1.9%, year-on-year.

Industrial employment increased in May by 22.5 thousand persons over May 2007(i.e. it was up 1.9%). The largest increases were registered in the manufacture of electrical and optical equipment (+6.7%), the manufacture of rubber and plastic products (+5.5%) and in the manufacture of transport equipment (+4.4%). Employment dropped the most in the manufacture of coke and refined petroleum products (-7.0%), the manufacture of textiles and textile products (-5.0%) and in the manufacture of leather and leather products (-4.7%).

The average monthly nominal wage was CZK 23,256 in May (up by 7.1%, y-o-y). The average hourly wage increased by 13.3% (CZK 164.7). Industrial labour productivity increased by 1.2% year on year. while hourly labour productivity was up by 7.4%.

In a separate report the statistics office said that seasonally adjusted total construction output at constant prices increased in May by 0.2%, compared with April. When compared with May 2007, output at constant prices fell by 2.9%. The planning and building control authorities granted 11 379 building permits, i.e. 11.5% up year-on-year. The approximate value of authorised constructions was up by 35.9% year-on-year and reached CZK 34.8 billion. Looking at the chart below the Czech Republic certainly hasn't been passing through a construction boom.

Czech Inflation Drops Slightly in June 2008

2008-07-08T05:32:00.001-07:00

Czech inflation slowed again slightly in June as the strong koruna helped to keep the rate down, giving the central bank room to delay further interest rate increases at this point. The inflation rate fell to 6.7 percent from 6.8 percent in May, the Prague-based statistics office said in a statement today. The inflation rate has now been dropping steadily since touching a nine year high of 7.5% in January and February. This months result is in line with the central bank's forecast, although it is still significantly above its 3 percent mid-point target. Month on month consumer prices rose 0.2 percent from May.

Today's report confirms central bank expectations that inflation may return to within the target range by early next year without any additional rate-lifting on top of eight in the past 2 1/2 years, to 3.75 percent. The koruna, which has risen by 21 percent against the euro and 41 percent against the dollar in the past year, maintained these gains even after the European Central Bank raised its benchmark rate to 4.25 percent last Thursday.

Prices of clothing, cars and some electronics fell on the month, while food stagnated from May and added 10.4 percent year on year. Cigarette prices and alcohol rose 0.2 percent from the previous month as producers and retailers began to run out of stocks accumulated before excise tax on tobacco was raised.

The price of motor fuels grew 3.3 percent in the month, reflecting a 10.1 percent jump in global oil prices in June on top of a 34 percent growth in the first five months of 2008.

The central bank expects the inflation rate to slide to its targeted range of 2 percent to 4 percent at the beginning of next year as a result of the koruna strengthening, a mitigating effect of one-time influences such as increases in indirect taxes and regulated costs wane and a faltering consumer spending.

That outlook suggests stable interest rates in the months to come and even the possibility of a reduction before the year's end, as suggested by the central bank's staff forecast from early May. The koruna may even allow policy makers to lower rates more than previously indicated minutes from the central bank's June 26 policy meeting indicate.

``Given the current exchange-rate trend, the implied interest rate path of the August forecast might be even lower than that of the May forecast,'' the bank said in the minutes, released on July 4. Decision makers next meet on Aug. 7 to set rates and to publish a new quarterly inflation prediction.

Czech Exports Slow in May

2008-07-04T07:06:00.000-07:00

Czech exports stagnated in May, after clocking in a 13 percent year on year increase in April, a sign that the twin effect of the rise in the koruna and faltering demand in Western Europe is now beginning to hurt exporters. Imports fell 2 percent from a year ago, contributing to a trade surplus of 9.2 billion koruna ($609 million). This surplus compares with 8.3 billion koruna one in April, and a 5.3 billion koruna a year ago.

The strange form the imports line adopts would seem to me to be more a consequence of the early calendar date of Easter this year than anything else. Demand for Czech goods in Western Europe is now waning as hedging contracts against the Koruna rise expire and the euro region economy, which is the Czech Republics key trading partner, visibly entering a slowdown.

The koruna has been the world's best-performing currency so far this year, and advanced 13 percent against the euro in the 12 months through May (and was 30.5 percent stronger against the dollar). This sustained appreciation gradually makes exporting more difficult and reduces the chances that we will see a fourth record full-year trade surplus in 2008.

May exports of 205.2 billion koruna, the lowest this year, were unchanged from a year ago. Exports were fueled by a 2.5 percent increase in exports of telecommunication equipment, computers and cars.

Imports fell to 196 billion koruna, also the lowest so far in 2008, which may indicate that companies are cutting back on investments, economists said. The koruna advance also lowers the value of imports in the domestic currency and the slowest household spending in 2 1/2 years dents imports for consumption.

Czech Retail Sales April 2008

2008-06-18T13:19:00.000-07:00

In April, seasonally adjusted retail sales (except automotive segment) grew by 0.7% month-on-month and by 2.0% year-on-year, at constant prices. The increase of 3.5% in not seasonally adjusted sales was higher than the average growth from the start of the year. Only sale of non-food goods grew; sale of food, beverages and tobacco continued to decrease. Seasonally adjusted sales in the automotive segment dropped by 0.4% month-on-month but were up by 2.3% year-on-year, at constant prices; not seasonally sales were up by 6.8%. Seasonally adjusted sales in hotels and restaurants increased by 0.2% month-on-month and unadjusted sales dropped by 1.1% year-on-year.

This is a modest increase, and if taken together with the data from Eurostat today showing the Czech construction industry declined by 3.5% year on year in April it would definitely suggest that the pace of growth is slowing at the present time.

Czech Producer Prices May 2008

2008-06-13T00:48:00.000-07:00

Czech industrial producer prices in May rose at the fastest pace in four months, fueled by refined products after global oil costs surged to a record. Prices advanced 1 percent from the previous month, after being unchanged in April. The annual rate increased to 5.2 percent from 4.7 percent in the previous month, according to the latest data from the Prague-based statistics office.

Agricultural producer prices, which are not part of the industrial price index and signal the future direction of consumer food prices, advanced 0.5 percent in the month while the annual rate climbed to 28.2 percent from 27.9 percent in April.

In May 2008, compared to the previous month, prices of agricultural and industrial producers, construction work and market services grew by 0.5%, 1.0%, 0.4% and 0.1%, respectively. In comparison to May 2007, prices of agricultural and industrial producers increased by 28.2% and 5.2%, respectively; prices of construction work and market services were up by 5.0% and 4.0%, respectively.

In April 2008, export prices did not change, import prices increased by 0.1%, month-on-month. Year-on-year, export prices fell by 5.0% and import prices by 4.2%. The terms of trade figures reached 99.9%, m-o-m, and 99.2%, y-o-y.

Agricultural producer prices grew by 0.5% in total. Prices of crop products rose by 2.4% due to higher prices of cereals (+2.1%), fruit and oil plants (+2.3% both), and hops (+93.4%). The prices of potatoes and vegetables fell by 2.7% and 20.2%, respectively. Prices of animal products decreased by 2.2%; prices of eggs (-5.6%) and milk (-5.8%) were lower. Higher prices were recorded for cattle for slaughter (+0.4%) and pigs for slaughter (+4.2%).

Industrial producer prices grew by 1.0% (no change in April). Prices went up most markedly in ‘coke, refined petroleum products’ (+9.1%, the highest increase since June 2004) and ‘basic metals, fabricated metal products’ (+2.1%). On the other hand, prices in ‘food products, beverages and tobacco’ went down by 0.2% (lower prices of tobacco and dairy products).

Construction work prices rose by 0.4%, construction material input prices grew by 0.2%.

Prices of market services in the business sphere grew by 0.1%, due to a 0.2% price rise in ‘real estate, renting and business services’ (prices of computer activities up by 0.6%).

Year-on-year comparison

Agricultural producer prices were higher by 28.2% (+27.9% in April). Prices of crop products grew by 41.1%, mainly due to higher prices of cereals (+57.7%), oil plants (+71.9%) and hops (+135.0%). The prices of fruit increased by 42.2%. The prices of potatoes and vegetables fell by 45.9% and 0.9%, respectively. Prices of animal products were higher by 12.6%. The prices of milk, poultry, eggs and cattle for slaughter grew by 17.6%, 15.8%, 14.2% and 8.0%, respectively. Lower prices were recorded for cattle for slaughter (-1.9%).

Industrial producer prices rose by 5.2% (+4.7% in April). The price level was the most influenced by prices of ‘coke, refined petroleum products’ (+28.3%) and prices of ‘food products, beverages and tobacco’ (+8.6%). Prices went up particularly in ‘prepared animal feed’ (+35.8%), ‘dairy products and ice cream’ (+10.4%) and ‘other food products’ (+8.0%). Prices of ‘electrical energy, gas, steam and water’ increased by 9.1%. Prices decreases were recorded only in ‘transport equipment’ (-4.1%), ‘rubber and plastic products’ (-2.8%), ‘wood and products of wood and cork’ (-3.9%) and ‘textiles and textile products’ (-0.5%).
Among the main industrial groupings, prices of ‘energy’ (+15.1%) and ‘non-durable consumer goods’ (+4.2%) increased the most.

Construction work prices were higher by 5.0% (+4.9 in April); construction material input prices grew by 2.6% (+ 2.9% in April).

Prices of market services in the business sphere were higher by 4.0% in total (+4.3% in April). Prices of ‘real estate, renting and business services’ increased by 5.6% (prices of advertising services up by 10.4%). Prices of ‘freight transport and storage services’ and ‘financial intermediation, except insurance and pension funding’ increased by 2.5% and 2.2%, respectively.

Czech GDP Q1 2008 (Revised Data)

2008-06-11T05:17:00.000-07:00

The Czech economy expanded at the slowest pace in more than three years in the first quarter as consumer spending weakened, taking some of the pressure off central bank policy makers to raise interest rates.

Gross domestic product rose 5.3 percent, compared with a revised 6.3 percent in the previous quarter and a preliminary 5.4 percent announced on May 15, the Czech Statistical Office said today. The economy's rate of expansion slowed for a third consecutive quarter after peaking at a record 6.8 percent in 2006.

Household spending was constrained by inflation, which accelerated to 7.5 percent in January, the fastest pace in a decade, before slowing to 6.8 percent in the past two months.

While inflation has been driven by global increases in food and fuel costs and the Jan. 1 tax and regulated-price increases, a fourth year of economic growth topping 5 percent, driven by rising wages and consumer spending, has also helped push prices up.

The waning impact of domestic demand on GDP growth, along with an appreciating koruna, has added to optimism that the inflation rate will fall to its mid-point 3 percent target early next year. The koruna has gained 7.6 percent against the euro so far this year and 16 percent over the past 12 months.

The Ceska Narodni Banka, the government and economists expect the economy to lose momentum this year, growing below 5 percent from a revised 6.6 percent in 2007 because of a projected slowdown in the euro region, faster inflation, limited government social expenditures and the appreciating koruna.

Consumer spending, the main engine of GDP growth in the past two years, rose 2.8 percent year on year in the first quarter, compared with 4.2 percent in the preceding period. Household spending accounted for 1.3 percentage points of GDP growth.

Exports of goods and services climbed an annual 13.8 percent in the first quarter, outpacing a 12.1 percent increase in imports. Government expenditure gained 0.7 percent in the January- March period.

Gross fixed investment rose an annual 2 percent, the slowest pace in more than two years, compared with 7.5 percent in the fourth quarter. That may signal that Czech manufacturers are cutting back on investment in reaction to falling orders from abroad.

The central bank, which forecasts this year's GDP growth at 4.7 percent and 4 percent in 2009, had expected the economy to grow by 6.3 percent from January through March, and the difference between this forecast and the actual result is largely the result of revisions in data for earlier quarters according to the central bank.

On the other hand the central bank's May inflation prediction anticipated a more moderate slowdown of consumer spending and an acceleration in investment growth.

Czech Inflation May 2008

2008-06-09T05:57:00.000-07:00

The Czech inflation rate in May was unchanged from April at 6.8 percent as rising food and fuel costs prevented a third consecutive decline in annual price growth and reduced short term prospects for an interest rate cut.

Consumer prices rose 0.5 percent month on month, following a 0.4 percent jump in April, according to the Prague-based statistics office today.

Inflation has exceeded the Ceska Narodni Banka's 4 percent upper limit in every month since November, driven by food and oil and rising taxes and regulated costs. The central bank predicted the rate would fall to its 3 percent target in early 2009 without raising rates.

The possibility definitely exists that the inflation rate may rise again above 7 percent in the months to come, after peaking at a decade-high of 7.5 percent in January and February. The central bank next meets on June 26 to set interest rates.

The cost of motor fuels added 3.9 percent from April, with diesel reaching a record, the office said. The increase reflected a 16 percent advance in global oil prices during May. Prices of food, with a one-fifth weighting in the consumer basket, surprisingly rose 0.7 percent from April and 10.6 percent from a year earlier, led by vegetables, fruit, bread and rice, according to the central bank.

The Czech central bank is to some extent relying on the koruna's strength to slow household and import demand this year and to counter the inflationary effect of a fourth year of economic growth of over 5 percent. The most recent staff projection seemed to imply a cut in what is the European Union's lowest main rate of 3.75 percent as early as this year, but this forecast is now looking extremely precarious.

The so-called monetary policy-relevant inflation rate, which excludes the first-round impact of tax changes, fell to 4.6 percent in May. Monetary policy makers disregard the primary impact of cost shocks and regulated-price influences as they are out of the reach of monetary policy and are typically of a one-time nature. Instead, the bankers focus on their second-round effects such as increased demands for pay rise as a way to compensate for inflation spike, which could prevent a decline in inflation.

May core inflation, (which is price growth adjusted for volatile items such as food and motor fuels) accelerated to 2.85 percent from 2.75 percent, suggesting persisting demand pressures and the danger of more "second round" effects.

Today's figure may add to concerns by some board members that the koruna, which gained 16 percent against the euro and 36 percent against the dollar in the past 12 months, may not now be as effective an inflation damping tool as it has been in the recent past.

Wages grew an annual 10.4 percent in the first quarter to 22,531 koruna ($1,398), the biggest jump in more than nine years, the statistics office reported on June 2. Even when adjusted for the fastest inflation in a decade, growth of real salaries accelerated to 2.8 percent from 1.7 percent in the fourth quarter of 2007.

Under the European Union's harmonized consumer prices index was up 0.4 percent month on month and 6.8 percent from a year earlier, following a 6.7 percent rate in April, the statistics office reported today.

Czech Wages and Salaries Q1 2008

2008-06-02T09:08:00.001-07:00

Czech real-wage growth accelerated in the first quarter, raising concern that the central bank will lift the European Union's lowest interest rates once again.

The average gross monthly wage added 10.4 percent to 22,531 koruna ($1,398), the biggest jump since Q4 1998. The average monthly paycheck rose 2.8 percent, adjusted for inflation, compared with a revised 1.7 percent in the previous quarter, the Prague-based statistics office said today.

Real wages will probably continue to grow more slowly this year as rising consumer prices eat up most of nominal pay increases. The central bank expects inflation to return to its 3 percent target early next year, but this obviously remains to be seen. Policy makers monitor wage growth as a secondary indicator of price growth.

The average inflation-adjusted monthly wage rose 4.5 percent at private companies as the jobless rate fell to 5.2 percent in April, the lowest since the data series started in 2004. Gross private wages rose 12.2 percent in a year.

Salaries of state employees grew 3.5 percent in the quarter from a year earlier to 20,204 koruna, a 3.6 percent decline in real terms. The government, which last year capped public wage gains to curb a jump in spending, will probably face increased pressure to raise public wages, economists said.

The smallest relative growth of nominal wage (by CZ-NACE section) was recorded in education, public administration and defence, compulsory social security (both by 3.0%) and in health and social work, veterinary activities (by 5.3%). The biggest growth was recorded in electricity, gas and water supply (by 18.2%), fishing, fish farming and related service activities (by 17.2%) and real estate, renting and business activities (by 17.1%).

Monetary policy makers will evaluate the effects of accelerating inflation and currency gains on economic growth before deciding whether to further raise interest rates from 3.75 percent, currently the lowest in the European Union.

Czech Retail Sales March 2008

2008-05-21T11:03:00.001-07:00

Czech retail sales showed fell month on month, and year on year in March, after 51 months of consecutive growth. The data were partly influenced by seasonal factors (Easter was in March)and but also provided some evidence of a trend towards slowing consumption. Retail sales fell 2.9 percent year-on-year in March, compared to a 6.3 percent growth in February, data from the Czech statistical office (CSU) showed today. The office said that a drop in sales of pharmaceuticals and food, along with the Easter holiday were the main factors behind the drop.

In March, seasonally adjusted sales in retail trade except of automotive segment dropped by 0.6%, month-on-month, at constant prices, and in the year-on-year comparison, sales increased by 0.7%. Seasonally non adjusted sales dropped by 2.1% after 51 months of incessant growth. The y-o-y sales decrease was recorded in the sale of food, beverages and tobacco and also in the non-food goods sale. Seasonally adjusted sales in automotive segment dropped by 2.2%, m-o-m, at constant prices, in the year-on-year comparison by 0.1% and not seasonally adjusted by 4.4%. Seasonally adjusted sales in hotels and restaurants decreased, m-o-m, by 0.5% and not seasonally adjusted dropped by 3.4%, year-on-year.
CSU Statistics Office

The figures were definitely influenced by seasonal factors and the fact there were two less working days. Overall, however, when adjusted to take allowance of this there is still clearly a deceleration trend.

Czech GDP Q1 2008

2008-05-15T06:32:00.000-07:00

The Czech Republic's economy expanded 5.4 percent in the first quarter, the slowest pace in more than three years, as consumer spending waned. The preliminary growth figure compares with 6.6 percent in the previous three-month period, the Czech Statistical Office said today. Seasonally adjusted GDP growth was also 5.4 percent, while quarter on quarter the economy expanded 0.9 percent.

The expansion has faltered as household consumption was damped by higher indirect taxes and surging inflation, which has been above Ceska Narodni Banka's ceiling since November. Inflation has been driven by global increases in food and fuel costs and government measures that are beyond the bank's influence.

The increase of economic performance was partially connected also with higher employment. According to an estimate that used the results of the labour force sample survey in combination with currently available administrative data, seasonally adjusted total employment in Q1 2008 increased by 0.3% quarter-on-quarter and by 1.7% year-on-year. NSA employment was by 1.9% higher year-on-year.

A third of the increase of economic performance was due to higher employment; the remaining two thirds are attributable to the growth of total labour productivity. The trend of certain price segments varied considerably – a marked seven per cent price growth of household expenditure on the one hand, and by 1.3 p.p. higher decrease of export prices than of import prices on the other. These and other impacts partially compensated one for another so that the overall price level measured by GDP deflator increased by three per cent.

The decreasing effect of domestic demand on GDP growth, along with an appreciating koruna, has added to the central bank's optimism that the inflation rate will slide back to the mid-point 3 percent target by next year, from 6.8 percent in April. A strong koruna, which has gained 6.1 percent against the euro this year, has helped temper rising prices

Consumer prices grew more than 7 percent in each of the first three months of 2007 and a close to a decade high of 7.5 percent in February. Rising prices prompted the central bank to raise its benchmark two-week repurchase rate to 3.75 percent in February, the fifth increase since May 2007.

Czech Industrial Output March 2008

2008-05-12T14:31:00.000-07:00

Industrial output data for March showed the first drop after 5-1/2 years of growth, adding to previous poor purchasing managers index (PMI) and foreign trade figures.
Output fell 2.1 percent year-on-year in March, far worse than a 4.8 rise forecast by analysts and in stark contrast to an 11.3 percent rise the previous month.
The Czech data mirrored March results elsewhere in emerging Europe. In Slovakia, the region's growth leader, output slammed on the brakes to grow just 1.8 percent.
Part of the drop could be attributed to the Easter holiday, which came earlier than usual this year.

Czech Unemployment April 2008

2008-05-12T14:07:00.000-07:00

The Czech unemployment rate fell in April, reinforcing concerns that the tight labour market poses a serious risk for the development of inflation.

Unemployment fell to 5.2 percent in April from 5.6 percent in the previous month, and in line with expectations in a Reuters analyst poll, data from the labour and social affairs ministry showed. Year-on-year, unemployment fell from 6.8 percent registered in April 2007.

Wages in industry are growing growing above 11 percent which reinforces the Czech central bank's concerns that the tight labour market and growing wages are the key upside risks to inflation.

On April 30, 2008 job offices registered altogether 316,118 job seekers. That is by
20,179 less than at the end of March. The number of job seekers decreased by 86,814 persons compared with the same period of the preceding year. The number of available job seekers job seekers currently available for work) was 292,465.

In the course of April, job offices registered altogether 42,515 newcomers. That is by 4,484 job seekers more than in the preceding month and by 1,659 newly registered job seekers more than in April of the preceding year. In April, job offices registration was terminated with 62,694 seekers. New jobs have been taken up by – 42,596 persons. In the course of the above-said month, job offices excluded 20,098 job seekers due to other reasons.

Harmonized unemployment rates (EUROSTAT) was 4.6 % in March 2008.

Czech Inflation April 2008

2008-05-12T13:46:00.000-07:00

The Czech Republic's April inflation rate fell less than economists forecast, raising the prospect that the central bank will hold off on cutting interest rates in the near future. The inflation rate dropped to 6.8 percent from 7.1 percent in March and a near decade-high of 7.5 percent in February, the Prague-based statistics office said today. The central bank forercast was for a rate of 6.7 percent. Consumer prices rose 0.4 percent in the month, following a 0.1 percent drop in March.

Housing costs were 0.6 percent higher than in March, led by a 2.9 percent increase in natural gas prices for households. Prices of food increased half a percent from March, following two months of a decline, and were 9.6 percent higher compared with March last year.

The inflation rate has exceeded Ceska Narodni Banka's 4 percent ceiling since last November, driven by global increases in food and fuel costs and government spending measures that are beyond the bank's direct influence.

The Czech central bank said today in a statement posted on its Web site that inflation has passed its peak and its expects price growth to return to ``low levels corresponding to its targets at the end of 2008 and the beginning of 2009.''

However the bank did say the reading exceeded its forecast as a result of higher-than-expected adjusted inflation without fuels which "could signal continuing inflationary pressures from the domestic economy."

The central has relied on the koruna's 12 percent gain against the euro in the past 12 months, slowing economic growth and the mitigating effect of regulated price growth to curb inflation to 2.9 percent in the first quarter and to 2.2 percent in the third quarter of 2009.

The Czech National Bank left its benchmark interest rate unchanged at 3.75 percent for a second consecutive meeting last week continuing to bank on the impact of a strong koruna and a developing economic slowdown to damp inflation.

Czech Imports and Exports March 2008

2008-05-07T06:32:00.000-07:00

In March 2008, according to preliminary data, exports and imports at current prices fell by 5.6% and 2.4% year-on-year, respectively. At the same time the trade balance reached a surplus of CZK 8.1 billion in March, CZK 7.4 billion less than March 2007. The balance was unfavourably influenced by a CZK 4.9 billion decrease of surplus in machinery and transport equipment and by a CZK 3.7 billion increase the deficit for mineral fuels, lubricants and related materials.

According to preliminary data, seasonally adjusted exports decreased by 6.2% and imports by 9.0%, month-on-month. The trend component fell by 1.2% in exports and rose by 0.2% in imports.

The March results were influenced by the smaller number of working days (March 2008 had two working days less than March 2007), the presence of the Easter holiday and by the high comparative base of March 2007.

Exports recorded the biggest fall since August 2002 and imports the biggest since May 2005. The last year-on-year decreases were registered in January 2004 (-0.2%) for exports and in July 2005 (-2.0%)for imports. Due to appreciation of the koruna against the euro and even more against the US dollar, external trade grew faster when measured in euros (exports +5.0% and imports +8.5%) and US dollars (exports +23.1%, imports +27.2%) than in korunas.

The Czech currency has strengthened by 12 percent against the euro in the past 12 months and is the world's second best-performing currency against the dollar over the past year.

The trade balance had a surplus of CZK 8.1 billion, which was down CZK 7.4 billion, year-on-year, registering the largest year-on-year fall since April 2003. The trade balance with EU states was positive by CZK 41.1 billion and with non-EU states negative by CZK 33.0 billion.

Trade balance was negatively influenced by the fall of surplus of trade in ‘machinery and transport equipment’ (by CZK 4.9 billion) and by the growth of deficit of trade in ‘mineral fuels, lubricants and related materials’ (by CZK 3.7 billion). Surplus of trade in ‘miscellaneous manufactured articles’ dropped by CZK 0.9 billion and the trade balances of ‘chemicals and related products’, ‘manufactured goods classified chiefly by material’ and ‘beverages and tobacco’ remained on the same level as in March 2007. Trade balance improved in ‘food and live animals’ (deficit down by CZK 1.5 billion) and ‘crude materials, inedible, except fuels’ (surplus up by CZK 0.4 billion).

Total exports of ‘machinery and transports equipment’ fell by 6.0% (CZK 7.2 billion), of which the biggest decreases were recorded in ‘road vehicles’ (CZK 3.9 billion), ‘other transport equipment’ (CZK 1.1 billion) and ‘general industrial machinery and equipment’ (CZK 0.7 billion). Total imports of ‘machinery and transport equipment’ were down by 2.7% (CZK 2.3 billion) and the biggest decreases were registered in the same commodity groups as in exports. The biggest increase in imports was achieved in ‘telecommunications and sound-recording equipment’ (CZK 1.9 billion).

Higher imports of ‘mineral fuels, lubricants and related materials’ by 36.0% (CZK 5.2 billion) were mainly due to higher imports of crude petroleum (+44.7% in value, +6.2% in volume) and natural gas (+47.2% in value, +39.2% in volume).

By group of countries, trade surplus with EU states dropped by CZK 7.3 billion and trade deficit with non-EU states increased by CZK 9.5 billion. Trade surplus grew with France (by CZK 2.6 billion), Romania (by CZK 1.3 billion), Ukraine (by CZK 0.5 billion) and Poland (by CZK 0.4 billion). Trade balance improved with Finland (by CZK 0.4 billion) as deficit turned into a surplus. Trade deficit rose with the Russian Federation (by CZK 3.3 billion), China (by CZK 1.2 billion) and Japan (by CZK 0.8 billion). Trade surplus deteriorated with Kazakhstan (by CZK 0.9 billion), Serbia (by CZK 0.8 billion) and the United States (by CZK 0.6 billion) as surplus turned into a deficit. Trade surplus fell with Austria (by CZK 0.6 billion), Germany (by CZK 0.5 billion) and Slovakia (by CZK 0.1 billion).

In the twelve months to March 2008, compared with the previous twelve months, exports and imports grew by 12.0% and 11.1%, respectively. The trade balance reached a surplus of CZK 81.4 billion, which was an improvement of CZK 27.5 billion.

Favourable development was reported for trade in ‘machinery and transport equipment’ (surplus up by CZK 36.8 billion), ‘crude materials, inedible, except fuels’ (surplus up by CZK 8.6 billion), ‘food and live animals’ (deficit down by CZK 2.8 billion)), ‘animal and vegetable oils, fats and waxes’ (deficit down by CZK 1.2 billion) and ‘beverages and tobacco’ (improvement by CZK 1.2 billion as deficit turned into a surplus). Trade balance deteriorated in ‘chemicals and related products’ (deficit up by CZK 12.2 billion), ‘manufactured goods classified chiefly by material’ (surplus down by CZK 8.0 billion) and ‘miscellaneous manufactured articles‘ (surplus down by CZK 2.3 billion) and ‘mineral fuels, lubricants and related materials’ (deficit up by CZK 0.4 billion).

By group of countries, trade surplus with EU states rose by CZK 65.5 billion and trade deficit with non-EU states increased by CZK 38.0 billion. Deficit decreased in trade with the Russian Federation (by CZK 21.0 billion); and surplus rose in trade with Slovakia (by CZK 15.3 billion), France (by CZK 12.8 billion), the United Kingdom (by CZK 10.3 billion), Italy (by CZK 7.8 billion), Poland (by CZK 7.3 billion) and Germany (by CZK 1.0 billion). Trade balance improved with the Netherlands (by CZK 7.1 billion) and Norway (by CZK 6.7 billion) as deficit turned into a surplus. Trade deficit grew with China (by CZK 48.5 billion), Japan (by CZK 15.8 billion), Thailand (by CZK 7.0 billion), Korea (by CZK 5.4), Ireland (by CZK 5.0 billion) and the United States (by CZK 5.4 billion). Trade surplus fell with Austria (by CZK 8.1 billion) and Hungary (by CZK 6.6 billion).

Czech National Bank Holds Interest Rates

2008-05-07T05:57:00.000-07:00

The Czech National Bank left its benchmark interest rate unchanged for a second consecutive meeting today as it banks on the strong koruna and an economic slowdown to damp inflation. The Ceska Narodni Banka seven-member board kept its two-week repurchase rate at 3.75 percent.

The inflation rate, at 7.1 percent in March, has exceeded the central bank's 4 percent ceiling since November. Still, policy makers, who doubled borrowing costs over the past 2 1/2 years, are reluctant to lift rates further as the strong koruna and a global economic slowdown threaten to weigh on local exporters and stifle economic growth more than anticipated.

The Czech currency's strengthening of 12 percent against the euro in the past 12 months may contain inflation by holding down import price growth and weigh on economic growth. The koruna was trading at 25.138 against the euro as of 2:34 p.m. in Prague, compared with 25.207 yesterday.

Rate setters consider the current inflation spike a one-time event, triggered by factors outside of the central bank's reach. They are concerned about the second-round effects of unexpectedly fast price growth, including accelerated pay increases after unemployment slid to an 11-year low.

In its last staff prognosis from February, the central bank predicted the inflation rate to drop to 3.4 percent in the first quarter of 2009 and 2.3 percent between July and September 2009.

The bank's target is 3 percent plus or minus a percentage point. When setting rates, policy makers focus on 12-18 months ahead, when their current decisions should have worked through the economy.

The main Czech lending rate is a still a quarter percentage point lower than the ECB's benchmark rate. Any eventual rate increase could spur additional gains to the koruna, which already is the world's second best-performing currency against the euro and dollar in the past year.

The central bank three months ago forecast the economy will expand 4.1 percent this year and 4.6 percent in 2009, compared with a record growth rate of 6.5 percent last year.

OECD Warn The Czech Republic on the Economic Impact of Ageing

2008-04-24T04:36:00.000-07:00

The Czech Republic must cut public spending, boost the retirement age and raise health-care co-payments to preserve economic growth, the Organization for Economic Cooperation and Development said in its most recent country survey out today.

The Czech Republic needs to be more ambitious in setting deficit targets while economic growth is at its current high levels, the OECD said in its 2008 country survey. It advised the Cabinet to support health-care and pension overhauls as the country's ageing population may start straining state resources as early as 2012.

The Civic Democrat-led three-party coalition this year introduced a flat income tax and medical fees and limited some social transfers to keep the public-spending shortfall below the European Union's threshold of 3 percent of gross domestic product. It also has plans to revamp the health-care and retirement system, though these may be jeopardized by the coalition's thin majority in Parliament, the OECD warned.

``To maintain these high growth rates, further reforms are necessary,'' OECD Secretary General Angel Gurria said today at a Prague press conference. ``If policy is not changed, spending will increase considerably'' amid a ``rapid pace of aging.''

The OECD urged Czech authorities to consider a ``full liberalization'' of rents, take steps to dscourage early retirements and reduce the length of parental leave to boost workforce supply (really I am not in agreement at all with this latter point, but I will need to find time for a longer post to explain why). It reiterated that tuition for university students is necessary to extend the number of people with higher education.

``Most important is a need to ensure fiscal sustainability through public-finance reform to put the economy in a better shape to cope with population aging,'' the OECD said. ``The current government made a positive start'' with ``a fiscal package that includes wide-ranging tax and spending reforms, many of which are aimed as first steps in more ambitious reform.''

``The recent global financial turmoil has so far not affected the economy, although weaker growth elsewhere may have some impact,'' it said. ``There is little sign of overheating so far; underlying inflation has remained moderate.''

The government earlier this month approved the outlines of an overhaul of the health-care system that includes allowing health insurers to make a profit. The Health Ministry's plan to sell all but one state-financed health insurer is opposed by two smaller coalition parties, however.

``The impact of the second phase of reform could be significant in strengthening competition on the quality and cost of services,'' the OECD said. ``Putting legislation through parliament is an uphill struggle because the coalition itself has a thin majority'' and ``as a result, many of these further reforms are uncertain.''

Concerning a change of the current pay-as-you-go pension system, the OECD recommends that ``mandatory'' transfer of social security payments to private pension funds be adopted rather than implementing the current proposal that would employees to choose between the two systems.

``Providing a permanent choice risks additional public expense because net contributors are likely to switch while net beneficiaries will stay with the full PAYG pension,'' the organization said.

The Czech Republic has dropped the 2010 entry date as a target for euro-adoption and has not set a new date. The government's strategy is to carry out long-term structural changes and allow the economy to close the distance with the richer euro-sharing nations to try and avoid an outcome whereby letting go of the possibility of an appreciating koruna doesn't trigger additional price growth (a problem that may arise in neighbouring Slovakia if the current entry bid is accepted). This government concern is shared by the OECD.

``A consequence of entering the euro area is that, with the loss of the exchange-rate channel, inflation has to do all the work in nominal convergence,'' the OECD said. However, ``delaying entry implies accumulating opportunity costs because it postpones the gains from adopting the euro.''

Czech Growth Forecast revised Up

2008-04-23T09:58:00.000-07:00

The Czech Finance Ministry has said today that it expects the economy to grow faster than originally expected this year as tax cuts and an inflow of funds from the European Union should boost economic activity. The ministry forecast gross domestic product to expand 4.9 percent, compared with a January estimate of 4.7 percent. It left its prediction for 2009 GDP growth at 5.1 percent. The economy grew a record 6.5percent last year.

The Jan. 1 introduction of a flat rate income tax and measures restricting social and health-care expenses should help ofset a growing shortage of workers and the negative effect the fastest inflation in 10 years on household spending, the ministry said. It raised its forecast for the average inflation rate to 6 percent from 5.5 percent in the previous forecast.

``The Czech Republic will remain a dynamically developing economy, attractive for foreign investors'' and ``the positive effects of fiscal reform and inflow of EU funds will be gradually seen,'' the ministry said. ``Reforms underway will reduce limiting factors and contribute to acceleration of economic growth.''

The Czech Republic may receive as much as 26.7 billion euros ($42.4 billion) from the EU in the period of 2007 to 2013.

The koruna is expected to weaken from the current levels to an average 25.8 against the euro this year before it rises to 25.4 a year later, the ministry estimated. The currency was at 25.052 per euro as of 5:52 p.m. in Prague, compared with 25.045 yesterday.

The unemployment rate will fall to 4.2 percent in 2008 and 3.6 percent in 2009, the ministry said, citing the government's measures adopted on Jan. 1, including a cancellation of automatic indexation of social payments that should prompt people to take a job rather than stay on welfare.

``Reform measures in public finances should lead to higher motivation to work by strengthening net earned incomes at the expense of social benefits, contributing thus to labor market recovery,'' the ministry said.

The current-account deficit is anticipated to represent 3 percent of GDP this year as the economy will generate a record full-year trade surplus of 111 billion koruna, according to the authority. The current-account gap will shrink to 2.1 percent of GDP in 2009, the ministry said.

The Czech budget deficit will continue to narrow to 1.5 percent of GDP this year from 1.6 percent in 2008, the ministry reiterated an estimate from April 21.

Czech Retail Sales February 2008

2008-04-17T07:46:00.000-07:00

Czech retail sales growth accelerated to the fastest pace in four months in February fuelled by increased wages and an extra working day. Sales jumped 6.3 percent from February 2007, following a revised 4 percent increase in January, the Prague-based Czech Statistical Office. When adjusted for the greater number of work days this year than last, retail sales were up 4.5 percent.

Nominal industrial wages rose an annual 13.1 percent in February as the inflation rate reached a decade-high of 7.5 percen, although the central bank expect higher prices to put a brake on household consumption later this year, at least that is one of the key assumptions of the central bank's forecast for inflation to drop to its 3 percent goal in 2009, even without further interest-rate increases.

Policy makers, who raised the benchmark interest rate by a combined 1.25 percentage points over the past 11 months to 3.75 percent, are mulling whether inflation will recede fast enough, thanks in part to the koruna's 15 percent gain against the euro since July, or whether an additional rate increase is necessary to ward off a second-round pickup of inflation.

"There are the first signs of demand-pull inflation. Should signs of faster, adjusted inflation persist or strengthen, it would justify a monetary-policy tightening.''
Deputy Central Bank Governor Miroslav Singer

Czech Republic Producer Prices

2008-04-14T07:30:00.000-07:00

Producer prices dropped back slightly in March, rising at an annual 5.3% versus the 5.6% registered in February. This is now the second month they have fallen on an annual basis, since in February they were down from the 6% high registered in January.

In March 2008, compared to the previous month, prices of agricultural and industrial producers were up by 1.2% and 0.3%, respectively; prices of construction work and market services grew by 0.5% and 1.4%, respectively.

Industrial producer prices rose by 0.3% (+0.1% in February). The growth of the price level was the most markedly influenced by higher prices of ‘coke, refined petroleum products’ (+3.7%), ‘basic metals and fabricated metal products’ and ‘chemicals, chemical products and man-made fibres’ (+0.6% both). The most significant drop of prices came in ‘food products, beverages and tobacco’ (-0.3%) after successive eleven months of growth. Of these the highest decreases were recorded for the prices of ‘dairy products and ice cream’ (-2.0%), ‘meat and meat products’ (-0.4%) and ‘other food products’ (-0.1%). Prices went down markedly in ‘coal and lignite; peat; crude petroleum’ (-1.2%), ‘wood and products of wood and cork’ (-1.0%) and ‘other manufactured goods n.e.c.’ (-0.9%).

Industrial producer prices grew by 5.3% (+5.6% in February). The price level was influenced most significantly by prices of ‘food products, beverages and tobacco’ which rose by 10.8%, of which prices of ‘dairy products and ice cream’ were up by 17.3%, ‘prepared animal feed’ by 35.6% and ‘other food products’ by 8.6%. Prices of ‘coke, refined petroleum products’ increased by 26.5% and prices of ‘electrical energy, gas, steam and water’ by 9.3%. Prices went down y-o-y particularly in ‘transport equipment’ (-4.0%), of which particularly ‘parts and accessories for motor vehicles and their engines’ (-7.2%). Prices of ‘rubber and plastic products’ dropped by 2.3% and prices of ‘wood and products of wood and cork’ by 2.9% (-1.0% in February), of which ‘wood, sawn, planed or impregnated’ by 13.0%.

Export Prices

In February 2008, export prices decreased by 1.0%, import prices by 1.1%, month-on-month. Year-on-year, export prices fell by 5.0% and import prices by 3.3%. The terms of trade figures reached 100,1%, m-o-m, and 98.2%, y-o-y.

Exports: following the slight month on month growth recorder in January, export prices recovered their downward trend in February and dropped by 1.0%, especially due to the strong appreciation of the koruna. The drop of the total m-o-m export price index came mainly from a 0.9% decrease in prices of 'machinery and transport equipment’ (particularly road vehicles) and 'manufactured goods classified chiefly by material’ by 1.6%. Among other sections important in terms of weight, decreases were recorded for ‘chemicals and related products’ by 1.6%, ‘miscellaneous manufactured articles’ by 1.3% and ‘crude materials, inedible, except fuels’ by 1.2%. Price growth was registered only for 'mineral fuels, lubricants and related materials’ by 1.3%.

Czech Industrial and Construction Output February 2008

2008-04-11T05:43:00.000-07:00

Czech industrial output grew 11.3 percent year-on-year in February, compared to 9.3 percent in January and against market expectations of 8.0 percent, data released by the Czech statistical office (CSU) showed.

The average number of persons employed in industry went up by 2.5% year-on-year in February 2008 (+28.6 thousand persons). Increases in average number of persons employed were registered in ‘manufacture of rubber and plastic products’ (+10.0%), ‘manufacture of transport equipment’ (+7.4%) and ‘manufacture of machinery and equipment’ (+6.6%).

Employment decreased most in 'electricity, gas and water supply' (-10.4%), ‘manufacture of textiles and textile products’ (-6.8%) and ‘manufacture of leather and leather products’ (-3.2%).

The average monthly nominal wage in industry rose by 13.1% year-on-year and amounted to CZK 21 248. The average hourly wage increased by 6.4% and stood at CZK 145.4. Labour productivity in industry grew by 7.4% and hourly labour productivity by 1.8%.

Industrial new orders in selected CZ-NACE activities concluded in February 2008 reached the value of CZK 162.7 billion (current prices), of which non-domestic industrial new orders made up CZK 104.3 billion. The y-o-y index of industrial new orders in total stood at 104.4%, the index of non-domestic industrial new orders was 98.6%. Non-domestic industrial new orders grew most in ‘manufacture of radio, television and communication equipment and apparatus’ (+43.4%, contribution to the growth of industry in total 2.8 percentage points), ‘manufacture of machinery and equipment‘ (+11.3%, contribution 1.5 p.p.) and ‘manufacture of electrical machinery and apparatus’ (+15.5%, contribution 1.5 p.p.). Non-domestic industrial new orders dropped in 'manufacture of motor vehicles, trailers and semi-trailers' (-7.5%, contribution -2.4 percentage points), ‘manufacture of office machinery and computers’ (-39.2%, contribution -2.1 p.p.) and ‘manufacture of basic metals‘ (-13.8%, contribution -1.2 percentage points).

Construction Output

February construction output grew 11.5 percent year-on-year, versus 1.0 percent growth in January, separate data from the statistics office showed this maorning. In February 2008 seasonally adjusted total construction output at constant prices was up by 2.4%, compared with January 2008. In comparison to February 2007, output at constant prices grew by 11.5%. The planning and building control authorities granted 8 608 building permits, i.e. by 5.5% more year-on-year. Approximate value of permitted constructions increased by 16.5% year-on-year and reached CZK 29.3 billion. Seasonally adjusted total construction output at constant prices grew by 2.4% month-on-month. The trend increased by 0.7% month-on-month .

Total construction output at constant prices increased by 11.5% year-on-year, working days adjusted (WDA) total output grew by 10.3% (February 2008 had one working day more). Civil engineering recorded a high year-on-year growth of construction output in new construction, reconstruction and modernisation, and in repair and maintenance as well. This was due to financially demanding construction of roads and highways including their reconstruction and modernisation. In comparison to February 2007 civil engineering output moderately increased. Construction work abroad dropped for the first time in the period exceeding one year.

Approximate value of constructions permitted in February 2008 increased by 16.5% in comparison to February 2007 and reached CZK 29.3 billion. New construction is valued at CZK 21.0 billion (up by 18.8%, contribution 13.2 p.p.). Renewals and enhancements will make available constructions worth CZK 8.3 billion (up by 11.1%, contribution 3.3 p.p.). Approximate value of new construction was differentiated by type of constructions. The highest growth was registered for non-residential buildings (by 56.6%, contribution 11.7 p.p.) and residential buildings (by 27.0%, contribution 5.6 p.p.). The approximate value of environmental constructions and other constructions remained constant and fell year-on-year, respectively. Approximate value of renewals and enhancements grew in non-residential buildings (by 31.4%, contribution 3.6 p.p.) and in other constructions (by 13.9%, contribution 1.2 p.p.).

The number of employees in construction enterprises with 20+ employees rose by 0.7%*) against February 2007. The average monthly nominal wage of employees increased by 16.7% year-on-year and reached CZK 20 859 (real wage increased by 8.6%). The average hourly wage grew by 6.7% year-on-year and stood at CZK 145. Labour productivity per employee increased by 10.1% and labour productivity per hour worked grew by 0.7%.

Inflation-Free Growth Capacity In The Czech Republic

2008-04-09T07:14:00.001-07:00

Can you get too much of a good thing? Normally we like to think we can't, but in practice we always can. Take economic growth. If we don't get enough of it we have increasing unemployment, we can't pay our health and pension systems, and people generally aren't too happy. But if we get too much of it, we spark off inflation, we become uncompetitive, people stop lending us money, and then all that wonderful growth comes grinding to a halt. The thing is, do we have a "happy mean", and how do we find it. This is normally what people call inflation-free, low unemployment optimal growth, and most of us would give our right hands to find the secret of this. Especially if we happened to be living right now in the Czech Republic, and doubly so if we just happened to be working for the central bank there.

Basically the Czech's have a decision problem, and it isn't an easy one to address. Their economy grew in the fourth quarter of 2007 at what was effectively the fastest pace in two years on the back of increased demand for consumer products and higher public spending on health care and construction works. Gross domestic product expanded year by 6.6 percent year on year during the quater, which compares with a revised 6.3 percent achieved during the third quarter.

And over whole year 2007 the Czech economy grew by a whopping 6.5 percent, following on the back of pretty strong performances in 2005 (6.5%) and 2006 (6.4%).

All of this is evidently very good news, since 6 percent plus growth over a three year period is nothing to be sniffed at, but, on the other hand, if we start to take a bit closer look at some of the data we have seen coming out of the Czech Republic in recent months, and in particular at the data for inflation, wages, and unemployment, we may begin to ask ourselves just how long this particular show can continue, and indeed we may just want to resurrect for ourselves that thorny old chestnut of a question: just what is the inflation-neutral sustainable growth rate for a country with the profile of the Czech Republic?

Inflation Under or Out-of Control?

So let's start with inflation, which dropped back slightly in March for the first time since last July, led by slowing growth in the cost of food and holiday packages. The Czech Republic's annual inflation rate fell to 7.1 percent in March from 7.5 percent in February, when it touched its highest level in a decade, according to data from the Prague-based statistics office earlier today. In fact consumer prices actually fell 0.1 percent from February, when they gained a monthly 0.3 percent over January.

In particular food prices fell back 0.3 percent in the month although they were still 10.8 percent higher than a year earlier. Costs of packaged holidays also fell, by 2.7 percent in the month.

Clearly, despite the fact that the rate of price inflation eased back slightly last month, inflation is still far too high, and there is no real guarantee that it will continue to move down rather than head on up again, unless the economy slows considerably, and this idea of slowing growth is one eventuality that is none to popular with the Czech government or even over at the central bank. So what are the alternatives. Well one restraint on price growth could be the continuing rise in the value of the koruna, which has risen 12 percent gain against the euro since January 2007.

But there are disadvantages to rising currency values, in particular since the impact on export prices may not be that different from actually having the inflation itself, and at the present moment in time the Czech economy is having a pretty successful run of it being an export economy.

And there are also structural dangers involved in letting the koruna rise too far, since in the fisrt place this would attract even more funds to lend to households to fuel consumer demand and construction activity, whilst at the same time weakening the country's burgeoning industrial base. Slowing economic growth - as a result of string of five rate increases from the central bank from the middle of last year - and the waning effect of Jan. 1 tax and regulated price increases are also hoped to have some effect. Indeed it was the combination of these three arguments that lead rate setters at the Czech central banlk to refrain from raising what is still Europe's second-lowest benchmark interest rate last month after raising it to a six-year high of 3.75 percent in February.

The central bank's revised February inflation forecast anticipates an inflation rate of 5.3 percent during the fourth quarter of this year and a 2.4 percent rate by the second quarter of 2009. The preferred mid-point of the central bank's inflation objective is 3 percent. Inflation breached the bank's 4 percent ceiling for a fifth month in a row in March due to the global growth in food and oil costs and a jump of indirect taxes and state-controlled prices such as rents and energy. Policy makers however are inclined to place more emphasis on so-called second-round effects of cost price shocks and tax adjustments such as elevated wage-growth demands that could thwart inflation's return to the desired level.

Indeed this is the interpretation placed on the situation by Czech National Bank board member Eva Zamrazilova speaking at a central bank conference in Prague this morning:

"The data show that the current surge of the inflation rate will be limited by time, the situation will gradually calm down and in early next year, inflation will return to levels very close to our target," she said "Today's figure fully corresponds with an outlook of stable interest rates in the near term"

Things may, however, turn out not to be quite so neat and tidy.

It is true that wage inflation has been slowing, and Czech real wage growth slowed the most in two years in the last quarter of 2007 even as inflation accelerated. The average monthly paycheck rose 1.9 percent when adjusted for inflation, compared with growth of a revised 4.9 percent for the preceding three-month period. The average gross monthly salary advanced 6.8 percent to 23,435 koruna ($1,435). For whole year 2007, real wages were up 4.4 percent, the fastest rate of increase in four years.

Employment and Unemployment

The Czech unemployment rate, on the other hand continues its historic descent, and fell again to 5.6 percent in March as sustained economic growth continued to create more jobs. The rate was down from the 5.9 percent registered in February.

As a result the number of registered unemployed dropped to 336,297, down 18,736 from the preceding month and down 94,177 from a year ago, according to data from the Czech Labor and Social Affairs Ministry earlier this week.

And employment has also been rising rapidly, with the number of first (main) jobholders in Q4 2007 reaching 4 967.3 thousand, up by 105.6 thousand (+2.2%) year-on-year. Employment thus reached it highest level since the start of 1997.

One evident consequence of this steady increase in employment and decline in unemployment is that labour shortages are now a growing reality in the Czech Republic, and one clear indication of this is the fact that the number of unfilled job vacancies is also steadily increasing, hitting a record 151,311 at the end of last month.

So with the Czech economy creating jobs at a rate of over 100,000 a year, and with unemployment falling at 95,000 a year, and realistically assuming that not all the 300,000 or so unemployed who remain are employable, then the Czech Republic may be what, 18 months or so away from running out of workers at this point. Of course, long before you actually get to run out of workers, you hit the limits of the inflation-free rate of growth which is possible with the workforce which remains, as we have been seeing in one East European economy after another, (and as we may now even be seeing in China). This is why the recent surge in Czech inflation, despite the slight fall back this month, should be giving some cause for concern over at the central bank.

And the situation is in fact even more complicated than these numbers reveal, since if we look at the chart below, which shows a breakdown of the Czech 2007 population by five-year age groups, then we can see that the largest cohort is now in the 30 to 34 age group, and after this each subsequent group has less people coming up behind them. Worse, the 55 to 59 age cohort is significantly larger than either the 15 to 19 one or the 20 to 24 one, which means that as people retire there will increasingly be less people entering the labour market to replace them, and especially since the tendency is for young people to spend an increasing number of years in training and education.

The root of the problem here is long term fertility, which only really crashed to very low levels in the 1990s, but which has, as can be seen in the chart, been hovering nervously below the replacement level since the late 1960s (with some ups and downs).

The result of this is the number of children being born has been dropping back continuously since the mid 1970s, and it is this process more than anything else which gives the current Czech population structure its very peculiar present shape.

So Is Migration The Answer?

Certainly migration can help (as can increasing participation rates among older workers) but the numbers involved are really quite large for a comparatively small country, and there are issues about preparedness to adapt to becoming a multi-cultural society (everything in Eastern Europe is just happening so quickly). The changeover is, however, taking place and foreigners now make up almost 4 percent of the Czech Republic's population (which is currently a little over 10 million), with the number of migrant workers in the country rising steadily year by year, and in particular in 2007. According to data from the Czech Statistical Office at the end of last year there were a total of 392,100 foreigners with long-term or permanent residence permits living in the Czech Republic. This was up by 70,600 in 2007 alone.

The largest group of foreign migrants with rights to work in the Czech Republic comes from Slovakia. At the end of last year, 101,233 Slovakians were legally worrking in the country. Ukranians are the second most numerous group with 61,592 working in the Czech Republic last year. The number Mongolian and Vietnamese workers is also increasing rapidly. In 2007 there were 6,897 Mongolians working legally in the CR (up from 2814 in 2006) and 5,4425 Vietnamese (up from 692 in 2006). The numbers of Vietnamese actually in the country is undoubtedly much larger, and according to the Czech police, there are almost 51,000 Vietnamese holding long-term or permanent residence permits for the CR, many of them with temporary student visas. Demand in Vietnam is also way up, and the Czech embassy in Hanoi had to close its doors to visa applicants temporarily in March to reorganise itself in order to cope with the influx.

It is evident that the Czech Republic's labour shortages are now making their present felt across the economy as a whole, and the world of business is now waking up to the implications of this situation. Bloomberg had an in-depth article earlier in the week, where they quoted Jiri Cerny, vice president of Toyot and PSA Peugeot Citroen's joint venture in the Czech Republic, as saying that three years after opening shop in the country he feels it is getting harder by the day to find workers, as a result he is now actively considering importing them from Mongolia.

TPCA, the Toyota-Peugeot joint venture about an hour outside of Prague, shows the strains created by this new investment. Along with average wage growth of more than 40 percent since the Czech Republic joined the EU in 2004, managers like Cerny also face a labor shortage that means they can't recruit all the workers they need just by offering higher pay.

"It's difficult; we are always looking for employees," says Cerny, wearing the plant's trademark gray overalls as he bounces between budget meetings and the factory floor. To find qualified workers, "we're thinking about Vietnam right now, as well as Mongolia," he says.

This story is being repeated in one country after another across Eastern Europe as companies that were attracted by the promise of cheap and plentiful labor are finding less of both, as faster growth drives up wages and open borders encourage emigration. Indeed there is increasing speculation that accelerating inflation may cause eastern Europe's investment- led boom to fizzle (and possibly even crash to a dead stop), with the Baltics and Balkans regions already threatened by a "hard landing" according to the International Monetary Fund and Standard & Poor's.

Of course in the short term migration will undoubtedly help, but in the longer run sustainability is going to be all about getting that fertility rate back up again, at least to something approaching replacement level, otherwise "catch up" economic growth will be simply unsustainable, while the pension and health systems will buckle under the weight of the large elderly population.

Update Thursday 10 April 2008

Development since I wrote this post only serve to confirm just how complex all of this is now becoming. This morning Czech central bank Governor Zdenek Tuma has an interview in the magazine HVG. He exxplaines in the interview that Czech monetary policy makers have kept interest rates down as low as possible in order to try to avoid excessive strengthening of the Korune. The central bank, which last met on March 26 and kept the 14-day repurchase rate at 3.75 percent, expects the inflation rate to fall to 5 percent by September and 3 percent next year from 7.5 percent in February, Tuma told the Budapest-based magazine.

``The low interest rate-level isn't surprising when you look at the past few months,'' he said in the interview published today. ``When an economy is catching up to a more advanced region, its national currency usually appreciates. That's what's happening in the Czech Republic.''

At the same time the Czech Cabinet have approved this week an agreement with the central bank designed to avoid putting more pressure on the koruna, so that it does not start weighing excessively on exports. The plan, submitted by Finance Minister Miroslav Kalousek, was passed by ministers at a weekly meeting in Prague yesterdat, reviving a similar arrangement made in 2002.

The objective is to keep the foreign-currency proceeds from state asset sales and European Union funds off the market to limit demand for the koruna. The plan is the result of an ``agreement with the Czech central bank on a series of measures which should work against the trend of the appreciating koruna,'' Kalousek told reporters.

The Czech government plans to sell state assets such as the national airline Ceske Aerolinie AS as early as this year. The government also wants to sell Lestiste Praha AS, operator of Prague's international airport, which could generate as much as 100 billion koruna ($6.3 billion). Kalousek said revenue from sales of state assets will be frozen on a foreign exchange account at the central bank and kept for an overhaul of the pension system. If the government needs part of the funds, it would use foreign exchange swaps until it adopts the euro in the future, he added.

If the Finance Ministry was to issue Eurobonds then ``we will hedge them so they have no impact on exchange rate developments.''

This is a reference to a ministry statement last December that it may sell euro-denominated debt this year with a value equal to no more than 50 percent of its annual borrowing needs of 180 billion koruna, depending on market conditions.

The Czechs are also entitled to receive as much as 26.7 billion euros ($42.1 billion) in EU funds during the period of 2007 to 2013. Kalousek said he is not in favour of hedging funds coming from the European Union as that would contribute to koruna appreciation and would weigh on exporters.

It ``would mean a transfer of all of the negative impacts on Czech exporters,'' he said. ``Both the public and private sectors must share exchange rate risks.''

Czech Trade Surplus February 2008

2008-04-08T00:34:00.000-07:00

The Czech trade surplus swelled in February to the largest in 11 months as exporters withstood the effect of the appreciating currency. The positive balance reached 14.3 billion koruna ($893.6 million) after January's 12.2 billion koruna and 12.9 billion koruna in February 2007, the Prague-based statistics office said earlier today.

February exports amounted to 215 billion koruna, increasing 11.4 percent from the same month of last year and led by vehicles and machines. Imports totaled 200.8 billion koruna, up 11.5 percent from a year earlier.

Czech monetary policy makers refrained from raising borrowing costs in March over concerns about the strong koruna and the prospect of a sluggish economy in the euro area will contain inflation and curb local economic expansion.

Czech Inflation March 2008

2008-04-08T00:32:00.000-07:00

The Czech Republic's March inflation dropped back slightly in March for the first time since last July, led by slowing growth in the cost of food and holiday packages. The annual inflation rate fell to 7.1 percent from 7.5 percent in February, when it was the highest in a decade, according to data from the Prague-based statistics office earlier today. Consumer prices fell 0.1 percent from February, when they gained a monthly 0.3 percent.

Prices of food fell 0.3 percent in the month and were 10.8 percent higher than a year earlier. Costs of packaged holidays fell 2.7 percent in the month.

Price growth is expected to be contained to some extent by the koruna's 12 percent gain against the euro so far this year.

Slowing economic growth and the waning effect of Jan. 1 tax and regulated price increases are also hoped to have an effect. It was these arguments that lead rate setters to refrain from lifting Europe's second-lowest benchmark interest rate last month after raising it to a six-year high of 3.75 percent in February.

The central bank's February forecast anticipates an inflation rate of 5.3 percent in the fourth quarter and a 2.4 percent rate in the second quarter of 2009. The preferred mid-point of the central bank's inflation objective is 3 percent. Inflation breached the bank's 4 percent ceiling for a fifth month in a row in March due to the global growth in food and oil costs and a jump of indirect taxes and state-controlled prices such as rents and energy. Policy makers however are inclined to place more emphasis on the so-called second-round effects of cost price shocks and tax adjustments such as elevated wage-growth demands that could thwart inflation's return to the desired level.

Indeed this is the interpretation placed on the situation by Czech National Bank board member Eva Zamrazilova speaking at a central bank conference in Prague this morning:

"The data show that the current surge of the inflation rate will be limited by time, the situation will gradually calm down and in early next year, inflation will return to levels very close to our target," she said "Today's figure fully corresponds with an outlook of stable interest rates in the near term"

Things may however not be quite so neat and tidy.

True wage inflation has been slowing, and Czech real wage growth slowed the most in two years in the last quarter of 2007 even as inflation accelerated. The average monthly paycheck rose 1.9 percent when adjusted for inflation, compared with growth of a revised 4.9 percent for the preceding three-month period. The average gross monthly salary advanced 6.8 percent to 23,435 koruna ($1,435). For whole year 2007, real wages were up 4.4 percent, the fastest rate of increase in four years.

Czech Unemployment March 2008 and the Need For Migrant Workers

2008-04-08T00:30:00.000-07:00

The Czech unemployment rate fell to 5.6 percent in March as sustained economic growth continued to create more jobs. The rate fell from 5.9 percent in February.

The number of registered unemployed dropped to 336,297, down 18,736 from the preceding month and down 94,177 from a year ago, according to data from the Labor and Social Affairs Ministry this week.

Labour shortages are growing with the number of job vacancies increasing to a record 151,311 at the end of last month.

And employment has also been rising rapidly, with the number of first (main) jobholders in Q4 2007 reaching 4 967.3 thousand, up by 105.6 thousand (+2.2%) year-on-year. Employment thus reached it highest level since the start of 1997.

So with the Czech economy creating jobs at a rate of over 100,000 a year, and with unemployment falling at 95,000 a year, and realistically assuming that not all the 300,000 or so unemployed who remain are employable, then the Czech Republic may be what, 18 months or so away from running out of workers at this point. Of course, long before you actually get to run out of workers, you hit the limits of the inflation-free rate of growth which is possible with the workforce which remains, as we have been seeing in one East European economy after another, (and as we may now even be seeing in China). This is why the recent surge in Czech inflation, despite the slight fall back this month, should be giving cause for concern over at the central bank.

Is Migration The Answer?

Certainly migration can help (as can increasing participation rates among older workers) but the numbers involved are really quite large for a comparatively small country, and there are issues about preparedness to adapt to becoming a multi-cultural society (everything in Eastern Europe is just happening so quickly). But the change is taking place and foreigners now make up almost 4 percent of the Czech Republic's population (which is currently a little over 10 million), and the number of migrant workers in the country has been rising steadily year by year in recent years, and in particular in 2007. According to data from the Czech Statistical Office at the end of last year there were a total of 392,100 foreigners with long-term or permanent residence permits living in the Czech Republic. This was up by 70,600 in 2007 alone.

The largest group of foreign migrants with rights to work in the Czech Republic comes from Slovakia. At the end of last year, 101,233 Slovakians were legally worrking in the country. Ukranians are the second most numerous group with 61,592 working in the Czech Republic last year. The number Mongolian and Vietnamese workers is also increasing rapidly. In 2007 there were 6,897 Mongolians working legally in the CR (up from 2814 in 2006) and 5,4425 Vietnamese (up from 692 in 2006). The numbers of Vientamese in the country is undoubtedly much larger - according to the Czech police, there are almost 51,000 Vietnamese holding long-term or permanent residence permits for the CR, many of these with student visas.

Certainly the Czech Republic's labour shortages are now making their present felt across the economy as a whole. Bloomberg had an in-depth article earlier in the week, where they quoted Jiri Cerny, vice president of Toyot and PSA Peugeot Citroen's joint venture in the Czech Republic, as saying that three years after opening shop in the country he feels it is getting harder by the day to find workers, and he is now actively considering importing them from Mongolia.

TPCA, the Toyota-Peugeot joint venture about an hour outside of Prague, shows the strains created by this new investment. Along with average wage growth of more than 40 percent since the Czech Republic joined the EU in 2004, managers like Cerny also face a labor shortage that means they can't recruit all the workers they need just by offering higher pay.

"It's difficult; we are always looking for employees," says Cerny, wearing the plant's trademark gray overalls as he bounces between budget meetings and the factory floor. To find qualified workers, "we're thinking about Vietnam right now, as well as Mongolia," he says.

This story is being repeated in one country after another as companies that were attracted to the formerly communist nations in eastern Europe by the promise of cheap and plentiful labor are finding less of both, as faster growth drives up wages and open borders encourage emigration. Indeed there is increasing speculation that accelerating inflation may cause eastern Europe's investment- led boom to fizzle (and possibly even crash to a dead stop), with the Baltics and Balkans regions already threatened by a "hard landing" according to the International Monetary Fund and Standard & Poor's.

Of course in the short term migration can help, but in the longer run sustainability is going to be all about getting that fertility rate back up again.

Czech Central Bank Keeps Interest Rates on Hold

2008-03-26T09:48:00.001-07:00

The Czech koruna fell against the euro today following the decision by the Czech central bank to keep what are till the European Union's lowest interest rate on hold to try to restrict the ongoing rise in the currency. This is a very tricky game to play indeed, and the bank effectively bucked the trend among other the other EU10 central banks who have some sort of autonomy left over their monetary policy (Romania raised rates today, as did Poland, while we could say that in Slovakia - where they have incraesingly less monetary policy options left by the day as they make one last desperate effort to converge with the eurozone despite a sudden acceleration in inflation and GDP growth - the decision not to raise was effectively taken for them, since they cannot afford to enter EMS with an excessively high partity rate with the euro).

The Prague-based bank left the repurchase rate where it was,at 3.75 percent. The koruna has gained 8 percent against the euro in the past six months alone, ranking it as the world's best performer during the period of global financial turmoil.

The Czech currency fell as much as 0.8 percent following the news, down to 25.662 per euro and was at 25.502 by 5:22 p.m. in Prague, from 25.471 yesterday. It has now fallen 1.8 percent since the central bank said March 18 it will freeze the proceeds from state-asset sales.

Policy makers want to revive a 2002 accord whereby foreign- currency proceeds from the sales would be put in a special account to keep fund flows out of the market and limit demand for the koruna, Deputy Governor Mojmir Hampl said. Policy makers are concerned more rate increases, after eight in the past two and a half years, would push the koruna even higher, threatening to become completely counter productive.

``The bank board has consensually agreed that the decision- making is uneasy and risks of leaving the current rate trajectory are relatively high,'' central bank Deputy Governor Miroslav Singer said today. ``We perceive the situation as burdened with balanced but substantial risks in both directions.''

Czech Retail Sales January 2008

2008-03-18T04:43:00.000-07:00

Czech retail sales grew at the slowest annual rate in four months in January as accelerating inflation curbed shoppers' purchasing power, supporting speculation that interest-rate increases may not continue. Sales rose 4.1 percent, compared with an annual increase of 5.4 percent in December, the Czech Statistical Office said today.

Retail sales, excluding cars and motor fuels, were up by 3.3 percent and were 4.9 percent higher when seasonally adjusted, led by clothing, furniture and electronics. Sales of cars and motor fuels grew 6 percent.

Consumer spending has eased back as inflation accelerated to 7.5 percent in January from 1.3 percent a year earlier. The central bank expects cooling household spending, the main driver of economic growth in the past two years, to restrain the Czech expansion back to a 4.1 percent GDP growth in 2008 from 6.5 percent 2007. If today's data give them some encouragement to believe they are succeeding then they may well leave the main interest rate at its current 3.75 percent. Certainly with an average inflation rate this year of over 6 percent and nominal wage increases of around 8 percent, real salaries may well increase by less than 2 percent following the 4.4 percent increase in real wages in 2007. So this would definitely be a move in the right direction if it can be sustained.

The koruna fell to 25.208 per euro by 10:47 a.m. in Prague, compared with 25.141 yesterday. The ask yield on the government benchmark bond maturing in 2018 rose 5 basis points to 4.59 percent.

Czech Producer Prices February 2008

2008-03-18T04:14:00.000-07:00

According to the latest release from the Czech Statistics Office prices of agricultural and industrial producers were up in February by 0.7% and 0.1%, respectively over January, while prices of construction work and market services grew by 0.4% and 1.1%, respectively.

In comparison to February 2007, prices of agricultural and industrial producers increased by 27.1% and 5.6%, respectively; prices of construction work and market services were up by 4.5% and 3.4%, respectively. That is core industrial producer prices are now rising at a 5.6% annual rate.

Agricultural producer prices grew by 0.7% in total. Prices of crop products rose by 2.0% due to higher prices of cereals (+3.4%). Prices of potatoes, fruit and vegetables fell by 5.8%, 2.3% and 1.7%, respectively. Prices of animal products fell by 1.0%; lower were prices of milk (-0.2%), poultry (-1.6%) and pigs for slaughter (-3.6%). Higher prices were recorded for eggs (+0.9%).

Industrial producer prices rose by 0.1% (+1.9% in January). The growth of price level came mainly from higher prices in ‘basic metals and fabricated metal products’ (+0.6%), ‘machinery and equipment” (+0.9%) and “chemicals, chemical products and man-made fibres’ (+1.1%). Prices increased in 'food products, beverages and tobacco’ by 0.2%, of which the most marked increase was recorded for ‘animal and vegetable oil and fats’ by 6.7% and ‘prepared animal feed’ by 2.4%. On the other hand, prices dropped in ‘meat and meat products’ by 1.6% and ‘dairy products and ice cream’ by 1.4%. Prices decreased in ‘transport equipment’ by 0.9%, ‘coke, refined petroleum products' by 0.8% and in ‘rubber and plastic products’ by 0.6%.

Construction work prices rose by 0.4%, and so did prices of construction material input (+0.6%).

At the same time export prices decreased by 2.6% in January (following a 2.1% decrease in December) dropping for the third month in a row. The underlying reason for this improved performance is undoubtedly the appreciation of the koruna. The biggest price decreases were registered in ‘miscellaneous manufactured articles’ which were down by 5.2% (particularly articles of apparel and clothing accessories), ‘machinery and transport equipment’ down by 4.9% (especially general industrial machinery and equipment) and ‘chemicals and related products’ down by 3.8%. In contrast, the highest price increases were recorded for ‘food and live animals’ - up by 12.7% (mainly cereals and cereal preparations) - and ‘mineral fuels, lubricants and related materials’ - up by 18.0% (particularly coal, coke and briquettes and electric current).

Czech Inflation and Unemployment February 2008

2008-03-10T15:54:00.000-07:00

Czech consumer prices rose by 0.3 percent in February, keeping annual inflation at the nine-year high of 7.5% which it reached in January, the statistical bureau said on today. Price growth was driven mainly by housing prices, including water and heating, and kept open the possibility that the central bank will raise interest rates once more in the next few months. A separate set of figures from the Labour Ministry showed unemployment fell to 5.9 percent in February from 6.1 percent in the previous month.

The data lacked the kind of negative surprise impact which shocked the market in January but this continuing high inflation may well prompt more monetary policy tightening. The central bank has raised the main repo rate by 200 basis points to 3.75 percent as the economy grwon at a tidy clip over the past three years.

The central bank has acknowledged inflation is still 0.6 percentage points above its fresh forecast, and has been struggling to try to anchor inflation expectations, suggesting that the current spike is largely a short-term deviation.

A major anti-inflationary factor has been the rise in the value of the koruna, which currently stands up some 11 percent year-on-year against the euro. It has been cooling off from the record 24.83 seen on March 4, and briefly dipped to 25.125 after the inflation data from 25.095 before but then firmed back to 25.033 by 1310 GMT.

There are various risks to the banks inflation forecast on both the supply and demand sides. One clear danger if that the rapid rise in some prices, even if only temporary, creates higher costs for businesses that may lead to rises in other prices as well as higher expectations for higher inflation among Czech consumers and companies. This risk may well prompt the Czech central bank to raise rates either this month or in the not too distant future.

On the supply side there are gowing pressures from labour shortages in some sectors. Separate unemployment data out today from the Ministry of Labour and Social Affairs showed the number of jobless fell to 5.9%, its third lowest level since 1998 in what is already tight labour market, further boosting the case for a rate hike.

In February the Czech employment offices registered a total of 355,033 job seekers. That is 9,511 less than at the end of January, and 99,704 less than in February 2007. The number of available job seekers (job seekers currently available for work) was 330,641. In the course of February, job offices registered a total of 40,002 first signings. That is 23,152 job seekers less than in January and 718 newly registered job seekers less than in February 2007. In February job offices registration was terminated by 49,513 job seekers. New jobs have been taken up by 31,735 persons.

In February 2008 the unemployment rate was 5.9 % (January 2008: 6.1 %, February 2007: 7.7 %). The unemployment rate was higher than average in 35 districts, the highest being in Most (14.9 %), Karviná (13.1 %), Znojmo and Jeseník both (11.9 %) and Teplice (11.8 %). The lowest unemployment rate was in the districts of Praha–východ (1.7 %), Praha–západ (1.9 %), Praha and Mladá Boleslav (both 2.2 %). The unemployment rate for women was 7.2 % and the unemployment rate for men was 5.0 %.

Czech Wages and Salaries Q4 2007

2008-03-07T04:50:00.000-08:00

Czech real wage growth slowed the most in two years in the last quarter of 2007 as inflation accelerated. The average monthly paycheck rose 1.9 percent when adjusted for inflation, compared with growth of a revised 4.9 percent for the preceding three-month period, the Prague-based statistical office said today. The average gross monthly salary advanced 6.8 percent to 23,435 koruna ($1,435). For whole year 2007, real wages advanced 4.4 percent, the most in four years.

The average inflation rate rose to 4.8 percent in the fourth quarter from 2.5 percent in the third, eliminating most of the nominal wage increase negotiated by unions and their employers. Policy makers at the central bank have said the inflation surge is only temporary and have urged against any reopening of wage talks in an attempt to prevent the inflation rate from rising.

In the private sector the monthly paycheck was 6.7 percent higher at 23,484 koruna. When adjusted for price growth in during the year, wages grew 1.8 percent, the office said.

State-employee salaries grew 7.1 percent in October through December from a year earlier to 23,259 koruna, translating into a 2.2 percent real advance.

The central bank indicated last month it may begin to bring down what are still the European Union's lowest rates as early as later this year, citing the strong koruna, faltering economic growth and the fading effect of cost and administrative shocks on inflation.

At the same time, policy makers have said they are ready to resume lifting borrowing costs to prevent inflation and a scarce labor force from sparking excessive wage growth.

Offering us one possible indicator of what may be to come Toyota Peugeot Citroen Automobile, a Czech car venture formed by automakers Toyota Motor Corp. and PSA Peugeot Citroen, have said this week that wages will increase by 7 percent with effect from from April 1.

Czech January Trade Surplus

2008-03-07T04:21:00.000-08:00

The Czech Republic posted a substantial January trade surplus following on the back of very healthy export growth, suggesting that manufacturers are still managing to weather the effect of the koruna's eight-month rally.

The 12.2 billion koruna ($748 million) surplus followed a revised 3.3 billion-koruna gap in December and a 9.8 billion- koruna positive balance in January 2007.

The koruna has advanced 15 percent against the euro since July, making it the world's best performer over the last half year. The strong currency puts pressure on exporters' revenue or makes their goods less competitive. The German economy, which is the destination for one-third of Czech exports, is expected to slow in 2008, with economic growth being forecast by the German government to reduce to 1.6 percent from 2.5 percent in 2007.

Exports in January rose 11 percent year on year and advanced to 210.1 billion koruna while imports amounted to 197.9 billion koruna, up 10.3 percent from a year ago.

The Czech Republic's 2007 trade surplus totaled a revised record 85 billion koruna, a third straight full-year surplus.

Czech GDP Q4 2007 Detailed Report

2008-03-07T04:02:00.000-08:00

The Czech economy grew in the fourth quarter of 2007 at the fastest pace in almost two years on increased demand for health care and higher public spending on construction works according to the final report from the statistics office which is out today. Gross domestic product expanded year on year by 6.6 percent, which compares with the preliminary estimate of 6.9 percent reported on Feb. 15 and a revised 6.3 percent for the third quarter.

The economy grew by a record 6.5 percent in whole year 2007.

The government raised indirect taxes and imposed fees to discourage people from overusing public health care. That triggered higher spending on items such as drugs in late 2007, more than outweighing the effect of surging inflation on household expenses. This year's growth will slacken to between 4 percent and 5 percent, according to the official forecast.

The central bank predicts GDP will grow 4.1 percent in 2008 and the inflation rate is projected to pick up to 6.3 percent from 2.8 percent.

Consumer spending, which was the dominant driver growth for a consecutive second year, rose by 4 percent in constant price terms in Q4 when compared with Q4 2007, the slowest pace in two years. On the other hand, government expenditure was up 3.1 percent in the October- December period, the first increase in real spending in three quarters.

One-time factors ``predominantly applied to increased performance of the health industry, which resulted in higher expenditures of health insurance companies, and more intensive repair of road network with the impact on final government consumption expenditures,'' the office said. Without these effects they estimated growth would have been around 6 percent.

Gross fixed investment growth accelerated to an annual 8 percent in real terms and 9.8 percent in nominal ones, adding 2 percent to the overall GDP growth.

Exports of goods and services climbed at an annual rate of 12.5 percent when adjusted for price growth, more than a 10.2 percent increase in imports, as Czech manufacturers continued to benefit from rising demand in other EU nations, and in particular in Germany and Slovakia. External trade accounted for 2 percent of the GDP increase.

Czech GDP Q4 2007

2008-02-15T01:57:00.001-08:00

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.......

Czech Industrial Output December 2007

2008-02-14T09:58:00.000-08:00

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.

Czech Current Account Deficit December 2007

2008-02-12T04:16:00.000-08:00

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.

Czech Inflation January 2008

2008-02-08T06:22:00.000-08:00

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.

Czech Central Bank Raises Main Interest Rate

2008-02-07T06:27:00.000-08:00

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.