The Czech Economy That Didn't Bounce?

The Czech republic has been making the news recently. On the one hand the country has been on the receiving end of massive, devastating floods, while on the other the country's government was brought to the brink of collapse (and beyond)  by the resignation  of Prime Minister Petr Necas following the arrest of one of his most trusted aides on corruption charges. After the deluge I suppose.

Curiously both these events serve to highlight one important underlying reality - Czech voters are deeply dissatisfied and in a highly skeptical mood, since following seven quarters without growth the country's economy is evidently stuck in the doldrums. The worst part is things look highly unlikely to improve anytime soon.

Naturally the flood damage has resurected an old and somewhat tiresome debate about whether or not destruction is actually good for an economy. The last time this surfaced in any significant way was in the aftermath of the Japanese tsunami (see my piece of the time here), and as we can now see all that reconstruction spending totally failed to get the economy back on track, although it did leave the ailing country with just a bit more debt.

As I think everyone agrees, flood damage is a form of wealth destruction. If you have a house on one day, and the next you don't then somehow you feel poorer. It isn't really surprising that you feel poorer because in actual fact  you are poorer. Naturally, if your home gets rebuilt, and you find yourself with an even better one as a result, then  you may even feel you have benefited (although what about all those valued personal belongings you lost), but that will be because someone else, either a government or an insurance company, has made good your loss, so they are poorer instead of you. As Reuter's reporter Michael Winfrey puts it: "Governments and insurers from Germany to Romania will have to pick up the costs of helping families and business recover from the floods, which have killed at least a dozen people and driven hundreds of thousands from their homes since the start of June".

Now clearly in the short term GDP may benefit, since spending money will generate economic activity. As the country's Finance Minister Miroslav Kalosuek told Czech Television at the time: "If we take just the normal households, and how many brooms, bleach and rubber gloves they must suddenly buy, that is demand. There will also be demand in construction, demand in renewing roads, higher demand for certain goods and services. And higher demand is pro-growth."

But will the extra demand really generate extra growth in the longer run, rather than simply advancing spending from the future to now (or as the Spanish expression so evocatively puts it "give us bread for today and hunger for tomorrow") ?  The evidence we have seems to suggest that it will if the problem the economy was suffering from was a lack of stimulus - which brings us nicely round in a circle to the stimulus versus austerity debate. But if lack of stimulus wasn't the problem, as we have seen in the Japan case, an extra reconstruction programme won't make a blind bit of difference at the end of the day. It will simply shift demand around a bit in time.

So which is it? Is the Czech Republic suffering from a normal common or garden recession, one in which a bit more stimulus might help, or is something deeper going on?

The Demographic Spanner Stuck In The Works

The Baltics, Hungary, Romania and Bulgaria are all recognized - each in their own way - to have encountered serious economic problems and generated sizable imbalances during the run in to the global financial crisis. These problems - at the time - were seen as placing serious question marks over the underlying soundness of a group of economies which in the pre-2008 world were often lauded for their growth prowess and fiscal abstemience when compared with their West European neighbors. The fact that these countries started, one after another, to go off the rails could be explained by viewing them as examples of  the "weaker economic cases"in the group.

But when, in a way which curiously parallels what is now happening in purportedly "core Europe" countries like Finland and the Netherlands in the West,  what were previously regarded as best-case-scenarios, like the Czech Republic and Slovenia, start to struggle and then continue to flounder, well perhaps we should be raising more than an eyebrow or two - indeed,  maybe we should really be asking ourselves some serious, thought-provoking questions not only about the structural depth of the problems being faced by the whole group of Eastern Accession countries, but also even about the very soundness and adequacy of the received theories the main multilateral policy institutions are working with.

In the current case, the Czech Republic is now in all probability in its eighth quarter of  recession - and the last time the economy actually grew was in the three months up to June 2011. This is quite a preoccupying outcome for a country which was not perceived to be suffering from any special problems - like outsize credit booms, or government fiscal largesse - in the pre-crisis world. The economy is now moving sideways, and, more importantly, substantial question marks hover over what the country's real future growth potential actually is. Certainly, and in any event, it is well below that which was considered a norm pre 2008.

In the past the country was characterised by and renowned for the soundness of its industrial base and  its strong export performance, but the continuing crisis in the Euro Area (the principal source of external demand for the country's products) has meant overseas sales have been largely stagnant for some quarters now. And with countries in Southern Europe striving to make a substantial competitiveness correction and claw back some of their lost ground, it is in the East of Europe where the impact of these efforts is likely to be most acutely felt. It was precisely during the time that the Southern economies were shifting over to credit-driven service ones that their Eastern counterparts were busy building their industrial foothold in the EU. Now those in the East face the risk that a sizeable chunk of this coupling and integration process may simply unwind. A rising tide may lift all boats, but what does a flat sea do?

Czech industrial activity has become virtually stagnant when it isn't actually falling.

And construction is steadily sliding downhill.

In addition to the loss of export leverage household consumption has remained very weak. As the IMF put it in their latest country report, "the export-led recovery observed in 2010-11 subsided as euro area import demand slowed, and growth has noticeably underperformed trade partners and peers since the middle of 2011 mainly because of weaker domestic consumption and investment."

Naturally, both the IMF and EU Commission assume that what is happening to the country does not go far beyond a short term blip, and both institutions take it as a given that "recovery" will set in somtime soon. As the IMF puts it, "The Czech Republic's economic fundamentals are strong." The EU Commission broadly agrees: "Due to a strong downturn in consumer confidence, a drop in public investment and a weaker external environment, real GDP is estimated to have decreased by 1.3% in 2012. As these factors ease off in 2013, economic activity is forecast to bottom out in the middle of the year. The recovery is expected to consolidate in 2014, supported by growth of real household income".

That being said a nuanced but interesting divergence has emerged between the two Troika partners over the immediate outlook for the country. While EU Commission see "domestic risks to the outlook" as "fairly balanced", the IMF feels general risks lie  "mainly to the downside" highlighting the risks of  "further deterioration of euro area growth" and the danger of "permanent scars to potential growth".

The Fund explain their concerns as follows:  "With recent disappointing export performance, the economy is at the risk of being dragged deeper into recession. Also, the current poor growth performance, if protracted, runs the risk of translating itself into a long-term decline in potential growth due to lower investment." I.E. the slowdown could eventually become self perpetuating if the recession becomes an even more dragged out affair. Unfortunately this possibility is far from being excluded.

Given the existence of such risks it is worth asking ourselves whether growth in the Czech economy really will bounce back to an average of around 2.8% a year between 2015 and 2018? What is there in the works which really could make such a growth spurt - from the current near zero level - possible? Or could the IMF forecast numbers not be just another example of what Christine Lagarde once called “wishful thinking” of the kind that has been habitually practiced in, say, the Greek case.

But let's put the question another way. What might impede the country from  reverting to a pattern of strong growth rather than simply continuing to bounce along the flatline?  Well, you've got it - it's the demography stupid!  The Czech Republics population and workforce just turned the historic corner pointing towards long term decline. To some this piece of information may seem surprising, but CEE demographics in general really are quite unique, since while fertility fell and life expectancy started to rise as it did in the West, due to the development delay produced by nearly half a century of communist government most of these countries are now in the process of getting old before they get rich, creating a very special set of economic growth and sustainability issues.

Czech fertility has long been below replacement level, and has been below the 1.5tfr level since the early 1990s.    

The Czech population has been virtually stationary over the last few years, but is now finally starting to contract.

As in many countries on the European periphery the decline is an indirect by-product of the economic crisis. Population levels which were previously precariously balanced around the zero growth line are suddenly being destabilised by the drop in births associated with the recession and the sudden disappearance of the positive net number of migrants arriving which helped keep the balance in the pre-crisis world.

"In the first three months of 2013.... net international migration was equal to minus 4 people – the number of emigrants was 9 998 people and number of immigrants was 9 994 people. The highest net migration was reached with the citizens of Slovakia (1 213 people) and Germany (334 people), followed by United States (290 people) and Romania (213 people). The considerable decrease was registered in the number of citizens of Ukraine (by 2 201 persons), Czech Republic (by 505 persons) and the number of Vietnamese citizens (by 427 persons)".

But even more important (in terms of GDP growth potential) than the overall population decline (which is still tiny) is the fall in working age population (WAP).  Following a pattern seen in country after country along the periphery, the start of the decline in this population group has also  coincided in time with the onset of the European debt crisis.

This means that employment growth will have the wind blowing against it, rather than behind it, and that it will become harder and harder to get GDP growth from adding extra labour (indeed at some point the number of those employed may well become negative) and the only major impetus towards headline GDP growth will have to come from productivity improvements. For an examination of this issue from the Portuguese point of view see this post here.

Is There Deflation Risk?

One of the lesser known details about the Czech economy is that - since it has retained its own currency, the Koruna - it has its own independent monetary policy and the central bank therehave now been holding interest rates about as near zero to zero as you can get  (0.05%) for  the past 8 months. This puts the country's bank in more or less the same situation as most of its better known peers across the globe - namely it is now up against the "zero bound" which makes it difficult to lower nominal interest rates any further.

With inflation weakening the debate at the central bank is now moving towards whether it will be necessary to use exceptional measures of the kind which would elsewhere be called QE. One option which is under consideration is a local version of "Abenomics" whereby the bank actively intervenes in the currency markets to provoke Koruna weakening - not so much to generate more export competitivness (banned by the G20) but rather in order to to try and raise the price level and avoid deflation risk (see these comments from central bank board member Lubomir Lizal). Such interventions, which (as in the Japan case) target the price level and not the currency value are for the time being accepted by the international community.

At the present time the Czech Republic is experiencing strong disinflation rather than outright deflation, but the IMF clearly see a danger if domestic demand remains weak and the economy continues to drift that this could become outright deflation.

The policy interest rate has reached the zero bound, but risks to inflation are to the downside. The Czech National Bank (CNB) was swift to cut its policy rate by 70 basis points to 0.05 percent between June and November 2012. Inflation declined below the 2 percent target level starting from January 2013, as the effects of 2012 VAT hike subsided and contributions from food and fuel fell. Inflation is projected to remain at around 1¾ percent through 2014, but risks are to the downside in line with the risks to the growth outlook.

and:

"If a persistent and large undershooting of the inflation target is in prospect, the CNB should employ additional tools. The CNB’s statement that additional monetary easing within the context of inflation targeting framework would come from foreign exchange (FX) interventions is welcome and has been clearly communicated. The mission agrees that FX interventions would be an effective and appropriate tool to address deflationary risks."

The risk of outright deflation is thus intrinsically linked by the Fund to the downside risks to headline GDP growth. If the economy under-performs, and investment does not bounce back then not only will there be damage to the country's long term growth potential, movements in prices might turn negative.


Japan With A Current Account Deficit And Negative Net External Investment Position?

Few, I suppose, would have thought there would be any good reason to make a comparison between the Czech Republic and Japan. Naturally it is noticeable that both countries have strong industrial bases and are very dependent on exports for growth. But beyond that it would seem the two countries have little in common.

Except, except.....  what about the decline in working age population (WAP)? Isn't that the factor that many feel is behind the ongoing battle that Japan is fighting with deflation? (See, for example, this post). The Bank of Japan has long recognised that there is some sort of correlation between the rate of workforce growth and the rate of inflation (see chart below), with price inflation turning negative at more or less the same time as labour force growth did. The causality behind the correlation would be connected with the rate of rise (or decline) in domestic demand (initially consumption and then investment). Movements in WAP could be considered to be a good proxy for movements in employment and incomes, and hence consumer demand. As a country's WAP enters decline then domestic demand tends to weaken and following this the investment which goes with such demand does not occur. This is why failure to adequately resolve the present malaise into which the Czech Republic has fallen could produce a long term negative consequence for trend growth, as the IMF have highlighted.

Thus it isn't just a coincidence that the Czech Republic is starting to notice a fall in domestic demand and a fall in investment at just the time when the working age population starts to decline. This is a development which needs to be closely watched.

But, beyond any loose similarities, there is one important sense in which the country differs from Japan - the state of its Net External Investment Position. 

The Czech Republic has, as I have repeatedly stressed, a strong export sector. So much so that the goods trade balance tends to be positive and large. What's more, it has been growing rapidly since the crisis. In fact, in Japan as the population has aged this balance has weakened.

But while in Japan the current account balance remains strongly positive, in the CR it is constantly negative.

The reason for this apparent paradox  lieswith the large negative income component in the current account.

This income component is largely made up of interest payments on external loans (for example in the banking sector between West European parent bank and Czech subsidiary) and dividends on equities owned by non residents (for instance non-Czech parent companies which bought into Czech utilities during the privatisation wave).

The income item is large and negative due to the country's strong negative Net International Investment Position. Simply put non Czech nationals have more investments in the Czech Republic than Czech citizens have abroad to the tune of some 50% of GDP. In an ageing society, with a shrinking workforce this situation is simply not sustainable. Czech companies and citizens need to save more, even though this will weaken domestic demand further and make the country even more dependent on exports, and more of these savings then need to be invested abroad to generate an income flow which will help the country support its rapidly ageing population from 2020 onwards. This situation is widespread across Eastern Europe (see Hungary here and Bulgaria here).

Summing up: In recent years Czech exports have performed remarkably well, and the country has a strong goods trade surplus. The problem is that most of the country’s exports have been geared to the European market, and consumption in this area is now stagnant with a tendency to decline. In addition the country is heavily indebted abroad. With each passing day the CR looks more and more like Germany and Japan, without the strong overseas investment stock which gives the economies of those countries some sort of stability. The country cannot gain enough export momentum and as a result the economy languishes in recession.

The thing about elderly economies is that they no longer stand on two pillars, domestic consumption steadily runs out of steam, and the economy becomes export dependent. This is what can be observed in the Czech Republic, and the country’s demographics make it unlikely we will ever see strong growth in private consumption again.

On the other hand the country has a low sovereign debt level – around 45% of GDP – and before the onset of the latest recession it did maintain a reasonably strict fiscal discipline, despite the fact that with an ageing population the costs of health care and pensions continue rising annually.

One of the reasons for the low sovereign debt level is the fact the country privatized a number of its state owned companies at the start of the century - and herein lies the problem on the income side of the current account. Privatising to overseas (rather than domestic) investors means the even though the sovereign itself is less indebted, the level of indebtedness of the country as a whole doesn't change much. Ultimately the sovereign supports the nation, and the nation the sovereign, so apart from the political debate about larger or smaller government the rest is more akin to moving the deckchairs around. This kind of privatisation does not guarantee long run sustainability for the country, and if not backed by a rise in domestic saving it can become "bread for today and hunger for tomorrow" as the Spanish expression goes.

So despite being out of the Euro, and having the ability to devalue, it is not clear to what  extent the Czech government will be able to withstand popular pressure to increase spending in the face of a stagnant economy. Without some plan for handling the ageing population problem calls for continuing austerity will likely fall on increasingly deaf ears as they do in country after country along the EU periphery. Despite talk of a constitutional change limiting public debt to 50% of GDP, as we are now seeing in the Polish case such laws are easier to enact than they are to implement. So it is likely that the current wave of austerity policies will increasingly come into question if, as seems probable, the economy continues to stagnate.  In which case watch out for credit rating downgrades, and future surges in yield spreads on the one hand and growing deficit and debt levels on the other. As Paul Krugman once put it, some countries have low growth because they have high debt, and others accumulate high debt because they have low growth. The latter is in dabger of becoming the Czech case.

Quick Reality Czech

The Czech Republic is the first economy in central and eastern Europe to slide back into a full technical recession during the current downturn (evidently it is unlikely to be the last), with a 0.3 per cent quarter-on-quarter GDP decline in the last three months of 2011, after a 0.1 per cent drop in the previous quarter.

The news, announced last Wednesday, is interesting but not entirely unexpected given the export dependence of the country's economy, and in particular on exports to the eurozone, which also saw a GDP contraction in the fourth quarter. Still, it is curious that the country which arguably has one of the strongest in the region was the first to slide back into contraction.

The country has a strong and competitive export sector, which normally drives growth forward. The problem with export driven economies is that once external demand (in this case mainly from German industry) weakens, domestic demand is not strong enough to maintain the growth dynamic.Thus such economies are inherently unstable. Unfortunately this is a pattern we are going to see more and more of now that domestic demand is only a real driver in relatively few EU economies (Poland, France, possibly Sweden).

Even after the relatively bounce-back, Czech GDP was still below the pre-crisis peak in the second quarter of 2011, before it fell into recession again.

Exports as can be seen from the chart below really surged during the first phases of the recovery, but since mid 2011 they have effectively been stagnating (second chart showing 3 month averages).

Fixed capital investment and construction activity, on the other hand, have fallen back substantially since the crisis, and look unlikely to recover in the short term.

Another interesting detail about the Czech economy is the fact that although the country runs a very healthy trade surplus, strong negative income flows on the current account means that the country actually runs a current account deficit. The reason for the deficit is interesting I think, since the whole external account only balances due to strong FDI and equity inflows plus reinvested earnings.

What this means is that the net international investment is deteriorating, and the day earnings are not retained and reinvested, that day the country will start to have a problem.  It seems to me that this kind of model, and especially for a country with an ageing population and weak domestic demand is not sustainable, one-way inbound FDI is not a development model for a mature economy.

Czechs need to save, and then invest elsewhere to generate income to help support their pensions and health system. This is the whole problem with ageing societies in the east of Europe, the low levels of accumulated savings they inherited  due to their earlier  history makes them very vulnerable.

In addition, the country is steadily accumulating a stock of sovereign debt as the need for a fiscal deficit has been created to support demand. Accumulated debt is still low, but it has grown sharply since the crisis, and remains on an upward path. The deficit was around 4% of GDP in 2011, and looks set to stay at the same level this year. More importantly the deficit is in danger of becoming structural (that is to say inbuilt into the country's economic growth) and may be hard to eradicate without a serious fiscal effort and a period of significantly under par growth.

The Czech Republic has its own currency (the Koruna) whose value tends to fluctuate in accordance with global risk sentiment (rather than for any local fundamentals) and has rebounded sharply (despite the fact that central bank interest rates have been held at 0.75% for many months now) as risk sentiment has risen following the 3 year ECB LTRO development.

Despite the very low interest rates, inflation is well under control. In December the EU HICP was running at an annual 2.8%.

Credit has slowed, but it is hard to tell whether this is not more the result of slow ongoing domestic delaveraging rather than any real shortage of funds to lend. Certainly there is no sign of a Baltic style credit crunch.

Looking at the manufacturing PMI, the industrial sector has been stabilising along with the rest of the EU, and the rate of contraction both in output and new orders is slow, so the economy should continue to stagger forward OK although there are few signs of an outright recovery, which will need to await a significant upturn in the Euro Area.

Obviously one of the key nagging questions is why the country is so export dependent. I have correlated this phenomenon with rising median population ages (like in Germany or Japan - in fact the Czech Republic looks awfully like Japan without the current account surplus) since the Czech Republic (along with Slovenia) has one of the oldest populations in Eastern Europe.

Others explain the phenomenon culturally - the Czech's are a nation of savers, unlike the Estonians whose reckless spending lead them into a housing boom/bust (do note the irony, please).

Sylvie Pekarova, a 33-year-old pharmaceutical researcher in Prague, has no debt. She doesn’t even own a credit card.


Consumers like Pekarova have helped the Czech Republic avoid the fate of the euro region, which is grappling with a debt crisis now into its third year. With private borrowing at half the euro region’s average, the country now boasts interest rates that are lower than 10 of the currency-bloc’s 17 members. That’s helping the government’s drive to sell benchmark Eurobonds, which started this week.

“It’s this feeling that if something goes wrong, you don’t want to be stuck with debts you don’t know how to pay back,” Pekarova, who lives in a rented apartment in central Prague, said in an interview. “Borrowing money for things like going on a holiday doesn’t make sense.”

So anyway, you can take your pick according to the model which takes your fancy. But I do wonder about the relative predictive power for investors of models which use cultural biases and those which simply take ageing populations. Which societies among the African underdeveloped economies will be the big new savers of the future, and which will be the spendthrift bankrupts? Median age analysis at least has the advantage that it makes prediction reasonably easly - Spain, for example, is about to become a nation of savers - but I wonder how those who use cultural analysis go about identifying the unexpected new savers we will see come 2020?

Eastern European Growth - Coming Rapidly Off The Boil?

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).

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

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

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

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

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.