How Near Is The Czech Economy To Recession?

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

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

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

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

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

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

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

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

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

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

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

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

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.