OUTLOOK 2019 Czech Republic

The Czech economy is driven mainly by private consumption that is expected to slow to 3.0% in 2018. Central and Eastern Europe (CEE) has been booming for the last few years, but it is slowing now that the region is running up against structural constraints – labour shortages being the most obvious of them.

Czech consumption is coming off the boil due to some sectors reaching production limits as well as a slow down in growth by the country’s main trading partners.

The growth is expected to continue declining in 2019 and 2020. The forecast for 2019 is 2.9%. Currently, the main negative risk for Czech economic growth is considered to be Brexit (which is a major importer of Czech-made cars) as well as the general impact on wider United Kingdom-EU relations caused by Brexit, especially in the area of free movement of goods and services.

For 2019 the growth should mainly be driven by investment, which is to be stimulated by EU financial support from the European Structural and Investment Funds, as well as a need of the private sector to innovate its technological equipment and also by decreasing relative cost of capital to the cost of labour at low real interest rates.

Investment growth is set to slow down after peaking in 2018. Both the private and the public sector will continue to support investment activity, in particular in housing and manufacturing. Capital expenditure is expected to increase further, according to the finance ministry plans, which call for investment allocation to rise by 36% in the 2019 budget.

Low productivity growth, together with strong wage increases driven by the labour shortages, has resulted in rising costs that businesses are partially transferring to consumers. According to the finance ministry, the forecast for average inflation is 2.2% in 2018 and 2.3% in 2019, above the target of the Czech National Bank (CNB). Price dynamics are expected to accelerate at the turn of 2018-2019, due to a rise in energy (gas and electricity) prices and a low comparison base in early 2018. A poor harvest in 2018 may also increase food prices in 2019.

Moderation in investment growth is expected to lead to a slight drop in import growth due to relatively high import-oriented Czech investment. Imports are currently growing faster than exports, reflecting import-intensive investment and household demand for imported goods. Exports, though with increasing tendencies, are to be hindered by limits of production capacity, particularly in the automotive industry. The competitiveness of Czech exports could be affected by increasing real unit labour costs, which are expected to grow strongly, around 5% in 2018 and slow down to about 2.5% in 2019 and 1% in 2020.

Household consumption remains strong, slowing down to 3.8%, supported by income and employment growth and lower saving.

In 2019, the CNB is expected to continue in gradual tightening of its monetary policy. Given the anticipated development of inflation and monetary policy of the CNB and the ECB, long-term interest rates are projected to rise throughout 2019 and 2020. In 2019, they can reach 2.6%. Higher domestic interest rates will reduce strong housing demand and household credit. Consumer loans will continue to draw their strength from the power play of the labour force on the labour market.

Except from July 2018, koruna-euro exchange rate was between CZK25.4/€and CZK26.0/€in the third quarter of 2018, averaging CZK25.8/EUR. The CNB expects the currency to reach an average of EUR/CZK25.25 in the fourth quarter of 2018.

In 2019, Czech currency could strengthen to CZK24.9/€as a consequence of the ongoing real convergence, expected developments of labour productivity and the positive interest rate differential between the Czech Republic and Eurozone.

In 2018, the general government budget surplus is expected to reach 1.6% of GDP, according to the finance ministry. The 2019 budget represents a less cautious plan, including very strong expenditure growth, with a large increase of mandatory spending. The government plans to prop up investment spending but does not plan to introduce any new measures. The official budget lacks the buffers of previous budgets.

In 2019, the ministry estimates surplus at 1.0% of GDP, reflecting the fulfilment of the government’s programme priorities in the social area, as well as in the investment expenditures in both physical and human capital. In 2020-21, the budget surplus is expected to remain broadly steady at around 0.8% of GDP. The structural balance should be positive in all years of the outlook. Given the surpluses and nominal GDP growth, general government debt should continue to decrease and reach 30% of GDP in 2021.

While revenues are expected to grow in line with the economy (by 5.2%, driven primarily by personal income tax - 12.4%, and social security contributions - 7.4% due to the high wage growth), expenditures are expected to increase significantly.

Czech average gross monthly nominal wage currently amounts to CZK31,516 (€1,217). With the effect from 1 January 2019, the minimum wage will be increased by CZK1,150 (€44.5) to CZK13,350 (€513).

Czechia is the wealthiest nation among other Central and Eastern Countries (CEE), the Allianz Global Wealth Report 2018 comparing 53 countries found. Czechia occupied the middle of the chart at 26 in the regional ranking. The net wealth was €15,290 per capita in 2017, up from €12,360 in 2016.

The wealth of neighbouring Slovakia was half that  of Czechia in per capita terms, or around €6,100. But whereas Czechia has already passed its economic peak and beginning to slow, Slovakia is still in the upswing and should be growing at 4.5% in 2019. In a long-term perspective, Slovakia is growing faster than Czechia and its wealth will catch up.

The situation in the automotive industry has become complicated due to Brexit, which could endanger car demand and Czech GDP. Adoption of new environmental regulations could temporarily hinder production too, having an adverse effect on the whole supply chain. The outlook for the automotive industry remains uncertain due to a slowing of the European countries´ economic growth and a high degree of market saturation.

The biggest issue in construction sector is a lack of demand for housing and exhausted capacity, which are the main drivers of strong demand in the private sector. The double-digit growth of 11.1% that is expected in 2018 will not be repeated in 2019. The mix of these two factors has been pushing up construction prices, which is likely to continue in 2019. The figure is expected to reach 4.7% in 2019.

MPs approved the budget for 2019 on December 18. The budget deficit for the year is expected to be CZK40bn, with funding for infrastructure, higher salaries for civil servants and free school lunches being amongst the items on the agenda.

Politics

Despite the fact, the Czech Republic will most probably be compliant this year with all the Maastricht convergence criteria, except for the exchange rate criterion, as it does not participate in the relevant mechanism, the Ministry of Finance and the CNB recommended that government does not set a target date for adopting the euro in 2019, which the government accepted.

In terms of Digital Service Taxation, The Czech Republic recognizes the need to flexibly react to the changing business environment in the context of digitalization, therefore, in 2019 onward it will support a common (short-term) approach within the EU.

In order to increase the transparency and effectiveness of investment incentives, the Investment Incentives Act is to come into force in 2019. The new system will favour projects involving technology centres and business support services centres.

In 2018, the Government adopted the national investment plan to set up a public investment government council responsible for coordinating, including over 17,000 investment projects worth CZK3.45tn (€133.1bn) for 2019-2030.

The political situation remains shaky due to unstable position of Prime Minister Andrej Babis (ANO) who faced the risk of his coalition breaking up several times in 2018. In December 2018, the European Parliament suspended EU subsidies to Agrofert conglomerate, a business founded by Babis, in a non-binding resolution. The European Commission decided to audit the funds received by the company, which is to take place in January and February 2019. Babis also survived a no confidence vote in November due to crisis following the revelation that the prime minister’s son Andrej Babis junior claimed his father kidnapped him and held him captive in the Crimea to prevent him from testifying in the Stork´s Nest corruption case.

In 2019, the Czech Republic will celebrate 30-year anniversary of the Velvet Revolution and 15-year anniversary of its accession to the EU.

World Bank doing business 2019 ranking

The Czech Republic sits 35^th (down by 5 rows y/y) with 76.10 of DTF score, Slovakia 42^nd with 74.90 of DFT core in the new list. In starting business, the Czech Republic is 115^th and Slovakia 127^th. In terms of getting credit, the countries share 44^th place. In terms of paying taxes, the Czech Republic and Slovakia are ranked as 45^th and 48^th, respectively. 

According to the 2017 Corruption Perceptions Index by Transparency International, Czechia was ranked as the 42nd least corrupt nation out of 175 countries. Corruption rank averaged 45.68 from 1996 until 2017, with an all-time high of 57 rank in 2011 and the lowest rank of 25 in 1996. Slovakia is the 54 least corrupt nation out of 175 countries. Its corruption rank averaged 54.20 from 1998 until 2017, the highest rank of 66 in 2011 and a record low of 47 in 1998.

Within the Global Competitiveness Index 4.0 2018 rankings, which measures national competitiveness, the Czech Republic reached the 29^th rank with the score of 71.2, same as in 2017. The Slovakia dropped down by 2, to 41, with 66.8 score.