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Czech Republic.

Growth is expected to be 4 3/4 per cent in 2005, with an exceptionally large contribution from net exports. For 2006 and 2007 the trade component will fall while domestic demand is expected to strengthen and GDP growth is projected to be 4 1/2 per cent. This will bring inflationary pressure and a slight tightening of monetary policy.

Though growth performance has strengthened since the early years of the decade, better progress in improving the business environment and labour-market efficiency would help reduce downside risks. In fiscal policy, even though there are good prospects of fulfilling the Maastricht criteria, further reform to the financing and provision of public services is needed to reduce the risk of unsustainable public finances in the longer term.

Signs of a pick-up in trade and consumption after a slow first half

Even though export growth slowed considerably in 2005, the contribution of net exports to growth increased because import volume growth slowed even more strongly. The import slowdown in part reflects muted domestic demand, but investment and detailed trade data also suggests that manufacturing activity has broadened and reduced the volume of imported intermediate goods used by producers. Recent monthly data show a pick-up in trade and there was an encouraging increase in domestic-demand growth in the second quarter. In addition, retail sales suggest that consumption is acquiring momentum. While inflation was low in the first half of 2005, partly reflecting falling import prices, it has since increased due to steep rises in transport and administered fuel prices.

Fiscal balances for 2005 have been surprisingly good

Though the Maastricht-defined deficit is expected to increase by one percentage point to 4% of GDP in 2005, this is a better outcome than previously expected. The 3% deficit outcome in 2004 had been helped by the inclusion of the reclassification of a state guarantee worth 0.8 percentage points of GDP and at the beginning of 2005 a deficit outturn of at least 4 1/4 per cent was expected. However, monthly revenue figures over the course of the year have exceeded expectations, notably in excise duty and value-added tax, and the deficit is now expected to be only 4%. Reduction in the government deficit is expected to continue, despite tax cuts in 2006, and the outcome for 2007 is projected to be close to 3 1/4 per cent.

Growth in 2006 and 2007 will remain robust

Growth is expected to fall only marginally in 2006 and 2007 with annual outcomes of 4 1/2 per cent. The projection has export growth rising by close to 13% in 2007 as well as increased import growth. The latter not only reflects export trends, but also strengthening private consumption which will be driven in part by cuts in personal-income tax. Demand pressure is expected to bring upward pressure on inflation. In 2006 this will be exacerbated both by continuing effects from the run-up in oil prices and, to some extent, by housing-rent increases due to legislative changes. These temporary effects will have dissipated by the end of 2006 and inflation will average around 3% in 2007. The monetary response to these inflation developments is not expected to be dramatic, in part because they are temporary but also because, despite the increases, inflation looks set to remain comfortably within the Central Bank's target band of 3+/-1%.


Export growth is uncertain and important reforms are stalling

There is a risk that the fall off in export growth in 2005 reflects something more permanent than base-level effects from the previous year. As regards fiscal policy, the 2006 budget spending exceeds ceilings set by the government's medium-term expenditure framework which was set up only in 2004. Though the budgeted spending does not strongly compromise fiscal goals, the apparent disregard for the ceilings has somewhat damaged the credibility of the expenditure framework. Slow progress on long-intended structural reforms means that downside risks in the growth outlook are larger than they would otherwise be and pose a threat to long-term fiscal sustainability. In particular, though some progress has been made recently regarding pensions, taxation and business legislation, reform of the labour code has been lacklustre, welfare reform has been timid and the government is not intending to embark on major reform of public health care before the general elections which are due to take place in June 2006.
Czech Republic: Demand, output and prices

                                            2002      2003   2004

                                           Current     Percentage
                                           prices       changes,
                                           [euro]       volume
                                           billion   (1995 prices)

Private consumption                        1 234.7     4.6    2.1
Government consumption                       555.2     3.8   -2.0
Gross fixed capital formation                643.3     4.7    7.6
Final domestic demand                      2 433.3     4.5    2.6
  Stockbuilding (1)                           30.9    -1.1    0.1
Total domestic demand                      2 464.1     3.5    2.6

Exports of goods and services              1 485.5     7.5   21.9
Imports of goods and services              1 535.0     7.9   18.4
  Net exports (1)                            -49.5    -1.3    0.4

GDP at market prices                       2 414.7     3.2    4.4
GDP deflator                                 --        2.6    3.0

Memorandum items
Consumer price index                         --       -0.1    2.8
Private consumption deflator                 --        1.8    2.7
Unemployment rate                            --        7.8    8.3
General government financial balance (2)     --      -12.4   -3.0
Current account balance (2)                  --       -6.3   -5.2

                                           2005   2006   2007

                                             changes, volume
                                              (1995 prices)

Private consumption                         2.0    3.4    4.2
Government consumption                     -0.5    0.5    0.6
Gross fixed capital formation               3.4    6.0    6.0
Final domestic demand                       1.8    3.5    3.9
  Stockbuilding (1)                        -1.1    0.0    0.0
Total domestic demand                       0.8    3.8    3.9

Exports of goods and services               8.5   11.2   12.8
Imports of goods and services               2.9   10.4   12.3
  Net exports (1)                           5.1    0.1   -0.3

GDP at market prices                        4.8    4.5    4.5
GDP deflator                                0.3    2.9    2.8

Memorandum items
Consumer price index                        1.9    2.8    3.0
Private consumption deflator                1.4    2.4    3.0
Unemployment rate                           8.0    7.8    7.6
General government financial balance (2)   -4.0   -3.6   -3.2
Current account balance (2)                -4.0   -2.8   -2.1

Note: National accounts are based on official chain-linked data.
This introduces a discrepancy in the identity between
real demand components and GDP. For further details
see OECD Economic Outlook Sources and Methods,

(1.) Contributions to changes in real GDP (percentage of
real GDP in previous year), actual amount in the first column.

(2.) As a percentage of GDP.

(3.) Since the change in methodology in 2004, high-risk state
guarantees are classified as capital transfers as soon as they are
called for the first time. In 2003, the activation of guarantees
issued mainly for the banking sector accounted for about
7.7 percentage points of the deficit.

Source: OECD Economic Outlook 78 database.

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Publication:OECD Economic Outlook
Date:Dec 1, 2005
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