The Czech Republic Future challenges and possible risks

The Czech Republic: Future challenges and possible risks Miroslav Singer Vice-Governor, Czech National Bank OECD, Seminar “ 20 Years After” Paris, 20 November 2009 M. Singer -– Czech Present Republic: Conditions, Staying Future Monetary challenges Ahead Policy of the and Curve opportunities Outlook with Regard inview Czech tothe Republic Monetary Policy M. The Financial economic Crisis: and Impacts Likely financial Impacts on crisis the on CR from the and CR the Lessons and point Lessons of for theand for Supervisors of Czech Supervisors M. Singer: Present Consumer Conditions, protection Monetary in financial Policy services: Outlook CNBbanks approach for CR

Contents • Economic performance of Czech economy during crisis • CNB forecast • Challenges and possible risks M. Singer – Czech Republic: Future challenges and opportunities

GDP growth: q-o-q Source: CZSO Technically, the recession stopped in 2009 Q 2 M. Singer – Czech Republic: Future challenges and opportunities

Cumulative GDP q-o-q growth: 3 Q 2008 -2 Q 2009 (not seasonally adjusted) Source: Eurostat, own computation The cumulative q-o-q GDP decline in the Czech Republic was comparable with the EU-27 average M. Singer – Czech Republic: Future challenges and opportunities

Manufacturing Source: CZSO The decline in manufacturing output seems to have bottomed out in mid-2009 M. Singer – Czech Republic: Future challenges and opportunities

Exports, imports and trade balance (annual percentage changes; percentage points; constant prices; seasonally adjusted data) Source: CZSO The decline in total foreign trade turnover was still marked in 2009 Q 2 M. Singer – Czech Republic: Future challenges and opportunities

Inflation (y-o-y in %) Source: CZSO Annual inflation fell towards zero in 2009 Q 3 M. Singer – Czech Republic: Future challenges and opportunities

CZK/EUR (1 Jan 2007 -17 Nov 2009) Source: Eurostat After appreciating in July 2008 and depreciating in February 2009, the koruna has returned to its previous trend M. Singer – Czech Republic: Future challenges and opportunities

CNB’s key rates Source: CNB To deal with the strong disinflationary pressures, the CNB has lowered its interest rates to a record low M. Singer – Czech Republic: Future challenges and opportunities

State budget balance Source: Ministry of Finance Note: GFS 1986 The economic crisis and earlier fiscal measures are reflected in a deteriorating state budget balance (vs. surpluses in 2007 and 2008) M. Singer – Czech Republic: Future challenges and opportunities

Loans to non-financial corporations and households (y-o-y change in %) Source: CNB Loans to non-financial corporations declined year on year for the first time since 2005 M. Singer – Czech Republic: Future challenges and opportunities

Newly extended loans (y-o-y change in %) Source: CNB New loans to non-financial corporations and households decreased M. Singer – Czech Republic: Future challenges and opportunities

Non-performing loans (% of total loans in segment) Source: CNB Non-performing loan ratios rose most significantly in non-financial corporations M. Singer – Czech Republic: Future challenges and opportunities

Summary • Financial and economic crisis was imported into Czech Republic • Czech economy was slightly overheated before crisis, but generally at macroeconomic equilibrium (low inflation, anchored expectations) • Monetary-policy and macroeconomic framework (inflation targeting and managed float) provided economy with necessary adjustment mechanisms own currency proved to be advantage in crisis • Main cause of vulnerability of economy: high export dependence • Domestic banking sector was in good condition before crisis: banks were well capitalised and profitable (negligible share of toxic assets) • Financial sector did not amplify impacts of crisis on economy and will not be source of major risks going forward • Stress tests: strong resilience, profitability, sufficient capital adequacy The Czech economy is currently coping with the crisis better than many other advanced European countries M. Singer – Czech Republic: Future challenges and opportunities

CNB Forecast (November 2009) M. Singer – Czech Republic: Future challenges and opportunities

GDP growth forecast (annual percentage changes; seasonally adjusted) Source: CNB After a decline in economic activity this year a moderate recovery will take place in late 2009 and early 2010 M. Singer – Czech Republic: Future challenges and opportunities

Headline inflation forecast (annual percentage changes) Source: CNB At the monetary policy horizon, the headline inflation forecast is slightly above the inflation target M. Singer – Czech Republic: Future challenges and opportunities

Main uncertainties in short run • What will course and intensity of recovery look like internationally and in Czech Republic’s major trading partners? W-shaped? • How strong are disinflation pressures (external inflation, nominal wages, domestic demand)? • How will Czech public finances develop in 2010 and 2011? • How will koruna exchange rate develop? • How effective is monetary policy transmission mechanism? Huge uncertainty still surrounds economic developments and monetary policy-making going forward M. Singer – Czech Republic: Future challenges and opportunities

Challenges and possible risks • Domestic: Fiscal policy • External: u u Protracted and painful recovery in Europe Hasty supervision and regulation changes M. Singer – Czech Republic: Future challenges and opportunities

Long-neglected fiscal problems • High share of mandatory or quasi-mandatory expenditures in total expenditures (above 70%) • No pension reform or healthcare reform (ageing!) • Lack of transparency in budgetary process • Atomisation of public budgets • Lack of audit of state funds Despite significant steps approved recently by parliament, the fiscal area represents the most serious macroeconomic risk going forward (persisting deficits even in good times and rapid growth in debt) M. Singer – Czech Republic: Future challenges and opportunities

Public finance deficits Note: ESA 95 Source: CNB computation, November 2009 forecast Public finance deficits will fluctuate between 5% and 6% of GDP over the next few years M. Singer – Czech Republic: Future challenges and opportunities

Public debt (as % of GDP) Source: CNB computation, November forecast After a period of stability public debt is expected to grow rapidly after 2008 M. Singer – Czech Republic: Future challenges and opportunities

GDP (2000 = 100) Source: Eurostat The longer term danger for Europe is still its too sluggish growth M. Singer – Czech Republic: Future challenges and opportunities 23

Current problems in financial market supervision • Planned European Systemic Risk Board at ECB and European financial supervision system may blur division of labour among existing supervisory authorities • Instead of precisely defining and identifying causes of crisis, illusion being created that more supranational supervision and regulation is guarantee against future repetition of crisis • Risk: if supervision is distanced from national level, current unsatisfactory state of affairs will deteriorate even further • Other topical issues put on back burner (cost-sharing) • Overregulation of the sector may further decrease the EU‘s growth potential. The past problems of Czech banks impacted “fairly” on Czech taxpayers, but in the future external problems might impact on them through no fault of their own! M. Singer – Czech Republic: Future challenges and opportunities

Five violated principles – what the current plans neglect/worsen 1. Uncertainty is fundamental (diversifying supervisory/regulatory policies reduces risks arising from fundamental uncertainty) 2. Positive motivation (eliminated value of banking licences for shareholders and profitability of traditional areas of banking) 3. Unpredictable response (regulated/supervised entities always react [rather] differently than reformers intend) 4. Communication of costs (costs often not even discussed at expert level, never mind communicated by politicians to voters) 5. Manageable number of institutions (any unification, or even just improvement of coordination, of supervisory/regulatory institutions at European level requires progress with integration of 80 or so institutions at national level) M. Singer – Czech Republic: Future challenges and opportunities

Conclusions • Risk of long-term fiscal “inaction” (structural deficit) currently being compounded by economic decline (cyclical deficit) and potentially by political stalemate in future • Due to high export intensity of the Czech economy a sluggish recovery in Europe will impose an impediment on domestic recovery • Hasty changes in financial market regulation and supervision may present future risks to financial stability of Czech economy (any mistakes in globalised supervision could be far-reaching and could even trigger new crisis) or to the growth in Europe. While the fiscal risk is domestic (and therefore influenceable), the risks of pan-European supervision are external (and therefore hard to influence) M. Singer – Czech Republic: Future challenges and opportunities

Thank you Miroslav Singer Miroslav. Singer@cnb. cz Tel: +421 224 412 008 Česká národní banka Na příkopě 28 115 03 Praha 1 M. Singer – Czech Republic: Future challenges and opportunities