What's next for the Czech economy? A leading economist's outlook for the future

Expats.cz spoke to Czech economist Lukáš Kovanda about the state of the Czech economy and forecasts for next year.

William Nattrass

Written by William Nattrass Published on 22.11.2022 15:35:00 (updated on 22.11.2022) Reading time: 6 minutes

The European economy is facing hard times. Estimates published by the European Commission suggest that the EU as a whole is heading into a recession, with growth forecasts for next year slashed.

Czechia remains particularly exposed to disruption in the energy sector and has already seen high inflation and rapid interest rate increases. Finance Minister Zbyněk Stanjura said the country is already in a “mild recession,” with the economy shrinking 0.4 percent in the third quarter of 2022.

On the other hand, the latest Czech inflation data paints a more optimistic picture, with overall inflation slowing down to 15.1 percent in October. Expats.cz spoke to Lukáš Kovanda, Chief Economist at Trinity Bank, to find out how worried we should be about the latest developments.

The latest inflation data seems to be positive, suggesting that price increases are finally slowing down. What’s your interpretation of this news?

The new inflation data is, in a sense, artificial. There’s no way that we should take this data as confirmation of a decrease in inflationary pressures. We still have inflation like before, and without statistical changes by the Czech Statistical Office, we’d probably have inflation as high as 18.6 percent, above the previous September high of 18 percent.

Government measures to lower prices for energy, and the fact that people are no longer obliged to pay a special tax for renewables, meant the prices of electricity and gas went down. But this isn’t because they were actually cheaper; it’s just because part of the price is now being paid by the government.

This, really, is artificial. But it’s more positive to present lower inflation, for both the government and the public. I think this is an illusion, and it may even be a dangerous one.

The EU as a whole is heading for a recession, and the Czech Republic is already in one. What’s your outlook for the coming months?

We are currently in a technical recession, meaning two quarters of negative GDP growth. But this recession is not having a devastating impact on the labor market, which is why we call it a “technical” one.

But next year, we may see more lay-offs and a slightly higher unemployment rate. It will be a difficult year for some. Companies will face higher costs and worsening demand for their products due to lower real incomes. Still, our unemployment rate should remain among the lowest in the EU, if not the lowest.

The government has introduced measures to combat inflation, including caps on gas and electricity prices. But I don’t yet see similar measures to help large industrial companies; this part of our economy is very important, but it still doesn’t have a solution to cope with high energy prices.

Some large companies have already warned that they may move away from Czechia next year, and Europe as a whole faces the danger of becoming less competitive for industry compared to other parts of the world. A recent unilateral move by Germany to cap energy prices much more generously will make the situation worse for Czechia in this regard. On the other hand, Germany’s energy aid package may help Czech companies that supply German industry and depend on good economic conditions there.

Do you expect interest rates to remain the same, or even go down, in light of the lower supposed level of overall inflation?

I think the Czech National Bank (CNB) will stick with its current 7 percent base rate. Next year, we may see a cut in rates, but only a small one and probably in the second half of the year. By the end of next year, it wouldn’t surprise me if we have a rate of 5.5 percent.

Inflationary pressures will still be there, especially compared to “normal times” before the pandemic and the war in Ukraine. This will prevent a more significant reduction in interest rates, which I think we’ll only see in 2024.

As well as high interest rates, I expect the CNB to continue its policy of intervening on the foreign exchange market to stabilize and strengthen the Czech crown against the euro. This is another way to fight inflation because it lowers the prices of imports, meaning everything imported into the country, such as oil, gas, and other products, becomes cheaper.

What’s your reaction to the government’s budget for 2023, with a deficit of CZK 295 billion?

The government is not keeping its promises. The coalition parties promised before the election and in the early months of this year to significantly reduce our deficit and the public debt. However, because of the war and the high prices of gas and electricity, they say they cannot do this.

That’s true to some extent, but I also think they are using these factors as an excuse not to take serious steps to put the public finances in order. The government needs to be more ambitious, but we don’t see this coming next year, or even in 2024 or 2025.

This is a problem, but it won’t bring about an economic crisis. Our public debt will still be among the lowest in the EU. International investors will continue to view us positively, even though some commentators like to suggest that we will go bankrupt. Such suggestions are nonsense.

Do you think tax rates may eventually have to rise to increase state revenues, given these economic difficulties?

The debate about the possibility of increasing taxes is becoming more and more intense. Just a few days ago, the deputy prime minister said the government will probably revise its program statement to include new targets, and I think this may concern taxes.

The government’s current position is that it won’t change tax rates. But this government will probably have to increase some taxes at some point, possibly including personal income tax.

This tax was dramatically reduced in 2020 by the ANO leadership together with the Civic Democratic Party (ODS), which is now the largest party in the current government.

That reduction cost the budget around CZK 100 billion, so it’s a major factor in the current state of the public finances. I can imagine a push to return this tax rate some way towards where it was back in 2020, and this may be a solution to help cope with our growing debt.

But as the ODS helped reduce this tax rate two years ago, and as many ODS voters want lower taxes, such a move would be a political defeat for them.

Finally, are you optimistic or pessimistic regarding the future development of consumer prices?

Regarding energy, I’m quite optimistic, because the current situation is more positive than experts feared in the summer. This is owing to mild weather and the fact that gas storages around the EU are full.

Companies and households have also been effective in reducing their consumption, and the EU as a whole has been able to create new infrastructure to get gas from sources other than Russia.

We can already see this in the declining prices of gas. If this trend continues, we may manage without any serious disruption to industry throughout the EU, which would help prevent a more serious recession. This would in turn prevent major increases in unemployment.

So I’m actually more positive than I was a couple of months ago. Next year, overall inflation will go down too, although it will remain elevated. This also gives us some cause for optimism.

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