Economy in focus: Czechia

Stable – both politically and economically – Czechia nevertheless faces the prospect of little or no growth in 2023. 

Czechia has long been emerging Europe’s golden child, an example of how a country can successfully carry out the transition from a planned to a free market economy with only a few minor hiccups along the way. 

In many ways, it is the country that (almost) everywhere else in emerging Europe aspires to become. Indeed, so successful has its transition been that many a Czech will privately grumble that their country should no longer be considered a part of what we call emerging Europe. “This is no emerging market,” says one Czech diplomat. 

The country’s headline numbers are certainly impressive. Since a delayed transformational recession in 1997, following the country’s failure to complete structural reforms in the mid-1990s, steady growth has been interrupted only by the global economic crisis of 2008 and the Covid-19 pandemic. GDP fell by 5.5 per cent in 2020, but recovered well in 2021 (3.5 per cent) and 2022 (2.4 per cent). 

The country has managed to avoid an exodus of its citizens: the population grew from 10.3 million in 1995 to 10.7 million in 2020. Czechia is an open economy: around 88 per cent of Czech exports go to other EU member states; of this, 32 per cent is exported to its largest trading partner, Germany. The United States is Czechia’s largest non-EU export destination. 

GDP per capita, at around 25,000 euros, is – Slovenia aside – significantly higher than any other country in emerging Europe, while according to Eurostat, just 10.7 per cent of the population were at risk of poverty or social exclusion in 2021, the lowest figure for any country in the EU. 

According to Fitch Ratings, the mostly foreign-owned banking sector is well-capitalised, with strong asset quality (in 2021, it had a non-performing loan ratio of 2.4 per cent). Exposure to Russia, Ukraine, and Belarus is minimal (less than two per cent of assets).  

Although obliged at some stage in the future to adopt the euro, Czechia is in no hurry to do so. The country’s prime minister, Petr Fiala, said late last year that it would not happen during the lifetime of his government and that “it is not realistic at the moment”. 

The year ahead 

At the beginning of 2023, the Czech economy continues to face strong pressure from high borrowing costs and double-digit inflation, although a slowdown in price growth appears to be around the corner, says Zuzana Zavarska, an economist specialising in Czechia at the Vienna Institute of International Economic Studies (wiiw). 

“The deterioration in real wages is taking its toll on household consumption; this, combined with gross fixed capital formation, will act as the main drag on growth in 2023,” she adds. “By contrast, industry is coping better than expected with the headwinds: the automotive sector is particularly strong and is contributing positively to Czechia’s exports.” 

This is good news: the automotive industry is crucial for the Czech economy, accounting for around ten per cent of GDP, and a quarter of all exports.  

According to the country’s Automotive Industry Association (AutoSAP), Czech car production grew by 10.2 per cent to 1.22 million vehicles in 2022 despite challenges from chip shortages, supply chain snags and soaring energy prices. 

“We have to prepare for ongoing volatility and swings in 2023,” says AutoSAP President Martin Jahn. “But I believe the outages will be of a short-term character and overall we will continue to raise production back to pre-crisis levels.” 

Increasing exports from other sectors of the economy (of which the services sector, at over 60 per cent, is the largest) will be crucial to boosting further growth. The IT sector offers plenty of scope: the sector accounted for just over two per cent of exports in 2021, although the percentage has been steadily increasing since 2016.  

In the latest Emerging Europe IT Competitiveness Index, Czechia ranked third in the region (behind Estonia and Poland) thanks to its favourable business climate, and its strong start-up ecosystem. 

For the wider economy, Zavarska believes that many of the challenges from 2022 will nevertheless carry over into the first half of this year. Consequently, the Czech economy is expected to report close to no growth (0.4 per cent) in 2023, followed by a modest rebound (2.4 per cent) in 2024.  

The impact of Russia’s war on Ukraine 

The Czech economy relied heavily on energy imports from Russia prior to Moscow’s invasion of Ukraine, with virtually all gas originating from Russia. This left the country scrambling for alternative suppliers.  

Remarkably, the government pulled it off. By the end of 2022, the country had reduced its Russian gas dependency from 97 per cent to just four per cent. The country replaced its Russian gas with imports from Norway and overseas LNG, which are distributed to the country through a terminal in the Netherlands.

“We were almost 100 per cent dependent on Russian gas and today the situation is completely different,” Fiala said last week. “We were able to get rid of our dependence on Russia very quickly.” 

Half of Czechia’s oil still comes from Russia, however, and the country still needs to find a new supplier of raw materials for its two nuclear power plants. Long term, it is one of several governments in the region looking at deploying small nuclear reactor (SMR) technology.

Fiala’s government introduced measures to cushion the impact of higher energy prices, including income support to households and SMEs, price caps on energy, and temporary cuts in excise taxes on fuels, partly financed by a newly introduced tax on excess profits of energy producers, traders and banks.

These have recently been extended, says Zavarska. 

“In the wake of pressure from firms struggling with soaring energy prices, the government has extended its support package to cover large enterprises (alongside SMEs and households); this will limit the scope for fiscal consolidation. Inflation will return to the Czech National Bank’s target range only in 2024. The policy rate will most likely remain stable at seven per cent over the coming months, before gradually decreasing towards the end of the year.” 

Czechia has witnessed a large inflow of Ukrainian refugees. According to the United Nations High Commission for Refugees, at end-October, around 455,000 refugees were recorded in the country, which is the highest ratio of all receiving countries and equivalent to 4.3 per cent of the total population. 

While the provision of basic services and cash transfers add to fiscal costs, around a third of refugees of working age were employed as of late August 2022, according to the Organisation for Economic Co-operation and Development (OECD), easing slightly the tightness of the labour market and reducing reliance on government aid. 

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The political context 

The victory of Petr Pavel – former NATO general – over the populist former prime minister, Andrej Babiš, in the Czech presidential election last month carries huge domestic and international significance, says Dominik Istrate, lead analyst for Central and Eastern Europe Aretera Public Affairs.  

While the role of the head of state in Czechia is a largely ceremonial position, the incoming president, given his strong Euro-Atlantic orientation and firm support to Ukraine (and also Taiwan), can very well play an outsize role in international politics, particularly when it comes to maintaining European support towards Kyiv as Russia’s war continues and supporting Ukraine’s integration into the Euro-Atlantic community. 

“His victory is also an indirect boost to political stability in the country,” adds Istrate. “Pavel was among the three presidential candidates endorsed by the centre-right SPOLU alliance, which includes three of the five ruling parties behind the Fiala government. The political proximity of the president-elect to the Czech political mainstream also indicates improving relations between the president’s office and the government – a sharp difference compared to the ties outgoing President Miloš Zeman had to Fiala’s cabinet.” 

Overall, concludes Istrate, Czechia – despite being run by an ideologically diverse, five-party government – belongs to the politically more stable countries in CEE, particularly in comparison with some other regional countries such as Slovakia and Bulgaria, both of which are heading for snap elections later this year.  

“Pavel’s election as president is an indirect contributor to stability in the short-term,” he adds. “However, going into 2023, the Fiala government will continue to face domestic political challenges as the economic climate is likely to worsen.” 

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