Czech Republic. Summary

Transcription

1 Czech Republic Summary Moody s A1 / S&P AA- / Fitch A+ 1 Economy: Agriculture 3%, Industry 37%, Services 60% The Czech Republic has a well-developed, open, and diversified economy, healthy fiscal and external balances, low inflation, one of the lowest unemployment rates in the EU, and comfortable levels of public debt. The current account has been balanced or slightly positive since 2014, and the country has an ample supply of foreign currency reserves, thanks largely to a multi-year policy of successfully preventing an appreciation of the koruna against the euro to combat deflation. The Czech National Bank successfully navigated away from this exchange rate policy in April after inflation began to pick up. Despite meeting all the necessary criteria, the government announced in 2015 that it is unlikely to adopt the euro for several years due to public opposition following the European debt crisis. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 19,935 19,719 17,557 18,239 20,078 24,118 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Bloomberg, Czech National Bank, Czech Statistical Office, IMF 191

2 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency AA A+ A A- BBB+ Local Currency AA- AA AA- A+ A A- BBB BBB Moody s S&P Fitch Moody s S&P Fitch As of December Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Local Yield Czech Republic GBI-EM Global Div As of December Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 192

3 Czech Republic Strengths Economic Diversification The Czech Republic has a well-developed services and manufacturing economy that is highly integrated with the rest of Europe. Manufacturing and services account for 27.1% and 65.4% of economic activity, respectively, with motor vehicle production accounting for a sizable share of manufacturing. 2 The Czech economy is extremely open, with imports and exports of goods and services amounting to 152.8% of GDP. 3 Exports of motor vehicles and other transportation equipment account for 29.4% of total exports; computers, electronics, and electrical equipment account for 17.4% of foreign shipments; and machinery and equipment make up another 11.0%. 4 The Czech Republic s trade links to Germany are particularly strong, with exports to and imports from Germany accounting for 32.2% and 26.0% of the total, respectively, between 2011 and The open economy and strong trade links to Germany leave the Czech Republic vulnerable to a downturn in EU activity. However, domestic demand is another key driver of growth, with household consumption fueled in recent years by rising real wages resulting from low inflation as well as a shortage of skilled labor, which is a common characteristic of many Eastern European countries. Investment has lagged somewhat in the last year, but it is expected to pick up as the pace of EU-funded infrastructure projects accelerates going forward. Policy Credibility The Czech Republic suffered a decline in investment and capital outflows during the global financial crisis in the late 2000s, but the economy emerged relatively unscathed, owing to its low level of public debt, stable banking sector, and minimal foreign currency-denominated debt among Czech households. The economy suffered another downturn during the European debt crisis in 2012 and 2013, but the Czech Republic has registered consistent annual real GDP growth since Economic activity has been supported by prudent economic policies, including adherence to the EU s Maastricht guideline of limiting the fiscal deficit to 3% of GDP. Inflation has been subdued, the external account has registered consistent surpluses, and foreign direct investment has been strong. Moreover, public debt is well below the EU limit of 60% of GDP and is projected to decline over the forecast horizon as steady growth and fiscal discipline further reduce the government s funding needs. The Czech Republic has been a member of the OECD since 1995 and in 2013 became the 26th member of the organization s Development Assistance Committee, which obliges the country to provide development assistance to non-oecd members. Although the country s contribution to development assistance amounts to only 0.12% of GDP, 6 the membership represents an important leadership position in helping developing countries transition to a democratic political system and market economy. The Czech Republic ranks 34 th and 68 th of 209 countries in the World Bank s Rule of Law and Control of Corruption rankings, respectively, and 27 th of 190 countries in the World Bank s Ease of Doing Business ranking. 7 NATO and EU Membership The Czech Republic became a member of NATO in 1999 and was among the first wave of Central and Eastern European countries to join the EU in These affiliations have facilitated the Czech Republic s integration with the broader European community, and the country has benefited from the explicit and implicit military, financial, and political support of these institutions. The Czech economy has also benefited from sizable structural support transfers from the EU over the years. Between 2004 and 2006, the Czech Republic received 2.6 billion of transfers (averaging 0.8% of GDP per year) from the EU to finance 193

4 Lazard Emerging Markets Debt economic and social programs aimed at reducing economic and social disparities between member countries. 8 The EU allocates these funds on a seven-year cycle, and 26.3 billion in transfers (averaging 2.4% of GDP per year) were budgeted for the Czech Republic between 2007 and However, only 21.7 billion, or 83%, of these funds were spent by the end of the programing period in 2015 due to delays in project completion. 9 For the 2014 to 2020 period, an additional 24.2 billion in EU transfers (equal to 2.2% per year, based on 2014 GDP), have been budgeted for the Czech Republic. 10 EU transfers beyond 2020 are more uncertain, since they are scheduled to decline as recipient countries converge to European levels of development. Moreover, Brexit has added to uncertainty about the amount of future structural support funds that will be available. Since joining the EU, the Czech Republic has pursued an alignment of its economic and financial policies with the rest of Europe. Czech GDP per capita amounts to slightly more than 80% of the European average, and the government has met the Maastricht criteria on limiting public debt levels. Moreover, the government s financial position, interest rates, and inflation have converged to European levels, leaving the country well positioned to join the euro area. However, the Czech authorities have been reluctant to take the final step of adopting the euro, citing deflation and high debt levels among some EU members, as well as lax enforcement of fiscal rules and considerable political, economic, and institutional uncertainty in the wake of the Brexit referendum. 11 As a result of these considerations, the Czech government has postponed a decision on the timing for joining the euro area. Weaknesses Large Stock of External Debt Although the Czech Republic s stock of public debt amounts to a relatively low 35% of GDP, the country s public and private external debt burden has spiked to more than 90.0% of GDP from 71.3% at the end of The share of short-term external debt has also risen sharply and now accounts for nearly half the country s total external debt. This acceleration of debt may appear alarming, but long-term external debt largely reflects intercompany loans that tend to be routinely renewed. The increase in short-term external debt reflects inflows from foreign investors anticipating a sharp koruna appreciation once the central bank abandoned its defense of the floor against the euro. Investors either deposited money with Czech banks (increasing the financial institutions short-term debt) or purchased short-term government securities (increasing the government s stock of short-term debt). This large increase in short-term external obligations was offset by a concurrent rise in foreign exchange reserves, leaving the Czech authorities well positioned to handle the unwinding of these trades without any threat to the country s liquidity or solvency. Rising Stock of Household Debt Tight labor market conditions have contributed to rising real wages, strong consumption growth, and rising real estate prices. The strong growth of credit and real estate prices has resulted in rising levels of household debt that the IMF has cited as a potential vulnerability, with household debt rising to more than 66% of seasonally adjusted annualized disposable income by the first quarter of from less than 59% in the first quarter of Unfavorable Demographic Trends The Czech Republic has an aging population and low population growth, which is contributing to a shortage of workers and a decline in productivity. Unlike other Eastern European countries, the Czech Republic limits inward migration, which further exacerbates labor short- 194

5 Czech Republic ages and wage pressures. Moreover, the limited availability of affordable childcare discourages women with young children from joining the labor force. These demographic trends have resulted in a rising dependency ratio and mounting healthcare and pension costs that could pressure public finances over the longer term. 13 Monetary and Exchange-Rate Policy Inflation/Monetary Policy The Czech National Bank (CNB) has been operating under a formal inflation-targeting regime since Besides price stability, the CNB is also in charge of financial market supervision. Interest rates are the main monetary policy toll. CNB currently uses a 2-week repo rate, a deposit facility, and a marginal lending facility. In addition to the vanilla tolls, FX intervention has recently been instrumental for monetary policy setting. In the period between the fourth quarter 2013 and the first quarter when facing the zero bound the CNB set a euro/koruna (EUR-CZK) floor in order to ease monetary conditions. The current inflation target is 2.0% (+/-1.0%); it has been in place since The bank board responsible for the monetary policy meets eight times a year. CNB is an independent central bank since its foundation in The 12-month headline CPI printed at 2.7% in September (the highest figure since 2013). Core inflation also reached a multi-year high at 2.6%. The acceleration of the 12-month inflation rate has raised eyebrows at the CNB as it suggests the economy may be overheating. Most of the acceleration has taken place in services prices. Unemployment is at a record low (4.0%) and nominal wages have accelerated at 7.4% pace. Long-term inflation expectations are well anchored at 2.0%, but the 12-month rate ahead has drifted slightly above 2.0%. We believe inflation may decelerate from current levels towards the 2.0% target by end of The CNB will continue to lead the policy normalization process in Central and Eastern Europe (CEE) and continue to diverge from ECB policy stance. The CNB abandoned the EUR-CZK floor at the end of the first quarter and initiated a hiking cycle in the third quarter of. The 2-week policy rate is currently 0.5%. With the economy growing at potential with inflationary pressures, we expect CNB to lift the 2-week repo towards 1.00% / 1.25% by end of In real terms (defined as the policy rate deflated by the 12-month CPI), the policy rate is at -2.20% (versus -0.95% for the 5-year average). The real policy rate spread compared to the EU is at -0.45% versus 0.12% for the 5-year average. Exchange Rate Policy The koruna is a deliverable managed floating currency. The timeline to adopt the euro has been suspended. There is no capital control in The Czech Republic but the CNB can intervene aggressively in the FX market. Between 2013 and it adopted a peg to the euro in order to ease monetary conditions and fight the risk of deflation. Accordingly, the CNB s international reserves reached $146 billion (as of September ) versus $47 billion at the time of the EUR-CZK floor adoption. The Czech Republic basic balance surplus was 3.9% of GDP (as of August ). Strong FDI inflows have been the main driver behind the surplus. The Czech Republic s current account surplus was at 0.8% of GDP (as of August ) versus 1.6% 12 months ago. Most of the contraction came from the income account (due to relentless reserve accumulation). The country s trade surplus remained strong at 5.1% (previous 12-month sum) with transportation equipment leading the exports receipts. The financial 195

6 Lazard Emerging Markets Debt account saw a sharp increase in portfolio flows ahead of the change in the FX regime. In fact, portfolio flows reached 8% of GDP (previous 12-month sum) and short-term inflows 19%. CNB reserve buying over the past 12 months reached 32.1% of GDP. The EU represents 51% of Czech trade; China 11%; US 4%; and Japan 2%. Following the global financial crisis of 2008, the EUR-CZK reached a high at in February Over the past 12 months it has traded in a range. The koruna real effective exchange rate (REER) is currently in line with its 10-year average. Adjusted by productivity, the koruna looks undervalued by 10% 15% in real terms. Inflation 8 USD/CZK Inflation Policy Rate As of December Source: Bloomberg REER REER Median since Dec 1999 Median last 10 yrs Median last 5 yrs As of December Source: Lazard, JP Morgan 196

7 Czech Republic Country Background Size Capital Population 78,867 KM 2 (117th) Prague 10.7 Million Religion Roman Catholic 10.4%, Protestant 1.1%, None 34.5%, Other 54.0% Median Age 42.1 Years Literacy Rate 99.0% Independence 28 October 1918 Political System Government Leadership Parliamentary Republic Next Election January 2018 Legislative Branch President Milos Zeman; Prime Minister Bohuslav Sobotka Bicameral Parliament Economy Agriculture 2.5%, Industry 37.5%, Services 60.0% Labor Force Agriculture 2.8%, Industry 38.0%, Services 59.2% Merchandise Exports Export Partners Currency As of November Source: CIA Machinery and Transport Equipment, Raw Materials, Fuel, Chemicals Germany 32.4%, Slovakia 8.4%, Poland 5.8%, United Kingdom 5.2%, France 5.2%, Italy 4.3%, Austria 4.2% Czech Koruna (CZK) 197

8 Lazard Emerging Markets Debt Country Timeline 1993 January - Vaclav Havel elected president of the Czech Republic following Czechoslovakia's "velvet divorce". Vaclav Klaus of the Civic Democratic Party (CDP) carries on as prime minister with the privatisation of the public sector as his top priority Klaus reappointed as prime minister in a minority coalition government following the Czech Republic's first general election since independence Klaus government resigns following collapse of coalition amid mounting disquiet over the economic reform programme and allegations of financial corruption. Caretaker administration led by Josef Tosovsky takes over Czech Republic becomes full member of NATO Czechs vote at referendum in favour of going ahead with EU membership in Vladimir Spidla resigns as prime minister. Stanislav Gross is appointed premier. A new coalition government involving the same parties is approved by parliament in August Stanislav Gross resigns as premier following allegations about his financial affairs. Coalition partners agree to form a new government headed by Social Democrat Jiri Paroubek Vaclav Havel dies. A week of mourning is declared. He is given a state funeral, which is attended by many world leaders Senate approves legislation allowing for the Czech president to be elected by popular vote instead of being chosen by parliament Former prime minister Milos Zeman beats conservative Foreign Minister Karel Schwarzenberg in the Czech Republic's first direct presidential elections. Source: BBC Notes 1 As of December. 2 As of December Source: Haver Analytics. 3 As of December Source: Czech National Bank and Lazard. 4 Ibid. 5 Source: The World Bank, World Integrated Trade Solutions, 6 As of Source: Organization for Economic Co-operation and Development, DAC Member Profile: Czech Republic, 7 As of Source: The World Bank, and European Union, European Structural and Investment Funds, , en/fondy-eu/programy KPMG, EU Funds in Central and Eastern Europe, Progress Report , 10 European Commission, European Structural and Investment Funds, Country Data for: Czech Republic, 11 Assessment of the Fulfilment of the Maastricht Convergence Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro Area, Ministry of Finance of the Czech Republic and the Czech National Bank, 14 December 2016, 12 Czech Republic: Article IV Consultation, International Monetary Fund, IMF Country Report No. 17/168, IMF, June, 13 Ibid. 198

9 Important Information Published on 26 February Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of 24 February and are subject to change. Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Specific to the political, religious and military unrest in Iraq, and as described in this paper, there exists a heightened risk of ongoing armed conflict and subsequent economic, political and social repercussions to all parties involved. Specific to the political and military unrest in Ukraine and Russia, and as described in this paper, there exists a heightened risk of ongoing armed conflict and subsequent economic, political and social repercussions to all parties involved. An investment in bonds carries risk. If interest rates rise, bond prices usually decline. The longer a bond s maturity, the greater the impact a change in interest rates can have on its price. If you do not hold a bond until maturity, you may experience a gain or loss when you sell. Bonds also carry the risk of default, which is the risk that the issuer is unable to make further income and principal payments. Other risks, including inflation risk, call risk, and prepayment risk, also apply. High yield securities (also referred to as junk bonds ) inherently have a higher degree of market risk, default risk, and credit risk. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one s home market. The values of these securities may be affected by changes in currency rates, application of a country s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries. This document is provided by Lazard Asset Management LLC or its affiliates ( Lazard ) for informational purposes only. Nothing herein constitutes investment advice or a recommendation relating to any security, commodity, derivative, investment management service or investment product. Investments in securities, derivatives and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard s investment portfolios, in particular alternative investment portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard s local regulatory authorizations. The Lazard entities that have issued this document are listed below, along with important limitations on their authorized activities. Australia: Issued by Lazard Asset Management Pacific Co., ABN , AFS License , Level 39 Gateway, 1 Macquarie Place, Sydney NSW 2000, which is licensed by the Australian Securities and Investments Commission to carry on a financial services business. This document is intended for wholesale investors only. Canada: Issued by Lazard Asset Management (Canada) Inc., 30 Rockefeller Plaza, New York, NY and 130 King Street West, Suite 1800, Toronto, Ontario M5X 1E3, a registered portfolio manager providing services to non-individual permitted clients. Dubai: Issued and approved by Lazard Gulf Limited, Gate Village 1, Level 2, Dubai International Financial Centre, PO Box , Dubai, United Arab Emirates. Registered in Dubai. International Financial Centre Authorised and regulated by the Dubai Financial Services Authority to deal with Professional Clients only. EU Member States: Issued by Lazard Asset Management (Deutschland) GmbH, Neue Mainzer Strasse 75, D Frankfurt am Main. Hong Kong: Issued by Lazard Asset Management (Hong Kong) Limited (AQZ743), One Harbour View Street, Central, Hong Kong. Lazard Asset Management (Hong Kong) Limited is a corporation licensed by the Hong Kong Securities and Futures Commission to conduct Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities only on behalf of professional investors as defined under the Hong Kong Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) and its subsidiary legislation. Korea: Issued by Lazard Korea Asset Management Co. Ltd., 10F Seoul Finance Center, 136 Sejong-daero, Jung-gu, Seoul, People s Republic of China: Issued by Lazard Asset Management. Lazard Asset Management does not carry out business in the P.R.C and is not a licensed investment adviser with the China Securities Regulatory Commission or the China Banking Regulatory Commission. This document is for reference only and for intended recipients only. The information in this document does not constitute any specific investment advice on China capital markets or an offer of securities or investment, tax, legal or other advice or recommendation or, an offer to sell or an invitation to apply for any product or service of Lazard Asset Management. Singapore: Issued by Lazard Asset Management (Singapore) Pte. Ltd., 1 Raffles Place, #15-02 One Raffles Place Tower 1, Singapore Company Registration Number W, which provides services only to institutional investors or accredited investors as defined under the Securities and Futures Act, Chapter 289 of Singapore. United Kingdom: Issued or approved by Lazard Asset Management Ltd., 50 Stratton Street, London W1J 8LL. Registered in England Number Authorised and regulated by the Financial Conduct Authority (FCA), providing services only to persons classified as eligible counterparties or professional clients under the rules of the FCA. United States: Issued by Lazard Asset Management LLC, 30 Rockefeller Plaza, New York, NY