All eyes on low crown exit scenario for 2017

Иллюстративное фото: Матей Скалицки, Чешское радио

The coming 12 months look fairly positive for the Czech economy with growth still expected to be strong and some room seen for unemployment to slide even further. But the big headline event for 2017 is likely to be the exit from the low crown regime that’s been in place for just over three years now. The move itself and the way it is handled will have a major impact on trade, investment, growth and jobs.

Jan Bureš, photo: Tomáš Adamec
Looking forward to this major test for the Czech National Bank, we spoke with Jan Bureš, the chief economist at Poštovní Spořitelna, and asked him when he saw the ceiling on the crown’s appreciation against the euro being lifted.

“I believe that the exit from the intervention regime should happen around the middle of 2017. My personal opinion is around the third quarter at a time when the Czech National Bank is sure that inflation is above target and is going to stay there for the foreseeable future. Maybe inflation could get beyond the target even earlier, I guess it could happen even at the end of the first quarter but the Czech National Bank might be willing to wait a little bit longer to make sure the inflation rate is stabilised above the intervention level. “

A lot of inflation is imported, for example through energy prices, is it really clear that the inflation rate will reach 2.0 percent by the middle or end of 2017?

“Most of the increase of consumer prices is going to happen due to the fading out of the effect of low oil prices and low food prices, that’s right. It is going to be mostly imported. But what the Czech National Bank is also going to see is also a moderate rise in core inflation due to growing wage pressures in the Czech economy. And if that is the case, I think it’s going to be an argument not for a dramatic shift in monetary policy with regards to severe tightening but for a step back from the extremely loose monetary policy that we have had here for the last three years.”

“I believe that the exit from the intervention regime should happen around the middle of 2017.”

And do you see a lot of pressure on the Czech National Bank ahead of the exit…a lot of pressure for intervention? I presume a lot of ordinary people will selling euros buying crowns and maybe even taking out loans in euros because they will not have to pay back so much. Will the pressure be a big problem for the central bank?

“So far we have seen some pressure on the market over the last two years. From time to time we have seen a growing inflow of foreign capital onto the Czech market. Some of the players are starting to bet on the exchange rate of the koruna and the gains after the intervention regime is abolished. On the other hand, we do not see from the statistics a significant rise in the hedging of open foreign currency exposure on the side of Czech exporters, which is quite surprising. Maybe the Czech exporters might not be using traditional tools to hedge against themselves against foreign currency risks, such as FX derivatives. Maybe some of the players are just hedging naturally by balance sheets, for example by taking out loans in euros or paying for inputs in euros as well. So that kind of natural hedge might be in place here as well. That might explain the low hedging outcomes in the surveys of exporters.”

Photo: Matěj Skalický
By the end of this year would you hazard any level for the crown against the euro after it has come out of the weak crown regime. Would you say 26, 25.50, how strong can it get?

“It’s very difficult to estimate a fundamental exchange rate and it’s questionable whether there is anything like a fundamental exchange rate. If we do our best, the Koruna could be around 25 crowns per euro if there were no interventions now. On the other hand, at the end of 2017 we do not believe that the Czech National Bank is prepared to allow the crown to appreciate that much and therefore my best guess is that the koruna around 26 crowns per euro. I believe the Czech National Bank will stay on the market and defend the crown against more significant gains.”

Turning away from the crown, maybe we can look at unemployment. The Czech level is very low around 5 percent. Do you think there is room for it to come down some more or are we reaching a level where many of the unemployed in the workforce are difficult to place without extra training? Are we reaching the bottom level of unemployment in the country?

“My estimate is of 5 percent to 6 percent wage growth year on year at the end of 2017.”

“I think it can go down a bit more in the next year but only slightly. As you mentioned, we are very close to record lows in unemployment. What we may see are growing wage pressures in the market and more significant flows in the labour market as the labour force might be more confident in changing their positions. That is quite typical for an over heating economy when the labour force changes jobs quite often and usually leads to wages increases which I believe will happen at the end of the next year. I guess we could see a more significant acceleration of wage growth, my estimate is of 5 percent to 6 percent wage growth year on year at the end of 2017.”

These are comparatively quite high figures, but a lot of the Czech economy has sectors which are doing quite well but many of them aren’t. That was highlighted recently in a government report which showed that many of the export areas, such as cars, are doing well but many domestic ones are not?

Photo: Miloš Turek
“It’s true that some of the sectors are doing better and some worse, but overall the economy is in pretty good shape. You are right that for some of the sectors it might not be acceptable but for some sectors it’s going to be okay to increase wages. There is on average scope to increase wages in the Czech Republic. There might be a structural change in the Czech economy and the companies that rely on cheap labour primarily could have problems. That is, I believe, from the Czech point of view a quite natural process as in the mid-term we are seeking to become a more expensive economy relying more on the companies that are creating more value added here and are more able to distribute on earnings and salaries.”

This last year will probably be a record year for Czech exports, do you see that continuing this year? Part of it is based on the low crown so if this gets higher it could be a brake?

“I believe that Czech exports are going to perform well as the most significant parameter that influences exports is foreign demand and I believe that foreign demand from the euro zone is going to remain pretty strong. What we may see is slower contribution or even a negative contribution to GDP growth. That would not be because of a significant slowdown in export growth but because of faster growth in imports due to faster domestic demand and therefore net exports could become a negative contributor.”

“And I believe that foreign demand from the euro zone is going to remain pretty strong.”

And the domestic economy, this last year has seen a bit of a slowdown in state investments in various projects and EU funds were not so high. This year is an election year, do you expect more of a slowdown?

“I think that there will be slightly higher public investment than last year, also private investment can be higher. Household consumption is going to contribute more than this year. Besides an increased investment in general public expenditure, I think there is going to be an increase, but only moderate so far, driver by higher subsidies to households with children. So there might be a minor contribution through that channel but I would not consider it to be a decisive factor for the state of the economy in 2017.”