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Government approves a tax reform to raise extra money to finance repairs of flood damage. GDP growth slows down while unemployment continues growing and inflation remains extremely low. In this week's edition of Economics Report, we have an analyst comment on the latest economic developments.

Government approves package of flood measures

The Czech government has approved a package of measures to raise extra money to finance repair of damage caused by the recent devastating floods. The government hopes to gain an extra 26 billion crowns for the state budget over the next two years. The measures include the introduction of a 35-percent tax on personal incomes exceeding 900,000 crowns annually, and an increase in VAT from 5 to 7 percent on services and selected goods, while the 22 percent VAT levied on most products will be decreased to 21 percent.

Czechs accept higher tax burden

A broad public opinion survey shows that the vast majority of Czechs have accepted the government's decision to increase taxes as a means of covering the cost of the recent floods. The STEM research agency, which conducted an opinion survey on the matter, said that the majority of respondents accepted the additional tax burden as inevitable. Three quarters of Czechs reportedly approve of the government's decision to introduce higher taxes. The agency said that for the present time the government was riding on a wave of solidarity, and the majority of Czechs gave it high marks for performance during and after the floods.

Czech economic performance worsens

Czech GDP growth slowed down in the second quarter of 2002 to 2.5 percent year-on-year, from 2.8 percent in the first quarter. It is the worst result since the third quarter of 2000. In the corresponding period of 2001, Czech GDP grew at a pace of 3.5 percent annually. Experts say the main factor behind the slowdown is weak foreign demand. I spoke to economic analyst Petr Zahradnik about the current development:

"In comparison with most European countries as well as with the United States, the Czech GDP result in the second quarter is not a disappointment. The main factor is the investment activities where it is possible to observe some deceleration in comparison with previous quarters. On the other hand, the household consumption remains relatively very strong, and there is also a visible improvement in net export. I think that the figures both for the second quarter as well as for the first half of 2002 as a whole offer a relatively very good picture of the Czech economy."

If we look forward, do you expect a further slowdown in the third quarter due to the floods for example?

"Yes. I think it is very probable and very realistic. I think that the floods will have a negative impact on GDP growth especially in the short-run, I mean until the end of this year. So, calculating with the impact of the floods, we would be relatively satisfied to see a GDP growth at the end of 2002 at slightly over 2 percent."

Unemployment continues growing

The Czech unemployment rate has been growing for three months and reached 9.4 percent in August. In July, unemployment stood at 9.2 percent. Analysts say the situation has worsened due to inflow of fresh school graduates to the labour market. However, Petr Zahradnik says this is not the only reason:

"For the August development itself, maybe this was the prevailing reason, but for the whole summer period, I think we have seen the impact of first, a very slow demand in the EU, and second, the impact of exchange rate appreciation. These two factors very much influenced short term or medium term business strategies, especially for exporters, and especially for exporters from the group of small and medium-sized companies. So, the seasonal factor of new school graduates plus these factors, connected with exchange rate appreciation and very weak economic performance in Europe contributed to the growth of unemployment rate."

The Social Democrats who were the ruling party in the previous term and now are the dominant partner in the ruling coalition, pledged to fight unemployment but it seems they have not been very successful - the unemployment is getting close to its record high from the beginning of the year 2000 now. What can the government do, what instruments does it have to tackle the problem?

"The main problem of unemployment right now in the Czech Republic is the so-called structural unemployment, and to solve the problem of structural unemployment, of course, takes time. It is almost impossible to solve the cause of this problem in one year, it is rather a task for several government terms. I think right now, the government should accelerate its so-called active employment policy, and also for example at this point to motivate people, including non-qualified people, to participate in the after-floods restructuring and recovery of the economy in the affected areas. I mean in this period, this effective motivation would help decrease the unemployment."

Consumer prices decrease in August

Czech consumer prices decreased in August. According to the Czech Statistical Office, the inflation rate decreased by 0.2 percent in monthly comparison, and remained at a record low of 0.6 percent year-on-year. The slowdown was mainly due lower prices of foodstuffs, clothing and fuels. On the other hand, prices of housing and health products have grown. I asked Mr Zahradnik about the outlook for the next period:

"I think also in he inflation performance, we should predict some negative impact of the floods, but also impacts connected with agricultural production which seems to be not very positive this year. However, I think that the inflation performance in the Czech Republic will remain excellent not only in the rest of this year but also in the beginning of next year, even better than inflation performance for example in EMU or in the United States. I think that the inflation performance is without any important domestic risks. I see only one, unrepeated risk, I mean that connected with the floods. There is another, external risk factor, connected with the oil prices, especially in the light of a potential conflict in Iraq. But the domestic Czech risk factors concerning inflation currently practically do not exist. So, I am very optimistic about the future short-term inflation outlook."

Govt to change terms of investment incentives

The government is considering changing the terms of under which it provides incentives to large investors. The private TV station NOVA quoted Prime Minister Vladimir Spidla as saying that the main impetus for a change was the recent experience with Flextronics, an electronics contract manufacturer with worldwide operations who recently decided to close down its production facility in the Moravian city of Brno and dismiss thousands of workers. Flextronics, the largest investor in Brno, received various investment incentives both from the state and the local authorities, such as an exemption from paying customs duties and the corporate tax, and a subsidy for the creation of new jobs.

Central Bank intervenes against strong crown

The Czech National Bank intervened against the strong crown on Monday, after it dropped below the 30-crown-per-Euro mark for the first time in six weeks. The crown weakened slightly as a result of the intervention but has been hovering just over the psychological level. The crown reached a record high in July of this year selling for 28.85 per Euro, an exchange rate that pleased tourists but was highly disadvantageous for Czech producers. The recent devastating floods weakened the crown temporarily, but it quickly recovered and returned to its former levels.

Czech Statistical Office to resume normal operation in 2 months

The Czech Statistical Office, whose Prague headquarters were flooded last month, may resume standard activity in two months. The office will be operating in an emergency regime until the end of 2003 when a new headquarters should be completed.

The Vltava river flooded two out of three storeys of the Statistical Office's building in Prague's Karlin district, causing damage to equipment and archives amounting to tens of millions of Czech crowns.