Czech economy in 2004: an outlook

Vladimir Pikora

The year 2003 saw Czech economic development gradually accelerate, mainly due to growth of household consumption, propelled by real wage growth and virtually non-existent inflation. Interest rates also hit rock bottom. However, unemployment reached a record high. 2003 was also a year of hot debate over much-needed public finance reforms. Finally approved before the end of the year, the first package of measures aimed at curbing the worrying public finance deficit came into force as of January 1, 2004. This year, the Czech Republic also joins the European Union and its single market, which will mean new opportunities as well as tougher competition for Czech companies. I spoke to economic analyst Vladimir Pikora of the Prague branch of Volksbank about economic developments expected in 2004.

Vladimir Pikora
"In 2004, we expect a slight improvement. The GDP should accelerate towards 3.1 percent and the main engine of the economy will remain household consumption as well as investments. Investments saw a change in 2003. At the beginning, we saw a slowdown. However, in the third quarter, investments started to increase due to record low interest rates. Besides that, we also saw a very strong household consumption which was supported by very fast real wage growth together with an increase of consumer credits. The Czech society has been changing slowly and now, there is no fear of debts. People therefore start to take consumer loans and buy almost everything with them, which is a very significant change of psychological approach in the Czech society."

Does it testify to a strong consumer confidence?

"Consumer confidence, which is measured by the Czech Statistical Office, is not very high right now. So, there is a mismatch between the confidence and the retail sales or consumption. The consumer sentiment is not so good due to expectation of high unemployment in January 2004 and also due to some worries in relation to the EU accession."

But how is it possible then that people take so much credit if they expect high unemployment and worsening of the situation?

"That's something new in the Czech society and we think that many people do not realise the danger of taking credit. Many people do not realise that in the future, they could lose their job and have difficulty repaying their debts. This also worries the central bank, because Czech authorities can see this threat that many households are not used to consumer credits and do not realise all the threats. That is why it was clear some time ago already that there would be no further interest rate cut, because it could further increase the amount of credits. Nevertheless, the inflation forecast shows that it is very unlikely that the interest rates would go down. It is much more likely that the interest rates will increase at the end of 2004."

A year ago, in January 2003, the unemployment rate reached a record high of 10.2 percent. Then it hovered between 9 and 10 percent. What developments more specifically can we expect this year?

"We expect that the unemployment rate will reach a peak in January 2004 at 10.7 percent, which will be a new record high. It will be caused by several factors. The economy is still weak. Although it has started improving, it has been only for a short time. Another factor is that many companies started a restructuring process and are laying off workers in an effort to reduce the costs. This process should intensify mainly in January. Besides that, many termed contracts expire in January. We therefore expect the unemployment to rocket. However, in the next month, it should slightly improve as new seasonal jobs will appear to reduce the unemployment rate to 9.5 percent. At the end of the year, though, it will slightly increase again. We expect the year 2004 to be the worst for the labour market since the Velvet Revolution in 1989. We consider troubles of the labour market to be very serious - as serious as the fiscal reforms and the government should pay more attention to it."

Moving on, some 80 percent of Czech exports go to the European Union, how we can expect the foreign trade to develop this year?

"The Czech foreign trade has improved very significantly. While in 2001, the rolling 12-month gap hovered around 130 billion crowns, now it is only slightly below 70 billion. We saw an acceleration of both exports and imports, which could be connected with the slow recovery of the European Union and mainly Germany. In 2004, we expect the foreign trade to improve further. The main engine of this improvement should be mainly the EU recovery as we expect a stronger demand for Czech goods abroad. However, we will see also larger imports of capital, technologies, and machinery, which will increase the capacity of the Czech economy in the future as many companies expect an acceleration of the European Union and higher demand. That is why the improvement of the trade balance will not be so big due to these imports. We expect that full-year deficit to hover around 60 billion crowns. We can therefore say that foreign trade deficit means no problem for the Czech Republic at the moment."

In 2003, for the first time in history, we experienced deflation, or a long period of deflation. However, as of January 1, some indirect taxes increased, which will certainly translate into a price hike and acceleration of inflation. Can you comment on that?

"The deflation was caused by several factors. The first factor was that food prices were declining for a long period. Another factor was that we felt the impact of a strong Czech crowns versus Euro and we imported deflation from abroad. Besides that, we saw strong competition among retailers who tried to cut prices as much as possible. Those were the reasons for deflation. Nevertheless, the deflation is over and this year, inflation should accelerate due to the increase in indirect taxes. The tax hike takes place in two waves: the first one was in January, the other will occur in May. Both of them will mean a significant jump of inflation upwards. However, the economy is healthy now and the impact of the tax hike will not be as significant as many would think. The inflation rate should increase only to 3 - 3.5 percent in the middle of 2004, returning to the Czech National Bank's inflation target. The level of 3 percent is common in Western Europe and other developed countries. There is really no need to worry about inflation. Besides the changes of the VAT and other indirect taxes, the main motor of inflation will be food prices because they have started to grow last summer because of poor harvest, which triggered the price growth. This trend will continue until May or June. Until then, the prices will keep growing. However, in January and May, the taxes will play a much more significant role. In February and March, the food prices will drive inflation upwards, however."