Downgraded: S&P ratings agency sees no short-term Czech political will to carry through on tough reforms


The Czech Republic's sovereign credit rating has been steadily increasing since the 1990s. So when the ratings agency Standard & Poor's late last week moved to take the country down a peg sent the country's economists and politicians into a minor analytic frenzy.

Moving from an 'A+' to an 'A' rating, they were quick to point out, would negatively impact on inward investment at a time when the state budget deficit is in desperate need of trimming. The downgrading could also cost the state hundreds of millions of crowns in higher yields on government bonds and will increase the cost of borrowing money.

So, was it the deficit, the inherent political instability of yet another shaky coalition government, or some other factor that prompted Standard & Poor's to downgrade the Czech Republic's credit crown-denominated credit rating?

Standard & Poor's analyst Beatriz Merino:

"It's a combination of a little bit of everything, and the way things develop. We saw that the fiscal situation in the Czech Republic had deteriorated over the past years and we thought that given the slim majority in Parliament of the new government, even if the government has set ambitious targets to reduce the fiscal deficit, we think it is going to be difficult for the government to pass these measures."

Under the terms of the European Union's "Stability and Growth Pact," governments cannot run a budget deficit greater than 3 per cent of GDP, nor can they have a debt ratio of more than 60 per cent of GDP. Thanks to taking on unusually high "one-off" loan guarantees, the Czech Republic last year posted a 12.9 per cent budget deficit as a percentage of GDP -- the largest of any EU country.

The continued rise of the Czech Republic's debt-to-GDP ratio was a significant factor in Standard & Poor's reassessment, says Ms Merino.

"Basically, in the case of the Czech Republic, the downgrade by one notch means that the probability that the government is going to repay its debts is a little bit lower than it used to be. And that reflects the fact that the debt-to-GDP ratio has been increasing over the past few years, in the case of the Czech Republic. So basically, if you have more debt, they have to make more payments in terms of interest and servicing this debt."

The board of Finance Ministers from the now 25 EU member states, known as Ecofin, in July approved a timetable put forward by the government of Vladimir Spidla to reduce the budget deficit. But the EU warned the Czech Republic against the difficulties posed by its aging population and called on the government to launch urgently needed health care and pension system reforms.

Although the outlook is "stable" it is not particularly rosy: Standard & Poor's sees little chance of the new government coalition of Stanislav Gross pushing through such reforms before the next elections. The agency forecasts that general government debt as a percentage of GDP will hit 41.5 per cent by 2007, up from an estimated 38.3 per cent in 2004.

Analyst Beatriz Merino again:

"The government has announced they are starting to work on the reform proposals, but probably any approval will take place after the 2006 election. As I said, the government has a slim majority in Parliament, it is losing popularity, so it is probably going to be difficult in front of the electorate to call for cuts in social spending and also because there are elections in 2006. And we know, in general, in every country, how difficult it is to try to cut spending ahead of elections."

The governor the Czech National Bank, Zdenek Tuma, said the Standard & Poor's downgrading sent an "unfavourable signal" that the country's public finances were in a poor state.

For its part, the Czech Finance Ministry says the move was unwarranted, as the public budgets have been developing favourably in year-on-year terms. Finance Minister Bohuslav Sobotka has said we would submit proposals next week to the government coalition that would cut the public budget deficit so that the country can meet the EU's Maastricht criteria and adopt the euro in 2010.