IMF cautions Czechs against lax fiscal discipline, mulls exit options from low crown
The Czech Republic has just been through its annual economic monitoring session with the International Monetary Fund (IMF). Basically, the international watchdog on economic good housekeeping and prudence, often accused of pushing an overly free market agenda, looks over the books and government performance over the last 12 months. The IMF published its findings after talking them over with the government.
But the IMF does warn against the government weakening its spending vigilance through tax cuts or higher expenditure as parliamentary elections loom in 2017. It specifically cautions against higher wage rises in the public sector beyond those already promised or more generous pension payments unless new financing for pensions or higher retirement ages are pushed through. And it also warns against another give away through lower VAT rates.
And the watchdog also regrets the fact that the Czech authorities have still to come up with a permanent mechanism for curbing fiscal deficits – a so called brake. That’s a measure on which the three government parties need to recruit support from the opposition in order to get a two-thirds constitutional majority.
On other structural improvements to the Czech economy, the IMF rings the alarm about the skills shortage and fact that many low skilled workers are unable to fill the vacancies increasingly cropping up in industrial sectors. With the available pool of workers expected to contract over the next years, the country could face a permanent rather than just a temporary skills shortage and that could erode productivity gains, it warns. The proposed solutions: incentives for workers to move and seek jobs, an education system that can better produce some of the technicians that are lacking.
It’s perhaps on monetary policy that the IMF’s observations will be most keenly noted.
And the IMF, echoing recent comments from Minister of Trade and Industry Jan Mládek, says the Czech Republic could better focus its research and innovation investments so that it can climb up the value added chain in manufacturing. The minister recently regretted the fact that Czech companies are in too many cases supplying German companies with parts and it’s in the final assembly in Germany that most of the value added occurs.
But it’s perhaps on monetary policy that the IMF’s observations will be most keenly noted. Head of its delegation Costas Christou admitted that it has been spending a lot of its time talking with the Czech National Bank about the scenarios for coming out of the low crown policy, the so-called exit strategy. That will probably need to be in place before this time next year, the earliest opportunity at which the central bank believe it possible for the current peg of 27 crowns or more to the euro to end.
That’s a subject that will be among the main issues which will be faced by a new governor of the national bank, to be named next week after Miroslav Singer steps down, and a new bank board. And the IMF believes that the Czech National Bank should be willing to use all the tools at its disposal to stop the crown from strengthening disproportionately once the low crown policy ends.
Christou said that one measure that might be considered are negative interest rates for some types of bank deposits in order to discourage speculative flows of currency. Negative interest rates mean that the depositor is basically paying the bank to keep his money there. The central bank has hinted already that that move, which could hurt local banks, might be part of its tool box.
“Another important factor is the source of the appreciation. Is it part of the nominal convergence or it because you have a lot of capital inflows that want to take advantage of the interest rate difference. If it is the latter, we have recommended that perhaps negative interest rates might be a tool which could be employed before the exit or after the exit depending on the nature of these pressures.”
But negative interest rates are a weapon that you can probably only use for a short period, a couple of months, half a year….Banks are not going to like it, they are going to complain, however happy and stable they are at the moment….
“Well, it depends on how you introduce the negative interest rates. The recommendation we have and you will see in the statement is that you introduce it only on the marginal deposits and the new inflows. So in that sense we try to discourage these kind of arbitrage opportunities. It depends on how you go on the negative interest rates but with the discussions we have with the banks is that if it is a small, moderate negative interest rate then they should be able to manage it…
For a few months, or a half year…
“It depends. On negative interest rates, the national experience shows that the rates are usually introduced as a temporary thing and then they become more permanent. But we see them basically as targeted to deter capital inflows and at some point agents will change their behavior, right, if you have them for a long time.”
Do you concur that with the central bank’s idea that annual inflation will be hitting the 2.0 percentage point target by around the middle of next year?
“If it is a small, moderate negative interest rate then they [the banks] should be able to manage it.”
“Around that yes, yes. Now a lot depends on that fact that a lot of this inflation is imported inflation so it will hang on what happens from external sources, but we do see inflation approaching the target around the middle of next year, maybe a little bit later, but around that time.”
Based mostly on wage growth in the Czech Republic?
“Yes, wage growth is robust. Actually, we were a little bit surprised that underlying inflation has not already picked up but from what we hear during the discussions, yes, the labour market is getting tighter and tighter and wage pressures are there. So hopefully we will see some pick-up.”
And the skills shortage you mentioned… Some of the remedies that the employers are looking for is basically the import of large numbers of skilled Ukrainians, Moldovans, Belarusians. Do you have any view on that, presumably it’s better for an economy to try and make best use of what you have here?
“Well, you have to look at both aspects. If you have very real skills shortages and there is no way to increase the participation of some groups, then you have to look outside. But we have also specific recommendations on increasing the participation of the low skilled. It’s important that the government and businesses put together some programmes to train the low skilled. So you move that segment of the population into the labour market. At the same time, we have seen over the past two years the participation of women in the labour force has been increasing. There are still steps to be taken there. But yes, if there are shortages and you have some other labour to tap, from Ukraine or other countries, as long as you do it in a systematic way, providing training and all that…This is something the government is considering and it is something that could alleviate this constraint.”
Finally, back to the low crown, are there any lessons the Czechs can learn from the experience of other countries which tied their exchange rates to another rate or anchored their rates as regards the exit…I presume the Swiss model is not the ideal one?
“We don’t want, we don’t advise surprises, a much more predictable setting and framework, that would do the Czech Republic very well.”
“Well, the Swiss model is actually something we have been studying and we definitely want to avoid a situation like that. In that sense, communication is very important and that is something that we have been stressing and that is that the central bank, as it has done in the past, should definitely continue its communication and to prepare the agents and the economy for the exit and make clear what are the critical points and when they would do it, depending on inflation and all that. In that sense, yes, we don’t want, we don’t advise surprises, a much more predictable setting and framework, that would do the Czech Republic very well.”
The Swiss model was the rather abrupt exit from the currency’s peg to the euro and the rapid appreciation of the franc afterwards in a fashion that hurt many exporters.
