Should Czechs rejoice or despair at the strength of their currency?

Foto: Štěpánka Budková

In 2001, if a Czech paid 50 dollars for a book or a record from an American-based internet vendor like Amazon, he would have forked out around 2000 crowns for his purchase. Today, he would only have to pay 800 crowns. That’s because the crown – or koruna as it’s called in Czech – has been steadily appreciating over the past decade. Since the start of the year, however, the gains it has made against other currencies like the dollar and the euro have been spectacular and have taken most economists by surprise.

In this week’s Talking Point, we look at the impact that a robust crown could have on the Czech economy.

News talk shows in the Czech media this week have been full of discussions about the Czech crown, which has been repeatedly breaking new records against both the dollar and the euro and leaving many financial analysts scratching their heads in amazement:

Aleš Michl is an economist with Raiffeisenbank:

Aleš Michl
“Right now, the Czech crown is the world’s best performer against both the US dollar and the euro so far this year. This means that the appreciation of the Czech crown is stronger than any other currency in the world. So I would say its current rise is robust, dramatic and even shocking.”

Many feel that the crown's current rapid rise is due to speculators trying to make a quick buck on the currency’s strength and that there will be a so-called correction in the coming months, which will see its value decline slightly.

Nonetheless, the underlying strength of the Czech economy with a strong trade balance and high GDP growth means that the Czech crown is still going to remain relatively robust and its value may continue to appreciate gradually in the long term.

Tomáš Sedláček is a leading economic analyst with the Czechoslovak Commercial Bank (CSOB). He says the strength of the Czech crown is very much a double-edged sword in that it puts more money in people’s pockets but could also potentially damage local industry, as Czech products become too expensive for people buying them in euros and dollars:

“An extreme example is to compare the Czech crown to the dollar. A few years ago the dollar was worth 42 Czech crowns. Now it’s worth two and a half times less that amount. So in that respect, we have literally during our sleep more than doubled our wealth vis-à-vis the American economy. So this is good news for Czech consumers and it’s great news for people who travel abroad. It also helps to push down the price of crude oil, petrol and other things we import. These are much cheaper than they would be if the crown was weaker. On top of this it’s a question of prestige. Having a strong crown is a prestigious thing. As we all know, the economy has two sides and two hands and there is no such thing as clearly good news. The price for all the good things is that our exporters suffer from this. The rest of the economy gains.”

Despite the fact that the crown has been appreciating steadily in recent years, Czech export levels are still quite buoyant. Tomáš Sedláček says that this is because Czech manufacturers have been increasingly focusing on producing quality goods which are not as price sensitive as other merchandise:

“It has been a general trend in the past 16 years that we have moved from price competitiveness – in other words selling medium-quality goods for a very low price – to a market where our goods are so well respected that are willing to pay a higher price. The prime example of this is the Skoda car, which used to be a very mediocre car at the beginning of the 1990s and if it ever was exported it was really for a low-end market. Now it’s a car that is well respected and it has a good name, so our customers are willing to accept an increase in the retail price.”

In the years since EU accession, there has been a big increase in Czech exports to the eurozone and this has helped offset much of the negative impact of the crown’s increased value.

Photo: European Commission
Nevertheless, there are signs that exports to other EU countries are starting to flatten out. If the crown were to continue appreciating in value this could hit Czech manufacturers pretty hard. Aleš Michl suggests that Czech exporters should start looking further afield to counter this potential problem:

“Right now I think that businesses could tackle this problem by changing their strategy from trading with the eurozone to trading more with the east. Right now, 90% of their trade is with countries like the US or states in the eurozone. So trading more with the east could solve this problem very easily and give our exporters a more balanced portfolio.”

Besides concerns that Czech exporters will have their work cut out to stave off the effects of a strong Czech crown, it seems that the currency’s appreciation has also caused complications in other areas.

It has come to light in recent weeks that at least ten percent has been wiped off billions of euros in EU cohesion funds, which were agreed with the European Union in 2005.

The money, which had been earmarked for vital public works projects to improve the country’s infrastructure, will now have to be supplemented from the public exchequer because the Czech authorities inexplicably failed to use any hedging mechanisms to protect the funds from currency fluctuations.

Tomáš Sedláček says the whole affair is a salutary lesson for Czech fiscal policymakers, who were perhaps naïve in their approach to handling EU monies:

“I think it was just overlooked. It’s not an issue anybody expected and perhaps it’s something of a novelty for us as well. We’re not used to this situation so it’s a good lesson for next time. All these things must and should be hedged.”

Considering that around 80 billion crowns – or approximately 4.75 billion US dollars at current exchange rates – are estimated to have been wiped off the value of EU subsidies to the Czech Republic, it seems that the Czech fiscal authorities have made a pretty expensive mistake. Not surprisingly, Aleš Michl does not take as charitable a view of the situation as Mr Sedláček:

Photo: European Commission
“I would say that the Ministry of Finance totally failed with hedging the position of EU funds. I would say it was a totally stupid policy. I can’t be polite about it. It was just stupid.”

One thing that the current appreciation of the Czech crown has brought into sharp focus is how vulnerable a small, export-dependent economy like the Czech Republic is to the vicissitudes of international markets.

In the past, many European countries used to use interventionist mechanisms such as currency devaluation to stave off the impact of adverse exchange-rate fluctuations. Some exporters have been calling on the Czech government to take similarly proactive approach to curbing the strength of the Czech crown. But is such an idea feasible in today’s global economy where non-protectionist, free-market thinking holds sway? Aleš Michl again:

“I would say there’s a simple answer to that. There is no option for the government. I would say the best choice for the government is not to do anything about the Czech exchange rate and to focus on the economic growth of the Czech Republic. I would say the Czech National Bank has no choice either because, although it can take some intervention measures that might bring about a short-term correction, they don’t have any chance of withstanding the pressures of the globalised financial market in the long-term.”

Photo: European Commission
Tomáš Sedláček generally concurs with this view, although he does add that there is actually one highly effective thing the government could do to eliminate exchange-rate uncertainty:

“One of the key reasons why the euro was introduced in the vast majority of European countries was to get rid of this very unpredictable, sometimes harmful strengthening and weakening of mutual currencies. So one thing the government could do is to speed up the adoption process. Apart from that there is very little the Czech National Bank or the government can do.”