czech convergence and impact of world economic crises on czech republic ludek niedermayer director,...
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Czech convergenceand impact of world economic crises on Czech republic
Ludek NiedermayerDirector, Consulting, Deloitte CRDecember 2009
Czech convergence(pre crises)
3 © 2009 Deloitte Czech Republic
Success story, mainly in this decade
Since start of this decade, very strong performance of Czech economy
GDP in euros has doubled, macro stability was preserved
Inflation was volatile but low, CA has been supported by surplus of in foreign trade
The key weakness was in the area of publics policies
Even with around 5% growth of GDP, the budged was not able to reach „close to balance“
Total debt has increased to around 30% of GDP, but declining IR helped to hold cost of debt service low
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Inflation
GDP (USD)
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GDP (Euro)
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4 © 2009 Deloitte Czech Republic
FX played role
Exporters handled stress wellLow inflation was reached mainly via exchange rate channel (and flexibility of the economy)
CZK was gradually appreciating against euro, the key currency for export and import (ex energy)
The economy was able to withhold appreciation of REER in this decade without creating large fragilities
With passing time, the „depreciation cushion“ from start of the reform was fading away, some types of the production are not possible to do at the Czech prices – economy is gradualy changing structure
Volatility of the currency is recently of more concern, as part of the economy is supplying to very competitive markets
Recovery on the way? Impact of world economic crises on Czech republic and region
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ECU/EUR Linear ( ECU/EUR)
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Období REER - deflator GDP (FT turnover, 2005=100
5 © 2009 Deloitte Czech Republic Recovery on the way? Impact of world economic crises on Czech republic and region
Summary : The economy is strong in macro stability and private sector, publics sector policies is lagging behind
• The key bottle necks of ČR
• Weak fiscal situation, the fast growth of revenues was hiding the budgetary problems and was transformed into permanent expenditures
• Reform of pension system did not take place
• Just small changes in health care, underestimated impact of demography
• No euro strategy, ideology instead of pragmatism
• EU „schizophrenia“
• The crises also has shown up, the potential role of the government in the economy is larger than expected, and so the quality of publics service matters a lot…
• Relatively strong external position (BoP and publics external debt) of ČR
• There are some macro fragile countries in the region, the others were partly affected by regional sentiment
• Good indicators of financial stability (loan to deposit ratio, FX lending, FX financing)
• Asset bubbles not too evident
• In some countries, high proportion of FX lending, in some cases also impact of weakness on the „owners“
• But still, impact of the slow down visible everywhere (asset quality decline, temporary increase of fiscal deficits)
• All countries in the region do suffer from large deficits, practically in no cases financial system was collapsing
6 © 2009 Deloitte Czech Republic
Czech EU / Euro debate
Combination of:
Strong growth
Low nominal IR
CZK excellent for storage of value
Skepticism of some parties about EU
Low willingness to consolidate publics finance
Lead to no enthusiasm about Eurozone entry
Even worse, the plan of social democratic government (2009 or 2010) was canceled as part of pre election campaign
But due to the structure of the economy, the euro adoption is not as indifferent, as some economists think.
Recovery on the way? Impact of world economic crises on Czech republic and region
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2WK
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Czech economy dealing with crises
8 © 2009 Deloitte Czech Republic Recovery on the way? Impact of world economic crises on Czech republic and region
From Golden years to crises
• Czech economy before crises reached most likely peak of the cycle
• Fast CZK appreciation in 1H of 2009 created large problems for economy
• Economy – private or publics - was totally unprepared for crises
• And politicians tried to play it down at the beginning
• The result for 2009 GDP would be close to 5% decline, instead of 5% average growth before the crises
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GPD CRCapital formation CRExports CRConsumption CR
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GDP bil. CZK
9 © 2009 Deloitte Czech Republic Recovery on the way? Impact of world economic crises on Czech republic and region
Czech recession
• Delayed start, but than large impact
• Wrong assumption (of the politician) about relative safety of the economy
• Strong link to EU market (cars and EU exports)
• High export to GDP proportion, high concentration
• Citizens affected by information similarly to any other country
• Small space for government policy
• Small countries have per se limited options, domestics demand stimulation does not work
• On the contrary, mainly for „floaters“, the macro stability is key priority
• The hypotheses, that “new countries“ will be less affected, did not work. The output losses will be substantial.
• In selecting government policies, not the stimulation of demand, but the support of eemployment is the key measure
• In Czech, situation was complicated by political crises
• Since 2Q, there are signs of stabilisation of economy. Recovery could be slower than expected, pre crises growth is “unlikely to be reach soon (if ever)“
10 © 2009 Deloitte Czech Republic
Crises – permanent loss of „value“ – read figures properly
Recovery on the way? Impact of world economic crises on Czech republic and region
2006 2007 2008 2009 2010 2011 2012 201385
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GDP
Crises Turning point Slower, post crises growth
Back on trend (not always)
LossPre crises growth
11 © 2009 Deloitte Czech Republic Recovery on the way? Impact of world economic crises on Czech republic and region
Deficit growth – money are gone
• More of debt means also higher interest rates and thus problem for next budgets
• The impact of “not good policy” can be as high as 30 bil. (almost 1% of GDP) for all future budgets
• Reaching 60% of GDP debt means permanent increase of debt service of 70 bil. at current prices
• Comparison (data 2008)
• Social transfers – 54 mld.
• Defence budget – 54 mld.
• University expenditures – 26 mld.
• So far there is no awareness of politicians of possible problem
• Adjustment 1% (GDP) per year is for most of them too aggressive
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Debt service
Current "debt“ 30% GDP, interest 4%
2011 optimistic (40% / 5%)
Higher interest rates(6%)
60% debt, at 5%
12 © 2009 Deloitte Czech Republic Recovery on the way? Impact of world economic crises on Czech republic and region
Short term outlook
State of global economy better than expected, the financial sector is not great concern
The world recovery should help to get Czech economy back to growth
In the short run, the investments, construction and mainly labor market will slow down Czech recovery
Inflation in near term not source of concern, but longer horizon is less clear
Still, being among the first countries starting with fiscal consolidation is good, the measures taken are less good (and changes are even worse)
Even in medium run, the potential of the economy is much lower than before crises
So the policies must be adjusted to this fact
• Nevertheless, it seems that competitive position of the economy is preserved, but it is one of the „most expensive“ in the region
• The problem is over capacity generated by global decline of the economy, so even relatively competitive countries will benefit just partly from this position
• The situation can improve, but still, it is not clear, where is world heading
Crises and CZK or Euro (my view)
14 © 2009 Deloitte Czech Republic Recovery on the way? Impact of world economic crises on Czech republic and region
Floating CZK – great helper ?
• Weaker CZK helps. More volatile no
• Look at past
• From mid 2007 to mid 2008, CZK has appreciated from 28 to 23
• The wage cost in Euro has increased in magnitude of 25% during 12 month
• This episode has weakened the Czech compatibility before the crises substantially
• Since start of the crises
• Depreciation reached max of 25%, volatility high
• Now, CZK has corrected the stronger level, but volatility is still hign
• Interest rates higher, but not much
• Hedging for exporters is difficult and expesive
• Euro is still (even more) priority for economy
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5Y Bond
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15 © 2009 Deloitte Czech Republic
Impression from the crises
• Very similar impact of the crises to all „new member states“ (apart of Poland)
• Mainly among floaters different experience with FX regime:
• Poland and Czech seems happy with their choice, Hungary (and maybe Romania) would benefit from euro greatly
• Also impact on banking sector very different. In some countries (mainly Hungary), FX regime triggered large euro-isation of the banking balance sheets
• Nevertheless, the lessons (especially partial) from the event happening once in decades is not good base for evaluation of the euro adoption
• Some more universal facts should be taken into account:
• High growth in new members states has reduce gap between them and rest of EU. Adoption of the euro is less risky
• Links between new and old Europe are stronger, so the risk of asymmetrical shocks is lower
• Crises have shown, that cost of volatility is higher than expected and due to lower liquidity of the markets the hedging is more costly
• So in my option, in most cases, Euro in more appealing than before
Recovery on the way? Impact of world economic crises on Czech republic and region
16 © 2009 Deloitte Czech Republic
Desirable or feasible ?
(yes and no, likely)
In most of the new member states, the period of the robust growth was not used for consolidation of fiscal policy
And in some cases, fiscal policy was pro cyclical
While is should be relatively easy to consolidate after the crises, the politicians have different view
So fiscal can be major obstacle
While inflation can be also problem, the other key concern is continuing believe of some Eurozone members, that enlargement can undermine the credibility of the euro
Recovery on the way? Impact of world economic crises on Czech republic and region
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GDP (%) Fiscal deficit (% GDP)
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© 2009 Deloitte Czech Republic
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