IMF Concludes 2016 Article IV Consultation with Czech Republic
The Czech Republic has been growing fast on account of a favorable external environment, high EU funds utilization, and accommodative macroeconomic policies. Strong efforts to absorb EU funds supported a sharp pickup in investment, while higher employment and wages, and improving consumer sentiment benefitted private consumption. Unemployment has fallen significantly to the lowest level in the EU. The current account surplus widened in 2015, on account of an improvement in the income account mainly due to stronger EU transfers. Headline inflation remained subdued in 2015, as positive domestic developments were offset by external disinflationary factors.
Fiscal performance was better than expected in 2015, on account of robust tax revenues and spending discipline. But, the main driver was a significant shift in the structure of funding of public investment during the transition between EU fund cycles. To maximize EU fund absorption, government units shifted its focus to EU-funded investments, postponing domestically-financed investments.
Monetary policy has remained accommodative. In November 2013, constrained by the zero lower bound, the Czech National Bank decided to use the exchange rate as an additional inflation targeting instrument to fight deflationary pressures. Appreciation pressures started building up in mid-2015 prompting the CNB to intervene and defend the floor. In February 2016, the CNB Board extended its commitment to the floor until end-2016.
The banking sector is stable and credit growth remains robust. Czech banks have high capital buffers and profitability, strong asset quality, and low non-performing loans. Credit growth has been driven by corporate sector demand for long-term investment loans and household demand for mortgages and consumer credit. Low mortgage rates have boosted lending, putting upward pressure on prices. Moreover, some deterioration in the affordability-of-housing indicators has taken place recently.
Economic activity is expected to decelerate in 2016. Higher disposable income and employment will boost private consumption, but growth will be affected by the slow start of investment projects financed by EU funds. As base effects from the oil price shock fade and domestic demand pressures build-up, inflation is expected to reach the 2-percent target in mid-2017. Over the medium-term, output growth is set to stabilize at around slightly above 2 percent in line with economy’s potential.
Executive Directors commended the Czech Republic’s favorable economic performance—including strong economic growth and a steady decline in unemployment—which has been underpinned by its solid fundamentals, a favorable external environment, positive growth impact from high EU fund utilization, and supportive macroeconomic policies. At the same time, Directors noted that potential growth is insufficient to achieve fast convergence toward the income levels of other advanced European countries. Accordingly, they encouraged the authorities to maintain their prudent macroeconomic management, while implementing structural reforms to boost potential growth.
Directors welcomed the authorities’ continued fiscal discipline, and deemed their medium-term fiscal deficit objective appropriate. They noted that, with the structural deficit already below this objective, there is space for increasing public spending on much-needed infrastructure to support higher medium-term potential growth. Directors urged the authorities to resist pressures to reduce taxes and increase current spending in the run up to next year’s elections, and to avoid changes in the pension system that could jeopardize its long-term sustainability. They emphasized that a speedy adoption of fiscal framework legislation would help anchor fiscal policy, guard against pro-cyclicality, and enhance predictability.
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