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A crown of thorns

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The weekly Respekt reported in August that a massive widening of the Czech budget deficit will burden taxpayers with an astronomical public debt and might take the state to the verge of bankruptcy. The deterioration of fiscal discipline also means that the country may not be able to adopt the euro until 2014 or later, which will likely upset Czech exporters and the local tourism industry.

Under regulations known as the Maastricht criteria, the European Union requires that member states wanting to adopt the common currency must keep their public sector deficit below 3% of their annual gross domestic product (GDP) before joining. Other restrictions apply for inflation, government debt, exchange rate stability and interest rates. But, as the recession hurts tax revenue and soaring unemployment further bleeds the state coffers, the Czech National Bank recently estimated that the budget gap could be 5.1% this year and around 6% in the next two years.

“Unless the accession requirements change, the gates of the eurozone will remain closed for a long time,” said Tomáš Sedláček, chief macroeconomic strategist at ČSOB and one of the government’s economic advisers. “The last country that squeezed through was Slovakia. We had a chance to join together with Slovakia, but we didn’t – which is a big shame.” Sedláček thinks that the earliest realistic date for Czech accession is 2015. “Provided we can fix public finance,” he said.

Oldřich Dědek, the government’s national co-ordinator for euro adoption, is slightly more optimistic. “From a technical point of view, we can still imagine accession in 2013,” he said. “But, given the current fiscal forecasts, a more realistic date is 2014.”

Too strong
After losing some of its value between mid-2008 and early 2009, the crown has resumed its solid pre-crunch growth. A euro is now worth CZK 25.4 instead of CZK 36 in 2000, and the Czech currency has more than doubled its value against the dollar. Sedláček and most other economists say that this is a long-term trend that will likely continue in the coming years.

Many Czechs may be enjoying cheap holidays or shopping in countries that seemed unaffordable 10 years ago. But exporters, who in 2005-07 were the main engine of the economy’s 6% annual growth and low unemployment, are much less excited. Škoda Auto, the largest Czech manufacturer and a vocal advocate of a speedy euro adoption, complained about its profits being trimmed by the strong crown even before the credit crunch cooled demand for Czech goods abroad. Local hoteliers and restaurateurs say that they, too, are losing out, as the country is getting more expensive for foreigners.

Czech business leaders have for years pressed the government to set a firm target date for the currency switch and to commit to meeting the Maastricht criteria. “A postponement of [this move] represents an element of major economic uncertainty for businesses and a reason behind a deterioration of their position during the recession,” reads a statement published in December 2008 by the Czech Confederation of Industry. The statement contests an earlier statement by the government and the central bank that having its own currency was shielding the country from the financial crisis.

Sedláček also believes that the crown has made things worse, saying that the small currency is an easy target for speculators and its fluctuation has “created rather than absorbed shocks” in the economy. “With the euro, we could sleep better,” he said. “The crunch was a trial by fire for the common currency. Although it has only existed for 10 years, it has now survived its first major crisis without significant damage.” Sedláček points out that no member state has seceded from the eurozone, while some European countries outside the club, including Hungary and Latvia, have found themselves on the verge of economic collapse.

Rescue package
Eduard Janota, the technocrat finance minister, now says state coffers may be in even worse shape than previously thought and that the 2010 deficit could get as high as 7% of GDP. He warned in a Czech Radio broadcast that the country could follow the Hungarian scenario, and he proposed an emergency package of fiscal reforms designed to cut the gap to some 5% of GDP. If adopted, the legislation would reduce some social spending, force top earners to pay higher social security contributions, and moderately increase VAT and the petrol tax. This could move the country a few inches farther from the abyss – and make the long wait for the euro at least a bit shorter for Czech exporters.

“The introduction of the euro itself is probably not the government’s top priority,” Dědek said. “Yet the government is doing all it can to make its fiscal policy stable and efficient again, something that is also required by the Maastricht criteria. The current crisis has only emphasised the need for fiscal reform. So it seems that a right reaction to the recession may be at the same time the right step towards joining the eurozone.”

Janota, who is part of a caretaker cabinet, is negotiating with parties to secure support in parliament. He knows his proposal will be a hard sell now, several weeks before general elections. “Politicians’ creativity and certain populism are growing the closer we get to election day,” the minister said. “Hence I expect a vast majority of them will be very, very cold.”

If he fails to rush his rescue package through parliament, there is still hope. The new government elected in October may have a stronger mandate to swiftly adopt more substantial reforms. UniCredit Bank analyst Pavel Sobíšek told the ČTK news agency that whichever party wins the elections it will have to adopt a package similar to Janota’s.

It remains unclear how much time the country needs, and how deep reforms need to run, in order to close the widening budget deficit and adopt the euro. Some Czech politicians and economists have suggested that the EU should loosen the accession requirements so countries could join even with deficits higher than 3% of GDP. “It is no secret that the Maastricht criteria are dead,” said Sedláček. “Few countries that are already eurozone members will be able to keep their budget deficit under 3% of GDP this year.”

Some bleak figures
The Czech economy has contracted by 4.8% so far this year, drastically undermining the state’s tax revenue and putting jobs to the axe. The unemployment rate, which has doubled over the past year, is now at 8.4% and is expected to grow close to 12% by 2011. Most economists expect the recovery will be slow, with no or very modest GDP growth predicted for next year.

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