In an interview with Hospodářské noviny, economist Pavel Kohout explains why the Czech Republic should worry about its budget deficit. “If the debt slowly grows from the current 33% of GDP and we continue saying ‘still not too bad’, the first crisis that hits will take us down much as the current crisis did to Hungary,” he says.
Are we on the way to bankruptcy like Hungary?
Yes, of course we are.
In how many years could we start experiencing serious problems?
Hungary is a slightly different story. It had two problems that we don’t have. At the beginning of the 1980s, it had a state debt of about four-fifths of GDP. Almost miraculously, it managed to bring it down to 50%. The country started spending and stopped saving. Today Hungary can serve as a warning example.
What’s more, it had a fixed currency, something we did away with in 1997. That was always the source of problems. You can either try to maintain a stable currency and let interest rates fluctuate. Or you can set you own rates. But in that case, you need to be willing to let your currency fluctuate freely, as the Czech National Bank did. You can’t shoot two rabbits with one gun. Hungary worked so hard on this that it made the forint into a soft, inflation-prone currency with high interest rates. That’s why so many Hungarians took loans in euros and Swiss francs.
But it’s becoming apparent that a low state debt alone is no guarantee. Latvia, for instance, had one of the lowest state debts in Europe, and yet investors have written the country off anyway.
Latvia, and in part also Lithuania and Estonia, got into difficulties for completely different reasons. Leftwingers have a tendency to make fun of this: You pointed to these countries as examples to emulate and now look what’s happened.
But why did this happen? Not because they had public finance debts. Not because they had bad conditions for doing business. The problem was that they experienced a gigantic uncontrolled expansion of debts. Local banks allowed this to happen because the country has pegged its currency to the euro. They behaved as Argentina did before its bankruptcy in 2002, when it had its peso pegged to the dollar.
How can you spot a country that’s about to go bankrupt and that no one will want to give loans to?
The breaking point is imaginary. The situation can look completely different in Hungary, Latvia, the Czech Republic or Italy.
How would the situation look in the Czech Republic? When will we reach a point when other countries will stop providing loans?
It’s hard to predict the timeline. If the debt slowly grows from the current 33% of GDP and we continue saying “still not too bad”, we could get into a similar situation. As soon as a crisis hits, it would take us down much as the current one did to Hungary.
Do we belong among the unhealthy countries that investors will write off at the first sign of any problems?
Unfortunately we have the dubious luck of being surrounded by many unhealthy countries. We won’t be the first to be put down.
How will we be able to tell after the elections that the new government is really trying to resolve the situation?
Politicians must begin to see that only three to five years separate us from where Hungary is today. Unlike some other countries, we have an advantage that politicians are abusing: Most state bonds are being bought by local banks, pension funds and insurance companies. We are less reliant on foreign investors than Hungary and Latvia were.
But that will end as the debts grow. Czech banks and funds won’t be able to keep buying bonds.
You only have to look at the yields on 10-year state bonds. This reflects how the market perceives the stability of the economy. And the interests on state bonds is growing quickly. The 10-year bonds already cost the state some 5%.
The current record-low interest rates pose a threat to the economy. Banks buy state bonds that have good yields, and won’t be interested in providing loans to anyone.
If a bank can choose between investing in a relatively risk-free government bond or giving someone a loan, it will choose the state. I say that this is the country creating crisis measures.
And that’s why politicians can unfortunately afford to create more debt. Do local banks make this easier for them than foreign investors?
Yes, but it doesn’t mean that the government should take advantage of this.
But it’s very likely that it will take advantage of this.
It’s fortunate that we are not obligated to contribute to private pension funds. These would be required to be used for state bonds. Paradoxically, it might be a good thing that the Czech pension system has not been reformed; otherwise it would serve as another dumping ground for state bonds …
But banks don’t need to buy Czech state bonds. All governments take loans. They could buy US or German state bonds, for instance.
But then there is an additional risk tied to the currency. If we had the euro already, pension funds would be “contaminated” with all the various complicated mechanisms that helped bring about the financial crisis.
Foreign investors are always less sensitive to turbulence in Czech politics than instability in other central and eastern European countries. Do we have some sort of immunity?
Maybe they have come to regard our political scandals as part of Czech culture, much as they do with Italy, another interesting case. Its state debt is 100% of the GDP and yet it survives. If we were to look at that country’s financial history, we’d see that it, too, is part of the culture.
Italy has a surprisingly high number of good economists who work in public finance. Studies there show that, if there is trust, a seemingly untenable situation can be sustained for a long time. They say that there is a way to help save even a very indebted country: the skilful operation of liquid assets and expenditures.
An indebted country needs someone aggressive who will fight for every loan?
The Italian Finance Ministry seems very skilled in that. In addition, you need a high level of trust. Italy is known as a country that has a new government every two years and massive debts. But it gets away with it because it has a sufficiently long history and so can say, “See, we Italians are able to live with it”.
Are we becoming the Italians of central Europe?
We are well on the way. But watch out. It’s possible to maintain a high debt, but it comes at a price. Last year Italy paid 5% of GDP in interest rates. And it’s been even worse. In the 1980s, when Italy had high interest rates, it was paying as much as 12% of GDP. Just to compare: Last year our interest reached 1.2% of GDP.
That, of course, doesn’t leave much room for any significant growth. Italy is coasting along thanks to its momentum. If you are travelling through the country, you don’t get any sense of suffering. It’s a rich country, but it’s drawing on reserves it took centuries to build up. We don’t have that advantage. Throughout our history, we’ve always managed to destroy all that we’ve worked for.
It’s been about one year since the fall of Lehman Brothers, considered to be the beginning of the most drastic part of the financial crisis. Three things have emerged from the ideas about post-crisis capitalism: fear of state debts, an effort to control big banks and attempts to regulate bankers’ salaries. Let’s start with the financial institutions. Are they so big that they pose a threat to society?
Banks don’t work the same way as automobile manufacturers. They don’t become more efficient if they are bigger. In fact, it works the other way around: the bigger the bank, the bigger the expenses and the problems. The number of successful bank mergers is smaller than in any other field.
How do you prevent the rise of big banks that then need to be bailed out by governments?
I’m not sure that any type of regulation would work.
Why do they merge if it doesn’t make economic sense?
Imagine a manager who is pushing 60. He can look forward to retiring, but he feels as though he hasn’t accomplished anything. His entire career was about doing paperwork. He wants to have a monument. In ancient times pharaohs built pyramids. In the business world, the modern-day version of a pyramid is a merger.
When the crisis first hit, everyone started recalling the Great Depression and feared possible social impacts. Why did they not come?
People have learned a lesson from the 1930s. Firstly, we have no gold standard to which we could peg currencies, as Latvia’s lat and the euro do. The longer the money is tied to the metal, the harder the impact. And, at the beginning of the 1930s, it was a very hard hit. Secondly, countries reacted quickly in 2008.
What helped tone down the effects of the crisis?
As a liberal economist, I believe that we shouldn’t interfere too much. But there are exceptions. If a house is on fire, everyone needs to take part in putting the fire out, regardless of whose home it is, because the whole village could burn down. In 2008 a house caught fire and we were able to put it out because the US government was able to save Bear Stearns, AIG and others. The fall of Lehman Brothers made the world panic because everyone started to worry that the whole village would be incinerated. If the US government had saved Lehman Brothers, it would have been costly, but it would have stopped the crisis sooner.
Did government stimuli help lessen some of the social impacts of the crisis?
It might sound surprising, but I’m not entirely against stimuli if the situation calls for it. And that was the case here. I’m not sure that Barack Obama didn’t overdo it somewhat with the planned deficit of 13% of GDP. This is a figure similar to 1942, during the second world war. But it can be explained. We’ve had a year to dust off old Keynes. Having a state budget deficit at a time of economic decline is not a sin.
Pavel Kohout
Economist and publicist
Originally worked as a developer of simulation training programmes
Has been in finance since 1993
Worked for PPF, Komero and ING Investment Management
Advisor to finance ministers Bohuslav Sobotka and Vlastimil Tlustý
Member of NERV, the government’s economic crisis advisory team
Co-founder and strategic director of the consulting company Partners
