VZCZCXRO3003
RR RUEHAG RUEHDF RUEHIK RUEHLZ
DE RUEHPG #0313/01 0861519
ZNR UUUUU ZZH
R 271519Z MAR 06
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 7140
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 PRAGUE 000313 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EUR/NCE, EUR/ERA, EB/IFD/OMA, E STAFF DAN MORRISON 
TREASURY FOR OASIA ANNE ALIKONIS 
STATE PLEASE PASS USTR LISA ERRION 
COMMERCE FOR ITA/MAC/EUR MIKE ROGERS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ELAB ETRD EZ PGOV
SUBJECT: CZECH ECONOMY: A "CENTRAL EUROPEAN TIGER" ROARS 
 
REF: A. PRAGUE 119 
     ¶B. 05 PRAGUE 1686 
     ¶C. 05 PRAGUE 1325 
 
¶1. Glowing 2005 Czech economic statistics led newspapers to 
trumpet the Czech Republic as one of Europe's "Economic 
Tigers". And in the run-up to the June 2-3 general elections, 
every politician is taking full credit.  GOCR figures put 
2005 GDP growth at 6 percent, inflation stable at 2 percent, 
doubling of foreign direct investment (FDI) at USD 11 
billion, and the first foreign trade surplus in Czech history 
(ref A).  2006 started off with the GOCR announcement that 
industrial output grew by 15.1 in January 2006.  The record 
economic performance in 2005 is attributed to exports 
(automotives), FDI (export-oriented manufacturing 
multinationals), and domestic consumption (real estate and 
consumer credit boom).  The only less-than stellar figure is 
the unemployment rate, which has been sticky at around 9 
percent, although that rate is still significantly lower than 
all of its neighbors except Austria. 
 
¶2. The highly-manufacturing-and-exports-dependent Czech 
economy remains vulnerable to business cycle swings, although 
a major downturn is not expected any time soon.  Fiscal 
adjustment remains a key vulnerability as the GOCR gears up 
to adopt the Euro as early as 2010.  2006 economic prospects 
remain quite strong with GDP growth expected in the 5 to 6 
percent range, although it is not likely to top the record 
performance of 2005.  Although the Czech National Bank (CNB) 
has a more conservative estimate of 2005 GDP growth (4.3 
percent), it is still above the Bank's 4 percent forecast. 
Along with neighboring Slovakia, the Czech Republic's 2005 
GDP growth ties it for fourth after the surging Baltics among 
EU member states.  According to Eurostat's preliminary 
estimate, the Czech Republic in 2005 reached 74 percent of 
the average EU GDP/capita.  The Czech national economic 
strategy remains to reach the EU average by year 2013. 
 
--------------------------------------------- ------- 
Domestic Consumption as Important as Exports and FDI 
--------------------------------------------- ------- 
 
¶3. Econoff met with local economists to review the rosy GOCR 
economic statistics and challenged them to account for the 
strong Czech economic performance and step out of their usual 
role of focusing only on the weaknesses and vulnerabilities 
the economy.  According to Pavel Kohout of PPF, the 6 percent 
GDP growth figure is significantly overstated due to the 
Czech statistical office's (CZSO) methodological biases.  The 
CZSO applies its own deflator for each component of GDP, 
which tends to understate the impact of world energy prices 
on GDP when energy prices increase and in reverse, overstates 
the impact when energy prices fall.  Once this methodology is 
accounted for, Kohout calculates the GDP growth for 2005 was 
around 4.3 percent.  Still, 4.3 percent growth is no laughing 
matter, and Kohout believes domestic consumption boosted by 
the local real estate boom and consumer credit boom is 
contributing equally significantly to GDP growth as are the 
more commonly credited export and FDI sectors.  Banking 
credits to households (mostly mortgages) grew by USD 4.2 
billion from 2004 to 2005, and as in the United States, this 
phenomenon can be explained by record low mortgage interest 
rates (currently 3.7 - 4.5 percent for 10 or 20 year loans), 
as well as baby boomers of the early 1970s who are starting 
to enter the consumer credit market.  Czech males between 30 
and 35 years of age have the lowest unemployment rate in the 
economy at 3 - 4 percent.  Kohout calculates domestic 
consumption accounted for up to 2.5 percent of GDP growth in 
¶2005.  For 2006, Kohout predicts GDP growth in excess of 4 
percent, assuming there are no drastic changes in world 
energy prices. 
 
--------------------------------------------- ----------- 
Manufacturing Dependence Means Business Cycle Dependence 
--------------------------------------------- ----------- 
 
¶4. Patria Finance's David Marek acknowledged that critics do 
not have much room in the face of such robust figures for 
¶2005.  He did, however, flag the "strange" structure of the 
economy that makes such robust growth unsustainable and 
highly vulnerable to the business cycle.  Specifically, Marek 
noted the strong ratio of manufacturing, predominantly the 
automotive industry, in the economy.  The manufacturing 
sector and related industries (plastics, rubber, steel) 
account for about 25 percent of industrial output and up to 
35 percent of GDP (using the Herfindahl Index).  According to 
 
PRAGUE 00000313  002 OF 002 
 
 
Marek, this is the most concentrated figure among the EU-25 
economies.  Marek noted that the pending mega-FDI project by 
Korean car manufacturer Hyundai would shift this 
concentration even higher and make the Czech Republic that 
much more vulnerable to the business cycle given the highly 
cyclical nature of consumer demand for automobiles. (Note: 
Hyundai and the Czech Republic have already signed a 
memorandum of understanding for this one billion Euro plant, 
which is expected to begin production in 2008.) Unlike 
Kohout, Marek attributes 2005 GDP growth mostly to foreign 
trade.  And because the German economy, the Czech Republic's 
largest trading partner, is likely to improve in 2006, 
prospects for Czech GDP growth in 2006 are bright.  Marek 
described Czech domestic demand as "sluggish" with a 3 
percent growth in 2005.  He attributed the relative 
sluggishness to the slow rise in disposable income resulting 
from multinational companies, the largest employers in the 
Czech economy, maintaining labor contracts that prevent a 
rapid increase in wages to maintain competitiveness.  Marek 
also explained that while there is a strong labor movement in 
the Czech Republic, labor unions are a force largely in the 
traditional and increasingly uncompetitive industries, such 
as textiles, and are relatively unimportant in car 
manufacturing and other growth sectors. 
CABANISS