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R 260624Z JUN 07
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 9283
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
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UNCLAS SECTION 01 OF 02 PRAGUE 000758 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EUR/NCE, EUR/ERA, EB/IFD/OMA, E STAFF 
TREASURY FOR OASIA ANNE ALIKONIS 
STATE PLEASE PASS USTR WENDY MOORE 
COMMERCE FOR ITA/MCA/EUR MIKE ROGERS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV EZ PGOV
SUBJECT: CZECH REPUBLIC: ECONOMY REMAINS ROBUST AS FISCAL 
DISCIPLINE REMAINS THE WEAK LINK 
 
REF: A. PRAGUE 698 
 
     ¶B. 06 PRAGUE 1173 
 
 ¶1. SUMMARY AND COMMENT: The Czech government on June 11 
approved a preliminary 2008 budget deficit of CZK 78.4 
billion (3% of GDP).  However, these figures are entirely 
dependent on the passage of the economic reform package (ref 
A), which Parliament will address after returning from its 
summer recess August 7.  The government will submit the final 
2008 budget to Parliament by end-September for approval by 
end-year.  In the meantime, despite continued erosion in 
public finances, the Czech economy is outperforming 
expectations of a moderate slowdown and may once again reach 
6% GDP growth in 2007.  Household consumption and exports are 
leading GDP growth, and accompanying this growth is much 
speculation about a credit bubble.  There has been 
significant and steady growth in household credit since 2003, 
but the overall level as a proportion of GDP remains far 
below the EU average and the Czech National Bank does not 
believe it poses a significant macroeconomic risk.  Despite 
the robust growth, economists continue to warn that public 
finances must be reined in quickly because structural growth 
is slowing.  Therefore, the pending economic reform package 
in Parliament will impact not only the political future of 
the coalition government, but also the sustainability of 
rapid growth for the medium to long term.  END SUMMARY AND 
COMMENT. 
 
--------------------------------------- 
ECONOMY DEFYING PREDICTIONS OF SLOWDOWN 
--------------------------------------- 
 
¶2. The Czech Ministry of Finance forecasts 2007 GDP growth at 
4.9%.  The OECD in May said that economic growth in the Czech 
Republic would slow from last year's 6.1% of GDP to 5.5% this 
year and 5.0% in 2008, citing a lower pace of consumption 
growth and an anticipated decline in exports.  The Czech 
National Bank forecasts GDP growth at a range of 4.9 - 6.5% 
for 2007 and 3.8 - 6.8% for 2008.  However, 
stronger-than-anticipated export and consumer demand data 
from the first four months of the year indicate these 
forecasts may need to be revised upward to somewhere closer 
to 6%. 
 
¶3. According to the Czech Statistical Office, Czech exports 
during the first four months of 2007 are up 17.4% from the 
same period last year while imports are growing more slowly, 
resulting in a record foreign trade surplus of CZK 37.5 
billion (about USD 1.8 billion).  Analysts attribute the 
surplus to the economic recovery in the Eurozone and 
particularly in Slovakia (note: Germany and Slovakia are the 
top two trading partners. End note).  Skoda Auto, the 
country's largest exporter, announced earlier this year that 
it was introducing Saturday production to meet soaring demand 
for its cars aboard.  This is all happening while the Czech 
Crown continues to appreciate against the Euro.  Private 
sector analysts point out that the market still believes the 
Czech Crown is 6 - 7% below the equilibrium foreign exchange 
rate, although that gap is slowly closing 
 
--------------- 
CREDIT BUBBLE?? 
--------------- 
 
¶4. Alongside record export growth, household consumption is 
the leading source of Czech GDP growth.  Consumption 
accounted for over a third of the 6.1% GDP growth in 2006, 
and consumption as a share of GDP has been rising steadily 
from 2.5% in 2005 to 4.8% in 2006 and to 5.6% in 2007.  Since 
2003, there has been a stable 30% growth annually in 
household credit, most of it in the form of mortgage lending 
(note: average mortgage rate is around 4%. End note).  The 
main reason for the increase is that the Czech Republic has 
been getting by on "cheap money," with interest rates and 
bond yields consistently lower than those in the Eurozone. 
Because the growth began from a low base, only recently have 
household credit figures become significant in absolute terms 
despite four years of steady growth.  Czech National Bank 
figures indicate that household credit/GDP ratio is 17% in 
the Czech Republic compared to 54% in the Eurozone, and more 
importantly, that this ratio is 40% below the long term 
equilibrium rate. 
 
 
PRAGUE 00000758  002 OF 002 
 
 
¶5. The Czech National Bank concluded in its recent 
presentation on a possible credit bubble that while household 
debt is on the rise at a significant rate, the pace is still 
relatively slow and the household debt/GDP ratio remains at 
about one third the average of developed economies. 
Therefore, while there is some risk especially for the lowest 
20% income bracket, there is not a general macroeconomic 
risk.  Meanwhile, private sector analysts warn of a slow down 
in structural growth, pointing to a slow down in fixed 
capital formation (from a growth rate of 7.6% in 2006 to 1.5% 
in 2007), and continue to pressure the government to reign in 
public finances and push for more radical reforms than the 
current economic reform package in Parliament. 
 
------------------------------------------- 
2008 BUDGET HANGS ON FATE OF REFORM PACKAGE 
------------------------------------------- 
 
¶6. Finance Minister Miroslav Kalousek (Christian Democrat) 
announced after a June 11 cabinet meeting that the Czech 
state budget for 2008 will have a deficit of CZK 78.4 billion 
(3% of GDP), down from the estimated deficit of CZK 91.3 
billion in 2006 (3.9% of GDP).  However, 2008 figures are 
pending passage of the economic reform package (ref A). 
Forecasted budget deficits for 2009 and 2010 are 2.6% of GDP 
and 2.3% of GDP, respectively.  Once again (ref B), ministry 
reserve funds (funds carried over from one year to next) 
reportedly amounting to CZK 50 - 60 billion (or 2% of GDP) 
are a major stumbling block in terms of budget transparency. 
As a result, Finance Minister Kalousek has stipulated that 
from now on, ministries can only keep reserve funds with the 
consent of the Finance Ministry.  The system of ministry 
reserve funds was put in to place as a way to curb end of 
fiscal year spending, but has now taken on a life of its own. 
 
¶7. To reach the 3% of GDP deficit figure in 2008, the largest 
cuts are planned at the regional development ministry 
(-25.6%), agriculture ministry (-16.1%), culture ministry 
(-14.8%) and industry ministry (-5.4%).  Spending will rise 
at the interior ministry ( 2.4%) and the defense ministry 
( 0.5%).  The Minister of Culture has been the most vocal in 
terms of publicly decrying these cuts, while the Minister of 
Defense has also warned that her paltry budget will mean the 
army cannot do much more than participate in ceremonial 
parades.  Such public comments are doing little to support 
the tough fight the coalition faces in Parliament for both 
the economic reform package and the 2008 budget. 
GRABER