VZCZCXYZ0011
RR RUEHWEB

DE RUEHPG #0035 0241358
ZNR UUUUU ZZH
R 241358Z JAN 08
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 9979
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS PRAGUE 000035 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EZ
SUBJECT: PRAGUE STOCK EXCHANGE DOWN 20% SINCE JANUARY 1 
 
REF: 07 PRAGUE 758 
 
¶1. SUMMARY AND COMMENT:  The good news is that the Czech 
Republic's economic fundamentals are strong; The bad news is 
that the Czech Republic is also impacted by negative 
sentiment stemming from the subprime mortgage crisis in the 
U.S. that has spread to global financial markets.  With key 
economic data in the U.S., Europe and the Czech Republic due 
out over the next two weeks, economists expect the 
instability to continue.  The surprise January 22 Federal 
Reserve rate cut was well received and, like elsewhere in 
Europe, helped soften the blow for the local stock exchange. 
The Prague Stock Exchange is down 20% since January 1 and 
down 10% year-on-year.  In the event of a protracted period 
of instability or significant economic slow down, economists 
believe that recently passed public finance reform shows 
further fiscal tightening would be possible without too much 
suffering, while the Central Bank is faced with a trickier 
situation of confronting increasing inflationary pressures. 
END SUMMARY AND COMMENT. 
 
ECONOMY SLOWING DESPITE STRONG FUNDAMENTALS 
------------------------------------------- 
¶2. Econoffs met with Czech investment bank Patria Finance 
Chief Economist David Marek and European financial group 
UniCredit Chief Economist Pavel Sobisek to discuss how the 
Czech economy is likely to fare in the current wave of 
financial instability stemming from the U.S. subprime 
mortgage crisis.  Both agree that the financial turmoil will 
likely continue in the coming weeks, but that Czech economic 
fundamentals are strong (reftel).  Having said that, even 
before the turmoil began, the Czech economy was expected to 
slow this year after three consecutive years of 6% GDP 
growth.  2008 GDP growth is projected to decrease from 6% to 
5%, inflation is expected to rise from 3% to 5.4%, and 
industrial production is expected to slow from 8% to 5%. 
 
¶3.  Marek, who sits on the trading floor, said there was a 
lot of screaming on the floor January 22 and that the 
negative sentiment continues.  The first week in February 
will be an especially active week for the Czech financial 
market, with data from the PMI index, trade balance, and 
inflation expected to be released, on top of Czech 
Presidential elections on February 8.  Sobisek shared the 
results of an internal research paper on the impact of a 
stock market crash on GDP growth rates using the Oxford 
Economic Forecasting model: (1) if share prices bounce back 
within the next four to eight weeks, the negative effects are 
negligible; (2) in the worse case scenario (i.e., a permanent 
10% drop in global stocks), there would be a 0.8% drop in 
U.S. GDP growth rate, 0.6% in Japanese GDP growth, 0.5% 
decrease in German GDP growth in 2008. 
 
 
CENTRAL BANK CONUNDRUM 
---------------------- 
¶4.  This month marks the ten-year anniversary of the Czech 
National Bank's (CNB) inflation-targeting policy.  And for 
the first time in ten years, the CNB is simultaneously 
confronted with the challenge of managing rising inflationary 
pressure and an economic slowdown.  Year-on-year inflation 
accelerated to 5.4% in December 2007 and is expected to reach 
6% in January 2008.  At the January 16 Euromoney Conference 
in Vienna, Austria, Czech Central Bank Governor Zdenek Tuma 
attributed the rise in Czech inflation to growing food and 
energy prices across the world and the impact of the public 
finance reform which raised the lower VAT rate from 5% to 9%. 
 More importantly, Tuma characterized the rise in inflation 
as temporary and said he expects inflation to return to 
"around 3% in 12 to 18 months."  He also said a U.S. 
recession would have little effect on the Czech banking 
sector. 
 
¶5. COMMENT: Czech GDP growth is primarily attributed to FDI 
and exports, although domestic consumption has been rising 
rapidly.  Approximately 70% of the companies listed on the 
Prague Stock Exchange are multinational corporations.  For a 
small open economy like the Czech Republic, strong economic 
fundamentals alone will not be sufficient to stave off the 
effects of a global economic slowdown.  As reported in 
reftel, a succession of short-lived coalition governments 
have pursued a pro-cyclical fiscal policy and modest reforms 
have only just begun.  At the same time, the highly-respected 
Czech National Bank is in a bind and expected to further 
raise interest rates at their next meeting to stave off 
rising inflation.  Therefore, the policy tools available to 
Czech officials to soften the impact of global financial 
instability or recession are limited and could finally tip 
the Czech economy into an economic slowdown that economists 
have predicted for the last two years. 
Graber