VZCZCXRO9294
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV RUEHSR
DE RUEHPG #0059/01 0301358
ZNR UUUUU ZZH
R 301358Z JAN 09
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 1067
INFO RUEHBS/USEU BRUSSELS
RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/TREASURY DEPT WASHDC

UNCLAS SECTION 01 OF 05 PRAGUE 000059 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EEB/IFD/OMA, EEB/EPPD AND EUR/CE 
STATE PLEASE PASS USTR 
 
E.O. 12958: N/A 
TAGS: EFIN ETRD ECON PGOV EZ
SUBJECT: GLOBAL FINANCIAL CRISIS: CZECH DOMESTIC AND 
INTERNATIONAL RESPONSE 
 
REF: A) 08 STATE 134459   B) 08 PRAGUE 683 
C) PRAGUE DAILY JAN 26    D) PRAGUE DAILY JAN 20 
E) PRAGUE DAILY JAN 9     F) PRAGUE DAILY JAN 6 
G) PRAGUE DAILY JAN 5     H) 08 PRAGUE DAILY DEC 18 
I) 08 PRAGUE DAILY DEC 12 J) 08 PRAGUE DAILY DEC 11 
K) 08 PRAGUE DAILY DEC 9  L) 08 PRAGUE DAILY NOV 25 
M) 08 PRAGUE DAILY NOV 18 N) 08 PRAGUE DAILY NOV 7 
 
(U) This cable is sensitive but unclassified.  Please 
treat accordingly. 
 
¶1. (SBU) Summary: Although the domestic banking system 
has remained relatively healthy, the small, open, export- 
oriented Czech economy is suffering from a significant 
drop in external demand for Czech exports.  According to 
recently released figures, exports fell a record 18 
percent, industrial production 17.4 percent and retail 
sales 6.3 percent year on year in November, while 
unemployment rose 0.7 percentage points to 6 percent in 
December.  The car industry, which together with its 
suppliers accounts for as much as 20 percent of Czech 
manufacturing, has been especially hard hit.  Many 
analysts now expect the Czech economy to stagnate in 
2009, with possible negative growth in the first two 
quarters.  The European Commission and Finance Ministry, 
however, continue to expect modest growth of 1.7 and 1.4 
percent respectively. 
 
¶2. (SBU) PM Topolanek created a ten person national 
economic council on January 8 to advise the government on 
an appropriate response to the economic slow down. 
Analysts note that since the economyQs main challenge is 
a drop in external demand, domestic remedies, such as a 
fiscal stimulus, can only help at the margins.  While 
some modest measures are likely, including additional 
interest rate cuts, more state export guarantees, and 
cuts in employee contributions to social programs, 
Finance Minister Kalousek opposes any measures that would 
significantly increase the Czech RepublicQs modest budget 
deficit.  Kalousek also intends to bring his fiscal 
discipline zeal to EU and G-20 discussions on responding 
to the global financial crisis.  The European Commission 
is representing the Czech EU presidency in the G-20 
working groups but the Czechs plans to participate 
actively in the senior-level discussions.  End Summary. 
 
Czech Financial System Remains Relatively Healthy 
 
¶3. (SBU) Despite the global financial crisis, Czech banks 
have remained relatively healthy.  The Czech Republic 
experienced a significant financial crisis from 1997-2002 
that cost around 20-30 percent of GDP to fix.  The result 
was the consolidation of the banking market, the removal 
of non-performing debts from balance sheets and fairly 
conservative banks and consumers.  Czech banks are not 
heavily leveraged, focused almost exclusively on the 
domestic market, and have largely eschewed complicated 
opaque investment vehicles in favor of domestic lending. 
Lending is financed by deposits; the Czech banking 
systemQs average loan to deposit ratio is less than 75 
percent (Ref B). 
 
¶4. (SBU) The Czech RepublicQs largest bank, CSOB, has 
been hardest hit by the global crisis, but despite 
writing off over 12 billion Czech crowns (approximately 
USD 600 million) of collaterized debt obligations (CDOs) 
and exposure to Icelandic banks, remained profitable in 
¶2008.  At the beginning of 2009, CSOB had a capital 
adequacy of over 10 percent and a loan to deposit ratio 
of 70 percent. The other major banks have fared 
significantly better.  The second largest bank, Ceska 
Sporitelna, reported a return on equity of 22.5 percent 
and an increase in net profits of 21 percent for the 
first three quarters of 2008.  The third largest, 
Komercni Bank, reported an increase in net profits of 22 
percent during the same period. 
 
¶5. (SBU) The Czech Republic has not experienced a 
financial crisis in 2008-09, maintains Unicredit Bank 
Chief Analyst Pavel Sobisek.  While a couple of banks had 
temporary liquidity problems in 2008, the Czech National 
Bank (CNB) reacted quickly to prevent any serious 
problems from emerging.  He conceded that the interbank 
lending market is not functioning, as banks do not trust 
one another, but argued that this has not been a problem, 
 
PRAGUE 00000059  002 OF 005 
 
 
as banks can easily borrow what they need from the CNB. 
According to Finance Minister Kalousek, the Czech 
Republic is only one of three OECD countries that has not 
had to inject capital into its banking sector. 
 
¶6. (SBU) Unicredit Bank Chief Analyst Sobisek also 
maintained that the Czech Republic is not experiencing a 
credit crunch.  Statistics, he argued, show that the 
volume of bank loans has continued to increase, albeit at 
a much slower rate than before.  He did admit that many 
banks have tightened their loan criteria and are 
reluctant to lend to certain sectors such as to real 
estate developers.  Fewer companies, however, are also 
seeking credit as they have decided to postpone new 
investments until better times.  Others, however, argue 
that while credit is still available to large customers, 
credit has become much more difficult and expensive for 
small and medium enterprises to obtain.  According to a 
Chamber of Industry survey, two thirds of companies 
reported that credit is now more scarce.  Latest 
estimates show a 20 percent decline in the volume of new 
mortgages in 2008. 
 
Real Economy Suffering from Drop in Demand for Exports 
 
¶7. (SBU) While Czech banks remain relatively healthy, the 
Czech real economy is suffering from a significant drop 
in demand in Western Europe for Czech products.  As an 
open, export-oriented economy, the Czech Republic is 
especially sensitive to economic slow-downs in its main 
trading partners.  The annual volume of Czech exports 
exceeds 80 percent of the Czech RepublicQs GDP.  Over 80 
percent of Czech exports go to other EU member states. 
Over 30 percent of total exports go to Germany alone. 
According to Ceska Sporitelna Bank analysts, for every 
percentage point drop in German GDP growth, Czech GDP 
growth drops by roughly 0.4 percentage points. 
 
¶8. (SBU) The Czech Statistical Office recently released 
figures for November showing a record year on year drop 
in exports (18 percent), industrial production (17.4 
percent) and the value of new industrial orders (30.2 
percent).  Retail sales also fell 6.3 percent. 
Unemployment increased 0.7 percentage points to 6 percent 
in December (although is still well below the December 
2006 level of 7.7 percent).  While these numbers were 
partly inflated due to fewer working days this November 
than last, the drop was much more severe than anyone 
expected, causing many analysts to further revise their 
growth forecasts for the fourth quarter of 2008 and for 
all of 2009 downward. While the European Commission and 
Finance Ministry continue to forecast modest growth in 
2009 of 1.6 and 1.4 percent, respectively, many private 
analysts now expect the Czech economy to stagnate, with 
possible negative growth in the first two quarters. 
 
¶9. (SBU) The Czech economy has been helped by the fact 
that it entered into late 2008 in strong shape.  Real 
economic growth had exceeded 6 percent annually from 
2005-2007 and remained above 4.2 percent year on year for 
each of the first three quarters of 2008.  Unemployment 
hit record lows in July of 5.2 percent (4.3 percent using 
EU counting methods), leading many businesses to view a 
shortage of labor as the largest constraint to continued 
strong economic growth.  To fill the gap, Czechs imported 
thousands of laborers from abroad, including from 
Ukraine, Vietnam and Mongolia.  The Czech national debt 
is roughly 30 percent of GDP and private indebtedness is 
also relatively low. 
 
¶10. (SBU) Nevertheless, a few industries have been 
especially hard hit.  Several large historic firms in the 
Czech crystal and ceramic industry, which had been 
struggling for some time, have now closed or filed for 
bankruptcy, sending several thousand people out of work. 
Four and five star hotels in Prague are reporting 
occupancy rates down 30 percent on 2007 levels since 
summer 2008.  The car industry, which had until recently 
been flourishing, grew only 1 percent for the year after 
expanding by as much 9.5 percent during the first three 
quarters.  The Czech Republic is the second largest 
producer of cars per capita in the world and the car 
industry accounts for as much as 20 percent of 
manufacturing.  All major vehicle manufacturers have cut 
production by as much 25 percent, laid off most non- 
 
PRAGUE 00000059  003 OF 005 
 
 
contract workers and implemented a four day work week. 
The automobile industry association is predicting that by 
summer, car manufacturers and their suppliers will have 
let go 13,500 of the industryQs roughly 130,000 
employees.  Skoda AutoQs External Relations Director 
Radek Spicar told us that the current situation was 
unique in that none of their export markets was immune 
from the crisis.  As a result demand for their product 
was falling not only in Western Europe, but in Russia, 
Ukraine, India, and Asia as a whole. 
 
Government Considering Modest Steps; Worried about Public 
Finances 
 
¶12. (SBU) The Czech National Bank (CNB) has responded 
aggressively to the financial crisis, lowering its two 
week repo rate by 75 basis points (bp) on November 7 and 
by 50 bp on December 18.  Since inflationary pressures 
are no longer a concern (inflation is currently 3.6 
percent and projected to fall below 2 percent by the end 
of the year), the market widely expects another 50 bp cut 
at the CNBQs next meeting in early February.  The CNB has 
also acted to provide liquidity into the banking and 
government bond sectors by enabling banks to borrow money 
directly from the CNB using government bonds as 
collateral. 
 
¶13. (SBU) With the exception of the Czech National Bank 
(CNB), however, the governmentQs response to the economic 
slowdown has so far been very modest.  On January 1, 
mandatory employee contributions to social programs were 
cut by 1.5 percentage points and a small government 
subsidy was offered to people under 36 buying a home. 
Both of these actions, however, were planned 
independently of the crisis.  The government also made 
available an additional 3 billion crowns (USD 150 
million) in capital to the state-owned Czech Export Bank 
and Czech-Moravian Guarantee and Development Bank to 
allow them to increase export guarantees and corporate 
lending.  Finance Minister Kalousek has repeatedly said 
that the government would take concerted steps to address 
the crisis only if Czech economic growth slowed to less 
than 2 percent.  Now that it is clear that this condition 
is being met, the government is scrambling to assemble a 
package of crisis measures. 
 
¶14. (SBU) After being unable to find anyone willing to 
accept the proposed position of Deputy PM for Economic 
Affairs, PM Topolanek announced January 8 the creation of 
a 10-member National Economic Council, charged with 
advising the government on an appropriate response to the 
economic slow down.  The Council consists of prominent 
economists and representatives of the banking and car 
industries. The opposition CSSD has refused to 
participate in the Council in a move that is widely being 
interpreted as an attempt to avoid being seen as sharing 
political responsibility for economic slow down.  CSSD 
has presented its own proposals, which would be partially 
financed by increasing taxes on the wealthy. 
 
¶15. (SBU) The Council met with key Government Ministers 
January 25.  According to PM Topolanek, the Council 
considered over 250 possible measures and gave priority 
to accelerating depreciation of business assets 
(including cars) lowering of social insurance 
contributions for new or recently retrained employees, 
providing state guarantees for corporate loans, and 
increasing government spending on research, education, 
the environment, infrastructure and some regional 
projects.  The Council and government are now preparing 
concrete measures for inclusion in a crisis response 
package that will be submitted to parliament in February. 
A press conference has been tentatively planned for 
February 15. 
 
¶16. (SBU) Council Member and CSOB Chief Macroeconomic 
Strategist Tomas Sedlacek reported that the Council had 
agreed that the governmentQs basic priority should be to 
help Czech exporters rather than to try to stimulate 
domestic demand.  Another Council member stressed to us 
that it will be very difficult for the government to 
address the economyQs main challenge (i.e., the drop in 
external demand), although he noted other countries 
stimulus packages will also help the Czech Republic. 
Former Industry/Economic Minister and Council member 
 
PRAGUE 00000059  004 OF 005 
 
 
Vladimir Dlouhy noted that domestic demand had fallen in 
November, but preliminary data for December suggested 
that the Czechs had not cut back on Christmas spending. 
He too noted that since the Czech Republic was a small 
open economy, any government actions would only help on 
the margins.  Nevertheless, he advocated for a government 
fund designed to help SMEs get better access to credit at 
more affordable rates. 
 
¶17. (SBU) On January 26, Finance Minister Kalousek 
introduced a revised budget with projected revenues based 
on one percent growth.  In December, the Parliament had 
passed the original 2009 state budget -- which was based 
on the unrealistic assumption of 4.8 percent growth -- 
with the caveat that it would have to be revised in early 
¶2009.  The newly revised budget makes only a few cuts and 
increases revenues mainly by forcing each ministry to tap 
into its reserve fund (i.e., unspent funds left over from 
previous fiscal years).  The newly revised budget 
envisions a budget deficit of 73.3 billion crowns (or 
roughly 2 percent of GDP). 
 
¶18. (SBU) The revised budget, however, does not include 
any of the new crisis response measures under 
consideration by the Council.  Council member Michal 
Mejstrik reported that the Council still did not know the 
level of funding the government was willing to devote to 
the proposed measures. Kalousek, who has the reputation 
as a strong fiscal conservative, has stressed that he 
will do all in his power to prevent the budget from 
ballooning, noting that in a period when all governments 
are borrowing heavily, he was concerned that the 
government bond market could burst.  Given the right-of- 
center political orientation of the current government, 
as well as PM TopolanekQs strong support for Kalousek, 
few analysts expect the government to put forward more 
than a few relatively inexpensive crisis response 
measures. 
 
Czech EU Presidency Response: Stressing Fiscal Discipline 
 
¶19. (SBU) Czech Finance Ministry officials have told us 
that coordinating the EU response to the global financial 
crisis is the MinistryQs main priority for the Czech EU 
Presidency.  Ministry officials have been having regular 
meetings with UK finance officials to coordinate Czech 
actions.  While our working level contacts have stressed 
the PresidencyQs responsibility to act as an honest 
broker, Minister Kalousek told Ambassador Graber January 
14 that he planned to interject three principles into EU 
discussions: 
 
 The need for fiscal discipline.  The Stability and 
Growth Pact was not just for good times; 
 
 The need for fair economic competition and resisting 
beggar they neighbor actions; and 
 
 The need for transparency.  The rationale for, and 
costs of, all measures should be presented to the public 
clearly.  One should not argue in favor of subsidies for 
new cars based on environmental grounds when the real 
purpose it to support the car industry. 
 
¶20. (SBU) Kalousek told the Ambassador that he viewed the 
financial crisis as primarily a problem of confidence and 
thus did not believe that a large fiscal stimulus was the 
answer.  He also raised long term concerns about the 
financing of debt, noting that even Germany was having 
problems selling government bonds. 
 
¶21. (SBU) Finance Ministry EU Department Head Drahomira 
Vaskova told us that the European Commission is 
representing the Czech EU Presidency in the G-20 Working 
Groups, and that the main document for the EU Economic 
and Financial Committee will also be prepared by the 
Commission.  The Czechs, however, plan to actively 
participate in the political level meetings.  The Czechs 
are planning an informal ECOFIN meeting (meeting of EU 
member state Finance Ministers) for Prague on April 3-4. 
The main topics for discussion will be an assessment of 
the economic and financial impact of the 2004 EU 
enlargement and a discussion of the recommendations of 
the Larosiere High-Level Group on financial supervision. 
The Czechs are also considering inviting Treasury 
 
PRAGUE 00000059  005 OF 005 
 
 
Secretary Geithner to participate in a working lunch with 
his EU Member State counterparts on the global financial 
crisis.  Other priorities for the Czech Presidency 
include preventing Qthe spread of protectionism and undue 
state intervention,Q implementation of the European 
Economic Recovery Plan, the review of the EU directive on 
capital adequacy of investment firms and credit 
institutions, negotiations on the EU directive regulating 
the insurance sector, the regulation on credit rating 
agencies, and the directive on electronic money 
institutions, as well as modernizing rules for applying 
VAT to financial and insurance services. 
 
Comment 
 
¶22. (SBU) The current Czech government is very fiscally 
conservative and skeptical of pan-European regulations 
and increased government involvement in the economy. 
This world view is informing its actions both 
domestically and internationally.  Although the Czech 
economy may contract in 2009, we do not anticipate a 
significant Czech fiscal stimulus program or any bail 
outs of key Czech industries.  With it low government 
debt, commitment to maintain fiscal discipline, still 
relatively strong currency, and low current account 
deficit (-2.3 percent on a yearly basis for the third 
quarter in 2008) the Czech Republic is unlikely to 
experience some of the same problems faced by other 
countries in the region.  Although the business community 
continues to lobby for the rapid adoption of the Euro, 
the crisis has done nothing to change the current 
governmentQs (mainly ideological) reluctance to adopt the 
common currency anytime soon.  PM Topolanek again 
postponed a decision on a target date until November and 
suggested that even a goal of 2013 or 2014 was far from 
assured. 
 
Thompson-Jones