The Czech Republic: Future challenges and possible risks

1. OECD, Seminar “20 Years After” Paris, 20November 2009 The Czech Republic: Future challenges and possible risks Miroslav Singer Vice-Governor, Czech National Bank M. Singer – Present Conditions, Monetary Policy and Outlook in Czech Republic 1 M. Singer - Czech Republic: Staying Ahead of the Curve with Regard to Monetary Policy 1 M. Singer: The economic and financial crisis from the point of view of the Czech banks 1 M. Singer: Financial Crisis: Impacts on the CR and Lessons for the Supervisors 1 M. Singer: Financial Crisis: Likely Impacts on the CR and Lessons for the Supervisors M. Singer: Present Conditions, Monetary Policy and Outlook for CR 1 M. Singer: Consumer protection in financial services: CNB approach 1

2. Economic performance of Czech economy during crisis CNB forecast Challenges and possible risks Contents

3. GDP growth: q-o-q Source: CZSO Technically, the recession stopped in 2009 Q2

4. Cumulative GDP q-o-q growth:3Q2008-2Q2009 (not seasonally adjusted) Source: Eurostat, own computation The cumulative q-o-q GDP decline in the Czech Republic was comparable with the EU-27 average

5. Manufacturing Source: CZSO The decline in manufacturing output seems to have bottomed out in mid-2009

6. Exports, imports and trade balance(annual percentage changes; percentage points; constant prices; seasonally adjusted data) Source: CZSO The decline in total foreign trade turnover was still marked in 2009 Q2

7. Inflation (y-o-y in %) Source: CZSO Annual inflation fell towards zero in 2009 Q3

8. CZK/EUR (1 Jan 2007-17 Nov 2009) Source: Eurostat After appreciating in July 2008 and depreciating in February 2009, the koruna has returned to its previous trend

9. CNB’s key rates Source: CNB To deal with the strong disinflationary pressures, the CNB has lowered its interest rates to a record low

10. State budget balance Source: Ministry of Finance Note: GFS 1986 The economic crisis and earlier fiscal measures are reflected in a deteriorating state budget balance (vs. surpluses in 2007 and 2008)

11. Loans to non-financial corporations and households (y-o-y change in %) Source: CNB Loans to non-financial corporations declined year on year for the first time since 2005

12. Newly extended loans(y-o-y change in %) Source: CNB New loans to non-financial corporations and households decreased

13. Non-performing loans(% of total loans in segment) Source: CNB Non-performing loan ratios rose most significantly in non-financial corporations

14. Summary Financial and economic crisis was imported into Czech Republic Czech economy was slightly overheated before crisis, but generally at macroeconomic equilibrium (low inflation, anchored expectations) Monetary-policy and macroeconomic framework (inflation targeting and managed float) provided economy with necessary adjustment mechanisms  own currency proved to be advantage in crisis Main cause of vulnerability of economy: high export dependence Domestic banking sector was in good condition before crisis: banks were well capitalised and profitable (negligible share of toxic assets) Financial sector did not amplify impacts of crisis on economy and will not be source of major risks going forward Stress tests: strong resilience, profitability, sufficient capital adequacy The Czech economy is currently coping with the crisis better than many other advanced European countries

15. CNB Forecast(November 2009)

16. GDP growth forecast(annual percentage changes; seasonally adjusted) Source: CNB After a decline in economic activity this year a moderate recovery will take place in late 2009 and early 2010

17. Headline inflation forecast(annual percentage changes) Source: CNB At the monetary policy horizon, the headline inflation forecast is slightly above the inflation target

18. Main uncertainties in short run What will course and intensity of recovery look like internationally and in Czech Republic’s major trading partners? W-shaped? How strong are disinflation pressures (external inflation, nominal wages, domestic demand)? How will Czech public finances develop in 2010 and 2011? How will koruna exchange rate develop? How effective is monetary policy transmission mechanism? Huge uncertainty still surrounds economic developments and monetary policy-making going forward

19. Challenges and possible risks • Domestic: Fiscal policy • External: • Protracted and painful recovery in Europe • Hasty supervision and regulation changes

20. High share of mandatory or quasi-mandatory expenditures in total expenditures (above 70%) No pension reform or healthcare reform (ageing!) Lack of transparency in budgetary process Atomisation of public budgets Lack of audit of state funds Long-neglected fiscal problems Despite significant steps approved recently by parliament, the fiscal area represents the most serious macroeconomic risk going forward (persisting deficits even in good times and rapid growth in debt)

21. Public finance deficits Source: CNB computation, November 2009 forecast Note: ESA 95 Public finance deficits will fluctuate between 5% and 6% of GDP over the next few years

22. Public debt(as % of GDP) Source: CNB computation, November forecast After a period of stability public debt is expected to grow rapidly after 2008

23. GDP (2000 = 100) Source: Eurostat The longer term danger for Europe is still its too sluggish growth M. Singer – Czech Republic: Future challenges and opportunities 23

24. Current problems in financial market supervision Planned European Systemic Risk Board at ECB and European financial supervision system may blur division of labour among existing supervisory authorities Instead of precisely defining and identifying causes of crisis, illusion being created that more supranational supervision and regulation is guarantee against future repetition of crisis Risk: if supervision is distanced from national level, current unsatisfactory state of affairs will deteriorate even further Other topical issues put on back burner (cost-sharing) Overregulation of the sector may further decrease the EU‘s growth potential. The past problems of Czech banks impacted “fairly” on Czech taxpayers, but in the future external problems might impact on them through no fault of their own!

25. Five violated principles – what the current plans neglect/worsen Uncertainty is fundamental (diversifying supervisory/regulatory policies reduces risks arising from fundamental uncertainty) Positive motivation (eliminated value of banking licences for shareholders and profitability of traditional areas of banking) Unpredictable response (regulated/supervised entities always react [rather]differently than reformers intend) Communication of costs (costs often not even discussed at expert level, never mind communicated by politicians to voters) Manageable number of institutions (any unification, or even just improvement of coordination, of supervisory/regulatory institutions at European level requires progress with integration of 80 or so institutions at national level)

26. Conclusions Risk of long-term fiscal “inaction” (structural deficit) currently being compounded by economic decline (cyclical deficit) and potentially by political stalemate in future Due to high export intensity of the Czech economy a sluggish recovery in Europe will impose an impediment on domestic recovery Hasty changes in financial market regulation and supervision may present future risks to financial stability of Czech economy (any mistakes in globalised supervision could be far-reaching and could even trigger new crisis) or to the growth in Europe. While the fiscal risk is domestic (and therefore influenceable), the risks of pan-European supervision are external (and therefore hard to influence)

27. Miroslav Singer Miroslav.Singer@cnb.cz Tel: +421 224 412 008 Thank you Česká národní banka Na příkopě 28 115 03 Praha 1