Quick Reality Czech
The Czech Republic is the first economy in central and eastern Europe to slide back into a full technical recession during the current downturn (evidently it is unlikely to be the last), with a 0.3 per cent quarter-on-quarter GDP decline in the last three months of 2011, after a 0.1 per cent drop in the previous quarter.
The news, announced last Wednesday, is interesting but not entirely unexpected given the export dependence of the country’s economy, and in particular on exports to the eurozone, which also saw a GDP contraction in the fourth quarter. Still, it is curious that the country which arguably has one of the strongest in the region was the first to slide back into contraction.
The country has a strong and competitive export sector, which normally drives growth forward. The problem with export driven economies is that once external demand (in this case mainly from German industry) weakens, domestic demand is not strong enough to maintain the growth dynamic.Thus such economies are inherently unstable. Unfortunately this is a pattern we are going to see more and more of now that domestic demand is only a real driver in relatively few EU economies (Poland, France, possibly Sweden).
Even after the relative bounce-back, Czech GDP was still below the pre-crisis peak in the second quarter of 2011, before it fell into recession again.
Exports as can be seen from the chart below really surged during the first phases of the recovery, but since mid 2011 they have effectively been stagnating (second chart showing 3 month averages).
Fixed capital investment and construction activity, on the other hand, have fallen back substantially since the crisis, and look unlikely to recover in the short term.
Another interesting detail about the Czech economy is the fact that although the country runs a very healthy trade surplus, strong negative income flows on the current account means that the country actually runs a current account deficit. The reason for the deficit is interesting I think, since the whole external account only balances due to strong FDI and equity inflows plus reinvested earnings.
What this means is that the net international investment is deteriorating, and the day earnings are not retained and reinvested, that day the country will start to have a problem. It seems to me that this kind of model, and especially for a country with an ageing population and weak domestic demand is not sustainable, one-way inbound FDI is not a development model for a mature economy.
Czechs need to save, and then invest elsewhere to generate income to help support their pensions and health system. This is the whole problem with ageing societies in the east of Europe, the low levels of accumulated savings they inherited due to their earlier history makes them very vulnerable.
In addition, the country is steadily accumulating a stock of sovereign debt as the need for a fiscal deficit has been created to support demand. Accumulated debt is still low, but it has grown sharply since the crisis, and remains on an upward path. The deficit was around 4% of GDP in 2011, and looks set to stay at the same level this year. More importantly the deficit is in danger of becoming structural (that is to say inbuilt into the country’s economic growth) and may be hard to eradicate without a serious fiscal effort and a period of significantly under par growth.
The Czech Republic has its own currency (the Koruna) whose value tends to fluctuate in accordance with global risk sentiment (rather than for any local fundamentals) and has rebounded sharply (despite the fact that central bank interest rates have been held at 0.75% for many months now) as risk sentiment has risen following the 3 year ECB LTRO development.
Despite the very low interest rates, inflation is well under control. In December the EU HICP was running at an annual 2.8%.
Credit has slowed, but it is hard to tell whether this is not more the result of slow ongoing domestic delaveraging rather than any real shortage of funds to lend. Certainly there is no sign of a Baltic style credit crunch.
Looking at the manufacturing PMI, the industrial sector has been stabilising along with the rest of the EU, and the rate of contraction both in output and new orders is slow, so the economy should continue to stagger forward OK although there are few signs of an outright recovery, which will need to await a significant upturn in the Euro Area.
Obviously one of the key nagging questions is why the country is so export dependent. I have correlated this phenomenon with rising median population ages (like in Germany or Japan – in fact the Czech Republic looks awfully like Japan without the current account surplus) since the Czech Republic (along with Slovenia) has one of the oldest populations in Eastern Europe.
Others explain the phenomenon culturally – the Czech’s are a nation of savers, unlike the Estonians whose reckless spending led them into a housing boom/bust (do note the irony, please).
Sylvie Pekarova, a 33-year-old pharmaceutical researcher in Prague, has no debt. She doesn’t even own a credit card.
Consumers like Pekarova have helped the Czech Republic avoid the fate of the euro region, which is grappling with a debt crisis now into its third year. With private borrowing at half the euro region’s average, the country now boasts interest rates that are lower than 10 of the currency-bloc’s 17 members. That’s helping the government’s drive to sell benchmark Eurobonds, which started this week.
“It’s this feeling that if something goes wrong, you don’t want to be stuck with debts you don’t know how to pay back,” Pekarova, who lives in a rented apartment in central Prague, said in an interview. “Borrowing money for things like going on a holiday doesn’t make sense.”
So anyway, you can take your pick according to the model which takes your fancy. But I do wonder about the relative predictive power for investors of models which use cultural biases and those which simply take ageing populations. Which societies among the African underdeveloped economies will be the big new savers of the future, and which will be the spendthrift bankrupts? Median age analysis at least has the advantage that it makes prediction reasonably easy – Spain, for example, is about to become a nation of savers – but I wonder how those who use cultural analysis go about identifying the unexpected new savers we will see come 2020?
7 Responses to “Quick Reality Czech”
The article is exact but also partial. The main reason for the negative economic growth in Czech Republic is its government policy of austerity, which included increase on VAT tax on housings and public budget cuts. This policy was implemented due to wish of the conservative government to reduce the public deficit to 3% from the GDP, (EU policy not taken seriously by any other country since 2008) . To me this policy seems inappropriate, since the public dept in Czech Republic is less than 40%. If to reduce the public deficit, it would be more appropriate to do it thru economic grow, but it cant be done with increasing domestic demand, because as rightly mentioned the strong propensity of the people for savings.
Czech Republic, if compared to other East European countries, has relatively good infrastructure, still a lot to be done to achieve the West European standard. If there is a wish to change the negative trend in economic growth, Czech Republic has the chance to use the opportunity of decreased demand and increase investments in infrastructure. The roads, railways, etc. are still in shameful shape and due to geographic location in the heart of the EU, investment in these facilities could have long term positive economic effect.
It seems obvious that in the following years the P.I.I.G.S. countries will have to reduce significantly their public and private expenses. This will reduce strongly the demand in EU, since they represent almost quarter of the EU population. Without demand can't be achieved the so needed economic growth in EU, unless this demand will come from some other place. The most reasonable source of increasing demand within EU can come only from countries with relatively low debt and potentially high perspective of economic growth. And i am not speaking about Germany, Scandinavia or Holland, but rather the Eastern European countries, with about same population as the P.I.I.G.S. countries, that on one hand have relatively low public dept, mostly bellow 50%, (except of Hungary), on the other hand in spite of being part of the European Union, have shamefully low standard of living and big deficit in infrastructure. For some unclear reason the governments in these countries are cutting the investments and expenses too. It is time Brussels initiate change of this policy and allocate financial racecourses, released from expected reduction of consumption in the P.I.I.G.S. countries, into investments in Eastern European countries. I am pretty sure, it is not only socially correct, but compared to any other alternatives; it could bring the highest yield on investment and long term positive economic growth. If implemented on large scale, this policy could bring the so crucially needed economic growth to the whole EU zone.
You mentioned the interesting phenomena, that the Czech economy runs a very healthy trade surplus, yet negative income flows on the current account. This is caused by large scale foreign ownership of the Czech Economy. This phenomena was caused by unsuccessful coupon privatization, initiated in the nineties, that brought the bankruptcy of the whole economic system in 1996 and later take over of most of the economic activity by foreigners. When these foreign mother companies started to take their Czech daughter companies profits home, and reduced the new investments into them, the current account became negative. In the one hand it causes depletion of the currency reserves, but on the other hand it weakens the Czech Krone and helps to increase the exports. It could not happened if Czech Republic would have Euro as its currency.
Rodeneugen, I think you are basically right. I have observed a similar phenomenon in Hungary. One of the issues here is privatisation. I am certainly not in any way against privatisation, but think you need to be able to draw on domestic savings (as they can in Italy) to be able to get the real advantage, otherwise you effectively convert sovereign debt into external debt. Structurally this may be OK if you are a developing country, but I am not sure it works the same in a mature economy unless you have two way flows (Spain – curiously Telefonica seem to be part owner of the Czech phone company). But in countries like Greece and Portugal with small export sectors, and large external debt already, I am not sure the privatisation outcome will be the one people expect (inside or outside the Euro) since this is just juggling round with debt. For information, the Chinese seem to have been very active in buying up Portuguese state assets, by chance they also have strategic interests in the parts of Africa (Angola eg) where Portugal has interests.
Incidentally Rodeneugen, in the last comment I was replying to your privatisation comment. On the more general issue, I don't think you are taking the question of demographics into account. I may be right or I may be wrong, but this is the core of my analysis. East European societies have limited state debt at this point (although outside outliers like Estonia it is now rising everywhere, and you should remember that in countries like Ireland and Spain debt to GDP was only just over 35% as recently as 2007). The thing is, most of these societies have very little in the way of accumulated savings due to their very special history, and now their governments face very large age related contingent liabilities. In the end, this is why they need to export, and themselves make FDI in third countries to be able – like Japan – to live to some extent off the profits. Also, my impression is that there is comparatively little in the way of patenting activity going on (do correct me if I am wrong). The way to pay for health systems is to invent, export the technology, and earn income.
This is rather off the direct Czech topic, but this link is incredibly interesting, the Chinese are buying into Portugal to get into Africa (as I said above). This will help state debt, but the countries net international investment position will also deteriorate. No free lunches, but if I were Portugal I would be rather more careful about what I was selling.
Edward hi, thank you for your response, and let me please put you more in details. If you check my blog; https://rodeneugen.wordpress.com/category/economi…
you will find out I certain involvement in economic events in Israel, (where I lived and have been active most of my life), in Czech Republic, (where I was born and am active since the early nineties) and a bit in Chine (where I have certain economic interests). As to the demography of Europe as the whole and Eastern Europe in particular, you are very right. Once I quoted in my blog the following;
“Demographic problems rise when a population grows to the point where there are too many children to feed or when it declines and there are too many old people to be taken care of. But I know of no country that its demographic situation is balanced. A largely elder population is a problem if they enjoy a pension system based on deficit; a young population is a problem if the country lacks the resources to educate them.”
If to compare the demographic situation in countries like Czech Republic and Israel, it is like an economic laboratory. While in Czech Republic the population is stable, and it also happens due to enormous increase in life expectancy by almost 10 years!!!, since the fall of the Communistic regime, in Israel is high natural growth of the population and with it relatively young population. While I assume the education level of these two countries is comparable, their economic dynamics is not. Yes Europe’s economic problems are very much a result of its demographic changes, but also of mentality of “leisure” in Czech Republic, compared to mentality of alertness that prevails in Israel and probably in US also. The aging society is not only problem of statistics and deficit in the pension system; it is also a problem of national mentality. I am not expert on this sociological-psychological phenomenon, and probably there have been done researches in the academy on the subject. (If not it could be a great subject for economic-sociological-psychological research, to find out how the economic, social and psychological behavior differs in a society with growing young population, compared to an aging society.)
To be practical, Czech Republic and Europe as whole, has to do something about the demographic development. Since I don’t see change in birth rates, the only solution is immigration. The mine problem with immigration is that if the immigrants come from very different cultural, social and political background, immigration endangers the social and political structure of Europe. So the solution is immigration from countries with relatively similar background. The only candidates for it are the population from Russia, Ukraine, Belarus or other post Soviet countries. Of course their population is also on process of demographic depletion, but this process seems to me irreversible.
As to the Chinese take over of Portugal i wrote an article in march 2009, that was widely published in Chinese press, that in a way predicted this development.