Monetary tightening
Since last autumn, central banks in the countries of the region have been implementing a round of monetary tightening to curb inflation. In the Czech Republic, the key benchmark rate has been raised by 675 basis points (bps) since April 2021 to 7%. The appointment of the new governor, Aleš Michl, viewed as more dovish compared to the members of the Monetary Board, should however not affect the current tightening judging by the size of the last policy rate hike (+125 bps).
Inflationary pressures have intensified in recent months. The Harmonised Index of Consumer Prices (HICP) rose by 15.2% year-on-year in May. Food and energy items added 3.7 points and 4.3 points respectively. Supply disruptions also contributed to the rise in durable goods’ prices. Inflationary pressures may ease in 2023 as a result of a relative easing of both agricultural and energy commodity prices and supply constraints. Furthermore, the wage-price spiral remains contained for the time being, given that salaries are rising at a slower pace than inflation. Nonetheless, the rate of inflation is likely to be well above the Central Bank’s target of 1–3%.
Limited deterioration in public and external accounts
The current account balance turned negative in 2021 at -0.9% of GDP. This can be explained by a sharp drop in the trade surplus to EUR 2.8 billion last year compared to EUR 10.6 billion in 2020. The trade balance was insufficient to compensate for the structural deficit in the income balance, which amounted to EUR 9.1 billion. As for the services account, it remained close to its four-year average at a surplus of EUR 4.3 billion.
The current account deficit is likely to persist over the next two years due to an increase in energy costs and a slowdown in exports. Energy imports from Russia are relatively high, at 42% of the total. This dependence is significant in terms of gas supply (71% of imports). For the time being, the Czech Republic, Hungary and Slovakia have obtained an exemption from the EU embargo on Russian oil imports.
Nevertheless, FDI flows and funds from the EU will still largely finance external needs, and foreign exchange reserves will likely increase. These will cover 9.4 months of imports in 2022, a very comfortable ratio.
The consolidation of the public finances will probably be delayed again this year. In this scenario, the budget deficit would remain high over the short term. The authorities anticipate a deficit of 4.5% of GDP for 2022 compared to the initial predictions of 3.3% last February. This revision aims to take account of the new government support measures. In addition to those in favour of households, guarantees on SME borrowings and deadlines for VAT payments are aimed at supporting businesses. Government debt would remain close to 40% of GDP by 2023, or about 10 points above 2019 level.
Importantly, the government’s debt service burden will increase due to the rise in 5-year or 10-year rates on the local bond market. However, compared to revenues which have steadily increased over the past 10 years, the increase is likely to remain limited.
