Czech govt's public finance reforms are bold but perhaps doomed

By bne IntelliNews April 3, 2007

Nicholas Watson in Prague -

On Tuesday, the Czech government officially unveiled a package of public finance reforms agreed the evening before, which it hopes will boost growth and cut spending as first steps toward meeting the criteria for joining the euro sometime after 2010. But with a hung parliament, few are prepared to bet that this reform package will actually pass.

The package of reforms is a bold political move in a country not noted for such events recently. For six months the country didn't even have a government. The conservative party of Prime Minister Mirek Topolanek won last June's elections on a radical tax cut and reform platform, but it wasn't until January that, with the help of two left-wing defectors, its cobbled-together centre-right coalition survived a confidence vote in parliament.

PM Topolanek

Today's package of reforms is designed to cut the fiscal deficit toward 3% of GDP from the 4% predicted for this year. Doing so would meet one criterion for adopting the euro, which the government has admitted won’t be possible by the previous accession goal of 2010. It has yet to set a new target date, though some economists indicate 2012 is a realistic target if the reforms can be pushed through.

"This plan is a necessary pre-condition for forming a decent budget for the next year," Topolanek was quoted by newswires as telling a business conference where the plan was unveiled to the public.

On the tax front, the proposals call for a 15% flat tax on all personal income from 2008 to replace the current progressive tax brackets, which comprise a 12% bottom rate and 32% top rate. There will also be a rise in the bottom VAT rate from 5% to 9%, while the basic VAT rate will remain at the current 19%.

On corporate tax, the proposals call for it to be reduced from the current 24% to 19% in 2010. According to a survey by Wood & Co, the brokerage says such a change would most benefit heavy tax-payers exposed predominantly to the Czech market, such as the utility CEZ, Belgian banking group Komercni Banka and Spanish telecom firm Telefonica O2.

"Heavy tax-payers with the biggest exposure to the Czech market such as CEZ, Telefonica and Komercni Banka should benefit the most and we expect roughly a 5% increase in profitability as of 2009. On the other hand, Pegas and real estate companies will benefit the least," Wood & Co says.

Radek Narovec, an analyst with Wood & Co, says this package of reforms is currently better than what there is right now, though the government needs to attack the other public finance pillar of spending – particularly the welfare legislation approved before the 2006 election, which will raise social transfers by 1.1% of GDP this year and by 1.3% of GDP in 2008.

The government plan includes cuts of €633m in sickness benefits and social spending next year. It is these cuts that promise to be the biggest obstacle to getting the package made into law.

Well hung

The main opposition Social Democrats (CSSD) have already said they will oppose the government's plans to ram the package through the lower house of parliament in June, where the government and opposition each hold 100 seats.

Analysts say the government will have to rely on those opposition defectors who prevented the coalition from being stillborn in January.

Furthermore, the government is not interested in horse-trading over specific parts of the package, so intends on presenting them as an all-or-nothing package. If the package doesn't pass a vote in the lower house, the government will probably call fresh elections.

"This plan...not only is necessary, it is also approvable [in parliament]," Topolanek declared in a fit of admirable, though perhaps misplaced, optimism.

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