Czechs vote for austerity

By bne IntelliNews May 31, 2010

Nicholas Watson in Prague -

Contagion from the Greek debt crisis is not only spreading through the markets, but also the populace of Europe. On May 28-29, Czech voters, like those in Hungary and the UK before them, chose centre-right parties dedicated to fiscal austerity over those more concerned with maintaining social spending.

Unlike in the UK and Hungary, the centre-left Social Democratic Party (CSSD) had been widely predicted to win the Czech parliamentary elections, brought forward to elect a government to replace the interim one that has governed since the previous centre-right coalition government (led by the Civic Democrats, or ODS) broke down in March last year.

As it turned out, CSSD did win the most votes, around 22.1%, but lack the partners necessary to form a government; the Communists failed to place in the top three for the first time, coming in fourth with 11.3% of the vote. Thus the three parties that had campaigned for responsible spending - ODS with 20.2%, TOP09 with 16.7% and Veci Verejne with 10.9% - have been given the opportunity to form a government. "The main focus is on the budget and fiscal consolidation, and it seems like populist spending policies do not pay off, suggesting that the political climate is maturing," reckons Marcus Swedberg, economist of East Capital.

The first positives to take from the result is that the three centre-right parties should be able to form a coalition comparatively easily, so removing the worry of weeks or even months of squabbling between the centre right and centre left. Should that centre-right coalition be formed, it will also mean that the for the first time in more than a decade the Czech Republic will have a government with a strong majority, having 118 deputies in the 200-seat lower house. "Suffice to say, a very market friendly election result in the Czech Republic," says Timothy Ash of Royal Bank of Scotland (RBS). "These elections suggest decisive action on the budget and pension reform. They should significantly ease market concern over any vulnerabilities."

The biggest weakness of the Czech economy is the budget deficit, which hit 5.9% of GDP last year, almost twice the limit for countries that use the single currency. Bringing that deficit down is crucial if the Czech government isn't to see its 'A1'/'A' credit rating go the way of other profligate nations such as Greece and Spain, downgrades that would increase the costs of its huge borrowing this year. The Czech state plans to sell a record CZK280bn ($13.5bn) of debt this year, including bonds denominated in euros.

In its latest convergence programme (which lays out how the government intends to bring its finances toward those levels needed to join the euro), the interim government targeted a reduction of the public deficit from the previously expected 6.6% of GDP in 2009 to 5.3% in 2010 and a further reduction of the deficit to 4.8% and 4.2% of GDP in 2011 and 2012 respectively. With data showing that the 2009 deficit was better at just 5.9% of GDP, this makes the government target for 2010 less ambitious. However, the European Commission has criticised the government's plan further out as one that, "does not provide sufficiently concrete measures on the expenditure side in 2011 and 2012, and no information is provided on deficit-reducing measures in 2013."

Eva Zamrazilova, a board member of the Czech National Bank, tells bne that the main challenge for the Czech Republic remains public finance reform. "It's crucial for future governments to take radical steps," she says.

That will include tackling such thorny issues as pension and health reform, something that simply wouldn't happen if CSSD had won - they had promised to pay bonuses to pensioners and boost medical benefits - and would be nigh on impossible without a government with a strong majority.

As it is, Vojtech Benda of ING in Prague says any radical reforms are unlikely anytime soon partly because of the approaching regional and Senate elections in the autumn. "This time it will be mainly ODS defending its seats in the Senate. CSSD has no seats to defend of the 27 up for election, hence theoretically only the left can gain from the election and possibly disrupt the centre-right majority in the Senate...[which] would significantly improve their chances for the presidential elections in 2013," he says.

Buying the country some time is its strong fundamentals - it has modest public sector debt and external debt levels, a solid banking sector and a current account deficit more or less covered by foreign direct investment. "Given the low levels of public debt (35% of GDP in 2009), the Czech Republic is apparently not in imminent threat of sharp fiscal deterioration," says Benda.

Even so, with the markets in a very unforgiving mood over debt levels, that time could run out sooner than many are predicting.

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