The Czech government should avoid further consolidation efforts until the economic activity gains straight and implement pro-growth measures, the IMF said after concluding the Article IV consultations with the Czech Republic.

The euro area slump and weak domestic demand have pushed the Czech economy into its longest ever recession and therefore the government should embark on short-term policies aimed at supporting growth and not creating additional drag, the IMF said. The fund recommended to the government to keep fiscal policy neutral in the next few years until the economic recovery gains strength.

The fund expects the Czech GDP to contract by 0.4% in 2013, revising down its forecast from an earlier expected growth of 0.3%. Next year’s forecast was also cut to a GDP growth of 1.5% from 1.6% expected in April.

On monetary policy, the IMF agreed that FX interventions would be an effective and appropriate tool to address deflationary risks. Koruna sales will quickly increase the price level and help boost inflation expectations toward the target. Inflation has stayed below the central bank’s 2% target since January.

The IMF said that main risk for the Czech banking system is a protracted or deeper recession that would harm the asset quality of banks and while the existing capital and liquidity buffers are expected to keep the system resilient, proactive supervision would add to the strength in the face of potential further economic weakening. The authorities should implement improvements in the areas of bank resolution and deposit insurance.

The fund also urged the authorities to strengthen policies to enhance investment in both physical and human capital, improve the business environment and increase labour participation in order to boost potential growth.