The Czech authorities should adopt a medium-term fiscal strategy that is growth friendly and maintain supportive monetary until inflation expectations become well anchored around the central bank’s 2% inflation target, the IMF said after concluding the Article IV consultations with the Czech Republic.

The fund expects the Czech GDP to expand by 2.5% in 2014, revising up its forecast from an earlier expected growth of 1.9%. Growth should be supported by a balanced contribution from external and domestic demand. The mid-term growth outlook is projected to stabilise at 2%, the IMF said adding that it is constrained by slow productivity growth, an aging population and structural obstacles in the labor market. The fund urged the authorities to advance structural reforms aimed at increasing labour force participation, enhancing investment in human and physical capital and improving the business environment.

On fiscal policy, the fund said the adoption of a clear medium-term fiscal framework, enshrined in legislation, is important for anchoring fiscal policy and avoiding pro-cyclicality. The finance ministry's updated proposal of the Fiscal Framework Reform includes expenditure ceilings derived from the mid-term objective of 1% of GDP structural deficit, a debt brake rule starting at 55% of GDP (net of financing reserve), and a Fiscal Council. “In the mission’s view, adoption of this proposal would help eliminate the pro-cyclical bias of fiscal policy, which exacerbated the economic cycle in recent years. The proposed structural deficit target strikes the right balance between reducing debt and creating long-term fiscal space on the one hand, and allowing adequate space for current fiscal policy priorities on the other. Moreover, this rule would be consistent with EU fiscal framework requirements”, the IMF said.

The fund expects inflation to gradually move towards the central bank’s target starting from late 2014 supported by the ongoing recovery and the foreign exchange intervention policy. Once deflation risks recede, the bank should exit the weak-koruna regime, the IMF recommended.

The IMF said the Czech financial system is sound and resilient. Banks, the majority of which are foreign-owned, are self-financed with a low average loan-to-deposit ratio and strong capital and liquidity buffers.