Jan Cienski in Prague -
Enthusiasts for joining the euro are fairly common across Central Europe, but there aren't many of them in the Czech government or in the Czech Central Bank, where the commitment to adopting the common currency is viewed as a necessary burden and not a boon for the economy.
"I'm sceptical of the euro adding to economic growth," says Zdenek Tuma, the Czech Republic's central banker, in a recent interview. "In the long run, I wouldn't overstate the role of the euro. I've been neutral for many, many years in this respect."
Tuma isn't alone in his views. The most powerful euro-sceptic in the country is Vaclav Klaus, the president, an economist who sees little benefit in giving up the Czech koruna for the euro.
"This country has historically been a low-inflation country, even the communists pursued fiscally prudent policies," says Kamil Janacek, chief economist for Komercni Banka in Prague.
Alexandr Vondra, the Czech deputy prime minister, says: "Czechs have no memory of inflation and economic instability so people do not see the euro as an anchor to save them."
That position infuriates the opposition Social Democrats, who warn that the euro is of more than just economic importance to the Czech Republic.
"We should be inside every club of which Germany is a member," says Josef Zieleniec, a Social Democrat Member of the European Parliament. "To be part of the Eurozone is to be part of a respected club."
Pushing the date back
That lack of emotional and intellectual attachment to the euro has meant that the centre-right Czech government has paid little political price for deciding to back away from an earlier commitment to join the euro by 2010. The finance minister has mused about 2012 as a possible entry date, but there is no official stance, prompting Tuma to remark: "I'm also curious about our euro-entry strategy."
The government of Mirek Topolanek, the prime minister, said earlier this year that it had to put off joining the euro because government spending had spun out of control.
"I believed that 2009 or 2010 was feasible, but in the past two years there has been quite a serious deterioration in public finances, especially prior to the last elections," says Tuma.
Government spending increased before last year's parliamentary election, when the ruling left-wing Social Democrats passed welfare reforms that lifted government spending by about 1.5% of GDP. The government deficit is expected to reach 4% of GDP this year, above the 3% mandated by the Maastricht criteria for euro membership.
Tuma criticises the Czech Republic's rulers for failing to act during strong economic growth (6.1% last year), when it would have been more politically palatable to trim government spending.
"There was no significant reform on the expenditure side and the stabilisation of public finances was primarily because of higher revenues because the Czech economy was doing better than expected," he says.
On April 3, the government presented a spending reform package that aims to cut some welfare benefits, while making the proposal politically palatable by introducing a 15% flat income tax. However, upon closer inspection the flat tax scheme is less generous than it first appears. Because the tax will be imposed on gross income, which includes employers' social security and health care contributions, the true taxation rate is closer to 23%.
Other tax cuts include lowering the corporate tax to 19% from 24% by 2010, raising the tax threshold and increasing the deduction for having children.
Although the measure will include the Czech Republic in the growing number of Central European countries adopting a flat tax, Tuma says that there is no intrinsic advantage to such a system.
"The crucial thing is tax simplification," he says, pointing out that the proposal is really a "good marketing tool".
The package faces a difficult time in the Czech parliament, where Topolanek's governing coalition has only 100 out of 200 seats. The government was formed last year with the acquiescence of two rebel Social Democratic MPs, who are, however, thought unlikely to support the reforms.
However, without spending reforms, there is no chance of Prague being admitted into the Eurozone, says Tuma.
"If a package of reforms is approved by parliament and implemented then it makes sense to consider a specific date, otherwise it would be quite premature," he says.
Another reason for the chill towards the euro coming out of Prague is that the Czech Republic has a 1.9% annual inflation rate, and an interest rate 1.5 percentage points below that of the European Central Bank. Tuma points out that would mean an interest rate rise for Czechs if the euro is adopted, a different situation than most of their Central European neighbours.
One result of the low interest rate only Japan and Switzerland are lower is that a carry trade has arisen, where investors borrow low interest koruna and invest in higher yielding assets elsewhere.
With interest rates so low, households are discouraged from saving," says Pavel Sobisek, chief economist for HVB Bank in Prague. "People are buying securities, real estate and consumer goods instead."
Tuma also says that he is keeping a close eye on inflation, adding he would be more comfortable if it were within a 1 percentage point band around the bank's 3% target rate.
"The bank is not happy if it is below that range," he says. "We still believe that inflation should go up so that we would be back within the band."
What may change Czech minds about the euro is the experience of neighbouring Slovakia. Many Czechs had looked down on their former countrymen as backward, and received a nasty shock when Slovakia was admitted to the European Exchange Rate Mechanism and looks to be on track to adopt the euro by 2009.
"Czechs are travelling to Slovakia to observe what is going on there," says Tuma. "Psychologically, it is more important than economically, but it could influence public opinion here."
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