Czech Rep ranked in top 10 safest sovereigns despite political crisis

By bne IntelliNews July 18, 2013

Tim Gosling in Prague -

The Czech Republic is facing a drawn-out constitutional crisis after a bid to oust the president's newly-appointed cabinet failed to whip up the required support in parliament in a vote on July 17. Meanwhile, investors maintain their aloof stance, with the Czech sovereign promoted into the top 10 of the world's least risky issuers by Standard & Poor's.

A proposal to dissolve parliament from the Social Democratic Party (CSSD) - a step needed to call early elections - mustered only 96 votes in the 200-seat lower house. A three-fifths majority of 120 votes was needed to carry the motion, which was sparked by President Milos Zeman's decision to push past the objections of political parties of all stripes to appoint a "government of experts" on July 10.

Headed by Zeman's economic advisor Jiri Rusnok - and stuffed with the president's allies - the new administration must face a vote of confidence in parliament by August 8. Even though it's unlikely to win the 50%+ it needs, Zeman could yet keep his pet cabinet in office for the next 10 months. The political parties have pledged to block its policymaking, threatening gridlock in governance. The first priority is to build a 2014 budget.

Despite all this, S&P Capital IQ's Global Sovereign Debt data report for the last quarter - released the same day as the parliamentary vote in Prague - saw the Czech Republic enter in the global top ten for safest sovereign debt. While the country benefited from the widening of credit default swap (CDS) spreads - the cost of insuring debt against default - in Australia and New Zealand, it also sits just 38 basis points (bp) above the UK in ninth spot.

Yields on 10-year treasuries sat at 2.11% as parliament went to the historic vote, reports Bloomberg. That's just 5bp above where they stood on June 12, the night before police raids hit multiple government buildings to carry out searches and arrest the closest aide of then-PM Petr Necas.

Constitutional meltdown - so what?

That illustrates investors are maintaining their traditional stance toward the country, ignoring the petty squabbles within the Czech political scene - perhaps even to the extreme. Throughout 2012, the coalition government flirted with collapse, but bond yields continued setting new record lows.

While emerging market currencies have been hard hit by the recent sell-off on the back of comments from the US Federal Reserve, the Czech koruna remains barely affected, leaving the Czech National Bank to continue to try verbal intervention in a bid to stimulate exports. The economy remains in its longest ever recession.

Now, not only does the country face the likelihood of political gridlock, but it also stands on the edge of potential constitutional meltdown. Zeman, who has been pushing at the boundaries of the presidency ever since he took office in March, appears determined to continue his grip on the levers of power by maintaining his "interim" government.

Both the centre-right coalition of ODS/Top09, which fell in June with the resignation of Necas, and the left-leaning CSSD object furiously to the administration. However, they fatally destined to pull in different directions in their strategies to overturn it.

The coalition insists it has majority support in the lower house and should be allowed to establish a new government to see out its term, which finishes in May 2014. The CSSD - a shoo-in to win the next election whenever it should fall - claims an early vote is the rightful solution.

However, with ODS and Top09 facing annihilation at the polls due to years of harsh austerity, the CSSD's proposal to dissolve parliament and hold a vote in September is doomed to failure. That leaves Zeman the opportunity to leverage the vaguely-worded constitution, stretching its spirit further in order to keep his cabinet in situ until the next scheduled elections.

Should he follow that route, it risks a legal fight over the constitution and the entire basis of the political system. The Czech Republic is officially a parliamentary democracy, but Zeman is widely accused of trying to push it towards a "semi" presidential system.

More immediately, two of the three possible routes - Zeman's cabinet or a CSSD government - promises to see fiscal policy relaxed. It was the hawkish stance of the coalition over the past three years that helped push Czech yields to outperform the likes of neighbouring Poland through the emerging market bond rally of the last few quarters.

Yet the market continues to push all this to one side, with analysts insisting that it matters little who governs the country - there's little room for fiscal manoeuvre anyway.

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