Markets shrug off another Czech crisis

By bne IntelliNews June 17, 2013

Tim Gosling in Prague -

Following tradition, the markets shrugged off the resignation of the Czech PM and likely collapse of the governing coalition on June 17. Indeed, as gains on the equities market hinted, it's possible investors are betting a left-leaning government is on the way, and that loosened purse strings will help push the economy out of recession.

Deep political uncertainty is usually enough to put the willies up investors in emerging markets at the best of times, let alone right now, when money is being pulled out of higher-yielding assets on the back of worries over the end of quantitative easing by western central banks. When Prime Minister Petr Necas walked, the country lost its longest-serving leader in the last decade.

Yet the years of bumbling calamity in Mala Strana, and indeed the constant news flow of deep-seated corruption, appear to have trained investors to keep calm and carry on. The Czech crown has hardly budged within its usual trading range of CZK24-26 to the euro through the latest episode, and strengthened on June 17 to 25.60 as the EM sell-off abated.

While the main index of the Prague Stock Exchange saw a limited sell-off when reports began emerging on June 13, shares spent most of the day that Necas was clearing his desk bubbling a little higher, before closing flat. The yield on the country's benchmark 2024 bonds retreated back to 2%.

Triggered by a series of anti-corruption raids late last week, and in particular the arrest of his close aide - and alleged lover - Jana Nagyova, Prime Minister Petr Necas gave up the ghost and quit his post on June 17. Under the constitution, the cabinet will now be dissolved also. The ruling three-party coalition - which controls just 98-100 of parliament's 200 seats - has said it will try to agree on a new government to see out its term.

It is under pressure, however, to go to the polls ahead of the scheduled election in June 2014. The opposition Czech Social Democratic Party (CSSD) is chomping at the bit given its huge lead in opinion polls, which is due to the harsh austerity programme that the coalition has followed since coming to power in 2010.

Meanwhile, populist President Milos Zeman - who is responsible for naming the next PM - has demanded an early vote several times in recent months. A former CSSD PM himself, Zeman has already proved he is ready to leverage the traditionally formal functions of his post to influence the country's political scene.

It's highly likely then, that Necas' centre-right Civic Democratic Party (ODS) and main coalition partner Top09 may well be forced to face the electorate a year early. Yet the administration looked set to crash and burn throughout 2012 as it stumbled from crisis to crisis. As they seem happy to do regardless, investors took the petty squabbles and grubby dealing in their stride, to continue pushing yields to lower and lower records throughout the year.

William Jackson at Capital Economics suggests that the latest show of resilience by the financial markets is also "justified". "After all," he writes in a note to clients, "both the current government and the opposition Social Democrats have fairly credible policy agendas. What's more, political instability is nothing new for the country. Mr Necas had survived multiple votes of no confidence during his three-year premiership (which made him the longest serving PM over the past decade)."

In fact it may be that investors - including those that have chased Czech debt to those historic lows - may be glad to see the back of Necas' government and its harsh austerity. That programme has been widely criticized for helping to drop the economy into its longest ever recession, having been in contraction since the last quarter of 2011. The grim outlook persists, despite the government having at least said recently that it will cease efforts to continue trimming its budget deficit.

Moody's Investors Service cut its growth forecast for 2013 earlier this month, with the rating agency now expecting GDP to contract by 0.6%. The International Monetary Fund warned in a report last month that "the current poor growth performance, if protracted, runs the risk of translating itself into a long-term decline in potential growth due to lower investment". In a clear rebuke of the Necas government's lust for austerity, it added: "Over the next few years, until the economic recovery gains strength, a neutral fiscal stance would be appropriate."

The refusal to offer any stimulus to help overcome depressed demand for exports out of the Eurozone - on which the economy is overwhelmingly dependent - has left the Czech National Bank in a corner. Interest rates were cut by 75 basis points last year to leave them at zero (essentially). The central bank has since been suggesting it may need to move to deflate the crown, although its interventions remain vocal for now.

At the same time, Erste Bank worries that "the market could be afraid that the leftist Social Democrats will take power," noting that CSSD has threatened to raise corporate taxes on utilities. That, however, is little more than "pre-election rhetoric" the analysts claim.

Indeed, in their opinion, like every other recent crisis, the latest explosive news out of Prague's grubby political scene is meaningless for the markets. "This government is done with the restrictions and is talking about relaxing fiscal policy a bit in the future. So whether it's now replaced by Social Democrats instead of being replaced by them in June 2014 doesn't make much of a difference." Any market reaction - pre-election positioning / uncertainty, higher volatility on both bonds and forex markets - they suggest, "won't be large and won't be long enough to influence either the economy or monetary policy".

Jackson appears to concur when it comes to the Czech markets, but suggests politics holds more sway in other Central and Eastern European countries. "However, the corruption allegations that led to [Necas'} departure, as well as the recent outbreak of protests in both Turkey and Bulgaria, serve as a timely reminder that Emerging Europe still suffers from governance problems," he writes. "Although the region is more advanced than most other emerging markets on this front, more still needs to be done to achieve convergence with developed countries."

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