OECD predicts Czech economy to flatline this year

OECD predicts Czech economy to flatline this year
/ bne IntelliNews
By Robert Anderson in Prague April 3, 2023

The Organisation for Economic Cooperation and Development (OECD) predicts Czech GDP growth of 0.1% this year, before a rebound to 2.4% in 2024 as global trade recovers, the intergovernmental economic organisation said in its 2023 Economic Survey.

The figure is more optimistic than that of the Czech authorities. The Ministry of Finance predicts a decrease of 0.5%, and the Czech National Bank (CNB) 0.3%. The country has been in recession since mid-2022.

The OECD also expects higher inflation, at 13.0% this year, while the ministry's estimate is 10.4 percent and the CNB's forecast is 10.8%. In 2024 the OECD predicts inflation will fall to 4.1%.

The OECD says Czechia has one of highest core inflations in the EU and that inflation is broad-based and entrenched. It points to the high inflationary expectations, with corporates expecting 7% inflation in a three-year horizon. It says inflation will only approach the central bank’s 2% target at the end of 2024.

The OECD says the immediate economic priority is to bring down inflation through a strict monetary policy, as well as by maintaining a tight macroeconomic policy stance.

The central bank maintained interest rates at 7% last week but there is strong speculation that doveish Governor Ales Michl may push to cut during the summer.

The OECD’s comments on the fiscal deficit were welcomed by Prime Minister Petr Fiala. His right-wing Civic Democratic party (ODS) has long pushed for cutting the deficit through spending curbs, rather than tax hikes.

The OECD says that in hindsight the loose overall macro-economic policy in 2020-21 (during the COVID-19 pandemic under the previous government of populist Andrej Babis) contributed to high inflation by boosting demand over supply capacity.

Fiala told a press conference on March 31 with OECD Secretary-General Mathias Cormann that his government wants to reduce the structural deficit annually by 1% of GDP, i.e. roughly CZK70bn. The total budget deficit of CZK360.4bn last year corresponded to 3.6% of GDP.

Fiala said: "I am glad that this important and independent organisation confirms the necessity of carrying out reform steps, which are sometimes not entirely pleasant and can be perceived as painful by some parts of society, but which are necessary for the good future of our country."

However, Fiala pointedly ignored the OECD’s recommendations on how to close the fiscal gap and its criticisms of the “untargeted tax transfers and permanent cut in tax revenues” in late 2020 that widened the gap. The ODS backed Babis’ tax cuts for the rich and the abolition of stamp duty that cost the state 2 percentage points in revenue and, according to the OECD. “aggravated the fiscal challenge”.

For the longer term, the OECD said pension and tax reforms could strengthen public finances in the face of looming costs from population ageing, while labour and education reforms would boost growth and incomes.

Too many Czechs still retire at 60. It said that without reform Czechia’s debt to GDP ratio is set to rise dramatically.

“Advancing pension and tax reforms would strengthen public finances in the face of rising spending needs. Bringing more skilled people into the labour market while boosting female workforce participation would help address the chronic labour and skills shortages that are weighing on growth,” the OECD said.

On tax, the OECD recommends cutting the high tax burden on labour, increasing the progressivity of the tax system, and raising the very low real estate and environmental taxes, mostly ideas anathema to the ODS. The OECD also recommends targeting help during the current cost of living crisis on the poorest, rather than the universal help the government has preferred for electoral reasons.

In terms of promoting growth, the OECD said that chronic labour shortages are a major obstacle to growth. It recommends lengthening working lives and broadening labour participation, for example by providing incentives for mothers to take up jobs. That could include better provision of childcare – with the number of places for under three-year-olds one of the worst in the OECD – and adjustments to parental leave and benefits, which it says are too generous.

Labour migration policy could also be better geared to attract skilled foreign workers. It says close to 90% from non-EU countries work in low- to medium-skilled jobs.

It also recommends investing in education and skills. Tertiary educational attainment, despite progress in recent years, lags significantly behind OECD peers, it points out. At the secondary level, it highlights that parents’ socio-economic status has a strong impact on performance in school, and it recommends that the system should be reformed to abolish tracking at too early a level.

On the environment, it says current environmental policies are not stringent enough to effectively curb carbon emissions. Effective carbon tax rates are among the lowest in the OECD. It also points out that Czech buildings have one of the highest emissions per square metre in the EU and that there are few incentives to make buildings more energy-efficient.

It recommends the government use the current energy crisis as an opportunity to strengthen its resolve on decarbonising its economy, which still relies heavily on coal for electricity production and heat generation. More public funding and an improved business climate could help to increase the investment needed to expand renewable energy sources and improve energy efficiency, particularly in housing. More stringent environmental policies would also help to bring down greenhouse gas (GHG) emissions.

In a separate review on governance, it says that more could also be done to strengthen the attractiveness of the public service by recruiting talent through streamlined recruitment processes. The national government should also look to encourage greater inter-municipal co-operation and planning, in particular through incentives, including financial ones, and new collaboration mechanisms.