Czech Republic

Czechia has been a decent performer among emerging economies. However, a strong dependence on exports (accounting for around 80% of GDP), in particular on automotive shipments, causes above-average cyclical fluctuations in growth. Moreover, a high dependence on global supply chains and energy imports has made the Czech economy very vulnerable in the current global context of ongoing supply disruptions and significantly higher energy prices.

Real GDP expanded by an average +2.5% over the past 20 years, and by +3.9% over the five years prior to the Covid-19 pandemic (slightly below the average of the Central and Eastern European EU member states but above the average for Emerging Europe as a whole). As a consequence of its dependence on exports and supply chains, the Czech economy was hit harder by the global Covid-19 crisis than others (-5.5% in 2020) despite strong economic policy support. And after a moderate recovery in 2021 (+3.5% growth), economic activity has slowed down markedly in 2022 as a result of the consequences of the war in Ukraine, notably the subsequent EU sanctions on Russia and soaring energy prices. We expect the Czech economy to enter a recession at the end of 2022, followed by a contraction of full-year real GDP in 2023.

Inflationary pressures will remain on the cards in 2023. Consumer price inflation rose into double-digit territory in early 2022 amid surging energy and food prices, and it approached almost 20% y/y in the second half of the year. The monetary policy framework is formally based on inflation targeting, with the Czech National Bank (CNB, the central bank) aiming to keep the increase in consumer prices within a 2% ±1pp band. Indeed, the CNB raised its key policy interest rate by a cumulative 675bps to 7.00% from June 2021 to June 2022. However, it stopped hiking thereafter, even though inflation continued to rise, leaving the real policy rate deeply negative and thus maintaining an overall loose policy stance. Nonetheless, the Czech koruna (CZK) has been relatively stable versus the EUR in 2022 overall. But this could change if investors get more concerned about Czechia or CEE in general amid the weakening economic propects of the region. An anylysis of the real effective exchange rate suggested that the CZK was more than 10% overvalued in Q4 2022. Should this result in a lasting depreciation at some point, more monetary tightening will be required to stabilize markets.

The Czech business environment is well above average. The World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are generally business-friendly, though a certain level of corruption is still perceived as present. The Heritage Foundation’s “Index of Economic Freedom” survey for 2022 assigns Czechia rank 21 out of 184 economies, reflecting strong scores with regard to property rights, judicial effectiveness, tax burden, trade freedom, investment freedom and financial freedom. Meanwhile, our proprietary Environmental Sustainability Index puts Czechia at rank 60 out of 210 economies, reflecting strengths in energy use and CO2 emissions per GDP, water stress and general vulnerability to climate change. However, there are still weaknesses in renewable electricity output and the recycling rate.

Overall systemic political risk is relatively low. Czechia is a well-established democracy and has good international relations, reflected in its EU, NATO and OECD membership. Fragile coalition governments have often resulted in ineffective policymaking and slow reform progress. Yet, broad policy continuation has been the rule after past government changes, whether early or on schedule.