The Czech Republic on its Way Towards the Euro
Conference: "Competitiveness of the South Eastern European Countries: Challenges on the Road to EU
Skopje, May 30, 2008
Petr KRÁL Petr KRÁL Monetary and Statistics DepartmentMonetary and Statistics Department
Czech National BankCzech National Bank
2
Presentation Outline Presentation Outline
• Milestones on the Czech Republic's way to the West
• Economic effects of the EU membership
• Economic aspects of the adoption of the euro
• Euro-adoption plans
3
Milestones on the Czech Republic's way Milestones on the Czech Republic's way to the to the WWestest
• Successful transition from central planning to a functioning market economy
1989 – “Velvet Revolution” in former Czechoslovakia
1993 – split of Czechoslovakia into the Czech Republic and Slovak Republic
1995 – OECD membership 1999 – NATO membership 2004 – European Union
membership (derogation on euro introduction
• Characteristics of a small open economy
4
Economic effects of EUEconomic effects of EU the the membership membershipPre-accession economic developments (i)Pre-accession economic developments (i)
• Fundamental transformation steps and so-called transitory
recession (1990 – 94)
• Demand-driven economic recovery with supply side lagging behind
resulting into an overheating (1994 – 1997)
• Financial and subsequent economic crisis (1997 – 1999)
• Abolition of pegged ER combined with monetary targeting (1997) and
adoption of inflation targeting framework (1998)
• Supply-side improvements (FDIs) and acceleration of
convergence (2000 – )
5
Economic effects of EUEconomic effects of EU the the membership membershipPre-accession economic developments (ii)Pre-accession economic developments (ii)
Penetration of foreign capital into enterpreneurial sector
0.00
10.00
20.00
30.00
40.00
50.00
60.00
98/I III 99/I III 00/I III 01/I III 02/I III 03/I III 04/I III
time
%
Share of EUFC on VA Share of EUFC on GFCF
FDI inflow and FDI stock
0
200 000
400 000
600 000
800 000
1 000 000
1 200 000
1 400 000
93/I 94/I 95/I 96/1 97/I 98/I 99/I 00/I 01/I 02/I 03/I 04/I
time
mil
. o
f C
ZK
0
20 000
40 000
60 000
80 000
100 000
120 000
140 000
160 000
180 000
FDI inflow (right axis) FDI stock
• massive inflow of FDI started in 1998 (paradoxically in economic bad times)
• introduction of government investment incentives and privatization of state-owned
property kicked-off the inflow
Král (2004):Identification and Measurement of Relationships Concerning Inflow of FDI: The Ca
se of the Czech Rep. (CNB Working Paper)
• subsequently enterprises under foreign control begun to gain growing share on
economic activity
6
Economic effects of EUEconomic effects of EU the the membership membershipPre-accession economic developments (iiPre-accession economic developments (iiii))
Shares on cumulative FDI inflow during 1993-2003
15%
21%
13%12%
8%
6%
4%
5%
16% Transport, storage and communications
Financial intermediation
Trade, hotels and restaurants
Machinery and equipment
Real estate and business activities
Electricity, gas, and water supply
Food and tobacco
Refined petroleum and chemicals
others
Shares on cumulative FDI inflow during 1993-2003
31%
13%11%
9%
7%
6%
5%
18%
GermanyNetherlandsAustria FranceUnited States BelgiumSwitzerlandothers
• inward FDI has been both vertical benefiting from the comparative advantage of the
Czech economy in terms of input prices, government promotion of FDI and economic stability
• and horizontal focusing on the LR growth and market size prospects arising from
the expected Czech Republic’s future accession to the EU
• FDIs were coming prevailingly from EU countries (Germany, Austria, Netherlands?)
7
Economic effects of EUEconomic effects of EU the the membership membershipPre-accession economic developments (iPre-accession economic developments (ivv))
• as a result the Czech Republic became one of the most FDI penetrated country in the region
and in the world and openness and export performance of the country are also tremendous
• positive effects of inward FDI on the supply side of the economy (capital stock + crowding-in
effects, primary and secondary technological spillovers) contributed significantly to the gradual
acceleration of potential (non-inflationary) output growth
FDI stock per capita (in USD)
0.0
500.0
1 000.0
1 500.0
2 000.0
2 500.0
3 000.0
3 500.0
4 000.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Czech Republic Hungary Poland Slovakia
FDI inflow per capita (in USD)
0.0
100.0
200.0
300.0
400.0
500.0
600.0
700.0
800.0
900.0
1 000.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Czech Republic Hungary Poland Slovakia
8
Economic effects of EUEconomic effects of EU the the membership membershipEU entry – acceleration of ongoing trends and new phenomenaEU entry – acceleration of ongoing trends and new phenomena (i) (i)
• EU single market – 4 freedoms of movement
Goods
Services
Labour
Capital
• EU regulations Acquis communautaire
EU norms, tax harmonization, common policies (e.g. trade, agriculture)
• Access to EU funds
• “Reputation” effect
9
Economic effects of EUEconomic effects of EU the the membership membershipEU entry – acceleration of ongoing trends and new phenomenaEU entry – acceleration of ongoing trends and new phenomena (ii) (ii)
-2
0
2
4
6
8
10
12
96 97 98 99 00 01 02 03 04 05 06 07 08 09
CZEAEE+LV+LTHU+PL+SI+SK
0
10
20
30
40
50
60
70
80
90
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0
5
10
15
20
25
Share-exports Share-imports
growth-exports (righ axis) growth-imports (righ axix)
• acceleration of GDP growth and its potential
• speed-up of the real convergence vis-à-vis western countries
• rapidly growing export capacities are the main driver (extreme in 2004)
• steadily increasing openness of the economy
10
Economic effects of EUEconomic effects of EU the the membership membershipEU entry – acceleration of ongoing trends and new phenomenaEU entry – acceleration of ongoing trends and new phenomena (iii) (iii)
0%
25%
50%
75%
100%
total total EU15 total EU15
Misc.manufacturedgoodsMachines, transportequipmentBasic manufactures
Chemicals
SITC 0-4 and 9
2000 20051993
-150-100-50
050
100150200250300350
fuels chemicals Manufacturedgoods
Machineryand transport
equip.
Manufacturedarticles
duben 04 srpen 04 prosinec 04 duben 05 srpen 05 prosinec 05 duben 06 srpen 06 prosinec 06 duben 07 srpen 07 leden 08
Czech exports have developed specialized in machinery and transport equipment, mainly as a result of FDI
As a result, trade balance turned to positivenumbers being driven by the surplus of thetrade with SITC 7 items
11
Macroeconomic policies MP – EU entry itself no major challenge (tax harmonization: no
large price shock)
FP – task to meet Stability and Growth Pact requirements
Economic effects of EUEconomic effects of EU the the membership membershipEU entry – acceleration of ongoing trends and new phenomenaEU entry – acceleration of ongoing trends and new phenomena (iv) (iv)
12
Economic aspects of the euro adoptionEconomic aspects of the euro adoption Why to adoptWhy to adopt the euro the euro
• Legal obligation (no opt-out clause, only derogation)• Economic reasoning
Exchange rate and interest rate stability Lower transaction cost (reduction in exchange rate risk, access to
more liquid financial markets) Higher price transparency Disciplining effect on domestic economic policies Final step in the EU integration
13
Economic aspects of the euro adoptionEconomic aspects of the euro adoption Possible risksPossible risks
• Loss of independent monetary policy Interest rates handed over to ECB
=> ECB’s common monetary policy does not have to fit the Czech reality
=> Limited reaction to asymmetric shocks Solution ?!
Economic alignment Flexible alternative
stabilization mechanisms Fiscal policy Labour market
• Inflation acceleration
0
20
40
60
80
100
120
140
160
180
0 20 40 60 80 100 120 140 160 180
HDP v PPS (2006, EU12=100)
Pri
ce
lev
el o
f c
on
su
mp
tio
n (
20
06
, EU
12
=1
00
)
y = 0.7547x + 24.529R2 = 0.8469
MK BG
FI
CZ
TR
CH
DKIS
IE
NO
LT
PL
HR
RO
SK
UK
AT
NL
CY
GR
SI
HU
EEMT
PT
LV
SE
ES
BEDE
IT FR
14
Economic aspects ofEconomic aspects of the the euro euro adoptioadoptionn Timing of the euro adoptionTiming of the euro adoption
Formal conditions Maastricht criteria
Price stability Inflation: below three best
performing EU countries’ inflation +1.5 pp
Sustainability of government finance
Fiscal deficit: < 3% of GDP Gov. debt: < 60% of GDP
Exchange rate stability Exchange rate: ERM II
participation for 2 years without sever tensions
Durability of convergence LT interest rate: below three
best (inflation) performing EU countries’ IR +2.0 pp
Compatibility of legal framework
Including the central bank status with EU regulation
Informal conditionsEconomic consideration
Symmetry Flexibility
15
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. Strategic documentsStrategic documents
• CNB & Government The CR’s EA accession strategy
First in 2003Updated in 2007
Assessment of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment of the CR with the EA
• CNB Analyses of the CR’s current economic alignment with the EA http://www.cnb.cz/en/monetary_policy/strategic_documents
• Government Convergence programme of the CR http://www.mfcr.cz/cps/rde/xchg/mfcr/xsl/conv_program.html
16
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. First EA Accession Strategy (2003First EA Accession Strategy (2003))
• Common stance by the CNB and the Government• Benefits outweigh risks, but risks can be reduced
quality preferred to speed
• CNB will continue in IT until the CR adopts the euro• Participation in ERM II only for minimum possible period
2 years
• Expected date of the euro adoption => 2009 – 2010 conditional on
Criteria fulfilment Including a consolidation of public finances
Achievement of a sufficient level of real convergence Adequate progress with structural reforms
Leading to a sufficient degree of economic alignment
17
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. Fulfillment of the Maastricht criteriaFulfillment of the Maastricht criteria
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Czech Republic Hungary Poland Slovakia
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Czech Republic Hungary Poland Slovakia
Inflation Fiscal deficit
BUT 2008
Public debt ERM II
LT sustainability?
-2
0
2
4
6
8
10
12
14
16
1999 2000 2001 2002 2003 2004 2005 2006 2007
Reference value Czech Republic Hungary Poland Slovakia
LT IR
0
2
4
6
8
10
12
14
2001 2002 2003 2004 2005 2006 2007
Reference value Czech Republic Hungary Poland Slovakia
18
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. Economic Alignment (i)Economic Alignment (i)
0
20
40
60
80
100
120
CZ AT DE PT HU PL SI SK
GDP per capita in PPP Average GDP price level
• Progress achieved• Important gap persists for the CR – especially in the price
level
=> expectation of the real exchange rate appreciation
2006; euro area average = 100
Long-run convergenceLong-run convergence
19
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. Economic Alignment (ii)Economic Alignment (ii)
0.0
0.2
0.4
0.6
0.8
1.0
CZ AT DE HU PL SI SK
year-on-year differences quarter-on-quarter differences
• Major difference between the cycle of the CZ and EA real GDP growth
• Low correlation with the euro area characteristic also for macroeconomic shocks
• Higher level of correlation seems to prevail for industrial production
vis-à-vis the euro area, 2001:Q1-2006:Q1
Correlation of GDP GrowthCorrelation of GDP Growth
20
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. Economic Alignment (iii)Economic Alignment (iii)
• Fiscal deficit structural in nature• Little room left for automatic stabilizers
• Some reforms have been implemented, some are in the pipeline and some have been announced
• Figures for 2007 - 2008 revised downwards • Long-term sustainability remains an issue
-1
0
1
2
3
4
5
6
7
8
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Cyclical def icit
Cyclically adjusted def icit
Total def icit
Fiscal deficitsFiscal deficits
21
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. Economic Alignment (iv)Economic Alignment (iv)
0
10
20
30
40
50
60
70
80
CZ AT DE PT HU PL SI SK
Long-term unemployment Variation coefficient
Both indicators are relatively high – showing structural problems
on the labour market (including low mobility)
Long-term unemployment:: % share of long-term unemployed (12Ms or more) in total unemployment, 2006
Variation coefficient of regional unemployment: NUTS2, 2005, CNB calculation
LT unemployment and regional differencesLT unemployment and regional differences
22
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. An Up-dated EA Accession Strategy (2007) (i)An Up-dated EA Accession Strategy (2007) (i)
• Strategy from 2003 has proven to be useful and in some sense fulfilled
BUT• Major obstacle was seen in fiscal consolidation
EDP should be abrogated ASAP (1st stage of fiscal reforms) Maastricht criterion not ambitious enough Medium-term objectives (SGP) should be targeted Long-run challenges stemming from demographic changes have to be
addressed
• Still low flexibility and efficiency of the economy the labour market must be markedly enhanced
23
Euro-adoption plans of the Czech Rep.Euro-adoption plans of the Czech Rep. An Up-dated EA Accession Strategy (2007) (ii)An Up-dated EA Accession Strategy (2007) (ii)
• Conclusion
No particular date of entry proposed
New euro-adoption date will not be set until sufficient progress is made in fiscal consolidation and flexibility of the economy
The same conclusions drawn in the last annual Assessment of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment published at the end of 2007
CR will not initiate the ERM II entry in 2008
