Jason Hovet

PRAGUE (Reuters – Czech officials have abandoned a long history of thrift over the past few years and pile tax cuts, wage hikes on top pandemic expenditure. The result is that the country’s debt will reach critical levels faster than any one expected.

It is a daunting task for any party that wins the Czech Republic’s weekend national elections.

Czech Finance Ministry projects that national debt will reach 43.5% GDP in 2019. This figure is up from 30% in 2019. After two years of budget deficits record, the International Monetary Fund predicts the country to have the second fastest growing debt load in Europe by 2025.

To avoid scaring away voters, the political parties have all ruled out tax increases and not shown any plans to do so. However, next year’s government will likely face a rude awakening, tough decisions about how to cut spending and find additional revenue.

Pavel Sobisek from UniCredit, Prague’s chief economist, stated, “The next government must come up with immediate savings. There must also be a credible plan within the next several years to reduce budget inequalities.”

“Raising taxes is necessary… This is certain.”

Public finances have been hit hard by the COVID-19 Pandemic. But Czech debt could skyrocket due to increasing budget commitments. This is a deviation from the past fiscal prudence of governments, both right and left.

The country was fourth in the EU for debt burden, and IMF spring projections show that debt will rise to 56% GDP by 2025.

    While debt levels are still modest compared to bigger countries – in the EU, the average state debt was 90.5% of GDP at the end of 2020 – it can be troubling for a smaller economy.

Czech law would make automatic budget cuts. This is something that no government wants. The Czech Republic is quickly approaching a 55% debt freeze. Independent state Fiscal Council previously predicted the danger of breaking debt limits wouldn’t occur before 2043. However, they now expect it to happen in the next decade.

** For an interactive graphic: https://tmsnrt.rs/3FlGXca

NEGATIVE CREDIT

It is not clear who will take over the task after the October 8-9 elections. Andrej Babis, Prime Minister of ANO is leading polls with about 26% support. But, he still doesn’t have clear partners who can help him secure a majority.

Babis’ centre left coalition government is in power from 2018, and budget expenditures like state pension increases, which are legally enshrined, cannot be reversed, as well as other expenses such que salaries that are necessary for state operations, have gone up 40%.

The central state budget deficit reached a new record of 367 billion Czech crowns (or $16.6 billion) at the close of the last year. This is almost double the record set in the past. The global fiscal deficit (which includes local and regional budgets as well as the state insurance system) reached 6.1% of GDP. It is double the EU’s limit.

Even after the coronavirus restrictions have been largely lifted, there is a record deficit in 2021. The economy will grow by 3.2% after contracted 5.8% last year. Alena Schillerova, Finance Minister, estimated that there was a deficit of 400 billion crowns on September 19.

Despite economic growth expected to increase to 4.2%, the government approved an almost identical deficit for next year.

Eva Zamrazilova is an ex-central banker and heads the Fiscal Council.

She stated that “the COVID crisis only exposed structural weaknesses,” and added that a major concern was the approaching debt brake. 

Sharp increases to state pensions, that went above and beyond the automatic increases required by law, are largely responsible. There have also been significant wage rises in public service. A record-breaking income tax cut was also implemented by the government this year. It is estimated that it will cost the state approximately 2% of GDP.

Schillerova stated that the state can borrow more, given the low debt levels it had before the COVID-19 crises. She also said consolidation is possible to stabilize the economy.

She said, “I don’t want to make the same mistakes as the previous crisis” in a Czech television debate program on Sept. 19, 2009. This was in reference to the budget cuts that were made following the 2009 financial crisis.

Babis responded to criticisms about how he handled the budget during Sunday’s election debate, saying that his government had increased teachers’ salaries by 22,000 crowns. However, a prior administration which included opposition parties added only hundreds of crowns.

Babis’s biggest challengers in this election are the liberal Pirate Party. This leads a two-party Pirates-Mayors Coalition that is second in polls. The centre-right Civic Democrats lead the three-party Spolu.

Both the former and latter want to limit state spending as well as return deficits below the EU-mandated 3 percent of GDP. They also propose to increase growth taxes such that they can be applied to mining. According to the latter, there will be no tax increases and a deficit of 1.5% by 2025. This is because it believes that EU funds can help stimulate growth and improve tax collection. According to the current government, there will be a deficit exceeding 4% by 2024.

Watchers of the budget say that it is necessary to make more money to protect the fiscal buffer as people reach retirement age.

The demand for debt auctions is still strong and the yields are slowly rising. The benchmark 10 year bond yield, which was for many years well below the central European peer group, is now 2.12%. This makes it almost equal to Poland.

Rating agency Moody’s (NYSE 🙂 rated the Czech Republic Aa3 in May. This is two notches higher than regional peers such as Poland and Slovakia, but ahead of Japan. It said that the medium-term fiscal plan for the country was lacking meaningful consolidation. They called it credit negative.

Zamrazilova warned that if the debt continues to rise, it could signal a market downturn.

She said, “The worst thing is for public finance consolidation to be forced by financial markets stress.” “Consolidation should be started as soon as it is possible.”

($1 = 21.8380 Czech crowns)