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Cablegate: Czech Republic: Economy Remains Robust As Fiscal

VZCZCXRO5664
RR RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHPG #0758/01 1770624
ZNR UUUUU ZZH
R 260624Z JUN 07
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 9283
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NSC WASHDC
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 PRAGUE 000758

SIPDIS

SIPDIS

STATE FOR EUR/NCE, EUR/ERA, EB/IFD/OMA, E STAFF
TREASURY FOR OASIA ANNE ALIKONIS
STATE PLEASE PASS USTR WENDY MOORE
COMMERCE FOR ITA/MCA/EUR MIKE ROGERS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV EZ PGOV
SUBJECT: CZECH REPUBLIC: ECONOMY REMAINS ROBUST AS FISCAL
DISCIPLINE REMAINS THE WEAK LINK

REF: A. PRAGUE 698

B. 06 PRAGUE 1173

1. SUMMARY AND COMMENT: The Czech government on June 11
approved a preliminary 2008 budget deficit of CZK 78.4
billion (3% of GDP). However, these figures are entirely
dependent on the passage of the economic reform package (ref
A), which Parliament will address after returning from its
summer recess August 7. The government will submit the final
2008 budget to Parliament by end-September for approval by
end-year. In the meantime, despite continued erosion in
public finances, the Czech economy is outperforming
expectations of a moderate slowdown and may once again reach
6% GDP growth in 2007. Household consumption and exports are
leading GDP growth, and accompanying this growth is much
speculation about a credit bubble. There has been
significant and steady growth in household credit since 2003,
but the overall level as a proportion of GDP remains far
below the EU average and the Czech National Bank does not
believe it poses a significant macroeconomic risk. Despite
the robust growth, economists continue to warn that public
finances must be reined in quickly because structural growth
is slowing. Therefore, the pending economic reform package
in Parliament will impact not only the political future of
the coalition government, but also the sustainability of
rapid growth for the medium to long term. END SUMMARY AND
COMMENT.

---------------------------------------
ECONOMY DEFYING PREDICTIONS OF SLOWDOWN
---------------------------------------

2. The Czech Ministry of Finance forecasts 2007 GDP growth at
4.9%. The OECD in May said that economic growth in the Czech
Republic would slow from last year's 6.1% of GDP to 5.5% this
year and 5.0% in 2008, citing a lower pace of consumption
growth and an anticipated decline in exports. The Czech
National Bank forecasts GDP growth at a range of 4.9 - 6.5%
for 2007 and 3.8 - 6.8% for 2008. However,
stronger-than-anticipated export and consumer demand data
from the first four months of the year indicate these
forecasts may need to be revised upward to somewhere closer
to 6%.

3. According to the Czech Statistical Office, Czech exports
during the first four months of 2007 are up 17.4% from the
same period last year while imports are growing more slowly,
resulting in a record foreign trade surplus of CZK 37.5
billion (about USD 1.8 billion). Analysts attribute the
surplus to the economic recovery in the Eurozone and
particularly in Slovakia (note: Germany and Slovakia are the
top two trading partners. End note). Skoda Auto, the
country's largest exporter, announced earlier this year that
it was introducing Saturday production to meet soaring demand
for its cars aboard. This is all happening while the Czech
Crown continues to appreciate against the Euro. Private
sector analysts point out that the market still believes the
Czech Crown is 6 - 7% below the equilibrium foreign exchange
rate, although that gap is slowly closing

---------------
CREDIT BUBBLE??
---------------

4. Alongside record export growth, household consumption is
the leading source of Czech GDP growth. Consumption
accounted for over a third of the 6.1% GDP growth in 2006,
and consumption as a share of GDP has been rising steadily
from 2.5% in 2005 to 4.8% in 2006 and to 5.6% in 2007. Since
2003, there has been a stable 30% growth annually in
household credit, most of it in the form of mortgage lending
(note: average mortgage rate is around 4%. End note). The
main reason for the increase is that the Czech Republic has
been getting by on "cheap money," with interest rates and
bond yields consistently lower than those in the Eurozone.
Because the growth began from a low base, only recently have
household credit figures become significant in absolute terms
despite four years of steady growth. Czech National Bank
figures indicate that household credit/GDP ratio is 17% in
the Czech Republic compared to 54% in the Eurozone, and more
importantly, that this ratio is 40% below the long term
equilibrium rate.


PRAGUE 00000758 002 OF 002


5. The Czech National Bank concluded in its recent
presentation on a possible credit bubble that while household
debt is on the rise at a significant rate, the pace is still
relatively slow and the household debt/GDP ratio remains at
about one third the average of developed economies.
Therefore, while there is some risk especially for the lowest
20% income bracket, there is not a general macroeconomic
risk. Meanwhile, private sector analysts warn of a slow down
in structural growth, pointing to a slow down in fixed
capital formation (from a growth rate of 7.6% in 2006 to 1.5%
in 2007), and continue to pressure the government to reign in
public finances and push for more radical reforms than the
current economic reform package in Parliament.

-------------------------------------------
2008 BUDGET HANGS ON FATE OF REFORM PACKAGE
-------------------------------------------

6. Finance Minister Miroslav Kalousek (Christian Democrat)
announced after a June 11 cabinet meeting that the Czech
state budget for 2008 will have a deficit of CZK 78.4 billion
(3% of GDP), down from the estimated deficit of CZK 91.3
billion in 2006 (3.9% of GDP). However, 2008 figures are
pending passage of the economic reform package (ref A).
Forecasted budget deficits for 2009 and 2010 are 2.6% of GDP
and 2.3% of GDP, respectively. Once again (ref B), ministry
reserve funds (funds carried over from one year to next)
reportedly amounting to CZK 50 - 60 billion (or 2% of GDP)
are a major stumbling block in terms of budget transparency.
As a result, Finance Minister Kalousek has stipulated that
from now on, ministries can only keep reserve funds with the
consent of the Finance Ministry. The system of ministry
reserve funds was put in to place as a way to curb end of
fiscal year spending, but has now taken on a life of its own.

7. To reach the 3% of GDP deficit figure in 2008, the largest
cuts are planned at the regional development ministry
(-25.6%), agriculture ministry (-16.1%), culture ministry
(-14.8%) and industry ministry (-5.4%). Spending will rise
at the interior ministry ( 2.4%) and the defense ministry
( 0.5%). The Minister of Culture has been the most vocal in
terms of publicly decrying these cuts, while the Minister of
Defense has also warned that her paltry budget will mean the
army cannot do much more than participate in ceremonial
parades. Such public comments are doing little to support
the tough fight the coalition faces in Parliament for both
the economic reform package and the 2008 budget.
GRABER

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