Cablegate: Czech Republic's Disappointing Revised Euro

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UNCLAS PRAGUE 001222

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN PGOV EZ
SUBJECT: CZECH REPUBLIC'S DISAPPOINTING REVISED EURO
ADOPTION STRATEGY

REF: PRAGUE 1201

1. (SBU) Unlike in some countries where euro-adoption serves
as a carrot to drive and provide political cover for
difficult reforms, the Czech euro adoption strategy remains
hostage to Czech domestic politics. While key
export-oriented industries continue to lobby hard for euro
adoption at the earliest possibility, the average Czech
citizen is at best apathetic and at worst fearful that euro
adoption will mean even faster acceleration in the cost of
living. Louder than industry lobbyists has been President
Vaclav Klaus, a well-known euro-skeptic. Last week, Prime
Minister Topolanek joined Klaus by stating to the local
equivalent of the Wall Street Journal that he rejects calls
from industry to establish a firm target date for euro
adoption, citing public skepticism about adopting the euro.
Topolanek took a difference approach in explaining his
position to the international press. In a November 11
interview with the Financial Times, he said the Czech
Republic is in no hurry to join the eurozone until further
economic reforms (i.e., healthcare and pension) are
completed. He also said his government wants to study
whether eurozone states enjoyed lower inflation and faster
growth than those outside, and whether his country had the
labor flexibility to join without damaging the economy.

2. (U) The Czech Republic initially hoped to adopt the euro
in 2009-2010. However, continued lack of structural reforms
combined with enthusiastic politically-motivated government
spending in the run-up to the 2006 general elections
significantly deteriorated public finances in 2007, resulting
in the Czech National Bank and the Ministry of Finance
jointly issuing on August 29 the "Updated Euro-Area Accession
Strategy," which delays the euro adoption timeline to
2011-2012. The Czech Republic will have to join ERM-II
during 2008, if it is going to meet the 2011 target.
However, as the revised Czech euro adoption strategy says,
further consolidation of public finances is not possible
without serious reforms (i.e., pension and healthcare).

3. (SBU) Private sector economists expressed general
disappointment with the revised strategy, saying that it
points out the obvious obstacles to euro adoption without
outlining how they will be tackled, and casting serious doubt
on the likelihood of its implementation. One economist
summarized the nine-page document as follows: "In order to
benefit from the euro adoption, we need to be able to replace
the loss of domestic monetary policy with something else.
This would be a stabilizing fiscal policy and flexible labor
market. This is not in place now, so let's wait until it
gets better. The government says that the next phase of
economic reforms will go in this direction." The joint
government-Czech National Bank strategy paper can be found
at: www.cnb.cz/en/monetary policy/strategic documents/
download/eurostrategy 070829.pdf

4. (SBU) In light of its aspirations to join the eurozone,
the Czech Republic has pledged to Brussels three things: (1)
continued decrease in general government deficit; (2) 2008
deficit will not be over 3%/GDP; (3) deficit will not be
higher than 1%/GDP by 2012. Revised data released by the
Czech Statistical Office on October 1 showed that the 2006
public finance deficit dropped to 2.69%/GDP from 3.49%/GDP in
2005. External sovereign debt also fell from 30.24%/GDP in
2005 to 30.11%/GDP in 2006. This means that in 2006, the
Czech Republic met its Maastricht criteria. The state budget
was in surplus at end-September, but expenditures tend to
accelerate in the last quarter of the year and the public
finance deficit for 2007 is projected at 3.6%/GDP. So the
Czechs will need to get back on track starting with the 2008
budget, the details of which are reported in reftel.
Graber

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