IMF Executive Board Concludes 2022 Article IV Consultation with the Czech Republic

F.P. Report

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Czech Republic.

Russia’s war in Ukraine has stifled the Czech Republic’s nascent recovery from the pandemic. Inflation is well above target, the labor market remains tight and vulnerabilities from a heated property market persist. Growth is projected to slow to 2.5 percent in 2022 and turn negative to around -0.5 percent in 2023 as households’ purchasing power weakens, and firms rein in investment amidst higher uncertainty and falling consumer sentiment. Labor market tightness is expected to ease as the economy cools and Ukrainian refugees integrate into the labor force. Growth is projected to significantly rebound by end 2024 mainly driven by consumption and exports. In the near term, inflationary pressures are expected to be driven by external and domestic factors. Barring additional shocks, headline inflation is projected to achieve the policy target range during 2024, as the contractionary monetary policy actions taken by the CNB take effect.

Uncertainty is high due to the war with risks to economic activity tilted to the downside and risks to inflation tilted to the upside. The economy remains vulnerable to the availability of and further increases in energy and commodity prices. In the unlikely event of a disorderly house price correction, financial disruptions could impair banks’ and households’ balance sheets, potentially suppressing aggregate demand. The risk of inflation expectations becoming untethered or wage-price spirals forming are high. Depreciation pressures on the koruna could arise if the interest rate differential versus major central banks narrows as they tighten their monetary policies. On the other hand, an unexpected significant fall in global demand could cause a fall in external inflationary pressures.

Executive Board Assessment [2]

The recovery from the pandemic is being hindered by the fallout from Russia’s war in Ukraine, likely turning 2023 into a recession year. Uncertainty around the outlook is very high with risks to economic activity titled to the downside and those for inflation to the upside.

Staff recommends further hikes to the policy rate in the short term to above the current level of the policy rate. While a careful balance between high inflation and weakening economic activity needs to be taken, priority should be given to decisively quell inflation. If inflation expectations become untethered, this would require a significantly higher tightening to restore price stability and thus entail more costly economic adjustments.

The contractionary fiscal stance is appropriate against the backdrop of high inflation and low unemployment, but previously-adopted untargeted support measures should be unwound to enhance policy space. The contractionary stance supports the overall policy mix by avoiding compounding inflationary pressures by adding to aggregate demand. While support for households and firms amidst the cost-of living crisis is justified, measures should be targeted, temporary, and preserve price signals. The PIT regime as well as the property transfer tax should be reinstated to pre-pandemic levels as soon as conditions allow, as untargeted policy support is unwarranted in the high-inflation environment. If increasing taxes in the current environment is not feasible, once the acute cost of living crisis wanes, the reintroduction of taxes could be undertaken in phases, while increasing the progressivity of the PIT and stepping up transfers for the vulnerable. The windfall tax can help offset the cost-of-energy relief measures, but its ad-hoc nature could disincentivize investment by undermining tax certainty.

The retightening of borrower-based measures is welcome as these have helped to tame risk taking, but debt servicing capacity should be monitored. While retightened borrower-based measures are increasingly binding for a growing number of borrowers, close monitoring of debt-servicing is warranted, especially if further increases in interest rates materialize or continued increases in the cost of living further limit the ability to service debt. Further loosening or tightening of macroprudential measures may be needed conditional on market developments and risk-taking behavior.

Improvements in risk measurement across the cycle and for individual exposures should be considered. Staff welcomes the CNB’s retightening of the countercyclical capital buffer rate and the development of models to assess sectoral risk weights. However, leveraging information for corporates, staff recommends to further enhance models to improve the measurement of risk at the individual exposure level.

Structural policies should enhance labor supply while facilitating the green-digital transition and preserving long-term fiscal sustainability. The employment prospects for disadvantaged groups should be stepped up, while further integrating migrants, and Ukrainian refugees. Spending on Active Labor Market Policies (ALMPs), including reskilling and vocational training should be increased to facilitate job matching, and the cross-sectoral reallocation of workers. The implementation of the RRP would help build digital skills, while supporting the green transition, which would bolster energy security by increasing energy efficiency and the supply of renewables. Streamlining the business regulatory framework and simplifying construction permitting remain essential. Streamlining the business regulatory framework and simplifying construction permitting remain essential. Strengthening long-term fiscal sustainability hinges on linking the retirement age to life expectancy.

It is recommended that the next Article IV consultation be held on the standard 12-month cycle.

[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] Management has determined it meets the established criteria as set out in Board Decision No. 15207 (12/74); (i) there are no acute or significant risks, or general policy issues requiring a Board discussion; (ii) policies or circumstances are unlikely to have significant regional or global impact in the near term; and (iii) the use of Fund resources is not under discussion or anticipated.

Czech Republic: Selected Economic Indicators, 2019–2027
Staff projections
National Accounts
Real GDP (expenditure)3.0-
Domestic demand3.2-
Contribution to GDP
Domestic demand3.0-
Net exports0.0-0.4-
Investment (percent of GDP)27.126.526.024.425.125.325.325.425.6
Gross domestic investments (percent of GDP)27.626.230.233.629.126.826.726.827.0
Gross national savings (percent of GDP)27.928.129.329.628.
Output gap (percent of potential output)2.8-
Potential growth2.2-
Labor Market
Total labor compensation7.
Unemployment rate (average, in percent)
Consumer prices (average)
Consumer prices (end-of-period)
Producer price index (average)
GDP deflator (average)
Money and credit (end of year, percent change)
Broad money (M3)6.410.06.8
Private sector credit4.93.68.9
Interest rates (in percent, year average)
Three-month interbank rate2.10.91.1
Ten-year government bond1.51.11.9
Exchange rate
Nominal effective exchange rate (index, 2005=100)100.999.7103.6
Real effective exchange rate (index, CPI-based; 2005=100)99.4100.0104.6
Public Finance (percent of GDP)
General government revenue41.341.541.441.742.941.540.840.740.7
General government expenditure41.147.246.546.
Net lending / Overall balance0.3-5.8-5.1-4.3-4.3-2.7-2.5-2.5-2.5
Primary balance0.8-5.2-4.5-3.6-3.4-1.5-1.3-1.3-1.3
Structural balance (percent of potential GDP)-0.8-5.5-5.5-4.5-3.9-2.5-2.5-2.5-2.5
General government debt30.037.742.041.843.744.144.244.945.9
Balance of Payments (percent of GDP)
Trade balance (goods and services)
Current account balance0.32.0-0.8-4.0-
Gross international reserves (billions of euros)133.4135.4153.3151.3160.3169.3178.3186.3192.3
(in months of imports of goods and services)10.511.911.
(in percent of short term debt, remaining maturity)129.9142.8139.7128.7129.5133.6139.6145.1150.3
Memorandum Items
Nominal GDP (USD billions)252.5246.0281.8293.08309.08325.81339.00346.89350.65
Population (millions)10.610.710.510.510.510.610.610.610.5
Real GDP per capita2.6-
GDP per capita (USD thousands)23.7123.0026.8527.8529.3230.8832.1232.8733.24
Sources: Czech National Bank; Czech Statistical Office; Ministry of Finance; Haver Analytics, and IMF staff estimates and projections.