1. EXECUTIVE SUMMARY
Czechia will hold a general election in October. The current senior ruling party ANO, led by Prime Minister Andrej Babis, will need to turn around a slump in public support and defend its handling of the coronavirus crisis.
Babis will be challenged by alliances from across the political spectrum as well as new political movement Lide PRO.
The European Commission's final audit recently confirmed a conflict of interest related to subsidies received by Babis’ Agrofert Group, further undermining trust in the prime minister.
The Czech economy is expected to recover in 2021 as vaccines become available. GDP should increase by between 3% to 5%.
The unemployment rate might grow to more than 3%, while inflation is forecast to decrease to around 2% in 2021. The Czech central bank forecasts private investment activity will be adversely affected by the pandemic in 2021, while business confidence is expected to decline.
Budget and debt outlook
The proposed state budget is projected with a general government deficit at 4.9% of GDP in 2021. Following the worst state budget deficit in Czechia’s independent history recorded at the end of 2020 (CZK341.5bn), the Ministry of Finance plans the 2021 budget deficit at CZK320bn.
Real economy outlook
Measures to combat the second coronavirus wave taking place in Czechia at the end of 2020 hit trade and services the hardest, while manufacturing was less affected than in spring 2020. The adverse effects of the second wave will have dissipated by mid-2021 and the sectors affected will return to their August 2020 levels of activity.
The development of the Prague Stock Exchange has broadly reflected the development of the epidemic over the last nine months. Since the beginning of November, the stock market has been gradually strengthening again.
The Czech crown is expected to strengthen the most among the CEE region currencies in 2021.
2. POLITICAL OUTLOOK
In 2021, Czechia will hold parliamentary elections on October 8-9. According to opinion polling carried out at the end of 2020, senior government party ANO led by the current Prime Minister Andrej Babis would win the elections with 27-28% of the vote. The fall to the lowest level of public support since 2017 is mainly due to the inconsistent way the government has dealt with the coronavirus crisis.
The Pirates party would come next with 17-21% of the vote, then STAN (Mayors and Independents) and the Civic Democrats are then level at around 11%. The junior government coalition partner, the Social Democrats, would barely cross the 5% electoral threshold for the first time in the country's independent history.
In 2020, three centre-right Czech parties, the Christian Democrats, TOP 09 and Civic Democrats signed a memorandum on forming an alliance ahead of the 2021 general election, to defeat the ruling ANO party. According to Civic Democrats chair Petr Fiala, the alliance aims at giving people hope that populism, empty words and lies will not rule the country. The alliance could get 20% of the vote. Another alliance, between the centrist STAN and the liberal Pirates party could receive up to 30% of the vote in the elections.
The main organiser of the anti-Babis demonstrations during 2019, Mikulas Minar, established a new political movement Lide PRO (People FOR) in December 2020, together with the former director of Czech Transparency International David Ondracka, who has campaigned against the prime minister’s potential conflicts of interest for years, Prague deputy mayor Pavel Vyhnanek of the Pirates party and other prominent Czech figures.
2021 should start with an important legislative change to be addressed in parliament: The new construction act promises to completely change the construction process in the country which, according to the World Bank’s Doing Business 2020, is ranked 157th in the world. The legislative draft submitted to the parliament by the Ministry of Regional Development during the summer 2020, however, was fundamentally different from the original proposal prepared a year ago. Significant amendments to the draft are being prepared by MPs. The new act is scheduled to take effect on July 1, 2023.
3. MACROECONOMY OUTLOOK
The coronavirus crisis has had a significant impact on the Czech economy. In its macroeconomic forecast, the European Commission (EC) expects Czech GDP to return to 2019 levels only at the end of 2022. GDP should increase by 3.1% in 2021, followed by 4.5% growth in 2022.
Private consumption is assumed to recover in 2021 and 2022 and return to the previous growth level depending on the impact of the crisis on employment and wage growth. Strengthening economic growth is expected to improve labour market conditions in Czechia in 2022, with the unemployment rate decreasing to 3.2%. In 2021, the unemployment rate is expected to grow to 3.4%.
Czech inflation is forecast to decline to 2.3% in 2021 and 2% in 2022. According to the Czech National Bank (CNB), weaker demand resulting from the second wave of the pandemic, together with the stronger currency, will lead to a decline in core inflation and a convergence of headline inflation towards the target in 1H20. Core inflation should ease in 2021.
The expected fading of the negative effects of the second coronavirus wave, inflation stabilising close to the target and a gradual return of domestic and foreign economic activity towards pre-crisis levels will allow the normalisation of interest rates to start during 2021. The two-week repo rate enters 2021 at 0.25%, the discount rate at 0.05% and the Lombard rate at 1%. The CNB has signalled three hikes of interest rates for 2021, which ING bank sees as unrealistic, with the board likely preferring a wait-and-see approach.
The CNB forecast private investment activity will be adversely affected by the pandemic and envisaged a repeated decline in business confidence next year.
4. REAL ECONOMY OUTLOOK
Anti-epidemic measures during the second coronavirus wave taking place in Czechia at the end of 2020 hit trade and services the hardest, while manufacturing was less affected than in spring 2020. The adverse effects of the second wave will have dissipated by mid-2021 and the sectors affected should return to the August 2020 level of activity.
Based on the PMI index by IHS Markit, year-on-year growth in Czech manufacturing is not expected to return before 1Q21, due to uncertainty in the global economy that is set to weigh on demand conditions. Companies expect fixed investment growth of 3.6% in 2021 and an expansion of 6.1% in 2022, according to the FocusEconomics Consensus Forecast.
The Czech construction industry is expected to shrink by 1.8% y/y in 2021. Construction output can be expected to drop, depending on how willing and able the public sector is to invest in further contracts. Czech regions and municipalities will have to address more urgent priorities than to boost construction; they will most likely have to deal with significantly reduced revenues, which will lead to a sharp reduction in investment. In 1Q21, construction companies will work at 81% of their capacity on average. The fall in construction investment may be softened by the sector’s existing order book and its reliance on local supply chains in 2021.
The impact of the pandemic has been long lasting on the Czech tourism industry, and the sector is not foreseen to recover in the near future. The Czech government agency CzechTourism, the Ministry for Regional Development and the Czech foreign ministry thus introduced their Tourism Strategy to rescue the tourism sector at the end of 2020.
According to CzechTourism director Jan Herget, the impact of the pandemic has been brutal. Revenues dropped by more than 50% in 2020, and more than 80% in Prague, putting 200,000 jobs on the line, not just in the tourist industry itself, but in related professions such as bakeries, cleaners and others.
In its 2021 strategy, CzechTourism will aim to lure tourists from Austria, Germany, Hungary, The Netherlands, Poland and Slovakia initially, followed by a campaign aimed at tourists from France, Great Britain, Italy and Spain by Czech Airlines. In the third phase, Czechia will strive to bring Americans, Asians and Russians to the country.
At the end of 2020, the European Investment Bank (EIB) signed a CZK5bn loan (€190mn) with the state-owned Czech Transmission System Operator (CEPS), aiming at strengthening the electricity transmission infrastructure of Czechia. The project will improve the security of the electricity system and facilitate power exchanges and transit flows mainly from Germany to Austria through Poland and Czechia.
According to the EIB, Czechia is a key country in CEE for power trading and transit, given its location next to Germany. The investment will be carried out over 2021-2024.
In the energy sector, Czechia should launch a delayed tender for the construction of the new nuclear unit at the Dukovany power plant in 2021. At the end of 2020, the Czech Nuclear Energy Committee discussed four possible options, one being the so-called ‘3+2 model’, where Russia and China could be allowed to take part in supplier consortia. This option is the preferred one.
In 2021, the Czech parliament will continue to debate the digital tax to be applied on international companies, such as Google, Facebook, Apple and Amazon, which was approved at 5% by the Czech government coalition partners in June 2020. If imposed, the digital tax is likely to threaten Czech-US relations. Already in June 2020, the US Trade Representative’s office said it was investigating digital services taxes being adopted or considered in several countries including Czechia.
5. BUDGET AND DEBT OUTLOOK
The Czech draft budget for 2021 targets fiscal consolidation and forecasts the debt-to-GDP ratio to continue increasing. The proposed budget is projected with a general government deficit of 4.9% of GDP and incorporates up to CZK41.2bn (0.5% of GDP) in Next Generation EU fund flows as government revenue in 2021. The budget also proposes decreasing some categories of non-investment spending by 83% year-on-year.
Under a no policy change assumption, the deficit is expected to improve further to 3.8% of GDP in 2022 as the economic recovery accelerates, improving tax revenues and offsetting expenditure growth.
According to the EC, the Czech general government balance is expected to end 2020 in a deficit of 6.5%, reflecting both lower tax revenues due to declining economic activity and government measures supporting the economy. On the revenue side, the biggest loss is likely to come from a drop in corporate income tax revenue followed by a decline in indirect tax revenue due to lower domestic consumption.
According to Fitch Ratings, with parliamentary elections next year, political considerations could increasingly influence fiscal settings. For instance, the senior ruling ANO party’s desired cuts to personal income tax rates would decrease tax revenue by up to 1.1 percentage points (pp) of GDP in 2021, although this could be partly offset by a boost to household consumption.
Public debt is likely to grow significantly to 40.5% in 2021 and 42.5% in 2022, reflecting primarily the evolution of the headline balance and nominal GDP, thus remaining among the lowest in the EU. Fitch’s expectation that debt will stabilise below the current AA category median is reflected in the stable outlook on Czechia’s AA- rating from July.
The Ministry of Finance plans the 2021 budget deficit to amount to CZK320bn, however, with this depending on the course of the pandemic in 2021, experts expect the deficit to exceed CZK400bn.
6. MARKETS OUTLOOK
At the end of 2020, the Prague Stock Exchange put in its strongest performance since the beginning of the COVID-19 epidemic in Czechia. Almost all major issues strengthened — though not all; the biggest decline was posted by shares of the Erste banking group.
The development of the stock exchange reflects the development of the epidemic and the related introduction or relaxation of emergency measures. Shortly after the first cases appeared in Czechia on March 1, the Prague Stock Exchange’s main index fell rapidly from more than a thousand points to about 690 points, followed by a gradual increase above 950.
With the slowdown of the epidemic and easing of measures, the index reached values above 950 points in the summer. The autumn acceleration of the epidemic and record increases in the number of infected people led to another decline, but since the beginning of November, the stock market has been gradually strengthening again.
The Czech koruna is expected to strengthen the most among the currencies of the Central Europe countries in 2021, according to a survey among analysts published by Reuters agency. The Czech koruna will strengthen by an average of 2.3% to CZK25.80 to the euro by November 2021.
According to the chief economist at Generali Investments CEE in Prague, Radomir Jac, the Czech koruna, like other regional currencies, benefited from the improvement in global sentiment at the end of 2020.
According to the CNB’s forecast, the koruna will start to appreciate gradually again in 2021, due to the recovery in external and domestic activity and the widening interest rate differential. Consistent with the baseline scenario of the forecast is stability of market interest rates initially, followed by a gradual rise in rates in 2021.