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Country Commercial Guides FY 1999: Czech Republic

CHAPTER II. ECONOMIC TRENDS AND OUTLOOK

A. Major Trends and Outlook

The Czech Republic has largely transformed itself into a western
market economy with more than 80% of enterprises in private hands.
Most analysts agree that the Czech Republic enjoys solid economic
fundamentals and political stability in spite of the current
slowdown in economic growth and changes on the political scene.
Indeed, macroeconomic elements remain impressive: low national debt,
a low budget deficit, strong foreign currency reserves, relatively
low inflation and moderate but rising unemployment. However,
lagging restructuring and loss of competitiveness have resulted
in worsening trade and current account deficits. Preliminary data
suggest GDP will grow by 1.4% for 1998, following growth of just 1%
in 1997. It also is positive that this economic growth is mainly
fueled by exports rather than domestic demand, which the govern-
ment austerity measures have succeeded in reducing. Gross
investment in fixed capital decelerated however(0.2% growth in the
first quarter 1998 vs. 0.9% growth in first quarter 1997). Govern-
ment spending  declined by 1.8% in 1997 and is expected to drop
by 0.8% in 1998. GDP growth is expected to improve in 1999.

The Czech Republic is undergoing a needed retrenchment after high
but unsustainable growth in 1995 and 1996. The roots of this
retrenchment lie in the failure to enact key structural reforms,
such as bank privatization, better capital markets regulation,
separation of company owners from lenders, and stricter bankruptcy
laws. As a result, the country began to run large trade deficits
beginning in 1996. Links among government banks and businesses
retarded restructuring.  Widespread fraud in banking and the stock
market drove away portfolio investors while corruption allegations
deepened popular cynicism about the economic transition. The
Czech government finally responded in April 1997 by introducing
a strict austerity program and announcing structural reforms,
followed by a de facto devaluation of the Czech crown and
further austerity measures in response to attacks by currency
speculators. Legislation implementing structural reforms was just
beginning to appear when the previous center-right coalition
government fell in November 1997.

The interim government of PM Josef Tosovsky (former Central Bank
governor), which came to power in January 1998, made solid
progress on these reforms. The new Czech Securities Commission has
begun to launch enforcement actions and develop plans to restructure
the dysfunctional trading systems. Parliament passed Glass-Steagal
type legislation to clear up the incestuous relationship between
banks and enterprises, which has caused inefficient industries to
be propped up. The interim government started privatization of the
three major state-controlled banks and has adopted a long-sought
package of incentives for foreign and domestic investment.

The depreciation, along with increases in controlled rents and
utilities, has resulted in inflation of 13.3% for the first quarter
of 1998, up from 8.5% for 1997. The Czech Statistical Office
forecasts up to 12.2% inflation for 1998.

Increased unemployment and a greater number of bankruptcies
indicate that austerity programs, government structural reforms,
and tight money policies may have succeeded in encouraging re-
structuring of firms. The expanding service sector has absorbed
much of the labor released from downsizing industry and
agriculture, but the overall unemployment rate for 1998 is
expected to approach 6%, following several years of 3.0 to 3.5%
unemployment up to 1996 and 5.2% in 1997. It is important to
note, however, that levels of unemployment vary by region,
with the industrial areas of North Moravia and North Bohemia
and the agricultural regions of South Bohemia being hit the
hardest.  The lowest unemployment rate is in Prague, where
numbers reach under 1%. 

B. Principal Growth Sectors

Foreign investment has played a major role in the development
of the Czech economy by providing both management experience
and capital needed to restructure Czech firms.  While foreign
capital flows from European Union countries are considerable,
the U.S. is the third largest investor in the Czech Republic
and U.S. firms stand to profit from the Republic's continued
economic growth. The chief imports are industrial goods
(SITC 6), which represented 20.6% of total imports during the
first five months of 1998. Machinery and transportation
equipment accounted for 39.2% and chemicals (SITC 5) 12.3%
of imports. After a boom in consumer goods imports in the
first months of the 1997 (at least 6.2% growth in the first
half of 1997), consumer demand cooled as a result of austerity
measures and the depreciation of the crown.

Primary business opportunities are related to the redevelop-
ment of basic infrastructure and restructuring of privatized
firms. In addition, major upgrades of pollution control
equipment, telecommunications equipment and services, energy
production and distribution, housing/municipal infrastructure
and medical services have been underway for several years.
In June 1998, the interim government announced plans to
privatize the energy sector. Unprecedented July 1997 floods,
which covered almost a third of the nation, severely damaged
transportation, telecommunication, and energy networks as
well as residential and commercial properties.  Previously
planned infrastructure upgrades as well as rebuilding efforts
will consume a major portion of municipalities' investment
monies.  New investments in plants and equipment will also
continue, particularly as restructuring gets underway in
more companies.  A thriving services sector, built up from
almost nothing, has emerged as the structure of the economy
has shifted toward services from industry and agriculture.

C. Government Role in the Economy

The Czech Republic's conservative fiscal and monetary
policies have been key to creating the nation's stable
macroeconomic environment.  The government's role in the
economy is still evolving from the initial privatization to
building up the necessary regulatory framework typical for
a standard market economy.  In order to promote an increasing-
ly attractive investment climate and consolidate the transition,
the government has continued to implement reforms including
more effective supervision of capital markets, banking, and
utilities, selling off the remaining state stakes in strategic
companies and major banks, and reforming the bureaucracy.
Another task will be to modernize infrastructure, especially
telecommunications and transportation.

Currently, over 75% of output is produced by nominally or
wholly private firms. However, the government (through the
National Property Fund -- NPF) still holds large majority
stakes in some large Czech enterprises, notably the basic
telephone and electricity monopolies.

Integrating the Czech economy into the West, specifically
into the EU, remains a government priority. The Czech
Republic was one of six applicants invited to begin accession
negotiations with the EU in December 1997. The Czechs started 
talks in March, but full-fledged membership in the EU is not
expected before 2003. In the meantime, the Czech Republic
benefits from access to EU markets under an Association
Agreement with the EU. Harmonization of Czech laws and
standards with EU norms continues as the country moves toward
membership. 

D. Balance of Payments

The effective devaluation of the Czech crown coupled with
faster growth in the Czech Republic's main western European
markets and lower consumer demand has reduced the country's
serious external balances. At the end of May 1998, the Czech
Republic's trade deficit was $976 million. Starting in 1997
and continuing into 1998, exports surged by 20.2%.  During
the first five months of 1998, SKODA automobiles comprised
approximately 10% of exports. Exports rose by 35% in nominal
terms, or 25% adjusting for currency movements. Imports
also continued to grow (+19.2%), with much of the growth
coming from imports of intermediate goods related to
expanding exports.  As a result, the current account deficit
is expected to decline to below 4% of GDP, after reaching the
worrisome level of 6.1% of GDP in 1997, and 7.6% of GDP in 1996. 

The trade deficit is partially offset by surpluses in services,
mainly tourism ($3.65 billion in 1997, and $650 million in
the first quarter of 1998) and vehicles. In 1997, foreign
direct investments (FDI) reached $1,300.4 million and portfolio
investments  $1,085.7 million. In the first quarter of 1998 the
inflow slowed down to FDI of $226.5 million.

The government has sought to pursue a balanced budget policy
and trimmed expenditures in mid-1997 in order to stay on track
for a balanced budget by the end of 1997.  The government
cut 38 billion crowns ($1.2 billion) to reduce the deficit
for 1997.  In the end, the 1997 budget closed with a deficit
of 20.5 billion CZK ($646.5 million) (1.2% of GDP, including
5 billion crowns or $157.7 million) added at the last moment
to cover losses at the state-owned Consolidation Bank.
Parliament approved a balanced 1998 budget but as of June
1998, Finance Minister Pilip expected a deficit of 20 billion
Czech crown ($600 million) or 1.6% of GDP, due to losses at
Consolidation Bank.

E. Infrastructure

Upgrading the nation's infrastructure, specifically tele-
communications and transportation, is critical for continued
economic growth and development.  Although recognized as a
priority, the massive nature of the rebuilding effort will
require capital as well as time. Sharp cuts in government
spending in 1997 and 1998 slowed infrastructure projects.
However, accelerated privatization of remaining enterprises,
if continued by the next government, could encourage private
investments into telecommunication and energy infrastructure.  

Resources to finance the country's extensive development plan
for the telecommunications industry include major loans
provided by the EBRD, European Investment Bank and both large
local banks and foreign banks. The Dutch-Swiss consortium
Telsource holds a 27% stake of the Czech telecommunication's
monopoly, SPT Telecom, which is upgrading and expanding the
telephone system. Cellular rates have fallen in the past year
as two GSM standard cellular telephone networks have emerged
(including one by a US West-Bell Atlantic joint venture with
SPT which also operates the existing analog network) in stiff
competition for customers.   In some under served areas,
private telephone companies have been allowed to provide
basic telephone service and a U.S. cable television joint
venture has also been offering telephone connections along
with TV service.  Many of these ventures are positioning them-
selves for the lifting of the SPT Telecom monopoly on basic
telephony in 2000.  The Czech Republic committed to lift this
monopoly by December 31, 2000, as part of the WTO basic tele-
communications agreement.

The need to overhaul the nation's transportation system is
also recognized as a major priority.  Unfortunately, state
budget allocations have been inadequate and the quality of
Czech transport networks and systems, as well as rolling stock
and vehicles, is generally below the standards of advanced
European nations.  All transport sectors, including railway,
highway, inland waterway and air have been targeted for infra-
structure upgrade. Projects currently include: a $3.5 billion
modernization of the rail system, with priority on the Czech
section of the important Berlin-Prague-Vienna Line; a plan to
modernize and extend the country's highway network; and plans
to develop the river transport system for intensive usage by
the container hauling industry.  With U.S. government assist-
ance, the civilian air traffic control system is being
integrated with military systems to provide more advanced
methods of air traffic control. This will not only allow
better utilization of airspace, but also improve the safety
of air traffic. A new terminal at Prague's International Airport
has opened, and plans are in the works for privatization and
overhaul of several other smaller airports including Karlovy
Vary, Brno and Ostrava.

[end of document]

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