I. General Information

I. GENERAL INFORMATION I. GENERAL INFORMATION I.1 Overview of the First Ten Years of Economic Transition Early Transition Policies and bankruptcy and foreclosure laws were weak, Outcomes making room for lax financial discipline. As The Czech Republic has awed observers a result, while the economy was growing, of transition economies since within three banks were accumulating nonperforming years of the fall of communism, the govern- loans at a distressing rate. While both Hun- ment liberalized nearly all prices, privatized gary and Poland lowered their share of non- much of the economy, decentralized wage performing loans from about 28% in 1994 setting, and opened the country to world to less than 10% in 1998, the Czech share trade while maintaining a relatively balanced stood at 33% in 1998, comparable to that budget, low inflation, and low unemploy- of Romania. ment, below 4% until 1995. The Czech GDP The local owners of privatized firms were per capita level of over five thousand US$, indebted from the start and lacked the man- with PPP adjustment factor of about two, agerial capital to restructure and operate was (and remains) high in comparison to firms, which faced fierce international com- other transition countries. Furthermore, the petition due to a high degree of openness. economy appeared to be on an accelerating The loose access to bank credit coupled with growth trajectory. By 1995, the initial trans- a weak legal and impotent judicial system formation recession and the negative impact resulted in massive asset stripping (tunnel- of the split of Czechoslovakia were over, and ing) of privatized enterprises. the economy grew by almost 6%. While Clearly, privatization was only one method 1996 recorded still a robust 5% growth rate, of creating private sector output. Through- in 1997, it was becoming increasingly clear out the early transition period new (de novo) that the macroeconomic success was not private firms were also being created. While based on solid microeconomic foundations. early on credit to small firms may have been In particular, mass privatization followed generous, retained profit was a major deter- a tacit doctrine of economic nationalism minant of new investment. Small firms were as most property was transferred to local apparently the force behind low Czech unem- owners, either by offering loans to local ployment. Survey evidence suggests that buyers or through the voucher scheme. Pri- small new private firms were responsible for vatization failed to generate sound corpo- almost all of the vigorous Czech job creation rate governance and often resulted in inces- during early reforms so that five years into tuous ownership relations. Large banks transition de novo firms offered more jobs remained under government control in than the state and privatized firms com- order to “fuel” transition with credit while bined. 5 I. GENERAL INFORMATION Year 1996 1997 1998 1999 2000 2001e GDP GDP Growth 4.8 -1.0 -2.2 -0.4 2.9 3.4 Foreign Trade Exports, y/y % 9.2 8.1 10.7 6.6 18.8 14.8 Imports, y/y % 14.3 7.2 7.9 5.8 18.7 16.1 Trade Deficit as % of GDP -10.0 -8.3 -4.4 -3.4 -6.3 -5.7 Balance of Payments as % of GDP and Its Main Components Current Account -7.4 -6.2 -2.5 -3.0 -4.7 -4.8 Capital Account 7.2 2.1 5.2 4.7 6.8 n.a. Inflow of FDI 2.5 2.4 6.6 11.9 9.3 9.2 Inflow of FDI (bln. USD) 1.4 1.3 3.7 6.3 4.6 4.5 Inflation, interest and credit CPI, y/y % 8.6 10.0 6.8 2.5 4.0 4.1 Prague Interbank Offer Rate (PRIBOR 3M, %) 12.0 16.0 14.3 6.8 5.4 5.2 Credit to Enterprises and Households, y/y % 10.6 9.4 -3.5 -3.9 -2.9 n.a. Labor Market Unemployment, % 3.1 4.4 6.1 8.6 9.0 8.6 Nominal Wages, y/y % 18.0 11.9 9.3 8.2 6.6 8.9 Labor Productivity, y/y % 4.6 -0.3 -0.8 1.4 8.0 6.6 Public Finances General Government Balance as % GDP -0.3 -1.2 -1.5 -0.6 -3.7 -4.9 Idem, Excluding Extraordinary Items -1.9 -2.0 -1.5 -3.0 -4.3 -9.0 Exchange Rates CZK per USD 27.1 31.7 32.4 34.6 38.6 38.1 CZK per DEM 18.1 18.3 18.3 18.9 18.2 17.2 Source: CSO, CNB, Ministry of Finance, World Bank, various local sources. The Currency Crisis and explicit and the worsening performance of Recession of 1997 the economy led to an increase of the pub- Weak corporate governance allowed lic budget deficit. Shortly after the current wages to grow two times faster than pro- account deficit ballooned to 7.4% of GDP ductivity, which led to higher demand for in 1996, the imbalances–both internal and imports of consumer durables and increas- external–were noticed by capital markets ing foreign trade and current account and led to an attack on the Czech currency deficits. These were financed by an inflow in May 1997. The attack forced the surren- of short-term foreign capital attracted by der of the fixed exchange rate regime and high interest rates locked in by the fixed the crown depreciated by approximately exchange rate regime. 10%. The Czech National Bank used high Eventually, however, the implicit liabilities interest rates to stabilize the currency and of soft loans to large old firms became also strengthened provisioning require- 6 I. GENERAL INFORMATION ments, leading to a credit crunch. Meanwhile, ing the recession, the new government the government was forced to implement a revived structural reform and privatization, strict austerity program. All of this naturally this time relying on strategic foreign part- sent the economy into a deep recession. ners. Further, in April 1998, the government The recession was prolonged with GDP introduced an aggressive FDI incentive in the red for three consecutive years while package for manufacturing investors, bring- other Visegrad countries enjoyed substantial ing more than USD 10 mln. Yet, 1999 GDP growth. Registered unemployment increased remained in the red. from 3.9 in 1996 to 9% in 1999 and wage Finally, in 2000 the economy took off. growth slowed down, hand in hand with gov- Investments started to grow, most of all ernment spending. The recession was driven thanks to the surge of foreign direct invest- by a decline in both private spending and ments, but domestic firms started to invest investments, while net exports were mostly more as well. Private consumption also accel- improving the overall picture – also thanks erated so that only net exports exhibited to the weaker currency. mixed performance. While GDP statistics do The downturn shattered the illusion of not reveal the fast growth of public spend- successful reforms and contributed to the ing, part of the government spending is fall of the long-serving coalition government of course hidden in the private demand headed by Václav Klaus’ Civic Democrats and investments components. Overall, GDP and the resulting early elections of 1998. growth stood at 2.9% in 2000. Further, following party finance scandals, In the first half of 2001,GDP growth a significant number of Civic Democrats accelerated further to 4%, still driven main- established a liberal right-center party. The ly by investments and private consumption. early elections of 1998 were won by Social Private consumption was fueled by increas- Democrats, who were unable to form a major- ing real wages (reaching an annual growth ity coalition. On the other hand, personal rate of over 4% in the second quarter of animosity among the leaders of the former 2001) and robust consumer confidence. right-center coalition partners blocked their This makes one wonder about net exports, majority coalition. The so-called “opposition which indeed have recently had a negative agreement” between the Social and Civic effect on GDP growth. Democrats opened a way out of the dead- The 1997-99 recession helped to limit lock. The Civic Democrats committed them- imports and thus also the foreign trade selves to tolerating a minority one-party deficit, the main cause of external imbal- government of ČSSD in exchange for a ance, from almost 160 bln. CZK in 1996 to dominating role in the Lower and Upper just above 60 bln. CZK in 1999. Yet, when Houses and participation in the sale of the economy started to grow in 2000 the remaining large state firms. deficit doubled again, and it continued to widen in 2001. In should be noted, however, Recent Macroeconomic that not all of the increase is attributable Development to the revival of economic growth. Higher Starting in 1998, the strict monetary prices of oil and other raw materials have policy was relaxed by the central bank. Fac- been among the significant factors behind 7 I. GENERAL INFORMATION growing imports as the Czech economy is only a part of the current account deficit is to a large extent dependent on imported of this nature. raw materials. Further, it was often the case The one macroeconomic variable that has that foreign investors imported the major been under control throughout the whole part of technology when investing in the Czech transition is inflation. Low domestic country. Finally, the economic slowdown in demand during the 1997-99 recession, the EU also limited the growth of exports. combined with relatively strict monetary pol- The EU is by far the largest trading partner icy and low commodity prices lowered the of the Czech Republic.

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