The unpredictable nature of the Czech Republic’s political landscape is the source of the country’s biggest challenges in recovering from the economic downturn. The government that took power in 2006 was hamstrung by instability and eventually collapsed, leaving a caretaker government to navigate through the financial crisis. Political leaders managed to push through two stimulus packages, but their failure to cut spending has raised the budget deficit to record levels. On top of that, a rise in age-related expenditures threatens the country’s fiscal balance in the long term. Taken together, political uncertainty, an unbalanced budget and demographic problems mean the Czech Republic’s outlook for long-term stability is dicey at best.

 

 

1. Political Instability and Unpredictability

 

Elections are approaching, but the constantly shifting Czech political landscape makes it impossible to predict the outcome. This uncertainty poses a significant risk because it keeps market players guessing as to the direction of economic policy. When the economic crisis struck, the administration of former Prime Minister Mirek Topolanek failed to implement meaningful austerity measures. Moreover, his efforts at structural reform often ran out of steam even before the economy started heading south. The most important example is healthcare reform: After the opposition Social Democrats scored a landslide victory in October 2008 regional elections, regional hospitals control stopped collecting the unpopular co-payments that Topolanek’s government had imposed to discourage wasteful consumption of medical services. Topolanek’s successor, interim Prime Minister Jan Fischer says the proposed 2010 budget will prevent the crisis from getting worse, but does not contain reforms that will be necessary to accelerate the economy in the long run. Although most potential future governing parties back the Fischer government, anything can happen during the murky process of coalition building. Thus the uncertainty may be augmented by the campaign and post-election politicking.

 

Confidence in political parties has eroded, pushing up the proportion of undecided or non-voters to nearly 40 percent in October. This casts serious doubts on voter behaviour next year.  The country’s party system is in flux. The two biggest parties, the Civic Democratic Party (ODS) and the Czech Social Democratic Party (CSSD) are watching their support bases shrink, while a new political party – the conservative TOP 09 – has emerged. TOP 09 was formed by two ODS defectors, former Finance Minister Miroslav Kalousek and former Foreign Minister Karel Schwarzenberg (who is set to become the new party’s leader). The group says it wants to offer disaffected Czechs a new alternative; in reality, it is little more than old politics in a new package. TOP 09 quickly became a political contender, which poses a headache for the CSSD: Although opinion polls give the Social Democrats a slight edge over the Civic Democrats, the CSSD might find it difficult to form a government if elections were held now. A coalition with the Communists is out of the question; although the KSCM has a massive voter base, other parties have imposed a cordon sanitaire around it. The CSSD cannot count on the imploding Green Party, either. Meanwhile, the OSD stands a decent chance of staying in power with support from TOP 09. The only sure thing is that nothing is for sure. There is also a danger that the next election will produce another deadlocked Parliament, portending even more instability.

 

 

Source: Centrum pro výzkum veřejného mínění Sociologický ústav


 

Background: An anatomy of instability

In the 2006, the government (ODS – KDU-CSL – Green Party) and the left-wing opposition each won 100 mandates in the 200-seat chamber. Prime Minister Mirek Topolanek was able to govern thanks to ad-hoc support from a handful of opposition MPs, but his grip on power was fragile at best. Government and opposition had entirely incompatible views on many important topics (e.g. the ratification of the Lisbon Treaty, the decision on hosting a US anti-missile radar base). This stymied parliamentary decision making.  Even the governing parties failed to find common ground on many issues. Conflicts and scandals soon caused MPs from all three coalition parties to bolt their caucuses. These renitent MPs were able to force the Topolanek government into making piecemeal bargains in exchange for their support. The prime minister was also battered by a series of no-confidence votes. In March 2009, the fifth no-confidence motion passed with 101 votes, spelling the end of the Topolanek era. However, dissolving Parliament was out of question, not least because the Czechs held the EU’s rotating presidency at the time. A caretaker government under interim Prime Minister Jan Fischer took over in May, backed by the former coalition parties plus the Social Democrats. This did little to quell the instability. Early elections proved impossible: After a long, drawn-out political debate, the Constitutional Court struck down plans to hold an early poll in October. The Social Democrats then refused to support a Constitutional amendment that would have effectively nullified the court’s ruling. This means Parliament will probably serve out its full term until May 2010, while the caretaker government that had planned to serve for only for a few months will remain in power for an entire year.  Ironically, this represents the first period of stability that Czech politics has enjoyed for a very long time.

 

 

ODS - Civic Democratic Party, KDU-CSL - Christian and Democratic Union - Czechoslovak People's Party, CSSD - Czech Social Democratic Party, KSCM - Communist Party of Bohemia and Moravia 

 

 

 

2. Deficit Dangers

 

Public confidence in Czech politicians has eroded thanks to the country’s permanent political instability, the tug of war over early elections, President Vaclav Klaus’s resistance to signing the Lisbon Treaty and what was widely perceived as a lacklustre performance in the EU presidency. These extreme tensions rendered the government incapable of responding effectively to the economic crisis. Although the government tried to revive the economy with two stimulus packages, its failure to cut expenditures sent the budget deficit on an upward trajectory. The government now expects the budget deficit to reach 6.5% of GDP this year, which is nearly 1% more optimistic than the National Bank’s – more realistic –prognosis of 7.4% of GDP in September.


The deficit stood at nearly CZK 170 billion ($9.91 billion) at the end of November, CZK 32 billion higher than a month earlier, according to preliminary figures from the Finance Ministry. This is the widest January-November deficit in the country’s history, and the Czechs’ 2009 shortfall will probably be the biggest in the CEE region. The deficit will likely remain the principal obstacle to recovery, especially since politicians tend to lose their inhibitions about overspending ahead of general elections.

 

Furthermore, the government postponed a decision on setting a target date for Euro adoption. This indicates that government members see the budget deficit as a long-term enemy, since other economic figures are mostly encouraging. Most analysts reckon 2015 is the earliest date that the Czechs might adopt the common currency.

 

 

 

Source: European Commission – European Economic Forecast Autumn 2009

 

A more favourable scenario exists: The government’s position is more stable than any time in the past few years. Trust in government doubled when Fischer replaced Topolanek and is still on the rise (see chart below). This political stability opens the possibility for a fiscally responsible budget  but still, this will be no easy task. (On the other hand, the extremely high confidence in the current government means the next government will have to live up to a much higher standard in the next term.)

 

 

 

The Chamber of Deputies has already passed on first reading a draft budget for 2010 that targets a deficit of 5.3% of GDP. Both the Social Democrats and the Christian Democrats have tried to loosen the fiscal discipline, even though the government’s social-spending cuts are hardly radical. Finance Minister Eduard Janota threatened to resign if lawmakers approve all the budget amendments under consideration. If the proposed changes are implemented, none of the original money-saving measures will remain intact, Janota warned. It remains to be seen whether the government can resist the temptation to soften its fiscal discipline; still, it is likely that the 2010 budget will pass without significantly raising the budget target. The long-term risk lies in delaying structural reforms.

 


3. Demographic Dilemma: The rise in age-related spending


Highly unfavourable demographic tendencies can also undermine economic health and pose a long-term threat to fiscal balance.


The European Commission’s 2009 Sustainability Report[1] reveals that the Czech Republic is in a group of countries at “high risk” of being unable to sustain public finances due to demographic trends. (Other members of the “high risk” group are Cyprus, Ireland, Greece, Spain, Latvia, Lithuania, Malta, the Netherlands, Romania, Slovenia, Slovakia and the United Kingdom). The Czech Republic needs to “improve its structural primary balance in a durable manner by 7.4% of GDP” in order to sustain public finances, the report said. This 7.4% “sustainability gap” is one of the highest among the “high risk” members. (All countries in the group have sustainability gaps above 6%).

 

High sustainability gaps are “the result of a very large projected increase in age-related expenditure, compounded in most cases by large initial imbalances, and hence they are exposed to higher long-term risks. This indicates that closing their gaps will require both ambitious consolidation programmes that reduce debts and deficits in the coming years, and profound reforms of social protection,” the report said.

 

This figure takes account of several factors. In present context, the most important is the increase in age-related expenditures; the Czech Republic’s outlook is more pessimistic than any other Visegrad country’s (see table below).

 

Source: European Commission – Sustainability Report 2009

 

 

The long-term cost of ageing is mostly driven by greater spending on pensions and healthcare. The EC’s study refers to essential structural reforms that cannot be delayed any longer: If the Czech Republic’s current demographic trends continue, the working-age population will decrease from 70.5% to 54.4% of the total in the next 50 years, while the old-age dependency ratio will climb from 21.8% to 61.4%. The necessary measures will naturally increase the deficit in the medium term. Meanwhile, political leaders are faced with the challenge of implementing these structural changes without amplifying the effects of the financial crisis.

 

 


[1] The analysis focuses on the long-term sustainability of member countries’ economies following recovery from the crisis.