Czech Republic Business  2012

The Czech economy is highly exposed to the ongoing eurozone sovereign debt crisis via investment, banking and trade links. As such, we expect the ongoing slowdown in eurozone request to translate to weaker exports out of the Czech Republic. Given that domestic request remains firmly in the doldrums, the country's export-led recovery is likely to experience a sharp slowdown in 2012.

While we remain broadly positive towards the Czech Republic's fiscal position given the ongoing commitment of the centre-right coalition government to fiscal austerity and the long-term sustainability of fiscal accounts despite ongoing intra-coalition ructions, we caution that the slowdown in economic activity in the country will make it increasingly difficult for the government to rein in the fiscal deficit. As such, we believe the coalition government will likely ease the pace of its austerity drive. That said, given that the lion's share of fiscal consolidation was front-loaded, we do not expect this to substantially affect the country's finances.

The centre-right coalition government still has a highly fractious nature. Our view that re-shuffles in the composition of the coalition would likely occur in 2011 played out, with a number of resignations and new appointments to the cabinet. We expect the government to maintain cohesion in 2012 in the face of the increasingly inclement situation in the eurozone, which would make a collapse of the coalition government disastrous for the country's creditworthiness. However, with pressure on (and within) the coalition set to remain high, we cannot quite policy out a collapse of the government in 2012.

Major Estimate Changes

We have revised down our real GDP estimate for the Czech Republic to 0.8% in 2012 from 2.3% before. The ongoing deterioration in the external environment, which has recently seen us estimate the eurozone economy to contract by 0.2% in 2012, will have a heavy impact on the Czech export-led economy. Further compounding a negative outlook is our revised view that consumer spending will remain in the doldrums for some time approaching. We as well highlight that risks to this outlook remain firmly to the downside. On the back of the worsening macroeconomic backdrop, we no longer believe that the government will be able to rein in the deficit below the 3.0% of GDP level mandated by the EU before 2014. We have revised our estimate for the fiscal deficit approaching in at 3.7% of GDP in 2012 from 3.4% before.

We have revised downwards our estimate for average inflation in the Czech Republic approaching in at 2.0% in both 2011 and in 2012, from 2.2% and 2.6% before. Our expectation for weak domestic request coupled with moderating commodity prices will work to keep inflationary pressures subdued in 2012. On the back of this revision, we have as well revised down our rate expectations for 2012, now expecting the policy rate to remain on hold at 0.75% until 2013.

Key Risks To Outlook

A additional pronounced slowdown in eurozone increase than we currently estimate would weigh considerably on Czech increase. The country is heavily reliant on the external market for increase, particularly while government expenditures are dragged down by fiscal austerity and as consumers struggle to bounce back from the world recession. Similarly, while we expect that a deepening of the eurozone crisis is a pre-requisite in order to catalyse a policy response, a failure of policymakers to address the issue would likely severely impact on investor sentiment towards the region, and by proxy, the Czech Republic. In this eventuality, we would likely revisit several of our forecasts.