Deloitte Business Club - The Czech economy at the turn of 2024/25

Our economy has gone through a number of significant shocks and turbulence in recent years, and hopefully we are returning to normal. In the case of gross domestic product, the fluctuations are very clear - in 2020 there was a pandemic, then a recovery, then our supply chains fell apart, and then we had an energy crisis, the war in Ukraine, and the development was very volatile. The last big blow was high inflation, which we got rid of at the beginning of this year. Last year, however, inflation held us back very strongly, and this year we also have a big brake, which is fiscal consolidation. Unfortunately, this cannot be done painlessly - if you want to reduce large budget deficits, it will bring something to the economy. As part of the consolidation, among other things, the corporate income tax rate has been increased, and this is of course something that takes away funds for companies to invest

This effect of public finance consolidation is estimated at 0.7 to 0.9 percentage points, which have taken a step down from GDP growth. If we talk about the economy growing somewhere around 1% this year, it would be almost 2% without fiscal consolidation. This is probably the main explanation for why growth has been so anemic this year. One factor that also needs to be mentioned is interest rates. They have started to fall, but they are falling much more slowly than they should. This is because the CNB is simply scared of the high inflation and prefers to stifle the economy a little rather than have new inflation hotspots appear somewhere.

Thirdly, the problem of the German economy is still gaining in importance. Problems in the automotive industry are starting to seep into the Czech supply chain, and I am afraid that this will be a factor that will spill over into next year.

Next year, we expect slightly better economic development, expecting growth of 2.4%, thanks to the fact that fiscal consolidation should no longer slow down the economy, and if all the assumptions of the state budget or public finances are met, then the operation of this sector should be more or less neutral. After all, the structural budget balance, which is taken as an indicator of how public finances affect the economy, should be the same as this year, i.e. about 2% of GDP. The fiscal impulse should therefore be almost zero, and this is one of the main factors that should slow down the Czech economy to faster growth.

If we look at the current economic situation, we often use the Purchasing Managers' Index (PMI), the advantage of which is that it is published on the first day after the end of the month. So while in the case of the GDP indicator, we know how the economy fared 2-3 months later, in the case of this indicator, which is correlated with GDP by about 95-98%, we know immediately. The latest data, which are available for a number of European countries, show that the cooling in the industrial sector in Central Europe is still visible. Germany, Austria, the Czech Republic and even France are negative, while Spain and Scandinavia are doing much better.

Interesting things are happening on the labour market, for the last seven years we have become accustomed to saying that the main problem of the Czech economy is that there are no people. This is no longer the case. We are starting to lack jobs, not people. The problem began to change a few months ago, but first vacancies, unfilled jobs began to be cancelled. That's why we don't see it in the unemployment rate yet. Now, however, after a long period when the number of vacancies, i.e. demand from companies exceeded supply from households, the situation has turned around and there are more available and job-seeking people than vacancies.

Let's also look at the development of wages, which were affected by the overheating of the labour market. Wages grew at a relatively brisk pace in the pre-pandemic period, which was only briefly interrupted during the covid and then the growth rate was similar. What has changed, however, is that wages have stopped keeping pace with inflation. This can be seen in the graph where real wages are expressed. Over the course of 2022-23, we lost quite a bit in the real value of wages and returned roughly to the level we were at in 2018. This can also be seen in the fact that the real values of household spending in shops correspond in a similar way, whether we look at retail sales or household consumption as part of GDP.

Finally, fiscal policy, which is a discipline in itself and few people understand it exactly, including politicians, but the basic story is that in 2017-18 there was a turnaround, when we started to fall from modest surpluses to lower surpluses, and then we fell very sharply into a huge deficit during the pandemic. Deficits subsequently decreased a bit, but negative deficits in 2021/22 and 2023 are still relatively high. The deterioration in 2023 was mainly due to the energy crisis and its solution. However, fiscal consolidation has come and we should now get to lower values.

The latest news is that consolidation should be successful, but it has not been completed. What economists, rating agencies and the International Monetary Fund want to do is get us into a situation where our debt-to-GDP ratio stops growing. To be on a path where we gradually slow down and the level of debt to GDP is sustainable and stable. This does not mean that you have to have balanced deficits, even with a slight deficit it is possible to achieve the desired goal, in a situation where you have economic growth higher than the interest rates that the state pays on its debt. The faster the growth, the faster the tax revenues and the faster the state is able to keep the debt to GDP stable even with modest deficits.

We have reached about 2% with the structural situation and we are missing about half a percentage point. That's about $40-50 billion to get to the point where the debt will grow over the next few years, but it will grow more and more slowly until it stops at a reasonably low level and then stays there. For next year, the draft state budget shows that the impact of fiscal policy should be neutral towards the economy and neutral from the point of view of consolidation. This means that it maintains the state of incomplete consolidation, but at the same time does not worsen the situation. However, if the deficit is not 240 billion, but some 280 billion, then the steering wheel of fiscal policy will turn again towards higher deficits, so we will see how it turns out in the end.