Fiscal Outlook of the Czech Republic (November 2017)
In the first half of the year, the Czech economy grew by 3.7% compared to the previous year. The growth was driven by robust domestic demand backed by high positive balances of foreign trade. The impressive dynamics of the Czech economy is also reflected in the performance of public finances. Without distortion by European Union projects, the balance of the state budget between January and October reached almost 17 billion CZK. By the end of September, local governments reported a surplus exceeding 44 billion CZK and health insurance companies reported a positive balance exceeding 6 billion CZK. Despite an increase in current and investment expenditure, the reason for such high surpluses is an above-average growth in tax revenue. Tax titles accounting for approximately three quarters of total tax revenue have been growing at least 8% this year.
In 2016, the Czech Republic’s public finances ended in surplus for the first time. The shift to surplus outcome was the result of a substantial improvement in the structural balance. The current forecast of the general government sector performance this year and in the coming years suggests that it was not an exception. In accordance with the expected macroeconomic development and budgetary impact of government policies we estimate for the coming years that the structural balance should continue to be positive and the overall balance should keep improving with a firm economic growth.
A set of legal regulations was adopted in January 2017 which transposed into Czech law Council Directive on requirements for budgetary frameworks of the Member States. From this group, the key Act on fiscal responsibility rules has completely changed the method expenditure frameworks for the state budget and state funds are set. Determination of expenditure frameworks now results from the medium-term budgetary objective based on the concept of structural balance, which does not include the effects of the business cycle and one-off measures. The medium-term budgetary objective ensures long-term sustainability of the entire general government sector as well as room for automatic stabilizers. The 2017 reform of the fiscal and budgetary framework connected the medium-term budgetary objective with the national budgetary methodology for the state budget and state funds, thus introducing EU regulations regarding the Stability and Growth Pact into the national budgetary process.
The values and derivations of expenditure frameworks for 2018 to 2020 are contained in the Budgetary Strategy for the General Government Sector of the Czech Republic, approved by the Government on 24 April 2017. The updated framework amounts are the basis for this year’s draft of the state budget for 2018, state fund budgets and their medium-term outlooks. The present Fiscal Outlook of the Czech Republic relies on them in particular at the level of public expenditure set-up. Moreover, it is based on the November Macroeconomic Forecast for the Czech Republic by the Ministry of Finance, to which it adds detailed aspects of the fiscal development.
The Fiscal Outlook of the Czech Republic expects a surplus of the general government sector performance of 1.1% of GDP for this year, consisting mainly of the balance of local governments. For 2018, we estimate a further increase in the general government surplus to 1.3% of GDP, despite considerable dynamics of employee compensation, social benefits and investment. The projected strong growth in tax revenue including social security contributions should be, similarly to this year, driven not only by the economic boom but also by revenues from the measures against tax evasion. The outlook of the economy beyond 2018 will be determined by the new set-up of economic policy of the government that will be appointed after October elections to the Chamber of Deputies. However, the current trend indicates a gradual improvement in the general government balance to 1.7% of GDP in 2020, and a decrease in the debt-to-GDP ratio to approx. 31% in the same year.
The Fiscal Outlook of the Czech Republic also brings first information about the result of new long-term projections of pension expenditure. The quantified future costs give an idea about the causes and magnitude of the risks for long-term sustainability of the pension system in the Czech Republic. The new Eurostat demographic projection foresees a relatively large decline in the population of the Czech Republic in the long term. The ratio of people over the age of 65 to the working age population (15–64 years) should almost double by 2070 and reach approximately 50%. Although the projection of the number and structure of the Czech Republic population is relatively pessimistic, its impact on the development of pension expenditure over the time is moderated by the current developments of the pension account. Its deficit in 2016 was 0.3% of GDP. In addition to demographic developments, the deficit of the pension system is significantly deepened by recent changes to the system, especially introduction of a ceiling on the retirement age. However, the current system contains a possibility of retirement age revision. If the retirement age is adequately increased based on life expectancy, future costs of the pension system may be significantly reduced.
The economic developments in the recent years have led to a sharp increase in the number of independent fiscal institutions in the world. In the European Union, the institutional framework for fiscal policy has been strengthened by an agreement on new common legislation that requires the introduction of elements of independent fiscal institutions in every Member State. On the occasion of coming into effect of the new Act on Fiscal Responsibility Rules, which established the National Budget Council in the Czech Republic, the last, thematic, chapter deals with the functioning of independent fiscal institutions, their functions and activities. From the formal point of view, the Czech National Budgetary Council is rather a small fiscal council, however, with a considerable methodological, consultancy and evaluation role in the national budgetary process.