Fiscal Outlook of the Czech Republic (November 2021)
Global economic development in 2021 is still heavily influenced by the COVID-19 pandemic, which hit the world in early 2020. While much better than in the same period last year thanks to vaccination coverage, the current epidemic situation is deteriorating rapidly. A perceptible increase in costs and a shortage of components for production hamper a more robust economic recovery. With real gross domestic product expected to grow by 2.5% in 2021, we estimate that the Czech economy should reach pre-crisis levels in 2022. Next year should the recovery be stronger at around 4.1%.
Economic recession, anti-epidemic measures and government stimulus instruments have significantly affected the performance of public finances worldwide. In the Czech Republic, we estimate the general government balance for 2021 at −7.2% of GDP and debt at the end of 2021 at 43.3% of GDP. Economic policy needs to strike a balance between a gradual return to neutral fiscal and monetary policy settings, maintaining fragile economic growth and slowing the upward momentum of the price level.
On the fiscal side, the aim is to consolidate public finances. In the Czech Republic, the draft state budget for 2022 foresees a deficit of CZK 376.6 billion (5.8% of GDP). The balance is based on an expenditure framework compatible with a structural deficit of 5.6% of GDP. According to the Act on Fiscal Responsibility Rules, the expenditure framework was derived on the basis of this year’s structural balance estimated by the Ministry of Finance in August 2021, increased by half a percentage point. In the following years, the pace of consolidation is also set at minimum of half a percentage point per year.
The minimum pace should not hamper economic growth. Moreover, it will start at a time when we estimate that the economy will again be in an expansionary phase. At the same time, however, if socio-economic conditions allow for faster consolidation, the law does not place any restrictions on proceeding with it. We predict that, with the current public finance settings, the public finances could be around −3.5% of GDP in 2024 and the debt burden could reach 51.3% of GDP.
Accelerating inflation is becoming a significant macroeconomic issue. In September 2021, annual inflation reached 4.9%, well above the upper end of the tolerance band of the Czech National Bank’s inflation target. High energy and other commodity prices are gradually feeding through to other price categories, including consumer prices. Supply-side frictions are proving to be a major factor in inflation. The average inflation rate is expected to reach 3.5% this year, then accelerating markedly to 6.1% next year. This is very likely to trigger an increase in government spending during 2022 in order to accommodate extraordinary pension indexation in line with current legislation. The government has also taken several steps to cushion rising energy costs for consumers.
From the perspective of social expenditure, the long-term sustainability of such actions has yet to be resolved. The probable next government coalition has singled out pension reform as a priority. In early December 2020, the Organisation for Economic Cooperation and Development presented a report on the Czech Republic’s pension system, in which it made recommendations for adjustments to the social system and the way the old-age security system is set up. Although the details of the emerging coalition proposal remain unknown, from a purely quantitative perspective the scope of the measures required can be demonstrated on three aspects of possible solutions – a rising retirement age, adjustments to the indexation mechanism, and an increase in the system’s revenue. Qualitative adjustments to the pension system will then have to take place within the scope set by these scenarios.
The Fiscal Outlook’s thematic chapter focuses on the inflow of funding from the funds and other instruments of the European Union, including its impact on the national economy. Between 2004 and 2020, the Czech Republic benefited from around CZK 1.6 trillion; approximately 55% of these funds increased capital expenditure. After taking into account payments to the EU budget from national sources, it received almost CZK 900 billion net. In the period ahead, we should mainly witness economic recovery and increasing resilience among Member States as the epidemic crisis recedes. Both the 2021–2027 financial perspective and the new Next Generation EU will be used for this purpose, with the Czech Republic able to draw on around EUR 30 billion. Resources under the most important Next Generation EU instrument, the Recovery and Resilience Facility, will be allocated in line with the approved National Recovery Plan. It brings together investment and reform actions worth almost CZK 191 billion, 39% of which are focused on achieving climate goals, 21% on digitalisation or 19% on other areas of education, the labour market and health care. We estimate that, at the end of the Fiscal Outlook horizon, the Czech gross domestic product will be more than 5% higher in aggregate than without these EU funds. However, this is only part of the impact. The strengthening and expansion of health care, the digitalisation of public administration, as well as investments in the environment, education, science and research will mostly be reflected in the longer term. As an investment in a better future.