Convergence Programme of the Czech Republic (April 2024)
The document specifies the basic aggregate fiscal data and the forthcoming most important measures in the form of medium-term budgetary impacts of the government's fiscal strategy.
Adverse events in the form of the pandemic followed by the Russian invasion of Ukraine and the associated extreme volatility in the energy markets have placed a heavy burden on society and the economy. In 2020, for the first time in history, the European Commission activated the general escape clause from the rules of the Stability and Growth Pact to allow EU Member States to respond flexibly through fiscal policy to cushion the impact of these shocks.
As risks recede and markets stabilise, fiscal policy stance in the Union is also changing - from purely expansionary in 2020–2022 and neutral in 2023, to restrictive in 2024 and beyond. There is also a change in emphasis from quick and rather across-the-board solutions to largely targeted solutions, focusing only on the most vulnerable in the economy. Economic policy in the Czech Republic has evolved broadly in line with these recommendations in recent years. The same assessment can be made for the period ahead, when fiscal policy should be restrictive this year and in the next few years.
Before 2020, the Czech Republic had a relatively low general government debt, among the four least indebted countries in the EU. The significant increase in debt and the structural imbalance between public revenues and expenditures made consolidation of public finances inevitable. The Czech government has therefore prepared measures to reduce the state budget deficit by around CZK 150 billion in 2024 and 2025. Act No. 349/2023 Coll. amending certain acts in connection with the consolidation of public budgets contains amendments to more than 60 legal acts. Among the most significant budgetary changes contained in the consolidation package are a reduction in subsidies, savings in the state’s operating expenses, the corporate income tax rate increase, the reintroduction of sickness insurance for employees, an increase in property tax, and the elimination or limitation of a number of tax exemptions. The content of the package is in line with a number of recommendations that the Czech Republic has repeatedly received from international organisations. The package also includes an amendment to the Fiscal Responsibility Rules Act, which accelerates the return to the medium-term budgetary objective.
In terms of economic dynamics, the consolidation is set at the beginning of a recovery, which, after a slight decline last year, is already confirmed by data from the end of last year and the beginning of this year. We expect the economy to grow by 1.4% this year driven by renewed household consumption and investment. Inflation will fall significantly this year and is forecast to remain below 3% for most of the year. Labour market imbalances related to labour shortages continue to manifest themselves. As a result, despite the weak economic momentum, the unemployment rate should not rise much in 2024. Moreover, the persistent labour market tightness will not allow nominal wage growth to slow down significantly, and earnings will increase in real terms after two years of decline. In terms of the business cycle, the economy is in a negative output gap, which should close next year.
Public finances in 2023 reflected extraordinary revenue and expenditure related to the energy crisis, rising social spending and sustained assistance to Ukrainian refugees. The overall general government deficit reached 3.7% of GDP last year. Despite the increase in state debt in 2023, general government debt declined to 44% of GDP year-on-year due to high nominal GDP growth.
For 2024, we estimate that consolidation and a minimum of one-off or other temporary expenditure should be reflected in a year-on-year reduction in the deficit to 2.3% of GDP, despite the negative position of the economy over the business cycle. Debt is expected to increase and exceed 45% of GDP. Public finances in the coming years will be primarily determined by the need for consolidation in line with the provisions of the Fiscal Responsibility Rules Act. At the end of the projection horizon, the maximum allowed structural deficit for expenditure ceilings is set at 1.25% of GDP.
In addition to addressing the current structural imbalances in public finances, the government is preparing a set of measures to strengthen the long-term sustainability of the pension system. The first phase of the pension reform concerned pension indexation and early retirement scheme. The second part is now in the final stage of preparation, which, from the point of view of financial sustainability, comes with the fundamental measures of linking the retirement age to life expectancy and a change in the calculation of pensions leading to lower replacement rates; on the other hand, the sharing of assessment bases for spouses or the introduction of a notional assessment base for carers is envisaged.
In April 2024, the Convergence Programme of the Czech Republic was subject to an inter-ministerial comment procedure. The document was approved by the Government of the Czech Republic on 24 April 2024.
As a result of the reform of the Stability and Growth Pact, the European Semester is undergoing significant changes. This year, the convergence programme has been put together for the last time and will be replaced by a so-called medium-term fiscal-structural plan, which will be prepared primarily for a period of 4 or 5 years. Member States should submit the first version of the plan by 20 September 2024. In the case of the Czech Republic, the specific setting of the plan will depend on the assessment of the excessive deficit procedure later this year.