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The Czech Republic on its Way Towards the Euro Petr KRÁL Monetary and Statistics Department Czech National Bank Conference: "Competitiveness of the South Eastern European Countries: Challenges on the Road to EU Skopje, May 30, 2008 Presentation Outline • Milestones on the Czech Republic's way to the West • Economic effects of the EU membership • Economic aspects of the adoption of the euro • Euro-adoption plans 2 Milestones on the Czech Republic's way to the West • Successful transition from central planning to a functioning market economy 1989 – “Velvet Revolution” in former Czechoslovakia 1993 – split of Czechoslovakia into the Czech Republic and Slovak Republic 1995 – OECD membership 1999 – NATO membership 2004 – European Union membership (derogation on euro introduction • Characteristics of a small open economy 3 Economic effects of EU the membership Pre-accession economic developments (i) • Fundamental transformation steps and so-called transitory recession (1990 – 94) • Demand-driven economic recovery with supply side lagging behind resulting into an overheating (1994 – 1997) • Financial and subsequent economic crisis (1997 – 1999) • Abolition of pegged ER combined with monetary targeting (1997) and adoption of inflation targeting framework (1998) • Supply-side improvements (FDIs) and acceleration of convergence (2000 – ) 4 Economic effects of EU the membership Pre-accession economic developments (ii) • massive inflow of FDI started in 1998 (paradoxically in economic bad times) • introduction of government investment incentives and privatization of state-owned property kicked-off the inflow Král (2004):Identification and Measurement of Relationships Concerning Inflow of FDI: The Case of the Czech Rep. (CNB Working Paper) • subsequently enterprises under foreign control begun to gain growing share on economic activity Penetration of foreign capital into enterpreneurial sector FDI inflow and FDI stock 60.00 1 400 000 180 000 160 000 1 200 000 50.00 140 000 1 000 000 40.00 800 000 100 000 600 000 80 000 60 000 % mil. of CZK 120 000 30.00 20.00 400 000 40 000 200 000 10.00 20 000 0 0 93/I 94/I 95/I 96/1 97/I 98/I 99/I 00/I 01/I 03/I 04/I 0.00 98/I III 99/I III 00/I III 01/I III 02/I III 03/I III time time FDI inflow (right axis) 02/I FDI stock Share of EUFC on VA Share of EUFC on GFCF 5 04/I III Economic effects of EU the membership Pre-accession economic developments (iii) • inward FDI has been both vertical benefiting from the comparative advantage of the Czech economy in terms of input prices, government promotion of FDI and economic stability • and horizontal focusing on the LR growth and market size prospects arising from the expected Czech Republic’s future accession to the EU • FDIs were coming prevailingly from EU countries (Germany, Austria, Netherlands?) Shares on cumulative FDI inflow during 1993-2003 Shares on cumulative FDI inflow during 1993-2003 15% 16% 18% Transport, storage and communications 5% Financial intermediation 4% 31% 5% Trade, hotels and restaurants Machinery and equipment 21% 6% Real estate and business activities Electricity, gas, and water supply Food and tobacco 8% 12% 13% Refined petroleum and chemicals others 6% 7% 9% 13% Germany Netherlands Austria France United States Belgium Switzerland others 11% 6 Economic effects of EU the membership Pre-accession economic developments (iv) • as a result the Czech Republic became one of the most FDI penetrated country in the region and in the world and openness and export performance of the country are also tremendous • positive effects of inward FDI on the supply side of the economy (capital stock + crowding-in effects, primary and secondary technological spillovers) contributed significantly to the gradual acceleration of potential (non-inflationary) output growth FDI inflow per capita (in USD) FDI stock per capita (in USD) 1 000.0 4 000.0 900.0 3 500.0 800.0 3 000.0 700.0 600.0 2 500.0 500.0 2 000.0 400.0 1 500.0 300.0 1 000.0 200.0 500.0 100.0 0.0 0.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Czech Republic Hungary Poland Slovakia 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Czech Republic Hungary Poland Slovakia 7 Economic effects of EU the membership EU entry – acceleration of ongoing trends and new phenomena (i) • EU single market – 4 freedoms of movement Goods Services Labour Capital • EU regulations Acquis communautaire EU norms, tax harmonization, common policies (e.g. trade, agriculture) • Access to EU funds • “Reputation” effect 8 Economic effects of EU the membership EU entry – acceleration of ongoing trends and new phenomena (ii) • acceleration of GDP growth and its potential • speed-up of the real convergence vis-à-vis western countries • rapidly growing export capacities are the main driver (extreme in 2004) • steadily increasing openness of the economy 12 90 25 80 10 20 70 8 60 15 50 6 CZ 40 EA EE+LV+LT 30 HU+PL+SI+SK 4 10 20 2 5 10 0 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 -2 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Share-exports Share-imports growth-exports (righ axis) growth-imports (righ axix) 9 Economic effects of EU the membership EU entry – acceleration of ongoing trends and new phenomena (iii) Czech exports have developed specialized in machinery and transport equipment, mainly as a result of FDI As a result, trade balance turned to positive numbers being driven by the surplus of the trade with SITC 7 items duben duben duben duben 100% 75% Misc.manufactured goods Machines, transport equipment Basic manufactures 50% Chemicals 25% SITC 0-4 and 9 0% total 1993 total EU15 2000 total EU15 2005 04 05 06 07 srpen srpen srpen srpen 04 05 06 07 prosinec 04 prosinec 05 prosinec 06 leden 08 350 300 250 200 150 100 50 0 -50 -100 -150 fuels chemicals Manufactured Machinery Manufactured goods and transport articles equip. 10 Economic effects of EU the membership EU entry – acceleration of ongoing trends and new phenomena (iv) Macroeconomic policies MP – EU entry itself no major challenge (tax harmonization: no large price shock) FP – task to meet Stability and Growth Pact requirements 11 Economic aspects of the euro adoption Why to adopt the euro • Legal obligation (no opt-out clause, only derogation) • Economic reasoning Exchange rate and interest rate stability Lower transaction cost (reduction in exchange rate risk, access to more liquid financial markets) Higher price transparency Disciplining effect on domestic economic policies Final step in the EU integration 12 Economic aspects of the euro adoption Possible risks • Loss of independent monetary policy Interest rates handed over to ECB => ECB’s common monetary policy does not have to fit the Czech reality => Limited reaction to asymmetric shocks Solution ?! 180 • Inflation acceleration y = 0.7547x + 24.529 R2 = 0.8469 160 Price level of consumption (2006, EU12=100) Economic alignment Flexible alternative stabilization mechanisms Fiscal policy Labour market 140 DK IS NO 120 FI CH SE IE UK IT FR 100 PT 80 CY HR TR 60 PL RO LV 40 MK MT NL DE BE GR AT ES SI EE HU LT SK CZ BG 20 0 0 20 40 60 80 100 120 HDP v PPS (2006, EU12=100) 140 160 13 180 Economic aspects of the euro adoption Timing of the euro adoption Formal conditions Maastricht criteria Price stability Inflation: below three best performing EU countries’ inflation +1.5 pp Sustainability of government finance Fiscal deficit: < 3% of GDP Gov. debt: < 60% of GDP Exchange rate stability Exchange rate: ERM II participation for 2 years without sever tensions Compatibility of legal framework Including the central bank status with EU regulation Informal conditions Economic consideration Symmetry Flexibility Durability of convergence LT interest rate: below three best (inflation) performing EU countries’ IR +2.0 pp 14 Euro-adoption plans of the Czech Rep. Strategic documents • CNB & Government The CR’s EA accession strategy First in 2003 Updated in 2007 Assessment of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment of the CR with the EA • CNB Analyses of the CR’s current economic alignment with the EA http://www.cnb.cz/en/monetary_policy/strategic_documents • Government Convergence programme of the CR http://www.mfcr.cz/cps/rde/xchg/mfcr/xsl/conv_program.html 15 Euro-adoption plans of the Czech Rep. First EA Accession Strategy (2003) • Common stance by the CNB and the Government • Benefits outweigh risks, but risks can be reduced quality preferred to speed • CNB will continue in IT until the CR adopts the euro • Participation in ERM II only for minimum possible period 2 years • Expected date of the euro adoption => 2009 – 2010 conditional on Criteria fulfilment Including a consolidation of public finances Achievement of a sufficient level of real convergence Adequate progress with structural reforms Leading to a sufficient degree of economic alignment 16 Euro-adoption plans of the Czech Rep. Fulfillment of the Maastricht criteria Fiscal deficit 14.0 16 Inflation 14 12.0 LT sustainability? 12 BUT 2008 10 10.0 8 8.0 6 6.0 4 2 4.0 0 2.0 -2 1999 2000 2001 2002 2003 2004 2005 2006 2007 0.0 Reference value Czech Republic Hungary ERM II Poland Public debt 70.0 60.0 1997 Slovakia 1998 1999 2000 2001 Czech Republic 2002 Hungary 2003 2004 Poland 2005 2006 2007 Slovakia 14 LT IR 12 50.0 10 40.0 8 30.0 6 20.0 4 10.0 2 0 0.0 1997 1998 1999 2000 2001 Czech Republic 2002 Hungary 2003 Poland 2004 2005 Slovakia 2006 2007 2001 2002 Reference value 2003 2004 Czech Republic 2005 Hungary 2006 Poland 2007 Slovakia 17 Euro-adoption plans of the Czech Rep. Economic Alignment (i) Long-run convergence 120 2006; euro area average = 100 100 80 60 40 20 0 CZ AT DE PT GDP per capita in PPP HU PL SI SK Average GDP price level • Progress achieved • Important gap persists for the CR – especially in the price level 18 => expectation of the real exchange rate appreciation Euro-adoption plans of the Czech Rep. Economic Alignment (ii) Correlation of GDP Growth 1.0 vis-à-vis the euro area, 2001:Q1-2006:Q1 0.8 0.6 0.4 0.2 0.0 CZ AT DE year-on-year differences HU PL SI SK quarter-on-quarter differences • Major difference between the cycle of the CZ and EA real GDP growth • Low correlation with the euro area characteristic also for macroeconomic shocks 19 • Higher level of correlation seems to prevail for industrial production Euro-adoption plans of the Czech Rep. Economic Alignment (iii) Fiscal deficits 8 Cyclical deficit 7 Cyclically adjusted deficit 6 Total deficit 5 4 3 2 1 0 -1 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 • Fiscal deficit structural in nature • Little room left for automatic stabilizers • Some reforms have been implemented, some are in the pipeline and some have been announced • Figures for 2007 - 2008 revised downwards • Long-term sustainability remains an issue 20 Euro-adoption plans of the Czech Rep. Economic Alignment (iv) LT unemployment and regional differences Long-term unemployment:: % share of long-term unemployed (12Ms or more) in total unemployment, 2006 Variation coefficient of regional unemployment: NUTS2, 2005, CNB calculation 80 70 60 50 40 30 20 10 0 CZ AT DE PT Long-term unemployment HU PL SI SK Variation coefficient Both indicators are relatively high – showing structural problems on the labour market (including low mobility) 21 Euro-adoption plans of the Czech Rep. An Up-dated EA Accession Strategy (2007) (i) • Strategy from 2003 has proven to be useful and in some sense fulfilled BUT • Major obstacle was seen in fiscal consolidation EDP should be abrogated ASAP (1st stage of fiscal reforms) Maastricht criterion not ambitious enough Medium-term objectives (SGP) should be targeted Long-run challenges stemming from demographic changes have to be addressed • Still low flexibility and efficiency of the economy the labour market must be markedly enhanced 22 Euro-adoption plans of the Czech Rep. An Up-dated EA Accession Strategy (2007) (ii) • Conclusion No particular date of entry proposed New euro-adoption date will not be set until sufficient progress is made in fiscal consolidation and flexibility of the economy The same conclusions drawn in the last annual Assessment of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment published at the end of 2007 CR will not initiate the ERM II entry in 2008 23 Thank you for your attention www.cnb.cz [email protected] 24