OECD Economic Outlook, Volume 2023 Issue 2

Czechia

GDP growth is expected to contract by 0.3% in 2023, before picking up to 1.6% and 2.1% in 2024 and 2025, respectively. Elevated inflation and tight monetary policy are weighing on domestic demand. Slower global growth and trade will moderate exports and activity, notably in manufacturing. Private consumption will pick up in 2024, underpinned by growing real wages. Inflation will continue to decline and get close to 3% – the upper boundary of the tolerance band – in early 2024. The labour market will remain tight with an unemployment rate below 3%. Volatility in energy supply and geopolitical tensions remain major risks. Shocks to commodity prices could make inflation more persistent.

Macroeconomic policy needs to maintain a tight stance until inflation is firmly under control, while monitoring risks to financial stability. Fiscal consolidation should also be pursued to rebuild fiscal buffers. An overdue reform of the pension system would help contain steep future rises in public expenditures. Higher labour participation, notably of mothers, would help address chronic labour shortages and support growth. Reducing emissions and reliance on coal would make growth more sustainable.

The economy has been stagnating

GDP stagnated in the first half of 2023 and declined in the third quarter. Tighter monetary policy and slower global growth are weighing on activity and trade, especially the manufacturing sector. Declining real incomes and low sentiment have hit household consumption. In contrast, public investment is accelerating due to the ending of the EU 2014-2020 programming period as well as the use of funds from the Next Generation EU. Consumer price inflation has declined rapidly since early 2023, to 8.5% in October. The labour market remains tight, with a low unemployment rate of 2.5% in the third quarter of 2023.

Czechia: Inflation and activity indicators

Source: Czech Statistical Office; and S&P Global.

Statlink

Czechia: Demand, output and prices

Statlink

Slow growth in trading partners over recent quarters has lowered export growth, offsetting the easing of supply chain bottlenecks and declining costs to producers. Despite this, the contribution of net exports to growth has been positive, as weak domestic demand has reduced imports. Continued monetary policy tightening by major central banks and a narrowing of the interest rate differential has contributed to a depreciation of the koruna since April 2023.

Macroeconomic policy has tightened

The Czech National Bank (CNB) has kept the policy interest rate at 7% since June 2022. The tight monetary policy stance has slowed the growth of bank loans to households and firms. A gradual easing cycle is projected to start in the first quarter of 2024, with the policy rate being reduced to 4% in 2025. Given the slowing economy, the CNB lowered the countercyclical capital buffer from 2.5% to 2%, effective from October 2023, to ease access to loans. The fiscal situation has deteriorated since the pandemic. The general government deficit is expected to be 3.6% of GDP in 2023. The state budget will likely post a higher deficit than budgeted, owing to measures to cushion the impact of high energy prices and an extraordinary indexation of pensions. For 2024, the government announced faster consolidation, with a 1.4 percentage point improvement in the general government balance as a share of GDP. A further fiscal consolidation of 0.5 percentage points of GDP is assumed in 2025. Expenditure financed by Recovery and Resilience Facility grants will amount to roughly 0.7% of GDP annually in 2023 and 2024, and 0.3% in 2025. General government debt (Maastricht definition) stood at 44.2% of GDP in 2022 and is projected to grow to 47.6% in 2025.

GDP will pick up in 2024

GDP growth is expected to pick up to 1.6% and 2.1% in 2024 and 2025, respectively. Stronger growth in trading partners will support exports. Inflation will drop to about to 3% in 2024 and real wage growth will turn positive, sustaining private consumption. The unemployment rate will remain below 3%. However, the outlook is clouded by uncertainty. Renewed energy supply disruptions could restrict economic activity. Unexpected further rises in commodity and energy prices, a steep depreciation of the koruna or rising inflation expectations could make high inflation more persistent and delay monetary easing. A sharp correction in housing prices could threaten financial stability and weigh on growth.

Ambitious reforms are needed to unleash labour supply and accelerate the green transition

Interest rates will have to remain elevated until inflationary pressures are well controlled. The authorities need to continue closely monitoring risks in the housing market. Steady fiscal consolidation is needed to rebuild buffers. An overdue reform of the pension system would help contain steep future rises in public expenditures. Without reform, costs linked to ageing - health, long-term care and pensions – are set to rise by 2.1 percentage points of GDP between 2024 and 2040. Policies to reduce the reliance on coal and greenhouse gas emissions would boost well-being and make growth more sustainable. Boosting the labour supply of mothers, by expanding the supply of childcare and shortening the maximum length of parental leave, as well as extending working lives would help strengthen growth. Improving skills provision and redesigning immigration policy would help attract and retain skilled labour.