Country risk: Czech Republic safety is called into question

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By:
Jeremy Weltman
Published on:

Analysts have downgraded the sovereign borrower, as full employment and rising wages constrain growth potential, and political risks also rise.

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Locked into a low risk profile, prospective dangers are coming into focus

Contrasting with many of the other markets in central and eastern Europe, the Czech Republic was downgraded in the second quarter of 2019 by experts contributing to Euromoney’s country risk survey.

That’s not to say it has suddenly become a big risk.

On a total score of 71.7 out of a maximum 100 points, Czechia – as it is now also known – is still 19th on Euromoney’s global risk rankings of 186 countries, and nine places higher compared with five years ago.

That puts it towards the top of the second of five tiers into which Euromoney apportions all countries according to their creditworthiness, commensurate with its respective AA-/A1/AA- credit ratings awarded by Fitch, Moody’s and Standard & Poor’s.

In fact the Czech Republic is one of the safest countries in central and eastern Europe, barely more than half a point behind neighbouring Slovakia in Euromoney’s survey.

The two are almost indistinguishable in risk terms and more than six points better off than Poland, lying 34th in the global rankings, or Bulgaria, Hungary, Croatia and Romania, who are further down the scale.

A cursory glance at macro-fiscal indicators helps to explain why.

GDP increased by 0.6% in the first quarter in real terms, resulting in a 2.6% year-on-year expansion. Consumer confidence and retail sales remain buoyant, supported by strong wages growth, while industrial production and the trade surplus are growing.

Overall, the economy is predicted to grow by 2.5% to 3% in 2019/20, according to forecasts from ABN Amro, whose economists contribute to Euromoney’s risk survey. One, Nora Neuteboom, says: “Exports increased by an average of 6.5% on an annual basis in the first four months of 2019, compared to an average of 3.8% in 2018.”

The fact exports can continue to rise despite slowing global trade, causing economic problems for Germany is because the Czech Republic (indeed the region as a whole) is becoming more diversified and less dependent on the German auto industry's supply chains, she says.

“While around 42% of the Czech Republic’s total exports went to Germany in 2000, this has now declined by around 10 percentage points to 32%”, which is just as well given the big decline in production and new orders in German manufacturing showing up in the latest purchasing managers’ indices.

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Attenuating risks

Still, the risks have undoubtedly increased.

One problem fully understood by followers of the nonagenarian Nobel prize winner Robert Solow is the need for more labour supply and a higher productivity of labour and capital to raise an economic growth trend.

That labour supply is a problem is clear from the latest seasonally adjusted harmonized unemployment rate of just 2.2% in May, the lowest of any country in the EU and easily fulfilling the economists’ definition of “full employment”.

That’s a good thing for social stability, clearly, but it also makes it harder for the corporate sector to source an adequately skilled supply of labour, which could see GDP growth stymied without more immigration.

It also means wages must rise steeply, eroding profits. This is obvious from latest data showing a rise of more than 7% year on year in the first quarter translating into real income gains.

The combination of insufficient skilled labour and higher wage costs is deterring inward foreign direct investment, which declined by around half last year, according to a recent survey.

Political problems are also affecting the risk profile.

The controversial billionaire prime minister Andrej Babis is under intense pressure to resign, with his government on the brink of collapsing more than two years short of the next elections.

Although it is not a given that Babis will relinquish his grip on authority, his own centrist-populist party ANO 2011 is in a minority coalition with the Czech Social Democratic Party (ČSSD) led by interior minister Jan Hamáček, and supported by the communists.

Babis is still clinging on after having survived another vote of no-confidence in June, despite public protests, and pressure from the opposition and foreign partners over his alleged involvement in an EU subsidy fraud.

The Social Democrats are also on the verge of quitting in protest over president Miloš Zeman’s refusal to accept the government’s wish to sack culture minister Antonín Staněk, whose position became untenable after he removed the heads of two prominent cultural institutions – despite, apparently, uncovering financial irregularities – thus sparking a political crisis.

All of this is reflected in risk scoring, with analysts downgrading several political indicators this year, including corruption and government stability.

With all five economic indicators downgraded, and structural ones too, a worsening global climate and brewing government crisis may make investors pause for thought, despite the country’s hitherto low-risk reputation.