Home Ratingové hodnotenia a Výskum Aktuálne platné ERA rates Czech Republic AA-, outlook Stable
ERA rates Czech Republic AA-, outlook Stable
Piatok, 01 Február 2019

The unsolicited credit rating AA- assigned to Czech Republic stems from fiscal surpluses, low debt, and high foreign exchange coverage ratios. Governance indicators, which are highly above average on the world scale, also support the final assessment. However, the governance score lags behind those of leading advanced economies and therefore constrains the final rating.

Rating components

Macroeconomic factors

Economic factors

High

Debt and current account sustainability factors

Very high

Public finance factors

High

Private finance factors

Very high

Foreign exchange stability factors

Very High

Liquidity factors

Very High

Final assessment

 Very High

Forward-looking factors

Political and economic stability

High

Efficiency and reforms potential

High

Final assessment

High

Overall score

Very High

Final rating

AA-


Macroeconomic factors of rating assessment

The Czech economy is very competitive, which is demonstrated by solid growth and extremely low unemployment. The government is using this to strengthen its public finances. Sound public finances, together with very high foreign exchange coverage rates, provide a sufficient cushion to tackle possible headwinds.

Lowest unemployment in the EU supports household consumption:

The Czech economy emerged from the financial and debt crises with very high competitiveness. This is illustrated by its ability to create jobs. The unemployment rate, which fell below 2% at the end of 2018, is by far the lowest in the EU. It's extremely tight job market spurs wage growth, which is expected to be around 8% for 2018 based on the European Commission's methodology. According to ERA's forecast, the wage growth peaked last year, but it should still remain above average in the medium-term.

Unemployment rate in the EU and Czech Republic

fig1

Source: Eurostat


A robust labor market and very strong wage growth are supporting household consumption, which is the main factor contributing to GDP growth. Although ERA expects the economy to slow down further in 2019 slightly below 3%, mainly due to weaker external demand, the strong household sector should provide a cushion against a sharper slowdown in economic growth. ERA expects economic growth to be close to the medium-term potential growth rate between 2.5 and 3% in 2019-2020.

In the medium-term, the economy should continue to grow at higher rates than the EU-average as a result of a continuing catch-up effect, which will be supported by the smooth transfer of technology and capital within the EU as well as by solid R&D expenditure, which is the highest in the region. In the long-term, however, the potential growth rate is expected to slow down mainly as a result of demographic stagnation.

The main risk to economic growth is the external environment. The Czech Republic has a relatively small, open, and export-oriented economy with exports accounting for approximately 80% of GDP and therefore its growth is strongly influenced by the development of external demand. Moreover, exports are very geographically concentrated. In 2018, almost one third of the exports went to Germany and only four countries account for more than a half of the merchandise exports (Germany, Slovakia, Poland, and France).

Sound public finances, new fiscal rules:

You can read more on ERA's assessment of the fiscal rules in the EU in our latest research here: http://www.euroratings.co.uk/index.php/sk/ratingove-hodnotenia/2019-01-30-12-41-09/232-strong-fiscal-rules-in-the-eu-do-not-guarantee-good-fiscal-health

The Czech government is using the current positive economic times to cut its debt. Government finances have been in surplus since 2016 and ERA expects them to remain there at least until end of 2019. As a result of sound fiscal policies, the debt to GDP ratio fell from its 2013 peak of 44.9% to around 33% at the end of 2018 and it is projected to fall further in the coming years. Recently, the government has adopted a set of fiscal rules setting limits on the debt to GDP ratio at 55% and on the government structural balance at -1% from 2020 (-1.25% in 2019). The actual figures show high compliance with these rules.

Very strong foreign exchange coverage ratios after central bank interventions:

In the fall of 2013, when the economy was in a mild recession and faced deflationary pressures, the central bank decided to substantially weaken the currency and set a floor on the EURCZK exchange rate at 27. The central bank kept the currency undervalued by selling domestic currency and purchasing foreign currency assets until April 2017, which led to a massive increase in foreign reserves. Their amount has risen by a factor of 3.6 since the start of the interventions. Foreign reserves currently account for more than 60% of GDP and cover almost three quarters of external debt and approximately 10 months of imports. As a result of these central bank interventions the foreign exchange coverage ratios are very strong.


Foreign exchange reserves in months of imports and % of external debt

fig2

Source: Czech National Bank, ERA

Sound private finance factors:

Private finances are in very good shape. Investment to GDP ratio for 2018 is estimated to be 26.5%, the second highest in the EU (EU average is 21.6%) and the saving to GDP ratio at 26.2%, far above the EU average of 23.6%. The banking sector shows high profitability levels (Return on Tier 1 equity of 18% in Q3 2018), low NPL ratios (2.6% in Q3 2018), and above average capital adequacy ratios (Tier 1 capital ratio above 18% in Q3 2018). Moreover, the private sector debt to GDP ratio is among the lowest in the EU (89% of GDP in Q2 2018, while the unweighted EU average stands at 159%).

There are some concerns regarding strong growth in house prices. Household credit growth has, however, been matched by an increase in GDP and, thus, the household debt to GDP ratio remains stable, slightly above 30%. Moreover, the central bank has adopted measures to mitigate household credit growth by limiting the LTV ratios and mitigate the risks in the banking sector by increasing countercyclical capital buffers. In light of these facts, ERA assesses the risks in the banking sector, which might have a negative impact on government's solvency, as low.

Forward-looking factors of rating assessment

Governance indicators, which score highly above average on the world scale, are improving and are the best in the region. Control of corruption is lagging behind the rest of the indicators.

The Czech Republic scores highly above average on the global scale in the assessment of governance indicators. It does extremely well in the social cohesion assessment, which is also supported by low income inequality. In 2017, the GINI index was the third-lowest in the EU (after Slovakia and Slovenia). However, it scores only slightly above average in the assessment of control of corruption, which is the main drag on the forward-looking assessment.

Selected World Governance Indicators (ERA score, 1-10):

fig3

Source: World Bank, ERA


Governance indicators are the best in the region:

Among the countries of the former Eastern Bloc, the governance assessment is second-highest after Estonia. Dynamics have been improving recent years, and the average score for all indicators followed by ERA was the highest on record in 2017. This recent positive trend has not been matched by its peers from the Visegrad Group, in which the Czech Republic established itself as a clear leader in terms of governance.

Average score for World Governance Indicators in the Visegrad Group

fig4

Source: World Bank, ERA

Outlook: Stable


The outlook has been assigned based on expectations of the soft landing of the country's main trading partners and continuation of sound fiscal policies.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon.

Key assumptions

• Economic growth in the range of 2.5-3.5% in the medium-term;

• Continuation of sound fiscal policies;

• Soft landing of the global economy after the current cyclical slowdown.

Potential outlook and/or rating change factors

A negative rating action may be prompted by:

• Material decline in exports above 10% year on year;

• Substantial deterioration of governance indicators.

A positive rating action may be prompted by:

• Substantial improvement in governance indicators;

• Further decline in debt to GDP ratio below 30%.

Appendix 1. Peer-analysis materials. Stance among the peer-group sovereigns (2018)


General government balance to GDP (%). The only positive balance within the peer-group.

fig5

Source: IMF


General government debt to GDP (%). The lowest debt to GDP ratio within the peer-group.

fig6

Source: IMF

Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018_E

2019_F

GDP, bln EUR

156.7

168.5

176.4

191.1

206

217

GDP growth rate, %

2.7

5.3

2.5

4.4

3.0

2.8

GDP per capita, ‘000 EUR

14.9

16

16.7

18.1

19.5

20.5

Population, mln

10.5

10.5

10.6

10.6

10.6

10.6

Unemployment, %

6.1

5.1

4

2.9

2.2

1.9

Consumer inflation, year-average, %

0.4

0.3

0.7

2.4

2.0

2.3

External debt to GDP, year-end %

67.9

68.5

73.4

89.3

83.0

80.0

Public debt to GDP, %

42.2

40.0

36.8

34.7

33.1

31.7

Wider public debt to GDP (incl. quasi-government sector), %

56.3

54.2

49.3

46.2

44.2

42.3

Gross Domestic Investment to GDP, %

25.9

28.0

26.0

25.8

26.5

26.6

Loans to economy to GDP, %

102.5

97.0

100.1

100.0

103

104

International reserves, bln EUR

44.9

59.2

81.3

124.3

124.5

124.5

Trade balance, bln EUR

10.0

9.8

13.1

13.8

14

13

Exports, bln EUR

129.3

136.4

139.8

153.1

159

167

Imports, bln EUR

119.3

126.6

126.8

139.3

145

154

Current account to GDP, %

0.2

0.2

1.6

1.1

0.6

0.3


Appendix 3. List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

Czech National Bank

Czech Statistical Office


Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section there is a rating scale including an explanation of the importance of each rating category and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e., was not initiated by the rated entity or a related third party. The rated entity participated in the rating process by providing the most recent data on government contingent liabilities. Other information and documentation for rating process was obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity’s internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies. The rated entity was notified on January 30, 2019 and after the notification there were no changes or amendments in the rating. This is the first release of the rating for distribution.


Download pdf:

Czech Republic_Sovereign_Report.pdf


Approved by the Rating Committee:

Natalia Porokhova, Head of credit rating analysts

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