Home Ratingové hodnotenia a Výskum Aktuálne platné ERA affirms AA- rating to the Czech Republic, outlook Stable
ERA affirms AA- rating to the Czech Republic, outlook Stable
Piatok, 26 Júl 2019

The unsolicited credit rating assigned to the Czech Republic stems from fiscal surpluses, low debt, and high foreign exchange coverage ratios. Governance indicators, which are significantly above average on the world scale, also support the final assessment. However, their score lags behind the 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 the current good times 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 global financial and debt crisis with very high competitiveness. This is illustrated by its ability to create jobs. The unemployment rate, which was slightly above 2% in May 2019, is by far the lowest in the EU. Its extremely tight job market spurs wage growth, which climbed to 7.5% in 2018, the highest since 2008. According to ERA's forecast, the wage growth peaked last year, but it should remain above average in the medium-term.

A robust labor market and very strong wage growth support household consumption, which is the main factor contributing to GDP growth. In 2018, the economy grew by 3%. ERA expects the growth to slow close to 2.5%, mainly due to weaker external demand. However, the country's strong household sector should provide a cushion against a sharper slowdown in economic growth.

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. This growth will be supported by the smooth transfer of technology and capital within the EU and also 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.


Unemployment rate in the EU and Czech Republic

Source: Eurostat


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


Sound public finances, new fiscal rules:

The Czech government is using the current good 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 32.6% at the end of 2018; it is projected to fall further in the coming years as a result of solid economic growth and sound fiscal policies.

The Visegrad Group consists of four countries – Poland, the Czech Republic, Hungary, and Slovakia. The V3 average label used in the chart denotes the average of the Visegrad Group except for the Czech Republic.


General government structural balance in Czech Republic, EU-28, and the rest of the Visegrad Group (% of potential GDP)

Sources: AMECO, ERA


In 2017, the government adopted a set of fiscal rules setting limits on the debt to GDP ratio at 55% and on the government structural balance (-1.25% in 2019, -0.75% starting in 2020). The actual figures show a high level of compliance with these rules. In 2018, the budget was in a structural surplus of 0.4% GDP (the general government surplus stood at 0.9%). In 2019, ERA expects the surplus to shrink and the structural balance to fall to around zero. Nevertheless, the fiscal condition should remain healthy on the global scale.


Sound private finance factors:

Private finances are in very good shape. The investment to GDP ratio for 2018 is estimated at 26.3%, the fourth highest in the EU (EU average at 21.7%), and the savings to GDP ratio at 26.5%, far above the EU average of 23.5%. The banking sector shows high profitability levels (return equity of 13.7% in Q4 2018), low NPL ratios (1.9% in Q4 2018), and average capital adequacy ratios (CET 1 ratio above 17% in Q4 2018) on the EU level. Moreover, the private sector debt to GDP ratio is among the lowest in the EU (89% of GDP in Q1 2019, unweighted EU average stands at 155%).

There are some concerns regarding large increases in house prices. Household credit growth has, however, been matched by an increase in GDP and, thus, the household debt/GDP ratio remains stable at slightly above 30%. The credit to GDP gap was close to zero in 2018 according to the BIS. Moreover, the central bank has adopted measures to mitigate household credit growth by issuing recommendations for the LTV ratios, DTI, and DSTI and to mitigate the risks in the banking sector by increasing countercyclical capital buffers. In light of these facts, ERA assesses banking sector risks, which could have a negative impact on government's solvency, as low.


Very strong foreign exchange coverage ratios:

In the fall of 2013, when the economy was in a mild recession and faced deflationary pressures, 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 rose by a factor of 3.6 since the start of the interventions. Foreign reserves currently account for more than 60% of GDP and cover 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.

After 5 years of surpluses, the current account is expected to return to a slight deficit in 2019 in light of weakening external demand and strong domestic consumption. The trade balance is, nevertheless, expected to remain strongly positive at around 6% of GDP. It will be offset by the deficit on the primary balance resulting from profit outflows by foreign-owned companies. The external debt position is contained despite the high portion of short-term external debt (58%) and the relatively high portion of foreign currency external debt (49%). The risks are mitigated by ample banking sector liquidity and high foreign currency reserves. The net international investment position increased from its all-time low of -47.7% GDP in Q2 2011 to -20.8% in Q1 2019. This is the highest among the EU CEE countries and far above regional peers.


Net international investment position for the Czech Republic and its regional peers

Source: Eurostat


Forward-looking factors of rating assessment

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


Governance indicators are significantly above average:

The Czech Republic scores well 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 2018, 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):

Sources: 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. This trend has been improving in recent years and average score for all indicators followed by ERA was the highest on record in 2017. This trend has not been matched by its peers from the Visegrad Group, where the Czech Republic has established itself as a clear leader in terms of governance.


Average score for World Governance Indicators in the the Visegrad Group

Sources: World Bank, ERA


Outlook: Stable

The outlook has been assigned based on expectations of a soft landing of the country's main trading partners and the 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 2-3% in the medium-term;

• Continuation of sound fiscal policies;

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


Potential outlook and/or rating change factors


A positive rating action may be prompted by:

• Substantial improvement of governance indicators;

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


A negative rating action may be prompted by:

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

• Substantial worsening of governance indicators.


Appendix 1. Peer-analysis materials

General government debt/GDP (%) 2018:

Source: Eurostat

General government fiscal balance/GDP (%) 2018:

Source: Eurostat


Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018

2019_F

GDP, bln EUR

156.7

168.5

176.4

191.7

206.8

217

GDP growth rate, %

2.7

5.3

2.5

4.4

3.0

2.6

GDP per capita, ‘000 EUR

14.9

16.0

16.7

18.1

19.4

20.3

Population, mln

10.5

10.5

10.6

10.6

10.6

10.7

Unemployment, year-average, %

6.1

5.1

4.0

2.9

2.2

2.1

Consumer inflation, year-average, %

0.4

0.3

0.6

2.4

2.0

2.4

External debt to GDP, year-end %

67.8

68.5

73.4

89.3

81.9

78

Public debt to GDP, %

42.2

40.0

36.8

34.7

32.6

31.3

Gross Domestic Investment to GDP, %

25.9

28.0

26.0

25.9

26.3

26.7

International reserves, bln EUR

44.9

59.2

81.3

123.4

124.5

129

Trade balance, bln EUR

10.0

9.8

13.1

14.7

13.1

12.7

Exports, bln EUR

129.3

136.4

139.8

154.2

162.3

167.4

Imports, bln EUR

119.3

126.6

126.8

139.5

149.2

154.7

Current account to GDP, %

0.2

0.2

1.6

1.1

0.2

-0.3


Appendix 3. List of material data sources

International Monetary Fund

World Bank

Bank for International Settlements

Eurostat

AMECO

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 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 did not participate in the rating process and the information and documentation for its development 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 July 24, 2019, and after the notification there were no changes or amendments in the rating. The rating was first released for distribution on February 1, 2019.

Download pdf:

Czech_Republic_affirmation.pdf


Approved by the Rating Committee:

Zuzana Hrebičková, Acting

Head of credit rating analysts

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