By Helena Horska, Raiffeisenbank a.s. Czech Republic, Gunter Deuber and Matthias Reith, RBI, Vienna |
COVID-19 infections are spreading globally and exponentially. In developed countries, incl. the Czech Republic, a crisis of healthcare systems seems imminent. As a result of containment measures and growing effects of the virus, we also see an existential economic crisis unfolding. We face an unprecedented economic shock in peacetimes in the Czech Republic, comparable in its size only perhaps to World War II or the 1930s Great Depression. Unlike recent crises, however, the current one is not of commercial origin. It is a textbook external shock. As economists we must confess: We do not have plenty of experience with downturns of this scale. While it is hard to forecast the magnitude of the downturn there are several aspects that are crucial for the recovery. Governments should ensure a smooth continuation of state institutions and restore production plus supply chains as soon as the situation allows for. Moreover, fast, well-aimed, and non-chaotic macro-stabilization measures, including monetary and fiscal stimulus packages, are key.
Czech economy – a victim of healthcare capacity limitations?
Prior to the COVID-19 outbreak experts always warned about the risks a large-scale pandemic implies. However, in the World Health Organization’s Global Health Security Index, tracking the preparedness for a pandemic, the Czech Republic’s performance is far from stellar. Relative to other nations, the country lags in risk communication, pandemic plans, and healthcare system capacity. Hence, the COVID-19 outbreak has caught the country unprepared, a fact that explains why politics adopted sweeping containment measures – the economy is put on hold now. Albeit the local economy was previously slowing due to the Covid-19 spreading in China/Asia and eventually Europe translating into first supply-chain cracks, recent downsides are harsher. Mid-March, the Czech government-declared the state of emergency (in tandem with ever-increasing Covid-19 infections). This led to a complete paralysis of large parts of the economy and finally (much to the government’s surprise?) major car makers suspended their production.
How deep is the Czech economy’s bottom?
A deep recession is inevitable. Restrictions affect many more producers than the car makers. Various firms face shortages of workers, outages of material and part supplies, transportation difficulties and decreasing demand. The local economy is losing about CZK three billion a day. Due to the extensive uncertainty, ranging from the undetermined duration of the state of emergency, nationwide quarantine, restrictions on cross-border movements, and unclear prospects regarding the reopening of schools it is hard to say when the bottom for the economy will be reached. In our current baseline scenario, we expect the virus’ spreading to peak by Easter (mid-April). Subsequently, a gradual and partial lifting of restrictions may follow, and the economy’s wheels could start turning again. In such a scenario the Czech as well as the euro area economy may hit the bottom in Q2 2020, the volume of production could decrease by “just” 9-10%.
If restrictions are gradually eased after Easter, there is still hope for a steady recovery in most industries; with the unfortunate exception of tourism which might still suffer from travel bans. Not even the resulting unfreezing of the Czech economy in the second half of the year can, however, bring its output all the way back to the 2019 level. We thus expect at least a year-on-year GDP drop by 5-6% in 2020. That said, all risks are to the downside: This is because the economic loss function possibly runs as exponentially as the corona infection curve depending on the duration of the containment measures. In other words: The longer the restrictions remain, the harder it will be for the economy to heal, growing irreparable damage will incur.
Only, a swift rebound would prevent massive lay-offs. In the tourism industry, however, up to 240 thousand jobs are at risk. Sadly, even in our baseline scenario, some destruction of both jobs and business opportunities is unavoidable. In our baseline scenario the unemployment rate might not exceed the levels from 2013/14, which were above 7%. This time the starting point on the labor market in the Czech Republic is exceptionally favorable with an unemployment rate below or close to 3% around the turn of the year 2019/2020. Despite that, by the end of this year, there might be 90,000 more people jobless than a year earlier. In March and April, we might temporarily even see a multiple of this number. That would correspond to a 5-year setback in the unemployment rate which might, nevertheless, remain among the lowest in Europe. In case the nationwide quarantine is prolonged through May, it will result in a double-digit drop in economic output for at least two quarters. In such a scenario the unemployment rate may reach 7% by year-end, the virus could deprive over 200,000 people of their jobs.
Czech Republic and Austria – fighting against the same enemy
Politics in the Czech Republic – like in Austria or Germany – are trying to arrest the economic Covid-19 fallout. We estimate support measures underway in the Czech Republic at 18% of GDP; compared to 9% in Austria (although direct measures are possibly higher in Austria than in Czech Republic). Nevertheless, both countries are acting in a bold way – which will be good for both given their strong economic and financial ties cultivated over the last 30 years.
With an export share (goods, 2019) of 3.5%, the Czech Republic is currently the seventh most important trading partner in goods trade and thus the second most important export market for Austria in CEE (after Hungary, 6th place). More importantly, Austria’s imports from the Czech Republic developed very dynamically in recent years, which is why a trade deficit has been recorded since 2011 (~EUR 1.3 bn in 2019). That said, both countries can profit from local support measures, that are also spilling over to foreign markets. Moreover, the Czech Republic is an important location for Austrian FDI. While since the Global Financial Crisis, Austrian FDI have largely been made in Western Europe or outside of Europe (and stocks in the CEE region have only risen slightly on balance) Austrian companies upped their investments in the Czech Republic. As a result, Austrian FDI in the Czech Republic still represent around 7% of total FDI abroad, down only marginally from 2007 (8%). The higher and, above all, more stable profitability of FDI in the neighbouring country certainly plays a role. With comparatively small fluctuations, it amounted to 13% between 2010-2018, compared with 8% in the CE region and 3% in Western Europe.
In banking Austria and the Czech Republic are exceptionally closely entwined. According to international banking statistics, Austria accounts for around 30% of balance sheet positions related to the Czech Republic. This makes Austria the country with the largest balance sheet position vis-à-vis the Czech Republic in absolute terms. In this respect, major Austrian CEE banks, but also other local credit institutions in Austria, clearly see the neighboring country as extended home market. It is therefore no coincidence that the Czech Republic is one of the CE/SEE countries in which large Austrian CEE banks have a combined market share of around 20%; a pattern only visible in Slovakia, Romania and Croatia. Compared to those peers, the Czech Republic dominates in absolute volumes, and exposures have been rising in recent years – a pattern in line with FDI trends sketched previously. This was less the case in Romania, Croatia and Slovakia. In this respect, Austrian banks should and might play an important role in the upcoming stabilization of the Czech economy. In our opinion, enough buffers are available to act in a countercyclical way. On the one hand, the banking market has been highly profitable in recent years, and on the other, non-performing loans are currently at an ultra-low level. In this respect, the basis for a meaningful crisis response has been laid. This is especially true if there is a sensible coordination of government and private sector support to borrowers.
Policy space is there!
On a very positive note, substantial policy space is available in the Czech Republic. Here, recent boom years have been well used to build-up enough countercyclical leeway. Adding up all countercyclical policy space (e.g. ultra-low public debt levels, their distance to prudential thresholds, fiscal surpluses, local monetary policy flexibility and countercyclical capital buffers in the banking sector) the Czech Republic probably has at least as much leeway as Germany or Austria – possibly even more. Some time ago we even labelled the country as “buffer champ” of Europe – and now those buffers are needed.
Helena Horska is Chief Economist at Raiffeisenbank a.s. in the Czech Republic.
Gunter Deuber is Head of Economics, Fixed Income and FX Research at Raiffeisen Bank International in Vienna.
Matthias Reith is Senior Economist for Austria and dealing with broader European topics at Raiffeisen Bank International in Vienna.