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The Czech Republic on its Way Towards the Euro

This presentation outlines the milestones on the Czech Republic's journey to the West, the economic effects of EU membership, and the economic aspects of adopting the euro.

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The Czech Republic on its Way Towards the Euro

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  1. The Czech Republic on its Way Towards the Euro Petr KRÁL Monetary and Statistics Department Czech National Bank Conference: "Competitiveness of the South Eastern European Countries: Challenges on the Road to EU Skopje, May30, 2008

  2. Presentation Outline • Milestones on the Czech Republic's way to the West • Economic effects of the EU membership • Economic aspects of the adoption of the euro • Euro-adoption plans

  3. Milestones on the Czech Republic's way to the West • Successful transition from central planning to a functioning market economy • 1989 – “Velvet Revolution” in former Czechoslovakia • 1993 – split of Czechoslovakia into the Czech Republic and Slovak Republic • 1995 – OECD membership • 1999 – NATO membership • 2004 – European Union membership (derogation on euro introduction • Characteristics of a small open economy

  4. Economic effects of EU the membershipPre-accession economic developments (i) • Fundamental transformation steps and so-called transitory recession (1990 – 94) • Demand-driven economic recovery with supply side lagging behind resulting into an overheating (1994 – 1997) • Financial and subsequent economic crisis (1997 – 1999) • Abolition of pegged ER combined with monetary targeting (1997) and adoption of inflation targeting framework (1998) • Supply-side improvements (FDIs) and acceleration of convergence (2000 – )

  5. Economic effects of EU the membershipPre-accession economic developments (ii) • massive inflow of FDI started in 1998 (paradoxically in economic bad times) • introduction of government investment incentives and privatization of state-ownedproperty kicked-off the inflowKrál (2004):Identification and Measurement of Relationships Concerning Inflow of FDI: The Case of the Czech Rep. (CNB Working Paper) • subsequently enterprises under foreign control begun to gain growing share on economic activity

  6. Economic effects of EU the membershipPre-accession economic developments (iii) • inward FDI has been bothvertical benefiting from the comparativeadvantage of the • Czech economy in terms of input prices, government promotion of FDI andeconomic stability • andhorizontal focusing on the LR growth and market size prospects arising from • the expectedCzech Republic’s future accession to the EU • FDIs were coming prevailinglyfrom EU countries (Germany, Austria, Netherlands?)

  7. Economic effects of EU the membershipPre-accession economic developments (iv) • as a result the Czech Republic became one of the most FDI penetrated country in the region • and in the world and openness and export performance of the country are also tremendous • positive effects of inward FDI on the supply side of the economy (capital stock + crowding-in • effects, primary and secondary technological spillovers) contributed significantly to the gradual • acceleration of potential (non-inflationary) output growth

  8. Economic effects of EU the membershipEU entry – acceleration of ongoing trends and new phenomena (i) • EU single market – 4 freedoms of movement • Goods • Services • Labour • Capital • EU regulations • Acquis communautaire • EU norms, tax harmonization, common policies (e.g. trade, agriculture) • Access to EU funds • “Reputation” effect

  9. Economic effects of EU the membershipEU entry – acceleration of ongoing trends and new phenomena (ii) • acceleration of GDP growth and its potential • speed-up of the real convergence vis-à-vis western countries • rapidly growing export capacities are the main driver (extreme in 2004) • steadily increasing openness of the economy

  10. Economic effects of EU the membershipEU entry – acceleration of ongoing trends and new phenomena (iii) As a result, trade balance turned to positive numbers being driven by the surplus of the trade with SITC 7 items Czech exports have developed specialized in machinery and transport equipment, mainly as a result of FDI

  11. Economic effects of EU the membershipEU entry – acceleration of ongoing trends and new phenomena (iv) Macroeconomic policies • MP – EU entryitself no major challenge (tax harmonization: no large price shock) • FP – task to meet Stability and Growth Pact requirements

  12. Economic aspects of the euro adoptionWhy to adopt the euro • Legal obligation (no opt-out clause, only derogation) • Economic reasoning • Exchange rate and interest rate stability • Lower transaction cost (reduction in exchange rate risk, access to more liquid financial markets) • Higher price transparency • Disciplining effect on domestic economic policies • Final step in the EU integration

  13. Economic aspects of the euro adoptionPossible risks • Loss of independent monetary policy • Interest rates handed over to ECB => ECB’s common monetary policy does not have to fit the Czech reality => Limited reaction to asymmetric shocks • Solution ?! • Economic alignment • Flexible alternative stabilization mechanisms • Fiscal policy • Labour market • Inflation acceleration

  14. Economic aspects of theeuro adoptionTiming of the euro adoption • Formal conditions • Maastricht criteria • Price stability • Inflation: below three best performing EU countries’ inflation +1.5 pp • Sustainability of government finance • Fiscal deficit: < 3% of GDP • Gov. debt: < 60% of GDP • Exchange rate stability • Exchange rate: ERM II participation for 2 years without sever tensions • Durability of convergence • LT interest rate: below three best (inflation) performing EU countries’ IR +2.0 pp • Compatibility of legal framework • Including the central bank status with EU regulation • Informal conditions • Economic consideration • Symmetry • Flexibility

  15. Euro-adoption plans of the Czech Rep.Strategic documents • CNB & Government • The CR’s EA accession strategy • First in 2003 • Updated in 2007 • Assessment of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment of the CR with the EA • CNB • Analyses of the CR’s current economic alignment with the EA • http://www.cnb.cz/en/monetary_policy/strategic_documents • Government • Convergence programme of the CR • http://www.mfcr.cz/cps/rde/xchg/mfcr/xsl/conv_program.html

  16. Euro-adoption plans of the Czech Rep.First EA Accession Strategy (2003) • Common stance by the CNB and the Government • Benefits outweigh risks, butrisks can be reduced • quality preferred to speed • CNB will continue in IT until the CR adopts the euro • Participation in ERM II only for minimum possible period • 2 years • Expected date of the euro adoption => 2009 – 2010 conditional on • Criteria fulfilment • Including a consolidation of public finances • Achievement of a sufficient level of real convergence • Adequate progress with structural reforms • Leading to a sufficient degree of economic alignment

  17. Euro-adoption plans of the Czech Rep.Fulfillment of the Maastricht criteria Fiscal deficit Inflation  LT sustainability? BUT 2008 ERM II  Public debt  LT IR 

  18. Euro-adoption plans of the Czech Rep.Economic Alignment (i) Long-run convergence 2006; euro area average = 100 • Progress achieved • Important gap persists for the CR – especially in the price level • =>expectationofthe real exchange rate appreciation

  19. Euro-adoption plans of the Czech Rep.Economic Alignment (ii) Correlation of GDP Growth vis-à-vis the euro area, 2001:Q1-2006:Q1 • Major difference between the cycle of the CZ and EA real GDP growth • Low correlation with the euro area characteristic also for macroeconomic shocks • Higher level of correlation seems to prevail for industrial production

  20. Euro-adoption plans of the Czech Rep.Economic Alignment (iii) Fiscal deficits • Fiscal deficit structural in nature • Little room left for automatic stabilizers • Some reforms have been implemented, some are in the pipeline and some have been announced • Figures for 2007 - 2008 revised downwards • Long-term sustainability remains an issue

  21. Euro-adoption plans of the Czech Rep.Economic Alignment (iv) LT unemployment and regional differences Long-term unemployment:: % share of long-term unemployed (12Ms or more) in total unemployment, 2006 Variation coefficient of regional unemployment: NUTS2, 2005, CNB calculation Both indicators are relatively high – showing structural problems on the labour market (including low mobility)

  22. Euro-adoption plans of the Czech Rep.An Up-dated EA Accession Strategy (2007) (i) • Strategy from 2003 has proven to be useful and in some sense fulfilled • BUT • Major obstacle was seen in fiscal consolidation • EDP should be abrogated ASAP (1st stage of fiscal reforms) • Maastricht criterion not ambitious enough • Medium-term objectives (SGP) should be targeted • Long-run challenges stemming from demographic changes have to be addressed • Still low flexibility and efficiency of the economy • the labour market must be markedly enhanced

  23. Euro-adoption plans of the Czech Rep.An Up-dated EA Accession Strategy (2007) (ii) • Conclusion • No particular date of entry proposed • New euro-adoption date will not be set until sufficient progress is made in fiscal consolidation and flexibility of the economy • The same conclusions drawn in the last annual Assessment of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment published at the end of 2007 • CR will not initiate the ERM II entry in 2008

  24. Thank you for your attentionwww.cnb.czpetr.kral@cnb.cz

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