Czech Economic Quarterly June 17, 2009
Economic Research
UniCredit Bank Czech Republic page 1 of 5 See last pages for disclaimer.
Facing a post-shock therapy
 In an unprecedented slump, the 1Q real GDP contracted by 3.4% in
both the q-o-q and the y-o-y adjusted terms. The drags included the
inventory adjustment, fixed capital formation and net exports, whilst
both the household and the government consumption rose.
 The recession is believed to be past its trough but signs of the
upturn are still unconvincing. Yet, we expect slightly positive
increments in the q-o-q GDP for the remainder of 2009, as the
industrial de-stocking may soon be over. The full-2009 GDP growth
forecast has been revised to -3.2%.
 Budgetary constraints will affect the economy in 2010 via lower
growth of social transfers and a reduction in publicly financed
investment. Unless external demand picks up visibly, the economy
is at risk of facing a double-dip recession. Our baseline GDP
forecast calls for a 0.7% growth.
 The CNB repo rate is seen bottoming at 1.25%. Monetary
conditions will be increasingly driven by CZK. The scenario of CZK
resuming the appreciation path in 2010 is consistent with the CNB
repo rate remaining at its bottom until 2H 2010. The fx rate outlook
is however marked by a considerable uncertainty.
REAL GDP (CONSTANT PRI CES OF 2 000, ADJUSTED)
1Q 2009 4Q 2008 revised
YoY
change
% of change
in GDP*
YoY
change
% of change
in GDP*
GDP total -3.4 -3.4 -0.1 -0.1
Household consumption (%) 3.0 1.5 2.4 1.1
Government consumption (%) 5.2 1.0 0.5 0.1
Fixed capital formation (%) -3.4 -0.8 -2.1 -0.5
Change in inventories (CZK bn) -28.7 -3.3 6.7 0.8
Net exports (CZK bn) -11.7 -1.7 -12.6 -1.6
Source: Czech Statistical Office. Calculations: UCB CZ.
*/ Real GDP in the same period of previous year
Remark: The national accounts are based on chain-linked data, which introduces a discrepancy
between GDP and real demand components.
Breakdown of GDP growth by demand
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
2001 2002 2003 2004 2005 2006 2007 2008
contributiontoGDPgrowthinp.p.
consumption gross capital net exports
Sources: UCB CZ, CZSO.
The sharp inventory adjustment along with the
contraction in fixed capital formation and the
ongoing drag of net exports brought the 1Q
GDP into the most severe decline since 1993.
The GDP drop was mitigated by consumption of
both the households and the government.
Author:
Pavel Sobisek
UniCredit Bank Czech Republic
Tel: +420 221 211 250
E-mail: pavel.sobisek@unicreditgroup.cz
Internet:
www.unicreditbank.cz
Czech Economic Quarterly June 17, 2009
Economic Research
UniCredit Bank Czech Republic page 2 of 5 See last pages for disclaimer.
1Q 2009: AN UNPRECEDENTED GDP CONTRACTION
The economic slump, observed since 4Q 2008, developed into a free fall by
1Q. Real GDP contracted by 3.4% y-o-y (adjusted) or 3.3% y-o-y
(unadjusted). At the same time, the 4Q's pace was downward revised to
negative 0.1% y-o-y (adjusted) or negative 0.6% y-o-y (unadjusted). In the
adjusted q-o-q terms, GDP posted 3.4% drop in 1Q after a revised 1.8%
decline in 4Q. Breakdown on the demand side pointed to private consumption
expanding 3.0% y-o-y, government consumption even adding 5.2% y-o-y,
whilst in contrast fixed capital formation declining 3.4% y-o-y and real-term
exports and imports down 20.5% and 19.6% y-o-y respectively. Gross capital
formation proved to be the key contributor to GDP contraction, taking away
4.1pp from it, of which 3.3pp were attributable to an inventory rundown. Net
exports shaved off 1.7pp from GDP. Nominal GDP growth maintained a
positive 0.4% y-o-y change in 1Q thanks to favorable terms of trade, yet the
increment hit the all-time low.
Severe declines in exports and gross capital formation came as no surprise.
On the issue of the sharp inventory correction it is worth noting that, apart
from manufacturers getting rid of their excessive stock, natural gas storage
capacities are believed to have been almost emptied by 1Q. This should push
gas imports higher in the remainder of 2009. The boost in government and
private consumption were in contrast rather unexpected. While government
spending was satisfactorily explained by an increased demand for healthcare
covered by the public insurance (which makes sense in the context of political
bickering over healthcare regulation fees), the private consumption boom
deserves a deeper analysis. We attribute it largely to higher consumption on
energies due to severe weather conditions, at least in comparison with the
previous, extremely mild winter. The energy consumption was no immediate
financial burden to household, as energy bills are paid ex post. Hence, the
increase in the overall household consumption from 1Q may be altered by a
slump in the remainder of 2009. A second, minor reason for solid spending
appetite could be a shift of demand from new cars (the statistics showed
investment on transport equipment down an unprecedented 16.7% y-o-y in
1Q) to various sorts of consumer goods.
ECONOMY IN 2Q 2009: PAST THE BOTTOM BUT WITHOUT
CLEAR UPTURN
All available evidence suggests that the recession hit the bottom in 1Q. That
said, signs of the economy picking up from the bottom still look
unconvincing. Industrial output saw a 22.1% y-o-y decline in April, failing to
deliver a positive reaction to a four-month unbroken rise in the manufacturing
PMI. While the production slump has eased visibly in many light industries
since the start of 2009, recession has got deeper in metal production and
machinery. The construction output reversed to 2.1% growth y-o-y in April
but we suspect that was largely weather-related. Nevertheless, the electricity
consumption by large corporations has turned higher since May, promising
some moderation in the y-o-y decrease in industry. In contrast, private
consumption is no more likely to surprise on the upside in 2Q. We hence
project a positive q-o-q GDP reading in 2Q, albeit not sufficiently to prevent
the y-o-y figure from falling further.
Czech industrial output and
manufacturing PMI
78
84
90
96
102
108
114
VII.03
X.03
I.04
IV.04
VII.04
X.04
I.05
IV.05
VII.05
X.05
I.06
IV.06
VII.06
X.06
I.07
IV.07
VII.07
X.07
I.08
IV.08
VII.08
X.08
I.09
IV.09
28
34
40
46
52
58
64
Industrial output (MA3 y-o-y) - lhs
Manufacturing PMI - rhs
Source: UCB CZ, CZSO.
Historically, PMI in manufacturing was closely
correlated with the industrial output but its lead
was minimal. Since the start of 2009, however,
PMI has made four steps up without that
translating into an adequate rise in the industrial
output momentum. The issue is whether the
PMI message is wrong or the output recovery
arrives with delay. We are inclined to bet on the
latter.
Orders in Czech and German industry
60
70
80
90
100
110
120
I.07
III.07
V.07
VII.07
IX.07
XI.07
I.08
III.08
V.08
VII.08
IX.08
XI.08
I.09
III.09
Industrial orders CZ MA3 y-o-y
Industrial orders Germany MA3 y-o-y
Source: UCB, CZSO.
Losses of industrial orders have been perfectly
synchronized in the Czech and German
industries. Troughs in both markets occurred in
January and since then, the indices have been
struggling to ease their declines. While in both
cases the upturn looks equally unconvincing as
yet, the fact remains that the Czech index is
9pp higher.
Czech Economic Quarterly June 17, 2009
Economic Research
UniCredit Bank Czech Republic page 3 of 5 See last pages for disclaimer.
THE REMAINDER OF 2009: A POST-SHOCK THERAPY
Industrial output is set to further moderate its y-o-y decline in 3Q, as much
of the de-stocking process will have been accomplished by then.
Consumption-related types of production are seen outperforming those
investment-related. Exports of goods in real terms are projected down about
15% y-o-y, with net exports still contributing negatively to GDP growth. The
outlook for 4Q from the production and exports side looks however much
brighter, with hopefully more signs of recovery in external demand and a
huge positive base effect in a y-o-y comparison. In contrast to a milder y-o-y
negative input to GDP from net exports and a neutral impact from the
inventory change in 2H, we are however rather bearish on fixed capital
formation. In 1Q, it was still bolstered by the deliveries of the formerly
ordered machinery equipment but this support may no longer be in place by
3Q. Prospect for construction-related investment is not good either, with
private businesses having little incentive to expand and the public
infrastructure investment starting to feel the pinch of budgetary constraints.
Private consumption will on the one hand be hit by increasing job losses, on
the other hand the ongoing public social transfers are set to render it a
meaningful stimulus. On balance, private consumption is projected to be more
or less flat and the whole GDP may post slightly positive q-o-q changes. This
would lead to the y-o-y dynamic of GDP reaching the bottom in 3Q around -
4.0% before shooting up above -2.0% in 4Q.
Of rather extensive changes in our macroeconomic forecasts for full-2009
since three months ago, the most noteworthy are:
Downward revision to GDP growth from -1.8% to -3.2%
Downward revision to industrial output from -5.0% to -10.5%
Downward revision to fixed capital formation from -3.8% to -6.5%
Upward revision to year-end unemployment rate from 8.2% to 9.3%
Upward revision to trade balance from CZK 55bn to CZK 82bn.
2010: STAGNATION ON SLUGGISH PRIVATE SPENDING
With the public sector deficit likely to be capped at close to a 2009's level,
fiscal incentives will no longer be in place. Exports are projected to resume a
moderate growth on improving external demand, which may with some delay
bolster also business investment activity. On the other hand, private demand
is set to remain subdued, as unemployment will keep growing at least through
1H 2010, wage growth may stay around 2% only (with entire stagnation in
the public sector) and the indexation of pensions should not exceed 2% either.
Public sector investment will also suffer from the lack of funding. On
balance, we expect GDP growth at mere 0.7% in 2010. Unless global
economy recovers faster than we assume, GDP growth in some quarters of
2010 may grind to a halt with the risk of causing a double-dip recession.
Industrial sales and exports
80
90
100
110
120
130
140
I.04
IV.04
VII.04
X.04
I.05
IV.05
VII.05
X.05
I.06
IV.06
VII.06
X.06
I.07
IV.07
VII.07
X.07
I.08
IV.08
VII.08
X.08
I.09
IV.09
Exports in CZK (y-o-y index, MA3)
Industrial sales in CZK (y-o-y index, MA3)
Source: UCB CZ, CZSO.
Global economic recession has broken the
pattern of a rising share of exports in the sales
of Czech manufacturers. Over the period of
August 2008 to February 2009, the index of
industrial sales at current prices was
outperforming that of exports. Only March saw
a reversal again, as a slight pick-up in export
demand triggered an inventory rundown. We
believe the spell of export underperformance to
be over. This may however rather mean weak
industrial output than strong exports in the
pipelines.
GDP and productivity
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009f
2010f
%YoY
GDP Productivity
Source: UCB CZ, CZSO.
The years of labor-extensive growth in the
Czech economy are over. At its peak in 2007,
the gap between GDP and productivity reached
as much as 2.8 percentage points. For 2009,
we predict the gap at negative 2.6 percentage
points. On a positive note, flexible reaction of
the corporate sphere in the area of employment
will allow the productivity to drop only negligibly
below nil despite severe recession. The other
side of the coin is fast growing unemployment.
Czech Economic Quarterly June 17, 2009
Economic Research
UniCredit Bank Czech Republic page 4 of 5 See last pages for disclaimer.
MONETARY CONDITIONS TO BE FX DRIVEN
On the backdrop of sinking GDP and subdued inflation, CNB is expected to
cut the repo rate once more, possibly already in June, bringing it to the alltime
low of 1.25%. Further down the road, the existing slack in the economy
should prevent demand-side inflationary pressures from mounting any time
soon. This will magnify the role of the exchange rate as a driver for monetary
conditions. The exchange rate will hence decide on the scale of policy
tightening by CNB. Our base scenario counts on EUR/CZK to stay within the
current narrow 26.5-27.0 band until the end of 2009, while thereafter,
improving exports should push CZK back on the appreciation track. Such a
scenario would be consistent with the interest rate hiking cycle starting only
in 2H 2010. That said, the move towards a firmer CZK looks far from certain.
Taking into account the options of possible distress on the CEE FX markets
and/or the carry trades evolving with CZK acting as a financing currency,
CZK might as well turn rather weaker than firmer. Easier monetary
conditions would in that case require tightening the monetary policy earlier
and more extensively.
FOCUS: MODELLING THE OUTPUT GAP
The economic recession is set to be finally overcome some time in 2010 but
its echoes may remain audible for as much as five years. Assuming that
potential GDP growth (i.e. the pace of growth that would keep the labor
market in equilibrium) declines to 2.5% in 2010 and converges towards 3.0%
thereafter, the ongoing recession followed by a sluggish recovery are
projected to open the negative output gap to as much as 6.5pp. If then GDP
actually resumes growth peaking around 4.5% per annum, the output gap will
sustain negative until 2015. Only at that time, the economy may start
suffering from the acute shortage of labor like in 2007 and 1H 2008. Hence,
wage and inflationary pressures are seen staying contained for an extended
period.
GDP growth and the output gap
-7.0
-5.0
-3.0
-1.0
1.0
3.0
5.0
2009
2010
2011
2012
2013
2014
2015
GDP forecast q/q
GDP forecast y/y
Output gap (pp)
Source: UCB CZ.
Under conditions we regard likely, the negative
output gap may keep opening until early 2011
to reach -6.5pp and may close no earlier than
2015.
Czech Economic Quarterly
Economic Research
UniCredit Bank Czech republic page 5 of 5
Czech Republic Macroeconomic Outlook
2006 2007 2008 2009
forecast
2010
forecast
GDP growth (real y/y change, %) 6.8 6.1 3.0 -3.2 0.7
Industrial output (real y/y change, %) 8.3 10.8 -1.5 -10.5 4.0
Gross fixed capital (real y/y change, %) 6.0 10.8 -0.1 -6.5 -3.5
Household consumption (real y/y change, %) 5.1 4.9 2.7 -0.2 -0.5
Unemployment rate (end of period, %) 7.7 6.0 6.0 9.3 9.5
Inflation rate (CPI y/y change, end of period, %) 1.7 5.4 3.6 1.7 1.8
Average wages (nominal y/y change, %) 6.5 7.3 8.5 2.7 2.2
External trade balance (CZK bn) 39.8 87.9 67.5 82.0 99.0
Current account balance (% of GDP) -2.6 -3.1 -3.1 -2.6 -2.1
FDI net inflow (% of GDP) 2.8 5.1 4.1 2.2 2.1
Official foreign reserves (end of period, EUR bn) 23.9 23.7 26.6 28.0 29.0
General government balance (% of GDP)** -2.6 -0.6 -1.5 -5.2 -4.8
Money supply (y/y change, end of period, %) 9.9 13.2 6.5 6.0 6.0
Interest rates (3-M PRIBOR, end of period, %) 2.55 4.11 3.63 1.80 2.00
EUR/CZK exchange rate (end of period) 27.50 26.62 26.93 27.00 25.50
Remarks:
**/ ESA 95 definition.
Sources: Czech National Bank, Czech Statistical Office.
Forecasts: UniCredit Bank CZ.
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