Alignment Analyses 2023 – how is the Czech economy faring in the context of the obligation to join the euro area?
The Czech National Bank has published the Analyses of the Czech Republic’s Current Economic Alignment with the Euro Area (pdf, 1.7 MB), an annual document that presents a long-term view of the Czech economy in the context of the country’s obligation to join the euro area. The document is based on the valid Euro-area Accession Strategy and its 2007 update. The analyses contained assess the Czech Republic’s economic convergence, cyclical and structural alignment with the euro area and the ability of the Czech economy to absorb potential asymmetric shocks after losing its own monetary policy. The analyses focus on a defined range of macroeconomic topics. The document does not examine the overall advantages and disadvantages of adopting the euro and does not formulate recommendations on this step. The political decision on the date of entry into the euro area falls to the government of the Czech Republic.
CZECH REPUBLIC
The characteristics of the Czech economy as regards euro area entry can be divided into three groups based on the results of this year’s analyses:
- Indicators suggesting a relatively low level of risk associated with potential euro adoption in the area analysed
This group has long included the Czech economy’s close trade and ownership links with the euro area. These factors represent preconditions for the realisation of the benefits of euro adoption and also foster alignment between the Czech and euro area business cycles. The latter is currently very high. However, it is not clear to what extent its increase is only a temporary consequence of the similar impacts of strong global economic shocks. The close trade links are also reflected in an increasing share of euro-denominated financing of Czech corporations. This was fostered last year by a high interest rate differential between koruna and euro interest rates as well. The Czech koruna remains aligned with the euro vis-à-vis the dollar and is thus not a barrier to joining the euro area either. As regards the adjustment mechanisms of the Czech economy, the low long-term unemployment rate, which is still among the lowest in Europe, can be positively assessed. The development of the domestic banking sector is also favourable. Its resilience to potential negative shocks remains high.
- Indicators with a neutral message
This category primarily includes the similarity of monetary policy transmission in the Czech Republic and the euro area. Although the Czech Republic differs from the monetary union average in some financial indicators, this cannot be considered a fundamental barrier to euro adoption. The depth of financial intermediation and the level of private sector debt in the Czech Republic are relatively low and thus do not represent a potential source of systemic risk. The alignment of the Czech and euro area financial cycles, and in the longer run the convergence of interest rates are also assessed as neutral. The volatility of the koruna exchange rate, which fell back to pre-crisis level as the energy crisis subsided and uncertainty on financial markets calmed, does not pose a risk either. The alignment of the Czech and euro area financial markets is also returning to the levels of the previous decade. Most labour market indicators are also neutral, improving gradually following a previous temporary deterioration. The geographical mobility of the labour force is rising further due to an increase in the share of foreigners in the population, while labour efficiency indicators are little changed. The participation rate of early-middle aged women in the labour market also remains low, which is linked with long parental leave and a low share of part-time jobs. As regards the risks associated with potential euro adoption, the assessment of general government debt is also neutral. However, the debt increased again last year.
- Indicators suggesting economic risks associated with potential euro adoption in the area analysed
These indicators include the unfinished process of economic convergence of the Czech Republic towards the euro area, especially as regards the convergence of the price and wage levels. Their lag behind the euro area average remains significant despite faster convergence last year, most notably in the case of wages and prices of some services. The relatively low structural similarity of the Czech economy with the euro area consisting in an above-average share of industry in domestic GDP would be a risk in the event of euro adoption. The persisting structural imbalance of Czech public finances is a problem as regards the adjustment mechanisms of the Czech economy. Several measures have been taken in recent years which have had a negative impact on public finance sustainability. At present, however, the government is seeking to improve fiscal indicators, either as a result of public finance consolidation via a recovery package or changes to the pension system. As regards the future smooth functioning of the Czech Republic in the euro area, it will be desirable to bring the general government budget closer to an approximate structural balance in the coming years.
EURO AREA
The short period of improvement in the economic situation following the coronavirus crisis came to an end last year with the onset of the energy crisis. However, the impacts of these events differed from country to country, thus further highlighting the economic heterogeneity in the euro area. Economic growth in euro area countries weakened significantly in both 2022 and 2023, and some economies even entered a recession. A combination of supply and demand factors led to a surge in inflation, which peaked in October 2022 in the euro area and is now slowing visibly. The fiscal positions of most euro area countries remain unfavourable, budget deficits from the coronavirus crisis are being reduced only gradually and some countries’ debt levels are at the sustainability threshold.
There was no substantial progress in integration and the deepening of the economic and monetary union, due mainly to persisting fundamental differences of opinion between Member States regarding the specific form of such integration. An important initiative, not only for the euro area, is the proposal to review the EU economic governance framework (Economic Governance Review), including a review of the rules of the Stability and Growth Pact. The review aims to streamline fiscal rules while improving their enforcement. Partial progress was made as regards the completion of the banking union, the deepening of the capital markets union and the digital euro project. Croatia became the 20th member of the euro area in January.
As regards the decision on the timing of the Czech Republic’s potential entry into the euro area, it should be noted that not all future fundamental obligations for the Czech Republic that may potentially arise from euro adoption are known at this time. This is due to the unfinished nature of some key projects which will greatly affect the functioning of the euro area and some persisting problems of the economic and monetary union. The potential decision about the timing of joining the monetary union is thus still accompanied by major uncertainties.
INFOGRAPHICS
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In preparing the Alignment Analyses, the CNB fulfils its obligation to regularly assess the Czech Republic’s progress in laying the groundwork for euro adoption. The analyses contained in the publication focus on the traditional range of macroeconomic topics without any ambition to assess all issues relevant to the Czech Republic’s entry to the euro area. This document does not analyse in detail the impacts of joining the banking union, including the transfer of powers in the area of prudential supervision and resolution of credit institutions to the supranational level and the related economic and financial impacts, the costs linked with ESM membership and other – for example legal and political – aspects of joining the euro area. The consequences of changes to the process of ERM II entry, which is a pre-condition for euro area entry, are not assessed either.
Note for journalists:
In line with The Czech Republic’s Euro-area Accession Strategy, the CNB together with the Czech Ministry of Finance assesses progress in laying the groundwork for euro adoption. The result is a joint report Assessment of the Fulfilment of the Maastricht Convergence Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro Area, based on the CNB’s Alignment Analyses. The assessment document will be published once it has been discussed by the Czech government.
