Forecasts for general government debt and debt service, and sensitivity analyses

Chart 1 shows general government debt and debt service against the backdrop of the general government balance. Following a period of stable government debt as a ratio to GDP in 2002–2008, this ratio has been rising over the last two years as a result of higher general government deficits and slow nominal GDP growth. The ratio of debt service to GDP, which was relatively stable at around 1% of GDP in the past, surged in 2009 but fell back again in 2010 as government debt servicing costs decreased because of lower interest rates on government bonds. This saving is not expected to apply in the years ahead.

Chart 1 (Box) General government debt, interest, and the general government balance
Government debt is rising sharply at the forecast horizon owing to the expected general government deficits
(% of nominal GDP)

The general government debt forecast is based on the outlook for the general government balance. Besides the general government balance for the given year, the change in general government debt is influenced by stock-flow adjustment (SFA) items, as shown in Table 1. The largest items are predicted for the purposes of the forecast: net acquisition of currency and deposits, shares and other equity, and other financial assets; net incurrence of other liabilities; and appreciation/depreciation of foreign-currency debt. The forecast for SFA items is based on selected indicators of the macroeconomic forecast (nominal GDP and exchange rates), on assumptions regarding the state budget (e.g. planned privatisations and EIB loans) and on other information (e.g. in the past, drawdown of reserve funds of organisational units of the state). Simple econometric models are specified for the forecast of selected SFA items, and trend projection or the average of previous years is used in some cases. Specifically, the item currency and deposits, for example, is linked to privatisation revenues and drawdown of reserve funds. Shares and other equity are inversely proportional to privatisation revenues. Growth proportional to GDP is assumed for other financial assets.

Table 1 (Box) Stock-flow adjustment items
The general government debt of the Czech Republic is rising by an amount less than that corresponding to the general government deficit
(% of nominal GDP)

1. ^a)A negative SFA means that the government debt increases less than the annual deficit (or decreases faster than implied by the surplus)

The forecast for debt service (interest) is based on the general government debt forecast and the “effective” interest rate path. In the first year of the forecast, the effective interest rate (see Chart 2) is set as a weighted average of long-term bond yields and short-term yields on T-bills and bonds with maturity of up to one year. In subsequent years, in addition to the aforementioned initial level, it takes into account the expected path of short-term rates according to the current forecast. After falling in 2010, the effective rate is thus rising in relation to the expected rise in monetary policy rates. The calculation of interest payments is performed through several iterations. These ensure that the debt level, interest paid and the general government balance are mutually consistent.

Chart 2 (Box) Effective interest rate on the general government debt
After falling in 2010, the effective interest rate will rise slightly
(%)

Given the uncertainty going forward, it is appropriate to perform sensitivity analyses for changes in interest rates and the government debt-to-GDP ratio. The first analysis measures the impact of an increase in government bond yields of 1 percentage point on the general government balance. The calculation assumes that the change in rates only affects debt with interest refixation of up to one year. The current results show a relatively low cumulative impact on the general government fiscal balance of around 0.1, 0.2 and 0.3% GDP over three years. The other sensitivity analysis measures the sensitivity of interest payments to a one-off increase in the government debt-to-GDP ratio of 5 percentage points amid unchanged interest rates. Such an increase in general government debt currently implies a rise in interest of around 0.2% of GDP in 2011.