Aleš Michl, CNB Board Member
Introductory Remarks to the Small Talks Symposium, Bank of America Merrill Lynch Seminar
also delivered to the Central & Eastern Europe Panel, JPMorgan Investor Seminar
at the time of the IMF/WB Annual Meetings 2019
Washington, D.C., 17th – 18th October 2019
This year, the Czech Republic celebrates three anniversaries:
- In April, it was 100 years since the introduction of the Czechoslovak koruna.
- Next, in November, we will celebrate 30 years since the Velvet Revolution and the fall of the communist regime in Czechoslovakia.
- Third, turning to the economy, it has been 10 years since the economic recovery started after the global financial crisis. This third anniversary is not only Czech one; it is an anniversary for all of us.
Let me compare the current economic situation in the Czech Republic with the peak before the crisis came, that is, with the first quarter of 2008.
1. GDP
GDP [in real terms] is above the 2008 level by 19.6%. Looking at the latest figure, GDP grew by 2.8% in year-on-year terms in the second quarter of 2019.
2. Industrial production
Industrial production [in real terms, excluding construction] is above 2008 level by 17.2%.
But in last 3 months we can see negative numbers in industrial production growth (y-o-y change; from June to August 2019). New industrial orders also dropped slightly (0.9% in y-o-y terms in August). And investment activity was in negative territory too (two quarters of q-o-q decline of fixed investments).
Czech manufacturing is flirting with recession. We follow the cases of Germany and the US, only with a delay.
Reasons: Economic slowdown in China and the moderation of global trade. This is why the German manufacturing sector is in recession.
3. The unemployment rate
The unemployment rate is at 2% now, which is the lowest figure in the European Union. It used to be 4.6% in 2008Q1.
The Czech economy lacks workforce, so a slowdown or an ordinary recession could be healthy for the labor market and ease some inflation pressures stemming from its tightness.
4. Unit labor costs
Unit labor costs [a ratio of labor costs to labor productivity; they can be expressed as the ratio of total labor compensation per hour worked to real output per hour worked] are above the 2008 level by 20.5%. Despite higher wages, the competitiveness of companies did not suffer. The export market share (the share of Czech merchandise exports on world total merchandise exports) increased from 0.97% to 1.06% between 2008Q1 and 2019Q2. Interestingly, the same figure for Germany declined from 9.51% to 7.88%.
5. House price index
House price index increased by 43.9% between 2008Q1 and 2019Q2. CNB staff estimates that house prices are overvalued by 15%, which is less than in 2008 when our models signalled overvaluation between 30 – 60%.
(X)
Leverages
General government debt-to-GDP ratio increased from 26.8% to 34% between 2008Q1 and 2019Q1. The peak was at 45.5% in 2013Q1 and it has been declining since then.
Tier 1 capital ratio of banks [Tier 1 capital / risk-weighted assets] increased from 11% in 2008Q1 to 19.8% in 2019Q2, i.e., banks are more resilient to adverse shocks.
The leverage of firms [debt / gross operating surplus] is the same as it was in 2008. (The most recent data says that it reached 205% in 2017.)
The leverage of households [loans as a ratio of annual gross disposable income] increased from 44.6% to 60.7% between 2008Q1 and 2019Q1. Among EU countries, it is still a low value.
All in all:
In 2017 we started to gradually increase our key repo rate from zero (0.05 %). This year, we increased our repo rate only once, in May. Since then, the rate has been stable at 2%.
Headline CPI inflation was 2.7% in September. CPI inflation is above our inflation target but still, it is within our tolerance band.
I will give preference to the stability of interest rates at our monetary policy meeting in November.
After that, we could have a move in either direction, a cut or a hike.
HIKE — if the industrial sector recovers and our models project that headline CPI inflation will stay above our inflation target for longer than expected.
CUT — because of a manufacturing recession.
What changed since our last hike is the slope of the yield curve which has become more steeply negative (spreads between 5-year and 1-year market rate). It could signal a potential ordinary recession.
Playbook:
The CNB cut its repo rate from 3.75 to 0.05% between August 2008 and November 2012.
Now we have about half the amount available for rate cuts (similarly to the Fed). The European Central Bank is running negative rates although the effectiveness of this measure is questionable.
After passing a new Czech law on the CNB we will be ready to launch a QE if it is necessary. In my opinion, it would be a better crisis policy tool than either the devaluation of our own currency (2013-2017) or introducing negative interest rates.
The Czech government has space to act in a potential deeper recession too. The governmental fiscal balance was in surplus in each of the past three years. The government could boost investment projects.
To conclude,
Ordinary slowing down of the economy isn't a terrible thing.
I would like the Czech economy to be based on savings rather than on debt and leverages, and to have a strong koruna. To achieve this goal, we should follow the recommendation of Alois Rasin, our first finance minister and mastermind of the currency reform of 1919. Let’s promote the spirit of hard work and savings.
