Fiscal Outlook of the Czech Republic (November 2019)
The autumn general government Deficit and Debt Notification raised the April forecast for 2018 to a surplus of 1.1% of GDP, confirming the fact that the Czech public finances were one of the best performing in the European Union that year. The increase in investments was also positive, with acceleration in the second half of 2018 resulting in an overall year-on-year increase of more than 30%. Strong growth continued into the first half of 2019. Last year’s increase in investment expenditure co-financed from EU funds amounted to an impressive 60%. The allocations from 2014 and 2015 were fully utilised and additional funds of almost CZK 37 billion were secured.
We expect public finances to remain in surplus both this year and next. However, these surpluses are following a downward trend. One of the reasons for this development is the gradual cooling of economic activity, associated with external influences. The forecast for real GDP growth for this year is 2.5%, while in 2020 it should slow to 2.0%. The significant slowdown in Germany, followed by the euro area as a whole, which may be further exacerbated by the emergence of risks to international trade, is an important factor and must be fully taken into account public finances setting for a small, open economy.
However, external economic risks stand beside internal factors, associated with an ageing population and the transition to an economy based on higher value added. The ageing of the population has not only reflected in the current labour market situation, but it also relates to future pressures on public revenue and expenditure. The considerable increase in spending on pensions, health and long-term care in the coming decades is already affecting fiscal policy through the medium-term budgetary objective and the resulting adjustment of the expenditure ceilings for the state budget and state funds. For the 2020–2022 period, this value has been set 0.25 percentage points lower than previously. This tightening down to −0.75% of GDP results from the absence of reforms of social systems ensuring their long-term financial sustainability.
The values and derivation of expenditure ceilings for 2020 to 2022 are contained in the Budgetary Strategy for the General Government Sector of the Czech Republic, approved by the Government on 29 April 2019. Updated ceilings are the basis for a draft state budget and state fund budgets for 2020 and their medium-term outlooks. The present Fiscal Outlook of the Czech Republic relies on them in particular in public expenditure set-up. Moreover, it is based on the November Macroeconomic Forecast for the Czech Republic.
This year, the Czech Republic’s fiscal outlook expects a general government sector surplus of 0.3% of GDP. For the year 2020, we estimate the surplus at 0.1% of GDP, reflecting the fulfilment of the Government’s programme priorities in the social area, as well as in the investment expenditures in both physical and human capital and a slowdown in the growth dynamics of the Czech economy. Over the coming years, we expect the general government balance to be slightly negative. The structural balance should reach moderate deficits of 0.3% of GDP for most years covered by the forecast and outlook, implying a neutral fiscal stance. The Czech Republic should therefore continue to meet its medium-term budgetary objective under the preventive arm of the Stability and Growth Pact during all the years covered by the outlook. General government debt should continue to decrease throughout the outlook, reaching below 30% of GDP in 2022, in line with expected developments in the balance and nominal gross domestic product. The state of public finances, both at present and in the near future, was also one of the factors that decided Moody’s to increase in the Czech Republic’s rating at the beginning of October this year.
The quantified future expenditure of the pension system in the Czech Republic gives an idea of the causes and magnitude of the risks for its long-term sustainability. The current Eurostat demographic projection foresees a relatively large decline in the population of the Czech Republic over the long term. The ratio of people over the age of 65 to the working age population (15 to 64) is projected to almost double by 2070 and reaching around 50%. By 2070, expenditure on pensions should increase by 2.8 percentage points from 8.2% of GDP to 10.9% of GDP. The real cost of ageing will also be significantly dependent on possible revisions of the retirement age, in line with expected life expectancy. During the first retirement age revision, the Government decided not to change the current set-up. A further evaluation will take place no later than in 2024. However, during the debate on the pension system, a number of arguments have emerged that merit further investigation. This is why this year’s Fiscal outlook, as part of the traditional analysis into long-term sustainability, provides additional information on the rise in healthy life expectancy and on determinants of pension expenditure, including an international comparison.
The thematic chapter deals with the issue of fiscal rules. The entire European Union is currently facing the question of how to reform its fiscal framework, including the established fiscal rules. It is clear that the existing framework is very complex, largely opaque and thus gradually losing credibility. The Ministry of Finance actively engaged in this debate and proposed a new design for European rules, based on an automatic structural balance system, accompanied by a corrective account to eliminate past errors.