Fiscal Outlook of the Czech Republic (November 2022)
Public finances have recently faced unprecedented pressures that go beyond those of normal economic crises. Anti-epidemic, stabilisation and redistributive measures that dominated discretionary interventions during the epidemic have been gradually replaced by instruments to help overcome periods of volatile and increased prices of key commodities. The growth prospects of the world economy, with the unresolved consequences of the pandemic, have been disrupted by the Russian Federation, which invaded the territory of Ukraine at the end of February and sparked a military conflict. The energy dependence on Russia, particularly in Europe, the sanctions imposed to dampen aggression and the instability in fossil fuel markets have led to massive energy price rises that are having a significant impact on households and businesses.
Rising energy prices are reflected in the entire economy in the form of more expensive production inputs and contribute to the overall increase in the price level. The annual rate of consumer price inflation has risen to close to 18% in the Czech Republic. The sharp rise in the cost of living and the decline in real household consumption will dampen economic activity in the first half of 2022 and probably early next year. The situation calls for emergency and temporary measures. On the other hand, high prices are creating extraordinary windfall gains in some sectors of the economy. It is in these sectors that the opportunity arises to mobilise additional resources to cover temporary government subsidy and transfer programmes.
The original draft of the state budget for 2022 with a deficit of CZK 376.6 billion was revised after the elections in October 2021. The balance was improved by almost CZK 100 billion after taking into account higher expected revenues and including adjustments on the expenditure side. The migration wave and the effects of high inflation led, due to either compensation transfers or an increase in social spending, to an increase in the approved deficit in 2022 to CZK 375 billion. For 2023, the government approved a state budget deficit of CZK 295 billion.
The balance of the public finances of the Czech Republic is primarily determined by the performance of the state budget. Therefore, we expect the general government deficit to exceed 4% of GDP both this year and next. In the following years, the balance could improve above −3% of GDP. Still significant deficits will be reflected in the level of debt. It could increase by about 4 percentage points over 2022 and 2023 and approach 47% of GDP in 2025. From an adjustment perspective, fiscal policy should be broadly neutral over the forecast and outlook horizon.
The structural deficit of around 3% of GDP is in line with the fiscal rule set by the Act on Fiscal Responsibility Rules. The expenditure frameworks were derived on a declining structural deficit trajectory, with a value of 3.7% of GDP applied for 2025. This implies that the fiscal rule should be obeyed in all years. On the other hand, structural imbalance of 3 percentage points is unsustainable in the long term. It is thus clear that public finances in the Czech Republic will have to undergo fiscal consolidation as soon as the situation allows. However, there will be room for this only after the end of current crisis and resolving its consequences.
In terms of spending in social systems, the issue of their long-term financial sustainability is still not solved. This has been negatively affected by the increase in debt in recent years. Structural reforms in the labour market, pensions, health care and long-term care thus become still more urgent. In its programme statement, the government declared its intention to prepare a comprehensive pension reform, which should be presented in 2023.
The thematic chapter of the Fiscal Outlook focuses on the institutional set-up of selected social systems in the Czech Republic and the possibility of increasing the long-term financial resilience of the pension system. The chapter is based on the identification of age cohorts for which there is potential to increase economic activity and employment rates. Based on the analysis, it therefore focuses primarily on two groups, namely women of prime working age at the beginning of their careers and the elderly. For working-age women, it reflects the institutional model of Austria and envisages adjusting the length of paid maternity and parental leave in line with our culturally close southern neighbour. For the elderly, we assume that the retirement age is shifted in line with life expectancy, as is already possible under Czech legislation, although it has not yet been applied.
These findings are consistent with the recommendations consistently given to the Czech Republic by international and supranational institutions. They have the potential not only to increase the growth of the Czech economy, but also to help address the financial aspect of the long-term sustainability of public finances. For example, by aligning the maternity and parental leave regime with Austria and shifting the retirement age in line with life expectancy, the future deficit in the pension system could be reduced by 1.6% of GDP, i.e. by CZK 107 billion in current prices.
Although even this amount would not resolve the entire expected magnitude of the pension imbalance, it would significantly reduce it and would move the Czech Republic from high to medium risk in terms of the sustainability of public finances assessment. In case of successful fiscal consolidation in the medium term and further reforms in the health and long-term care systems, the Czech Republic could return to the low risk category, improving its position in financial markets and preparing for future challenges.