Fiscal Outlook of the Czech Republic (November 2023)
Over the past few years, public finances have gone through a period that has been exceptional in many respects. The recession in 2020 caused by the supply shock of the epidemic and related supportive measures was replaced by only a slight and temporary economic recovery. However, this was halted by the Russian aggression against Ukraine, the subsequent volatility and high prices of key commodities. The economy went through a mild recession in the second half of 2022 and has been essentially stagnant quarter-on-quarter since then. A recovery is not expected until the end of this year. In the following period, the economy should then grow at annual rates of between 2 and 2.5%.
Economic performance has been hampered by high inflation reaching double-digit levels for the second year running. High inflation also affects public finances, which cover additional expenditure, mainly in the social area or in subsidies and other transfers. Although some tax revenues are growing significantly faster, the overall effect on public finances is far from being clear. An example was the two extraordinary pension indexations during last year and another one since June this year. In particular, an extraordinary indexation based on data from January 2023 would already be so financially demanding that the government was forced to modify it. According to the forecast, inflation is expected to fall significantly next year to slightly above 3%, while price growth is expected to slow further in the outlook years to around 2%.
The draft state budget and state funds for 2024, as well as the year-on-year evolution of public finances, is influenced by several important factors. First, a number of one-off measures primarily related to energy prices will end. At the same time, a set of measures of the consolidation package, which brings changes to more than 60 legal norms, will enter into force. The impact of the end of the one-off measures and the consolidation package on the balance is more than 2 percentage points for 2024. In the opposite direction will be an increase in mandatory spending, including defence spending, and an increase in infrastructure investment.
The result of the public finances of the Czech Republic is primarily determined by the performance of the state budget. This reflects both the estimated result for this year of -3.6% of GDP and the expected year-on-year improvement of 1.4 percentage points to −2.2% of GDP for 2024. The expenditure frameworks for 2024 allowed the government to draft the state budget and state funds with a total deficit of CZK 270 billion. This space was used for a deficit of CZK 252 billion for the state budget and CZK 18 billion for the State Transport Infrastructure Fund. The deficits will also be reflected in the level of debt, which could increase by almost another 2 percentage points during 2023 and 2024, and by the end of 2026 the debt should reach around 47% of GDP.
Fiscal policy should be restrictive in subsequent years. The structural deficit of 2.5 % of GDP for this year is in line with the fiscal rule set by the Act on Budgetary Responsibility Rules. Over the next three years (until 2026), the structural deficit should gradually decline to a maximum of 1.75% of GDP according to the set trajectory. The current forecast projects the structural deficit in 2026 to be just below this value.
The issue of long-term financial sustainability of social systems has not been resolved. This is also negatively affected by the deterioration of public finances after 2019. The latest projections of pension expenditure confirm previous trends of negative developments in the pension account balance from the end of the current decade. This trend will then be accelerated by the de facto capping of the retirement age at 65 taking place during the 2030s. Tightening of early retirement and the limitation of indexation will reduce the financial imbalance, but the potential linking of the retirement age to life expectancy would reduce the pension deficit by more than 40% at the end of the projection horizon.
The government’s efforts to improve public finances in the form of the consolidation package are the subject of this year’s thematic chapter. The first part of the chapter provides an overview of approaches to public finance consolidation, in particular the factors that have the potential to influence the success of the process.
Next, we present the content of the package and its most important measures. We also link these to the recommendations that are consistently made to the Czech Republic by international and supranational institutions, particularly regrarding tax mix adjustment. This applies not only to excises, but especially to property taxes. However, the most significant revenue item is the 2 percentage point increase in the corporate income tax rate. In the case of a relatively lower rate, an increase in this tax is recommended by research studies as one of the least damaging revenue measures. The expenditure side of the package is primarily characterised by a decrease in subsidies, cuts in salaries and in operating costs of all ministries.
The last section quantifies the impact of the package. In terms of the volume of consolidation measures, the macroeconomic impacts on the performance of the Czech economy are not significant. Its timing in a period of renewed economic recovery, improved economic sentiment and lower uncertainties helps to fulfil the assumptions for the successful implementation of the consolidation, whose accompanying effect should be an anti-inflationary market effect.