Fiscal Outlook of the Czech Republic (November 2024)
The last few years have brought several difficult challenges for the Czech national economy and public finances. First, the global pandemic, which necessitated a number of restrictive measures and contributed to the economic downturn. Then, at the beginning of 2022, the military conflict in Ukraine broke out in full force, the consequences of which hit the European economy in particular, including the Czech economy. Increased market volatility and significantly higher energy prices halted the economic recovery and led to a stagnation of the Czech economy in 2023. Economic growth is already resuming in 2024. The economy could grow by 1.1% this year, accelerate to 2.5% in 2025 and virtually keep this momentum in the outlook years.
The weaker economic performance, high inflation and the Government’s proactive measures have had an impact on public finances. Measures of a temporary nature total almost CZK 350 billion. However, on top of this, there were permanent changes that have led to a deterioration in the structural balance. Among the most significant were adjustments in the area of the personal income tax and the significant increase in pension benefits due, among other reasons, to high inflation. In response to the permanent deterioration of the public finances, the Government came up with a set of more than 60 measures in the form of a consolidation package. This had the ambition to reduce the structural deficit by more than 1 percentage point. The structural deficit should fall below 2% of GDP in 2026, in line with the Fiscal Responsibility Rules Act, and then be further reduced to 1% of GDP in 2028.
Public finances in the Czech Republic are strongly influenced by the results of the state budget. It reflects the vast majority of the fiscal impact of past crises, including compensation and assistance to other parts of the public budgets. For this year, however, we expect the general government balance to meet the Stability and Growth Pact benchmark for the first time since 2019, falling below the 3% of GDP deficit to 2.8% of GDP. The deficit is then expected to narrow further to 2.3% of GDP in 2025. The expected outcomes in both years take into account, among other things, growth in defence spending in line with the statutory requirement of at least 2% of GDP, an increase in investment in transport infrastructure, as well as the cost of repairing the damage caused by the floods in September this year.
The expenditure framework for 2025 originally allowed the Government to draft the state budget and state funds with a deficit of CZK 231 billion. This space was fully used for the state budget deficit, which was then increased by an additional CZK 10 billion in September under the provisions of the Budgetary Rules Act due to a natural disaster. The final state budget deficit for next year is therefore CZK 241 billion.
Government deficits will be mirrored in the level of debt, which could rise by more than 2 percentage points during 2024 and 2025. However, by the end of 2026, the debt ratio is expected to peak at around 45% of GDP.
In terms of its setting, fiscal policy should be restrictive in the coming years. The structural deficit of 2.1% of GDP for this year is in line with the fiscal rule set by the Fiscal Responsibility Rules Act, which prescribes a structural deficit of no more than 2.75% of GDP. Over the next years, the Act imposes a gradual reduction of this ceiling, with a structural deficit of no more than 1.25% of GDP in 2027.
In terms of the medium- and long-term development of finances, the Government has prepared several important measures in the area of pensions which were submitted to the Parliament of the Czech Republic in two waves. The first part included changes mainly in early pension scheme and the indexation system. The second part, currently under discussion in the Chamber of Deputies, focuses, among other things, on adjustments to the statutory retirement age and the setting of the calculation of newly granted pensions.
The completion of the process of economic governance reform in the European Union, with implications for national legislation, is also linked to the longer horizon and the sustainability of public finances. Therefore, the Fiscal Outlook focuses in a thematic chapter on the most significant changes, which undoubtedly include coordination, adjustment of fiscal surveillance and enforcement of fiscal rules. The setting of budgetary and fiscal policy in the countries of the European Union is now determined by the analysis of medium-term debt sustainability. Only one operational indicator – the dynamics of adjusted public expenditure – is used to achieve fiscal goals. The indicator is defined as total public expenditure that is adjusted for debt service expenditure, projects co-financed by the European Union, the effects of the business cycle on unemployment benefits, but also net of discretionary or one-off revenue measures. The “net expenditure path”, as the regulation calls the series with the percentage year-on-year change in adjusted expenditure, is approved by the Council of the European Union for each country in the framework of the so-called national medium-term fiscal and structural plans. These plans replace convergence or stability programmes as well as national reform programmes. They describe measures to respond to recommendations on possible macroeconomic imbalances and indicate what reforms and investments the country will make to address its own structural problems along with the common priorities of the European Union.