Fitch Ratings-Paris/London-01 September 2017: Fitch Ratings has revised the Outlook on Czech Republic's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) to Positive from Stable and affirmed the IDRs at 'A+'.
KEY RATING DRIVERS
The revision of the Outlook to Positive reflects the following key rating drivers and their relative weights:
There has been a marked improvement in fiscal balances, which reflects prudent policy and strong economic performance. Fitch expects the general government balance to record a surplus of 0.1% of GDP in 2017 after 0.6% in 2016 and versus an average deficit of 4.1% of GDP in 2009-2013. The improvement reflects the positive impact of strong economic growth on revenues and contained government spending. Planned pre-electoral measures (including an increase in wages for some civil servants and social transfers) should only have a limited impact and the agency expects the deficit will be 0.1% in 2018 and 0.3% in 2019. The new fiscal framework includes an expenditure rule, which should support fiscal prudence.
A rapid decline in the debt to GDP ratio is supporting the building of fiscal buffers to face future shocks. Fitch expects that tight government balances will contribute to a sustained fall in government debt, to 32.2% of GDP by end-2019 (vs. 48.2% for the 'A' median and 42.3% for the 'AA' median) from 34.7% in 2017 and a peak of 44.9% in 2013. In the medium term, Fitch expects government debt to continue to decline and reach 26.7% by 2026.
Fitch expects growth to remain above its potential over the 2019 forecast horizon. The agency forecasts GDP growth will accelerate to 3.7% in 2017 (after 4.7% y/y in 2Q-2017) from 2.6% in 2016, driven by stronger domestic demand and a favourable external environment. Investment is boosted by the ramp up in EU funds and strong private sector investment. Household consumption benefits from a historically low unemployment rate (at 2.9% in June 2017). Growth is set to decelerate to 2.7% by 2019.
The exit from the FX floor policy has not led to financial or macro instability. In response to rising inflation (2.4% in July for the HICP), the Czech National Bank scrapped the floor on the exchange rate in April 2017 and increased its policy rate in early August. The exchange rate has only appreciated gradually since April, gaining about 3%. The share of foreign holdings in CZK government debt has also remained fairly stable since then (48% in June 2017). Fitch notes that the risk of volatility on government bonds due to potential outflows from those investors is mitigated by strong fiscal finances and a liquid banking system (loan to deposit ratio is 80%), which should ensure high demand for bonds.
Czech Republic's 'A+' IDRs also reflect the following key rating drivers:
GDP and GNI per capita on a Purchasing Power Parity basis, are in line with the 'A' median, but much lower than the 'AA' median. More rapid growth in GDP per capita allowing convergence towards EU level of development is constrained by a relatively low GDP growth potential, which Fitch estimates at slightly higher than 2%. The key challenges to increasing potential growth include raising productivity and tackling adverse labour force dynamics.
Czech Republic is a net external creditor, with net external debt at -16% of GDP in 1Q17. This is underpinned by the sovereign's net external creditor position (38% of GDP), which has benefited from interventions of the Czech central bank to support the FX floor before its removal. As of the end of March 2017, central bank reserves were USD131 billion from USD55 billion at end-2014. Fitch expects the current account surplus to decline to 0.4% of GDP in 2017 after 1.1% in 2016, reflecting the impact of acceleration of domestic demand on imports. The surplus should decline to 0.2% by 2019 reflecting higher investment and the potentially negative impact on the current account from the appreciation in the currency.
Czech banks are mostly foreign owned, well capitalised and liquid. Non-performing loan ratios are low (4.6%). Fitch's macro prudential indicator is '2', indicating that credit growth is more than five percentage points above its long-term trend. In response to rapid lending growth, the central bank has issued tighter macro prudential recommendations. The stock of credit is still relatively low, with households' indebtedness equivalent to 30% of GDP at end-2016, versus 50% on average in the EU. Fitch expects growth in credit to the private sector to decelerate in the coming years, reflecting tighter monetary conditions.
Fitch expects broad policy continuity after the October 2017 general election. The party currently leading the polls is ANO, a junior party in the current governing coalition. Its leader, Mr. A. Babis, was minister of finance in the current coalition until May 2017. ANO would likely need to form a coalition to govern. This could lead to modest instability, a recurrent issue in Czech politics, which has an electoral system of proportional representation.
General institutional strength is underpinned by EU membership. World Bank Doing Business indicators and Human Development index and governance indicators are all in line or above the 'A' median and close to the 'AA' median.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Czech Republic a score equivalent to a rating of 'A+' on the Long-Term FC IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could, individually or collectively, lead to an upgrade are:
- Continued reduction in the government debt to GDP ratio supported by tight budget balances.
- Stronger GDP per capita, potentially supported by economic reforms, and without the emergence of macroeconomic imbalances.
The main factors that could, individually or collectively, lead to a stabilisation of the Outlook are:
- Worsening dynamics in government finances, for instance, brought about by a reversal in the government's fiscal stance after the October elections.
- Evidence of rising macroeconomic imbalances that pose a risk to macro and financial stability.
Fitch assumes that growth in the eurozone, Czech Republic's main economic partner, will be 2.0% in 2017, 1.8% in 2018 and 1.4% in 2019 after 1.8% in 2016.
The full list of rating actions is as follows:
Read the press release.
1st February 2019
9th November 2018