Council opinion

of 4 March 2008

on the updated convergence programme of the Czech Republic, 2007-2010

(2008/C 74/06)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [1], and in particular Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 4 March 2008, the Council examined the updated convergence programme of the Czech Republic, which covers the period 2007 to 2010.

(2) The Czech Republic is experiencing a period of high growth which is expected to moderate in the medium term. The recent sharp fall in unemployment can be mainly accounted for by cyclical factors. Structural rigidities still appear to remain in the labour market, indicated by a high level of vacancies, evidence of skills mismatches, and regional disparities in unemployment, which will need to be addressed by future employment policy.

The stabilisation programme adopted in 2007 appears to be a step in the right direction while further measures will be necessary to continue fiscal consolidation. Notably, risks remain with respect to long-term sustainability of public finances, given the ageing population and current state of pension and health care systems. A well-devised pension reform could also have a positive impact on potential growth. While taking into consideration the good track record of the Czech Republic, inflationary pressures are set to increase due to rises in indirect taxation and rising international commodity prices.

(3) The convergence programme estimates GDP growth to be about 6 % in 2007 and moderate to about 5 % over the rest of the programme period. Assessed against currently available information [2], this scenario appears to be based on plausible assumptions. The Commission services' autumn 2007 forecast expects private consumption growth to remain strong on the back of high wage increases in the private sector and rising employment, while moderating from the high level in 2007 linked to the government's planned fiscal consolidation. Both the convergence programme and the Commission services' autumn forecast predict a steep rise in inflation in 2008 due to increases in indirect taxation and rising commodity prices, which may weigh on nominal convergence.

(4) For 2007, the Commission services' autumn forecast and the convergence programme estimate a general government deficit of 3,4 % of GDP, which is 0,6 percentage points below the target set in the previous update. However, recent information on budgetary implementation indicates that the 2007 outturn could be significantly better than envisaged in the current programme: the most recent information suggests that the general deficit in 2007 could be about 2 % of GDP. The lower estimated fiscal outcome is mainly due to the base effect of a higher revenue-to-GDP ratio in 2006 than anticipated in the previous convergence programme, as well as some expenditure restraint in 2007 and dynamic revenue growth thanks to stronger nominal GDP growth than anticipated. A lower 2007 deficit compared to the 2006 budgetary outcome is in line with the invitation in the Council opinion of 10 July 2007 on the previous update of the convergence programme [3] to limit the budgetary deterioration in 2007.

(5) The main goal of the budgetary strategy in the programme is to correct the excessive deficit in 2008 and thereafter to continue consolidation towards the achievement of the medium-term objective (MTO), which is a structural deficit of 1 % of GDP, in 2012. The general government deficit is projected to decrease from 3,4 % of GDP in 2007 to 2,9 % of GDP in 2008, 2,6 % of GDP in 2009 and 2,3 % of GDP in 2010. The primary deficit follows a similar path, narrowing from 2,3 % of GDP in 2007 to 1,1 % of GDP in 2010. The consolidation will be mainly expenditure-driven. In particular, the expected fall in the revenue-to-GDP ratio (partly attributable to the introduction of a flat tax in 2008) will be more than offset by a cut in the expenditure-to-GDP ratio. The latter is relatively broad-based but affects social and welfare benefits most significantly; public investment is the only spending category that is planned to increase as a share of GDP. Building on the better-than-expected outturn in 2006, the targets for public finances have been improved compared to those in the previous convergence programme. The most recent estimate of a lower general deficit in 2007 implies that these targets should be comfortably within reach.

(6) The outcome for 2008 could be better than expected while the balance of risks is neutral with respect to budgetary outcomes from 2009 onwards. On one hand, the Czech Republic has a history of achieving lower-than-planned deficits and the latest estimate for 2007 is significantly better than foreseen in the programme, which may have a favourable base effect from 2008. While there are a large amount of tax changes occurring, which makes forecasting difficult, the programme's tax estimates appear cautious. On the other hand, the targeted consolidation requires significant expenditure restraint, including public sector wage restraint and cut backs in the number of public employees, while expenditure ceilings have been breached in previous years. After 2008, further consolidation measures remain to be spelled out.

(7) In view of this risk assessment, namely in the light of the better-than-expected outturn in 2007, the budgetary stance in the programme seems consistent with a durable correction of the excessive deficit by 2008, as recommended by the Council. This is conditional on continuing expenditure restraint and a close monitoring of the fiscal impact of the tax reforms in the stabilisation programme. However, a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations would not be achieved within the programme period. In the years following the correction of the excessive deficit, the pace of adjustment towards the MTO implied by the programme should be strengthened and backed up with measures to be in line with the Stability and Growth Pact. In particular, while the Czech Republic has experienced a period of strong growth, the programme target for 2010 implies that a significant adjustment will have to be made in 2011-2012 to achieve the MTO by 2012.

(8) The Czech Republic appears to be at high risk with regard to the sustainability of public finances. The initial budgetary position in the programme is not sufficiently high to stabilize the debt ratio over the long-term. The long-term budgetary impact of ageing is well above the EU average, influenced notably by a substantial increase in pension expenditure as a share of GDP as well as a significant increase in health care expenditure. Implementation of structural reform measures notably in the field of pensions and health care aimed at containing the significant increase in age-related expenditures would contribute to reducing risks to the sustainability of public finances. While initial steps have been made to reform the health care system, reform of the pension system still lacks implementation against a definite timetable.

(9) The convergence programme seems to be consistent to some extent with the October 2007 implementation report of the national reform programme. The national reform programme includes a number of actions taken with the objective of improving the long-term sustainability of public finances; increasing the amount and quality of education and research; and increasing the motivation to take up employment. While the convergence programme does not provide systematic information on the direct budgetary costs associated with the main reforms envisaged in the national reform programme, the programme's budgetary projections seemingly take into account the public finance implications of the reforms envisaged in the implementation report of the NRP.

(10) The budgetary strategy in the programme is partly consistent with the country-specific broad economic policy guidelines included in the integrated guidelines in the area of budgetary policies issued in the context of the Lisbon strategy given the limited actions on pension and health care reform.

(11) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme provides all required data and most of the optional data [4].

The overall conclusion is that the programme is consistent with a correction of the excessive deficit in 2008, conditional on continuing expenditure restraint and close monitoring of the impact of the fiscal impact of the tax measures in the stabilisation package. Owing to the positive macroeconomic outlook and a likely better 2007 budgetary outturn than expected in the programme, there could be ample opportunity to bring the 2008 deficit below the 3 % of GDP reference value by a larger margin, and to achieve stronger-than-targeted fiscal consolidation afterwards. The main risks are in the reliance on reductions to public sector employment and relate to the fact that further consolidation measures remain to be spelled out after 2008. The Czech Republic remains at high risk with respect to the sustainability of public finances, while first steps have been made on health care reform.

In view of the above assessment and also in the light of the recommendation under Article 104(7) of 10 October 2007, and given the need to achieve sustainable convergence, the Czech Republic is invited to:

(i) exploit the likely better-than-expected 2007 budgetary outcome to bring the 2008 deficit below the 3 % of GDP reference value by a larger margin by continuing to exercise expenditure restraint;

(ii) exploit the high rate of growth in the economy by further strengthening the pace of adjustment so as to build a safety margin against breaching the reference value as soon as possible, and speed up the achievement of the MTO;

(iii) in view of the projected increase in age-related expenditures, improve the long-term sustainability of public finances through the necessary pension and health care reforms.

Comparison of key macroeconomic and budgetary projections

Notes:

[5] [6] [7]

Sources:

Convergence programme (CP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.

| 2006 | 2007 | 2008 | 2009 | 2010 |

Real GDP (% change) | CP Nov 2007 | 6,4 | 5,9 | 5,0 | 5,1 | 5,3 |

COM Nov 2007 | 6,4 | 5,8 | 5,0 | 4,9 | n.a. |

CP March 2007 | 6,0 | 4,9 | 4,8 | 4,8 | n.a. |

HICP inflation (%) | CP Nov 2007 | 2,1 | 2,4 | 3,9 | 2,3 | 2,1 |

COM Nov 2007 | 2,1 | 3,0 | 3,8 | 3,2 | n.a. |

CP March 2007 | 2,4 | 2,6 | 2,5 | 2,5 | n.a. |

Output gap [5] (% of potential GDP) | CP Nov 2007 | 0,9 | 1,8 | 1,4 | 0,7 | 0,5 |

COM Nov 2007 [6] | 1,1 | 2,1 | 2,1 | 1,4 | n.a. |

CP March 2007 | 0,9 | 1,1 | 1,0 | 1,0 | n.a. |

Net lending/borrowing vis-à-vis the rest of the world (% of GDP) | CP Nov 2007 | – 2,7 | – 2,4 | – 1,6 | – 0,4 | 1,5 |

COM Nov 2007 | – 2,7 | – 2,5 | – 2,1 | – 1,9 | n.a. |

CP March 2007 | – 2,8 | – 1,4 | 0,2 | 1,1 | n.a. |

General government balance (% of GDP) | CP Nov 2007 | – 2,9 | – 3,4 | – 2,9 | – 2,6 | – 2,3 |

COM Nov 2007 | – 2,9 | – 3,4 | – 2,8 | – 2,7 | n.a. |

CP March 2007 | – 3,5 | – 4,0 | – 3,5 | – 3,2 | n.a. |

Primary balance (% of GDP) | CP Nov 2007 | – 1,8 | – 2,3 | – 1,7 | – 1,3 | – 1,1 |

COM Nov 2007 | – 1,8 | – 2,3 | – 1,8 | – 1,7 | n.a. |

CP March 2007 | – 2,4 | – 2,6 | – 2,0 | – 1,6 | n.a. |

Cyclically-adjusted balance [5] (% of GDP) | CP Nov 2007 | – 3,3 | – 4,1 | – 3,4 | – 2,8 | – 2,5 |

COM Nov 2007 | – 3,3 | – 4,1 | – 3,6 | – 3,2 | n.a. |

CP March 2007 | – 3,9 | – 4,4 | – 3,9 | – 3,5 | n.a. |

Structural balance [7] (% of GDP) | CP Nov 2007 | – 3,1 | – 4,1 | – 3,4 | – 2,8 | – 2,5 |

COM Nov 2007 | – 3,3 | – 4,1 | – 3,6 | – 3,2 | n.a. |

CP March 2007 | – 3,9 | – 4,4 | – 3,9 | – 3,5 | n.a. |

Government gross debt (% of GDP) | CP Nov 2007 | 30,1 | 30,4 | 30,3 | 30,2 | 30,0 |

COM Nov 2007 | 30,1 | 30,2 | 30,3 | 30,5 | n.a. |

CP March 2007 | 30,6 | 30,5 | 31,3 | 32,2 | n.a. |

[1] OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

[2] The assessment takes notably into account the Commission services' autumn forecast and the Commission assessment of the October 2007 national reform programme.

[3] OJ C 204, 1.9.2007, p. 1.

[4] The data on COFOG for 2010 are not provided.

[5] Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the information in the programmes.

[6] Based on estimated potential growth of 4,5 %, 4,7 %, 5,0 % and 5,6 % respectively in the period 2006-2009.

[7] Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures in the convergence programme of November 2007 are 0,2 % of GDP in year 2006; deficit-increasing. There are no one-offs in the Commission services' autumn forecast.

--------------------------------------------------