Political Economy of the Czech RepublicProfessor Donald Fuller

21st May, 2008Tyrone Schiff

Political Economy of the Czech Republic

The Czech Republic has a long and storied history. It is an ancient country that

has been involved in many of the most crucial events in European history. The 20th

century in particular has been an interesting one for the Czech Republic. It has gone in

and out of Communism, and finds itself currently in a transitionary stage along with

many of its neighboring states in Eastern and Central Europe. Aside from the fact that

its culture and government are transitioning, the economy is also doing the same. This

has made the last decade or so a very interesting and significant portion of Czech

economic activity. While there is a tremendous realm of activity that could be and is

monitored, this paper will only delve into a very specific set. In particular, I will

explore the debt and deficit that exists in the Czech Republic. I’ll discuss how the

country’s debt came about, what is doing currently to finance it, and what some good

ideas are for the future. In addition, I will look at the inflationary climate in the

country. I’ll make comparisons to states that are in similar phases as the Czech

Republic, as well as provide analysis of the current and recent past of inflation in the

Czech Republic. Of course, all of these elements mean nothing without knowing what

sort of impact they all have on the country. This will be a critical component of my

paper, and I will discuss how each one of the economic figures influences the society

and country.

Let us first tackle the issue of state debt in the Czech Republic. As of March

2008, the state debt for the Czech Republic stood at 860.1 billion CZK ($54.02

billion) (Ministy of Finance). This number by itself doesn’t really make all that much

sense. It is better to disucss debt in terms of a country’s GDP, because then you can

get a sense of how large that number truly is. The Czech Republic has a public debt

equal to 31.1% of its GDP (World Fact Book). Compared to some of its neighbors,

1

the Czech Republic can be seen as doing quite well in regards to state debt. Slovakia,

its neighbor to the east, at first glance may appear as though it is outperforming its old

partner in terms of debt.

This may be true on a dollar by dollar basis, but in fact, Slovakia has a public

debt equal to 34.8% of its GDP, which is slightly worse than the Czech Republic.

Germany’s public debt is at a whopping 65.3%, France 66.6%, and Hungary’s public

debt stands at 70.2% of GDP (World Fact Book). In fact, the Czech Republic ranks

73rd out of 126 countries in terms of its ratio of public debt to GDP, 126th having the

best ratio (World Fact Book).

Now that I’ve explained where the Czech Republic is in terms of its debt

relative to some other countries in Europe, I think it is pertinent to explain why and

how debt occurs. Essentially, “countries accumulate debt whenever they run a budget

deficit” (iadb.org). Even more specifically, if there are greater public expenditures

than the country produces revenue, then there will also be an increase in public debt.

The Czech Ministry of Finance goes even further in their definition of public

debt. For instance, they break debt down into four different categories: domestic debt,

foreign debt, marketable debt, and non-marketable debt. Marketable debt are things

like treasury bills and treasury bonds. One of the easiest ways of accruing debt is by

borrowing from another country, and thus adding to your foreign debt as the Ministry

alludes to. This can have devastating effects if the borrowing country goes through

extreme inflation.

Consider the example of borrowing $1 from the United States and paying for

it with 16 CZK. If the Czech Republic goes through a significant inflationary period

and the country’s exchange rate spikes to 30 CZK for $1, paying that $1 back will be

2

significantly harder for the government. This can be seen in many different instances

in the countries of South America.

Unfortunately, since 2005, public state debt has been rising quite dramatically

in the Czech Republic, increasing from just about 500 billion CZK to now over 800

billion CZK. In order to deal with this debt, the Czech Ministry of Finance has

outlined a couple of key strategies to deal with the issue. One of the first measures

that the Czech Republic will employ in order to finance their own debt is by engaging

in medium term government borrowing. The Czech Republic mainly engages in this

via borrowing from the European Investment Bank. In the first quarter of 2008, the

Czech Republic borrowed 1.4 billion CZK from the bank (Ministry of Finance).

Another way that the Czech Republic can finance its debt is through selling its

debt off right now in exchange for a promise to pay it back to the loaner at a later

date. This method is commonly referred to as selling bonds. The sale of bonds is a

huge industry in Europe and in the Czech Republic in particular. During the first

quarter of 2008, the Czech Republic sold 0.9 billion CZK worth of government bonds

and sold back 5.6 billion CZK.

The gross issuance of bonds in the Czech Republic equals 35.3 billion CZK

currently. When an individual takes out a bond, the idea is that they will be paid back

at a later date. In the Czech Republic, an individual will typically be paid back for

buying up the country’s debt within 6 or 7 years (Ministry of Finance).

A final way to improve a country’s debt is by getting other countries to pay

you back from previous loans you have given to them. The Czech Republic, however,

has recently decided to nullify two different outstanding loans. On the 13th of May, the

Czech Republic and Cambodia finally came to an agreement over a longstanding debt

3

that Cambodia had with the Czech Republic. Cambodia owed the Czech Republic $3

million for purchasing arms during the Cold War.

Czech Deputy Finance Minister Toma Zibek said, “We have told the

Cambodian government it does not need to pay this money back to our country”

(VOA News). The Czech government is apparently looking very kindly upon

Cambodia as it is also offering, “a package for development projects for energy, the

environment, health care and education” (VOA News). Cambodia is currently also

seeking a cancellation of their debt to Russia, which totals a lot more than the debt

they had owed to the Czech Republic, $1.5 billion.

The Czech Republic has also decided to forgive most of the debt it had owed

to it from Syria. In an agreement made just days ago, 18th of May, “Czech Finance

Minister Miroslav Kalousek signed with Syrian representatives agreements on the

prevention of double taxation and the settlement of Syria's debt” (CeskeNoviny.cz).

The Czech Republic has agreed to reduce Syrian debt from 23.4 million CZK to 11.8

million CZK. The impetus for this agreement is due to the Czech Ministry’s

motivation to make entering into the Syrian market easier for Czech entrepreneurs, as

well as, improve trade relations amongst the two countries.

Czech trade with Syria has often resulted in a significant surplus for the

country, so in order to maintain and even progress those relations, the Czech Ministry

of Finance thought that it would be a favorable move to eliminate some of Syria’s

lingering debt that it had with the country. The debt relief may also be the result of

mounting oil prices. In 2001 to 2004, the Czech Republic purchased Syrian oil and

exported over 4 billion CZK to their country (CeskeNoviny.cz). Since then, both

imports and exports have been meager. I think that this will have a positive impact on

4

the trade and business climates between the two states, which will ultimately work out

to be profitable.

I would now like to turn the discussion towards the balance of payments in the

Czech Republic. While, debt and deficit are very interrelated, they are not entirely the

same thing. A budget deficit is when a government spends more money than it takes

in (Wikipedia.org). While this may sound similar to debt, it is the accumulation of this

deficit over time that accrues and forms a country’s debt. The deficit is one direction

that a country’s balance sheet can go in. A country’s balance sheet looks at various

things that come into the country and various things that leave the country, financially

speaking, and assesses how it is doing based on that information. Similar to a personal

balance sheet, if a country is continually handing out more money than is coming in,

the likelihood is that country will become poor. Countries can also run at a surplus if

they are able to bring in more revenue than expenditures.

A country’s balance sheet that determines whether they are running a budget

deficit or surplus is composed of two main parts. There is the capital account and the

current account. The capital account is composed of five distinct categories. They

include: increase in foreign ownership of domestic assets, increase of domestic

ownership of foreign assets, foreign direct investment, portfolio investment, and other

investment. The current account is split up like this: balance of trade (exports minus

imports), net factor income from abroad, and net unilateral transfers from abroad.

In order to get a very good sense of the Czech Republic’s balance of

payments, I’d like to go through both the capital and current account. All the

following numbers are courtesy of the Czech National Bank and are considered

preliminary data when compiled through the 6th of March, 2008. Additionally, all of

5

the figures refer to quarters one through four, so it takes the entire year of 2007 into

account.

First, let us begin with the current account. The balance of trade was positive,

which implies that exports were greater than imports. This means that the country is

producing more to sell on the foreign market than it needs to buy. The balance of

trade equaled 117 billion CZK. The balance of services was also positive. This

includes services that the Czech Republic can trade on the foreign market. This

implies that the Czech Republic is offering more services to the world than it is

required to buy. Some of the larger components in the balance of services include

transportation and travel. The Czech Republic has a surplus in the balance of services

in the amount of 55 billion CZK. The next component of the current account would be

net income from abroad. Essentially, this is the amount of money that investments

made by the Czech Republic are accruing abroad. The income balance is heavily

negative; a loss of 253 billion CZK was reported in 2007. Finally, there are the net

unilateral transfers from abroad. This totaled a loss of 8 billion CZK (Czech National

Bank).

Now, we can deal with the capital account, which can also be referred to as the

financial account. In 2007, the Czech Republic saw an influx of foreign ownership for

domestic assets, which is seen as a positive addition to the balance sheet, because the

flow of money is in to the Czech Republic. This totaled 21 billion CZK. On the other

hand, the Czech Republic did not venture out and purchase much foreign assets

abroad, only investing 1 billion CZK. Portfolio investment is another component of

the balance of payments. The Czech Republic took on a great deal more liabilities

than assets in 2007, which helped decline their portfolio investment by 53 billion

CZK. Other investments that the Czech Republic made, which include both short-

6

term and long-term assets and liabilities that are accrued over the year also hurt the

balance of payments by 2 billion CZK. Perhaps one of the most critical components

of the balance of payments or any economy is such a globalized world these days, is

the amount of direct investment, which includes that which is foreign. This number

truly indicates how the host country and the rest of the world feel about the prospects

and possibility of economic success in that country. Logically, it makes sense that

those countries that have a great deal of direct investment in themselves and from

foreigners show strong economic potential. The Czech Republic is extremely positive

in this regard, netting a positive investment of 158 billion CZK. All together, the

current account and the capital account show a budget surplus of 15 billion CZK

(Czech National Bank).

This is a positive indicator for the country. I think when you consider the

balance of payments, it is never a good sign if there is too much of a surplus, nor is it

good to have too much of a deficit. Rather, I think that when the balance of payments

are actually in balance, there is a lot of good that can come from this.

Finally, I would like to discuss the status of inflation in the Czech Republic

and what the impacts of this measurement are. According to the Czech Statistical

Office, “inflation is the growth of price level over a certain period of time” (Czso.cz).

The way this is done is by taking the prices of simple goods, things that you probably

buy in a grocery store every day, and comparing the prices of those goods at two

different periods (Czso.cz). These goods are typically placed in a “basket” of around

790 items in order to give a representative look at how the prices of items in an

economy are fluctuating.

In the Czech Republic, since the year 2000 until the year 2006, the inflation

rate, essentially the prices of goods year over year, have increased somewhere

7

between 0 and 5 percent. In 2003 the inflation rate was just 0.1 percent, whereas in

2001 the inflation rate was 4.7 percent. However, the inflation rate has most typically

been between 1 and 2 percent (Worldwide-tax.com). The inflation rate in the Czech

Republic is for the most part in line with other European countries. Countries like

Germany, Austria, and Italy are a little more consistent in their inflation rates

compared to the Czech Republic, but the numbers are for the most part quite similar

(Worldwide-tax.com). When comparing the inflation rate of the Czech Republic to

other Eastern European and transitioning economies, the Czech Republic is outdoing

them completely. Countries like Hungary and Slovakia are far more erratic and are hit

far harder with inflation than the Czech Republic (Worldwide-tax.com).

Inflation has far reaching consequences on the economy and the people who

live in it. Consider when an individual is sitting down and writing out a contract with

an employer. Inflation is one of the critical components of this contract, because if

your wage does not keep pace with inflation then it will be equivalent to earning less

money. This can also come into play, again with the writing of contracts, when people

are signing rents. Most financial statements will incorporate inflation into them and

this is no different in the Czech Republic.

This paper has examined three critical components of an economy: debt,

balance of payments, and inflation. However, there are several other measures when

considering the overall political economy of a country. The Heritage Foundation, an

economic think tank, recently published a report that ranks and explains a country’s

economic freedoms. They do this by organizing data in ten different economic realms.

It is interesting to note that the Czech Republic ranks 37th on their list of 157 countries

and 21st out of 41 in the European region (Heritage Foundation). In order to truly get a

full grasp of the economic standing of a country, there are countless more measures

8

and figures to take into account. The Czech Republic is doing very well though, and I

am sure they will continue to improve.

9

Bibliography

“Balance of Payments in CZK.” Czech National Bank. 2008. 19 May 2008. <

http://www.cnb.cz/en/statistics/bop_stat/bop/bop_czk_en.htm>.

“CIA World Fact Book.” CIA. 2008. 19 May 2008. <

https://www.cia.gov/library/publications/the-world-factbook/>.

“Capital Account.” Wikipedia. 2008. 19 May 2008. <

http://en.wikipedia.org/wiki/Capital_account>.

“Chapter 3: How Does Debt Grow.” Inter-American Development Bank. 2008. 19

May 2008. < http://idbdocs.iadb.org/wsdocs/getdocument.aspx?

docnum=837089>.

“Current Account.” Wikipedia. 2008. 19 May 2008. <

http://en.wikipedia.org/wiki/Current_account_deficit>.

“CzechRep Signs Agreements on taxation, debt settlement with Syria.” Ceske

Noviny. 2008. 19 May 2008. <

http://www.ceskenoviny.cz/prilohy/blizkyvychod/index_view.php?

id=313291>.

“Index of Economic Freedom 2008 – Czech Republic.” The Heritage Foundation:

Leadership for America. 2008. 19 May 2008. <

http://www.heritage.org/index/country.cfm?id=CzechRepublic>.

“Ministry of Finance of the Czech Republic: State Debt.” Ministry of Finance of the

Czech Republic. 2008. 19 May 2008. <

http://www.mfcr.cz/cps/rde/xchg/mfcr/xsl/state_debt.html.>

“When You Say Inflation.” Czech Statistical Office. 2001. 19 May 2008. <

http://www.czso.cz/eng/topical/inflat/inflation.htm>.

10

“Worldwide-Tax.com.” The Complete Worldwide and Tax Site. 2008. 19 May 2008.

< http://www.worldwide-tax.com/>.

Sakada, Chun. “Czech Republic Cancels Cambodian Debt.” VOA News. 2008. 19

May 2008. < http://www.voanews.com/khmer/2008-05-13-voa2.cfm>.

11