OVERVIEW of Small and Medium-Sized Enterprises in Czech Republic

Economic growth remains solid in the Czech Republic. After the strong expansion in 2017 (4.3 %), real GDP growth slowed down in 2018 (2.9 %), according to the Commission Winter 2019 Forecast. Domestic demand was the main driver of economic growth in 2018, with household consumption propelled by rapid increase in wages and private and public investment. By contrast, net exports provided a negative contribution in 2018, after 2 years of positive balance. The slowdown in external demand together with the appreciation of the koruna contributed partly to this development.

Growth may slow over the coming years but economic convergence is set to continue. In 2019 and 2020 it is projected to reach 2.9 % and 2.7 %, respectively. The current expansionary cycle that started at the end of 2013 will likely continue in 2019 and 2020, when GDP growth is estimated to converge towards its potential. Domestic demand is set to be the key driver of growth, as the contribution of the external sector will be neutral. Growth projections are around 1 percentage point (pp.) above those for the euro area, stressing the robustness of the convergence process in the medium term.

The Czech Republic has undergone a sizeable catch-up process relative to the EU average. Large inflows of foreign direct investment (FDI) have played a leading role in the process, creating jobs and boosting productivity growth. The convergence process slowed down between 2008 and 2013, when the Czech Republic was more affected by the global crisis than other countries in the region. It then resumed in 2013 as both real wages and productivity started to increase. Between 2000 and 2017 the gross national income (GNI) per person, adjusted for purchasing power parity, rose from 70.2 % to 82.7 % of the EU average, a real convergence of 12.5 pps. Economic policies that encouraged both foreign and domestic investment, combined with significant financial support through EU funds, underpinned the convergence process. While the catch-up pace was lower than in other Central and Eastern European countries (particularly in the Baltic region), the Czech Republic is one of those closest to the EU average in terms of economic development and living standards.

As a small and open economy, labour shortages and uncertainties in global demand could potentially constrain future growth. The Czech Republic highly depends on potential frictions in global trade and the economic development of some of its main trade partners (e.g. Germany, France or the UK). In addition, the cost-competitiveness of exports might erode if the observed tightness in the labour market persists and the resulting real wage growth continually outpaces productivity growth. The Czech Republic has the lowest rate of unemployment and that of job seekers per vacancy in the EU and the OECD. In this context, businesses have started to invest more in machinery to offset the current labour shortages. However, the lag in the investment-to-productivity could possibly restrain economic growth in the near future.

Potential growth moved beyond the peak of the cycle. After reaching almost 3 % in 2017, in the coming years it will gradually abate towards 2 %. After widening in 2017 and 2018, the output gap will likely stabilise at around 1 % of GDP in 2019 and 2020.

The decline in the working-age population and technological change brings new challenges. Demographic changes and limited gains in productivity hamper potential GDP growth. Besides tapping into the labour potential of underrepresented groups, measures to sustain growth through the labour market include integrating of workers from EU and non-EU countries and extending working careers (i.e. through healthier and more productive lives). Furthermore, mismatches in qualitative skills can emerge in relation to the transition to Industry 4.0, requiring new education and training measures. Administrative burden and low trust in the public administration may hamper further foreign and domestic investment and contribute to the shadow economy, estimated at around 15 % of GDP in 2015.

Household consumption is the main driver of economic growth. High employment, higher wages, increasing real disposable income and low credit costs have boosted private consumption growth in recent years. The 3 % to 4 % annual growth seen since 2015 will likely continue until 2019. According to the Commission Autumn 2018 Forecast, the moderation in wage growth predicted for 2020 is expected to go hand in hand with a deceleration of private consumption growth (2.5 %). Household savings could recover from their current low levels to a rate of almost 11 % of gross disposable income up to 2020. There is also a change in consumption patterns associated with record levels of consumer confidence. The more buoyant consumption categories in 2017 were semi-durable and durable goods, both with an annual growth of around 10 %.

Despite steady wage growth, the Czech National Bank (CNB) contained inflation below the upper limit of the tolerance band (3 %). Consumer price inflation, measured by the the Harmonised Index of Consumer Prices, slowed down slightly in 2018 to 2.0 %, from 2.4 % in 2017. The rapid growth in energy prices in the second half of 2018 was offset by the moderation in food prices. Further tightening in monetary policy is likely to ensure that inflation stabilises at CNB’s 2 % target in the second half of 2019 and remain close to that in 2020. Consumer prices are forecast to grow by 2.1 % in 2019 and 1.9 % in 2020.

The CNB increased the base rate seven times in 16 months. This was in response to the increased activity in the credit market and inflationary pressures. As a result, the base interest rate (two-week repo rate) increased from 0.05 in July 2017 to 1.75 % in November 2018, further widening the rate differential with the euro area. Further interest hikes may follow in the coming quarters.

The Czech labour market continues to be a top performer. The employment rate has risen steadily in the last 7 years, reaching 80.0 % in Q3-2018. Overall employment growth is expected to slow down to 0.3 % in 2019, given reduced scope for further increases in the participation rate (see Section 3.3). The unemployment rate fell to a record low of 2.9 % in 2017 and 2.1 % in Q4-2018, the lowest in the EU for the second year in a row and will likely stabilise at around 2.5 % over the next 2 years. There have also been recent improvements in terms of youth (5.3 % in Q4-2018) and long-term unemployment (0.7 % in Q3-2018). With the economy near full employment, labour shortages are becoming more acute and have spurred wage increases after several years of more subdued growth. About 45 % of manufacturers and 40 % of builders cited labour shortages as a factor limiting production in Q4-2018 and the number of job vacancies has been twice that of unemployed people since mid-2018.

The rate of employment is weaker for low-skilled workers, women with young children, people with disabilities and older-age groups. As they bear most of the care responsibilities, the employment rate of women in 2017 (70.5 %) is below that of men (86.3 %). The employment rate of low-skilled workers in the labour market has stagnated since EU accession. Their employment rate of around 30 % is around 50 pps below the Czech average. At 62.2 %, the employment rate of those between 55-64 years old was 24.6 pps below that of workers aged 25-54. The employment gap is also high for people with disabilities. Participation in training and lifelong learning is low, in particular for underrepresented groups.

The observed convergence and overall social situation mask increasing regional disparities. GDP per person varies from 63 % of the EU average in the Northwest region to 182 % in Prague. The Northwest region actually saw its GDP per head diminishing in absolute terms since 2010. Furthermore, while regions like Moravia- Silesia have been losing people, Prague and Central Bohemia regions have witnessed positive demographic developments.
The distribution of opportunities and challenges is concentrated in certain areas. In general, rural regions are poorer, have a lower productivity, higher gender inequalities, increasing levels of homelessness, high indebtedness, a higher early-school leaving rate, low capacity to innovate and acute demographic challenges. These regions also witness increasing numbers of socially excluded localities and seizure orders, while facing a lack of affordable social housing. The gap between Prague and Brno and the less developed regions has further increased, most visibly compared with the Northwest region. Migration towards richer regions is increasing the process of suburbanisation in metropolitan areas, putting pressure on the housing stock and infrastructure networks.

The general government balance will decline but will remain positive until at least 2020. On the back of the growing economy, the general balance has been in surplus since 2016, supported by growth in tax receipts and by lower-than-expected levels of public investment. Measures to prevent tax evasion, such as electronic evidence of sales and VAT control statements, have proven to be efficient and contributed to the revenue increase. Additional VAT receipts are expected to grow in line with GDP growth over the forecast horizon. Significant wage increases since 2017 in both the public and private sector boosted direct taxation receipts. On the expenditure side, most increases relate to public wages and pensions, which are expected to increase significantly in both 2018 and 2019. As the current EU funds cycle is advancing, public investment will likely pick up.

In line with the headline balance, the structural balance is also expected to decline towards zero. It will likely remain positive until at least 2020, amid a constant output gap. According to the Commission Autumn 2018 forecast, the debt-to-GDP ratio will continue to decrease, reaching around 31.2 % of GDP in 2020.