Bloomberg News

Czech Austerity Revolt Threatens Cabinet as Slump Bites

August 22, 2012

Czech Premier Petr Necas is battling to save his government as a revolt mounts against an austerity drive that threatens to deepen the nation’s recession.

The 47-year-old lost his parliamentary majority in April when his coalition crumbled after budget and personnel rows. He must secure enough lower-house support to overturn last week’s Senate rejection of tax increases to cut the fiscal deficit below the European Union’s limit next year. The vote is likely to take place after parliament reconvenes in Prague on Sept. 4.

Governments across Europe are struggling to hold on as austerity measures enacted to combat the euro-area debt crisis plunge their economies back into recession, four years after the start of the global financial crisis. The Czech economy has contracted for three quarters as Necas’s previous budget cuts curbed domestic demand and the debt crisis hurt exports.

The lower house’s repeat vote “on this package will be, in a way, a vote about the government’s existence,” Jiri Pehe, a former adviser to late President Vaclav Havel and director of New York University in Prague, said by phone on Aug. 17. “It’s possible that Necas will link it to a confidence motion, or threaten early elections if the proposal isn’t approved, tactics he used before and that worked for him.”

Maintaining Confidence

Necas, who credits previous austerity measures with helping reduce borrowing costs, says his latest plan will maintain investor confidence by cutting the deficit below 3 percent of gross domestic product next year through an increase in the sales tax and a levy on the highest incomes.

Budget cuts are “an absolute priority” as the country risks higher borrowing costs if the fiscal strategy “loses credibility,” he said in an Aug. 18 interview with newspaper Lidove Noviny. Scrapping the tax increases would only be done by “a different government with a different premier,” he said.

The yield on the two-year Czech bond fell to a record low of 0.513 percent today, about one-fifth what Italy pays to borrow for two years, according to generic data compiled by Bloomberg. The koruna slid 0.8 percent, the most among major emerging-market currencies tracked by Bloomberg, to 24.967 per euro by 2:10 p.m. in Prague.

Deficit Cutting

The two-year-old Cabinet has cut investment, raised the sales tax and curbed spending on public wages, helping to push the budget shortfall to 3.1 percent of GDP last year, from 4.8 percent in 2010.

The $215 billion economy shrank 0.2 percent in the second quarter from the previous three months, the third consecutive contraction, as households curbed spending in response to Europe’s worsening economy. The Czech Republic, which isn’t part of the 17-country euro region, relies on the 27-nation EU to buy 80 percent of exports, including from companies such as carmaker Skoda Auto AS.

“The Czech economy is fundamentally healthier than most European economies, but it’s still lagging behind in performance,” Vaclav France, an analyst at Raiffeisenbank AS in Prague, said. “The government should be very cautious about austerity measures.”

The Czech Republic, which joined the EU in 2004, expanded more than 5 percent for 13 quarters on an annual basis through 2007. Even with a spike in deficits following the collapse of Lehman Brothers Holdings Inc. in 2008, Czech public debt at 41 percent of GDP last year was about half of the EU average.

Belgium, a euro-area member with about the same population and an economy more than twice as large, had debt of 98 percent of GDP and a deficit of 3.7 percent of GDP in 2011. Its two-year yield was 0.437 percent today.

The Czech Republic has benefited from positive investor sentiment and a “solid track record of fiscal prudence” underpins its policy credibility, which keeps funding costs low, Moody’s Investors Service said in a note yesterday.

‘Credit Negative’

While the Cabinet is committed to cutting the deficit, “the unsupportive macroeconomic environment continues to hinder consolidation efforts and could jeopardize the stabilization of debt ratios, which would be credit negative,” said Moody’s, which rates the Czech Republic at A1.

Apart from the opposition Social Democrats, the plan to raise taxes has also been criticized by President Vaclav Klaus, an economist who founded Necas’s Civic Democratic Party, or ODS, after the collapse of communism two decades ago, as well as the premier’s own lawmakers.

Tax increases during a recession would further curtail economic growth and “border on economic suicide,” Klaus told newspaper Mlada Fronta Dnes in an interview published Aug. 18. Necas shouldn’t “force deputies to vote in a way that would violate the long-standing program of the ODS,” which traditionally eschews tax increases, lawmaker Petr Tluchor said Aug. 17, according the CTK newswire.

‘Real Test’

Rejection of the proposed package “could result in a coalition breakup,” Jaromir Sindel, an economist at Citigroup Inc. in Prague, said by phone. The vote in the lower house will be a “real test of the coalition’s integrity,” Sindel said, expecting lawmakers to eventually approve the bill.

Opposition to austerity measures has upended governments across Europe. The region’s three-year-old sovereign-debt crisis has resulted in the ouster of leaders in Ireland, Portugal, Greece, Italy, the Netherlands, Romania, Spain, Slovenia, Slovakia and Finland.

Private consumption will fall this year because of weak real disposable-income growth and negative sentiment, with full- year GDP to shrink 0.9 percent in 2012, the central bank forecasts. Retail sales declined in every month in the second quarter, while consumer confidence fell to the lowest level in almost 13 years in May, according to the statistics-office data.

Weak Demand

“We’ve been registering very weak household consumption in several recent quarters, and its growth rate seems to be the weakest in the modern history of the independent Czech Republic,” Vladimir Tomsik, a central bank vice-governor, said in an Aug. 15 interview.

Finance Minister Miroslav Kalousek, stepping up efforts to push through the austerity plan, last week evoked “nasty Wall Street imperialists” that will “dictate” policy to nations with irresponsible finances. “A country that loses access to the markets and to credit lines stops being sovereign and free,” he said during the Senate debate on the legislation.

Number Crunching

The Social Democrats have a majority in the Senate, with the ruling coalition holding 100 mandates in the 200-seat lower house. That’s one vote short of the majority needed to override Senate motions.

While Necas doesn’t have clear backing from all his lawmakers for the tax increase, declining public support for the three ruling parties in opinion polls is adding to pressure on deputies to back his policies, according to Pehe.

“There’s a number of politicians who know that if the government falls, their political existence is over,” Pehe said. “The likelihood of the government surviving is greater than that of it falling.”

-- Editors: Jeffrey Donovan, Alan Crosby

To contact the reporters on this story: Peter Laca in Prague at placa@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at

bpenz@bloomberg.net


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