The following ratings have been affirmed to the Government of the Czech Republic (hereinafter, the Czech Republic, or the country) under the international scale:
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Long-term foreign currency credit rating at AA and local currency credit rating at AA;
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Short-term foreign currency credit rating at S1+ and local currency credit rating at S1+.
The outlooks on the long-term foreign currency credit rating and the local currency credit rating are Stable. The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.
Positive rating assessment factors
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Relatively high level of welfare.
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Moderate level of public debt with a relatively deep domestic market.
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Prudent monetary policy.
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Strong external position.
Negative rating assessment factors
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Small size and high openness of the economy.
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Low diversification of the industrial sector.
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High dependence on the key trade partner.
Credit rating rationale
After relatively slow growth in 2021 (3.3% according to flash estimate of the Czech Statistical Office), which was influenced by prolonged lockdowns and supply shortages of semiconductors, which negatively affected the automobile sector, ACRA expects the Czech economy to grow by 3.0% and 2.7% in 2022 and 2023, respectively. In 2022, despite the new COVID-19 strain (omicron) spreading much faster than previous variants, ACRA does not expect severe economic consequences thanks to the relatively high vaccination rate (around 64% of the population) in the country.
Recovery to the level of pre-COVID GDP is expected in the second half of 2022. In ACRA’s view, the potential GDP growth rate is likely to slow to 1–2% compared to 2–3% observed before the coronavirus crisis. Expected slower growth rates could be improved by EU funds. In September 2021, the Council of Europe adopted the Czech Republic’s Recovery Plan, which will open access to EUR 7.0 bln of EU grants for the country. In the same month, the country had already received EUR 0.9 bln of grants. Overall, according to the new EU 2021–2027 budget, the country will receive the equivalent of 20% of its GDP in funds, which is significantly higher than the amount received under the previous seven-year EU budget.
In the long term, the country’s GDP growth is constrained primarily by the high concentration on the automotive industry, which accounts for 10% of output and 23.3% of total exports. It exposes the country to industry-specific risks and risks associated with global trade tensions and environmental policies. Moreover, carmakers may be susceptible to major changes in the industry with the larger focus on electric vehicles, self-driving cars, and car sharing. Relatively high R&D expenditures (around 2.0% of GDP in 2019) and a high share of investments (27% of GDP) could mitigate these risks.
The Czech Republic, along with other countries worldwide, is suffering from rising inflation. In January 2022, inflation reached 9.9% y-o-y, which is significantly above the upper tolerance level of the target (3.0%). There are common and unique factors behind this. Common global factors include energy price growth, supply chain disruption, fast recovery of domestic demand, and import prices. Housing, water, energy, and fuel together contributed 3.7 p.p. to the increase, whereas transport alone was responsible for 1.6 p.p. Unique factors include the tight domestic labor market with the lowest unemployment rate (2.2% in December 2021) in the EU, which triggered a rise in wages. The growth momentum of household earnings in 2021 was partially driven by one-off bonuses in selected segments of the government sector. In addition, local currency appreciation will help to stabilize prices.
In response to rising inflation pressure, the Czech National Bank (CNB) has hiked the key rate six times since June 2021 by 425 bp cumulatively and set it at 4.5%. Not all inflation drivers are of a monetary nature, so monetary policy could affect prices to some extent. In this environment, heightened inflation is likely to remain for a certain period. At the same time, it is reasonable to expect that the CNB will be more aggressive in its monetary policy. ACRA expects the average inflation rate to be 8.0% this year before it slows to 2.5% in 2023.
ACRA expects the general government deficit to stay at 4.0% of GDP this year, compared to 5.6% and 6.5% of GDP deficits in 2020 and 2021, respectively. Previous deficits occurred due to structural measures, such as decisions on personal tax cuts, social support, and one-off measures to support economy during the crisis. At the same time, the new government that was elected last year has demonstrated willingness to consolidate the budget quicker than previously planned by presenting consolidation measures worth around 0.5% of GDP for this year’s budget. As for the years beyond 2022, it is reasonable to assume that deficits will be lower than planned, however, compared to the pre-pandemic surpluses, the budget is likely to stay in deficit.
General government debt is expected at 41.9% of GDP at the end of 2022 compared to 30% of GDP in 2019, before the crisis. Financing needs this year are estimated by ACRA at 8.4% of GDP, compared to 11.3% of GDP last year. ACRA believes that the government will comfortably cover its needs with borrowings. Thanks to a developed and relatively deep domestic market, the budget deficits in 2020 and 2021 were successfully financed mostly by fixed-rate, local currency-denominated notes and bonds. Unlike other central banks in the CEE region, the CNB did not buy government bonds in the secondary market. In 2019, the government started to issue a limited amount of foreign currency-denominated bonds, but has no plans to increase their issuance. Potential new issues in foreign currency will be used only for refinancing needs. Besides, the Czech Ministry of Finance has stated that it is ready to issue Eurobonds if necessary. Taking into account the fact that the last Eurobond issuance was in 2012, demand for a potential new issuance will be strong. Non-resident investors’ holdings of government bonds are stable at around 30% of central government debt in securities.
Debt affordability remains high with the ratio of interest payment to revenues low at 1.7% in 2021. ACRA expects this ratio to remain at 1.8% in 2022.
A long-term challenge for the country is the increasing cost of its aging population in terms of pensions, healthcare costs, long-term care, and education. According to the EU 2021 Aging Report, these costs will increase by 6.1 p.p. and reach 24.7% of GDP in 2070 vs. 18.6% of GDP currently. This increase of costs is the third largest among peers, after Slovakia and Slovenia.
The banking sector seems to have weathered the crisis well. The fundamentals of the country’s banking industry were solid prior to the crisis. Forbearance measures such as six-month holidays for social payments and a moratorium on the repayment of loans and mortgages were lifted at the end of 2020. The ratio of NPLs to gross loans decreased to 2.39% in December 2021, close to the lowest level (2.37%) recorded in October 2020, despite an increase in credit. Outstanding bank loans to the private sector had increased by 8.6% as of the end of December 2021 compared to December 2020, with mortgages rising by 12.2%. By the end of Q3 2021, residential property prices had risen by 22.0% y-o-y — the highest rate in the EU. Prices are driven by strong demand and supply shortages of housing stock. In November 2021, the CNB responded by reintroducing several macroprudential measures, which were lifted during the crisis, and raising the countercyclical buffer to 2%. Banks are well positioned to face this environment. Capitalization remains strong (the regulatory capital to RWA ratio was 21.5% in Q3 2021). The banking sector’s profitability has recovered. In ACRA’s opinion, there will be no need for the government to support the banking sector.
In 2021, exports of goods and services measured in USD rose by 16.6% compared to 2020, while imports increased by 23.3%. The comparatively weaker dynamic of exports could be explained by lower machinery production and exports due to supply shortages of semiconductors and lower travel receipts due to restrictions. In 2021, outflows from primary account increased to USD 8.5 bln compared to USD 6.9 bln in 2020. Due to these factors, the current account balance was negative at USD -0.5 bln (-0.2% of GDP) compared to a USD 8.9 bln surplus in 2020. ACRA expects a 1.0% current account deficit this year due to a wider primary income deficit and an increase in imports.
The Czech Republic’s ability to withstand external shocks is backed by a high level of reserves — USD 172.7 bln (61.74% of GDP in December 2021). In Q3 2021, the country’s foreign currency reserves covered 86.3% of total external debt, short-term (due in one year) external debt is covered by 6.8x (in H1 2021), with the short-term deposits of non-residents taken into account the coverage decreases to 2.7x (in H1 2021).
The country’s institutional framework is robust and the strongest among CEE peers. Almost all of the Czech Republic’s governance indicators have been historically strong, with some having slightly improved in recent years. In October 2021, the ruling party (ANO) lost a parliamentary election to the SPOLU coalition. It is reasonable to assume the continuity of economic policies under the new government. The first positive step was fiscal consolidation in 2022.
Sovereign model application results
The Czech Republic has been assigned an AA- Indicative credit rating in accordance with the core part of ACRA’s sovereign model. A number of modifiers in the modifiers part of the model allow the Indicative credit rating to be increased. These include the following, which are determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:
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Monetary policy efficiency;
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Fiscal policy and fiscal flexibility.
In view of the abovementioned modifiers, the Czech Republic’s Indicative credit rating has been raised. A Final credit rating of AA has been assigned. There are no analytical adjustments and limitations that could result in an adjustment of the Final rating. In connection with this, the long-term foreign currency credit rating remains at AA.
Potential outlook or rating change factors
A positive rating action may be prompted by:
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Stronger than expected growth;
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Improvement in the budget position in the coming years;
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Alleviating costs of aging and economic competitiveness issues.
A negative rating action may be prompted by:
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Worsening of the fiscal position;
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Lower than expected growth.
Regulatory disclosure
The sovereign credit ratings have been assigned to the Czech Republic under the international scale based on the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.
The sovereign credit ratings of the Czech Republic were published by ACRA for the first time on October 29, 2019. The sovereign credit ratings and their outlooks are expected to be revised within 182 days following the publication date of this press release as per the Calendar of sovereign credit rating revisions and publications.
The sovereign credit ratings are based on information from publicly available sources and ACRA’s own databases. The sovereign credit ratings are unsolicited. The Government of the Czech Republic did not participate in the sovereign credit rating assignment.
In assigning the credit ratings, ACRA used only information, the quality and reliability of which was, in ACRA’s opinion, appropriate and sufficient to apply the methodologies.
ACRA provided no additional services to the Government of the Czech Republic. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.
