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 highly 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.
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High energy dependence.
Credit rating rationale
In 2022, the Czech Republic’s economy was severely hit by increased energy prices. After previous prolonged lockdowns and supply shortages of semiconductors, economic growth was one of the lowest among the EU countries (1.5% y-o-y in Q3 2022). The economy is export-oriented, thus the EU slowdown this year will negatively affect growth. The Czech National Bank (CNB) heavily used its reserves to prop up the national currency and cover increased imports. Last year, reserves measured in USD fell by 18.5%, but remained sufficient (9.3 months of imports in Q3 2022). The CNB was one of the first central banks to start an interest hike cycle, and inflation has been falling from its peaks. The fiscal position has deteriorated to some extent. In the coming years, the general government balance is expected to stay in deficits compared to the surpluses before the COVID-19 crisis, and debt is expected to rise. However, due to a strong domestic market, the budget’s needs are financed by local currency bonds, and debt (44.2% GDP according to ACRA’s estimate for 2024) is still below the Maastricht debt criterion and the Stability and Growth Pact (60% of GDP). ACRA believes that the presidential elections in January this year will not significantly affect economic policies. Therefore, the existing external buffer and fiscal space coupled with strong institutional framework keep the rating at AA with a Stable outlook. The key ratings risks are the pace of budget consolidation, future dynamics of reserves, prospects of growth, and price dynamics.
Macroeconomics
In 2022, the Czech Republic’s economic growth exceed expectations, but remained weak compared to other EU countries. ACRA expects last year’s growth at 2.5% compared to 1.2% previously. Last year, growth was supported mainly by the strong first two quarters, driven by household consumption and investments. In 2023, ACRA expects growth to fall by -0.1% and recover to 3.3% next year. Lower purchasing power of households due to inflation and weaker external demand will be the key factors affecting the economy this year.
High energy prices will continue to weigh on growth. The economy depends heavily on Russian energy imports. 100% of its total gas imports and 50% of oil imports come from Russia. Due to this and because the country is landlocked, the Czech Republic, along with Hungary and Slovakia, was excluded from the EU ban on Russian oil imports. According to official estimates, recent steps to diversify the country’s gas supply using a Dutch LNG terminal will help it substitute around one-third of Russian gas imports.
The Czech Republic will continue to benefit from EU funds in the coming years. The total amount of available financing is around EUR 30 bln. In 2013–2020, the country received more than EUR 25 bln of EU funds. According to official estimates, the cumulative impact of EU funds until 2024, since the accession to the EU in 2004, is estimated at 45% of real GDP in 2020.
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 a larger focus on electric vehicles, self-driving cars, and car sharing. Relatively high R&D expenditures (around 2.0% of GDP in 2020) and a high share of investments (26% of GDP) in 2021 could mitigate these risks.
Inflation started to decline from its peak of 18.0% y-o-y in September 2022 to 15.8% y-o-y in December 2022. On average, prices rose by 15.1% last year, which is consistent with ACRA’s estimate (closer to 15%). Average inflation is estimated at 9.0% this year and 3.0% in 2024.
Public finances
The central government budget demonstrated a strong performance in 2022. Revenues increased by 9.2% compared to 2021, while expenditures were up by 4.1%. Financing needs were covered by domestic bond issuance.
The need to support the economy postpones budget consolidation. In 2023 and 2024, according to official estimates, budget deficits are planned to be more than 4% GDP and debt is planned to be 46.7% of GDP in 2025. This year, ACRA estimates the budget deficit at 4.5% of GDP and 3.5% of GDP in 2024. The debt level is expected to rise to 44.3% of GDP in 2024 (30% of GDP before COVID in 2019).
General government expenditure will increase this year by 9.0% (CZK 276 bln) mainly due to social benefits increasing by CZK 100 bln (additional pension indexation, family support, unemployment benefits) and compensation of employees growing by CZK 45 bln (due to exceptional remuneration and moderate salary indexation). Higher interest rates will increase interest costs to CZK 73 bln this year (CZK 46 bln in 2021), eating into debt affordability, and interest payments to revenue will increase from 1.8% in 2021 to 2.5% in 2023. The government plans to cover increased needs mainly by temporarily imposing higher taxes on the extraordinary profits of utilities companies and banks. Thus, the debt increase will be moderate. Officials believe that this increase in spending will be temporary and should gradually decrease. Previous steps to consolidate the budget support this position, limiting fiscal risks.
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 government declared its intention to prepare a comprehensive pension reform, which should be announced this year. The reform should help to decrease future deficits of the pension system and lower the fiscal burden.
External position
In 2022, the Czech Republic’s external position experienced the most significant pressure compared to other sectors of economy. From January to November 2022, due to the deterioration of terms of trade, imports of goods increased by 5.0% measured in USD (by 24.5% measured in EUR) compared to the same period in 2021, while exports of goods increased by 10% (18.6%). Energy prices were the main driver of import dynamics. The primary account deficit also continued to widen. As a result, in 2022, the current account deficit is estimated at -5.5% of GDP, compared to -0.8% of GDP in 2021. To cover extensive foreign currency needs, the CNB used its reserves, which decreased by 18.5% measured in USD (by 13.5% measured in EUR). During the first three quarters of 2022, the CNB also increased its external debt by 6.8 bln EUR; this could be associated with liquidity management (repo transitions). This year ACRA expects the current account deficit to be 5.0% of GDP.
Institutions
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. ACRA believes that the presidential election in January 2023 will not have a significant impact on economic policies.
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. One of the modifiers in the modifiers part of the model allows the Indicative credit rating to be increased. This includes the following, which is determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:
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Fiscal policy and fiscal flexibility.
In view of the abovementioned modifier, 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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Prolonged negative impact of high energy prices;
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Further decrease of external buffers;
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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 were, 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.
