Rising risks push Czechia and Slovakia down the rankings

Already downgraded, the outlook is still foggy for the Czech Republic and Slovakia

The Czech Republic and Slovakia are among the 20 countries showing the biggest increases in risk this year, according to Euromoney’s ‘crowd sourcing’ country risk survey of more than 300 analysts worldwide, and the only two in Europe.

That’s not to say that either is a major concern. Both countries are still considered low-to-medium risks, with Slovakia ranking 30^th out of 174 countries and stabilizing in the second quarter of 2020 following the elections in February.

The Czech Republic is 34^th, which puts it in the third of Euromoney’s five risk categories, where the first tier contains the world’s least risky sovereign borrowers and tier five the biggest default risks. Slovakia is in tier two.

Yet the two neighbours were considered much safer bets at the beginning of the year, before plunging 11 places in the global risk rankings to below France, Estonia, Portugal and others.

Covid-19 has clearly had an impact.

Outlook

The economic outlook is far less promising in the wake of coronavirus lockdowns, ongoing social distancing and hygiene controls, and a global economy still finding its feet with Covid-19 re-emerging.

A second wave of the pandemic and foreign exchange market intervention by the Czech National Bank (central bank) are key risks according to one of the survey’s contributors, senior economist Michal Brozka, who says: “Financial markets are paving the way for further koruna strengthening as positive sentiment in global markets and rising interest rates are pushing the koruna to higher valuations which will continue in the coming months and especially next year.”

A strong currency and weakened global demand will impact on the key automotive manufacturing sector that both countries rely upon for export earnings and investments contributing to economic growth.

The dependence on the automotive sector is high – at around 13% of GDP in Slovakia and slightly below 10% in Czechia – and it has been significantly hit by the Covid-19 crisis, with double-digit declines in both sales and production of new cars across Europe.

The return to work with the lockdowns eased means the recovery is under way, but the outlook is still shrouded in considerable uncertainty until a vaccine is found

As in other countries, GDP has shown an alarming, but not entirely unexpected, real-terms decline in the second quarter of this year. In the Czech Republic it was down by 11% year-on-year and in Slovakia by 12.1% – the largest falls since Czechoslovakia split – caused by a slump in private consumption, investment and net exports, with the hit also showing in huge output declines for manufacturing and services.

The return to work with the lockdowns eased means the recovery is under way, but the outlook is still shrouded in considerable uncertainty until a vaccine is found, with corporate investments delayed and tourism undermined by border closures and the risk of a quick-fire imposition of quarantine regulations each time Covid-19 cases pass a certain threshold.

One contributor, economist Jakub Seidler, says: “Although the worst is behind us in terms of falling GDP, many economic indicators might start to deteriorate with a delay, and especially after the end of government support programmes – notably the unemployment rate.”

Another contributor is freelance political journalist David Hutt, who says that “although Czech Republic and Slovakia have emerged relatively well from the Covid-19 pandemic, infection case numbers are now rising again. The Czech government ordered that from this month onwards, face-masks must once again be worn in most indoors public spaces.”

Brozka reiterates the risk posed by a second wave of the pandemic. “Although we think that in this event the lockdown would not have as destructive an impact as in March-May, GDP growth both this and next year would be significantly lower,” he says.

He also observes that the implementation of announced fiscal measures “has been rather complicated, and their future remains unclear”. Noting the looming risks attached to Brexit, which is “an unresolved issue that could have a major negative influence on European trade” and global trade wars, he adds that “with Donald Trump as the [re-elected] president of the US, the risk of renewed foreign trade tension remains and could jeopardize the recovery at any time.”

Another contributor got in touch anonymously to say the outlook for the automotive manufacturing segment “remains foggy not only due to the Covid-19 crisis, but also because of technological and regulatory changes, which will make the years ahead challenging for local industries”.

Rise of populism

It was also suggested that the Czech Republic could see the rise of populism ahead of elections in 2020-2021, which will probably lead to a considerable loosening of fiscal policy, with “higher deficits than needed because of the coronavirus crisis”.

In Euromoney’s risk survey, the GNP-economic outlook, employment/unemployment and government finances indicators are among those areas downgraded the most by experts for both countries. This increased economic risk, plus a worsening outlook for capital access, is offsetting political and structural risks since the beginning of the year.

For the Czech Republic, however, its foreign policy has become a little more concerning too, as the row with China over Taiwan has increased.

“The visit to Taiwan by senate president Miloš Vystrčil from an opposition party has put the Czech government in a difficult position,” says Hutt.

“Beijing reacted furiously and promised to punish Vystrčil. If that threat extends to Czech businesses – and Beijing could make a symbolic gesture like banning Czech beer imports, as it did by banning Norwegian fish imports a few years ago – Prague could be pressured by the growing anti-China sentiment within the Czech Republic to retaliate against Beijing.

“This could prove problematic for Czech exporters, who in recent years have looked to China as a new market, and weaken Chinese investment in the country, which admittedly has been limited in recent years – another source of frustration for the Czechs.”

The country also stages regional elections in October, and national elections next year, and in view of its mixed reviews for managing the pandemic, the government led by prime minister Andrej Babiš appears to be leaning towards more populist gestures.

This is already incurring criticism from the CNB governor Jiří Rusnok, following the introduction of a personal tax cut worth CZK74 billion ($3.4 billion) despite the fiscal deficit widening to 6.5% of GDP this year, or even 8.3% according to the OECD’s double-hit scenario that factors in a second wave of the virus.

In view of its mixed reviews for managing the pandemic, the [Czech] government led by prime minister Andrej Babiš appears to be leaning towards more populist gestures

 Although denying it is a sweetener ahead of the elections, the additional stimulus, coupled with a pension bonus and other measures to curry favour among the electorate – plus any additional moves from the government in its final year in office – are a risk to the country’s reputation for fiscal probity.

Whereas the electoral uncertainty in Slovakia has passed since voting in February saw the anti-corruption party Ordinary People (OL’aNO) sweep to victory, the October elections in Czechia are still an important focus as they test the popularity of Babiš, a controversial leader, and his party, ANO 2011.

“It is well known that president Milos Zeman, who was re-elected in 2018, wants to gain more political control and authority for himself at the expense of the government, and to some extent Babiš’ popularity has prevented that,” says Hutt.

“A disastrous election in October for Babiš could alter how the government is able to prevent the president from amassing more control.”

In Slovakia, too, there is still some political risk to contend with. For one thing, OL’aNO was forced to cobble together a potentially unstable four-party centre-right coalition which notably includes both socially conservative Eurosceptics and economic liberals.

For another, the trial for the murder of the investigative journalist Ján Kuciak and his fiancée, Martina Kušnírová, which caused the previous government to collapse, issued a not guilty verdict this week on the business figure Marián Kočner, who was accused of masterminding the plot.

While this will invariably raise eyebrows, it also demonstrates how pervasive corruption and institutional failings have become, the risks of which have steadily grown and now pose a formidable challenge for the current government, after it took office pledging to address them.