The Czech Republic’s Missing Mate Mooring

Czech Republic stocks, after a 20 percent MSCI index advance through September, rocketed on the sweeping election win of former Finance Minister Babis, a wealthy business executive, who formed the new Ano (Yes) party in a clear break from years of traditional political group coalition reshuffling. His platform was pro-business and Europe but otherwise vague, as the campaign was shadowed by allegations of inordinate tax break claims and other questionable transactions. He resigned from the last government to protest his innocence, and if other parties are invited to join the administration representatives will likely be drawn from a fresh pool to leave behind the outgoing prime minister and peers as adversaries. Babis took a similar anti-immigration populist stand as in neighbors Hungary and Poland but has otherwise talked of running the country in more company-like fashion to regain the bellwether competitive position of the early post-communist transition. Local brokers argue another wave of state enterprise privatization and big IPOs could be forthcoming, and that unlike the rest of Central Europe where private pensions are under threat or been dismantled, these schemes could be strengthened with overdue social security reform. These ambitions may be misplaced but exchange rate and monetary policies recently generated excitement, as the longtime koruna-euro ceiling was removed and a first interest rate hike accompanied an above target inflation rise to 2.5 percent. Hungary in contrast has continued to ease in unconventional fashion through loan facilities and long-term yield curve reduction, with inflation still under 2 percent. Despite leadership spats with Brussels, EU cohesion funds pour in and contribute to a 5 percent of GDP external surplus. Prime Minister Orban has ignored a European Court of Justice ruling that 2015 refugee quotas organized by Germany should be honored, and pointed to Chancellor Merkel’s setback in recent elections as vindication of his position. Inflation is also below-target in Poland with the central bank on hold, as court interference proposals which drew international condemnation were diluted and fiscal discipline honored despite increased social spending to keep Law and Justice party campaign promises. Consumption has maintained 4 percent GDP growth, aided by emigrant return from the UK post-Brexit which has kept downward wage pressure as compared with Romania, where large civil servant salary jumps have concerned the IMF under a monitoring program. The budget giveaway prompted the central bank to shrink the interest rate corridor in response as monetary policy tries to fight back.

Investors worry the Balkans pattern of public sector imbalance could be repeated as in Croatia struggling to preserve its credit rating with a 1 percent of GDP deficit, and in Serbia where a Fund arrangement in place will produce a small surplus with moves like airport divestiture and tax system revamp. Meanwhile in Greece fiscal consolidation has outperformed on 2 percent growth and bolstered the EU austerity camp view that a 3.5 percent primary surplus can be met over the medium term. The IMF continues to cooperate but presumes future additional debt relief as the latest deal ends in less than a year. The remaining banks with 40 percent bad loans have ignored the debate and begun to return to global bond markets for recapitalization capitalizing on an historic buying frenzy.