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IP/99/824

Brussels, 9 November 1999

European Commission Government of the Czech Republic - Joint Assessment of Economic Policy Priorities of the Czech Republic

Mr Pavel Mertlík, Vice Prime Minister and Minister of Finance of the Czech Republic, and Mr Pedro Solbes Mira, Commissioner for Economic and Financial Affairs at the European Commission, signed today a "Joint Assessment of economic policy priorities of the Czech Republic" for the period up to 2005 as part of the Accession Partnership process.

In accordance with the recommendations of the Accession Partnership, the Czech Government has prepared, together with the Directorate General for Economic and Financial Affairs of the European Commission, a Joint Assessment of the Czech Republic's medium-term economic policy priorities. This document presents an agreed set of medium-term economic policies necessary to advance the Czech Republic's economic transformation and to prepare it for accession to the European Union. It also presents a quantified macroeconomic scenario consistent with the full and timely implementation of the policy measures outlined. Progress in the implementation of these policies will be assessed regularly within the framework of the Europe Agreement. The Joint Assessment will become the basis for an ongoing evaluation of the Czech Republic's economic progress and its medium-term economic policy priorities.

Mr Solbes recognised that "the Joint Assessment sets out an ambitious reform agenda". He also stressed that "implementing the economic policies identified in this document is essential in order to increase the competitiveness of the Czech economy and to achieve strong and sustainable economic growth." Mr. Mertlík said "the Czech government is firmly committed to the social and economic policies outlined in this document, and to maintaining the momentum for structural reforms that are necessary to improve the Czech Republic's prospects for early EU membership". They both agreed regularly to assess progress towards meeting the objectives of the Joint Assessment within the framework of the European Agreement.

The framework

The Joint Assessment, the establishment of which was a short-term priority under the Accession Partnership, complements other documents. Two key documents are the Czech Republic's National Programme for the Adoption of the Acquis (which focuses more on the legal and institutional approximation of the acquis communautaire), and the Czech government's "Economic Strategy for EU accession Competitiveness, Growth, Employment, Solidarity" (May 1999) Since the details of structural policies are discussed in these other documents, this Joint Assessment only examines structural policies to the extent that they have a critical and direct impact on macroeconomic variables.

Moreover, since May rapid progress has been made in some policy areas the Joint Assessment also includes these developments. In particular, the long-term monetary strategy of the central bank, and medium-term fiscal projections produced by the government, have been important contributing documents to this Joint Assessment.

This Joint Assessment of Medium-term Economic Policy Priorities reflects the agreed view of the Czech government and the services of the European Commission on medium-term social and economic policies in the Czech Republic. These policies should help to consolidate economic transformation whilst establishing the conditions for strong and sustainable growth of economic activity and improvements in the living standards of the population. EU accession is the overriding aim of the Czech Republic, but it cannot be an objective of economic policy in its own right. The drive towards EU accession also helps to maintain the momentum for structural reforms which are in any case necessary to enable the Czech Republic to catch up with more developed industrialized economies in the longer term.

Objectives

The main objective of the economic policy of the Czech government is to meet the Copenhagen criteria, and to close the gap in GDP per capita between the Czech Republic and the European Union. To this end, the medium-term target for economic growth has been set at 2 to 3 percentage points above GDP growth in the EU. In a break with the past, economic policy is to be pursued with greater attention to sustained increases in the competitiveness of the Czech economy, rather than focussing too much on macroeconomic policy. In this context, it will also be important to contain wage pressures.

The aim of the Joint Assessment is to help in the prioritization of policies and in their sequencing. Economic priorities and the timetable for the completion of social and structural reform have to be set realistically and carefully. If the Government tries to do too much over too short a period, it will quickly run into significant budgetary constraints; the accumulation of high general government deficits will prove unsustainable in the long run and make it difficult for the monetary authorities to be more accommodating. On the other hand, if the Government fails to tackle the high levels of mandatory expenditures on the public budgets, and fails to make the public finances more transparent, it is likely to encounter the same problem even without having set the necessary reforms in motion.

The only way out of this dilemma is the route chosen by the current government, which is the same as that followed by EU governments in the run up to EMU. Firstly, public finances need to be made completely transparent and hidden debts must be revealed. Secondly, the remaining administered prices should be liberalized in accordance with a clear timetable. This will allow monetary policy to be based on the convergence at a reasonable pace of inflation rates to euro-zone levels, and will help to build a lasting social consensus behind the need to keep real wage increases below the trend of labour productivity improvements. For this, it is essential that wage bargaining is based on forward-looking inflationary expectations and that the monetary authorities provide an explanation to the public when they are not able to keep inflation within the specified target range. In turn, the need to maintain a sufficient degree of exchange rate stability will act as an indispensable disciplinary force on the fiscal authorities.

Performance of the Czech economy so far

The Czech Republic began its transformation process from a relatively favourable starting position and it attracted considerable inflows of foreign investment. GDP started to recover from the first transitional recession in 1993, and in 1995 reached growth rates of more than 6% before a second recession set in. This later recession was the product of a number of weaknesses in the enterprise and financial sectors. During the last two years measures have been taken to overcome the most fundamental problems, but their favourable effects are only likely to materialize over the medium term. The unemployment rate has risen quickly from a low 4% in 1996 to nearly 9% in 1999, and continues to grow. A return to growth, driven by strengthening domestic and foreign demand, and a continuing influx of foreign direct investment, is expected in 2000.

The macroeconomic scenarios

This Joint Assessment, which describes Government policy to meet its economic policy objectives, outlines two quantitative macroeconomic scenarios. The scenarios extend to the year 2005 and serve as an illustration of the likely macroeconomic outlook under different policy choices.

A "pro-growth" scenario

The more optimistic main scenario, the "pro-growth" scenario, assumes that the government adopts proactive macro and micro economic policies designed to eliminate the remaining structural weaknesses in the economy and promote competitiveness. This pro-growth scenario projects low but positive annual GDP growth of an average 2.1% between 2000 and 2002, accompanied by a rise in unemployment due to accelerated economic restructuring. This would be followed by much higher growth of 5% per year from 2003 onwards. Consumer price inflation edges up in the first three years, partly as a result of the final steps of price deregulation, which will be completed by 2002. Nevertheless, the underlying trend in net inflation is downwards, and the scenario is compatible with the Czech National Bank's proposed long-term target of 2%(±1%) for the end of 2005. The general government deficit is reduced from over 3% of GDP in 2000, or more than 5% before net lending, to sustainable levels after the year 2002. The current account of the balance of payments is projected to return to close to balance by 2002.

A "do-nothing" scenario

As a reminder of what would happen if the authorities do not take appropriate, timely and decisive action, the results of the pro-growth scenario are contrasted with those of a "do-nothing" scenario. This second scenario does not incorporate any of the measures to improve competitiveness, corporate governance and the structure of the economy. Under this scenario, growth would be lower in the short-term as well as over the longer term horizon. In 2003-2005 annual GDP growth would be as low as 2% on average. The general government deficit would be nearly 6% of GDP and the current account would remain in deficit. This scenario illustrates the risk of not following the medium-term economic policy measures outlined in this document.

Moreover, if a sustained recovery in economic growth (which can only be the result of continued deep structural reforms) does not materialise, the social consensus for reform and for wage moderation could collapse. In this case there could be a serious risk of delay to the implementation of financial and enterprise sector reform and price deregulation. A postponement of the remaining price deregulation might mean the Czech Republic faces a jump in prices upon EU entry.

The full Joint Assessment report can be obtained from the Office of Gerassimos Thomas, Press and Communication Service, BREY 6/92.


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