Home Ratings and Research Currently valid ACRA Europe affirms unsolicited credit ratings of AA to the Czech Republic, outlook Stable
ACRA Europe affirms unsolicited credit ratings of AA to the Czech Republic, outlook Stable
Friday, 24 July 2020
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The Czech Republic (hereinafter, the Czech Republic, or the country) has been assigned the following ratings:

  • Long-term foreign currency credit rating at AA and local currency credit rating at AA;
  • Short-term foreign currency credit rating at S1+ and local currency credit rating at S1+.

The outlook on the long-term foreign currency credit rating is Stable and local currency credit rating is Stable.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

The COVID-19 crisis will cause a deep recession and place a heavy burden on the country’s public finances. In ACRA Europe’s view, the Czech economy has entered the current recession in good shape given its very low unemployment rates, low government debt load, strong reserve position, and sound banking system. In light of these factors, the government should be able to meet its elevated financing needs with favourable financing conditions and, thus, be able to mitigate the impact of the crisis.

Credit rating rationale

Positive rating assessment factors

· Strong pre-COVID-19 fiscal position.

· Solid and job-rich pre-COVID-19 economic growth.

· Strong credibility of monetary policy.

· Strong reserve coverage ratios.

· Solid institutional factors.

Negative rating assessment factors

· COVID-19 shock negatively impacts a wide range of macroeconomic indicators.

· Relatively high total external debt, predominantly of a short-term nature.

· Relatively high dependence on the automotive industry and exports to Germany.

Potential rating upgrade factors

· Further improvement in the institutional framework.

· Strengthening economic diversification.

· Reduction of external debt.

· Substantial decline in government debt load after the fading of the COVID-19 crisis.

Potential rating downgrade factors

· Long-lasting impact of the COVID-19 crisis on the country’s growth potential and public finances.

· Severe financial shock resulting in a costly bailout of the banking system.

· Material deterioration in institutional quality.


Sovereign model results (based on 2019 data)

Block

Indicative credit rating for the block

Modifier

Score

Modifier corrections to the indicative credit rating

Final credit rating for the block

Macroeconomic position

AA+

Potential economic growth

0

0

AA+

Sustainability of economic growth

-1

Efficiency of structural, economic and monetary policies

+1

Public finance

AAA**

Contingent liabilities and risk of them materializing on the sovereign balance sheet

0

+1

AAA

Fiscal policy framework and fiscal flexibility

+1

Market access and sources of funding

0

Debt sustainability

0

External position

AA

Balance of payments vulnerabilities

0

0

AA

External debt sustainability

0

Stability of currency regime

n/a

Institutional framework

AA

Willingness to pay

0

0

AA

Default history

0

Political instability and recent political decisions

0

Involvement in geopolitical conflicts, exposure to geopolitical risks

0


Assigned credit rating

Indicative credit rating

AA*

Modifier corrections to the indicative credit rating

0

Final credit rating

AA

Assigned credit rating

AA

* The AA Indicative credit rating was used to obtain the Final credit rating, even though the core part of the rating model based on 2019 data put the Czech Republic at AA+. According to the methodology, this conservative correction was made because the indicative score only crossed the AA+ lower boundary by a small amount and due to the expected negative impact of the COVID-19 crisis on a variety of indicators used in the model.

** ACRA Europe expects the indicative rating for the public finance block to decline to AA or AA- in 2020. This should, however, not impact the Final credit rating under the current expectations.

MACROECONOMIC SITUATION AND ECONOMIC POTENTIAL

ACRA Europe assesses the Czech Republic’s macroeconomic position as strong. This assessment is based on a solid economic performance in recent years and low and stable inflation along with credible and efficient central bank policies. The assessment is constrained by the relatively weak diversification of the economy. This assessment may be downgraded in the future based on the depth and duration of the ongoing economic slump related to the COVID-19 shock.

Trade openness and a high share of manufacturing makes the economy more susceptible to global fluctuations.

The Czech Republic is an advanced economy with a GDP per capita (by purchasing power parity) of over 38,800 international dollars (IMF, 2019), the highest among the EU-CEE countries. It is a member of the European Union, OECD, Schengen Area, and NATO. As a relatively small and very open economy (the share of exports in the GDP reached around three-quarters of GDP in 2019) with a high share of manufacturing in total output (gross value added in manufacturing accounts for 22.4% of GDP, the second highest in the EU), it is more susceptible to the global economic cycle, especially to developments in the German economy. The diversification of exports is rather weak. In 2019, 31% of merchandise exports went to Germany, while 28% of exports were attributed to motor vehicles.

The Czech economy has enjoyed favorable economic conditions in recent years. Real GDP growth averaged 3.7% from 2015 to 2019, supported mainly by household consumption and investment. Robust and job-rich economic growth has led to a strong decline in the unemployment rate from 7% in 2013 to 2% in 2019, the lowest among both EU and OECD countries.

ACRA Europe expects the Czech economy to contract at around 8% this year followed by a 5% recovery in 2021.

The economic prospects are grim for 2020 due to the COVID-19 pandemic. The Czech economy will suffer amid the coronavirus-induced shutdown of a significant portion of the economy and a poor external environment. After growing 2.3% in 2019, the economy is expected to contract significantly in 2020. ACRA Europe expects a contraction of around 8% this year followed by a 5% recovery in 2021. Nevertheless, the final GDP figure is subject to significant uncertainty related to both the domestic and external development of the pandemic.

Given the high share of manufacturing and exports in GDP, the recovery will to a significant extent depend on the recovery in foreign demand. High-frequency indicators have shown a deeper than EU-average slump in industrial production (-25.7% in May compared to -20.5% for the EU-27) and a an above average decline in nominal exports (-29.7% in May compared to the unweighted EU-27 average of -26.1%). Car exports have declined 50% year-on-year in the three months ending May.

From the long-term perspective, the growth prospects for the Czech economy are among the best in the EU-CEE region. This is due to both the solid innovative capacity of the economy underpinned by the second highest R&D expenditures among regional peers (1.9% in 2018), solid investment rates (25.8% in 2017–2019), and a much lower projected decline in the working-age population in the region (-5.5% by 2040 compared to approximately -15% for the EU-CEE).

PUBLIC FINANCE

ACRA Europe assesses the Czech Republic’s fiscal strength as strong (based on our 2020 forecast for the public finance indicators). This assessment is based on low general government debt, low debt servicing costs and the low FX exposure of the debt. Although public finance metrics are expected to deteriorate due to the COVID-19 crisis, they are very likely to remain low compared to the majority of advanced economies.

The anti-crisis fiscal package (including guarantees and liquidity support) accounts for 19.2% of 2019 GDP.

To counter the negative impact of the COVID-19 pandemic, the government has adopted several fiscal, liquidity and guarantee measures (amounts correspond to the quantification of the measures as of July 20, 2020):

  • Revenue-side measures (CZK 109.8 bln, or 1.9% of 2019 GDP) — among others, direct payments to self-employed, micro-sized businesses and contractors disbursed by the tax authorities, or VAT reduction for accommodation, cultural and sporting events, loss carryback measure, exemption of self-employed from social and health insurance minimum payments and SSC paid by some employers;
  • Expenditure-side measures (CZK 113.5 bln, or 2.0% of 2019 GDP) — among others, healthcare related expenditures, wage contributions for employers, increased social transfers, or an increase in public investments, support for agriculture, sport, culture, accommodation services;
  • Liquidity measures in the form of postponed tax payments (CZK 28.4 bln, or 0.5% of 2019 GDP);
  • Guarantees (maximum amount of new guarantee programs: CZK 851.5 bln, or 14.8% of 2019 GDP and current guarantee programs)

The central government has revised its cash deficit target from 0.7% to 8.8% of 2019 GDP.

The direct fiscal impact of these measures accounts for 3.9% of 2019 GDP, but is likely to increase over time as indicated by the latest budget revision. The central government has already revised its budget three times, from the initial cash deficit of CZK 40 bln (0.7% of 2019 GDP) to 200, 300 and most recently to 500 bln (8.7 % of 2019 GDP), with almost CZK 125 bln attributable to the shortfall in revenues due to the economic slump.

In ACRA Europe’s view, there are both positive and negative risks to the central government’s new planned budget deficit. The upside risks are related to the lower-than-budgeted utilization of the crisis support. As of the end of June, the central government deficit stood at CZK 195 bln (or 39% of the revised target), while the cost-intensive lockdown measures have been almost completely phased-out. As of the end of June, direct fiscal support related to the pandemic stood at CZK 102.6 bln, or 46 % of the budgeted support (excluding liquidity measures and credit/guarantee schemes).  Moreover, CZK 33.8 bln (0.6% of 2019 GDP) is budgeted for yet-unspecified fiscal measures. In case of positive economic developments, part of this reserve may remain untapped. The downside risks are related to a worsening of the epidemiologic situation and weak recovery of external demand, both of which would increase the need for fiscal support.

Taking into account the latest budget revision, ACRA Europe expects the general government debt to GDP ratio to increase from 30.8% in 2019 to around 41% and the general government interest expenditure to increase from 0.7% to around 1%, both still very low by EU standards. As a result, the 2020 gross financing needs have increased to around 13% of 2019 GDP.

The share of FX debt in total debt is low.

ACRA Europe sees a very low risk of the country having trouble funding its elevated financial needs. Domestic market conditions remain favorable, also in light of the Czech National Bank’s (ČNB) lowering of its two-week repo rate from 2.25% to 0.25%. The 10-year government bond yielded around 0.8% on the secondary market at the time of publishing this report. As of the end of June, the government had been able to issue debt worth more than CZK 500 bln, covering 73% of its expected gross financing needs. The FX share of the general government debt is low compared to other non-eurozone EU CEE countries. It stood at 11.4% in 2019 and is very well covered by FX reserves (over 17 times). Thus, the FX risk is contained in ACRA Europe’s view.

The utilization of the guarantee facilities is low so far.

The government’s contingent liabilities will increase as a result of the COVID-19 crisis, but they remain low by EU standards. The fiscal package includes guarantees worth around CZK 850 bln (14.8% of 2019 GDP). However, the utilization of the guarantee schemes is low so far. As of the end of June, the amount of COVID-19 related credits and guarantees stood at CZK 25.1 bln (3% of the maximum amount). Aside from the state guarantee bank and the state development bank (which are the main vehicles for the government’s guarantee scheme), the state is not involved in the banking sector and therefore its direct exposure to the banking sector’s potential losses is limited.

Banking sector indicators were sound prior to the COVID-19 shock.

The resilience of the banking system is higher than the EU average in ACRA Europe’s view. Prior to the COVID-19 crisis, the banking sector was relatively well capitalized (CET1 ratio stood at 18.2% in 2019), had ample liquidity (liquid assets to short-term liabilities stood at 56.1%), low NPLs (1.5%), strong profitability (return on equity was 13.9%), and credit to the private non-financial sector in terms of GDP was stable. However, given the extraordinary extent of the COVID-19 shock, the need to provide public sector support to the banking sector cannot be ruled out. As of July 10, credits amount of CZK 287.9 bln has been deferred based on the government-induced moratorium and a further CZK 140.4 bln outside the moratorium (7.4% of GDP in total).|

EXTERNAL RISKS

ACRA Europe assesses the Czech Republic’s fiscal strength as strong. This assessment is based primarily on the country’s strong international reserve position and low currency volatility. It is constrained by a relatively high external debt with a high share of private sector and short-term components.

The impact of the COVID-19 crisis on the current account is uncertain at this stage. The primary income deficit (5.6% of GDP in 2019) is expected to improve due to a decline in profitability of foreign investments. Conversely, the surplus in the balance of services (1.8% of GDP) is likely to shrink on the back of lower international travel volume. The final outcome of the balance of goods (+4.1%) will depend predominately on the development in external demand. Foreign trade data for March to May indicates that the balance of goods is likely to deteriorate in 2020. Despite this uncertainty, ACRA Europe does not expect a significant deviation of the current account balance from the recent healthy levels (-0.3% of GDP in 2019).

External debt is predominately short-term and private.

External debt (77% of GDP in 2019) is relatively high by non-eurozone EU CEE standards. Moreover, it is predominately short-term (58%) and attributable to the private sector, excluding direct investment (58%), which points to a higher refinancing risk. Such structure is to a significant extent attributable to speculative portfolio investment inflows prior to the ČNB’s exit from the exchange rate commitment to keep the EUR/CZK rate above 27 in 2017.

The ČNB has large international reserves at its disposal.

However, the refinancing risk stemming from the maturity and sectoral structure of the total external debt is mitigated by ample banking sector liquidity, a relatively low FX share in external debt (49%), and large ČNB international reserves, which can cover around 80% of the gross external debt, around 140% of the short-term external debt and around 160% of the FX external debt. Given the sizable international reserves of the ČNB, an unwanted strong depreciation of the currency in case of market stress is highly unlikely. In 2020, the koruna has lost around 4% of its value against the euro, which is in line with the Czech Republic’s regional peers.

INSTITUTIONAL FACTORS

The governance framework is solid by global standards.

ACRA Europe assesses the Czech Republic’s institutional strength as strong. The Czech Republic’s institutional framework is well above the global average, but slightly below EU standards. The country scores especially strongly in the Political Stability and Absence of Violence indicator. This assessment is largely attributable to the ability of governments to carry out their mandates as early elections are rare events. By contrast, the Control of Corruption indicator is the main constricting factor according to the World Bank’s Worldwide Governance Indicators. Looking at the trend, the quality of the institutional framework has stagnated over the past decade, indicating a lack of political will for further improvement.

For a more detailed assessment of the creditworthiness of the Czech Republic, see our January report.

Appendix 1. Comparative analysis of the Czech Republic and the sample group

Comparison of macroeconomic and institutional indicators

 

Czech Rep.

Poland

Hungary

Slovakia

Slovenia

Period

Macroeconomics

GDP per capita (1,000 USD, PPP)

38.8

33.9

34.4

36.4

38.3

2019

Real GDP growth (% y-o-y)

2.3

4.1

4.9

2.4

2.4

2019

HICP inflation (% y-o-y average)

2.6

2.1

3.4

2.8

1.7

2019

Openness of economy (% of GDP)

143

106

163

185

160

2019

Unemployment

2.0

3.0

3.4

5.6

4.1

Q1 2020

Public finance

Consolidated government debt (% of GDP)

30.8

46.0

66.3

48.0

66.1

2019

External consolidated government debt (% of GDP)*

12.4

20.5

22.1

27.6

40.4

2019

Consolidated government budget balance (% of GDP)

0.3

-0.7

-2.0

-1.3

0.5

2019

Interest payments (% of GDP)

0.7

1.4

2.3

1.2

1.7

2019

External position

Current account (% of GDP)

-0.3

0.4

-0.9

-2.9

6.6

2019

Net international investment position (% of GDP)

-20.6

-46.4

-45.1

-67.0

-16.8

2019

External debt position (% of GDP)

77.0

59.4

91.0

112.0

91.8

2019

Short-term external debt to total external debt (%) **

47.3

16.0

10.0

39.1

24.7

2019

Export diversification index ***

0.43

0.40

0.41

0.48

0.46

2018

Institutional framework ****

Political stability and absence of violence

1.04

0.55

0.76

0.75

0.91

2018

Government effectiveness

0.92

0.66

0.49

0.71

1.13

2018

Rule of law

1.05

0.43

0.56

0.53

1.06

2018

* At original maturity, excluding direct investments.

** Indicates the extent of differences between the country’s trade structure and the average world indicator and ranges approximately from 0 (weak differences) to 1 (strong differences).

*** Assessment of effectiveness ranges from approximately -2.5 (weak) to 2.5 (strong).

Sources:  Eurostat, ECB, IMF, UNCTAD, World Bank

Appendix 2. List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

European Commission

Organisation for Economic Co-operation and Development

European Central Bank

Czech National Bank

Czech Statistical Office


Appendix 3. Key indicators

Balance of payments, EUR bln

2015

2016

2017

2018

2019

Balance of goods

6.9

9.6

9.8

7.9

9.2

Exports

115.6

118.3

129.2

136.4

139.3

Imports

108.7

108.8

119.4

128.5

130.1

Balance of services

3.2

3.9

4.7

4.7

4.1

Exports

21.0

22.0

24.2

25.9

27.1

Imports

17.8

18.1

19.5

21.3

23.1

Balance of income

-9.3

-10.4

-11.6

-11.6

-13.9

Income receivable

10.0

10.2

12.6

13.2

14.6

Income payable

19.3

20.5

24.3

24.8

28.6

Current account

0.7

3.1

2.9

1.0

-0.7

Current account, % of GDP 

0.5

1.8

1.6

0.5

-0.3

International reserves at the end of the period

59.2

81.3

123.4

124.5

133.4

Sources: Eurostat, ECB

External position (assets and liabilities), EUR bln

2015

2016

2017

2018

2019

External debt

115.4

129.5

171.1

171.5

172.5

long-term

63.0

66.0

73.4

70.3

71.9

short-term (up to 1 year)

52.5

63.4

97.7

101.2

100.6

           

Sovereign issuer, including

28.7

33.0

38.1

34.1

33.8

monetary authorities

2.7

3.8

6.7

6.9

6.7

consolidated government

26.1

29.2

31.4

27.3

27.1

Banks

31.4

40.6

69.7

69.0

66.4

Other sectors

55.3

55.9

63.3

68.4

72.3

including intra-corporate loans

28.3

31.8

34.5

37.0

38.0

External assets, excluding shares

132.2

153.9

194.5

197.8

203.9

Sovereign issuer, including

55.5

75.5

114.0

115.6

120.6

monetary authorities

54.3

74.2

112.8

114.8

119.8

consolidated government

1.2

1.3

1.2

0.8

0.8

Banks

26.2

25.5

26.1

25.8

25.2

Other sectors

50.5

52.9

54.4

56.4

58.1

Net debt

-16.8

-24.4

-23.4

-26.3

-31.4

Sovereign issuer

-26.8

-42.5

-75.9

-81.5

-86.8

Banks

5.1

15.1

43.5

43.2

41.2

Other sectors

4.8

2.9

8.9

12.0

14.3

International investment position (net),% of GDP

-33.1

-27.4

-25.2

-24.8

-20.6

External debt, % of GDP

68.1

73.0

88.2

81.3

77.0

Sources: ECB, Eurostat, ČNB

Budget indicators, % of GDP

Consolidated government

2015

2016

2017

2018

2019

Income

41.1

40.7

41.0

42.2

42.1

Expenses

41.7

40.0

39.5

41.2

41.9

including debt servicing expenses

1.1

0.9

0.7

0.8

0.7

Primary budget balance

0.4

1.6

2.2

1.7

1.0

Overall budget balance

-0.6

0.7

1.5

0.9

0.3

Consolidated government debt

40.0

36.8

34.7

32.6

30.8

% of income

98

90

87

77

74

Central government

         

Income

29.1

29.1

29.3

29.7

29.7

Expenses

30.3

29.5

28.7

29.6

30.3

including debt servicing expenses

1.0

0.9

0.7

0.7

0.7

Primary budget balance

-0.2

0.5

1.2

0.9

0.1

Overall budget balance

-1.2

-0.4

0.5

0.2

-0.6

Central government debt

37.9

36.0

34.4

32.9

31.7

% of income

131

124

121

110

108

Note: nominal GDP, EUR bln

169.6

177.4

194.1

210.9

223.9

Source: Eurostat

Rating history

The rating was first released for distribution on February 1, 2019, with the last review on January 24, 2020.

Regulatory disclosure

The sovereign credit ratings have been assigned to the Czech Republic under the Methodology to assess Sovereign entities, applicable from October 4, 2019. An explanation of the importance of each rating category and a default definition is included on the ACRA Europe website. Information on the rate of historical failure is available at cerep.esma.europa.eu. The default rate means a percentage of ratings that were changed to default from the overall number of ratings, for each rating category and given period. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. Since July 30, 2012, ACRA Europe has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies.

The sovereign credit ratings and their outlook are expected to be revised within 6 months following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.

The credit rating was issued as unsolicited. The rated entity did not participate in the credit rating assignment. ACRA Europe did not have access to the rated entity’s internal documents or management. ACRA Europe, in the context of routine care, verified all sources entering the rating process and considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The rated entity was notified on July 22, 2020, and after the notification there were no changes or amendments in the rating.

ACRA Europe provided no additional services to the Czech government. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.

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