Coronavirus hits the Czech Republic’s economy hard…

The advantages of the Czech Republic are numerous: geographic crossroads between emerging and developed Europe, relatively inexpensive and skilled labour force, growing internal demand, destination of a lot of foreign investments and manufacturing sector largely integrated with Germany (the largest economy in the Eurozone). All this has led the Czech Republic to become an integral part of the European and even global production chain and to experience significant economic and social development over the past decade. Unfortunately, these strengths are also weaknesses when crises like the one we are currently experiencing arise.

Indeed, while the European manufacturing sector had already been waning since mid-2018 and while trade tensions and Brexit added to uncertainties, the coronavirus suddenly delivered the fatal blow that no one was expecting anytime soon. The various measures taken in the affected countries (confinement, closing of stores and borders, etc.) marked a halt to the retail and tourism sectors at first but then led to a partial halt of manufacturing activities in Europe and the rest of the world. The local Czech manufacturing sector, strongly integrated into the international supply chain and dependent on exports, is severely impacted.

… impacting the automotive and manufacturing sectors

The Czech Republic’s first export sector is the automotive sector (20% of exports of goods in value in 2019), which is also among the most affected ones. Already in 2019, the slowdown in vehicle sales in Europe and China combined with Sino-American trade tensions and Brexit uncertainty had an impact on the growth of the automotive sector in the Czech Republic and, more broadly, in Europe. To illustrate this, the Czech Republic’s domestic sales of passenger cars in 2019 declined by 4.4% vis-à-vis 2018 while sales at the EU-level increased by only 1.2%. The coronavirus outbreak came to drive the point home, leading to a further drop in sales on the back of the temporary closure of automobile production plants in the Czech Republic because of the lockdown but also because of shortages of supply. It is thus impacting domestic sales, which in the first quarter of 2020 declined by 16% vis-à-vis the same period in 2019 and by 36% in March 2020 compared to March 2019. To get a regional picture, European Union sales declined by 51% in March 2020 vis-à-vis March 2019 (and by 26% in the first quarter of 2020 in comparison with the first quarter of 2019). An EAMA estimate indicates that the lockdown in the Czech Republic resulted in the dead loss of around 140,000 non-produced motor vehicles, affecting 45,000 employees. Given the uncertainty regarding the evolution of the pandemic, it is hard to guess when the difficulties in the sector will stop. Figures from Bloomberg suggest that the automotive production in the Czech Republic may decline further in 2021 before gradually recovering. According to these figures, the pre-coronavirus production level should be reached after 2024 (compared with 2022 in Germany). Indeed, only a gradual recovery is expected. It will be linked to the loosening of lockdown measures and the evolution of the European motor vehicle production chain. Another sector badly hit by a sharp drop in external demand is the machinery and equipment sector. Again, the short-term forecast is not positive. If we look at the manufacturing PMI of IHS Markit, it stands at 41.3 for March 2020, much below 50 (contraction zone) and at its lowest since May 2009. Back then, it had taken 5 months for the PMI to return to positive territory (above 50).

The Czech authorities adopted prevention and containment measures at an early stage, impacting other sectors of the Czech economy: the tourism and retail sectors (other than supermarkets and pharmacies), the transport sector and the leisure sector. The confinement measures include the closure of schools, creches and universities, the closure of borders to foreigners as well as a ban on going out except for basic needs (ban on restaurants and marketplaces). And, on 16 March, the authorities imposed a nationwide curfew until the end of the emergency state. These measures will weigh on the domestic economy. All in all, the contraction of real GDP in 2020 should be much worse than in 2009: -6.5% in 2020 according the IMF’s projection versus -4.8% in 2009. There is still considerable uncertainty surrounding the recovery, as it partly depends on the evolution of the covid-19 and the related containment measures. What is certain is that the current economic crisis is the worst since the Great Depression of 1930.

This economic downturn is already having consequences for the Czech economy, even if measures have been taken by the Czech authorities to support the country’s economy. The Czech National Bank cut its main rate to 1% (from 1.75%), which had the effect of putting the Czech koruna under pressure (see graph 2). This depreciation of the koruna should help Czech manufacturers to remain competitive on the export market but will also lead to increasing the cost of imported products. The various support measures adopted by the government should help to absorb part of the internal shock (by supporting demand for example) but are not sufficient to cope with the fall in external demand (dependent on a recovery at European level). As a result, the unemployment rate is increasing, which will put additional pressure on the public finances. The latter are already affected by a decrease in tax revenue and increased costs (cf. supportive measures). On the positive side, the public debt is low (30.8% of GDP in 2019), one of the lowest in the European Union, which leaves fiscal room to the government, even in case of a significant deficit in 2020.

Conclusion

The coronavirus outbreak is hurting the Czech Republic badly. The real GDP growth is expected to drop by 6.5% in 2020 as the economy is hit by lockdown measures as well as by a sharp deterioration in the economic activity of its trade partners. This large and unexpected shock is leading to a deterioration of macroeconomic indicators (unemployment, exchange rate, current account balance and public finances). The most impacted sectors are the automotive sector, tourism, retail (other than supermarkets and pharmacies), restaurants, hotels, transports and the manufacturing industry. There is still great uncertainty regarding the evolution of the covid-19. That being said, the Czech authorities – which have sufficient fiscal room – have already announced large support measures which should boost the domestic economy. As the Czech economy is very open and well integrated in European supply chains, a large part of its recovery will depend on the recovery of its main trade partners, located mainly in the European Union.

Analyst: Matthieu Depreter – m.depreter@credendo.com