A cyclical downturn but strong fundamentals
Overview:
The Czech Republic (CR) has long been characterised by strong economic performance and weak governments. It is one of the only countries in the region that has grown robustly in the last few years without relying on a surge in credit and increasing reliance on short-term debt. Given its highly open nature1 and reliance on the EU as a market for its exports the CR will endure a sharp cyclical slowdown but otherwise exhibits far less economic vulnerability than most of its peers as the price of credit rises and its availability falls. Productivity growth is strong and the current account deficit small and well financed. The ODS government has a weak parliamentary position but has managed to win passage of a key fiscal reform. It has, however, yet to confirm a target date for ERMII entry or Euro adoption.
Recommendation:
The central bank has moved quickly from a rate hike cycle to rapid easing as it has become clear that slowing growth rather than inflation is the key threat to the economy. The koruna (CZK) has weakened along with all (non-fixed) Eastern European currencies as global risk appetite has receded. As and when global economic conditions start to normalise we believe that countries with stronger fundamentals will prevail. We are therefore overweight the CZK.
1 Merchandise exports and imports account for 160% of GDP.