Czech Republic will be ready for Euro adoption

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The governor of the Czech Republic’s central bank Jiri Rusnok said that the country is ready to adopt the common European currency, but “it would be better to wait until local wages and prices approached those of core euro members.”

Rusnok added that one of the reasons the country is committed to joining the euro is that the Czech crown is now floating after the Czech central bank scrapped its cap on the crown in April, allowing it to float freely to stronger levels against the euro for the first time since 2013.

He said the Czech Republic would not be adopting the euro for five to ten years, adding that while wage rises in some of the leading European economies are almost zero, the average salary increase in the Czech Republic is currently around five percent so that the trend was positive. He also admitted that joining Eurozone is entirely political decision and currently the CNB does not consider it essential to set a date.

Czech President Milos Zeman has said the country has been ready to join the Eurozone for almost ten years but that the public was “irrationally afraid” to do so. “We have been fulfilling the Maastricht criteria, but there is a mental barrier to its adoption. A mere 30 per cent of Czechs are in favor of entering the Eurozone,” he said.

Statistics show that the nominal rate of wage rises in the Czech Republic was 5.3 per cent in the first quarter of the year. Average Czech wages are around EUR10 an hour, while across the EU the figure is around EUR25. Even if there were a real five-percentage-point rise in wage rises, it would still take 15 years at that rate for average Czech wages to catch up with those of neighboring Germany, an unnamed economist told Radio Praha.

“For us to remain at the core of the EU, sooner or later we will have to respond to the question of not whether, but when the Czech Republic is capable of adopting the single European currency, ʺ said Czech Prime Minister Bohuslav Sobotka. The Czech officials’ announcements follow recent media reports the European Commission wants all 27 members of the bloc to adopt the euro by 2025. Officials from the EU are reportedly seeking to draw up a euro budget able to incorporate a fixed tax payment from all the member states.

But Sobotka also stressed that “There is no need the Czech Republic to accelerate Eurozone entry process because the British voters have decided to leave the EU. (…) No one is pressuring about that even as some older EU members advocated for a need of deeper European and EMU integration after Brexit.”

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The Czech economy grew by 2.4 per cent in 2016 and unemployment is now the lowest in the EU, while headline inflation is at its target level and external deflationary pressures have faded, while nominal incomes are growing solidly: according to the IMF.

Given the momentum in the economy, real GDP growth is projected to increase to 3 per cent in 2017, largely driven by domestic demand. But labor shortages are expected to constrain growth to about 2.5 per cent over the medium term. With tight labor markets and strong aggregate demand, inflation is expected to reach 2.3 per cent this year, before coming back to the 2 per cent target, according to the IMF.

Monetary policy has been accommodative, but the process of normalizing monetary conditions has begun. The CZK/EUR exchange rate floor that had been in place for over three years was removed in April. Capital inflows accelerated in the run-up to the exit from the CZK floor. But financial market reaction to the removal of the floor has been muted, with the CZK appreciating by 2.5 per cent so far. The policy rate remains unchanged at 0.05 per cent.

The banking system remains liquid and profitable. Private credit has continued to expand. The Czech National Bank has responded to risks arising from the residential housing market with steadily tighter limits on loan-to-value ratios, but some borrowers are nonetheless becoming overstretched.

Fiscal over-performance last year, including from lower capital spending and strong tax revenues, led to a surplus of 0.6 per cent of GDP. General government debt has declined to just above 37 per cent of GDP, one of the lowest levels in the EU. Strong economic growth and better revenue collection mean a surplus of 0.4 per cent of GDP is expected for 2017; current policies and improved tax collection would imply continued small surpluses from 2018.

Some progress has been made on structural reforms, including measures targeted at R&D and the labor market. However, challenges remain, including with infrastructure, the planning framework for public investment, a high labor tax wedge, and shortages of skills. Additionally, complex administrative procedures for building permits limit the ability of housing supply to respond quickly to demand.