For foreign economic institutions, the destiny of the Czech economy is obviously related to the development of the economy in the eurozone and particularly in Germany.
Christian Blaabjerg, chief equity strategist at the Danish investment bank Saxo Bank, said that the Czech economy is, however, placed in pole position to become a winner when the global economy fully recovers. Saxo Bank is the author of the classical 10 outrageous predictions for the world economy that it releases at the beginning of every year. In 2009, it was one of the few economic institutions that predicted that central banks will continue to lower interest rates to fuel the recovery of the global economy.
Q: At the beginning of 2009, investors were placing all the Central and Eastern European (CEE) countries in the same problematic basket. Has this perception changed during last year?
A: Yes, it did. Now you have one basket of countries virtually on the verge of state bankruptcy that live at the mercy of the IMF (International Monetary Fund). Then you have a middle layer of countries that is holding up, but not doing well; and then the top players where the Czech Republic is. You do face consequences, in the sense that a lot of your production is going to exports and the main receivers of this export were countries that weren’t so interested in buying. Yet, the whole debt component is very important and this gives you a significant advantage compared to other countries, because you have [virtually] no debt.
Q: However, there is criticism pointing at the speed of growth of the Czech public deficit in 2009 that is expected to grow at the same pace this year as well. Shouldn’t that worry us?
A: We expect the speed of growth in your current account to gross domestic product (GDP) to be a little less than in 2009, at 1.5 percent on year, and then to pick up again in 2011 at 1.8 percent. But I’m much more interested in your GDP, which is supposed to grow significantly in 2010 and 2011. [The public deficit] isn’t something I would be worried about if I was the central bank of the Czech Republic. Unlike mainland or the old Western Europe, you won’t have these mild deflationary pressures.
The reason why I believe this is that if you look at your salary structure, it’s a lot lower than in Western Europe. Those countries have a huge problem because if you look at the general salary levels compared to productivity, the ratio is outrageously high. That’s why you’re going to see within the next decade—or at least the next five years—a high reluctance of workers in old Europe to ask for higher wages because if that is the demand, then managers from companies will say: fine, we’ll just outsource it.
The old Europe has failed to realize that people in CEE are as well educated, but they only need 50 percent of the salary that [Westerners] do to do the same job. So, I’m not worried about the Czech economy. You’ll have a period with current account deficits because you need to take care of the welfare benefits, even though they are lower than in Western Europe for the unemployed. Yet, I don’t think this causes a problem for you.
Q: What do you expect for the CEE stock markets?
A: I think you’ll have some positive interferences; this means that when markets are growing higher or risk is re-entering the markets like we see now, your markets will move higher than the general European markets. But, when the second half of 2010 comes, then you’ll move faster the other way round because mainly Old World investors will be pulling their money out of emerging markets. So, when it goes down, it goes down faster. I wouldn’t see a problem for some markets to grow by 50 to 70 percent in the first half of the year then retrace to be a bit higher than at the beginning of the year 2010.
Q: One of the biggest issues discussed on the Czech market is that local banks declined to clean their bad loan portfolio in 2009 and postponed the problem for later. Do you share this view? If so, when do you think banks will find the courage to start cleaning their books?
A: It isn’t about courage, it’s about money. Banks don’t have courage, they only believe in one thing and that’s money. It’s the same in Western Europe. What happens is that banks aren’t solvent enough yet to close down these loan portfolios. There are two processes going on. First of all, there are definitely going to be increased demands on tier capital ratios for banks. I think it’s fair to say that the next Basel III will come up with a claim of a 12 percent ratio—now it’s 9 percent. It might also bring an upper threshold toward the level of leverage on the balances of banks. So, we’ll have a process where banks will allocate all their profits toward getting new market shape, especially on the liquidity size.
When this process is over, then they’ll start to close down those nonperforming loans that are unsustainable. But actually it’s far cheaper in the current situation for banks to let them roll and keep their credit lines open than to close them down, because if they close them down, that will take a toll on their balance sheets and then they would be in trouble with the Basel convention. Most likely, central banks will start to raise the figures and you need to recapitalize.
As a bank in this environment, you can’t recapitalize, you can’t go to the market to raise equity capital, you can’t go to bondholders, so you will keep it running, hoping that you will have enough profits to re-allocate some cash into the balance sheet and then, at some certain point in time, you’ll start closing down these loan portfolios. I think for 2010 we’ll see a continuation of keeping credit lines open, then bolstering the balance sheet with more liquidity and cash and maybe then late in 2010, most likely in 2011, start to close down some of the worst performing loans.
Q: Does this bring some stability risk for banks, particularly in CEE?
A: Once again, I don’t think banks in CEE are different from the rest of Europe. There is a different ball game played in the U.S., but old Europe as such is facing the same situation. What we see in the banking sector is that in 2009 a lot of profit has been made in the trading activity of the banks. Abnormally high trade profits have been made and now it’s very questionable whether this will continue. I don’t think it’ll continue at these levels, but I think we’ll still see a lot of money in trading activity, not as banks taking risks, but bank customers, especially companies, seeking any kind of insurance of their cash flows. As you know, banks are very well prepared to handle such issues. I don’t think we’ll see any movement on the credit line side; we’ll see bolstering capital on the balance sheets and when it reaches a certain higher level they’ll start closing down.
Q: What risks do you perceive for the Czech economy in 2010?
A: The overall risk for the Czech economy, even though it has nothing to do with Czechs, is about Germany. The risk is whether these reforms from German Chancellor Angela Merkel about public investments, but mainly the tax reforms, will play out in terms of increasing growth and increasing demand. The tax reform has been put in place; there is going to be another reform in 2010. Merkel pointed out in early November that there will be two reforms in 2010 on the tax side.
One issue to which she very realistically pointed was the company tax to be lowered to 15 percent. I’m pretty sure that will have an enormous effect on demand in Germany, but I think they’ll solve this ‘wait and see’ approach, then they’ll launch one reform, see how it works and then launch another if it doesn’t work as anticipated. The European, not only the Czech economy heavily rests with what’s going to happen in Germany, whether we like it or not.
Q: What trends do you foresee for Czech companies and entrepreneurs in 2010?
A: I hope that Czech entrepreneurs and companies have reoriented their look toward the world; that’s what I would be doing if I were a Czech company. I wouldn’t put any dime on the old Europe or the U.S.; I would be looking toward emerging markets, particularly toward emerging Asia and countries like Vietnam, Indonesia, maybe also China. I would be looking at Brazil to see if I have any possibilities of doing business there. Also partly India, but this is a missed case and it’s very difficult to perceive India as a united whole with growth all over because that’s not the case. But definitely Brazil and Indonesia, Vietnam, China—these countries would be looking for entrepreneurs like those from the Czech Republic. That is where demand is going to uphold.
Q: Where do you see the Czech economy at the end of this year?
A: I think the sentiment at the beginning of the year will be quite positive; I think we’ll see improvements in macroeconomic numbers. It’ll also be positive at the end of 2010, despite the fact that we expect higher unemployment, but for company holders and entrepreneurs, the German tax reforms will definitely stimulate domestic demand quite significantly.
Since a lot of your exports go around in the eurozone, I believe it’ll be quite positive. However, there could be drawbacks. I think the German case is quite solid; I’m relieved by the fact that Merkel took the government because she has the will and now the power to do those necessary reforms that should have been done for the last 20 years. Yet, the major drawbacks could most likely come from the U.S. housing market.
The major question, in my perspective, is how much the second wave of defaults in the U.S. housing market will affect Europe. I think that lending standards have been a lot tighter in the eurozone compared to the U.S., which is why we haven’t seen the labor markets going as far down as in the U.S. But, if we have a second dip, the question is simply how much effect it is going to have in Europe. So, overall it’s positive but there could be drawbacks. Yet, I believe in the way the German government has approached this crisis by very marginal little governmental induced investments. Now, we believe more in tax reforms.
This article was originally published by Czech Business Weekly journal. Author: Cristina Muntean
