VZCZCXYZ0011
RR RUEHWEB
DE RUEHPG #0035 0241358
ZNR UUUUU ZZH
R 241358Z JAN 08
FM AMEMBASSY PRAGUE
TO RUEHC/SECSTATE WASHDC 9979
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
UNCLAS PRAGUE 000035
SIPDIS
SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EZ
SUBJECT: PRAGUE STOCK EXCHANGE DOWN 20% SINCE JANUARY 1
REF: 07 PRAGUE 758
1. SUMMARY AND COMMENT: The good news is that the Czech
Republic's economic fundamentals are strong; The bad news is
that the Czech Republic is also impacted by negative
sentiment stemming from the subprime mortgage crisis in the
U.S. that has spread to global financial markets. With key
economic data in the U.S., Europe and the Czech Republic due
out over the next two weeks, economists expect the
instability to continue. The surprise January 22 Federal
Reserve rate cut was well received and, like elsewhere in
Europe, helped soften the blow for the local stock exchange.
The Prague Stock Exchange is down 20% since January 1 and
down 10% year-on-year. In the event of a protracted period
of instability or significant economic slow down, economists
believe that recently passed public finance reform shows
further fiscal tightening would be possible without too much
suffering, while the Central Bank is faced with a trickier
situation of confronting increasing inflationary pressures.
END SUMMARY AND COMMENT.
ECONOMY SLOWING DESPITE STRONG FUNDAMENTALS
-------------------------------------------
2. Econoffs met with Czech investment bank Patria Finance
Chief Economist David Marek and European financial group
UniCredit Chief Economist Pavel Sobisek to discuss how the
Czech economy is likely to fare in the current wave of
financial instability stemming from the U.S. subprime
mortgage crisis. Both agree that the financial turmoil will
likely continue in the coming weeks, but that Czech economic
fundamentals are strong (reftel). Having said that, even
before the turmoil began, the Czech economy was expected to
slow this year after three consecutive years of 6% GDP
growth. 2008 GDP growth is projected to decrease from 6% to
5%, inflation is expected to rise from 3% to 5.4%, and
industrial production is expected to slow from 8% to 5%.
3. Marek, who sits on the trading floor, said there was a
lot of screaming on the floor January 22 and that the
negative sentiment continues. The first week in February
will be an especially active week for the Czech financial
market, with data from the PMI index, trade balance, and
inflation expected to be released, on top of Czech
Presidential elections on February 8. Sobisek shared the
results of an internal research paper on the impact of a
stock market crash on GDP growth rates using the Oxford
Economic Forecasting model: (1) if share prices bounce back
within the next four to eight weeks, the negative effects are
negligible; (2) in the worse case scenario (i.e., a permanent
10% drop in global stocks), there would be a 0.8% drop in
U.S. GDP growth rate, 0.6% in Japanese GDP growth, 0.5%
decrease in German GDP growth in 2008.
CENTRAL BANK CONUNDRUM
----------------------
4. This month marks the ten-year anniversary of the Czech
National Bank's (CNB) inflation-targeting policy. And for
the first time in ten years, the CNB is simultaneously
confronted with the challenge of managing rising inflationary
pressure and an economic slowdown. Year-on-year inflation
accelerated to 5.4% in December 2007 and is expected to reach
6% in January 2008. At the January 16 Euromoney Conference
in Vienna, Austria, Czech Central Bank Governor Zdenek Tuma
attributed the rise in Czech inflation to growing food and
energy prices across the world and the impact of the public
finance reform which raised the lower VAT rate from 5% to 9%.
More importantly, Tuma characterized the rise in inflation
as temporary and said he expects inflation to return to
"around 3% in 12 to 18 months." He also said a U.S.
recession would have little effect on the Czech banking
sector.
5. COMMENT: Czech GDP growth is primarily attributed to FDI
and exports, although domestic consumption has been rising
rapidly. Approximately 70% of the companies listed on the
Prague Stock Exchange are multinational corporations. For a
small open economy like the Czech Republic, strong economic
fundamentals alone will not be sufficient to stave off the
effects of a global economic slowdown. As reported in
reftel, a succession of short-lived coalition governments
have pursued a pro-cyclical fiscal policy and modest reforms
have only just begun. At the same time, the highly-respected
Czech National Bank is in a bind and expected to further
raise interest rates at their next meeting to stave off
rising inflation. Therefore, the policy tools available to
Czech officials to soften the impact of global financial
instability or recession are limited and could finally tip
the Czech economy into an economic slowdown that economists
have predicted for the last two years.
Graber