"In many ways, the Czech Republic's credit fundamentals compare well with its 'A' rated peer group," said David Heslam, a Director in Fitch's Emerging Europe Sovereign team. On a European System of Accounts (ESA) basis, general government debt is in line with the peer group median of 31% of GDP and better than the median when expressed as a share of government revenues, reflecting the country's deep tax base. Fiscal performance has benefited from accounting revisions and an economic upswing, with the general government deficit narrowing to an estimated 3% of GDP in 2006 from an average of 6.4% of GDP in the early years of this decade. Improvements in underlying trade performance and strong net inflows of foreign direct investment (FDI) have also continued to support the Czech Republic's relatively strong external finances. Gross external debt ratios compare well with the peer group median and the Czech Republic is the only net external creditor in central and eastern Europe. On a net basis, the country's external creditor status compares with a median net external debtor position for the 'A' rated group
"The ratings and Outlooks reflect a balance between the Czech Republic's evident credit strengths, its relatively short history of fiscal prudence and increased uncertainty over the fiscal path from 2007," said Mr Heslam. The general government deficit fell below 6% of GDP only in 2004 and there are signs that the expenditure control mechanisms that contributed to the narrowing of the deficit have weakened. The 2006 elections resulted in a stalemate between the left and right wing blocs in parliament and a cross-party agreement to significantly increase mandatory social expenditures became effective from this year. Subsequently, Fitch expects the general government deficit to widen to 4% of GDP in 2007
Over the medium- to long-term, strong GDP growth and ongoing real income convergence with wealthier EU states are likely to lead to upward pressure on the ratings. However, the political impasse does not bode well for a reduction of the fiscal deficit from 2008 and is likely to mean that key reform challenges - particularly pension reforms - remain outstanding. Increased confidence in the outlook for public finances will be a key consideration in any future rating action.
