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      FRIDAY, 26/04/2024 - Scope Ratings GmbH
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      Scope affirms Czech Republic’s credit ratings at AA- with Stable Outlook

      A favourable track record of sound macroeconomic policies and moderate debt drive the affirmation. Vulnerability to external shocks, labour shortages and rising budget pressure from an ageing population are credit challenges.

      Rating action

      Scope Ratings GmbH (Scope) has today affirmed the Czech Republic’s long-term local- and foreign currency issuer and senior unsecured debt ratings at AA-, with Stable Outlooks. The short-term issuer ratings for the Czech Republic have been affirmed at S-1+ in local- and foreign currency, with Stable Outlooks.

      The affirmation of the Czech Republic’s ratings reflects its favourable track record of sound macroeconomic policies, evidenced by robust annual GDP growth during the pre-pandemic period and sustained current account surpluses, which enhance economic stability. The sovereign's comparatively stable fiscal position, characterised by moderate budget deficits and debt levels, contributes to its overall resilience. Challenges include the country's reliance on global supply chains and external demand, which expose it to external shocks. Additionally, budget constraints and labour shortages resulting from an ageing population are limiting potential growth and increasing medium-term pressure on public finances.

      Download the rating report.

      Key rating drivers

      Favourable track record of sound macroeconomic policies. The first driver of the affirmation reflects the Czech Republic’s track record of sound macroeconomic policies, evidenced by robust annual GDP growth averaging 3.9% during the pre-pandemic period of 2015-2019, along with sustained current account surpluses averaging 0.9% of GDP, which enhance economic stability. This is supported by a robust institutional framework underpinned by EU membership. Despite facing short-term growth challenges from successive pandemic and energy price shocks, the Czech Republic has contained enduring impacts on its long-term macroeconomic outlook.

      Economic output saw a decline of 0.4% in 2023, primarily due to decreased household consumption. Scope forecasts modest growth of 0.6% for 2024, mainly attributed to reduced external demand and the impact of fiscal consolidation measures initiated in January 2024. Looking ahead to 2025, GDP growth is projected to improve to 2.2%, driven largely by the recovery in household consumption as real incomes rise. Initial signs of this recovery were evident in Q4 2023. Long-term growth is expected to stabilise around a medium-term potential of 2.5% in subsequent years, a robust performance compared to peers but below pre-crisis levels. Annual consumer price inflation decelerated to 2.2% in February (CPI), with expectations of a trajectory towards the central bank's 2% target by 2025. The Czech National Bank responded by gradually reducing the two-week repo rate to 5.75% in March, marking a shift from the previous peak of 7% observed between June 2022 and December 2023.

      The Czech Republic's economic resilience is underscored by its robust external balance sheet. The country maintained a consistent current account surplus before the successive crises of recent years averaging 1.0% of GDP from 2014 to 2020. The war in Ukraine highlighted the Czech Republic's high reliance on Russian energy imports, which exceeded 25% of total imports in 2021. Promptly following the conflict, the government secured alternative oil and gas sources, including investments in LNG terminals and regional initiatives. By 2023, the current account had significantly improved, shifting towards a balanced state from a 6.1% deficit in 2022. This improvement was driven by a return to a trade surplus, supported by stabilising supply chains and reduced energy imports. As industry and energy price pressures ease and major trading partners recover, Scope expects the Czech Republic's current account balance to gradually improve over the next two years, aided by its status as a net exporter of electricity. Moreover, the country's external liabilities primarily consist of foreign direct investment and equity rather than debt, which enhances its resilience to sudden shifts in investor sentiment.

      Moderate budget deficits and debt. The Czech Republic’s AA- rating is supported by a strong fiscal policy framework, moderate budget deficits and stable debt levels. Despite the recent rise in public debt, the debt-to-GDP ratio remains among the lowest in the European Union. In addition to moderate financing needs, Scope forecasts a modest uptick in government debt to around 45% of GDP in 2024, remaining stable over the forecast horizon until 2029.

      The budget deficit decreased to 3.2% in 2022, primarily due to strong tax revenue and social contributions, following a peak of 5.1% of GDP in 2021. Despite substantial government aid for energy costs and humanitarian support for Ukrainian refugees, the deficit increased moderately to 3.7% in 2023, with continued assistance for households and businesses. The government's fiscal consolidation package, initiated in January 2024, aims to reduce the deficit by 1.1 percentage points in 2024 through tax hikes, subsidy reductions, and other measures. However, the modest growth presents challenges to the planned implementation of this consolidation. Scope expects the Czech Republic to maintain a budget deficit below the threshold of 3% of GDP also in 2025, coinciding with parliamentary elections, and does not consider further CZK depreciation a material risk.

      Rating challenges: vulnerability to external shocks due to reliance on external market demand, labour shortages and rising budget pressure resulting from an ageing population.

      First, Czech Republic’s AA- credit ratings are constrained by the country's reliance on external demand, exposing the Czech Republic to external shocks as shifts in external markets could impact its economic stability. Moreover, the country's vulnerability to international supply chain disruptions, particularly in its energy-intensive automotive sector, which is a key employment and growth driver, poses risks to its growth, contingent on the strategies and performance of foreign entities. For the Czech Republic, this implies a delayed recovery in external demand, with little GDP growth impulse expected in 2024 given the subdued economic prospects for Germany.

      Second, rising budget pressure and labour shortages due to an ageing population are constraining potential growth and increasing medium-term pressure on public finances. Medium-term budget prospects are hindered by persistent primary deficits, estimated at around 0.5% of GDP between 2024-2029, compared to the pre-pandemic period of 2015-2019 when the Czech Republic maintained an average primary surplus of about 1.2% of GDP. Structural fiscal pressures are particularly related to the government's commitment to increase military spending to 2% of GDP starting in 2024, coupled with rising pension expenses driven by demographic shifts such as an ageing population and labour market constraints limiting the capacity for additional social contributions. Long-term stability depends on proposed pension reforms, which involve significant changes to the pay-as-you-go pension system, potentially raising the retirement age and offering early retirement for certain professions with health issues.

      Outlook and rating sensitivities

      The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the coming 12 to 18 months.

      Upside scenarios for the ratings and Outlooks are (individually or collectively):

      1. Fiscal performance improves materially, resulting in a significant decline in the public debt ratio;
         
      2. The country’s resilience to external shocks strengthens materially, supporting macroeconomic sustainability.

      Downside scenarios for the rating and Outlooks are (individually or collectively):

      1. Elevated budget deficits result in unsuccessful fiscal consolidation and hinder government targets;
         
      2. medium-term growth prospects were constrained, for example as a result of high inflation.

      Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

      Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘aa-’ for the Czech Republic. Under Scope’s methodology, the indicative rating receives 1) no positive adjustment from the methodological reserve-currency adjustment; and 2) no negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘aa-’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of the Czech Republic’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

      Scope identified the following QS relative credit strengths for the Czech Republic: 1) long-term debt trajectory; and 2) external debt structure. Conversely, Scope identified the following QS relative credit weakness for the Czech Republic: 1) environmental factors. On aggregate, the QS generates no adjustment for the Czech Republic’s credit ratings, resulting in final AA- long-term ratings. A rating committee has discussed and confirmed these results.

      Environment, social and governance (ESG) factors

      Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

      The Czech Republic faces significant environmental challenges, with high CO2 emissions per GDP and GHG emissions per capita, though it has low natural disaster risk and a moderate ecological footprint of consumption relative to available biocapacity. Scope rates its qualitative adjustment for environmental factors as ‘weak’ due to transition risks associated with its carbon-intensive economy and energy sector. The Czech Republic continues to rely heavily on coal for its energy with notably high greenhouse gas emissions and relatively slow progress in transitioning to renewables. However, the government aims to phase out coal by 2033, earlier than initially planned.

      The Czech Republic has favourable scores in the SQM for income equality and labour participation but faces challenges with a high old-age dependency ratio. Scope assigns a ‘neutral’ qualitative adjustment for social factors. While the strong labour market contributes to its social-related strengths, challenges from demographic trends and employment gaps persist, with an ageing population expected to strain public finances due to rising pension and healthcare costs.

      Finally, the Czech Republic performs strongly under governance factors assessed through the SQM as measured by the World Bank's Worldwide Governance Indicators and furthermore receives no negative indicative-rating adjustment from the model’s separate stand-alone political-risk adjustment. Scope assesses its qualitative adjustment for governance factors as ‘neutral’. Ahead of the 2025 general election, fiscal discipline is expected to ease somewhat, though Scope expects the government to maintain a budget deficit below the Maastricht threshold of 3% of GDP. With a majority of the government coalition supporting euro adoption, its timeline could dominate the 2025 election agenda.

      Rating committee
      The main points discussed by the rating committee were: i) the Czech Republic’s economic outlook and medium-term growth potential; ii) fiscal and debt-sustainability developments; iii) external-sector vulnerabilities; iv) banking-sector and non-financial private sector balance sheet developments; v) ESG considerations; and vi) peer comparisons.

      Methodology
      The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model version 3.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months. 

      Solicitation, key sources and quality of information
      The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
      With Rated Entity or Related Third Party Participation    NO
      With Access to Internal Documents                                 NO
      With Access to Management                                           NO
      The following substantially material sources of information were used to prepare the Credit Ratings: public domain. 
      Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
      Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks were not amended before being issued.

      Regulatory disclosures
      These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
      Lead analyst: Jakob Suwalski, Senior Director
      Person responsible for approval of the Credit Ratings: Eiko Sievert, Director
      The Credit Ratings/Outlooks were first released by Scope Ratings on January 2003. The Credit Ratings/Outlooks were last updated on 26 May 2023. 

      Potential conflicts
      See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings. 

      Conditions of use / exclusion of liability
      © 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.

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