AMBASSADOR'S INTRODUCTORY CALL AT CZECH NATIONAL

C O N F I D E N T I A L PRAGUE 001327 SIPDIS SENSITIVE SIPDIS STATE FOR EUR/NCE ERIC FICHTE, COMMERCE FOR ITA/MAC/EUR MIKE ROGERS TREASURY FOR OASIA ANNE ALIKONIS E.O. 12958: DECL: 10/22/2016 TAGS: ECON EFIN PGOV EZ SUBJECT: AMBASSADOR'S INTRODUCTORY CALL AT CZECH NATIONAL BANK REF: A. PRAGUE 1239 ¶B. PRAGUE 1173 Classified By: Acting Political and Economic Counselor Karen Reider for reasons 1.5 b+d ¶1. (C) Summary: During the Ambassador,s October 20 introductory call on Czech National Bank (CNB) Governor Zdenek Tuma, Tuma reviewed the progress that Czechs have achieved in liberalizing the banking and economic sectors, but expressed a cautious note that the ballooning government deficit and political stalemate could hurt the country,s business climate. Tuma conceded that perhaps because the Czechs' level of inflation and indebtedness is one of the lowest in the EU, politicians feel little pressure to pursue economic reforms at this time. End Summary ¶2. (C) Czech Central Bank Governor Zdenek Tuma explained the progress Czechs have made in liberalizing their banking sector. He reported that nearly 95% of all assets are held by foreign banks, thanks in large part to a good business and legal climate. He also noted that many Czech local banks had been merged with bigger foreign banks, such as the purchase of the oldest Czech bank, Zivnostenska Banka, by the Italian conglomerate UniCredito Italiano, S.p.A in 2003. Tuma believes that a medium-sized economy such as the Czech Republic must remain open and linked to the West if it wants to remain competitive. ¶3. (C) Tuma explained that there are few macroeconomic ramifications from the current political stalemate (reftel A),but cautioned that it could hinder future foreign direct investment (FDI) and implementation of needed economic reforms. Tuma said the impact of politics on the economy is negligible due to vast privatization and independence of the private sector. He described the role of government in setting up an environment and the legal framework for business, and noted that continued uncertainty and lack of political mandate could damage this framework and harm the Czechs' reputation in the long term, especially if the budget deficit is allowed to mushroom beyond 3.0%/GDP. Tuma pointed out that Hungary was the darling of FDI in the 1990s, but is no longer today because of its &bad reputation8 and macroeconomic instability. ¶4. (C) Although monetary policy is in good shape, Tuma blamed the previous, left-of-center Social Democrat (CSSD) government for its poor fiscal management. He noted government deficits for 2003, 2004, and 2005 were below EU convergence criteria, but they were the results of better-than-expected GDP growth rather than due to government fiscal policy. He lamented that no effort was taken to restructure public finances (e.g. pension and health care systems) during these good times to make them more sustainable, and lamented the ballooning new social spending before the elections. He characterized these new social expenditures as "unprecedented" and reported that it would cost CZK 60-70 billion (USD 3 ) 3.5 billion) in new spending. He estimated a 2007 budget deficit of 4.0%/GDP, which is a full percentage point higher than the Maastricht convergence criteria, and will delay Euro adoption (reftel B). On the other hand, he admitted few are convinced of immediate corrective action because of the current low level of inflation (3.0%, the lowest in the EU) and indebtedness (just over 30%, one of the lowest in the EU) along with a forecasted 5.0% GDP growth for 2007. GRABER