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