CZECH REPUBLIC: INFORMATION REQUEST IN ADVANCE OF

C O N F I D E N T I A L SECTION 01 OF 06 PRAGUE 000120

SIPDIS

STATE FOR EUR/CE AND EEB/OMA AWHITTINGTON
TREASURY FOR IMB BMURDEN, WMONROE AND MBEASLEY

E.O. 12958: DECL: 03/04/2019
TAGS: ECON EFIN PGOV EUN EZ
SUBJECT: CZECH REPUBLIC: INFORMATION REQUEST IN ADVANCE OF
G-20 MEETINGS

REF: A. SECSTATE 17502

B. PRAGUE 109

C. PRAGUE 79

D. PRAGUE 65

E. PRAGUE 59

F. 08 PRAGUE 683

G. FEB 25 PRAGUE DAILY

H. FEB 23 PRAGUE DAILY

I. FEB 17 PRAGUE DAILY

J. FEB 13 PRAGUE DAILY

K. FEB 12 PRAGUE DAILY

L. FEB 11 PRAGUE DAILY

M. FEB 10 PRAGUE DAILY

N. FEB 09 PRAGUE DAILY

O. FEB 06 PRAGUE DAILY

P. FEB 02 PRAGUE DAILY AND PREVIOUS

Classified By: DEPUTY POLITICAL/ECONOMIC COUNSELOR MARTINA
STRONG. REASONS 1.4 B AND D.


1. (SBU) Summary: The Czech Government (GoCR) views the EU
response to the financial crisis as an important test of its
EU presidency. Within EU fora, the GoCR has consistently
warned against protectionism and beggar-thy-neighbor
policies, as well as revolutionary changes to regulation and
oversight, while stressing the importance of sustainable
public finance. The Czechs are willing to sacrifice these
preferences, however, in the pursuit of a common EU approach
to the crisis. In the G-20 context, Czech officials have
stressed that their overriding goal is to represent a united
EU position and to ensure that the London summit is able to
agree on common guidelines that meet market expectations.


2. (SBU) The GoCR has not had to provide direct assistance to
the inward-looking Czech financial sector, which remains
profitable. Both public and household debt is relatively
small, and households have not borrowed in foreign currency.
The Czech current account deficit is modest and sustainable.
All major banks, however, are owned by European banking
groups, many of which have significant exposure to some of
the more troubled economies in the region. While the banking
sector remains relatively healthy, the small, open
export-oriented real economy is suffering from a significant
drop in external demand. The GoCR is very concerned about
the potential consequences to the Czech economy should
international investors put it in the same category as
Hungary or Latvia. Consequently, the GOCR has opposed any
regional internal EU programs, insisting that each country be
judged on its own merits and on a case-by-case basis. End
Summary.

Summary of Key Issues:


3. (U) The comments below are keyed to the questions in
paragraph 5 of Ref A.


4. (SBU) Stimulus: On February 15, the GoCR announced an
economic recovery package totaling approximately 2 percent of
GDP. The program is designed to limit unemployment and
support exports by cutting employer contributions to social
security programs, accelerating depreciation on business
equipment (including cars),refunding VAT paid by businesses
on vehicles, deferring the tax payments of businesses with
less than five employees and increasing the capital of two
state-owned banks that specialize in SME loans and export
guarantees. The government has resisted opposition calls for
a car scrap subsidy and increasing pensions, arguing that
stimulating local demand will do little to help the heavily
export-oriented Czech economy. The GoCR plans to fund its

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program through increased public debt and the use of funds
left over from previous state budgets. Current Czech public
debt is under 30 percent of GDP. The 2008 Czech budget
deficit was 1.2 percent of GDP. The budget deficit in 2009
is expected to reach 4 to 5 percent of GDP.


5. (SBU) Financial Sector: The Czech Republic had its own
financial crisis in the late 1990s that led to government
intervention to remove impaired assets and to consolidate and
privatize the banking sector. The banks that emerged are
very conservative and concentrate almost exclusively on the
domestic market. Czech banks also are not highly leveraged
and finance loans primarily through deposits (the average
loan to deposit ratio is 77 percent). Consequently, Czech
banks had only minimal exposure to mortgage backed
securities, Icelandic banks, Lehman Brother or CDOs and have,
at least so far, remained profitable. European banking
groups currently own all major Czech banks. According to the
Czech National Bank (CNB),Czech banks are net creditors
rather than net debtors within their banking groups. The CNB
closely monitors the relationship between the Czech
subsidiaries and foreign parents to ensure that significant
amounts of capital or liquidity are not leaving the Czech
banking sector. While the GoCR supports increased
coordination among national regulators, it opposes the
creation of pan-European regulators.


6. (SBU) Real Economy: Manufacturing and especially the car
industry are the heart of the small, export-oriented Czech
economy, which is suffering from a significant drop in
external demand for Czech goods. Exports, industrial output
and new orders all experienced double digit drops in late
2008, and the economy is expected to contract by as much as 2
percent in 2009. The government is planning to refund VAT
payments to businesses buying new vehicles and to accelerate
depreciation on business vehicles. Since almost 90 percent
of cars manufactured in the Czech Republic are exported
abroad, the government has rejected calls for a car scrap
subsidy or a broader stimulus program. The government is
very conscious of EU internal market rules and its WTO
commitments and has been a consistent advocate of the need to
avoid protectionism and beggar-thy-neighbor policies.


7. (SBU) Social/Labor Impact: The Government is trying to
support employment by reducing business contributions of
employees to social security and by helping businesses
through accelerated depreciation, tax deferrals and VAT
refunds on cars. The GoCR has also began a program that will
pay up to 2,000 newly unemployed foreign workers to return to
their home countries, increase controls on illegal foreign
workers, and make it harder to bring non-EU foreign labor to
the Czech Republic. While there has been some criticism of
the government for doing too little too late, as well as some
scattered protests among unemployed workers, the level of
public protest has remained modest. The GoCR has not
increased benefits to the unemployed.


8. (SBU) Dimension of the Crisis: Czechs, by and large, seem
optimistic that the economic slow down should peak this year,
with the economy beginning to recover in late 2009. They
understand, however, that they are linked to their main
export markets, especially Germany, and fear that the German
recession could be deeper and more protracted than expected.
Czech banks concentrate primarily on the domestic market and
do not have extensive exposure to other countries, although
their parent banks are very exposed to some of the more
troubled economies in Central and Eastern Europe. The
foreign borrowing of Czech households is a negligible 0.1
percent of total household borrowing. Corporate borrowing in

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foreign currency is less than 20 percent. The GoCR has
contributed to EU programs to help Latvia. Fearing the
consequences of being seen by international investors as in
the same boat as some of the more troubled economies in the
region, the Czech Republic has resisted any regional approach
within the EU to the crisis, insisting instead that each
country should be regarded individually and on a case by case
basis.


9. (SBU) Role of the G-20: Finance Ministry Officials have
told us that the GoCR does not have its own purely national
objectives for the G-20 summit in London. Rather, as the EU
presidency country, the Czechs want to accurately represent
all 27 EU countries in the meeting. To this end, the Czech
goal is to forge a common EU position before the G-20
meeting. The Czechs also believe that it is critical that
the G-20 summit be regarded as a success as the markets will
be watching closely. To this end, the Czechs believe that it
is critical that the G-20 agree on a common set of
guidelines.

Objectives of the London G-20 Summit:


10. (SBU) The GoCR has consistently warned against
protectionism, beggar-thy-neighbor policies and excessive
public spending. Finance Minister Kalousek has also
suggested that he favors evolutionary rather than
revolutionary changes to financial regulation and oversight.
He has cautioned that governments should take the time to get
regulation right, rather than rush to pass new laws that
could have unintended consequences. While supporting
increased coordination of recovery programs and national
regulators, the GoCR opposes the creation of any pan-European
or global regulators. In general, the GoCR believes that it
is important to follow EU rules in good times, but even more
so in times of crisis. Finance Ministry officials have
suggested, however, that the EU growth and stability pact may
need to be revised to make it less pro-cyclical. The GoCR
also views strengthening the EU internal market and removing
remaining barriers to labor mobility and trade in services as
one of the best ways of dealing with the economic crisis.


11. (SBU) The Czechs, however, view the EU's response to the
financial crisis as an important test of their EU presidency
and they take the Presidency's role of a neutral coordinator
seriously. Thus, it is very important to them that the EU
has a united position at the London summit, and that it is PM
Topolanek representing the EU as a whole. They also believe
that it is imperative that the G-20 demonstrate a united
front and present a common set of guidelines on responding to
the financial and economic crisis. Thus, they are willing to
subsume their national preferences to this goal. Thus, in
the G-20 context, they are likely to push only those issues
identified as important to the EU, such as a common approach
to impaired assets and eliminating tax havens.


12. (SBU) The GoCR is very concerned about the consequences
of international investors tarring them with the same brush
as other more troubled economies in the region. As a
consequence, they opposed the Hungarian proposal for a
special EU fund for EU CEE economies, insisting instead that
the EU treat each country on its own merits, rather than by
its geographic location.

Impacts of the Global Financial Crisis


13. (SBU) According to Finance Minister Kalousek, the Czech
Republic is one of only three OECD countries not to have had
to recapitalize any of its banks. The Czech Republic had its

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own financial crisis in the late 1990s that led to government
intervention to remove impaired assets and to consolidate and
privatize the banking sector. Consequently, the banks that
emerged are very conservative and concentrate almost
exclusively on the domestic market. Czech banks are also not
highly leveraged and finance loans primarily through
deposits. According to the Czech National Bank, the average
loan to deposit ratio is only 77 percent.


14. (SBU) Czech banks had only minimal exposure to more
sophisticated investment vehicles such as mortgage-backed
securities or CDOs. While Czech banks have written off some
exposure to Lehman Brothers, Icelandic Banks, and CDOs, all
major Czech banks reported profits for 2008. Banks may have
more difficulties in 2009, however, as the real economy
continues to contract.


15. (SBU) All major Czech banks are owned by European banking
groups (including Erste, KBC, Societe Generale, etc).
According to the CNB, in most cases, the Czech banks are net
creditors rather than net debtors within their banking
groups. The CNB closely monitors the relationship between
the Czech subsidiaries and foreign parents to ensure that the
parent banks are not sucking capital or liquidity out of the
Czech banking sector. Czech authorities, believe the risk of
the spread of contagion through the parent companies, is not
great and that the subsidiaries could even survive the
collapse of their parent.


16. (SBU) While major companies continue to have access to
capital, SMEs and certain sectors (e.g., property developers)
are reporting more difficulties in obtaining loans, as the
banks have tightened their lending criteria and increased
risk premiums. Over the past several years, interest rates
in the Czech Republic have generally been below Euro interest
rates, and up until mid-Summer, the Czech crown was on a
strong appreciation trend. Thus, unlike some of their
neighbors, Czech households have not borrowed heavily in
foreign currency. According to the CNB, the foreign
borrowing of Czech households is a negligible 0.1 percent of
total household borrowing.


17. (SBU) In November 2008, the GoCR increased the Czech bank
deposit guarantee to the equivalent of 50,000 Euro, up from
the first 80 percent of the equivalent of 25,000 Euro.
According to Finance Minister Kalousek, 97 percent of all
household deposits are now covered. The CNB has also made it
easier for banks to borrow directly from it and began
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