October 14, 2016 / 8:17 PM / 9 months ago

Fitch Affirms Czech Republic at 'A+'; Outlook Stable

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(The following statement was released by the rating agency) PARIS/LONDON, October 14 (Fitch) Fitch Ratings has affirmed Czech Republic's Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'A+' with a Stable Outlook. The issue ratings on Czech Republic's senior unsecured foreign and local currency bonds have also been affirmed at 'A+'. The Country Ceiling has been affirmed at 'AA+' and the Short-Term Foreign and Local Currency IDRs at 'F1+'. The ratings on Czech Republic's senior unsecured short-term foreign and local currency issues have also been affirmed at 'F1+'. KEY RATING DRIVERS The affirmation of Czech Republic's 'A+' ratings reflects its strong external creditor position (net external debt was -30% of GDP at end-2015), strengthening government finances thanks to close-to-balance general government accounts, and solid banking system. The general strength of the country's institutions is underpinned by European Union (EU) membership. GDP per capita is in line with the peer group median but well below that of the 'AA' rating category. The path of convergence towards EU level of development has slowed relative to pre-2008. In 2016, Fitch expects the government's fiscal deficit will be 0.4% of GDP, from 0.6% in 2015, and well below regional and most European peers. The budget benefits from strong revenues related to an improved economy and stronger tax compliance. Lower public investment, consistent with the EU fund cycle, and negative yields on new debt issues are pushing down expenditure. Part of the fiscal space will be used to increase wages in the period leading up to the general election scheduled for late 2017. Fitch consequently expects the deficit to increase to 0.7% in 2017 and 2018. Fitch expects government debt will continue to decline as a result of lower government deficits, to 37% of GDP by 2018 and 32% by 2025 from 41.1% in 2015. The expectation of currency appreciation after the removal of the exchange rate floor has prompted speculative foreign inflows into the CZK-denominated government debt, pushing the share of non-resident holdings up to 26% in July 2016 from 15% in 2013. This potentially exposes government debt market to capital outflows. This risk is mitigated by highly liquid domestic banks and strong government finances dynamics. Fitch expects real GDP growth will slow to 2.4% in 2016 from 4.6% in 2015, reflecting lower public investment given the start of a new EU financial disbursement cycle. Consumption will be the main driver of growth, supported by the fall in unemployment (4.2% in July 2016). In 2017 and 2018, growth should accelerate to 2.6% as public investment gradually recovers. The main risk to the forecast is the uncertain external environment. The expected removal of the exchange rate floor in 2017 could also affect export performance via strengthening of the currency. Monetary policy is highly accommodative, with a combination of an historically low policy rate and the floor of EUR/CZK27 on the exchange rate since November 2013. The floor was introduced to counter deflationary pressures by preventing the koruna from appreciating against the euro. Inflation has remained well below the Czech National Bank's (CNB) 2% target, at 0.5% y/y in September 2016. Based on the guidance provided by CNB members, the exit from the policy should take place when inflation is back at the 2% target, in a sustainable manner, which the CNB expects to see in mid-2017. The exit strategy will also in part depend on ECB policy. Both the floor on the euro-Czech koruna exchange rate and its possible removal in 2017 are consistent with our view that the Czech Republic benefits from a credible and advanced monetary policy framework. The floor has helped growth recover, improved external metrics and should help boost inflation towards the 2% target. No direct negative impact on public finances should arise from potential central bank losses linked to balance sheet expansion. Macro-financial risks associated with removing the floor appear manageable. The accommodative monetary stance has supported an acceleration in banks' lending to the private sector, to 6.0% y/y in August 2016 (from 2.7% in 2014). Growth in housing loans has been especially strong at 8.1% y/y in August prompting the central bank to tighten macro prudential requirements. In Fitch's view, Czech banks have sufficiently high capital ratios (common equity Tier 1 ratio at 16.8% in June 2016) to continue credit expansion in housing loans. Banks also benefit from ample liquidity (loan to deposit ratio at 78%) and limited non-performing loans (5.3%). Doing Business indicators by the World Bank are slightly below the 'A' median. The Czech Republic ranks 36th out of 189 countries in the World Bank's Doing Business survey for 2016, behind Slovakia (29) and Poland (25) but above Romania (37) and Hungary (42). Fitch expects that the coalition government, in place since January 2014, will hold until the general election due in autumn 2017, although tensions will likely rise between the main coalition parties, ANO (centre right) and the ruling CSSD (social democrat), in the run-up to the election. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Czech Republic a score equivalent to a rating of 'A+' on the Long-Term FC IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside pressures on the rating are currently balanced. The main factors that could, individually or collectively, lead to positive rating action are: -Higher growth rates that would drive faster income convergence towards the median for 'AA' rated countries over the medium term, without a build-up of imbalances. -An improvement in structural indicators including the business environment. -Sustained reduction in general government debt consistent with continued tight budget deficit. The main risk factors that could, individually or collectively, trigger negative rating action are: -A substantial deterioration in Czech economic growth, for example, due to a global slowdown or changing growth patterns in key export partners. -A material increase in the public debt ratio, for instance, brought about by substantial fiscal loosening. KEY ASSUMPTIONS Fitch assumes that growth in the eurozone, Czech Republic's main economic partner, will be 1.4% in each of 2017 and 2018 from 2.1% in 2015 and 1.6% in 2016. Contact: Primary Analyst Arnaud Louis Director +33 1 44 29 91 42 Fitch Ratings S.A.S. 60 rue de Monceau 75008 Paris Secondary Analyst Krisjanis Krustins Associate Director +852 2263 9831 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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