Waving goodbye to the Czech miracle

Date: 28/01/1999

The Czech Republic has gone from being eastern Europe's rising star to one of its strugglers. Chris Johnstone explains why it is no longer the example that all EU applicants strive to follow

Humble pie should perhaps become the new Czech national food as the country faces up to severe economic and political challenges.

Times have changed since the mid-1990s, when the Czech Republic sold itself as the example to follow for other central and eastern European countries rushing to embrace the West and achieve the twin objectives of European Union and NATO membership.

The country is now deep in recession, with the trend of negative economic growth in the first nine months of last year likely to be confirmed when the figures for the final quarter are published. They are expected to show that the Czech Republic's gross domestic product fell by 2&percent; during 1998.

Many economists believe that the country will not fare much better this year, with some forecasting feeble growth of just 0.5&percent; while others suggest the figure will be closer to zero.

This poor performance is all the more galling since neighbours Poland and Hungary are posting positive growth figures which can only bolster their bid for EU membership.

For the Czech Republic's Social Democrat government, which has been in power since June 1998, other chickens are also coming home to roost.

Corruption scandals, the latest focused on allegations that Dutch phone company Telsource paid bribes to ensure a stake in national phone company SPT Telecom, have tarnished the republic in the eyes of foreign investors.

Unemployment, which stood at only 4.7&percent; two years ago, has now reached 7.5&percent;, with some economists predicting that it could rise to around 9&percent; by the end of the year. Delayed privatisations and economic reforms, especially in the already bailed-out banking sector, need to be pushed through urgently.

Prime Minister Milos Zeman is attempting to clear up the mess while, justifiably, trying to deflect most of the blame onto his predecessor Vaclav Klaus. “Klaus has left Zeman a time bomb and it is beginning to explode,” says Rick Fawn, lecturer in international relations at St Andrews University, Scotland.

Unfortunately for Zeman, blaming his predecessors and long-time rivals is not an ideal recipe for political survival.

Zeman's Social Democrats, the first left-wing party to hold power since the Velvet Revolution a decade ago, rely on the support of Klaus' Civic Democratic Party to retain office in what appears to be an inherently flawed coalition. Even worse, Klaus' stock with the voters appears to be rising as he reaps the benefits from his semi-detached position in the corridors of political power.

Klaus has taken up a largely symbolic post as president of the chamber of deputies (the lower house of parliament) in a direct swap with Zeman. Last month, an opinion poll put his party ahead of the Social Democrats for the first time since the general election.

Even so, the odd couple of Czech politics look destined to stay together for some time to come, largely because there are no other viable options.

In spite of Zeman's forced reliance on the Communist Party to get his budget through the lower house at the start of this month, a long-term alliance between the two is not seen as a realistic prospect, according to Fawn. “Zeman's greatest achievement was distancing himself from the Communists,” he says.

Although it gained around 10&percent; of the vote last June and has a youthful - somewhat trendy - following, the Communist Party is still a pariah for many other political parties and voters who recall the purges, state trials and hypocrisy which characterised much of its 40-year rule.

There is speculation about a possible split within the Communist Party between the hardliners who oppose NATO membership and the reformers prepared to accept, but most analysts believe that this would not radically recast the political landscape.

At the other end of the political spectrum, Klaus is reckoned to have offended so many of his possible coalition partners by his brusque behaviour during his term in office from 1992 to 1997 that few would happily contemplate working under him again.

“Such reservations are an important obstacle to creating a right-of-centre coalition,” says Jiri Pehe, senior policy adviser to Czech Republic President Vaclav Havel. In any case, Klaus is believed to have his eyes firmly focused on the presidency itself whenever Havel steps down.

New party combinations or a grand coalition to tackle the country's problems are therefore unlikely this year, according to Pehe. As a result, it is Zeman who is likely to bear the burden of administering some painful medicine to the Czech economy.

Analysts warn that he could find himself under attack on two fronts. His attempts to cushion the impact of reform run the risk of both offending foreign investors and failing to fend off criticism from his party's supporters.

The privatisation of the country's banking sector, with the state selling off its majority stake in the two biggest banks (Ceska Sporitelna and Komercni Banka) should be completed by the end of next year. However, the price for restoring the two to health will be high - up to €2 billion, according to ABN AMRO economist Elena Graziadei.

Failure to restructure the financial sector has been identified by the European Commission as one of the Czech Republic's biggest problems. The shake-up has been held up by the mountain of bad loans which banks have accumulated, and fears that fresh problems could be uncovered by any clean-up.

Past privatisations under the Czech voucher system, where every citizen was given a stake in the company being sold off, have left a confused legacy, with ownership unclear in spite of holding companies' attempts to buy up the small stakes. “Companies coming in would often like to start with green-field sites rather than attempt to tidy up the mess,” says Graziadei.

Skoda Auto, which took a different route when it was taken over by German car giant Volkswagen, is a success story, with so many workers being taken on at its Mlada Boleslav plant that it has sparked a mini-boom in local real estate. In spite of the western jokes, Skoda cars outsell all other models combined in the republic.

Some of the industrial monoliths cherished by the former Communist Party also face a painful confrontation with the market economy. Restructuring plans for the steel and coal sectors, engineering company Skoda Pilsen (which specialised in building nuclear reactors for most of the former Soviet bloc) and CKD (whose main unit builds transport equipment) should be prepared this year.

The possible job losses are massive. Initial estimates for the national railway, for example, show that it only needs around one-third of its current workforce of 100,000.

“Many businesses are still kept going on state subsidies,” says Fawn. “Various programmes under Klaus kept people employed. Some of the jobless figures were cooked, with a lot of people taken out of the workforce rechristened under other categories like early retirement.”

Regional and investment packages will accompany the restructuring measures, with Czech government officials promising that the Commission will be consulted before they are put in place. Such consultations are necessary under the competition agreement between the EU and Czech Republic.

More generous tax perks for outside investors have already been outlined. However, some foreign investors such as British brewer Bass are still licking their wounds after the failure of the local competition authority to take a tough line. Brewers Radegast and Krusovice, which were found guilty of tying pubs to restrictive supply agreements, were fined less than €2,000.

Beer, so cherished by the Czechs, offers another, perhaps symbolic, lesson. If the definition of a recession is when pubs close, the Czech Republic has gone one step further. Five breweries, some with 400 years of history behind them, shut their doors last year.