Letter from... the Czech Republic

David Creighton reports on why many analysts in the Czech Republic are optimistic about any effect the credit crunch will have on their economy

The credit crunch affecting the US and other countries is often referred to as global. Although the crisis will have a worldwide impact, it will be felt less sharply in some countries than others. The Czech Republic is one example, and while analysts predict its economy will be affected, it is not expected to suffer the problems plaguing the US and the UK. 'I believe we will not have a credit crunch in the Czech economy. The economy is still going to grow, just at a slower pace,' says Marketa Sichtaˇrova, director of Prague-based financial consultancy Next.

This view is shared by other analysts, who point to a combination of factors helping the Czech economy so far avoid the crises of confidence seen, for example, in the UK. Czech financial institutions have not had the same level of exposure to American sub-prime debt, with only 0.30% of total assets in banking, 0.15% in the insurance sector and 0.45% in pension funds, points out Jan Frait, head of financial stability at the Czech national bank.

Frait notes that the liquidity levels in the Czech banking sector and its strong deposit base have also helped. 'Deposits (red line) still stand at roughly 110% of total loans. Major institutions do not have to rely on external sources of financing of their credit expansion,' he explains.

The business approach of Czech banks has also helped. They have adhered to traditional business models, concentrating on deposits and loans, and avoided risky investment deals. Mortgages have not been offered to potentially risky clients, unlike in the US. In addition, 'mortgages are also collateralized better than in some advanced economies - the loan to value ratio is conservative, without a tendency to grow,' says Pavel Mertlík, chief economist of Raiffeisenbank in the Czech Republic.

Although they have been cautious, Czech banks have had to adopt tougher approaches to lending as a result of the credit crunch. Most of them are owned by foreign parent companies, which were themselves affected by the squeeze. As a result, Czech banks have tightened lending rules. Petr Bartek, CEE real estate analyst at Ceska sporitelna bank, argues that the banks' stricter lending policies are already having a negative effect on the real estate investment market, resulting in lower development activity. 'Banks are more careful in evaluating each project, and smaller developers already face higher requirements on pre-leases and own equity in projects,' he says. 'The mortgage lending market is very competitive and this outweighs the credit crunch effects on the lending margins, says Stanislav Roušar, senior manager and financial risk professional at advisory firm KPMG.

Despite such restrictions, the real estate market is expected to continue to perform well in the Czech Republic, albeit less dynamically. The Czech National Bank sees the slowdown in the number of loans provided as a positive factor stabilising a market which has enjoyed a great boom recently, particularly last year. In addition, the healthy liquidity situation, and the as yet unsaturated market in Central and Eastern European market help prevent credit conditions from worsening.

One very obvious indirect impact of the credit crunch on the Czech economy is international trade. 'The more pronounced impact of the credit crunch in the US is causing a slowdown abroad, which in turn may reduce demands for Czech exports. The Czech Republic has a very export-oriented economy, and therefore is open to a downturn of its major customer markets, e.g. Western Europe,' says Stanislav Rousar, who notes that the problem could get worse with the weakening US dollar.

Czech exports to the US are already much more expensive, largely due to the recent strength of the Czech crown against the dollar and other currencies. The crown reached record levels against the dollar and euro earlier this year. Paradoxically, this was partly due to the credit crisis because investors used the crown for trading.

In the long-term, the Czech economy is expected to slowdown party due to the sub-prime crisis fallout, as the economy faces lower demand from exports from the EU. Estimates of year-on-year GDP growth are around 5% in 2008 and 5.5% in 2009, which are less optimistic than the forecast for 2006-2007. Yet many analysts are still confident about the future. 'We share the opinion that the American and global problems will affect the Czech Republic's real estate markets only partially,' says Pavel Mertlík.

David Creighton is a freelance journalist and regular contributor to Czech Business Weekly.