Alignment Analyses 2019 – how prepared is the Czech economy to adopt the euro?

Future adoption of the single European currency should further increase the benefits accruing to the Czech Republic from its intense involvement in international economic relations. However, the risks associated with potential euro adoption still include an unfinished process of real economic convergence of the Czech Republic towards the euro area, persisting structural dissimilarity of the economy, with its high share of industry in GDP, and decreasing room for fiscal policy to play a macroeconomic stabilising role in the future.

Czech Republic

This year’s analysis divides the characteristics of the Czech economy as regards euro area entry into three groups:

1. Indicators suggesting a relatively low level of risk associated with potential euro adoption in the area analysed

These have long included the high degree of openness of the Czech economy and its close trade and ownership links with the euro area. These factors provide preconditions for the existence of benefits of euro adoption, such as a reduction in transaction costs and the elimination of exchange rate risk. The strong trade integration also fosters a high degree of cyclical alignment with the euro area; however, the alignment of the Czech business cycle has decreased somewhat in recent years. This group also includes the use of the euro in the Czech economy, which is gradually increasing but is concentrated mainly in the trade relations of the Czech business sector. Some indicators are also suggesting preparedness for adopting the euro as regards the adjustment mechanisms of the Czech economy. They include, for example, increasing labour market flexibility and a stable banking sector resilient to economic shocks.

2. Indicators with a neutral message

These include small differences in the level of interest rates from the longer term perspective and the overall similarity of monetary policy transmission in the Czech Republic and the euro area. The Czech Republic differs from the monetary union average in some financial indicators, but this cannot be considered a disadvantage or a fundamental barrier to euro adoption. The configuration of the tax and benefit system, which reduces the incentive for low-income groups in particular to return to employment, continues to reduce labour market flexibility. The Czech Republic’s competitiveness score is also neutral. The current Czech public finance situation contains positive and negative aspects. On the one hand, there is a favourable starting position and budget surpluses. On the other hand, however, fiscal policy has much more often been procyclical than countercyclical in past years.

3. Indicators suggesting economic risks associated with potential euro adoption in the area analysed

These include a still unfinished process of real economic convergence of the Czech Republic towards the euro area; lower structural similarity also persists. Misalignment of the Czech and euro area financial cycles would be a risk in the event of euro adoption. The main problem as regards the adjustment mechanisms of the Czech economy is public finance sustainability, as population ageing and increasing mandatory expenditure are reducing the room for fiscal policy to play a macroeconomic stabilising role in the future.

Euro area

The work of the EU and the euro area on deepening integration, especially in the area of economic and fiscal policies, has seen no substantial progress in 2019. In addition, all areas of European policy are being strongly affected by the UK’s process of withdrawal from the EU.

Economic growth in the euro area has slowed over the last year; moreover, a number of structural problems persist in the euro area. Fiscal problems in certain euro area member states and the vulnerability of their financial sectors also remain a risk. This shows that the euro area may not be an optimum currency area for all its member countries.

The euro area member states’ demand that countries wishing to enter ERM II must simultaneously join the banking union was also applied to Croatia this year. The impacts of this situation on the Czech Republic and other EU countries will have to be taken into account in the Czech Republic’s future decision on the timing of joining the monetary union.

Note for journalists:

The document Analyses of the Czech Republic’s Current Economic Alignment with the Euro Area (Alignment Analyses) assesses both the preparedness of the Czech economy to join the euro area and the economic and institutional situation of the euro area itself. However, it does not examine the overall advantages and disadvantages of adopting the euro and does not formulate recommendations on this step.

In line with The Czech Republic’s Euro-area Accession Strategy, the CNB together with the Czech Ministry of Finance regularly assesses progress in laying the groundwork for euro adoption. The result of this assessment is a joint document Assessment of the Fulfilment of the Maastricht Convergence Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro Area, based on the CNB’s Alignment Analyses. As the government decided last year not to assess the Czech Republic’s fulfilment of the criteria and its degree of alignment with the euro area again until 2020, the CNB prepared only a brief biennial edition of the Alignment Analyses this year.