Czech Voters May Hinder Spending Cutbacks by Electing Minority Government

The Czech political future may look a lot like its recent past after this weekend’s election: a government without the political strength and will to cut the country’s 163 billion koruna ($7.8 billion) budget deficit.

The European Union member will probably emerge from the May 28-29 vote with a minority government or a coalition dominated by the Social Democrats, who promise to increase social spending, opinion polls show. The new administration will have to cut the fiscal gap in half by 2013 to meet EU requirements.

The deficit widened to 5.9 percent of gross domestic product last year, compared with the EU target of 3 percent, as the country’s deepest recession since the end of communism curbed tax revenue. The government plans to sell a record 280 billion koruna of bonds this year as Europe’s sovereign debt crisis drives up bond yields.

“Polls suggest that there will be no easy way to set up a functioning coalition,” said Jaromir Sindel, an economist at Citigroup Inc. in Prague. “We expect the koruna to weaken versus the euro in the short term, reflecting the uncertainty about the fiscal consolidation effort.”

The koruna has dropped 2.3 percent since reaching a 17- month high on April 14, the third-biggest drop among 25 emerging market currencies tracked by Bloomberg. Only the Polish zloty and Hungarian forint have fallen more. The koruna traded at 25.582 to the euro as of 5:25 p.m. in Prague, 0.3 percent stronger from yesterday’s close.

Instability

The Czech Republic has been ruled by 59-year-old Prime Minister Jan Fischer’s interim government for the past year. His predecessor, Mirek Topolanek, 54, of the Civic Democrats, lost a confidence vote in March 2009 over his handling of the economy.

The country has had two minority governments and two interim cabinets in the past 12 years. It took Topolanek seven months to form a government after the last elections in 2006.

“Risk of a hung parliament is very high,” Morgan Stanley analysts said in a May 24 note to clients. The possibility of “a long period of horse-trading” after the election “points to a high risk of policy paralysis,” they said.

Opinion Polls

The Social Democrats, who teamed with the Communist Party to push through increases in welfare spending in December, may win the most seats in the 200-member lower house, polls show.

A poll taken May 7 to May 12 by Factum Invenio showed the Social Democrats with 62 seats, and the Civic Democrats with 55. The poll of 1,004 people had the Communists with 28 deputies; Veci Verejne, which pledges to cut state administration, 26; TOP 09, a member of Topolanek’s cabinet, 21; and the Christian Democrats 8. Factum didn’t give a margin of error.

A May 17 poll by the researcher Stem showed the Social Democrats with 75 seats, followed by the Civic Democrats at 55, the Communists at 28, and TOP 09 and Veci Verejne with 21 each. The survey, based on responses from 1,257 people, has a margin of error of as much as 2.5 percentage points.

The Social Democrats promise to pay bonuses to pensioners and boost medical benefits, partly financed by dividends from state-controlled power company CEZ AS in Prague. While party leaders pledge to cut the deficit by raising taxes for wealthy residents and reducing spending on state administration, they plan to avoid rapid cuts to protect growth.

“If we simply take hasty savings actions, the economic crisis will return in some form,” Social Democrat leader Jiri Paroubek, 57, said May 19 at a party economic conference.

While the Czech economy is strong today, the “dynamics of indebtedness” will take over if the country doesn’t control the deficit, Civic Democrat leader Petr Necas said.

‘Greek Scenario’

“We are warning against a Greek scenario, which would happen if the promises of the Social Democrats and the Communists are realized,” Necas, 45, said in an interview.

The central bank and Finance Ministry have said the country needs spending cuts and higher taxes to reduce the shortfall. The next government will have curb expenditure and boost revenue by about 60 billion koruna in total in 2011 to meet the deficit target of 4.8 percent of GDP, Finance Minister Eduard Janota said in an interview with Hospodarske Noviny, published today.

“Putting fiscal policy on a sustainable basis” will require “spending restraint, particularly on pensions, health care and welfare benefits, and institutional changes to strengthen the fiscal policy framework,” the Organization for Economic Cooperation and Development said in its updated Economic Outlook, published today.

Credit Rating

The Czech Republic’s A1 credit rating, the fifth-highest investment grade, may be at risk if the vote fails to break the deadlock in parliament, said Dietmar Hornung, a senior sovereign risk analyst at Moody’s Investors Service, in a March 5 interview.

“The Social Democrats will try to form a coalition with some of the small parties, such as Veci Verejne,” said Bohumil Dolezal, a political scientist in Prague. “If that isn’t possible, then I see the most likely option as a minority Social Democrat government with the support of Communists.”

All parties with a chance to enter parliament have ruled out a formal coalition with the Communists.

The government postponed a planned sale of international bonds in April as concern that the Greek debt crisis might spread hurt demand for sovereign debt. The country last sold euro-denominated debt in April 2009.

The yield on that bond, due in 2014, rose to 2.969 percent yesterday in Prague, from 2.861 percent on April 21, the lowest since the security was sold. The premium investors demand for holding the Czech bond over German debt of similar maturity narrowed to 157.9 basis points, from a high of 161.9 on May 7, according to Bloomberg data.

“A situation when no political party would be able to form, in a reasonable time, a functioning government able to push through a budget next year that saves, is a risk,” analysts at Raiffeisen Zentralbank Oesterreich AG in Prague said in a note to investors. “A financial market reaction to unclear election results may be massive.”

To contact the reporter on this story: Peter Laca in Prague at placa@bloomberg.net

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