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German-Beating Czech Government Debt May Fall as Cabinet Spars Over Budget

Bickering within the Czech Republic’s ruling coalition may prevent the government from overhauling state finances, undermining investor confidence that has helped the country’s bonds outperform German debt.

Prime Minister Petr Necas in July pledged to cut the budget deficit after assembling the largest majority since independence in 1993 in a country plagued by political squabbling. Now the smallest party in his coalition is threatening to quit over appointments to the Cabinet, leaving Necas with a minority government. Party leaders will discuss the issue next week.

“We are priced as if they delivered everything they have said, and we know the internal divisions,” said Lars Christensen, chief emerging-markets analyst at Danske Bank A/S in Copenhagen. “It’s not going as fast as one could have hoped,” he said, adding that Czech yields may rise as much as 1 percentage point if the government program faces further delays.

The yield on five-year Czech government debt has risen 6 basis points to 2.785 percent in the past year, the third-best performance among European Union members, behind the U.K. and Hungary, according to data compiled by Bloomberg. The yield on German debt of similar maturity rose 90 basis points in the period.

Necas’ goals include overhauling the deficit-plagued pay- as-you-go pension system, boosting private savings for retirement, and revamping the state health insurance program. Progress has been slow.

‘Turbulence’ Not Favorable

While the coalition parties agreed that workers will be able to divert part of their mandatory pension insurance payments into private accounts beginning in 2013, the ministries have yet to draft the required legislation. The Cabinet will send laws overhauling spending to parliament by the end of June and will tie them to a confidence vote, Necas said April 19.

“Investors’ sensitivity to such events may rise in the coming weeks,” because “necessary fiscal reforms must be approved before the summer holidays,” said Jan Vejmelek, an economist at Komercni Banka AS in Prague, the Czech unit of Societe Generale SA. “The recent situation and turbulence on the political scene are not favorable for koruna investors.”

The Czech currency has weakened 2.1 percent against the euro since April 26, the first trading day after Necas said his government would have no reason to stay in power unless efforts to cut public spending were passed by the end of June. It was the biggest decline of all currencies of post-communist EU members in that period.

The koruna is still up 5.45 percent since the May 2010 elections, the best performance among 25 emerging-market currencies tracked by Bloomberg. It was little changed at 24.573 per euro as of 10:44 a.m. in Prague today.

The Czech Republic has a history of political infighting. The EU’s second largest ex-communist economy had two minority governments and two interim Cabinets in the past 13 years, stalling budget measures. In 2009, the administration of Mirek Topolanek lost a no-confidence motion halfway through the country’s six-month term as EU president.

Coalition Tensions

Tensions inside the Cabinet flared this month when the leader of Public Affairs, smallest of the three coalition parties, demanded that Necas dismiss Defense Minister Alexander Vondra and Finance Minister Miroslav Kalousek, saying the prime minister had interfered with his right to select his own team. Radek John quit as deputy prime minister on May 11, setting up a debate between leaders of the coalition next week.

Public Affairs may leave the coalition while continuing to support its legislative program, John said May 12. Necas says he expects the government to continue implementing its agenda.

“I strongly hope that political responsibility will prevail and the ruling coalition will focus on tasks it was elected to achieve, which means reforms,” Necas said May 20, after submitting John’s resignation to President Vaclav Klaus.

Coalition Support Wanes

The coalition parties may not want to trigger early elections because their popularity has declined since the 2010 elections, said Jiri Pehe, a political analyst and director of New York University in Prague.

Public Affairs would get 2.3 percent of the vote if elections were held this month, below the 5 percent needed to gain seats in parliament, according to a poll by Prague-based Stem conducted May 2-9. Public Affairs won 10.9 percent in last year’s elections.

Necas’ Civic Democrats were backed by 13.8 percent of those surveyed, compared with 20.2 percent during the elections. Support for TOP09, the third coalition member, was 10.3 percent, down from 16.7 percent. The poll of 1,219 people had a margin of error of 1.5 to 2.5 percentage points.

The three parties, which hold 115 votes in the 200-seat lower house of parliament, wouldn’t be able to form a majority government if elections were held today, according to the poll. The opposition Social Democrats were the most popular party in the poll, garnering the support of 27.8 percent of those surveyed, up from 22.1 percent last year.

The ruling parties “are rightly afraid of an election fiasco,” Pehe said.

‘Substantial’ Risks

While it is in the interests of the coalition parties to remain in government, government stability is a concern for investors, said Peter Attard Montalto, an economist at Nomura International Plc in London.

“The worry is that we see a slowing down of the reform process,” he said in a phone interview. “Political risks are substantial and questions about the momentum in fiscal consolidation are being raised.”

Moody’s Investors Service says threats to the government’s program are “relatively low.” Still, Moody’s is waiting to see progress before it raise the country’s A1 credit rating, the fifth-highest investment grade.

“We’ve taken on board the measures, we’ve taken on board the government’s commitment,” Anthony Thomas, a Moody’s analyst, said in a May 4 interview in Prague. “We just now want to see some delivery.”

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

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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