In a Bad Neighborhood, the Czech Republic Becomes Investor Haven

Incoming Czech Prime Minister Bohuslav Sobotka Interview

The headquarters of the Czech government stand in Prague.

Photographer: Martin Divsek/Bloomberg
  • It's got problems, but looks good versus Poland and Hungary
  • A strong “degree of trust by investors in Czech institutions”

The Czech president this week quipped that he might settle his differences with the prime minister “with a Kalashnikov.” The country’s finance minister is a billionaire who sees no conflict of interest in controlling a chemical and media empire. And communists who advocate an exit from NATO are the third-most-popular party. In the Czech Republic’s neighborhood, that counts as stability.

The land-locked nation of 10.5 million has cemented its position as central Europe’s biggest draw for capital as populist governments consolidate their control in Hungary and Poland. Investor confidence is so high that only four other countries -- Japan, Switzerland, Germany, and the Netherlands -- have lower 10-year borrowing costs.

Andrej Babis
Andrej Babis
Photographer: Martin Divisek/Bloomberg

Since the Czech Republic joined the European Union 12 years ago, its economy has doubled in size, unemployment has fallen to the lowest in the EU, and its currency has jumped by about a fifth against the euro. The largest businesses have been sold and are generating billions of dollars in revenue every year for owners such as Volkswagen AG and Societe Generale SA.

“Czech politicians have respected and welcome foreign investment in a way that hasn’t really happened elsewhere in the region,” said Peter Attard Montalto, an economist at Nomura Plc who follows the region from London. “There is a fundamental degree of trust by investors in Czech institutions and rule of law.”

With the country rebounding from recession, growth accelerated to an annual 4.7 percent in the third quarter, the third-fastest pace in the EU. That, combined with a narrowing budget deficit, is attracting more capital. Foreign holdings of Czech domestic bonds jumped 36 percent in the year to Nov. 30, government data show. That compares with Poland’s 5 percent increase and a 21 percent decline in Hungary during the same period.

It pays to have troubled neighbors. The yield on Czech 10-year sovereign bonds dropped to 0.63 percent in Prague on Thursday, trading 0.22 percentage point above German state securities of similar maturity. That compares with rates of 3.13 percent in Poland and 3.54 percent in junk-rated Hungary.

Polish markets slid after Standard & Poor’s on Jan. 15 cut the country’s credit rating, citing concern that its new leadership is weakening the independence of institutions such as courts and media. Following a victory in elections in October, the Law & Justice party has said it wants to finance increased welfare benefits with income from extra taxes on big banks and retailers. The plans echo policies of Hungarian Premier Viktor Orban, who in 2010 shored up the budget with levies on selected businesses, mostly foreign-owned.

That’s not to say the Czech Republic is an investor paradise. Sure, the cobblestone lanes of its medieval capital, Prague, draw about 6 million tourists a year and the country is one of the world’s top auto manufacturers in per capita terms, churning out almost twice as many vehicles as Italy last year. But given today’s political culture, it seems fitting that Prague was Franz Kafka’s hometown.

Disgruntled Citizens

While the current two-year-old administration has outlasted the average life expectancy of a Czech government, the coalition has gotten bogged down in bickering over spending priorities, tax policies and the path to euro adoption. The squabbling made headlines on Jan. 26 when President Milos Zeman joked that if elections failed to remove Prime Minister Bohuslav Sobotka, “an undemocratic option would be with a Kalashnikov.” (A Zeman spokesman called the comment “hyperbole.”)

The other leader of the coalition is Andrej Babis, a former Communist-era trade official and the country’s second-wealthiest citizen, with a fortune of at least $2.2 billion, according to the Bloomberg Billionaires Index. In 2011, Babis created an upstart party called ANO -- the Czech word for “yes” and an acronym that stands for Action of Disgruntled Citizens. After Babis spent lavishly on advertising in elections two years later, ANO finished second, elevating its founder to the post of finance minister.

Babis campaigned against what he said was rampant corruption. Since taking the government post, he has spurned allegations of conflicts of interest and rejected calls from Prime Minister Sobotka call to sell holdings in the chemical, food and forest industries as well as two of the largest national newspapers.

“It is counterproductive, and to some extent dangerous, when one of the richest people in the country not only holds high political positions, but also owns a media empire,” said Jiri Pehe, a top adviser to former president Vaclav Havel who now serves as director of New York University in Prague. “That’s where democracy faces the risks of oligarch power.”

Riverfront Palace

Babis doesn’t hide his impatience with parliamentary procedure; he has joked that firing half of the lawmakers would produce quicker results than the lengthy debates typical of the Baroque legislative chamber. But investors have praised his efforts to cut the budget deficit and his resistance to Sobotka’s proposals to raise corporate taxes.

The coalition government has boosted pensions and agreed to build more highways, but the Czech sovereign debt load, around 41 percent of economic output, is less than half the EU average. The budget, though, may come under pressure in coming decades because of an aging population, according to the Organization for Economic Cooperation and Development.

That isn’t fazing investors seeking steady returns and low risk. Despite frequent changes of leadership -- 13 cabinets have occupied the 19-century riverfront palace beneath Prague Castle since the partition of Czechoslovakia 23 years ago -- it’s the economic track record that counts, said Dmitri Barinov, a money manager in Frankfurt with Union Investment Privatfonds GmbH.

“Compared with Poland and Hungary, the Czech economy and its growth outlook are more closely tied to Germany,” said Barinov, who says Czech debt is popular with risk-averse clients. “Investors treat the country as a developed rather than an emerging market. Good, stable, but somehow boring.”