Klaus Eats Humble Pie

But his austerity moves may not help him

If pride goeth before a fall, then Czech Prime Minister Vaclav Klaus should have known better. Two years ago, he declared to the world that the economic transformation of the Czech Republic was complete. Since then, half a dozen banks have collapsed amid allegations of fraud. Shady deals and lax rules have scared off $500 million in portfolio investment. And a huge current account deficit of 8.6% of gross domestic product prompted currency traders to assault the Czech koruna, forcing the central bank to effectively devalue the currency by abolishing its trading band. "A little more humility is in order," says William Wallace, a Central European specialist at the London School of Economics.

A chastened Klaus is finally admitting that things haven't gone quite as planned. On May 28, he introduced a series of austerity measures to shore up the koruna--the second such package in two months. It's a rather vague pledge to cap wages until yearend and hike interest rates. If necessary, Klaus says, he's prepared to introduce import duties and nontariff barriers.

But having refused to intervene for so long, an about-face won't wash with the public now. Klaus's popularity has plunged to 14%, its lowest ever. "Klaus should say: `Sorry, I was wrong,' and make room for someone else," says Jiri Pehe, a political analyst with Radio Free Europe in Prague.

More humility may be in the offing. Klaus has called for a vote of confidence in the parliamentary session that will open on June 10. With the 200-seat chamber evenly divided between government and opposition members at 100 apiece, it will take only one dissenter to topple the ruling coalition.

That would give President Vaclav Havel, the former playwright and moral conscience of the country, three choices. He could dissolve parliament and call new elections--his least likely course of action. He could ask the main opposition, the Czech Social Democratic Party, to join a grand coalition government joining right and left. Or, in the most likely scenario, he could ask another senior member of Klaus's Civic Democratic Party, such as Deputy Premier and Foreign Minister Josef Zieleniec, to form a new cabinet. Havel has called on Klaus to resign but can't force him to do so unless his government loses a vote of confidence.

EXITS. Whoever takes the reins, the Republic needs a period of stability. Political infighting has brought policymaking to a halt ever since Klaus lost his majority in last year's parliamentary elections. Further chaos ensued when three cabinet ministers resigned in May, including two key members of his team--Trade & Industry Minister Vladimir Dlouhy and Finance Minister and Deputy Prime Minister Ivan Kocarnik.

Now, with Klaus's policy U-turn, all political parties agree on the need for belt-tightening. Even Richard Falbr, head of the Czech Chamber of Trade Unions, an umbrella organization with 2 million members, is on board. Although Falbr argues that workers are being forced to pay for the government's mistakes, he agrees that wage caps are necessary for now. "The direction is absolutely right," adds Susanne Gahler, senior economist with J.P. Morgan & Co. in London.

Nevertheless, Klaus's package still doesn't address the fundamental changes needed to put the economy on track. Interest rates shot up in the attempt to defend the koruna--one Czech bank is offering a 30% annual rate on a seven-day deposit. Until rates come down again, investment will remain depressed. Some analysts are predicting that the economy won't grow at all this year, after rising 4.4% in 1996. Unemployment is expected to hit nearly 6% by yearend--up from 3.8% now.

It was only a matter of time before Klaus's house of cards came tumbling down. Privatization via coupons in 1991, trumpeted as a way for all citizens to reap the benefits of capitalism, handed cheap shares to passive investment funds. But the funds had no interest in restructuring the companies they owned. Almost from the start, wage hikes of up to 70% outpaced productivity gains at many factories. Rising costs, combined with Klaus's fixation on a strong currency, hurt the competitiveness of Czech companies compared with their Polish and Hungarian rivals. At the same time, better-paid consumers demanded more goods. It was a one-two punch that pumped up the trade deficit and fatally undermined the currency.

Meanwhile, Klaus was slow to regulate the securities markets, which have been plagued by insider-trading scandals. Restructuring of state-controlled banks is also long overdue. As owners of investment funds, some banks have concocted secret deals and discriminated against small shareholders, damaging the Czech market's reputation.

As Czechs await the confidence vote, they're snapping up Japanese cd players and German cars before importers jack up prices. For some, such as Prague plumber Jaroslav Sulc, it's already too late. He wanted to buy his son a cassette player, but prices have jumped 20%, way above his budget. "You work hard, you save, and suddenly, the money men pull a trick," he grumbles. There's sure to be more where that came from.

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