Czechs Yearning for Growth Set to Abandon Merkel Path

Czechs are ready to ditch austerity and ask their government to spend after three years with an administration that never wavered from German Chancellor Angela Merkel’s recipe of budget-deficit cuts.

The Social Democratic Party, promising to kickstart growth by stepping up outlays financed by higher taxes, is poised to win next month’s election to replace the government that called debt public enemy number one. While outdoing Germany on budget cuts helped push borrowing costs to the lowest in emerging Europe, the economy is on course to be the only one of the four largest eastern European Union members to shrink this year.

Merkel’s disciples kept the country on the austerity path until a spying scandal toppled Prime Minister Petr Necas’s cabinet in June. Now, polls show that voters are set to propel the opposition Social Democrats to power next month, joining an electoral trend that has ousted leaders from Spain to Finland since Europe’s debt crisis started nearly four years ago.

“The’ve actually been more German than the Germans,” Daniel Hewitt, an economist at Barclays Plc in London, said by phone Sept. 17. “There seemed to have been some sort of fiscal obsession. The lower yields could be seen as an achievement, but I think the austerity push was overdone.”

Bonds Gain

Czech deficit reduction has helped secure the highest rating in the post-communist EU at Moody’s Investors Service and Standard & Poor’s, on par with euro-region member Estonia. It also boosted government bonds to record highs.

The yield on the Czech government’s 10-year koruna bond has risen since reaching an all-time low of 1.48 percent in May, along with a pullback from emerging-market assets as investors braced for the prospect of the U.S. Federal Reserve paring its stimulus. The yield dropped 11 basis points, or 0.11 percentage points, to 2.25 percent as of 1:40 p.m. in Prague today after the Fed refrained from cutting its bond purchases.

Czech borrowing costs have increased less than those of neighboring Poland, the EU’s largest eastern economy, and are holding below comparable U.S. Treasuries, according to data compiled by Bloomberg.

The government in Prague undershot deficit targets in 2011 and 2012 by curbing investments and raising the value-added tax. During a visit to Prague in April 2012, Merkel praised the Czechs for making progress toward meeting the EU budget-deficit limit of 3 percent of economic output.

“This can make the Czech Republic an example” for other EU countries, Merkel said.

German Election

Merkel is set to win the backing of Germans in an election Sept. 22, polls show. Support for her Christian Democratic bloc held at 39 percent in a weekly Forsa poll for Stern magazine published Sept. 18, compared with 25 percent for the Social Democrats. Forsa polled 2,502 voters on Sept. 10-16. The margin of error was as much as 2.5 percentage points.

In the Czech Republic, the policies she praised frustrated the public and damped private consumption, exacerbating the economic contraction.

The previous government’s stance was “very restrictive and choked economic growth,” interim Finance Minister Jan Fischer said in an interview at Bloomberg’s Prague office today.

“Nobody was trying to find a new paradigm of economic and fiscal policies,” Fischer said. “The only paradigm was savings, savings, savings, and nothing else.”

Spending Dips

The austerity measures cut into disposable incomes and, combined with a traditional Czech aversion to debt that kept deposits more than 30 percent above loans, prompted the biggest decline in private spending among EU members outside the euro area last year, according to European Commission data.

That hurt profit at businesses from utilities to steelmakers. CEZ AS, the country’s largest power producer, reported a 16 percent drop in second-quarter net income as the recession eroded demand for electricity and dragged down power prices.

The government may have overestimated people’s understanding the necessity of deficit reductions, said Miroslav Kalousek, who was finance minister in Necas’s cabinet from 2010 until this year.

“I accept this criticism, and very often I worry in the evenings about what I should have said differently; whether I wasn’t scaring people too much in some situations,” Kalousek said in an interview with Reflex magazine, according to a transcript on the website of his TOP09 party.

Election Race

TOP09, a member of the previous three-way ruling coalition, may not be in a position to remedy the fiscal tightening after the Oct. 25-26 election.

The Social Democrats have 21.9 percent support, compared with 10.5 percent for the communist party and 9.1 percent for TOP09, according to the Prague-based polling company Stem, which surveyed 1,093 people Aug. 29-Sept. 8. The poll had a margin of error of 2 percentage points for smaller parties and 3 percentage points for larger parties.

The Social Democrats pledged to keep the public-finance deficit, the fiscal yardstick for assessing an EU member’s readiness to join the euro, below the 3 percent limit.

The party’s priorities, which include higher taxes for banks, telecommunications companies and energy utilities, will probably form the core of the next government’s program, said Otilia Dhand, an analyst at Teneo Intelligence, a London-based political risk evaluator.

‘Fiscal Responsibility’

“On the fiscal front, the CSSD is committed to fiscal responsibility despite its critique of spending cuts under Necas,” Dhand said by e-mail. “It will look to restore or enhance some social spending at the cost of increased personal-income taxation for top earners, changes to capital gains taxes and, potentially, taxation of regulated industries.”

The $196 billion economy in the second quarter exited the recession that lasted for six quarters, which was the longest decline since records started in 1996. Still, household and government consumption declined in the April-June period. Gross domestic product will drop 0.4 percent this year, one of two EU economies outside the euro area along with Croatia to shrink, according to the European Commission.

Taking power “sooner rather than later” would allow the new government to boost growth by softer spending restraint, according to Mohammed Kazmi, an emerging-markets strategist at Royal Bank of Scotland Group Plc. in London.

“Such a relaxation of fiscal austerity measures would be a welcome relief for growth,” Kazmi said by e-mail yesterday.

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