Pain in the Czech Republic

Will Hodges reports from a country struggling to keep its changing economy growing

Up on Hradcany Hill, home to Prague Castle and centuries of Czech history, a flag flutters assertively over the Prague skyline. However, rather than the blue, white and red tricolour of the Czech Republic, the flag is the familiar green and white of what is arguably a far more prominent world power: Starbucks.

The US coffee shop business currently has seven outlets in the Czech capital, including this flagship store overlooking downtown Prague. The coffee has a distinctly American flavour to it, as do the prices. A caramel macchiato will set you back 115 koruna, equivalent to about £3.50.

Czech bounce

Scroll back 20 years and a visitor to Prague would have been met with a city with a very different feel.

In 1994 the Czech people were enjoying their first full year under a freely elected government, with the country having undergone a shaky transition to democracy following the disintegration of the Communist bloc in 1989.

There were no Starbucks outlets back then, or indeed many bucks to be had at all, as the capital had yet to become the mecca for international tourists it is today.

If the country was slow to embrace free-market principles back then, the two subsequent decades have more than made up for it. Walking the streets of the old town, you see little to connect the capital with its communist past - a grim 1960s tower block here, a Soviet-era monument there.

In fact, apart from the distinctive architecture, there is little to distinguish the city from that of any other European capital, with McDonald's, Subway and Tesco among the major global brands jostling for pavement space along the main street.

The coming of capitalism has been kind to the Czech Republic. A significant rise in income levels has been one of the main legacies of the transition to democracy, with GDP per capita growing by 390 per cent between 1990 and 2012 to just over $17,000 (£10,200) a year. To put that figure into perspective, UK growth over the equivalent period has been a little under 45 per cent.

Czech mates

Accession to the EU in 2004 is one of the main reasons for the country's rapid economic development. Membership has granted exporters unhindered access to major markets such as France and Germany, which combined now take 37 per cent of Czech exports.

Meanwhile, an ongoing privitisation programme has turned over a number of unprofitable state-owned assets - including banks and steelworks - to private bidders, allowing them to be more competitive on the global stage.

European integration has had its drawbacks for the Czech Republic, however. Having one's fortunes tied to those of France and Germany is a boon during the good times yet, like many eastern European states, the Czech Republic has found itself sucked into the economic crisis that has enveloped the eurozone.

The country's economy, undermined by falling exports and slowing tourist numbers, contracted by a hefty 4.5 per cent in 2009. It recovered, growing by 2.5 per cent the following year, only to shrink again in 2012 when it contracted by 1 per cent.

As the Czech government attempts to get the economy growing once more, a key weapon in its armoury has been not adopting the euro as the Czech national currency, which it originally planned to do in 2012.

In contrast to Ireland, Greece, Portugal and a multitude of other smaller EU states, the Czech government is able to manipulate its own currency, allowing it to keep the value of the Czech koruna low in order to stimulate exports.

At its current level, one koruna is worth about 0.037 euro, or 0.030 of a pound - a level at which Czech exports of steel and heavy machinery can remain competitive against those from neighbouring countries such as Poland and Ukraine.

The governor of the Czech National Bank (CNB), Miroslav Singer, has said he plans to keep the currency frozen at its current level for at least another 18 months and expects the weak valuation to add about 1 per cent to the country's GDP growth this year.

Poles apart

Overall growth (forecast by the CNB at more than 2 per cent for 2014) should put the Czech economy on a similar trajectory to that of its eastern European neighbours.

With the economy of the central and eastern Europe region still heavily linked to that of western Europe, the past few years have seen the majority of former Eastern Bloc states - Croatia, Bulgaria, Romania, Hungary, for example - suffer to a certain extent as the Czech Republic has done.

Only Poland has bucked the trend, and was the sole economy in the European Union to grow during the worst year of the crisis in 2009. Key to the country's success has been its ability to develop a large internal economy built on demand from local consumers rather than the needs of neighbouring states.

As business is booming, Poles, formerly famous for their migratory tendencies, have been heading home in their droves in recent years. Government estimates suggest that about 150,000 Polish workers left the UK during 2008-2009, lured by higher wages and improved job opportunities in Poland.

The Polish success story might provide a model for the Czech Republic and other smaller Eastern economies to follow: a strong export sector balanced with a thriving domestic economy supporting local companies. It may be time for Prague's macchiato drinkers to wake up and smell the coffee.

Eastern European economies in figures

Bulgaria

Population 7.4 million

GDP (2013) $51 billion (£30.7 billion)

GDP growth forecast (2014) 1.6 per cent

Croatia

Population 4.3 million

GDP (2013) $60.1 billion (£36.2 billion)

GDP growth forecast (2014) 1.5 per cent

Czech Republic

Population 10.5 million

GDP (2013) $196 billion (£117.9 billion)

GDP growth forecast (2014) 1.5 per cent

Hungary

Population 9.9 million

GDP (2013) $126.9 billion (£76.3 billion)

GDP growth forecast (2014) 1.3 per cent

Poland

Population 38.2 million

GDP (2013) $514 billion (£309.2 billion)

GDP growth forecast (2014) 2.4 per cent

Romania

Population 20.1 million

GDP (2013) $184 billion (£110.7 billion)

GDP growth forecast (2014) 2.2 per cent

Sources: CIA World Factbook, IMF

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