No Pain, No Gain

Czech economy recovering from banks' reluctance to face difficult reforms.

Without a doubt, Skoda Auto is the Czech Republic's industrial star. Accounting for 9.6% of the country's exports, Skoda is the largest Czech manufacturer and has helped the automotive-supply industry in the Czech Republic become a major force in the emerging markets of central and eastern Europe. Unfortunately for the Czech Republic, few former state-owned industries have come close to emulating the success of Skoda. In fact, the automaker's former sister, the once-mighty Skoda Plzen, is in grave danger of crumbling, and the company's board has turned to a 31-year-old chief executive in a desperate bid to keep the company alive. The other Skoda, explains Skoda Auto's Chairman, Vratislav Kulhanek, ran into trouble because "the former government of the Czech Republic preferred sale of the company to 'Czech hands' instead of offering it to a prospective strategic partner" such as Siemens. Those "Czech hands" were state-run banks that the Organization for Economic Cooperation and Development blames for the recession that hit the country in 1997. The banks, says the OECD, "provided relatively easy access to credit," which, in conjunction with "largely unregulated capital markets and confused corporate governance," dealt a debilitating blow to the country's economy. Once the best-off of the former Soviet satellites, the Czech Republic saw its gross domestic product drop by 2.3% in 1998, with unemployment jumping from a 1997 figure of 4.8% to a rate of 9% in the first quarter of 1999. In the last five quarters, there have been signs of recovery. Exports began to rebound in the middle of 1999 and the most recent GDP figure showed a first-quarter increase this year of 4.4% -- significantly higher than the 2% expected by most analysts. What led to the downturn, say analysts, was the former government's refusal to take the short-term pain required to restructure the Czech economy. And a chief problem there was the failure to privatize the state-owned banks. That privatization finally got under way last year, with the sale of the first of the four major state banks, Ceskoslovenska Obchodni Banka AS, to a foreign partner. The Czech government now is trying to sell off the other three, but that may turn out to be a difficult proposition because of the number of bad loans the banks are carrying in their portfolios. That's one problem the Czech economy faces. But the OECD, in a report issued earlier this year, cited three main challenges Czechs must overcome if they are to see a sustained recovery. First, says the OECD, there has not been enough business investment. Figures released in June indicated that investment jumped by 2.2% in the first quarter after declining for nearly three straight years. Next, the Czech government and people need to endure the short-term pain of restructuring in favor of long-term growth. And finally, the OECD says, the Czech economy is especially vulnerable to exchange-rate fluctuations, since its economy essentially lives or dies on the strength of exports. Exchange-rate uncertainty could be all but erased if the Czech Republic is accepted into the European Union, but that is unlikely to happen before 2003 at the earliest.

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