Main Development Trends in Czech Economy in 2012 and Outlook for 2013

(May 2013)

Czech Industrial Performance in 2012 in the Context of the EU Market and Outlook for 2013

Industrial Production Development in 2012

Industrial production surged by 10.3% in 2010 thanks to a strong recovery in Germany and the fact that the EU's other major economic powers rebounded as well. In 2011, however, a lower growth of global demand in individual quarters caused a gradual slowdown. Still, the growth of industrial production was relatively high, amounting to 6.5%. Production continued to grow slightly into the first quarter of 2012, but the rest of the year saw a gradual decline that clocked in at 1.5%, 2%, and as much as 3.9% in the second, third, and fourth quarters respectively. Overall, industrial production dropped by 1.2% in 2012.

The negative result was caused by deepening problems in the industrial sector sparked by sluggish foreign demand and a slump in demand on the domestic market. Problems faced by the European automotive industry caused by weak demand slowed down production in the Czech Republic's dominant sector; in 2012, the automotive industry accounted for 24.9% of industrial production.

Index of industrial production (annual% change)

Source: Czech Statistical Office, March 2013, graph MIT, Department for Economic Analyses

Production in the processing industry, which amounted to 46.5% of national production, grew in five sectors in 2012, specifically the manufacture of electrical equipment (5.8%), chemical substances and preparations (5.3%), coke production and crude oil refining (2.9%), manufacture of machinery and equipment (2.4%), and manufacture of motor vehicles (2.2%).

In contrast, production decreased in 18 sectors that accounted for 53.5% of total industrial production. The largest drop was recorded in the manufacture of computers, electronic devices, and optical instruments (11.8%), production of basic metals, metallurgy, and foundry production (9%), printing and reproduction of recorded media (8.6%), production of basic pharmaceutical products and preparations (7.4%), repair and installation of machinery and equipment (6.9%), wood

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2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

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processing and manufacture of wooden products (6.3%), and production of leather and related products (6.2%). The year-over-year decrease in production in other industrial sectors was lower.

Industrial production, employment and new orders, including trends (organizations with 50 or more employees, year-on-year changes in %)

Source: Czech Statistical Office, March 2013, graph MIT, Department for Economic Analyses

Weak economies and low industrial growth in the Eurozone, including Germany, took its toll on the

performance of the Czech industrial sector as well, considering the country’s close business and

economic ties with the rest of Europe. The correlation coefficient calculated for the period of January

2009 to December 2012 shows a strong link between the development of industrial production in the

Czech Republic and in the Eurozone (0.926) as well as between the Czech Republic and Germany

(0.908). Other countries in respect of which the Czech Republic’s correlation coefficient is high

include France (0.921), United Kingdom (0.905), Italy (0.903), Poland (0.897), and Slovakia (0.870).

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Industrial production in the Czech Republic, Germany and the Eurozone, including the trend

(year-on-year changes in %)*

Source: Czech Statistical Office, April 2013, graph MIT, Department for Economic Analyses

The decline in domestic industrial production affected the structure of production in key industrial sectors. Lower production translated into investment cutbacks in the corporate sector, particularly in the third and fourth quarters of 2012. Further, production dropped in the manufacture of non-durable goods (3.2%), production for intermediate consumption (2.4%), the manufacture of durable goods (1.5%), and energy generation (0.8%).

As regards the processing industry’s technology-intensiveness makeup, the medium high-tech sector

played the most important role, accounting for close to a half of revenues (49.5%). The sector's

revenues grew by 5.3%, and their share in the total income generated by the processing industry

increased year-over-year by 1.2 p.p. in 2012. The sector includes such prospering segments as the

electronics, chemical, automotive, and mechanical engineering industries. A slight growth of

revenues was recorded in the low-tech sector (1.8%); however, the sector's share declined by 0.2

p.p.to 15%. This sector includes less important segments, such as the food production, clothing

manufacture, leather manufacture, manufacture of wooded products, printing and reproduction of

recorded media, and furniture manufacture. Further, there was a slight increase in revenues

generated by the medium low-tech sector (1.2%), as the sector's share fell by 0.4 p.p.to 26.2%. This

sector includes segments that cater to the automotive industry (manufacture of rubber and plastic

products), metallurgy, manufacture of metal structures, coke production, crude-oil refining, and

manufacture of other non-metallic mineral products. A decrease in revenues was recorded in the

high-tech sector (3.7%), as the sector's share declined by 0.6 p.p.to 9.3%. The sector relies on

advanced technologies and generates high value added. Besides the sizeable computer

manufacturing segment, it includes the production of pharmaceutical products and preparations and

the manufacture of aircraft and aircraft engines.

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Development of manufacturing industry production by technological intensity of production

(y-o-y change in %, share in %, difference in pct. points)

CZ-NACE Revenues from

industrial activity

Share in

revenues of

manufacturing

industry

Share in

revenues of

manufacturing

industry

Difference

2011-2012

Manufacturing industry total 2,8 100,0 100,0 0,0

HIGH-TECH -3,7 9,9 9,3 -0,6

MEDIUM HIGH-TECH 5,3 48,4 49,5 1,2

MEDIUM LOW-TECH 1,2 26,6 26,2 -0,4

LOW-TECH 1,8 15,2 15,0 -0,2

Source: Czech Statistical Office, table by the Ministry of Industry and Trade, March 2013

The direction of future development is suggested by the overall quantity of contracts in the relevant sectors, which grew by 3.3% in 2012 (a 1.9 p.p. year-over-year decrease). Foreign contracts, which increased by 6.1% (year-over-year decline by 6 p.p.), accounted for the largest share (70.2%). Due to close economic ties, their development was affected by the situation in Eurozone countries, particularly Germany, the Czech Republic's most important trading partner that accounts for 31% of the total value of Czech exports. Domestic contracts declined by 2.9%.

In 2012, the growth of revenues generated by the processing industry (2,8%) and higher unemployment (0.2%) translated into a slight increase in productivity by 2.2%, which exceeded real-wage growth by 0.8 pp. This development resulted in a slight increase in nominal unit wage costs and a decrease in real unit wage costs. Productivity grew (17) in most of the aforementioned processing sectors, where the highest increases were recorded in coking and crude oil refining (17.5%) and the chemical industry (12.6%). Conversely, there were six sectors where productivity dropped: repair and installation of machinery and equipment (7.2%), printing and reproduction of recorded media (7%), pharmaceutical production and metallurgy (both 5.5%), manufacture of other non-metallic mineral products (3.2%), and manufacture of other means of transportation and equipment (3.1%).

Industrial Production Development Forecast for 2013

The end of 2012 was marked by a slowdown within the Eurozone, including the Czech Republic's most important trading partner – Germany, manifested by a weakening of foreign demand. Low foreign demand on the part of Eurozone countries continued to affect German industrial production into the first month of 2013. Due to the close ties, the development of Germany’s economy will have an impact on the Czech industrial sector as well.

Leading indicators recorded in foreign countries at the beginning of 2013 (Purchasing Managers Index [PMI] in Germany) suggest a gradual improvement; for instance, the PMI reached the 50.1 point mark in February 2013 and began to grow following close to a year of stagnation. According to the Munich-based Ifo Institute, the business climate in Germany has improved considerably as well, as the index continued to grow in February for a fourth month in a row. This trend suggests that the German economy may see a strong recovery in 2013, as opposed to its sluggish growth in 2012 that included a period of contraction at the end of the year. According to a survey targeting economic growth conducted by the Czech Statistical Office among a sample of industrial corporations, the business sector expects a slight growth of production.

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At the beginning of 2013, the German economy will have to deal with the EU-wide recession, but the second half of the year will see an increase in private consumption that will translate into higher production in Germany's key industrial sectors. According to the German central bank, Germany's industrial production will grow by 1.5% in 2013 depending on the development in the Eurozone and on the strong Asian markets, where the Chinese processing industry appears to be positioned to resume growth, having reached a 19-month maximum in December 2012. The forecast expects a production increase in Germany's key industrial sectors, specifically the automotive industry (2%), the electronics and chemical industries (both 1.5%), and the machining, mechanical engineering, and pharmaceutical industries (all 1%). The favorable development in German industry will result in an increase in Czech exports and large foreign contracts. The Czech economy will follow a similar trend, where recovery is expected to be sparked mainly by growing domestic demand.

Another important factor will be the development in the Czech automotive industry, the dominant sector that drives the entire economy and accounts for a quarter of total industrial production. Further, growth in this sector will spark an increase in production among its suppliers.

Individual carmakers are planning a number of new offerings for 2013. Skoda Auto has prepared seven innovations for the upcoming year, including four new models and facelifts of three existing models. The carmaker will gradually roll out several variants of the new generation of the flagship Octavia as well as modernized versions of the Superb, Superb Combi, and Yeti models. Unlike other manufacturers, Skoda Auto will not cut down investment costs and will go ahead with the planned construction of a new engine development center in Mladá Boleslav.

Hyundai will launch the production of a new three-door variant of the i30 model with a view to using up the full capacity of its facilities projected to allow manufacturing 300,000 cars a year. The least optimistic are prospects faced by the Kolín-based TPCA whose declining trend is expected to continue into 2013, as production will remain below 180,000 cars, where 270,000 automobiles were manufactured in 2011, and figures for 2012 are expected to reach 215,000. At the turn of the decade, as many as 300,000 cars were being made in Kolín annually.

According to officials from the Automotive Industry Association, to preserve the favorable development of demand for Czech automobiles, it will be necessary to concentrate focus on the developing markets in China, South and North Americas, and Russia, such as the manufacture of the Skoda Rapid model in Russia planned to begin in the spring of 2014.

In view of current developments and projected growth in the second half of the year, for 2013 we can anticipate a very slight decline in industrial output. The improving lead indicators from Germany show some promise for the future; the indicators for Czech industry are currently in preparation.

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Foreign Trade in 2012 and Foreign Trade Development Forecast for 2013

Foreign Trade in 2012

Despite the complicated economic situation in the Eurozone, the Czech Republic's balance of trade developed favorably in 2012. Trade surplus reached a record high CZK 310.8 billion, surpassing by CZK 119.7 billion the result achieved in 2011. Although the tempo at which foreign trade grew gradually declined in the course of the year due to decreasing demand for subcontracted production in both the Eurozone and the EU on the whole and due to lower domestic demand, exports and imports increased overall by 6.4% and 2.4% year-over-year, respectively.

Foreign Trade of the years 2000-2012 (current prices)

Source: Czech Statistical Office, April 2013, graph MIT, Department for Economic Analyses

The main factors that affected the balance of trade in 2012 were:

A slowing down of both the European and global economies and a culmination of the European debt crisis had a negative impact on the balance of trade particularly in the second half of the year.

A lasting weakness in demand on the part of domestic households caused by pessimistic consumer expectations slowed down imports.

There was a year-over-year decrease in industrial production caused by weak domestic and foreign demand.

As regards the development of exchange rates, the crown strengthened vis-à-vis the euro by 2.3% in 2012, as the EUR/CZK exchange rate reached 25.1. The increase in the value of the Czech crown vis-à-vis the US dollar was even higher ‒ 10.6%. The average USD/CZK exchange rate was 19.6.

Export and import prices grew by 2.9% and 4.2%, respectively, in 2012. Prices increased mainly due to the development of the cost of mineral fuels, where import prices grew by 15.7% on average. On the export side, the highest rise was registered in respect of

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CZK bn%

Balance (CZK bn) Export (annual change in %) Import (annual change in %)

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beverages and tobacco, where export prices increased by approximately 5.1%. The terms of trade for the entire year amounted to the negative value of 98.8%.

Import and Export Prices, Terms of Trade (%)

Source: Czech Statistical Office, April 2013, graph MIT, Department for Economic Analyses

The bulk of Czech exports and imports last year were exchanged within the European Union. In total, 80.8% of goods exported from the Czech Republic went to EU 27 countries, accounting for 64.1% of imports. Year-over-year, the Czech Republic's dependence on the EU therefore dropped by 2.2 p.p.; in absolute terms, exports to EU countries grew by CZK 85 billion. Conversely, there was a 0.3 p.p. year-over-year increase in imports from the EU, which translates into CZK 48 billion. Exports to other EU countries grew by 3.5% from the previous year, and imports strengthened by 2.8%. Thus, the balance of trade with EU Member States resulted in a surplus of CZK 710 billion, a CZK 36.6 billion increase over the result achieved in 2011. As in the past, Germany was the most important trading partner.

In 2012, the highest trade surplus was registered in transactions with Germany, as Czech exports to this country grew by 3.7% and imports strengthened by 0.7% from the preceding year. The trade surplus amounted to CZK 266.9 billion, a year-over-year increase by CZK 29.4 billion. Slovakia was the second most important country as regards net exports. Trade surplus with Slovakia amounted to CZK 109.5 billion, a CZK 5.0 billion increase over 2011. The five countries with which the Czech Republic achieved the highest trade surplus also included the United Kingdom (CZK 94.7 bil.), France (CZK 68.5 bil.), and Austria (CZK 53.1 bil.).

Conversely, trade deficit was recorded with countries from outside the EU. The worst result was recorded in trade with China, where deficit amounted to CZK 271.9 billion. This figure, however, is CZK 33.1 billion lower than trade deficit incurred in Czech-Chinese trade in the previous year. The second largest trade deficit was registered in exchange with South Korea (CZK 49.8 bil.), a worsening by CZK 9.9 billion compared to the preceding year. Further, high deficits were incurred in trade with Japan (CZK 42 bil.), Russia (CZK 34.7 bil.), and Azerbaijan (CZK 29.3 bil.).

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1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

2008 2009 2010 2011 2012

Export prices Import prices Terms of trade

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Foreign trade by regions in 2012 (2012 preliminary data)

*) China, North Korea, Cuba, Laos, Mongolia, Vietnam

Source: Czech Statistical Office, table by the Ministry of Industry and Trade, March 2013

Foreign trade by selected countries in 2012 (2012 preliminary data)

Source: Czech Statistical Office, table by the Ministry of Industry and Trade, March 2013

As regards the commodity structure, machinery and means of transportation accounted for the largest part of the favorable foreign trade results. Their share in exports and imports amounted to 54.2% and 41.3%, respectively, only slightly less, by 0.3 p.p. and 0.6 p.p., than in 2011. The exports of these commodities increased by 5.4% year-over-year and imports grew by 0.9%; the result was a trade surplus of CZK 523.97 billion.

Annual EXPORTS Annual IMPORTS Annual

change change change 2011 2012

Indicator CZK mil. Share v % in % CZK mil. Share v % in % CZK mil. Share v % in % CZK mil. CZK mil.

Total 5 814 797 100,0 4,5 3 062 779 100,0 6,4 2 752 018 100,0 2,4 191 128 310 760

Developed market economies 4 678 555 50,5 4,1 2 698 506 88,1 4,7 1 980 049 71,9 3,2 659 011 718 457

EU countries 27 4 237 172 72,9 3,2 2 473 592 80,8 3,5 1 763 581 6401,0 2,8 673 446 710 011

EFTA countries 126 838 2,2 7,8 67 568 2,2 4,8 59 270 2,2 11,4 11 247 8 297

Other developed market countries 314 545 5,4 15,3 157 347 5,1 27,4 157 198 5,7 5,4 -25 682 148

Developed countries 336 898 5,8 11,0 124 703 4,1 16,2 212 195 7,7 8,1 -88 918 -87 492

European transition economies 37 585 0,6 3,0 24 226 0,8 -2,6 13 359 0,5 15,0 13 246 10 867

Commonwealth Independent States 400 036 6,9 15,2 175 668 5,7 30,7 224 368 8,2 5,4 -78 547 -48 700

Other *) 347 072 6,0 -6,9 35 458 1,2 12,5 311 615 11,3 -8,7 -309 864 -276 157

OECD countries 4 653 833 80,0 5,4 2 642 879 86,3 5,9 2 010 955 73,1 4,8 577 002 631 924

TURNOVER BALANCE

2012 2012 2012

2011 2012Annual

change

CZK mil. in % CZK mil. in % CZK mil. in %

Austria 229 583 10 306 4,7 3,9 141 379 10 715 8,2 4,6 88 203 -354 -0,4 3,2 42 156 53 176 11 019

Belgium 119 802 596 0,5 2,1 72 806 1 567 2,2 2,4 46 996 -1 008 -2,1 1,7 23 245 25 811 2 566

China 337 198 -26 947 -7,4 5,8 32 697 3 187 10,8 1,1 304 500 -30 115 -9,0 11,1 -305 011 -271 803 33 208

Germany 1 655 594 38 803 2,4 28,5 961 418 34 303 3,7 31,4 694 177 4 825 0,7 25,2 237 470 267 241 29 771

Spain 104 426 -1 055 -1,0 1,8 61 224 -184 -0,3 2 43 202 -882 -2,0 1,6 17 323 18 022 699

France 241 217 -1 945 -0,8 4,1 154 953 -1 407 -0,9 5,1 86 264 -433 -0,5 3,1 69 662 68 689 -973

United Kingdom 201 923 20 988 11,6 3,5 148 288 18 097 13,9 4,8 53 635 2 844 5,6 1,9 79 379 94 653 15 274

Hungary 133 333 9 533 7,7 2,3 69 540 4 852 7,5 2,3 63 793 4 616 7,8 2,3 5 502 5 746 245

Italy 216 953 -7 172 -3,2 3,7 109 760 -9 415 -7,9 3,6 107 193 2 307 2,2 3,9 14 233 2 568 -11 665

Japan 69 747 4 502 6,9 1,2 13 874 3 559 34,5 0,5 55 873 934 1,7 2,0 -44 618 -41 999 2 619

Netherlands 192 930 3 597 1,9 3,3 98 761 -2 845 -2,8 3,2 94 169 6 570 7,5 3,4 14 006 4 593 -9 414

Poland 379 416 21 138 5,9 6,5 185 973 4 536 2,5 6,1 193 442 16 783 9,5 7,0 4 811 -7 469 -12 280

Russian Federation 275 838 40 280 17,1 4,7 120 535 27 887 30,1 3,9 155 303 12 298 8,6 5,6 -50 312 -34 768 15 544

Slovakia 438 557 27 923 6,8 7,5 274 036 16 483 6,4 8,9 164 521 11 478 7,5 6,0 104 488 109 515 5 027

USA 131 472 23 175 21,4 2,3 70 119 14 203 25,4 2,3 61 353 8 959 17,1 2,2 3 520 8 766 5 247

CZK mil.Annual change

Country

Turnover Export Import Balance

2012 2012 2012

CZK mil.Annual change Share in

%CZK mil.

Share in

%CZK mil.

Annual change Share in

%

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Comodity structure of foreign trade in 2012 (2012 preliminary data)

Source: Czech Statistical Office, table by the Ministry of Industry and Trade, March 2013

According to the ownership change methodology (national concept), exports strengthened by 7.2% and imports grew by 4.5% from the previous year. The trade balance was in a surplus of CZK 74.7 billion.

Foreign Trade Development Forecast for 2013

Growth in foreign trade for the Czech Republic in 2013 will depend mainly on the further course of the European economic recession. According to the latest results of research from March and April, we have to say that optimism was higher at the beginning of the first quarter than at the beginning of the second. Any slowdown in economic growth has the tendency to overflow into economies which until now have been healthy. Currently the necessary positive impulses are not coming even from Germany. However, economic activity outside Europe is also slowing down. In view of the overall unfavourable economic position we should expect better results only from the second half of this year.

The March foreign trade results have not unfortunately brought any major improvement. According to Czech Statistical Office provisional figures, Czech foreign trade in March remained at a surplus of 32.3 bn CZK, a year-on-year reduction of 4.1 billion. However, the high value of the trade surplus is rather the result of a marked decline in imports than of an increase in exports. Although the foreign trade balance appears optimistic, this is not the case for the March import and export figures. According to the provisional figures both exports and imports showed year-on-year reductions, export by 7.1% and imports by 6.5% The reasons for this are still the same. On the export side, the worsened economic situation in the eurozone and in economies outside Europe continues, while for imports, domestic demand continues to be weak.

Annual Annual

change change 2011 2012

Indicator CZK mil. Share in % in % CZK mil. Share in % in % CZK mil. CZK mil.

Total 3 062 779,0 100,0 6,4 2 752 018 100,0 2,4 191 128 310 760

of which:

0 Food and live animals 107 360 3,5 17,5 136 295 5,0 10,7 -31 807 -28 935

1 Beverage and tabaco 19 695 0,6 15 18 716 0,7 14,5 776 979

2 Crude materials 85 266 2,8 5,5 78 561 2,9 -1,9 783 6 705

3 Fuels and related products 118 241 3,9 7,9 304 789 11,1 6,5 -176 647 -186 548

4 Animal and vegetable oils, fats and waxes 9 121 0,3 91,9 5 230 0,2 -11,4 -1 152 3 891

5 Chemical and related products 188 503 6,2 4,6 307 383 11,2 4,7 -113 524 -118 880

6 Manufactured goods classified chiefly by material 529 042 17,3 4,2 490 583 17,8 0,1 17 652 38 459

7 Machinery and transport equipment 1 661 071 54,2 5,4 1 137 110 41,3 0,9 449 475 523 961

8 Miscellaneous manufactured articles 340 133 11,1 10,7 266 060 9,7 2,5 47 687 74 074

9 Not specified 4 348 0,1 23 7 293 0,3 29,1 -2 112 -2 945

EXPORTS IMPORTS BALANCE

2012 2012

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