Boston, MA -- (SBWIRE) -- 05/21/2012 -- Core Views The Czech economy is highly exposed to the ongoing eurozone sovereign debt crisis via investment, banking and trade links. As such, we expect the ongoing slowdown in eurozone demand to translate to weaker exports out of the Czech Republic. Given that domestic demand remains firmly in the doldrums, the country's export-led recovery is likely to experience a sharp slowdown in 2012. While we remain broadly positive towards the Czech Republic's fiscal position given the ongoing commitment of the centre-right coalition government to fiscal austerity and the long-term sustainability of fiscal accounts despite ongoing intra-coalition ructions, we caution that the slowdown in economic activity in the country will make it increasingly difficult for the government to rein in the fiscal deficit. As such, we believe the coalition government will likely ease the pace of its austerity drive. That said, given that the lion's share of fiscal consolidation was front-loaded,we do not expect this to substantially affect the country's finances. The centre-right coalition government still has a highly fractious nature. Our view that re-shuffles in the composition of the coalition would likely occur in 2011 played out, with a number of resignations and new appointments to the cabinet. We expect the government to maintain cohesion in 2012 in the face of the increasingly inclement situation in the eurozone, which would make a collapse of the coalition government disastrous for the country's creditworthiness. However, with pressure on (and within) the coalition set to remain high, we cannot completely rule out a collapse of the government in 2012. Major Forecast Changes We have revised down our real GDP forecast for the Czech Republic to 0.8% in 2012 from 2.3% previously. The ongoing deterioration in the external environment, which has recently seen us forecast the eurozone economy to contract by 0.2% in 2012, will have a heavy impact on the Czech export-led economy. Further compounding a negative outlook is our revised view that consumer spending will remain in the doldrums for some time to come. We also highlight that risks to this outlook remain firmly to the downside. On the back of the worsening macroeconomic backdrop, we no longer believe that the government will be able to rein in the deficit below the 3.0% of GDP level mandated by the EU before 2014. We have revised our forecast for the fiscal deficit to come in at 3.7% of GDP in 2012 from 3.4% previously. We have revised downwards our forecast for average inflation in the Czech Republic to come in at 2.0% in both 2011 and in 2012, from 2.2% and 2.6% previously. Our expectation for weak domestic demand coupled with moderating commodity prices will work to keep inflationary pressures subdued in 2012. On the back of this revision, we have also revised down our rate expectations for 2012, now expecting the policy rate to remain on hold at 0.75% until 2013.
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