Rating Action: Moody's affirms the Czech Republic's Aa3 ratings and maintains stable outlookGlobal Credit Research - 05 Feb 2021Frankfurt am Main, February 05, 2021 -- Moody's Investors Service ("Moody's") has today affirmed the Government of the Czech Republic's long-term issuer and senior unsecured local and foreign currency debt ratings at Aa3 and maintained the stable outlook.Concurrently, Moody's has affirmed the Czech Republic's senior unsecured foreign currency MTN programme rating at (P)Aa3, and the other short-term foreign currency rating at (P)P-1.The key drivers for the rating action are:(1) Despite the severe coronavirus pandemic-induced growth shock in 2020, the Czech Republic's medium- to long-term economic resiliency remains strong;(2) The Czech Republic entered the crisis with a low debt level and strong debt affordability, and overall fiscal strength will stay solid despite an increase in the debt burden over the coming three to four years.The stable outlook reflects the Czech Republic's inherent fundamental credit strengths and the low exposure to event risks, which are based on a resilient and stable banking sector, as well as strong government and external liquidity metrics.The Czech Republic's local and foreign currency country ceilings remain unchanged at Aaa. The three-notch gap to the sovereign rating is supported by the limited government footprint in the economy, the high degree of reliability and predictability of government actions, as well as low political risk. In addition, the very high capital account openness and moderate external indebtedness inform the zero notch gap between local currency and foreign currency ceiling. These ceilings typically act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.RATINGS RATIONALERATIONALE FOR AFFIRMING THE Aa3 RATINGSFIRST DRIVER: ECONOMIC RESILIENCE REMAINS STRONG DESPITE GROWTH SHOCKThe first driver of affirming the Czech Republic's Aa3 ratings is based on the country's medium- to long-term economic resiliency. Fundamentally, the Czech Republic compares favourably to similarly-rated peers and those at comparable economic strength levels. Moody's does not expect significant permanent scarring from the pandemic, and the economy will return to its pre-crisis real GDP level by 2022. Compared to its close rating peers -- particularly Belgium and the United Kingdom -- the Czech Republic has a stronger potential growth rate, which the Czech National Bank estimates at around 3%.Following a sharp contraction in real GDP growth in 2020 of almost 6%, the Czech economy will start recovering from the second half of 2021, and Moody's forecasts real GDP growth to average 3.2% in 2021 and 2022. The Czech Republic's expected growth performance will be broadly in line with that of its close peer group median. In Moody's view the recovery in consumption will be faster (potentially reaching the Q4 2019 level during the second half of this year already), while the recovery in investment growth could take well into 2023.The Czech Republic has a high share of manufacturing in gross value added (25% in 2019), and particularly automotive. This is slightly lower than for Korea and Taiwan, but higher than for Germany and other European peers. While there was a sharp contraction in manufacturing industrial production during the first wave of the pandemic, Czech industry recovered very quickly once the lockdown measures were lifted, underlining the sector's flexibility and competitiveness.Government restrictions in response to elevated infection rates since the autumn of 2020 will remain in place for at least the first quarter, and the rebound in economic activity will remain dependent on pandemic developments, as well as effective administration of the vaccination programme. Downside risks to the growth outlook remain and the evolution of business and consumer confidence, as well as developments in the Czech Republic's main trading partners and particularly Germany will be crucial in 2021 and beyond.SECOND DRIVER: AMPLE FISCAL SPACE SUPPORTS FISCAL STRENGTH IN LIGHT OF RISING GOVERNMENT DEBT BURDENThe second driver of today's rating action is based on Moody's expectation that the Czech Republic's overall fiscal strength will stay solid, despite the expected significant increase in the debt burden over the coming three to four years. The Czech Republic's low government debt burden of only 30.2% of GDP in 2019 provides fiscal space for government support measures, which amounted to an available envelope of around 20% of GDP in 2020, consisting of direct fiscal measures and sizable guarantees. That said, only 60% of the direct support envelope was actually paid out, and 8% of the announced guarantees were demanded by companies, resulting in only 2.7% of GDP of direct fiscal support and 1.1% of GDP in guarantees being used.Moody's estimates that the Czech Republic's general government debt ratio has increased to 37.5% of GDP by the end of 2020, reflecting significant borrowing increases in light of the large stimulus package and due to declining nominal GDP as result of the economic shock.Mainly due to the general elections in October 2021, Moody's does not incorporate any meaningful fiscal consolidation measures into its projection. Fiscal deficits will therefore stay sizable (at around 6% of GDP in 2021 and 2022), and the debt-to-GDP ratio will continue to rise to 45% in 2022 and above 48% by 2024. This means that the Czech Republic's debt burden as a share of GDP will deviate from the Aa3-rated median of 34.9% of GDP in 2020. Having said that, the Czech Republic's debt affordability will remain strong, and its relative position compared to its peers will not deteriorate significantly. Moody's forecasts average annual interest payments-to-revenues of 1.8% during 2020-24, below the Aa3-rated median of 2.4% over the same period.RATIONALE FOR THE STABLE OUTLOOKThe stable outlook reflects the Czech Republic's inherent fundamental credit strengths and the low exposure to event risks, reflecting the resilient and stable banking sector, as well as strong government and external liquidity metrics.Czech banks are well-capitalized, highly liquid and the share of NPLs has remained low in 2020, although some increase is expected in 2021 and 2022. Overall, there are limited risks of contingent liabilities from the banking sector for the sovereign. Strong demand for residential real estate and the limited supply of new flats pushes up prices and according to estimates by the Czech National Bank apartment prices are overvalued by around 17%. However, there are no visible imminent threats to financial stability, and the private sector shows only very limited foreign currency exposure.The Czech government has strong market access and no difficulties in funding its borrowing needs in domestic and international markets. In addition to market access, the government has a sizable liquidity buffer in the single treasury account (about 7% to 8% of GDP in 2020), and has access to EU funds under the Next Generation EU facility, with grants amounting to about 3% of GDP for the three years 2021-23. Given its favourable funding conditions, the Czech government decided not to utilise loans under SURE, the EU's unemployment support scheme, in 2020.Moreover, the Czech Republic does not face external liquidity pressures. Moody's expects a large current account surplus of close to 4% of GDP in 2020, reflecting the dampening effect on imports from the coronavirus pandemic, strong export competitiveness and narrowing of the primary income deficit. Foreign direct investment into the country has continued in 2020, albeit at a lower level than in previous years, but nevertheless underlining its attractiveness as an investment destination. As a result, the Czech Republic's net international investment position has further improved, reaching a net liability position of only 12% of GDP (based on data for the first three quarters), up from above 20% in 2019.ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONSThe Czech Republic's ESG Credit Impact Score is neutral-to-low (CIS-2), reflecting low exposure to environmental and social risks, and a very strong governance profile that supports the capacity to respond to shocks.The Czech Republic's overall E issuer profile score is neutral to low (E-2), reflecting low exposure to environmental risks across all categories.Moody's assesses the Czech Republic's S issuer profile score as neutral to low (S-2), reflecting low exposure to social risks across most categories. Demographic change in the form of relatively fast population ageing poses a long-term fiscal sustainability challenge to the Czech Republic and entails a moderately negative social risk. Without further pension and healthcare reforms the very strong government balance sheet could deteriorate significantly from the mid-2030s. While overall unemployment rates are low, persistent skills mismatches could lead to rising challenges for new entrants to the labour market and labour and income considerations therefore pose a moderately negative social risk as well.The Czech Republic's strong institutions and governance profile support its rating and this is captured by a positive G issuer profile score (G-1). The country has an overall strong institutional framework (despite some concerns about the control of corruption). The Czech Republic also benefits from independent and high-quality monetary policy, and fiscal policy formulation and implementation are overall prudent and transparent. Coupled with high wealth levels and a strong government financial position, this supports a high degree of resilience, mitigating further already low E and S risks.GDP per capita (PPP basis, US$): 42,670 (2019 Actual) (also known as Per Capita Income)Real GDP growth (% change): 2.3% (2019 Actual) (also known as GDP Growth)Inflation Rate (CPI, % change Dec/Dec): 3.2% (2019 Actual)Gen. Gov. Financial Balance/GDP: 0.3% (2019 Actual) (also known as Fiscal Balance)Current Account Balance/GDP: -0.3% (2019 Actual) (also known as External Balance)External debt/GDP: [not available]Economic resiliency: a1Default history: No default events (on bonds or loans) have been recorded since 1983.On 2 February 2021, a rating committee was called to discuss the rating of the Government of the Czech Republic. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed. Other views raised included: The issuer's institutions and governance strength, have not materially changed.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSWHAT COULD CHANGE THE RATING UPA positive rating action seems unlikely over the next two years, given the expected further weakening in key credit metrics. Having said that, a clear focus on comprehensive social security system reform, including old age pensions but also health and long-term care, that contains the projected rise in old-age related spending would be positive for the Czech Republic's credit profile. Similarly, signs that the economy moves into a higher value-added, innovation-driven stage together with faster-than-currently expected income convergence with higher-rated peers would also support a change in the outlook to positive, and could ultimately lead to a rating upgrade.WHAT COULD CHANGE THE RATING DOWNThe formulation and implementation of a strategy to reduce fiscal deficits and stabilize or lower the government debt burden will be key for the Czech Republic's rating trajectory after 2022. Fiscal deterioration beyond the current baseline expectations would be credit-negative and could lead to a change in outlook to negative from stable. Similarly, a weakening in the Czech Republic's economic strength, or a significant rise in event risk exposure would be negative for the rating.The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. 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