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Rating Action:

Moody's upgrades Czech Republic's ratings to Aa3, changes outlook to stable from positive

04 Oct 2019

Frankfurt am Main, October 04, 2019 -- Moody's Investors Service ("Moody's") has today upgraded the Government of the Czech Republic's senior unsecured and long-term issuer ratings to Aa3 from A1 and changed the outlook to stable from positive.

Concurrently, Moody's has also upgraded the Czech Republic's senior unsecured MTN programme rating to (P)Aa3 from (P)A1. The related short-term rating was affirmed at (P)P-1.

The key drivers for the rating upgrade to Aa3 are:

- Czech Republic's fiscal strength metrics have further improved and compare now very favourably to rating peers.

- Government reforms focused on increasing the share of value-added in the industry and on fostering innovation across sectors, supporting Czech Republic's economic strength.

The stable outlook reflects Moody's expectation that the Czech Republic's fiscal strength indicators will remain resilient and in line with the median for Aa3-rated peers even under an adverse scenario. Moreover, the stable outlook balances intrinsic strengths in the Czech Republic's economic structure, as well as an overall strong institutional framework, with credit challenges that predominantly relate to the negative impact of an ageing society on long-term fiscal stability, as well as continued reform needs in order to maintain income convergence with more advanced economies similarly rated.

Moody's has changed the Czech Republic's long-term foreign currency bond ceiling to Aa1 from Aa2 and the long-term foreign currency deposit ceiling to Aa3 from A1. The short-term ceilings for foreign currency bonds and bank deposits remain unchanged at P-1. The long-term local currency country ceilings for bonds and deposits were changed to Aa1 from Aa2.

RATINGS RATIONALE

RATIONALE FOR THE UPGRADE TO Aa3

FIRST DRIVER: FISCAL STRENGTH HAS IMPROVED FURTHER AND COMPARES VERY FAVOURABLY TO Aa3-RATED PEERS

Debt burden and debt affordability metrics have become stronger than the Aa3-rated median and the positive trend in these key metrics is expected to be largely immune to potential downward revisions in growth forecasts. More specifically, the Czech Republic's debt burden is below the Aa3-rated median, and has also seen the sharpest reduction within the peer group of A1- and Aa3-rated sovereigns since 2012.

Even with lowered growth forecasts, Moody's expects the Czech Republic's government debt burden to decline further in 2019 and 2020, reach 30.8% of GDP by the end of 2020, and fall below 30% of GDP by 2023. Primary surpluses of 0.4% of GDP on average between 2019 and 2023 will be the main contributor to continued reduction in the debt burden, followed by a positive contribution from economic growth.

Czech Republic's debt burden indicators are broadly in line with those of Taiwan (Aa3 stable), and significantly stronger than those of Belgium (Aa3 stable). In general, Czech Republic's debt burden, when measured as share of revenues, as well as its debt affordability indicators, will be significantly stronger than the median for both A1- and Aa3-rated peers throughout the coming years.

Although Moody's expects both headline and structural fiscal balances to turn into small deficits of less than 1% of GDP over the coming years, Czech Republic's prudent fiscal policy framework and adherence to national and EU fiscal rules will in Moody's view prevent a significant deterioration. The strong fiscal framework (and adherence to its rules) is another area where the Czech Republic compares strongly to peers. This is also reflected in the government's gross borrowing requirements having halved as percentage of GDP between 2012 and 2018, whereas peer group medians have shown a deteriorating trend.

Together with very low contingent liabilities, and fairly low levels of non-financial public sector debt, Moody's views this as an important buffer in case of a growth or fiscal shock, but also puts the Czech Republic in a favourable position when it comes to the long-term fiscal sustainability pressures that the country faces from population ageing.

SECOND DRIVER: GOVERNMENT REFORM INITIATIVES SUPPORT CZECH REPUBLIC'S ECONOMIC STRENGTH

Aside from the very strong government balance sheet and fiscal flow indicators, the Czech Republic also shows further improvements with respect to its already high economic strength. Since 2013, both labour and total factor productivity growth rates have been outpacing the medians for A1- and Aa3-rated peers.

Overall, the Czech government has made some progress with structural reforms, broadly in line with European peers rated Aa3 or Aa2. Most relevant from a long-term potential growth perspective, the Czech Republic has made some progress in increasing labour market participation of underrepresented groups, and also some progress in strengthening the education system. Moody's research also shows that the Czech Republic exhibits only relatively limited structural reform gaps compared to the OECD average, mainly in areas such as labour market and innovation capacity.

In Moody's view, government initiatives, such as the Innovation Strategy and implemented changes to the Investment Incentives Act, have the potential to further strengthen Czech Republic's economic structure. According to the European Innovation Scoreboard or the World Economic Forum's Readiness for the Future of Production report the country is a moderate innovator and ranks in the upper-middle segment compared to EU peers. The innovation environment of the Czech Republic shows a number of basic strengths, but also areas for improvements, which the government aims to tackle with its new Innovation Strategy.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects balanced credit strengths and challenges at the Aa3 rating level. Moody's expects that fiscal strength indicators will remain resilient even under an adverse scenario, and in line with the median for Aa3-rated peers. Moreover, the stable outlook balances intrinsic strengths in the Czech Republic's economic structure, as well as a strong institutional framework with key credit challenges that predominantly relate to the negative impact of an ageing society on long-term fiscal stability and government debt sustainability, as well as continued reform needs in order to maintain income convergence with more advanced economies similarly rated.

In addition, exposure to event risks are low. Very small government gross borrowing requirements and the sovereign's strong market access at low cost limits government liquidity risks. Moody's forecasts small current account surpluses of around 0.6% of GDP over 2019 to 2021. Together with the improving net international investment position of close to -23% of GDP in 2018 (from -46% in 2010) this supports Moody's view of low external liquidity risks by counterbalancing the potential outflow from non-resident deposits in the banking system. Private sector debt is rising but still at very low levels compared to peers, and the very strong banking system limits in Moody's view the risk of contingent liabilities crystallizing on the government's balance sheet.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental considerations are not material to the Czech Republic's credit profile, and the country has not been identified as part of the group vulnerable to physical climate change risks in Moody's heatmaps. Having said that, certain sectors of the economy, particularly agriculture and forestry, have been negatively impacted by hot and dry weather conditions in 2018 and 2019.

As discussed above, demographic change in the form of relatively fast population ageing poses a long-term fiscal sustainability challenge to the Czech Republic. Social considerations are therefore material to the sovereign credit profile, and without further pension and healthcare reforms the very strong government balance sheet could deteriorate significantly from the mid-2030s. More near-term, as a result of rapidly rising residential property prices, housing affordability has worsened, but not to a degree that would threaten social stability.

Governance considerations form an integral part of our credit analysis for the Czech Republic. The country has an overall very strong institutional framework. However, there are concerns about the control of corruption. On the positive side, the Czech Republic benefits from independent and high-quality monetary policy, and fiscal policy formulation and implementation are prudent and transparent.

WHAT COULD MOVE THE RATING UP/DOWN

The successful implementation of reforms to ensure long-term fiscal sustainability of Czech Republic's pension and health-care systems would be credit positive. Similarly, signs that the economy moves into a higher value-added, innovation-driven stage would support a change in the outlook to positive, and could ultimately lead to a rating upgrade.

Conversely, a marked and permanent deterioration in the government's very strong balance sheet and long-term economic growth prospects would exert downward pressure on the Czech Republic's rating. In addition, any signs of severe weakening in the institutional framework would also be credit-negative and could lead to a negative outlook and ultimately to a downgrade of the rating.

NATIONAL SCALE RATINGS

Moody's will shortly publish an update to its National Scale Rating (NSR) map for the Czech Republic to reflect the upgrade of the government's long-term issuer rating. Moody's NSRs are ordinal rankings of creditworthiness relative to other credits within a given country, which offer enhanced credit differentiation among local credits. NSRs are generated from Global Scale Ratings (GSRs) through correspondences, or maps, specific to each country. However, unlike GSRs, Moody's NSRs are not intended to rank credits across multiple countries. Instead, they provide a measure of relative creditworthiness within a single country. The full maps can be accessed through the "Index of Current and Superseded Compendia of National Scale Rating Maps by Country". As a result of the rating action on the Czech Republic and the expected impact on other ratings, the NSR mapping will be revised, from the current standard map based on an A1 anchor point, to the standard map based on a Aa3 anchor point.

GDP per capita (PPP basis, US$): 37,371 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.6% (2018 Actual) (HICP)

Gen. Gov. Financial Balance/GDP: 1.1% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.3% (2018 Actual) (also known as External Balance)

External debt/GDP: 81.7% (2018 Actual)

Level of economic development: Very High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 01 October 2019, a rating committee was called to discuss the rating of the Czech Republic, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have increased. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially increased. The issuer's susceptibility to event risks has not materially changed. An analysis of this issuer, relative to its peers, indicates that a repositioning of its rating would be appropriate.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. 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 DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Steffen Dyck
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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