Debt Ridden or On The Move?

In his article published in Hospodarske noviny (available in Czech for registered users only), Petr Gapko, Macroeconomic Analyst from GE Money Bank Czech Republic, raises the question of public finances and state debts in Central Europe and the ‘tax’ we hesitate to pay for their restructuring and for further economic growth.

Guest post by Petr Gapko, Macroeconomic Analyst, GE Money Bank Czech Republic

In the last decade, Central Europe was perceived as a region of opportunity. Massive flow of investment enabled fast economic growth and the region was gradually catching up with more advanced economies.  It was even capable of dealing with the crisis better than Western Europe. Can we expect another period of strong growth?

Restructure public finances to slow debt growth

The major part of Central European economic growth was financed by debts which caused intermediate problems in public finances.  While the Central European countries began looking for ways of setting their finances right after the recent recession, second crises stepped in making the region´s governments rethink their public finance efforts.  Slovakia, a Eurozone member, shows the biggest need to keep its finances under control and push the public finance deficit below 3% of GDP. The Czech Republic follows its own responsible fiscal policy and tries to balance public finances, even though the Czech economy could afford a bigger short time deficit. Hungary needs to set its public finances right due to international help and Poland must be very careful about cuts since its rather closed economy is more liable to changes in government´s  investment.

The current hottest issue is debts, of course.  That is not (with the exception of Hungary perhaps) the tightest spot the region needs to get out of.  The Visegrad Group joint debts – measured by public finances debts to GDP – were about 55% in 2011, far lower comparing with EU joint debts reaching over 82%. The EU has also shown faster running into debts in recent years.

So, are cuts in budgets really necessary?

The decrease in a country´s economy while decreasing government´s spending is determined by the so called fiscal policy multiplier (the ratio of a change in national income to the change in government spending that causes it). When used for multiplying the government’s spending, it shows the loss of the entire economy.  The Czech National Bank estimates that the government´s cuts in 2011 resulted in a drop-down of Czech economic growth of one percentage point.  The bank has also calculated that the government had to cut its investment in 2011 of approx. 1.7% GDP (approx. 63 billion CZK). Thus the Czech economy lost 38 billion CZK in 2011. Compared to the case if the government had spent those 63 billion, in 2020 the Czech economy will be about 45 billion CZK poorer. However, in case the Czech government had realized the 63 billion CZK investments in 2011, the debt would have gone higher.  In this case if the government would want to make cuts causing the same impact in public finances in 2020, it would have to cut nearly 78 billion CZK, due to 15 billion CZK interests.  In 2020, those 78 billion CZK would mean a 47 billion CZK loss in the entire economy. Comparing 47 CZK billion with 45 billion CZK shows that a nine year delay in cuts would cause a loss to the Czech economy of approximately 2 billion CZK.

The conclusion is clear. The sooner public finances undergo restructuring, the slower debts will grow, including interests and pressure on the upcoming budgets.  The expense of such a process is temporarily slowed economic growth. A tax we hesitate to pay.