Czech Republic WT/TPR/S/89
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I. ECONOMIC ENVIRONMENT
(1) RECENT ECONOMIC DEVELOPMENTS
Summary
1. The Czech economy is recovering from the 1997-99 recession.  The performance of the
economy in recent years has been influenced by the 1997 currency crisis, and the subsequent
restrictive macroeconomic stabilization measures implemented by the Government.  Thesemacroeconomic developments resulted in negativ e growth in 1997-99 but, combined with important
structural reforms, served to promote a significant restructuring of the economy.  The Czech Republic
was perceived, until 1996, as the most successful transition economy.
1  Until then, the authorities
were moving speedily with the structural reform agenda in a seemingly stable macroeconomic
environment.  By 1995, the country had relatively low inflation (9.1%) and unemployment (2.9%)(Table I.1).  The GDP growth rate was high (5.9%), while the external current account deficit was
moderate (2.6% of GDP).  Structural reforms included an innovative privatization programme
(voucher system), liberalization of foreign trade, wages and prices, and reforms in the social sectors.
However, in 1997 the economy started its downward trend, contracting by 0.8% in 1997 and 1.2% in
1998.
Table I.1
Selected economic indicators, 1993-2000
1993 1994 1995 1996 1997 1998 1999 2000
Real economy (Percentage change)
Real GDP growth rate 0.1 2.2 5.9 4.3 -0.8 -1.2 -0.4 2.9
(Per cent)
Share of non-state sector in GDP 45.1 61.3 66.5 71.9 76.0 77.6 77.2 76.2
Unemployment rate (end of period)a3.5 3.2 2.9 3.5 5.2 7.5 9.4 8.8
Inflation (consumer price index, period average) 20.8 10.0 9.1 8.8 8.5 10.7 2.1 3.9
Private consumption/GDP 49.9 50.7 50.1 51.5 52.9 51.6 53.3 53.7
Gross national savings/GDP 28.7 27.8 29.9 27.3 26.3 27.0 25.6 25.6
Gross domestic investment/GDP 28.5 29.6 32.2 31.9 30.9 28.3 26.8 27.2
Labor productivity (percentage change) .. 1.1 5.2 4.6 -0.3 -0.8 1.4 3.8
Public finances (Per cent of GDP)
State budget balance, excl. privatization revenues 0.1 0.9 0.5 -0.1 -0.9 -1.6 -1.6 -2.4
General government balance, excl. privatization revenues 0.4 -1.9 -1.6 -1.9 -2.0 -2.4 -1.9 -4.2
General government balance, incl. privatization revenues 2.6 0.8 0.3 -0.3 -1.2 -1.5 -0.6 -3.1
Revenues 43.8 42.6 41.9 40.5 39.4 38.4 40.3 39.5
Expenditures 41.2 41.9 41.5 40.8 40.6 39.9 40.8 42.7
Gross public debt 18.8 17.6 15.3 13.2 12.9 13.1 14.5 16.9
Money and credit (Percentage change)
Broad money (M2) 19.8 19.9 19.8 9.7 9.8 5.4 8.1 6.5
Credit to enterprises and households 19.1 16.8 13.2 10.6 9.4 -3.5 -3.9 -2.8
Net foreign assets .. 68.0 60.2 -9.5 20.1 25.6 34.1 18.0
Interest rates (Per cent)
Interbank offer rate (3 months PRIBOR) 13.1 9.1 10.9 12.0 16.0 14.3 6.8 5.4
Average lending rate 14.1 13.1 12.8 12.5 13.2 12.9 8.7 7.2
Average deposit rate 7.0 7.1 7.0 6.8 7.7 8.1 4.5 3.4
Table I.1 (cont'd)
                                                     
1 World Bank (1999a), Vol. 1.WT/TPR/S/89 Trade Policy Review
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1993 1994 1995 1996 1997 1998 1999 2000
Balance of payments (Per cent, unless indicated otherwise)
Trade balance/GDP -1.5 -3.4 -7.1 -10.1 -8.6 -4.5 -3.5 -6.5
Merchandise exports (US$ billion) 14.2 15.9 21.5 21.7 22.8 26.4 26.3 29.0
Merchandise exports (volume change) .. 6.5 17.0 6.2 13.7 13.7 8.7 8.1
Merchandise imports (US$ billion) 14.8 17.3 25.1 27.6 27.3 28.9 28.2 32.3
Merchandise imports (volume change) .. 20.2 27.0 12.5 10.7 8.0 6.0 6.4
Current account balance/GDP 1.3 -1.9 -2.6 -7.4 -6.1 -2.3 -2.9 -4.7
Financial account/GDP 8.6 8.2 15.8 7.2 2.0 5.1 5.6 6.6
Gross official reserves (US$ billion, end of period) 3.9 6.2 14.0 12.4 9.8 12.6 12.8 13.1
Reserve cover (in months of merchandise imports) 3.2 4.2 6.7 5.5 4.7 4.8 5.7 4.8
Reserve cover (in months of current payment) .. 3.1 5.3 4.1 3.3 4.0 4.1 4.1
Gross external debt (convertible currencies)/GDP 24.9 25.4 31.9 36.4 44.0 39.1 43.1 41.1
External debt serviceb.. 8.7 9.3 10.9 15.7 15.1 12.5 12.2
Exchange rates
Nominal exchange rate (CZK per US$, average) 29.2 28.8 26.5 27.1 31.7 32.3 34.6 38.6
Nominal effective exchange ratec99.3 99.9 -0.9 1.0 -3.7 -0.6 -3.6 6.0
Real effective exchange rate (ULC)c87.3 3.1 3.9 5.8 -0.4 8.1 -0.7 ..
Memo: Gross domestic product (current US$ billion) 34.9 41.1 52.0 57.9 53.0 56.9 54.5 50.8
.. Not available.
a Per cent of labour force.
b Per cent of goods and non-factor services exports.
c Increase indicates depreciation.
Source : Information provided by the Czech authorities; IMF (2000a),  Public Information Notice (PIN) No. 00/60;  IMF
(2000b), IMF Staff Country Report No. 00/96;  and World Bank (1999a), A World Bank Country Study - Czech
Republic Towards EU Accession.
2. Both microeconomic fundamentals and macroeconomic imbalances caused the recession.
Among the microeconomic factors were an unreformed enterprise sector (resulting from the diffuse
ownership that emerged from the voucher privatization programme) and imprudent lending by state-owned banks.  These factors permitted excessive wage increases (growth in real wages outstripped
GDP growth) and labour hoarding (i.e. firms being reluctant to lay off excess workers).
2  As a result,
the external competitiveness of domestic firms deteriorated, which worsened the current account
position and undermined confidence in the currency.  At the same time, large capital inflows rendered
monetary policy difficult and led to a continued appreciation of the real exchange rate, whichcontributed to the decline in competitiveness.  Dr iven by investors' perception of an unsustainable
current account deficit (7.4% in 1996), the authorities were forced to abandon the pegged exchange
rate policy regime and to introduce a strict austerity programme.  Tight fiscal and monetary policies
that followed the currency crisis, contributed to the recession.  A subsequent loosening of these
policies and movement on the structural agenda (including bank and enterprise restructuring)contributed to the recent recovery.  Following th ree years of contraction, the economy recovered by
2.9% in 2000 and is estimated to expand by 3.5-3.8% in 2001-02.  The recovery of demand in the EU,
the Czech's most important trading partner, and a surge in foreign direct investment have helped to
turn the economy around.
3  Unemployment, which increased sharply during the recession, reached its
peak in January 2000 at 9.8%, it had decreased to 8.1% by May 2001.
                                                     
2 Finance & Development (2000).
3 Exports of goods and services increased by almost 19% in 2000.  While the recovery was initially
export-led, higher oil prices and strengthening domestic demand resulted in a worsening of the current accountdeficit.Czech Republic WT/TPR/S/89
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3. The economic recession took a heavy toll on GDP per capita.  Agriculture continues to play a
diminishing role in the Czech economy: its share of GDP dropped from 4.4% in 1995 to 3.4% in
2000, while industry's share remained at about the same level (Table I.2).   Over the same period,
services fell slightly, mainly construction and wholesale, but still accounted for more than half of
GDP in 2000.
Table I.2
Czech Republic at a glance, 1990-2000
1990 1995 2000
GDP per capita (US$) 3,366 5,036 4,820
Population (million) 10.4 10.3 10.3
Growth of population (percentage change) 0.0 -0.1 -0.1
Fertility rate (births per woman) 1.9 1.3 1.1
Life expectancy 71.5 73.2 74.8a
School enrolment ratio, secondary (per cent) 87.0 98.0 98.0
Share of GDP (per cent):
Agriculture, hunting, forestry and fishing 7.7 4.4 3.4
Industry 34.5 31.1 31.8
Services 51.9 57.9 56.2
Construction 10.2 8.1 6.5
Wholesale and retail trade, restaurants and hotels 11.5 14.0 13.2
Transport, storage and communication 3.5 7.6 8.6
Financial services 4.3 4.4 3.9
Business services 11.1 10.8 10.7
Public administration, education and health 11.3 13.0 13.3
Taxes minus subsidies 8.4 11.4 11.7
FISIMb-2.5 -4.8 -3.1
Share in employment (per cent):
Agriculture, hunting, forestry and fishing 11.8 6.3 4.8
Industry 37.8 32.5 32.8
Services 50.4 61.2 62.4
a 1999 data.
b Financial intermediation services indirectly measured, calculated as the difference between interest received and paid by bank s.
Source : WTO Secretariat, based on information provided by the Czech authorities.
Balance-of-payments developments
4. The Czech economy experienced large macroeconomic imbalances in the mid-1990s.  Large
capital inflows, amounting to some 16% of GDP in 1995, stimulated excessive growth in domestic
demand (Chart I.1 and Table AI.1).  Coupled with high real wage increases, the economy overheated
and the current account deteriorated.  The current account deficit worsened by almost five percentage
points between 1995 and 1996 to 7.4% of GDP.  The decline was mainly due to a sharp fall in export
growth and to a strong expansion of private cons umption and investment, putting pressure on import
demand.4  The export slowdown was due to the worsened competitiveness associated with a fixed
exchange rate.  The contraction of the Czech Republic's main export markets in Europe (notably
Germany) also contributed to the fall in exports.  The increasing macroeconomic imbalances
eventually led to a speculative attack on the currency in early 1997.5
                                                     
4 The current account imbalance was not a result of fiscal pressure.  It should be noted, however, that it
is difficult to measure the true fiscal position of the Go vernment.  This is due to many off-budgetary activities as
well as large amounts of "hidden debt" (see below).
5 It has been argued by several observers that an earlier switch to a floating regime would have
prevented the large capital outflows in May and June 1997.WT/TPR/S/89 Trade Policy Review
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0369121518
1993 1994 1995 1996 1997 1998 1999 2000
-8-6-4-202
1993 1994 1995 1996 1997 1998 1999 2000
0510152025
1993 1994 1995 1996 1997 1998 1999
010203040506070
1993 1994 1995 1996 1997 1998 1999 200002468101214
ExportsForeign direct investment, net
(right-hand scale)Chart I.1
External develo pments , 1993-2000
(a) Financial account of the balance of payments (per cent of GDP)
(b) Current account balance (per cent of GDP)
(c) Gross external debt and official reserves (US$ billion)
(d) Merchandise trade and net foreign direct investment (per cent of GDP)
Source : WTO Secretariat , based on information provided b y the Czech authorities.ImportsGross external debt
Gross official reservesCzech Republic WT/TPR/S/89
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5. The external situation has recovered since the attack on the currency.  The current account
deficit improved from 6.1% of GDP in 1997 to 2.3% in 1998, partly reflecting an improved trade
account.  Import growth declined, due to the depressed state of the economy, and exports recovered in
response to improved competitiveness associated with the depreciation of the currency as well as
renewed demand from Europe.  However, since then, foreign trade and current account deficits have
worsened somewhat, reflecting, inter alia , the rise in world oil prices.6
6. During the recession, the stock of external debt increased substantially (Chart I.1).  Gross-
external debt (in convertible currencies) rose from US$7.1 billion in 1993 to US$20.8 billion in 1996.
Over the same period, short-term debt tripled to US$6 billion.  Nevertheless, gross public debt
remained modest, at about 13% of GDP in 1996.  Since then, external debt has accumulated at a slow
pace (reflecting short-term debt developments).  Ho wever, short-term debt in relation to foreign
exchange reserves is still relatively high, estimated at 68% in 2000.   Moreover, looking ahead, the
public debt is expected to increase as a result of banking sector restructuring and expanding fiscal
deficits.7
7. The Czech Republic remains highly integrated into the world economy (Chart I.1).
Merchandise trade (exports and imports) as a share of GDP amounted to some 120% in 2000 and theratio of total foreign investment to GDP was 5.3%.  These numbers reflect a relatively open trade and
foreign investment regime, with few measures restricting market access.  Already in 1995, the Czech
Republic signed the IMF's Article VIII obligations for current account convertibility.
8
The fiscal stance
8. The Czech Republic has maintained a nearly balanced State budget (Table I.1). However, the
consolidated General Government balance – including the operations of the local governments,
various extra-budgetary funds, and changes in the State Financial Assets (SFAs) – provides an
enhanced instrument to evaluate the Czech fiscal position, as it shows a more complete picture of the
Government's fiscal stance.9  In contrast to the State budget, the consolidated General Government
balance (corrected for privatization proceeds) shows a deterioration in almost every year since the
early 1990s, to 4.2% in 2000 (Table I.1).  On the revenue side, cuts in direct tax rates and changes in
tax regulations resulted in a progressive fall of revenue to 38.4% of GDP in 1998.  On the expenditureside, no major changes in the level were recorded between 1996 and 1998.  Thereafter, expenditures
have increased, reflecting enhanced transfers to households and increased support to financial and
non-financial enterprises.
9. Looking ahead, the fiscal situation may deteriorate even further. The reliance on uncertain
financing sources (i.e. privatization receipts) in a weakening global external environment could pose athreat to macroeconomic stability.
10  In this regard, the authorities' efforts in the area of public finance
transparency are important measures to address the fiscal situation (Box I.1).
                                                     
6 IMF (2000c).
7 IMF (2001).
8 IMF (1995).
9 Extrabudgetary funds include the Czech Land Fund, the National Property Fund, the State Fund for
Culture, the State Fund for Environmental Protection, th e State Fund for Soil Fertilization, and the State Fund
for Support and Development for Czech Cinematography.  The SFA comprises the central government's accountat the central bank, in which the state budget surpluses from previous years are deposited (World Bank, 1999a ,
Vol. 2).
10 IMF (2001).WT/TPR/S/89 Trade Policy Review
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Box I.1:   Hidden government debts – the move towards more transparency in budget accounts
Fiscal policy in the Czech Republic appears to be blurred by a wide range of contingent liabilities held byvarious non-government agencies.  Hidden public liabilities include those of the Konsolida čni Banka, Ceska
Finacni, the National Property Fund, and various state loan guarantees.  Other potential liabilities include the
Government's equity position in some commercial banks (Komer čni Banka and Ceska Sporitelna) as well as
some highly indebted firms (such as the state-owned railroad).   Also, the effect on government debt of thefunds spent on bank restructuring (equivalent to some 10% of GDP) is unclear.  So far, most of the costshave not appeared in the Government's books but have been financed through the transfer of non-performingloans to Konsolida čni Banka.  The full amount of the liability is unclear and the annual burden on current
spending only materializes imperfectly as bank losses. Consequently, official data on the fiscal position
provide a misleading picture of the overall financial position of the Government.
The large amount of off-budget activities creates seve ral weaknesses.   Hidden public liabilities generate
sudden, and not always expected, claims on the budget.  Thus, the Government could end up in a situationwhere the fiscal stability is endangered.
The widespread off-budget activities also affect the Governments' ability to conduct fiscal policy in atransparent manner.  Off-budget activities are not subj ect to the same screening and vetting process as "on-
budget" activities.  Low priority activities, which would not have passed the usual screening and vetting
process, could be financed through the off-budget resources.
Complete information is not available on the size of the government's hidden debt.  However, according to a
government evaluation, undertaken in co-operation with the World Bank, the hidden public liabilities ofKonsolida čni Banka, Ceska Finacni, the National Property Fund, and various state loan guarantees (net of
provisions) amounted to 12.4% of GDP in 1998.  The implications on the fiscal deficit may also be
substantial.  Taking into account operations of various off-budgetary institutions, the World Bank estimatesthat the General Government deficit in 1998 would have been 3.5 percentage points higher than indicated byofficial statistics.
To address these issues, the authorities have undertaken a study to estimate the size of the "hidden debt" heldby the off-budget agencies.  Another effort to increas e fiscal transparency and accountability was to include
a medium-term fiscal framework based on consolidated government accounts in the 2000 Budget.
Moreover, new rules for budget implementation, which entered into force in January 2001, should, overtime, impose enhanced discipline on off-budget spending and make the approval process for issuing loanguarantees stricter.
Source: World Bank (1999a), A World Bank Country Study – Czech  Republic Towards EU Accession;
OECD (2000), OECD Economic Surveys 1999-2000 Czech Republic;  and EIU (2000), Country
Report – Czech Republic.
 Monetary and exchange rate policies11
10. The Czech National Bank (CNB, the central bank), which has the sole responsibility for
monetary policy, has been committed to achieving a gradual reduction in inflation, while retaining its
"primary objective to ensure stability of the Cz ech national currency" (Act No. 6/1993 on the Czech
National Bank).  In January 2001, a new Central Bank Act became effective and changed the centralbank's primary objective to one of maintaining price stability.  Until May 1997, the central bank relied
on a fixed exchange rate to encourage the convergence of domestic inflation to world levels, in
particular to those of the EU Member States.  It  also influenced the evolution of money supply (M2)
through open market operations and changes in reserve requirement, as well as in its discounts and
Lombard rates.  As discussed above, in early 1997 external sector developments were perceived bythe "market" as unsustainable.  It culminated in May 1997 when, after ten days of large foreign
                                                     
11 This section draws on OECD (1998a).Czech Republic WT/TPR/S/89
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exchange interventions and steep increases in interest  rates, the authorities were forced to introduce a
managed float exchange system.12
11. With the exchange rate floating, monetary policy no longer acted as a nominal anchor, a
situation that persisted until 22 December 1997, when the central bank replaced M2 with an inflation-
targeting framework.  Within this framework, the central bank now focuses on changes in headline
prices to ease targeting "net inflation", which is defined as consumer price inflation less the effects ofchanges in administrated prices and indirect taxes.
13  The aim is to converge towards EU inflation
levels by the end of 2005.
12. In the initial years of the transition, the Czech Republic handled inflation problems relatively
successfully.  Inflation (as measured by consum er price increases) quickly dropped below double-
digit values and then continued its downward trend.  The disinflationary process was disrupted by theexchange rate turbulence in May 1997.  The sharp depreciation of the exchange rate, as well as rent
and energy prices liberalization, put pressure on inflation in 1998 (Table I.1).  To address the rise in
inflation, the central bank pursued tight monetary policy with short-term interest rates kept at
historically high levels (exceeding 15% until July 1998).  The tight monetary policy was supported by
tight fiscal and income policies.  However, with the unexpected rapid deceleration in price increases(significant undershooting of the "net-inflation" target in 1998 and 1999
14), monetary policy was
relaxed and the central bank cut interest rates.15  The fast pace of disinflation was, however, pursued
at the expense of an economic slowdown, which was a sign of the structural problems in the economy.
Although inflation picked up somewhat in 2000, reflec ting higher prices on imported oil and food, the
underlying inflationary trend does not seem to have increased.16
(2) STRUCTURAL REFORMS – THE CAUSES OF THE FINANCIAL CRISIS AND BEYOND
13. The Czech Republic has made substantial progress towards establishing an institutional
structure compatible with a well-functioning market economy.  In addressing the 1997 crisis, the
Czech Republic largely abstained from protectionist measures.17  Instead, it took steps to address the
root causes of the financial crisis.  The reforms undertaken have focused on capital market reforms
and bank restructuring.  Important legal reforms were also implemented as part of the harmonization
of legislation with EU's acquis communautaire .  The already relatively liberal foreign direct
investment regime was further liberalized in December 1995 when the Czech Republic acceded to the
Organization of Economic Cooperation and Developmen t (OECD).  Also, trade liberalization (notably
tariff reduction) has continued during the review period.
                                                     
12 Leading up to the currency crisis, the central bank tightened monetary policy (raising its discount
rate by 100 basis points to 10.5%), thereby contributing to the real currency appreciation and a rise in market
interest rates.  The three-month PRIBOR rate averaged 26% in May 1997 and the central bank's Lombard rate
was set at 50%.
13 See Czech National Bank and IMF (2000) for a description of inflation targeting in the Czech
Republic.
14 In 1998 the target was 5.5-6.5% compared with an outcome of 1.7%, while in 1999 the
corresponding numbers were 4-5% and 1.5%.  It has been noted that, in view of the significant undershooting of
the inflation target, monetary policy could have been too slow in relaxing (OECD, 2000a).
15 Its main policy variable (the two-week repo rate) was cut seventeen times, falling from 15% in mid-
1998 to 5.5% in October 1999, while short-term interest rates declined to 6.1% in October 1999.
16 IMF (2000c).
17 However, a six months import deposit scheme was in place during 1997 (Chapter III(2)(v)).WT/TPR/S/89 Trade Policy Review
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Legal reforms – enhancing the private sector environment
14. The regulatory framework for the capital market has been improved in several steps during
the period under review.  Amendments to the Commercial Code and the Investment Fund Act
improved disclosure and minority shareholder protection rules, and prevented a further conversion of
investment funds into holding companies.  Measures have also been taken to increase the transparency
and regulation of capital markets by creating an independent securities exchange commission and byenhancing rules protecting minority shareholders. Transparency in the investment privatization funds
market has been improved by opening the closed-ended funds whose shares were traded at significant
discounts relative to the market value of the stocks held by them.  The Commercial Code, the
Securities Act, and the Accounting Act have been amended several times with a view to improving
transparency in corporate decisions, accountability of boards, and shareholder rights.
18
15. A number of other legal reforms have also been implemented during the period under review.
The Czech Republic's competition rules as well as its intellectual property rights legislation have been
strengthened, while the standards law has been amended providing for simplified testing and
standardization procedures.  Amendments to the bankruptcy law include improved creditors rights,
and efforts to reduce the often long delays in the bankruptcy process.  The enactment of the PublicAuctions Act also serves to strengthen creditor rights.  Nevertheless, weaknesses in the dispute
resolution system continue to be a factor impeding the business environment.
Bank and enterprise restructuring
16. In recent years, privatization has focused on the banking sector.  With the privatization of
three large state-owned banks – IPB in 1998, CSOB in 1999, and a savings bank CS in 2000 – the
only remaining state-owned commercial bank is Komer ční Banka (KB), which is slated for
privatization by mid 2001.  Building on programmes from the early 1990s, progress has also beenmade in improving the health of the small banks.  The cost of bank assistance has been substantial,
estimated at 10.5% of GDP (measured as a share of 1998 GDP) during the period 1991-98.
19
17. In addressing enterprise restructuring, the authorities established a Revitalization Agency in
1999 as a subsidiary of Konsolida ční banka (KOB) with the objective of facilitating the financial and
operational restructuring of a limited number of heavily indebted and money-losing firms forprivatization.  In 2001, the Agency's activities are to be incorporated into KOB's organizational
structure.
18. Recognizing that the State is still active in a number of areas where the private sector could
do a better job, the authorities are separating non-competitive from competitive activities.  Non-
competitive activities are to continue to be controlled by the State.  For the time being, a number ofcompetitive activities are also to remain controlled by the State.
(3) T
RADE AND FOREIGN INVESTMENT PERFORMANCE
(i) Trade patterns
19. The geographic distribution of merchandise trade has continued to move away from the
former Soviet Union towards Western Europe during the period under review. This shift reflects theCzech Republic's continued integration with Western Europe, improved conditions in Western
Europe, and economic difficulties in the former Soviet block.  The European Union accounted, in
                                                     
18 World Bank (2000a).
19 World Bank (1999a), Vol. 1.Czech Republic WT/TPR/S/89
Page 9
2000, for almost 69% of total merchandise exports and 62% of imports (Tables AI.2 and AI.3).
Germany is the Czech Republic's largest single trading partner (accounting, in 2000, for 40% of
merchandise exports and 32% of merchandise imports).  The share of trade (in particular merchandise
exports) with Eastern Europe has continued to decline since 1996.  A large part of this drop is
accounted for by a declining share of trade with the Slovak Republic.
20. Export growth is driven by manufacturing.  The share of manufactured products in total
merchandise exports increased from 84% in 1996 to 88% in 2000, at the expense of a number of
traditional sectors (agriculture and mining) (Table AI.4).  Within manufacturing, exports of machinery
and transport equipment – such as the automotive products industry – have grown significantly.  The
manufacturing sector has benefited from the presence of foreign-owned firms.  By contrast, the export
shares of iron and steel, and chemicals have declined.  The share of agriculture in total merchandiseexports has also declined consistently.  Manufactured products also dominate the Czech Republic's
imports, accounting for close to 80% of total merchandise imports in 2000 (Table AI.5).  Machinery
and transport equipment and chemicals are the most important import items.  The share of agriculture
in total merchandise imports has continued to decline.
21. The Czech Republic has relatively high levels of intra-industry trade, accounting for more
than 60% of its total merchandise trade in 2000 (Chart I.2).
20  Its levels even surpass many of the EU
Member States' levels.21  In 2000, Czech's intra-industry trade with the EU comprised almost 62% of
the trade between these countries, while its intra-industry trade with the CEFTA member countries
comprised just above half of the trade.  Intra-i ndustry trade with the former Soviet bloc, although
increasing, accounted for a mere 6.5% of the 2000 trade.
01020304050607080
Note:
Source:The extent of intra-industry trade is measured by the Grubel-Lloyd index (at the four-digit SITC Rev.1).
WTO Secretariat calculations, based on UNSD Comtrade database fi gures.Chart I.2
Intensity of intra-industry trade with selected partners, 1996 and 2000
Per cent
1996     2000 1996     2000 1996     2000 1996     2000 1996     2000Worl d
Former USSRCEFTAGermany EU15
                                                     
20 Intra-industry trade refers to the importing and exporting of goods in the same product category.
21 Kaitila (1999).WT/TPR/S/89 Trade Policy Review
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(ii) Investment patterns
22. Foreign direct investment has contributed to the development of the Czech economy through
several channels.22  The potential for foreign direct investment to accelerate enterprise restructuring
was identified at an early stage of the transition.  Foreign direct investment also acts as a supplement
to domestic savings and raises total capital investment in the economy.  FDI has contributed to the
growth of exports.  In addition, foreign participation in the privatization process brings in governmentrevenues.  Data on Czech firms suggest that the impact on labour productivity is predominantly due to
intangible assets introduced by foreign firms, rather than simply the fixed capital investment
associated with foreign direct investment.
23
23. Foreign direct investment inflows have increased markedly in recent years, responding to
substantial improvements in the regulatory environment, the expected accession to the EU, and a newinvestment incentive scheme (Table I.3).  Fore ign investment (net) jumped from 3.5% of GDP in
1996 to 5.3% in 2000, more than offsetting the current account deficit (Chart I.1).  This development
reflects the surge in net foreign direct investment, which has almost quadrupled since 1996.  The
Czech Republic ranked number two in terms of FD I inflow among the Central and Eastern European
countries in 1999.
24  The amount of foreign direct investment made by Czech nationals abroad is
minor compared with the amount of inflows (Table AI.1).  While net foreign direct investment rose
rapidly, net portfolio investment fell to an outflow of US$1.8 billion or 3.5% of GDP in 2000 (notably
debt securities).
Table I.3
Foreign direct investment by sector and country, 1995-2000
(US$ million and per cent)
1995 1996 1997 1998 1999 2000
Foreign direct investment, net (US$ million) 2,526 1,276 1,275 2,641 6,234 4,477
Portfolio investment, net (US$ million) 1,362 726 1,086 1,069 -1,395 -1,767
Total foreign investment, net (US$ million) 3,888 2,002 2,361 3,710 4,839 2,710
Total foreign investment, net/GDP (%) 7.5 3.5 4.5 6.7 9.1 5.3
Foreign direct investment by activity (per cent of total):
Non-manufacturing 66.5 55.2 68.6 68.5 76.0 65.6
Agriculture, hunting and forestry 0.3 0.0 0.5 0.2 0.2 0.2
Mining and quarrying 0.9 0.5 0.0 0.0 5.3 0.5
Electricity, gas and water supply 1.6 11.2 28.8 7.8 6.1 4.4
Trade, hotel and restaurants 5.7 19.8 9.5 22.1 25.3 20.8
Transport, storage and communications 52.8 12.9 0.1 11.6 2.5 4.5
Financial intermediation 2.5 2.3 22.9 18.6 26.8 19.5
Real estate and business activities 0.0 0.0 3.2 5.6 6.6 12.4
Other 2.7 8.5 3.5 2.6 3.5 3.1
Manufacturing 33.5 44.8 31.4 31.5 24.0 34.4
Food and tobacco 4.8 5.1 7.2 5.1 4.4 4.1
Wood, paper and publishing 0.0 5.7 7.8 3.5 2.3 1.9
Refined petroleum and chemicals 3.5 23.4 3.9 2.4 4.1 1.6
Non-metallic products 6.9 4.3 1.3 1.3 3.5 3.3
Basic metals and metal products 0.0 0.0 6.1 10.5 2.3 4.2
Machinery and equipment 18.2 4.8 1.2 1.9 5.9 17.8
Other 0.1 1.6 3.8 6.8 1.4 0.4
Table I.3 (cont'd)
                                                     
22 Czech law does not define portfolio investment, while foreign direct investment is defined as the
establishment, or acquisition, of an exclusive share in  a business activity, or the participation in a business
activity with at least 10% of the capital of the co mpany, or at least a 10% of the voting rights.
23 Barrell and Holland (2000).  Djankov and Hoekman (2000), find that foreign direct investment in the
Czech Republic has a positive impact on total factor productivity growth.
24 Czech Business and Trade (2000).Czech Republic WT/TPR/S/89
Page 11
1995 1996 1997 1998 1999 2000
Foreign direct investment by country of origin (per cent of total):
Western Europe 83.2 69.0 59.9 61.1 77.3 86.3
Belgium 1.0 4.0 4.3 1.8 25.3 2.5
Germany 22.2 17.4 30.1 21.2 16.0 22.0
Netherlands 0.0 18.1 10.3 23.9 14.9 21.9
Austria 3.4 14.6 7.3 9.6 12.9 20.4
Switzerland 26.5 3.9 3.6 3.3 6.3 4.1
United States 3.9 17.7 7.6 10.2 11.5 3.2
Other 12.8 13.3 32.5 28.7 11.2 10.5
Source : Data provided by the Czech authorities; and IMF(2000d), IMF Staff Country Report No. 00/119 Statistical
Appendix.
24. Foreign direct investment has flowed into a variety of sectors, with trade, hotels and
restaurants (21% of total foreign direct investment) and financial intermediation (19.5%) attracting the
largest inflows in 2000 (Table I.3).  Inflows contin ue to be heavily dominated by the EU and EFTA
member countries, accounting for 86% of the total in 2000.  Portfolio investment inflows have largelymirrored the waves of voucher privatization.  Portfolio investment is focused on short-term debt
instruments and the most liquid blue-chip shares.
(4) O
UTLOOK
25. Along with economic recovery, the authorities have addressed a wide range of structural
reforms.  Many of the reforms are those required by the EU accession process.  In this respect, theCzech Republic needs to complete the process of creating the appropriate legal regulations, and the
required institutional framework, in line with EU member countries.  Meeting this challenge will
continue to require significant reform efforts, touching on most aspects of the economy.  Other
reforms, which are not formal requirements for EU membership, but are crucial for the success of
Czech companies to compete on the European market, include enterprise restructuring andprivatization.  Moreover, the imbalance in the fiscal positions is becoming a major constraint to the
Czech Republic's economic performance.  In this regard, expenditure reforms (including reform of the
pay-as-you-go pension system) as well as revenue measures are important.