EUROPEAN COMMISSION Brussels, 27.2.2019 SWD(2019) 1002 final COMMISSION STAFF WORKING DOCUMENT Country Report Czech Republic 2019 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2019 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2019) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Competitiveness reforms and investment Annex A: Overview Table Annex B: Commission Debt Sustainability Analysis and fiscal risks Annex C: Standard Tables Annex D: Investment Guidance on Cohesion Policy Funding 2021-2027 for the Czech Republic References LIST OF Tables Table 1.1:Key economic, financial and social indicators - Czech Republic Table 2.1:Annual assessment of the 2018 Country Specific Recommendations for the Czech Republic Table C.1:Financial market indicators

Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Real GDP growth and breakdown Graph 1.2: Gross national income per person (PPS) as a percentage of the EU average Graph 1.3: Potential GDP and drivers Graph 1.4: Investment by sector as a share of GDP Graph 1.5: Unemployment and job vacancies Graph 1.6: Regional disparities in the Czech Republic Graph 1.7: Nominal unit labour cost (breakdown) Graph 1.8: Current and capital accounts Graph 1.9: Private sector indebtedness Graph 2.1: Overall multiannual implementation of 2011-2018 CSRs to date Graph 3.1.1: Tax revenues by main taxes compared to EU average in 2017 (in % of total taxation) Graph 3.2.1: Financial liabilities growth Graph 3.2.2: Private credit growth

Graph 3.2.3: Overvaluation gap Graph 3.2.4: Deflated house prices Graph 3.2.5: Housing supply (4 quarters aggregate) Graph 3.3.1: Labour market developments Graph 3.3.2: Employment rate by age and education level in 2017 Graph 3.3.3: Age groups at risk of poverty or social exclusion in 2017 Graph 3.4.1: GVA per worker and the productivity gap (in PPS) Graph 3.4.2: Breakdown of contributions to GVA growth in the manufacturing sector Graph 3.4.3: Value-added of foreign-controlled firms as a share of total value added in specific manufacturing sectors in 2015 Graph 3.4.4: Investment in the total economy Graph 3.4.5: Motorway network in the Czech Republic Graph 3.4.6: Highly-cited publications vs public R&D intensity as a share of GDP Graph 3.4.7: Change in GDP per inhabitant in 2007-2016 compared to the change of the EU average in the Czech and neighbouring NUTS 2 regions Graph 3.4.8: Change in GDP per inhabitant vs change in R&D intensity in the Czech NUTS 2 regions LIST OF Boxes Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in the Czech Republic 15 Box 3.1.1: Effects of the potential income tax reform Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 3.4.1: Investment challenges and reforms in the Czech Republic

Executive summary Continued economic growth offers a valuable opportunity to intensify structural reforms ( ). Since 2004, the country has undergone a sizeable process of catching up with the EU average. Nonetheless, a number of unaddressed structural weaknesses may hinder further progress. Growth prospects would benefit in particular from better-targeted investment in infrastructure, human capital and innovation, reducing administrative burden and addressing the labour shortages. Alleviating these challenges through well-designed structural reforms would help increase the potential for long-term growth and speed up the country’s convergence towards the level of the higher-income economies. Economic growth remains solid but may soften somewhat in the coming years. According to the Commission 2019 Winter Forecast, real GDP growth expanded strongly by 4.3 % in 2017, but slowed to 2.9 % in 2018. Household consumption remained the main driver of growth, propelled mostly by significant wage increases. Net exports are expected to have a neutral impact on GDP in the coming years. A high reliance on exports and on foreign direct investment are key vulnerabilities for a small open economy such as the Czech Republic. Addressing strategic investment gaps may increase productivity and, therefore, contribute to sustainable growth. Public finances are sound but long-term sustainability is less favourable. The general government balance is expected to remain in surplus until at least 2020, supported by growth in taxes, allowing public debt to fall to around 30 % of GDP. By contrast, long-term sustainability is worsening due to higher costs related to ageing. The performance of the labour market is very good but labour shortages are becoming more acute, spurring wage increases. Over the past 7 years, the employment rate has risen to nearly 80 %. Unless relevant measures are taken to support the employment of certain underrepresented groups, the scope for further employment increases is limited. The overall picture of relatively low inequality and the continued rise in living standards masks some increasing regional disparities. While disparities are lower than in some other peer countries, the distribution of opportunities and challenges remains concentrated within certain regions. In general, poorer areas have lower productivity, higher gender inequality, increasing levels of homelessness, high indebtedness and more acute demographic challenges. On the other hand, richer regions perform much better in education and have a higher capacity to innovate, making them more attractive for investment. Focusing investments in education and upskilling, domestic innovation, and transport and digital infrastructure would strengthen the potential for long-term growth. Labour and demographic constraints in a manufacturing-intensive economy warrant more investment in education and upskilling to ensure the country is prepared for future technological changes. Affordable childcare and tailored active labour market policies, to help people find, stay in or return to work, require particular attention to achieve inclusive growth. If combined with an increased focus on domestic innovation, productivity could be raised across the entire business spectrum, including small and medium-sized enterprises. Subpar road, railway and broadband networks appear to exacerbate regional disparities and hinder private investment. More effort is also needed to tackle the challenges posed by adverse climate and environmental effects, in particular for air quality and water management. Annex D identifies key priorities for support by the European Regional Development Fund, the European Social Fund Plus and the Cohesion Fund over 2021-2027 period in the Czech Republic, building on the investment needs and challenges outlined in this report. The Czech Republic has made some progress ( ) in addressing the 2018 country-specific recommendations (CSRs). There has been some progress in: ·Reducing the administrative burden on investment and in addressing weaknesses in public procurement practices. ·Strengthening the capacity of the education system to deliver quality inclusive education and in fostering the employment of women, the low skilled and the people with disabilities. There has been limited progress in: ·Removing the bottlenecks hampering research, development and innovation. There has been no progress in: ·Improving the long-term sustainability of public finances. Regarding progress in reaching the national targets under the Europe 2020 strategy, the Czech Republic currently meets, or is on track to meet targets in most areas. This includes the respective targets for poverty, social exclusion, employment, renewable energy, greenhouse gas emissions and tertiary education. More progress will be needed to increase the energy efficiency target, reverse the increasing rate of early school leaving and to achieve the target of 1 % of GDP for public R&D expenditure. The Czech Republic performs relatively well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights. The labour market is strong and the country is one of the best performers in addressing the overall risk of poverty and the social exclusion rate. However, the country shows a low participation in early childhood education and care. Gender inequalities in terms of pay and employment remain high due to parental leave rules and a lack of affordable childcare and long-term care facilities. While the poverty rate is low, there is a lack of affordable and quality social housing and the personal indebtedness of certain socio-economic groups and homelessness are increasing. Key structural issues analysed in this report, which point to particular challenges for the Czech Republic’s economy, are the following:

·Recent pension measures have helped to improve the adequacy of pensions but lack safeguards to ensure long-term sustainability of public finances. Pension-related policy measures taken in recent years have worsened the long-term budgetary outlook by around 2 percentage points of GDP by 2070. Expected gains in life expectancy are not automatically taken into account and corresponding adjustments to the retirement age are at the government’s discretion. The projected rise in age-related spending on healthcare also puts long-term sustainability of public finances at risk. Further consolidation of the hospital sector and investment in primary and integrated care could improve the cost-effectiveness of the healthcare system. ·The affordability of housing is deteriorating due to increasing prices. Both house prices and the volume of mortgage lending have grown fast since 2016 on the back of economic expansion, strong wage inflation and supply constraints. House prices are estimated to be slightly overvalued but still below the level of significant risk. In this context, the Czech National Bank has issued macro-prudential recommendations, which, however, are not binding. Furthermore, the central bank has reacted to the increased activity in the credit market and inflationary pressures, by increasing the base rates 7 times in 16 months. ·Despite its good performance, the Czech labour market has a high level of labour shortages and persistent structural issues. Parental leave rules, the lack of formal childcare and the fact that caring responsibilities are often taken up by women are all factors that prevent women’s labour market participation. In addition to the underused labour market potential of women, various socio-economic factors and inefficient targeting of active labour market policies are holding back low-skilled people, older people and people with disabilities from entering the labour market. Furthermore, integrating foreign workers into the Czech labour market is challenging. ·Low investment, the limited attractiveness of the teaching profession and socio-economic inequalities are negatively affecting the level of education achieved. There is a shortage of teachers due to low job prestige, low salaries compared to other professions and limited development opportunities. The early school leaving rate has increased, albeit from low levels, reflecting rising socio-economic inequalities in school outcomes. The impact of the reform on inclusive education has been positive overall but, so far, it remains modest on the participation of children from some disadvantaged socio-economic backgrounds in mainstream education. ·The lower investment in transport infrastructure can increase regional disparities. Being a transit country places great demands on the Czech Republic’s infrastructure and its different forms of transport. However, investment in transport infrastructure is below EU average levels. The completion of the European transport corridors is far from being finalised and the suburban transport infrastructure remains deficient, limiting the ability to commute for work and housing affordability. Weak transport links also deter business activity, particularly in remote regions. ·The country has not yet created a fully functioning innovation ecosystem based on domestic research and development. The country remains a moderate innovator at EU level, despite an increase in research and development intensity. This may be linked to public investment lacking a coherent strategy to increase the modest research performance and improve cooperation between the private sector and the academia. Productivity is driven mostly by large foreign companies, while domestic firms lag behind in terms of value added generation. Moreover, total factor productivity, indicating how efficiently capital and labour are being used in production, has been growing at a relatively slow pace. Therefore, investment needs to support technology uptake and increase the innovation performance of firms, notably the domestic small and medium-sized enterprises. ·Most regions have unused potential and require tailored support based on their specific needs. While richer regions suffer from housing unaffordability and pressures on the suburban transport networks, the poorest areas face weak connectivity, demographic pressures, social exclusion, and low focus on innovation. Tailored measures could address these disparities and increase positive education outcomes, foster upskilling and improve the infrastructure. ·A large administrative and regulatory burden may hurt further investment. Fast-changing legislation and complex administrative procedures are seen by most firms as major obstacles to further investment, particularly in less-developed regions. A new construction law is being prepared in order to reduce the complexity of issuing building permits. Tax compliance costs for businesses appear to have increased. ·Despite progress, public sector performance and government effectiveness continues to be a challenge. Administrative capacity is particularly limited in terms of strategic planning. Public procurement has seen some improvements, but certain practical challenges remain. Progress in adopting anti-corruption measures and in ensuring independence of the civil service seems to have slowed. 1. Economic situation and outlook Economic growth Economic growth remains solid in the Czech Republic. After the strong expansion in 2017 (4.3 %), real GDP growth slowed down in 2018 (2.9 %), according to the Commission Winter 2019 Forecast. Domestic demand was the main driver of economic growth in 2018, with household consumption propelled by rapid increase in wages and private and public investment. By contrast, net exports provided a negative contribution in 2018, after 2 years of positive balance. The slowdown in external demand together with the appreciation of the koruna contributed partly to this development. Graph 1.1:Real GDP growth and breakdown Source: AMECO, Commission Winter 2019 Forecast Growth may slow over the coming years but economic convergence is set to continue. In 2019 and 2020 it is projected to reach 2.9 % and 2.7 %, respectively (Commission Winter 2019 Forecast). The current expansionary cycle that started at the end of 2013 will likely continue in 2019 and 2020, when GDP growth is estimated to converge towards its potential (Graph 1.1). Domestic demand is set to be the key driver of growth, as the contribution of the external sector will be neutral. Growth projections are around 1 percentage point (pp.) above those for the euro area, stressing the robustness of the convergence process in the medium term. The Czech Republic has undergone a sizeable catch-up process relative to the EU average. Large inflows of foreign direct investment (FDI) have played a leading role in the process, creating jobs and boosting productivity growth. The convergence process slowed down between 2008 and 2013, when the Czech Republic was more affected by the global crisis than other countries in the region. It then resumed in 2013 as both real wages and productivity started to increase. Between 2000 and 2017 the gross national income (GNI) ( ) per person, adjusted for purchasing power parity, rose from 70.2 % to 82.7 % of the EU average, a real convergence of 12.5 pps (Graph 1.2). Economic policies that encouraged both foreign and domestic investment, combined with significant financial support through EU funds, underpinned the convergence process. While the catch-up pace was lower than in other Central and Eastern European countries (particularly in the Baltic region), the Czech Republic is one of those closest to the EU average in terms of economic development and living standards. Graph 1.2:Gross national income per person (PPS) as a percentage of the EU average Source: Ameco, European Commission As a small and open economy, labour shortages and uncertainties in global demand could potentially constrain future growth. The Czech Republic highly depends on potential frictions in global trade and the economic development of some of its main trade partners (e.g. Germany, France or the UK). In addition, the cost-competitiveness of exports might erode if the observed tightness in the labour market persists and the resulting real wage growth continually outpaces productivity growth. The Czech Republic has the lowest rate of unemployment and that of job seekers per vacancy in the EU and the OECD. In this context, businesses have started to invest more in machinery to offset the current labour shortages. However, the lag in the investment-to-productivity could possibly restrain economic growth in the near future. Potential growth Potential growth moved beyond the peak of the cycle. After reaching almost 3 % in 2017, in the coming years it will gradually abate towards 2 %. After widening in 2017 and 2018, the output gap will likely stabilise at around 1 % of GDP in 2019 and 2020, which should partially temper inflationary pressures (Graph 1.3).

Graph 1.3:Potential GDP and drivers Source: European Commission The decline in the working-age population and technological change brings new challenges. Demographic changes and limited gains in productivity hamper potential GDP growth. Besides tapping into the labour potential of underrepresented groups, measures to sustain growth through the labour market include integrating of workers from EU and non-EU countries and extending working careers (i.e. through healthier and more productive lives). Furthermore, mismatches in qualitative skills can emerge in relation to the transition to Industry 4.0, requiring new education and training measures. Administrative burden and low trust in the public administration may hamper further foreign and domestic investment and contribute to the shadow economy, estimated at around 15 % of GDP in 2015 (European Commission, 2017). Household consumption Household consumption is the main driver of economic growth. High employment, higher wages, increasing real disposable income and low credit costs have boosted private consumption growth in recent years. The 3 % to 4 % annual growth seen since 2015 will likely continue until 2019. According to the Commission Autumn 2018 Forecast, the moderation in wage growth predicted for 2020 is expected to go hand in hand with a deceleration of private consumption growth (2.5 %). Household savings could recover from their current low levels to a rate of almost 11 % of gross disposable income up to 2020. There is also a change in consumption patterns associated with record levels of consumer confidence. The more buoyant consumption categories in 2017 were semi-durable and durable goods, both with an annual growth of around 10 %. Investment Investment has gained momentum in the last two years and its outlook remains positive. Investment in physical infrastructure increased by 3.3 % in 2017 and has accelerated to 7.8 % in 2018 (Commission Autumn 2018 forecast). Automation and robotisation needs in manufacturing, public investment supported by EU funds and the revival of investment in construction in the first half of 2018 contributed to this surge. Investment growth may moderate in 2019 and 2020, but will remain above 3 % on the back of increased inflows of EU funds. Investment in automation represents an opportunity for Czech industry, in particular for carmakers. Investment activity as a proportion of GDP has traditionally been around 5 pps above the EU average (24.7 % vs 20.0 % in 2017) due the weight of the manufacturing sector in the economy, which requires high levels of investment in equipment (Graph 1.4). Manufacturing amounted to 26.8 % of gross value added (GVA) in 2017, 12.5 pps more than the aggregate EU average. The automotive sector is the largest branch of Czech industry, both in terms of output and employment. However, the current context of severe labour shortages and revised CO2 emission standards for cars, poses significant challenges in the sector. Therefore, despite the high degree of automation, carmakers and other manufacturers are expected to increase investment in equipment (see Section 3.4). Graph 1.4:Investment by sector as a share of GDP Source: AMECO Inflation and monetary policy Despite steady wage growth, the Czech National Bank (CNB) contained inflation below the upper limit of the tolerance band (3 %). Consumer price inflation, measured by the the Harmonised Index of Consumer Prices, slowed down slightly in 2018 to 2.0 %, from 2.4 % in 2017. The rapid growth in energy prices in the second half of 2018 was offset by the moderation in food prices. Further tightening in monetary policy is likely to ensure that inflation stabilises at CNB's 2 % target in the second half of 2019 and remain close to that in 2020. Consumer prices are forecast to grow by 2.1 % in 2019 and 1.9 % in 2020 (Commission Winter 2019 Forecast). The CNB increased the base rate seven times in 16 months. This was in response to the increased activity in the credit market and inflationary pressures. As a result, the base interest rate (two-week repo rate) increased from 0.05 in July 2017 to 1.75 % in November 2018, further widening the rate differential with the euro area (see Section 3.2). Further interest hikes may follow in the coming quarters. Labour market The Czech labour market continues to be a top performer. The employment rate has risen steadily in the last 7 years, reaching 80.0 % in Q3-2018. Overall employment growth is expected to slow down to 0.3 % in 2019, given reduced scope for further increases in the participation rate (see Section 3.3). The unemployment rate fell to a record low of 2.9 % in 2017 and 2.1 % in Q4-2018, the lowest in the EU for the second year in a row and will likely stabilise at around 2.5 % over the next 2 years (Commission Autumn 2018 forecast). There have also been recent improvements in terms of youth (5.3 % in Q4-2018) and long-term unemployment (0.7 % in Q3-2018). With the economy near full employment, labour shortages are becoming more acute and have spurred wage increases after several years of more subdued growth. About 45 % of manufacturers and 40 % of builders cited labour shortages as a factor limiting production in Q4-2018 ( ) and the number of job vacancies has been twice that of unemployed people since mid-2018 (Graph 1.5). The rate of employment is weaker for low-skilled workers, women with young children, people with disabilities and older-age groups. As they bear most of the care responsibilities, the employment rate of women in 2017 (70.5 %) is below that of men (86.3 %). The employment rate of low-skilled workers in the labour market has stagnated since EU accession. Their employment rate of around 30 % is around 50 pps below the Czech average. At 62.2 %, the employment rate of those between 55-64 years old was 24.6 pps below that of workers aged 25-54. The employment gap is also high for people with disabilities. Participation in training and lifelong learning is low, in particular for underrepresented groups. Graph 1.5:Unemployment and job vacancies Source: Eurostat Social developments Overall, income inequality remains low in the Czech Republic. The income of the richest 20 % of the population was around 3.4 times higher than the income of the poorest 20 % in 2017, significantly lower than the 5.1 ratio in the EU. This ratio has remained stable since 2005 as real disposable household income grew relatively evenly across the different income groups. Low inequality is due to market incomes (i.e. income received by households before taxes and social transfers) being distributed relatively equally. The gap between market income inequality and disposable income inequality (i.e. after taxes and transfers) is similar to the EU average, suggesting that the Czech tax-benefit system is in line with the EU in terms of reducing inequality. Inequality of opportunity is significantly influencing educational outcomes and the risk of poverty. The risk of poverty for the children of low-skilled parents is among the highest in the EU, but among the lowest for the children of high- skilled parents. Socio-economic backgrounds also strongly influence educational outcomes. Unequal opportunities start early in life as high costs limit access to childcare for low-wage earners (see Section 3.3). Regional disparities The observed convergence and overall social situation mask increasing regional disparities. GDP per person varies from 63 % of the EU average in the Northwest region to 182 % in Prague. The Northwest region actually saw its GDP per head diminishing in absolute terms since 2010. Furthermore, while regions like Moravia-Silesia have been losing people, Prague and Central Bohemia regions have witnessed positive demographic developments.

Graph 1.6:Regional disparities in the Czech Republic Source: Eurostat, European Commission The distribution of opportunities and challenges is concentrated in certain areas. In general, rural regions are poorer, have a lower productivity, higher gender inequalities, increasing levels of homelessness, high indebtedness, a higher early-school leaving rate, low capacity to innovate and acute demographic challenges (Graph 1.6). These regions also witness increasing numbers of socially excluded localities and seizure orders, while facing a lack of affordable social housing. The gap between Prague and Brno and the less developed regions has further increased, most visibly compared with the Northwest region. Migration towards richer regions is increasing the process of suburbanisation in metropolitan areas, putting pressure on the housing stock and infrastructure networks (see Section 3.4.3). Competitiveness Robust job creation and the tightening labour market have pushed up wages. Nominal wages of employees increased by 6.4 % in 2017 with a further 8 % growth expected in 2018 and 2019 (Commission Autumn 2018 forecast). Real wage growth amounted to 4.1 % in 2017, while net earnings increased by 3 %. The wage bill grew by 8.3 % in 2017, driven by both wage increases and employment growth. Over the past 3 years, the growth of the wage bill was above the GDP increase and exceeded the benchmarks calculated based on economic fundamentals. As growth of the wage bill also exceeded the speed of productivity growth, nominal unit labour costs kept growing in 2017 and 2018 (Graph 1.7). Nonetheless, this recent wage growth went hand in hand with the gains in export market shares, suggesting that it has had limited effect on competitiveness so far. Graph 1.7:Nominal unit labour cost (breakdown) Source: Commission Autumn 2018 forecast The increase in the minimum wage responded to the market trends. The planned minimum wage for 2019 is CZK 13 350, a 67 % cumulative increase in the last 5 years. Nonetheless, currently only 4 % of employees receive the minimum wage. In order to improve the living conditions of low-skilled workers, there is currently a domestic debate regarding further increases of the minimum wage. External position The Czech Republic’s trade balance has been systematically positive since 2004. It recorded a surplus of 7.5 % of GDP in both 2016 and 2017. The contribution of goods and services to the trade balance surplus remained roughly unchanged compared to 2016, although the goods balance shows more historical volatility than the services balance. According to the Commission Autumn 2018 forecast, the trade balance may decline to 6.7 % in 2018 due to a smaller surplus in the trade of goods. Weaker external demand, in particular from Germany, and strong domestic demand have influenced these developments. The strong appreciation of the real effective exchange rate in the first half of 2018 was also detrimental to the trade balance, which will likely remain close to 7 % of GDP in 2019 and 2020. The current account will remain balanced due to the large primary income deficit. The primary income balance is traditionally negative, due to a large extent, to profit outflows by foreign-owned firms operating in the Czech Republic (Graph 1.8). Graph 1.8:Current and capital accounts Source: European Commission Note: 2018 is estimated based on quarterly data Financial sector Banks in the Czech Republic remain highly profitable and display healthy stability ratios. Since EU accession, their profitability rate has persistently been among the highest in the EU. The interest rate increases attract abundant euro area liquidity. The growth of financial sector liabilities escalated at the turn of 2016 to 2017, as non-residents purchased deposits denominated in korunas before the end of the currency exchange rate commitment in April 2017. These dynamics were caused by investors' expectations and abated once the Czech koruna floated freely again in foreign exchange markets. House prices are estimated to be slightly overvalued. Both housing prices and the volume of mortgages have grown fast since 2016, on the back of economic expansion, strong wage inflation and supply constraints. Depending on the methodology used, house prices are estimated to be overvalued in the range of 0 to 10 %, still below the level of significant risk. In addition, household debt is still moderate compared to the EU average, despite increasing in the recent period. To control credit growth, the CNB has implemented a number of measures directed at lenders and borrowers (see Section 3.2). Private indebtedness Private indebtedness in terms of GDP (67.4 %) is low compared to the EU average (140 %). Nominal GDP has been growing nearly as fast as mortgage stocks. Household sector debt decreased by 1.6 pps to 29.7 % of GDP at the end of 2017, while the debt of non-financial corporations remained broadly stable at around 38 % of GDP. Both ratios of interest payments on gross disposable income for households and on value added for non-financial corporations were lower than the euro area levels at the end of 2017. Increasing interest rates do not yet pose a significant risk on repayments, although they might affect the non-performing loans (NPL) ratio. Overall, 9.7 % of people over 15 years were affected by enforcement orders in 2017 (see Section 3.3). The most exposed group appears to be lower income debtors with consumer loans. It is high in regions with the largest proportion of low-skilled people (over 20 % in the Ústecký region). Graph 1.9:Private sector indebtedness Source: Eurostat Public finances The general government balance will decline but will remain positive until at least 2020. On the back of the growing economy, the general balance has been in surplus since 2016, supported by growth in tax receipts and by lower-than-expected levels of public investment. Measures to prevent tax evasion, such as electronic evidence of sales and VAT control statements, have proven to be efficient and contributed to the revenue increase. Additional VAT receipts are expected to grow in line with GDP growth over the forecast horizon. Significant wage increases since 2017 in both the public and private sector boosted direct taxation receipts. On the expenditure side, most increases relate to public wages and pensions, which are expected to increase significantly in both 2018 and 2019. As the current EU funds cycle is advancing, public investment will likely pick up. In line with the headline balance, the structural balance is also expected to decline towards zero. It will likely remain positive until at least 2020, amid a constant output gap. According to the Commission Autumn 2018 forecast, the debt-to-GDP ratio will continue to decrease, reaching around 31.2 % of GDP in 2020.

Table 1.1:Key economic, financial and social indicators - Czech Republic Source: Eurostat and ECB as of 31-1-2019, where available; European Commission for forecast figures (Winter forecast 2019 for real GDP and HICP, Autumn forecast 2018 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 68 % of all country-specific recommendations addressed to the Czech Republic have recorded at least ‘some progress ( ). 32 % of these CSRs recorded ‘limited’ or ‘no progress’ (see Graph 2.1). In several areas the Czech Republic made ‘substantial progress’ or reached ‘full implementation’. For example, there has been a full implementation in securing a timely and durable correction of the excessive deficit and ensuring compliance with the medium-term budgetary objective. Furthermore, substantial progress was achieved in adopting legislation to strengthen the fiscal framework. Graph 2.1:Overall multiannual implementation of 2011-2018 CSRs to date Source: European Commission The Czech Republic has made limited progress in improving the long-term sustainability of health and pension expenditure. Most measures adopted in the recent years have increased pension adequacy but lacked safeguards to ensure the long-term sustainability of public finance. The retirement age was capped at 65, a figure that will be reviewed in 2019 when the government is expected to issue a report on the pension system. The projected increase in age-related public expenditure on healthcare also puts long-term fiscal sustainability at risk. Some progress was made in increasing labour market participation of some underrepresented groups. Improvements supported through EU funds increased the number of childcare facilities, supporting women’s labour market participation. However, there are delays in implementing other policy measures. The announced changes in the provision of individualised services by public employment services, which could further help other underrepresented groups, have not yet brought tangible results. Due to the ineffective targeting and a lack of tailored measures, the progress in improving effectiveness of active labour market policies was limited, preventing these groups from benefitting from the favourable conditions of the labour market. The Czech Republic has made some progress ( ) in addressing the 2018 country-specific recommendations. However, no progress has been made in improving the long-term sustainability of public finances. The government adopted new measures, which, on the one hand, may improve the adequacy of the pension system, but, on the other hand, worsen sustainability. There has been some progress in addressing weaknesses in public procurement practices and reducing the administrative burden on investment. The public procurement training system was improved and there has been increased cooperation of contracting authorities with professional authorities. Nonetheless, the proportion of tender procedures attracting only one bid remained very high, with most opting for the price-only criteria. As regards reducing administrative burden, an amendment to the current legislation has the potential to shorten and improve the effectiveness of permits proceedings relating to strategic infrastructure. There was limited progress in removing bottlenecks hampering research and innovation. The announced ‘Investment package’, if well designed, could attract higher value investments in the country and thus strengthen the innovation potential. Nonetheless, the Czech Republic remains only a ‘moderate’ innovator as the proportion of innovative Czech enterprises is below the EU average There was some progress in improving the quality and inclusiveness of the mainstream education and in fostering employment of some underrepresented groups. In education, several measures were adopted or announced, including an increase in funding in 2019 and a reform of the funding system in regional schools. Nonetheless, the progress in increasing the attractiveness of the teaching profession has been more limited. The labour market participation of women, low skilled and people with disabilities has somewhat improved but the effectiveness of active labour market policies needs to be further addressed. Table 2.1:Annual assessment of the 2018 Country Specific Recommendations for the Czech Republic Source: European Commission Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in the Czech Republic The Czech Republic is one of the largest beneficiaries of the European Structural and Investment Funds (ESI Funds). The total allocation in the current multiannual financial framework amounts to EUR 24 billion, potentially amounting to around 1.8 % of the annual GDP. By the end of 2018, around EUR 14.6 billion (61 % of the total) was allocated to specific projects. In addition, EUR 1.2 billion was allocated to projects on strategic transport networks through the Connecting Europe Facility. Furthermore, over 780 projects implemented by research institutions, innovative companies and researchers benefited from EUR 221 million of additional EU funding via Horizon 2020, covering a very broad thematic spectrum from transport, energy and ICT to environment, health and agriculture. EU action also strengthened national, regional and local authorities and the civil society. Over EUR 560 million was allocated to strengthen the capacity of the public administration at different levels. The European Commission’s Coal Regions in Transition Initiative implemented at national level under the Strategic Framework for Economic Restructuring (RE:START) receives significant support from ESI Funds to enhance socio-economic and technological transformation in three regions with a sizeable coal mining industry. EU funding is helping to address policy challenges identified in the 2018 CSRs. ESI Funds contribute to the removal of bottlenecks in research and innovation and support closer cooperation between business and research institutions. Overall, by the end of 2018, EU funding helped to improve infrastructure for more than 4 800 researchers and nearly 4 000 companies. Over 700 km of roads and 120 km of rail were built or reconstructed. Furthermore, water supply for over 360 000 people was improved, and over 200 000 people are now protected from flood risks. The European Social Fund (ESF) is instrumental to the reform of education and training in the Czech Republic, including by improving inclusive education. There are almost 10 000 projects being implemented by education institutions which helped, among others, to include 1 000 Roma children in mainstream education and to create more than 12 500 affordable childcare places. The funds also helps vulnerable groups to find work, aiding some 8 000 people with disabilities to get into employment. In addition, the Commission can provide tailor-made technical support upon request from a Member State via the Structural Reform Support Programme to help implement growth-sustaining reforms to address challenges identified in the European Semester process or other national reforms. The Czech Republic is receiving support to establish a national e-health centre in view of improving the quality and cost-effectiveness of the health care. The Commission is also assisting the authorities to increase energy efficiency and to develop the national capital market. In addition, in 2018, the work has started on developing a national strategy to strengthen SMEs and increase capacity on tax collection and digitalisation in transport infrastructure. EU funds mobilise private investment. ESI funds mobilise additional private capital by allocating nearly EUR 567 million in the form of loans, guarantees and equity. A total of EUR 744 million allocated under the European Fund for Strategic Investments (EFSI) is set to trigger EUR 4.1 billion in additional private and public investments. Under the EFSI Infrastructure and Innovation Window, 13 approved projects worth EUR 189 million are expected to trigger around EUR 711 million in total investment. Under the EFSI Small and Medium-Sized Enterprises (SME) Window, 17 agreements with intermediary banks were approved for a total of EUR 555 million in financing. This should mobilise around EUR 3.4 billion in investments with more than 20 036 SMEs and mid-cap companies expected to benefit from improved access to finance. 3. Reform priorities 3.1.Public finances and taxation Taxation Tax revenues have continued to increase in 2017, contributing to the general government surplus. They increased from 34.8 % of GDP in 2016 to 35.4 % of GDP in 2017. This brought the tax revenues to the highest level since 2004, although still below the EU (40.2 %) and euro area (EA) (41.4 %) averages. This increase was mainly driven by a significant increase in receipts from VAT and import taxes and duties, which, as a share of GDP, have been constantly higher than the EU and EA averages. The Commission Autumn 2018 forecast projects a further increase to around 36.5 % in 2018. These measures, together with the robust economic growth, have doubled the general government surplus in 2017 to 1.6 % and brought the government debt below 35 % of GDP. Receipts from labour and consumption taxes have been increasing. Net social contribution revenues have increased in recent years on the back of a buoyant labour market and economy. By contrast, revenues from direct taxes, which mostly include taxes on income and wealth, are still significantly below the levels seen in the EU and EA. The share of direct taxes collected from households (mainly from labour income), for example, accounts for 4.0 % of GDP compared to 9.2 % in the EA. On the other hand, the implicit tax rate on employed labour is higher than the EU average ( ) due to a higher reliance on social contributions (Graph 3.1.1). As a share of GDP, receipts from the corporate tax (3.5 %) have been slightly above the EA average (2.7 %). While the recurrent property tax is one of the least harmful taxes to economic growth (OECD, 2010), the receipts collected in the Czech Republic remain very low. In addition, the tax deductibility of mortgage interest decreases the cost of home ownership, contributing also to the housing price dynamics ( ). Environmental tax intake remains relatively low, representing only 5.9 % of all taxes and social contributions collected in 2017.

VAT compliance, a government priority, has further increased. Tax evasion, as measured by the VAT compliance gap ( ) has declined from 20 % in 2012 to 14 % in 2016 (CASE, 2018). After first phases of the electronic evidence of sales and the control statements were introduced, the VAT gap fell 3 percentage points (pps) in 2016 compared to 2015. Nonetheless, the estimated figure remains above the unweighted EU average of 12.3 % and higher than in some other neighbouring countries. Graph 3.1.1:Tax revenues by main taxes compared to EU average in 2017 (in % of total taxation) Source: European Commission; EUROSTAT The taxation of labour for both low and average wage earners remains very high. Although the tax wedge is around 3 pps above the EU average for single persons with no children and receiving the average wage, the difference is particularly pronounced at lower wage levels. At 67 % of the average wage, the tax wedge is almost 4 pps higher than the EU average. At 50 % and 33 % of the average wage, the tax wedge gap vis-à-vis the EU average jumps to around 6 pps. In general, single persons with children, earning less than the average wage, have a significantly higher tax wedge compared to the EU average ( ). By contrast, for couples with no children and only one earner making 167 % of the average wage, the tax wedge is 3 pps below the EU average. The wedge is mainly influenced by the high rate of employer’s social security contributions. High tax wedges combined with high childcare costs may have a particular negative impact on the labour market participation of low-wage and secondary earners. In addition, self-employed people continue to benefit from a lower assessment base for social contributions. This can encourage activity but may also lead to some bogus self-employment. Tax compliance costs for businesses remain above the EU median. According to the World Bank (2018a), the time needed to pay and file taxes in the Czech Republic totalled 230 hours in 2017, 18 hours less compared to 2016 but higher than in other neighbouring countries. The new VAT control statement requirements have increased the time to comply by around 14 hours. A proposed VAT reduction for certain products and services might also add complexity to the VAT system, while having a questionable efficiency. According to a recent study (European Commission, 2018a), almost 50 % of the respondents consider the complexity of tax laws in the Czech Republic as very burdensome, with another 29 % perceiving it as burdensome. In early 2018, the government outlined a possible reform of the income tax. That particular proposal aimed to balance the reduction of the labour income tax base with an increase in the personal income tax rate. The government is currently elaborating the parameters of the final reform proposal. The European Commission carried out a simulation of the government’s initial proposal (Box 3.1.1), which suggests that the (first-order) potential net budgetary cost could amount to around 0.26 % of GDP, mainly due to the decrease in income tax revenues. Additional tax reforms shifting taxes away from labour to more growth-friendly tax bases could be considered, especially since the implicit tax rate on labour is relatively high. Targeted changes in favour of low-skilled and secondary earners might also prove particular beneficial. Fiscal framework The independent fiscal institution became operational in early 2018. The main tasks of the Fiscal Council are the publication of an annual report on long-term sustainability and the evaluation of the fiscal framework. The Committee on Budgetary Forecast, composed of appointees from public and private organisations, also started assessing the macroeconomic and fiscal forecasts prepared by the government. The Parliament ratified the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union in December 2018. The key element of the treaty, the Fiscal Compact, is not binding for non-euro area countries and the government does not intend to adhere to it voluntarily. Fiscal coordination among the various levels of general government remains low. A third of the general government expenditure is autonomous and outside the state budget. The Fiscal Responsibility Law of January 2017 introduced a cap of 60 % of the 4-year average of revenues for local governments’ debt. The Ministry of Finance will assess the compliance with the new debt management rule in 2019. The Czech Republic has not yet fully transposed Council Directive 2011/85/EU on the requirements for the budgetary framework. The deadline for the transposition was 31 December 2013. In particular, the Legal Act on Management and Control Systems in Public Administration has not been adopted yet. Debt sustainability analysis and fiscal risks There are no fiscal sustainability risks in the short run. In addition to a favourable initial budgetary position, the government debt is expected to remain significantly below the 60 % of GDP threshold, reaching around 31 % in 2020. As a result, the medium-term fiscal sustainability risk indicator (S1) is at -2.9 pps of GDP. The long-term sustainability of public finances may worsen. According to the recent Fiscal Sustainability Report (European Commission, 2019) ageing costs are expected to increase by 4.7 pps of GDP in the long term. The Fiscal Council (2018), in a recent report, provides even more pessimistic projections due to a different assumption regarding demographics and a no-policy change scenario. The report stated that if the current tax and spending policy were to be maintained, public expenditure on old-age pensions could almost double in the next 50 years. Pension expenditure is the main factor reducing long-term sustainability. The measures taken in recent years and changes in demographic projections have worsened the long-term budgetary outlook by around 2 pps of GDP by 2070. The retirement age was capped at 65, a figure that will be reviewed in 2019 when the government is expected to issue a report on the pension system. Nonetheless, according to the national authorities, the report will have no impact on the long-term sustainability but merely open a debate about an increase of the retirement age. Currently, expected gains in life expectancy are not automatically taken into account, since the Parliament, at the government’s proposal, has to approve any system change. Recent measures increase pension adequacy but are not coupled with policies that improve long-term sustainability. The government made pension indexation more generous by taking into account one half (rather than the previous one third) of real wage growth. It will also top up pensions with CZK 1 000 for all pensioners over 85 years of age and increase the flat rate share of the pension from 9 % to 10 % of the average wage. These measures will likely increase costs further and worsen the sustainability indicator (S2) by around 0.2 to 0.3 pps of GDP in the long term. While the government agreement mentions pension reform among its priorities, it is unclear what reforms are envisaged and if they can improve the sustainability of the pension system. The projected increase in age-related public expenditure on healthcare also reduces long-term fiscal sustainability. Public expenditure on healthcare is projected to increase by 1.1 pps of GDP by 2070, above the EU average increase of 0.9 pps. Taking into account the impact of non-demographic drivers, it may increase by 1.9 pps of GDP by 2070, 0.3 pps above the EU average (European Commission, 2018b). In the short term, the health insurance funds present a surplus, but analyses shows that they are sensitive to an economic downturn (Křeček, 2017). An additional state contribution to the health insurance funds of about CZK 3.5 billion per year is planned until 2020. The health system is still centred more around hospitals compared to other EU countries, suggesting inefficiencies in providing service. While overall expenditure on inpatient care was below the EU average in 2016, the total number of hospital beds remained above the EU average (6.9 per 1 000 inhabitants vs 5.1 per 1 000 inhabitants in the EU). In addition, hospital discharges and average length of stay are well above the EU average, while the percentage share of day cases in total discharges is substantially below the EU average (3.2 % versus 30.4 %). Patients in long-term care have a financial incentive to receive prolonged hospital treatment rather than being transferred to specific long-term care facilities, where they will have to make co-payments. Furthermore, long-term care focuses mainly on institutional care, which may not always be cost-efficient. The system would benefit from further investment in primary, integrated, and psychiatric care, including in the required infrastructure. Ongoing policy reforms have the potential to increase efficiency. These include the mandatory introduction of e-prescription as of January 2018, a pilot project on centralised procurement, further development of Health Technology Assessment and a new system of inpatient care reimbursement and hospital benchmarking (new Diagnosis Related Groups). The latter, however, is still in a pilot phase and will most likely not be used for reimbursement before 2020. Developments in the area of e-health provision and scaling up centralised procurement are also needed. Ageing poses an increasing risk of future shortages of health care staff in certain specialty fields and less urbanised regions. Even if the Czech Republic has around the same level of doctors and nurses per inhabitant as the EU average, there are regional disparities and a large proportion of the health workforce will reach retirement age in the coming decade. Efforts are under way to increase the number of medicine and nursing graduates and increase wages in the sector. Ageing and multiple chronic diseases will put an additional burden on long-term and social care. The government has announced a new strategy on long-term care aiming to support home care and non-institutional care. It has also indicated its willingness to continue the reform of psychiatric care. The reform on deinstitutionalisation is less clear. There are plans to reduce the current high percentage of children under 3 years old in institutional homes but there is room for further investment. Box 3.1.1: Effects of the potential income tax reform The European Commission Joint Research Centre conducted simulations of the effects of the proposed income tax reform presented in February 2018. These were based on the EUROMOD model using 2016 EU-SILC data (1). The proposal aimed to reduce the effective tax rates and abolish the super gross tax base calculation. In a super gross tax base system, the tax base for employees comprises gross wages and salaries, including social and healthcare contributions of employers, amounting to 34 % of the income. The microsimulation assumed five parts of this potential reform: (i) abolishment of the 7 % solidarity surcharge; (ii) increase of the 15 % tax rate to 19 %; (iii) introduction of a second bracket tax at 23 % for annual incomes above CZK 1.5 million; (iv) removal of the employer social and health contributions from the tax base; and (v) reduction of the tax base by ¾ of social and healthcare contributions for self-employed. The ceteris paribus net budgetary effect of the reform could amount to CZK 14.2 billion, or 0.26 % of GDP. The net effect comprises a CZK 13.7 billion decrease in income tax revenues and CZK 0.4 billion increase in means-tested benefits, the latter mainly being driven by the income tax bonus. On the other hand, the reform can reduce the average tax burden by 0.6 pps. Compared to the self-employed, employees seem to benefit the most from the reform. The distributional impact is plotted in Graph I, which presents the percentage change in mean annual disposable income by decile vis-à-vis the baseline without reform. In order to disentangle the impact of the different elements of the reform, four sub-scenarios have been simulated: Reform 1 – only part (v); Reform 2 – only part (iv); Reform 3 – only parts (i), (ii) and (iii); Reform 4 – full reform with all parts (2). As shown in Table 1, the ceteris paribus deduction of social and healthcare insurance contributions for self-employed people (Reform 1) decreases the average tax-burden for this group as compared to employees, which was one of the aims of the full reform. However, this effect is not expected to fully materialise in the full scenario (Reform 4). The independent simulations of the other components (Reform 2 & 3) could give an indication on the reasons. Employees, for instance, experience a significantly higher decrease of their average tax burden when moving to a standard tax base (Reform 2). (1) EUROMOD is the tax-benefit microsimulation model for the EU. It simulates individuals' and households' benefit entitlements and tax liabilities (including social security contributions) according to the rules in place in each Member State. Incomes reported in the EU-SILC of 2016 refer to 2015. (2) The independent simulation of the reform components serves as a guide to assess independently the parts of the reform but remains an approximation. Given the tax system’s non-linearities (i.e. the interplay of the reform’s different parts), the full reform scenario cannot be broken down into separate contributions for each of the parts. (3) The economic status refers to the current main activity status at the time of the interview. This is determined based on how most time is spent. 3.2. Financial sector

Financial sector The Czech financial system is showing stable profits and adequate capitalisation. Close to 90 % of the system is foreign-owned and highly bank-centric, with the largest five banks accumulating a market share of two thirds of total assets. Banks are well capitalised and produced stable results even during the financial crisis, contributing over-proportionally to their group profits. Unlike other banks in the neighbouring countries, Czech banks were not affected by foreign currency mortgages or similar costly one-offs. Insurance companies are also well capitalised and most of them maintain stable profitability. In general, the Czech capital market is relatively thin compared to similar sized economies (see 2018 Country report) but more advanced than in most new Member States. The soundness of the indicators suggests financial strength. Capital ratios have been stable since 2014, with a Common Equity Tier 1 ratio ( ) above 16 %. The strong credit growth, which reduces the capital ratio, is offset by retained earnings and a renewed drop in aggregate risk weights (CNB, 2018). In addition, the CNB is proactive in hiking capital buffers. It was the first non-Scandinavian supervisor in Europe to introduce a countercyclical buffer of 0.5 % in 2017. This buffer was raised to 1.25 % in January 2019, with further biannual 25 basis points’ hikes announced, reaching 1.75 % as of January 2020. According to CNB's simulations, banks have sufficient capital cushions overall to accommodate forthcoming hikes in the countercyclical buffer and support further growth in credit, assuming reasonable dividend policies. However, this space could decrease if profitability were to fall. Additionally, several banks have a systemic risk buffer ranging from 1 to 3 % of their capital. Given the relatively good capital levels of the banks, reaching the targets for minimum requirements for own funds and eligible liabilities is generally considered unproblematic. The profitability rate of Czech banks is among the highest in Europe. Return on equity has been stable and remained in double digits since EU accession, with the bigger banks reaching 14.5 % in June 2018. Income on interest remains the banks' main source of profit, as interest rate margins have been increasing in 2018. The loan-to-deposit ratio rose to 99.2 % in Q2-2018 coming from below 80 % 3 years earlier. While acting as net creditors to their parent organisations until 2012, Czech subsidiaries of the major foreign banks now borrow abroad to lend domestically. The cost-to-income ratio has been constant over the last decade, reaching 48.2 % ( ) in June 2018, significantly below the EU average. Banks are also quite reactive in adapting administrative costs to demand fluctuations. The non-performing loans (NPL) ratio remains low. On the back of strong loan growth, the ratio halved between June 2016 (4.6 %) and June 2018 (2.2 %) for the system in aggregate. The NPL of domestically owned banks fell from 21.9 % to 7.2 % over that timeframe (). This is a usual pattern during periods of strong economic expansion and may be concealing risks in the background (CNB, 2018). The NPL coverage ratio has increased steadily in the last 2 years reaching 52 % at the end of Q2-2018. Graph 3.2.1:Financial liabilities growth Source: Eurostat Non-resident holdings of commercial bank deposits soared before the end of the exchange rate commitment (Graph 3.2.1). After April 2017, deposit growth slowed but the levels remain largely unchanged. This process was the counterpart to the CNB accumulating external assets. The central bank’s external reserves are expected to remain stable in the short term at around 60 % of GDP. While there is a low risk of a disorderly withdrawal of foreign deposits, a gradual securities’ sell-off may be preventing the appreciation of the Czech koruna. The positive interest rate differential makes a sudden outflow of deposits held by foreigners unlikely. Since 2016, the continued spiral between property prices and mortgage loans has been the most significant domestic risk. Private sector loans grew by 6.7 % ( ) in the 12 months to September 2018 driven mainly by the increase of mortgages (Graph 3.2.2). In September 2018, mortgages made up 40.6 % of total loans provided to the private non-financial sector and 23.8 % of Czech GDP, slightly decelerating since the 2017 peak. The continued supervisory action taken by the CNB, particularly in terms of macro-prudential measures, may explain the trend and ease the risks. Graph 3.2.2:Private credit growth Source: European Central Bank Housing market Housing prices grew swiftly in 2017 but the escalation moderated in 2018. According to Eurostat, deflated house prices in the Czech Republic grew by 9.1 % on average in 2017, one of the fastest growth rates in the EU. However, these have moderated since the end of 2017, growing by 5.7 % year-on-year in Q3-2018. Since the beginning of 2015, the 23 % cumulative growth has been one of the highest in the EU and has outpaced real wage growth by more than 10 pps. As a result, housing affordability has been deteriorating. Estimates indicate moderate positive valuation gap in the Czech housing market in the range of 0-10 %. Three standard metrics ( ) of the degree of imbalance, based on historical averages for price-to-income and price-to-rent ratios, suggest little overvaluation of the housing market in 2017 (Graph 3.2.3). The highest gap relates to the price-to-income ratio compared to historical average. This estimate is close to the CNB's model-based approach, which suggests that in mid-2018 apartment prices were around 10 % above levels consistent with fundamental factors. Graph 3.2.3:Overvaluation gap Source: European Commission According to the CNB, the affordability of apartments declined between 2015 and 2017. This relates to both price-to-income and debt-service-to-income ratios (CNB, 2018). Some analyses on the price-to-income ratio (OECD, 2018) confirm this assessment and estimate that affordability in Q2-2018 was very close to the 2008 price levels. Other sources suggest the Czech Republic is the country with the least affordable own housing in 2017 in a sample of 12 EU countries ( ). Affordability of housing may further deteriorate due to increasing interest rates on mortgages. Affordability problems are most acute in Prague and other large cities. As more than 60 % of residential property transactions in the country are concentrated in Prague, developments in the capital city considerably affect national aggregates. Bid prices for new flats in Prague increased by 69 % between Q1-2015 and Q3-2018, 38 pps more than in the rest of the country. Both demand and supply factors explain this price escalation. While demand-side factors are broadly spread across the country, supply constraints are particularly acute in Prague and other large cities such as Brno. Graph 3.2.4:Deflated house prices Source: Eurostat

Note: One of 14 scoreboard indicative thresholds, covering the major sources of macroeconomic imbalances: y-o-y changes in house prices relative to a Eurostat consumption deflator, with a threshold of 6 % Good economic conditions have boosted the demand for residential properties and lead to an increase in mortgage loans. Overall, the stock of loans for house purposes increased by CZK 92.2 billion in 2017 reaching a total amount of CZK 1 152 billion (+8.7 % compared to the end of 2016). The proportion of homes occupied by an owner with a mortgage or a loan has almost doubled from 2008 (11.9 %) to 2017 (20.7 %), 4 pps below the EU average. Mortgage lending growth has stabilised at around 8 % year-on-year and is predicted to slow, in line with stricter macro-prudential rules introduced in October 2018. The CNB still lacks statutory powers to issue binding macro-prudential recommendations. To upgrade the central bank's macro-prudential powers, the government tried to pass an amendment to the Act on the CNB in 2017. However, the end of the parliamentary term interrupted the legislative process. The government is expected to resubmit the amendment but the political support is not guaranteed. The private banking sector does not fully support this amendment, despite being broadly compliant with the central bank's recommendations. In contrast, the CNB believes that setting universal conditions for all lenders by law would ensure fair and transparent competition. The CNB sets recommendatory caps to protect homeowners and mortgage lenders against negative equity. The recommendations mostly relate to the loan-to-value ratio. Lenders should not provide loans with loan-to-value ratios above 90 %. The volume of new loans with ratios of 80-90 % should be limited to a maximum of 15 % in every quarter. So far, the compliance with these rules is relatively high. However, the effectiveness of these caps could be put at risk if certain circumventive practices were carried out such as an optimistic assessment of the collateral value or a parallel provision of an unsecured loan to finance a purchase. The debt of the borrowers should not exceed nine times their net annual income. To address the risk linked to loans with high loan-to-value ratios and take into account borrowers' ability to repay, the CNB has introduced two supplementary recommendations as of 1 October 2018. In terms of debt-service-to-income, applicants should spend no more than 45 % of their net monthly income on debt service. The debt-to-income rate was set at nine times the net annual income. Furthermore, only 5 % of the new loans provided in a trimester may exceed the limits on the debt-to-income and debt-service-to-income ratios. Through the new measures, the CNB intends to reduce borrowers’ vulnerability and cool the housing market. The three recommendations are complementary and their interaction could lead to even stricter limits. Certain private banks suggest the new debt-service-to-income limits are the most constraining factor as they prevent standard housing loan applicants from obtaining the maximum value of a loan.

Interest rates for new mortgages have increased slightly but are expected to have only a limited effect on demand. The average rate has moved from an historical low of 2.1 % in November 2016 to 2.6 % in September 2018 in line with the increase of the 2-weeks repo interest rate from 0.05 % to 1.75 %. Thus, new borrowers could face higher debt service costs due to higher mortgage rates and the fact that, until recently, their incomes have grown more slowly than housing prices. The new debt-service-to-income limit and the recommendation that lenders should assess clients' debt servicing capacity for a scenario of a 2 pps lending rate increase should protect future borrowers. Mortgage rates are still relatively low and attractive for clients, both in terms of consumer price inflation and income growth. Graph 3.2.5:Housing supply (4 quarters aggregate) Source: Czech Statistical Office (CZSO) Recent data on started dwellings and building permits indicate a drop in the coming quarters (Graph 3.2.5). The number of completed dwellings grew by 4.6 % year-on-year in 2017 based on the nationwide average, but declined by 4 % in Prague. The completion of dwellings accelerated in the three first quarters of 2018 and reached a 20.2 % year-on-year growth in Q3-2018. As a result, figures on construction output and investment in construction obtained from the national accounts have been buoyant during that period. These dynamics may change, as the number of started dwellings decelerated in 2018 and its year-on-year growth rate turned negative (-1.6 %) in Q3-2018. Moreover, labour shortages and associated wage pressure are becoming a particularly acute constraint in the construction sector. Burdensome planning procedures continue to limit housing supply. Demand has continuously outstripped supply in some regions, particularly in Prague and other large cities, contributing to the increase in house prices. Although completion of new dwellings is enough to absorb the low demographic growth of the country, household size fell to 2.37 persons in 2017 (). Meanwhile, the expansion of Airbnb and other shared accommodation companies helps to explain the rise of real estate prices in Prague. Because of sustained housing demand growth, sufficient supply could mitigate upward pressures on prices and affordability. The flow of newly issued building permits remains far below historic averages. The number of building permits for dwellings issued in 2017 was 3.4 % higher than in 2016 but was the fifth lowest in the last 20 years. Although the trend has been positive since 2015, the outturn of 2017 noticeably decelerated compared to 2016 (7.3 %). The outlook is not positive, as 2018 is expected to end in the red (-3.1 % year-on-year growth in Q3-2018). In this context, a new construction law is under preparation (see Section 3.4). The regulatory burden is also augmented by regional disparities and planning rigidities. A new metropolitan plan for Prague is under discussion, to replace the old one adopted back in 1999. On average, 21 procedures need to be undertaken to receive a building permit in the country, compared to 12.5 across OECD countries (World Bank, 2018a). 3.3. Labour market, education and social policies Labour market The Czech labour market is one of the best performers in the EU but is increasingly tight. The employment rate of those aged 20-64 has continued to rise and reached 80.0 % in Q3-2018. The activity rate reached a new peak of 81.9 % in Q3-2018. The unemployment rate is the lowest in the EU, at a record low of 2.1 % in Q4-2018. Long-term unemployment (0.7 % in Q3-2018) and youth unemployment (7.6 % in Q3-2018) have declined to below pre-crisis levels. The share of young people (aged 15-24) neither in employment nor in education and training declined from 7.5 % in 2015 to 6.3 % in 2017. Graph 3.3.1:Labour market developments Source: European Commission Labour shortages can limit economic growth. The job vacancy rate, reflecting the unmet demand for labour, was one of the highest in the EU in 2017. It grew from 3.6 % in Q2-2017 to 5.9 % in Q3-2018. The number of job vacancies was more than twice as large as the number of unemployed people in Q3-2018. It increased more than eightfold since 2010 to 270 588 in Q3-2018. Shortages are especially pronounced in manufacturing and construction - in Q4-2018 45 % of manufacturers cited labour shortages as a factor limiting production ( ) and investment (EIB, 2018). The country has the highest share of enterprises in the EU (79 %) reporting difficulties in hiring ICT specialists. Expected demographic changes will have a significant impact on the labour market and public finances. The size of the working age population has been gradually declining, falling from 7.4 million in 2010 to 6.9 million in 2017. Until recently, the employment rate increased due to declining unemployment and increasing activity rates in view of high demand and wage increases. While the decline in working-age population cannot be eliminated, its impact can be mitigated and the potential labour force increased by tapping into the labour force potential of those less active, including mothers of young children, the low-skilled, older workers, the people with disabilities and Roma. Foreign workers could also help alleviate labour shortages. The labour market expansion can improve the participation of underrepresented groups. Women are overrepresented among the inactive, having an employment rate well below that of men (70.5 % vs 86.3 % in 2017). These differences are higher among women younger than 40. The share of women choosing inactivity due to care is one of the highest in the EU (84 % of the inactive women aged 25-34 and 70 % of those aged 35-44). The activity rate of the low-skilled (12.1 % of the labour force) has stagnated at around 30 % since EU accession and has not changed, despite the economic boom (Graphs 3.3.2). Their employment rate increased to 49.2 % in 2017 but remains below the employment rate of medium- (79.4 %) and high-skilled (84.2 %) groups. The employment rate of older workers (55-64), at 62.1 %, lags behind that of younger workers (86.7 % for those aged 25-54), as does their activity rate (63.6 % versus 89.1 %). There is also a large employment gap between people with and without disabilities (32.8 pps compared to the 25.8 pps at EU level). Female labour force participation falls with childbirth, contributing to the gender employment and pay gap. The employment gap between women with a child below the age of six and women without children was 48.3 pps in 2017, the highest at the EU level. Evidence suggests that gender inequalities persist throughout their career, as the average hourly wage of a man in 2016 was 21.8 % higher than that of a woman. Part of this difference suggests a potential important role for gender discrimination. Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights is designed as a compass for a renewed process of upward convergence towards better working and living conditions in the EU. It sets out 20 essential principles and rights in the areas of equal opportunities and access to the labour market; fair working conditions; and social protection and inclusion ( I ). The Czech Republ ic performs well on most indicators of the Social Scoreboard supporting the European Pillar of Social Rights . The Czech Republic has the lowest level of unemployment in the EU (2.1 % in Q4-2018) and long-term unemployment and youth unemployment have furthe r declined to below pre-crisis levels. The risk of poverty or social exclusion and the degree of income inequality are among the lowest in the Czech Republic. However, the risk of poverty would increase by at least 4 pps if indebtedness was taken into acc ount. Challenges remain in relation to the equality of opportunities. In education, socioeconomic background strongly affects student performance. The quality of the education system could be promoted by policies to ensure the inclusion of vulnerable group s, to increase the attractiveness of the teaching profession and to increase participation in adult learning. The Czech Republic combines a low participation in early childhood education and care (4.7 % of children younger than 3 years in 2016) with a high gender employment gap (the employment rate of women is 15.8 pps below that of men, for an EU average of 11.5 pps). In the tightening labour market and amid significant gender inequality, the provision of affordable childcare and reducing the tax wedge for single earners can be important policies, supporting the Pillar principles on ‘work life balance’ and ‘childcare and support to children’. The Czech Republic has been undertaking reforms and using the support from the European Social Fund (ESF) to substantially increase the availability of childcare. Compulsory participation in pre-school for children aged 5 and the entitlement for a place for children from the age of 3 have been introduced. Altogether approximately 18 000 new places in childcare facilities were created with the support of EU funds over the last three years, which reduced the shortage by half. Moreover, an ESF pilot was up-scaled for micro-nurseries for children from 6 months to 4 years of age and more will be built in future. Further plans include legislation changes and financing from the national budget to make new types of childcare facilities sustainable and to broaden the creation of places for children younger than 3 years. Graph 3.3.2:Employment rate by age and education level in 2017 Source: European Commission Parental leave rules, lack of formal childcare and caring responsibilities result in women's long career breaks. Long parental leave (rarely taken by men) and a lack of affordable childcare contribute to lower female labour market participation. The Social Scoreboard of the European Pillar of Social Rights flags the formal childcare enrolment of children aged 0-3 (4.7%), which remains significantly below the Barcelona target of 33%, as a critical situation. Public spending on family benefits is above average but childcare costs are high. While cash benefits and tax-credits are relatively high, public spending on services such as childcare is only half of the EU and OECD averages. In the past two decades, the figure has hardly changed, hovering around 0.5 % of GDP. Families have to bear high out-of-pocket childcare costs: at 17 % of the average household earnings, the cost is significantly higher than in many of the neighbouring countries ( ). For single parents earning below the average wage, the net cost goes as high as 21.4 % of their earnings, one of the highest rates in the EU ( ). A secondary earner currently faces tax disincentives to work, as the primary earner loses the dependent spouse allowance when the secondary earner has an annual income above CZK 68 000. Together with the cost of childcare, this helps explaining the low female labour market participation.

Policy responses, such as increasing the number of childcare facilities, are promising. By November 2018, EU funds had already supported 850 child groups with a capacity of more than 11 000 places for children from 1 to 6 years, 276 places in micro-nurseries (for children aged 6 months to 4 years) and almost 5 000 in children’s clubs were created. Despite this significant improvement, this capacity was insufficient to meet the estimated unmet demand for childcare of 14 000 children below 3 years old in the 2017/2018 school year (Hora et al., 2018). Thus, further EU funding is planned (including on infrastructure) with existing facilities financed from the national budget. More flexibility in parental leave may increase female labour market participation. The recent proposal to make the maximum duration of parental leave more flexible and to introduce 'shared jobs' to allow mothers with small children and other carers to work part-time is a step in the right direction. However, there is scope for investment in further measures in this area. Sufficient and coordinated provision of formal accessible, high quality and sustainable long-term care services remains a challenge. Their underdevelopment can be another major impediment for women to stay in employment. The three-month caretaker leave introduced in June 2018 has not met expectations as only 400 have benefitted from the new right, far below the 30 000 target originally estimated by authorities. A complex combination of socio-economic factors negatively impacts the labour market performance of the low skilled. Low-skilled workers represent a relatively small group (7 % of the workforce in 2017). However, with an unemployment rate of 12.6 % and an employment rate of 43.7 %, they perform below average when compared to the rest of the population and the low skilled in other EU countries. This group faces disincentives to work such as the high tax wedge on low earners, especially in the case of women with young children. Their participation tax rates are as high as 50 % (see Section 3.1). Moreover, the low skilled are often employed in low paid jobs and under poor working conditions. Health and abuse issues and social background create more obstacles to employment. Indebtedness is an important impediment to employment. It is high in regions with the largest proportion of low-skilled people. Overall, 830 000 people were affected by enforcement orders in 2017 (9.7 % of people over 15 years). In some regions, like Ústecký, this rate is over 20 %. This can generate a high prevalence of undeclared work. When entering declared employment most of the salary is seized to repay the creditors, creating a financial motivation for workers not to declare their income. On the employers' side, addressing creditors' requests increases their administrative burden, decreasing the motivation for regular employment (Hora et al., 2018). Lack of specific measures, low participation in training and subsidised jobs further hinder employment of the low skilled and the people with disabilities. The job subsidies do not compensate for the lack of motivation on both the employer and unemployed side. Most labour market interventions do not specifically address the issues of the low skilled and of people with disabilities. While (often used) public works have proved insufficient, other active labour market policy programmes are not robust enough. Investment in a comprehensive individualised approach, taking into account health conditions and other disadvantages (old age, low skills, family obligations, and abuse issues), tailored training to overcome skills barriers, and effective counselling to address indebtedness in combination with social work, is needed. A limited range and inefficient targeting of active labour market policies deepen the segmentation on the labour market. The effectiveness of the three principal programmes for the unemployed were analysed in a study covering the 2014-2016 period (Horakova and Sirovatka, 2018; Hora et al., 2018). Overall, training programmes as well as subsidised jobs in the private sector tend to target those with fewer barriers in the labour market instead of supporting those most in need. Only one in five participants in subsidised jobs were long-term unemployed. Instead, the groups further from the labour market, with combined handicaps, are mostly placed in public works although they do not contribute to permanent employment. The increase in the number of social enterprises is promising for integration of underrepresented groups, although the regulatory framework is still lacking. The business model of public employment services does not provide individualised support to vulnerable groups. A single point of contact for distributing employment and social benefits and services was established. However, its potential for outreach and activation is not fully used, also due to the limited interoperability of the IT platform, which represents room for investment. The individualised approach for registered jobseekers has not been implemented as a universal measure and depends largely on ESF funding. A basic form of profiling is applied but has a more intuitive than formalised or systematic nature. Investment in modernising of public employment services and a broader range of measures would offer the right intervention mix to jobseekers. A systemic framework for cooperation between public employment services and other stakeholders is lacking. Setting common objectives for public employment services, non-governmental organisations and other partners in the labour market and investing in developing their capacity could tackle weaknesses in addressing barriers faced by underrepresented groups. Higher activity rates for older workers can tackle labour shortages but their skills may need to adapt. A declining labour force means that workers will need to adapt to longer careers. This implies investment in health and adapting their skills to the changing work environment. Work places also need to be adapted to age-related needs. Therefore, tailored measures in employment, health, social work and pension reforms are needed to face the expected demographic change (with the share of those aged 55-64 years increasing from 19.5 % in 2016 to 22 % in 2030) (European Commission, 2018b). The tight labour market and administrative burden induces risks of increasing undeclared work. Many companies react to the situation by hiring workers illegally, mostly from non-EU countries. The association of employment agencies estimate that around 250 000 people are working illegally, even though only 2 900 illegal workers were detected last year. The bureaucracy related to work and residency permits may push law-abiding immigrants into illegal work. Their situation is often not regularised due to the absence of appropriate employment permits. The ‘employment card’ approach, combining both the residence and work permit, resulted in a slight decline in, the still high, administrative costs. Foreign workers also often work without proper contractual arrangements, when their employment relations at least border on regular long-term employer-employee relations. Investment in their integration, accelerating immigration procedures, reducing the bureaucracy and modernisation of labour inspectorate could help to address the issues. Preparing the labour market for technological change is high on the political agenda. Investment needs to remain vigorous, underpinned by a revival of construction activity, greater use of EU funding, the need to compensate for labour shortages and a general trend towards industrial automation. Indeed, investment is needed to support the transformation of the national economy towards higher-value added production, which can increase labour productivity and innovation. This in turn could help address the problem of relatively low wages while maintaining competitiveness. Qualitative skills mismatches, due to future automation and robotisation, could arise, notably in the digital sector. Within the next 15 years, the number of jobs disappearing due to technological change (450 000) is expected to be compensated by demographic prospects (-400 000 people). The new jobs will require new competences and large investment particularly in digital skills. According to the Digital Economy and Society Index, only 24% of Czechs have above basic digital skills, while the EU average is 31%. Deployment of high-level skills and closer cooperation with the business sector would enable the diffusion and uptake of innovation and industrial transformation. Investments in training and education could facilitate such economic transition and increase productivity of workers. Promoting adult learning and lifelong learning under the Government's Strategy and Action Plan Work/Education 4.0 can support employability and help to avoid a structural qualitative mismatch. For example, the ESF-funded project PRIM promotes an education programme in basic coding and robotics and, if successful, can become standard in all schools by 2020. A comprehensive skills strategy could help to adapt the labour force to future changes. Such a strategy should also target non-EU nationals, as this could contribute to further reducing labour shortages. Although various initiatives were developed over recent years, these have not yet grown into a genuine comprehensive system for producing and interpreting skills intelligence. In addition, a single national Skills, Competences, Qualifications and Occupations classification has not been finalised (see Country Report 2018). Plans to further develop vocational education and training have not yet been implemented. Investment in the modularisation reform of the curricula could increase the flexibility and adaptability of vocational education and training systems to changing labour market needs. Furthermore, remunerating apprentices could help prevent early programme leaving. Social partners play a strong role in raising awareness about labour and skill shortages. Stakeholder engagement and local and regional dialogues between policymakers, employers, and education and training providers are key to identifying needs and increasing the relevance of vocational education and training and higher education. Investment in strengthening the social dialogue could help to achieve the objectives. Social policy The share of people at risk of poverty or social exclusion (AROPE) is low but differences across population groups and regions have increased. The AROPE is one of the lowest in the EU, having decreased further in 2017 by 1.1 pp. to 12.2 %. The country performs above EU average when it comes to the adequacy of its minimum income scheme, which in 2016 represented around 60.6 % of the poverty line and 56.5 % of a low wage earner (compared to an EU average of 57.5 and 46.1 %) ( ). However, among the elderly (aged 65+), the AROPE share increased from 10.1 % to 12.6 % (Graph 3.3.3). Moreover, regional differences are high, with the highest levels seen in the Moravskoslezský and the Severozápad regions. There is also a worsening trend in these regions on other indicators such as education outcomes, the number of socially excluded localities and persons living in them and access to health care. Graph 3.3.3:Age groups at risk of poverty or social exclusion in 2017 Source: European Commission; EU-SILC The increase in private indebtedness could potentially increase the risk of poverty. If taking into account enforcement proceedings and insolvencies, the proportion of poor people ( ) would increase by about 4 pps (or 300 000 adults). However, the statistics consider income before debt deductions, which is higher than the actual take-home pay. If indebtedness was taken into account, higher levels of poverty would be observed, notably in more deprived regions.

Over-indebtedness and property seizures have multiple causes, notably unpayable mortgage loans. High mortgage loans related to rising housing costs (see Section 3.2), high consumption on credit, failed business projects, lack of social capital, poor financial literacy, and loss of income from economic activity are among the causes on the debtor side. As for the creditors, insufficient screening of loan applicants is highlighted. Lastly, the institutional set-up via arbitration clauses, difficulties in penalising usury, regulation allowing deliberate abuse of the system by creditors, high enforcement charges for minor debts and difficulties in implementing a debt-relief scheme, hinder preventing or tackling over-indebtedness. The legislation on debt-relief, under discussion for more than two years, was adopted in a lighter version. While it can still improve the debt relief procedure, two major changes to the current legislation were not adopted. The new legislations keeps the requirement to pay off at least 30% of one’s liabilities within the 5 year debt relief period. The proposal to make the debt relief mechanism more flexible for debtors who are able to pay higher instalments was not included. There is a growing number of socially excluded localities. Housing exclusion and homelessness, high indebtedness and unemployment affect the most vulnerable groups, including Roma. The number of socially excluded localities has almost doubled in 2006-2014 but in the Moravskoslezský and Karlovarský regions it has more than tripled (see Country Report 2015). Recently, the inhabitants of socially excluded localities have been moving to more remote municipalities with less functional infrastructure. Housing exclusion and homelessness are increasing among low-income households, while related policies are lacking implementation. The draft Act on Social Housing, which was supposed to set eligibility and quality criteria for access to social rental housing, was not adopted in 2018. The current legislation does not sufficiently address the lack of affordable and quality social housing and its negative social impact and there are no plans to revise it until 2023. Instead, the government plans to replace it with a subsidy-credit programme called ‘Construction’. This program would finance social housing for people at risk of exclusion, but above all accessible housing ‘in the public interest’, e.g. to attract bottleneck public professions in the municipalities. However, the proposal lacks an integrated approach combining social services with housing, despite the proven success of piloted ESF projects, such as Rapid Rehousing. Regional social disparities were also supposed to be addressed in a coordinated approach of the ‘RESTART’ strategy. However, implementation of the social aspects has been limited due to lack of political support. Further investment, including in food and basic material assistance for the socioeconomic integration of the socially excluded is also needed. Health status has improved recently but there are regional disparities, correlating with the level of unemployment, among other things. While overall self-reported unmet medical needs are among the lowest in the EU, the unmet needs due to distance to health care are above the average. Overall health status is still below the EU average and varies significantly by region (e.g. life expectancy at birth for both men and women can differ by more than 4 years). These differences are largely due to socio-economic and behavioural risk factors such as alcohol consumption. There is a significant negative correlation between (long-term) unemployment, poor health/disability and lower life expectancy (OECD, 2018; Hora et al., 2018). To contribute to better health outcomes, the health system would benefit from further investment in primary care and integrated care including necessary infrastructure notably in laggard regions (see Section 3.1). Education and skills The general government expenditure on education as a share of GDP decreased and it is now below the EU average (4.5 % vs 4.7 % in 2016). Expenditure per student at all education levels was among the lowest in the EU in 2015. Teachers’ and school principals’ salaries are among the lowest both internationally and compared to other workers with tertiary education. The 15 % salary increase initially planned for September 2018 was postponed to January 2019, while the Chamber of Deputies and employers call for further increases. Announcements on increases do not mention a timeline. Public funding for higher education has increased in 2019 with scope for further investment. The teaching profession faces severe challenges. These include shortages, demographic challenges, weak education governance, low prestige, low salaries and limited development opportunities. There is a shortage of qualified teachers in particular in primary education. Besides low salaries, there is no career system for teachers, leading to a flat career structure. Teachers also do not receive sufficient training in the classroom during their initial education. These elements contribute to the high drop-out rate during the first years of teaching. Low participation in continuous professional development is reportedly linked to a lack of incentives and low impact on careers as well as being of little relevance to teachers’ needs. This relates particularly to differentiated types of teaching according to pupils’ needs, poor offer of distance-learning and absence of compensation for replacement teachers. ESF projects support teachers at the beginning of their career and their continuous professional development. They also contributed to finalising standards for university programmes that prepare future teachers. A special fund enables education for more future teachers. While below the EU average, the early school leaving rate has continued to increase since 2010. At 6.7 % in 2017, the rate exceeds the 5.5 % national target for 2020. Wide regional disparities and a high proportion of early leavers among Roma pupils (57 % in 2016 among the Roma families that participated in the survey) call for strengthened analysis and targeted measures (see Country Report 2018, FRA, 2016). This trend contrasts with the steadily decreasing EU average. The most affected schools have less qualified teachers and high staff turnover. In 2018, a study (Bicakova and Kaliskova, 2018) showed that young people dropping out of school are attracted by the current easy access to paid employment. However, they often end up in low paid, low quality and short-term jobs. Thus, they add to the number of the low-skilled unemployed. Incentives to attract young people back to education, as well as prevention measures and second chance education are under discussion. Socio-economic inequalities in school outcomes have increased in recent years. The share of low achievers in science and reading among 15-year-olds has risen significantly since 2012. The gaps between socio-economic groups and between schools are increasing and are reflected in regional disparities. The selectivity of the school system and early tracking tend to increase inequalities. Only 18 % of children whose parents did not attain tertiary education obtain a tertiary degree and, in general, are less likely to graduate from vocational programmes. The authorities are reviewing the national curricula to increase effective equal opportunities and better focus on skills needed for future jobs. As there are no incentives to attract qualified teachers to disadvantaged schools (OECD, 2016), better support could be beneficial. While being positive overall, the impact of the inclusive education reform on the participation of Roma children in mainstream education remains limited. The reform is a major concerted effort (see Country Report 2018; Centre for Policy Studies, 2018) but the government reported that 10.3 % of Roma elementary school age children attend special schools or special classes, 8.3 pps more than in the case of elementary school pupils as a whole. Roma pupils represent 29.1 % of all pupils in a programme with light mental disability. Free individual support measures for pupils with special educational needs, including those from disadvantaged socio-economic backgrounds, were introduced to enable them to participate in mainstream education. The 2017 evaluation by the School Inspectorate indicates that the reform has improved the support for these pupils, reaching around 98 % of education providers at all levels. In addition, a survey of school professionals found that 49 % of school principals believe they can now provide better support to these children. However, the recruitment of teaching assistants is a challenge, with 21 % of schools failing to find qualified candidates. Some regional and local authorities resist transforming former practical schools for political reasons. Investment in skilled pedagogical staff, training tools, teaching materials or technological equipment is needed to meet the reform objectives. Participation in early childhood education and care continues to catch up with other Member States. It is estimated that only about 34 % of Roma from the age of four participate in this level of education (FRA, 2016). Under current conditions, it is crucial to maintain the recently established right of all children over 3 years to attend pre-school and, subsequently, to guarantee places in kindergartens. The highest proportion of home-school pupils was registered in the Usti region, where, children would benefit most from being educated at school in an inclusive environment. The full support of municipalities is im