EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 502 final COMMISSION STAFF WORKING DOCUMENT Country Report Czechia 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 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(2020) 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 3.5.Environmental sustainability Annex A: Overview table Annex B: Commission debt sustainability analysis and fiscal risks Annex C: Standard tables Annex D: Investment guidance on Just Transition Fund 2021-2027 for Czechia Annex E: Progress towards the Sustainable Development Goals (SDGs) References LIST OF Tables Table 1.1:Key economic and financial indicators - Czechia

Table 2.1:Assessment of the 2019 CSR implementation in Czechia (*) Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators58 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 Table E.1:Indicators measuring Czechia’s progress towards the SDGs LIST OF Graphs Graph 1.1: Real GDP growth and its components Graph 1.2: Gross National Income per person, in purchasing power standards (% of EU average) Graph 1.3: Potential GDP and drivers Graph 1.4: Private and public investment, quarterly profile 8 Graph 1.5: Investment by sector as a share of GDP 9 Graph 1.6: Breakdown on the nominal unit labour cost 9 Graph 1.7: Evolution of labour productivity 10 Graph 1.8: Unemployment and job vacancies 10 Graph 1.9: Evolution of household debt and housing loans 11 Graph 2.1: Overall multiannual implementation of 2011-2019 CSRs to date 14

Graph 3.1.1: Structure of environmental taxes (% of GDP) 17 Graph 3.2.1: Number of started and completed housing projects (12 month moving average) 21 Graph 3.2.2: Evolution of housing loans and mortgages 22 Graph 3.3.1: Labour market developments 23 Graph 3.3.2: Evolution of labour shortages 23 Graph 3.3.3: Difference in reading scores between advantaged and disadvantages schools 27 Graph 3.3.4: Groups at risk of poverty or social exclusion 29 Graph 3.4.1: Composition of Czech exports, % of total 32 Graph 3.4.2: Venture Capital in 2018 as a share of GDP 32 Graph 3.4.3: Completed km of highways 36 Graph 3.4.4: Business churn in selected sectors in 2017 39 Graph 3.4.5: Regional Competitiveness Index 2019 39 Graph 3.5.1: Energy intensity in selected countries 44 Graph 3.5.2: Final energy consumption by sector and production by source 45 Graph 3.5.3: Greenhouse gas emissions per capita 46 Graph 3.5.4: Coal regions in Czechia 48 LIST OF Boxes Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights 24 Box 3.4.3: The National Development Fund

Box 3.4.4: Automation and Artificial Intelligence in Czechia Box 3.4.5: Investment challenges and reforms in Czechia 24 Executive summary Czechia’s ability to diversify its economy will be crucial for maintaining a solid catch-up in living standards (). The industry-intensive economy, underpinned by trade openness and foreign investment has allowed Czechia to steadily catch up with the rest of the EU. However, this growth model may have reached its limits. The direction of the economy will depend on its capacity to diversify and increase productivity and the value added of its products and services, while remaining an attractive destination for investment. Future growth also depends on Czechia’s ability to face the challenges associated with population ageing, technological change and ensuring environmental sustainability. Factors such as: (i) the low investment in sustainable transport and in the transition to low-carbon energy sources; (ii) a moderate performance in domestic research and innovation; and (iii) acute labour and skill shortages, are a major structural obstacle to a successful socio-economic transition. Implementing these structural reforms would help Czechia achieve further growth in living standards and ensure a sustainable development. Economic growth is set to slow down in the coming years. According to the Commission’s Winter 2020 Forecast, real GDP growth continued to slow down in 2019 to 2.5%, reflecting international developments. A solid wage increase in a tight labour market continues to support consumer spending as the main driver of growth. The slowdown in foreign demand has led to a drop in private investment and a much lower increase in exports and imports. In the context of a stagnating industrial production, economic growth is expected to slow down further up to 2021. There are no short-term risks to public finances but the long-term outlook is worsening due to ageing-related costs. In the short-term, public finances are expected to remain in balance and the public debt is expected to fall to around 30% of GDP. On the other hand, a lack of concrete action to deal with increasing ageing-related costs puts increasing pressure on the long-term sustainability of public finances. The labour market remains strong, but labour and skills shortages and continuous increases in unit labour costs may hinder further growth. The employment rate reached 80% and unemployment is at a record low. However, persistent labour shortages are a cause for concern. Low unemployment levels pushed wages upwards, increasing the unit labour costs and potentially reducing overall cost-competitiveness. In the medium term, a continuous increase of wages above labour productivity growth could reduce the profitability of companies and adversely affect investment. Despite some improvements, the low skilled, older people and people with disabilities are still not fully integrated into the labour market, partly because active labour market policies are not well targeted and tailored. Female participation in the labour market is hindered by the lower availability of affordable childcare. The integration of foreign workers into the labour market is also a challenge. Czechia has made limited progress in addressing the 2019 country-specific recommendations. There has been some progress in: ·removing the barriers hampering the development of a fully functioning innovation ecosystem; ·increasing the quality and inclusiveness of the education and training systems, including by fostering technical and digital skills and promoting the teaching profession; ·supporting more quality-based competition in public procurement. There has been limited progress in: ·focusing investment-related economic policy on transport, notably on its sustainability digital infrastructure, and low carbon and energy transition, including energy efficiency, taking into account regional disparities; ·adopting pending anti-corruption measures; ·fostering the employment of women with young children, including by improving access to affordable childcare, and of disadvantaged groups; ·reducing the administrative burden on investment. There has been no progress in:

·improving long-term fiscal sustainability of the pension and health-care systems. Overall, Czechia performs well on the Social Scoreboard supporting the European Pillar of Social Rights. The employment rate is among the highest in the EU and the unemployment rate is the lowest. Yet, there is still scope to improve access to the labour market for women and vulnerable groups. The gender pay gap is also still one of the widest in the EU. While the share of people at risk of poverty or social exclusion is comparatively low, poverty remains high in some areas and for some population groups. The rate of early school leaving remains below the EU average. While levels of basic digital skills are higher than the EU average, further efforts to promote advanced digital skills will be needed to fully capture the benefits of the digital transformation. Czechia has met, or is on track to meet national targets in most areas under the Europe 2020 strategy. This includes targets for poverty, social exclusion, employment, renewable energy, greenhouse gas emissions and higher education. However, the targets for public R&D spending and for early school leaving have not yet been reached. Overall, Czechia is making progress on the United Nations Sustainable Development Goals. It has made at least moderate progress in all areas, particularly in eliminating poverty. However, more progress is needed on climate action (SDG 13) and gender equality (SDG 5) (). Key structural issues analysed in this report, which point to particular challenges for Czechia’s economy, are the following: ·There is a lack of action to ensure the long-term sustainability of public finances. While the authorities acknowledge that long-term sustainability is an increasing problem and while they have discussed pension reform, the government recently decided not to link expected gains in life expectancy with the statutory retirement age for the next 5 years or to implement alternative measures. The projected rise in age-related spending on healthcare also puts the long-term sustainability of public finances at risk and there may be scope to increase the cost-effectiveness of health and care services. ·Labour taxation remains high while property and environmental taxes are among the lowest in the EU. Taxation of labour is high, particularly for people with low wages. Conversely, property and environmental taxes have remained low, despite the significant increase in house prices and the high carbon intensity of the economy. ·Despite slowing down, rising house prices are making housing less affordable. Various indicators suggest that the housing market is overvalued by 10-20%. Strong price growth is due to supply constraints coupled with an increasing demand for housing in large cities. A proposed new construction code may help simplify and accelerate construction-related procedures. Although the growth of the housing loan stock slowed in 2019, partly due to the implementation of the central bank’s macroprudential recommendations, rising property prices may be a risk to financial stability in the medium term. ·The social protection system shows some weaknesses. Older people, the unemployed, single parents, and people with disabilities, are at a higher risk of poverty or social exclusion. Factors such as over-indebtedness, homelessness and a growing number of socially excluded areas contribute to poverty and inequality. The health, social and long-term care services are also not fully prepared for an increasingly ageing population. ·Educational outcomes are negatively affected by the limited attractiveness of the teaching profession, and by socio-economic inequalities and low investment. There is a shortage of teachers due to low job prestige, limited development opportunities and lower wages compared to other professions of similar qualification levels. Public spending per student at all education levels remains comparatively low. While early school leaving declined at the national level, regional disparities further increased. Socio-economic status continues to affect educational outcomes and access to higher education. ·Progress in improving the transport infrastructure is sluggish, hampering private investment. The level of public investment in transport infrastructure is below the EU average and, therefore, the transport network has significant gaps. Uneven development and connectivity primarily affect the south and the northeast of the country. The recently unveiled National Investment Plan is supposed to address some of these investment gaps. However, the plan does not sufficiently address sustainable mobility, given the increasing greenhouse gas emissions from transport. There are plans to use some innovative financing options, including public-private partnerships, but, so far, the country has limited experience in using this type of financial instrument. ·Some barriers to entrepreneurship and competition point to a suboptimal allocation of resources. The regulatory burden on professional services and professions is an obstacle to growth and competitiveness. Business dynamism is back to pre-crisis level, but remains weak. Fast-changing legislation and complex administrative procedures are seen by most firms as major obstacles to further investment, particularly in less-developed regions. ·Domestic innovation is important for supporting a sustainable economic growth model. Czechia remains a moderate innovator at EU level, despite some progress in recent years. Public investment is not underpinned by systemic reforms to improve research performance and cooperation between the private sector and academia. On the back of an insufficient number of graduates in science, engineering and computing as well as skills shortages, the innovation performance of domestic firms and the technology transfer remain rather low. ·Support for innovative domestic firms remains limited. The promotion and support of entrepreneurship remains low, hampering productivity growth. Foreign investment has been a major contributor to the country’s growth but spillovers to the domestic firms have been limited. Czech firms are highly integrated in global and regional value chains but their main focus is still on low value added activities, particularly in manufacturing. While some successful innovative initiatives were brought to market, venture capital and equity capital remain very low. There are plans to increase financial support to innovative firms, particularly those delivering higher value added products and services. Improving the insolvency framework could also enhance economic efficiency. ·New digital technologies provide opportunities for the economy to become more innovative. As the automotive industry remains a backbone of the economy, Czechia is expected to be strongly affected by technological change. Driven by foreign investment, robotisation is already a significant component of the Czech economy. Recently, automation and artificial intelligence have also become major policy priorities, but progress remains to be seen. Adequate, efficient and sustainable investment in skills is needed to support and reap the benefits of a broader economic change. ·Czech regions have different challenges. While richer regions suffer from housing unaffordability and pressures on the suburban transport networks, the poorest areas face remoteness, demographic pressures, social exclusion, and an insufficient focus on important areas such as energy transition innovation, and digitisation. ·Improving the performance of the public sector is crucial for economic change. The professionalism of the civil service, the transparency of government and controlling corruption all fall below the EU average. Despite significant progress, so does e-government. Czechia also has one of the largest regional variations in terms of quality of governance. Although the public procurement framework is improving, it may warrant further fine-tuning. Some anti-corruption measures are still awaiting adoption. ·Czechia is facing difficulties in reaching climate neutrality and in transitioning from solid fossil fuels. The country still relies heavily on solid fossil fuels with high CO2 emissions. The use of renewable energy is below the EU average, as the sector lacks the appropriate legal and institutional framework to support its further development. The transition away from coal is expected to impact the regions where the mining sector is still important. The use of low-carbon technologies can ease the transition, but the ambition to invest in them remains low. Identifying investment needs in green technologies and sustainable solutions, and securing adequate funding will be key to deliver on the climate and energy objectives and shape a new growth model. The Commission’s proposal for a Just Transition Mechanism under the next multi-annual financial framework for 2021-2027, includes a Just Transition Fund, a dedicated just transition scheme under InvestEU, and a new public sector loan facility with the European Investment Bank. It is designed to ensure that the transition towards EU climate neutrality is fair by helping Czechia’s most affected regions to address the social and economic consequences. The Just Transition Fund’s key priorities, set up as part of the Just Transition Mechanism, are set out in Annex D. They build on the analysis of the transition challenges outlined in this report. 1. Economic situation and outlook

Economic growth The economy continued to grow at a more moderate pace than in 2018, reflecting external developments. In 2019, the economy is estimated to have grown at 2.5% (Commission Winter 2020 Forecast), continuing the decelerating trend observed in 2018 (2.8%). Private consumption was the main driver of growth, supported by a continuous and strong wage increase in a tight labour market. By contrast, investment decelerated sharply in 2019. Net exports are estimated to have contributed to growth, but the slowdown in external demand and geopolitical uncertainties led to a lower increase in both imports and exports. Graph 1.1:Real GDP growth and its components Source: AMECO, Commission Winter 2020 Forecast An economic slowdown is expected in coming years, mirroring developments in main trading partners. In 2020 and 2021, the economy is projected to continue to grow at a slower pace, at 2.1% and 2.2% respectively (Commission Winter 2020 forecast). Domestic demand growth will moderate but is likely to remain the main growth driver. Investment is expected to decelerate in 2020. Czechia’s exports and imports will continue to be strongly influenced by the economic developments of its main trading partners. Global developments, trade uncertainties, a tight labour market and the transition to a greener economy pose challenges to growth. Ongoing geopolitical tensions are expected to reduce the demand from the main trading partners. This is particularly relevant for a small open economy like Czechia. The tight labour market and the resulting high wage growth can pose an increasing risk to the cost-competitiveness of exports. With the lowest unemployment rate in the EU and the highest job vacancy rate, the labour market risks overheating. The increase in real wages (5.3% in 2018) and unit labour costs (6.3% in 2018) and the subdued growth in productivity (with sector-specific variations) point in that direction. There were nevertheless signs of a slight ease in both labour shortages and wage growth in the first half of 2019. Finally, the green transition for a highly industrialised and carbon-intensive economy like that of Czechia may require significant investment. Graph 1.2:Gross National Income per person, in purchasing power standards (% of EU average) Source: AMECO Economic convergence towards the EU average continues. Foreign direct investment, driven by geographical proximity and wage competitiveness, and the inflow of EU funds has been boosting productivity growth and employment since the 2000s. Convergence halted throughout the 2009 recession but since 2013 it has picked up again at relatively fast and constant rates, reaching 88% of the EU average, similar to some older Member States (see Graph 1.2). Looking ahead, growth rates are forecast to be around one percentage point (pp.) above the euro area average, continuing the convergence process. Graph 1.3:Potential GDP and drivers Source: European Commission Potential output is set to slowly decline and converge towards real GDP growth. After remaining constant in 2017 and 2018 at 2.9%, potential growth is expected to decline to 2.5% by 2021, due to labour market developments (see Graph 1.3). This will translate into the closing of the output gap from 1.4% in 2018 to 0.3% in 2021. Slower employment growth, notably in terms of hours worked, and high but more moderate wage growth suggest that the business cycle may have reached its peak. This should reduce inflationary pressures. Looking ahead, population ageing will lead to a continued decline in the working-age population, putting additional pressure on potential growth. In this context, a further deepening of the capital stock and investments in intangible capital and high value-added technologies can help diversify the economy and improve potential growth. Household consumption continues to be the main growth driver, but is set to slow down in coming years. High employment levels coupled with an increase of real wages and gross disposable income have boosted household consumption. While high employment and wage increases will continue to support consumption, global developments and increased trade uncertainty are expected to have a negative impact on production and confidence indicators, already reflected in some related indexes. Consumer confidence remains relatively high but has been decreasing since the beginning of 2019. Combined with potentially higher interest rates, this might encourage households to reduce consumption and increase precautionary savings, partly offsetting the wage effect. Graph 1.4:Private and public investment, quarterly profile Source: Eurostat After two very positive years, investment was more restrained in 2019. Following a growth of 3.7% in 2017 and 7.6% in 2018, investment is estimated to have increased by only 1.1% in 2019 and is projected to grow by 1% in 2020 (European Commission Autumn 2019 forecast). Private investment has decreased in 2018, particularly in machinery. The economic slowdown in the main trading partners and the global trade tensions translated into a decreasing number of orders and very weak confidence indicators. The manufacturing Purchasing Managers’ Index (PMI) has decreased to the lowest levels in the last decade – from almost 60 points at the end of 2017, to below 45 at the end of 2019. Public investment, accounting for around 15% of total investment, grew solidly in 2018 due to an inflow of EU funds, but then significantly slowed down in 2019 (see Graph 1.4). Investment activity remained above the EU average thanks to the manufacturing sector. In 2018, investment activity remained above the EU average: 25.5% of GDP compared to 20.9% (see Graph 1.5). It increased in most sectors, but especially in manufacturing and construction. Labour shortages and wage increases have made investment in automation a priority for firms, particularly in manufacturing, to keep their competitiveness and counter the demographic and technological changes ahead. Graph 1.5:Investment by sector as a share of GDP Source: Eurostat Competitiveness and productivity Low unemployment levels pushed wages upwards, potentially reducing overall cost-competitiveness. Nominal wages per employee increased by 8% in 2018 following a 6.3% growth in 2017, significantly above the EU average of 2.7%. The minimum wage was further increased in 2020 by CZK 1,250 to a total of CZK 14,600. As overall productivity growth lagged behind wage growth, unit labour costs increased by 6.3% in 2018, up from 3.6% in 2017 (see Graph 1.6), significantly higher than the EU average of 2.5%. A continuous increase of wages above labour productivity growth could reduce the profitability of companies, translating into higher consumer and export prices, and affect their investment behaviour in the medium term. Increasing labour costs have not yet translated into a loss of export market share. Until 2018, Czechia has managed to keep and even increase its export market share, partly due to worsening world exports compared with Czech exports. In absolute terms, the growth of Czech exports is estimated to have gone down in 2019. The European Commission Autumn 2019 forecast points to a gradual worsening of the export market share as of 2019. At the same time, it predicts a slowdown in nominal wage growth to 5.2% in 2019 and 4.7% in 2020 as well as in unit labour costs (to 3.7% in 2019 and 1.1% in 2020). Graph 1.6:Breakdown on the nominal unit labour cost Source: AMECO Labour productivity has been increasing but the gap with other advanced economies persists. At 12.8%, the growth of the gross value added per hour worked between 2010 and 2018 has been above the EU average (8%), but below some neighbouring countries such as Poland (26.5%) or Slovakia (17%) More broadly, since 2000, it increased by 55.9%, compared to 23.2% in the EU. This equates to an average annual growth rate of 3.1%, significantly above the EU average of 1.2% (see Graph 1.7). The productivity gap between Czechia and the EU decreased from 59% in 2000 to 48% in 2018. Similarly the gap to Germany decreased from 69% to 59% but most of the catch-up took place before 2009. The contribution of manufacturing to the economy remains very high. With one of the highest contributions of manufacturing to GDP (23.1%), Czechia ranks above the other Visegrad countries as well as the EU average (14.3% of GDP). The automotive sector is the largest branch of the Czech industry in terms of output. In 2017, it accounted for around 25% of gross total output, 18% of total value added, 13% of total employment and 35% of total exports in the industry (Polish Economic Institute, 2019). Significant inflows of foreign investment boosted productivity growth and the automotive sector is now among the most productive sectors in manufacturing. However, it faces several challenges, including global trade uncertainties, labour shortages, revised CO2 standards and increasing global demand for electric cars. While not yet reflected in exports, which remain robust, these challenges place the industry at a critical juncture, calling for strategic changes and investment in equipment and automation to keep the sector competitive and/or create first-mover advantages.

Graph 1.7:Evolution of labour productivity Source: Eurostat Labour market The strong labour market performance continues but may reach its limits. The employment rate of those aged between 20 and 64 reached 80.4% in Q3-2019, 6.3 pps above the EU average. The activity rate (82.1%) was also well above the EU average (78.8%). The unemployment rate dropped further to around 2%, making Czechia the best performer in the EU. The labour market expansion may have already reached its limits, in particular in Prague and the surrounding region. Despite slightly easing in 2019, the shortage of skilled labour persists, with many firms advancing automation and relying on foreign workers to fill their vacancies. The vacancy rate remains significantly high (see Graph 1.8). The employment rate of the low skilled is still lagging behind that of the medium and high skilled. Furthermore, gender inequalities in pay and employment remain high and there is further scope to improve the employment outcomes of people with disabilities. Graph 1.8:Unemployment and job vacancies Source: Eurostat Inflation and monetary policy Inflation increased in 2019 but is set to decline towards the 2% target by 2021. Consumer price inflation reached 2.6% in 2019. The increase, which took place mainly in the second half of the year, was mostly due to the rise in food prices and regulated prices. The trend is likely to continue in the first half of 2020, mainly due to new excise duties for alcohol and tobacco. In the second half it is expected to ease due to a slower growth of prices for food, electricity, imported goods and services. As a result, inflation is forecast to drop to 2.4% in 2020 and 2.0% in 2021 (Commission Winter 2020 Forecast). The exchange rate has remained rather stable after the marked appreciation throughout 2017. The nominal effective exchange rate depreciated slightly throughout 2018 and the beginning of 2019. In January 2020 it witnessed a significant appreciation to the highest level since the end of the exchange rate commitment. The real effective exchange rate has also shown a similar trend. There are currently signs of currency undervaluation, considering fundamentals, and the real effective exchange rate is expected to appreciate further in the medium term, as incomes catch up with the rest of the EU (IMF, 2019). The policy rate was raised to 2.25%, significantly above the euro area. After seven hikes between July 2017 and November 2018, the policy rate was kept rather stable in 2019, with a single hike to 2% in May 2019. Somewhat against market expectations, in February 2020 it was raised to 2.25%. The rate is likely to remain rather stable in the coming quarters, but its movement will depend on future economic developments. External position Czechia’s trade balance remains high, despite a slight contraction. More dependency on energy imports and a lower goods surplus led to a contraction of the trade balance surplus to 6.3% of GDP in 2018, 1.3 pps lower than in 2017. This left the current account balance at 0.3% of GDP in Q3-2019, 0.2 pp above the fundamental benchmark (). Weaker external demand, particularly in Germany and in other euro area countries, as well as geopolitical uncertainties and the continued appreciation of the real effective exchange rate throughout 2018 were the main factors behind the slowdown in exports. On the other hand, strong domestic demand led to an increase of imports of more than 5% (compared to the 4.4% increase in exports), further reducing the balance. Imports are nevertheless expected to drop significantly in the coming years due to a slowdown in production and investment, maintaining a positive external balance until 2021 (Commission Autumn 2019 forecast). The net international investment position continued to improve. It reached -19% of GDP in Q3-2019, well above the prudential benchmark (-57%). It increased by 5.2% year-on-year, mainly due to nominal GDP growth and an improvement of the external liabilities from banks. This represents a sizeable increase compared to 2011 (-45% of GDP), largely driven by growth in reserve assets. External liabilities comprise mostly foreign direct investment (-50%). The net investment position without non-defaultable debt reached 32% of GDP in Q3-2019, 4 pps higher than in 2018, indicating that Czechia does not have a problematic debt profile. Housing market and private indebtedness Housing prices continue to grow, reducing affordability. Supply constraints and strong demand have been pushing house prices upwards, particularly in the biggest cities. Although price growth flattened off in 2019, it remains above wage growth, reducing affordability. Burdensome planning procedures continue to limit housing supply, which is not expected to meet demand in the near future, despite an increase in construction (see Section 3.2). Graph 1.9:Evolution of household debt and housing loans Source: European Central Bank and European Commission Household debt is increasing but does not yet pose a systemic risk to the banking sector. Household debt as a share of disposable income increased to 61.4% in 2018, but remains significantly below the EU average (100.6%). Similarly, household debt to GDP remained below both the fundamental benchmark (44%) and the prudential threshold (70%), reaching 32% in the first half of 2019, significantly below the EU average (53%) (). The total value of loans for house purchase, which represent around three quarters of all loans to households, continued to increase throughout 2018 and the first half of 2019. However, the volume of new mortgages saw a marked decrease in 2019 (-16.9%), as a result of limited housing supply, reduced affordability, and the new macro-prudential recommendations put forward by the central bank (see Section 3.2). Rising property prices and the non-legally binding nature of the central bank macroprudential recommendations may still pose a risk to financial stability in the medium term. Social developments While the overall risk of poverty is low, some challenges remain. 12.2% of the population was at risk of poverty or social exclusion in 2018 (EU average 21.9%). Overall income inequality has remained low and stable in recent years. Nonetheless, there are some concerns about the affordability of housing, personal indebtedness and homelessness of certain population groups. Inequalities of opportunities for children persist (see Section 3.3). Regional disparities Regional disparities indicate a clear division between Prague and the rest of the country. Prague is a highly developed region whose GDP per capita is 187% of the EU average. Six regions are considered as moderately developed (between 73% and 84% of EU average), while one region (Severozápad) stands out as being poorer (63% of the EU average). While the growth rate in most regions has been above the EU average, the GDP per capita in Severozápad grew by only 0.16% between 2010 and 2017. Productivity is converging to the EU average at different speeds. While productivity in Prague is around 50% higher than the national average, in Severozápad it is 23% lower. In all regions but Prague and Střední Čechy, labour productivity is less than half of the EU average. While, productivity growth has been above the EU average in all regions, in Severozápad and Moravskoslezsko the increase was more marginal (see Section 3.4).

Public finances Public finances are expected to remain in balance in the short term. The general government balance has been in surplus since 2016 due to a steady increase in revenues, mostly from indirect taxes. Value-added tax (VAT) collection, in particular, has benefited from improved compliance. New revenue measures are also likely to be put in place in the next years (see Section 3.1). Nonetheless, public expenditure is expected to grow more rapidly, mostly due to the continuous increase in public wages and pensions. Growth in public investment is also likely to remain robust, as the current programming period for EU funds enters its final years. In line with the shrinking general balance, the structural balance is expected to move into negative territory. By contrast, the debt-to-GDP ratio will continue to decrease, reaching around 30% of GDP by 2021 (Commission Autumn 2019 forecast). The long-term sustainability of public finances remains a concern. The increase in pension expenditure is the main risk to long-term sustainability. Measures taken in recent years and changes in demographic projections have worsened the long-term budgetary outlook. Despite these concerns, the government recently decided not to increase the retirement age above 65 years or to link the retirement age with life expectancy gains (see Section 3.1). Progress with Sustainable Development Goals Overall, Czechia performs well with regard to the United Nations’ Sustainable Development Goals. In the past 5 years it showed at least some moderate progress in all areas (Annex E). It is one of the top performing Member States in areas such as eliminating poverty (SDG 1) and reducing inequalities (SDG 10). The share of people at risk of poverty is significantly below the EU average, while the level of inequality (measured by the Gini coefficient) is among the lowest. The country is still lagging behind in terms of gender equality (SDG 5), as the gender gap in employment and pay is among the highest in the EU. Despite some progress in the past 5 years, Czechia also struggles in reaching the targets on climate (SDG 13), as its energy-intensive economy continues to emit some of the highest greenhouse gas emissions per capita in the EU. Table 1.1:Key economic and financial indicators - Czechia Source: Eurostat and ECB as of 4-2-2020, where available; European Commission for forecast figures (Winter forecast 2020 for real GDP and HICP, Autumn forecast 2019 otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 59% of all country-specific recommendations (CSRs) addressed to Czechia have recorded at least ‘some progress’ (). ‘Limited’ or ‘no progress’ has been made on 41% of the CSRs (see graph 2.1). In several areas Czechia made ‘substantial progress’ or reached ‘full implementation’. For example, there has been substantial progress in fighting against tax evasion and strengthening the fiscal framework. Graph 2.1:Overall multiannual implementation of 2011-2019 CSRs to date Source: European Commission In a multiannual assessment, Czechia has made limited progress in improving the long-term sustainability of public finances. Most measures focused on pension adequacy but lacked safeguards to ensure long-term fiscal sustainability. The Czech authorities now expect that public expenditure on pensions will increase up to 14.5% of GDP in 2059. The projected increase in age-related public expenditure on healthcare also puts pressure on the country’s long-term fiscal sustainability. Still, a number of initiatives improved the efficiency of the healthcare system. Some progress has been made in increasing labour market participation for underrepresented groups. The number of childcare facilities increased thanks to EU funds, supporting women’s labour market participation. Due to ineffective targeting and a lack of tailored measures, progress in improving the effectiveness of active labour market policies was limited, preventing the underrepresented groups from benefiting from the favourable conditions of the labour market. Czechia has made limited progress () in addressing the 2019 CSRs. No progress has been made in improving the long-term sustainability of public finances. Still, some limited progress in improving the health-care system was noticed. Progress with adopting the anti-corruption measures has been limited as some of the pending measures were not yet adopted by the government or approved by the Parliament. There was also limited progress in supporting the employment of women with young children and of disadvantaged groups. There has been some progress in addressing the recommendations related to education, public procurement and innovation. Efforts to support quality-based competition have intensified and the professionalisation of contracting agencies increased. The recently adopted Innovation Strategy aims to remove barriers to the development of a functioning innovation ecosystem but progress remains to be seen. Automation and artificial intelligence have also become policy priorities for the government. Some progress was achieved on education, in particular in promoting the teaching profession and digital skills. Progress on focusing investment-related economic policy and on reducing administrative burden was more limited. The recently approved National Investment Plan for 2020-2050 allocates a significant amount of investment to road and rail transport infrastructure. Investments in low carbon and energy transition are still rather low. Administrative burden remains a barrier but a new construction law is being developed and expected to become effective as of 2021. Upon request from a Member State, the Commission can provide tailor-made expertise via the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since 2016, such support has been provided to Czechia for 30 projects. In 2019, several projects have been delivered on the ground. The Commission, for example, assisted the authorities in simplifying the permit process in order to accelerate the building of the Trans-European Transport Network infrastructure, in the preparation of the SMEs Support Strategy 2021+, and in improving the administrative capacity for tax collection though e-services. In 2019, work started on reducing regional disparities in education outcomes, on increasing the affordability of housing across regions and on defining a national strategy for the Circular Economy. Table 2.1:Assessment of the 2019 CSR implementation in Czechia (*) Source: European Commission (*) The assessment of CSR 3 does not take into account the contribution of the EU 2021-2027 cohesion policy funds. The regulatory framework underpinning the programming of the 2021-2027 EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework (MFF).

3. Reform priorities 3.1.Public finances and taxation Taxation Public finances remain in balance and the public debt continues to decrease. Due to the robust economic growth, 2019 is estimated to be the fourth consecutive year with a positive general government balance. However, the general balance is expected to turn slightly negative as of 2020. The general debt as a share of GDP has dropped to almost 30% - one of the lowest in the EU. Tax revenues reached a new high in 2018 but remain below the EU average. Their level increased from 35.4% of GDP in 2017 to 36.1% in 2018. While the figure remains 3.1 percentage points (pps) below the EU average, the gap has narrowed (5 pps in 2009). Nonetheless, Czechia continues to have one of the EU’s lowest shares of tax revenues as a share of GDP. The Commission Autumn 2019 forecast projects only a slight increase in tax revenues by 2021, pending the adoption of some new measures. The contribution of direct taxes to total revenues remains significantly below the EU average. Whereas direct taxes in the EU in 2018 accounted for 13.4% of GDP and 34.3% of total tax revenue, in Czechia they only amounted to 8.0% of GDP and 22.2% of total tax revenue. Receipts from personal income tax are among the lowest in the EU, accounting for only 12% of total tax revenue (vs 24.2% in the EU in 2018), while receipts from corporate income tax (around 3.5% of GDP) are among the highest in the EU (EU average 2.7% of GDP). A possible personal income tax reform has been put on hold. VAT collection has increased since the electronic registration of sales was introduced. At 7.7%, the share of VAT receipts in GDP was above the EU average of 7.1% in 2018 and 1 pp higher than in 2010. Tax evasion, as measured by the VAT compliance gap, is estimated to have declined to around 12% in 2018, 7 pps below the 2013 estimates and roughly in line with the unweighted EU average (Center for Social and Economic Research, 2019). The rollout of the final two phases of the electronic registration of sales in 2020 is expected to further boost the VAT revenue. In 2019, Czechia was authorised to apply the generalised reverse charge mechanism for VAT between 2020 and 2022 for transactions above €17,500. The authorities plan to introduce a new digital services tax. Pending Parliament approval, the proposed 7% tax on selected digital services is supposed to apply to corporations that cumulatively have a global turnover of over €750 million, a turnover on the Czech market of over €4 million and more than 200,000 user accounts in Czechia. The taxable services will include advertisement campaigns, the use of multi-sided digital interfaces and the sale of user data. According to the authorities, it is a transitional measure to be applied until a general agreement on digital taxation at the global or European level is reached. Graph 3.1.1:Structure of environmental taxes (% of GDP) Source: Eurostat Receipts from environmental taxes are very low and have been decreasing. Only €25 million in pollution and resources taxes were collected in 2018, one of the lowest amounts in the EU and only about half of the amount collected in 2010. Most receipts were from energy taxes, although these have seen a decrease in the share of GDP in the past 10 years (see Graph 3.1.1). Transport taxes are also very low and vehicle taxes is not based on CO2 emissions. Despite the high carbon intensity of the economy, there are no concrete plans to increase environmental taxes. Property taxes are among the lowest in the EU. While deemed less harmful to growth than other taxes, receipts in 2018 were only 0.6% of GDP (2.5% in the EU). Recurrent taxes on immovable property are particularly low at 0.2% of GDP (1.5% in the EU). Despite the significant increase in house prices (see Section 3.2), these taxes have remained constant since 2005. Labour taxation for low wage earners is high. The tax wedge on labour costs for low wage earners is among the highest in the EU (3 pps above the EU average). Contrary to the overall trend in the EU, the wedge has slightly increased since 2009. It is relatively high for single people with children and relatively low for couples with a single earner. Combined with relatively high childcare costs, it can lead to lower labour market participation of low-wage and second earners (see Section 3.3). Meal vouchers provided to low-income earners somewhat compensate the high tax burden. The self-employed continue to benefit from a lower assessment base for social contributions. The authorities are currently discussing the possibility of easing the cap for lump-sum expenses and increasing the pension contribution requirements but no concrete proposals have been presented yet. As any new proposal will most likely be voluntary, the contrast between employees and the self-employed will most likely continue. Authorities plan to increase the digitalisation of the tax system. For certain types of taxes, the rate of electronic filing remains rather low. Significant progress has been made between 2015 and 2018 in the case of VAT, where the share of electronic forms increased from 45% to 85%, or in the case of corporate taxation where the share grew from 50% to 90%. By contrast, e-filing of personal income tax returns accounts for only 15% of all tax returns (up from 3% in 2014) and in the case of property tax it is just slightly above 5%. Authorities are currently discussing plans to further digitalise the filing system. Tax compliance costs for businesses remain high. The time needed to prepare and pay taxes is still high and has not significantly improved in the past years (World Bank, 2019a). In particular, the recent reforms to combat VAT evasion may, as a side effect, increase the time needed to comply with consumption tax rules. In addition, some measures to be implemented in 2020, such as VAT exemptions for intra-community supplies of goods and, to a lesser extent, a lower VAT rate for certain goods and services, may also drive up compliance costs. It is nevertheless possible that these effects will be reabsorbed once businesses learn how to best deal with the new requirements. Debt sustainability analysis and fiscal risks The Czech Fiscal Council issued two reports on long-term sustainability and on compliance with the rules of budgetary responsibility. Based on an assessment done by the Ministry of Finance, the Fiscal Council concluded that local governments are compliant with the debt management rules imposed in 2017. Three municipalities did not meet their obligation but remedied the situation within the given timeline. Short- and medium-term fiscal sustainability risks are low. The general government debt is expected to remain significantly below the 60% of GDP threshold, reaching around 30% in 2021. As a result, the medium-term fiscal sustainability risk indicator (S1) is at -2.9 pps of GDP (see Annex B). The long-term sustainability of public finances remains a concern. Total ageing costs are expected to increase by 6.2 pps between 2016 and 2070, out of which 2.8 pps for pension expenditures, 1.1 pps for healthcare expenditures and 1.6 pps for long-term care expenditures, putting the long-term fiscal sustainability risk indicator (S2) at a medium risk. The increase in pension expenditure is the main risk to long-term sustainability. The statutory retirement age was capped at 65 years for both men and women and expected gains in life expectancy are not automatically taken into account by the system.

Recent policy measures have focused mostly on pension adequacy. The government has decided to increase pensions in 2020 above the standard indexation formula, generating an additional cost of 0.1 % of GDP. According to the Czech Fiscal Council, expenditure on pensions will peak in 2059 at 13.2% of GDP, 4.8 pps above the 2020 figure. By 2059, the number of old-age pensioners is estimated to increase by around one third. In 2019, the government decided to not increase the statutory retirement age for the next 5 years. In a report endorsed by the government in 2019, the Ministry of Labour and Social Affairs recommended to keep the 65 years retirement age cap. The report provides a baseline scenario based on the current system and an alternative scenario that links retirement age with life expectancy. In the former expenditure on pensions is expected to peak in 2059 at 14.5% of GDP, from the current 8%, while in the latter the expenditures would be around 1 pp lower. While the report recommends maintaining the status quo, it also recommends a greater focus on sustainability and finding alternative sources of funding. In 2019, the authorities created an advisory Commission for Fair Pensions, to provide recommendations on pension reform. The Commission, composed of various stakeholders, is currently discussing a strategic redesign of the pension system with a focus on transparency and simplification, adequacy and sustainability. The projected increase in age-related public expenditure on healthcare also puts pressure on long-term fiscal sustainability. Public expenditure on healthcare is projected to increase by 1.1 pps of GDP by 2070, adding to the ageing costs. The use of Diagnostic Related Groups will be piloted for reimbursement on a limited scale in 2020, with the aim to further increase the scope in 2021. It still remains unclear when it will become the main payment mechanism of hospital services. The government also plans to reinforce outpatient emergency departments in hospitals to reduce unnecessary hospital admissions. Acute care bed density and average length-of-stay have fallen in the past 10 years, but are still above the EU average. The low occupancy rate (70% vs 77% in the EU in 2017), together with the comparatively high number of discharges (198 per 1,000 people vs 174 in the EU in 2017) point to overcapacity. This is partly due to financial incentives and the lack of political consensus on hospital network transformation. Overconsumption and inefficient use of outpatient care are still prevalent in the system. While funding for outpatient care is high, avoidable hospital admissions for some common conditions (e.g. diabetes and congestive heart failure) are higher than the EU average. This points to weaknesses in the prevention of risk factors and the management of chronic conditions, and insufficient integration of healthcare services. Despite some initiatives, primary care doctors still do not play a gatekeeping role. Patients may consult specialists directly without any user fees, which partly explains the comparatively high number of outpatient consultations (8.0 contacts per person compared to an EU average of 6.2). The cost-effective use of medicines, medical devices and equipment in hospitals and outpatient care is less than optimal. The full introduction of e-Prescription in 2019 has the potential to improve the use of pharmaceuticals and their related expenditure. Further developing and implementing health technology assessments together with centralised procurement procedures for pharmaceuticals and other medical and non-medical goods may generate savings to payers, while ensuring access to high-quality products in the health system. Fragmented governance and financing structures hinder the adequate and efficient provision of long-term care services. Financial incentives still exist for prolonging the hospital treatment of patients in need of long-term care (see Section 3.3). The planned transformation of acute care into long-term care hospital beds is expected to increase transparency and save costs. A 40% increase in the reimbursement rate for home care services may reduce the length of hospital stays, but only as long as there is a sufficient provision of home care services. 3.2.Financial sector Financial sector The Czech financial sector remains stable. The banking sector accounts for almost 80% of the financial sector’s assets, with the rest divided between the insurance sector, pension funds and other financial intermediaries. Approximately 90% of the banking system assets are foreign-controlled. In terms of concentration, the share of assets of the five largest banks has grown slightly since 2014, reaching 65% at the end of 2018. Banks remain funded mostly by deposits and their assets are mostly in loans. The insurance sector is mostly foreign-owned and remains profitable, despite a drop year-on-year. The eight pension management companies active in Czechia are well capitalised and witnessed an annual increase in the number of participants in the funds in Q3-2019. The banking system is well capitalised. Total banking sector capitalisation (with a total capital ratio of 18.7% in June 2019) has been steadily increasing for several years and is above the EU average. The common equity Tier 1 (CET1) ratio increased in the first half of 2019 to 17.3%. The Czech National Bank has been proactive in requiring banks to build up capital buffers. The countercyclical buffer introduced in 2017 was raised several times, reaching 1.75% as of January 2020 and 2% as of July 2020. With several banks having also a systemic risk buffer ranging between 1% and 3% of their capital, the central bank considers there are sufficient capital cushions to accommodate potential shocks to the sector, assuming reasonable dividend policies. Given the relatively good capital levels of banks, reaching the targets for minimum requirements for own funds and eligible liabilities is generally considered unproblematic (). However, due to their deposit-based funding model, banks have issued few debt instruments and compliance with these requirements could entail higher costs. Czech banks continue to be profitable. Return on equity has been stable and has remained in double digits for several years, reaching 15.2% in the first half of 2019 (annualised data). Income on interest remains the main source of profit, with the net interest margin (as a share of assets) at 1.9% in 2019. A lower cost-to-income ratio (47.1% compared to 48.3% in the first half of 2018) suggests that banks are aiming to improve profitability through increased efficiency. The loan-to-deposit ratio rose to 102.7% in the second half of 2019, from 99% in 2018, as Czech subsidiaries of the major foreign banks borrow abroad to lend domestically. Insurance companies are also well capitalised and most of them maintain stable profitability. The non-performing loans ratio remains low, but some vulnerability risks might emerge. Following the strong growth of new loans, as well as the sale of non-performing loans, the ratio more than halved between Q2-2016 (4.6%) and Q2-2019 (1.8%). The coverage ratio has increased steadily in the last 2 years reaching 53.8% in Q2-2019. Private sector loans also grew year-on-year. To mitigate the potential build-up of a systemic risk in the financial sector, the central bank, as the macro-prudential authority, issued an official communication on the provision of retail loans secured by residential property. Among the recommendations put forward, the supervisor proposed limits on loan-to-value, debt service-to-income and debt-to-income ratios. Various measures have been introduced to boost the development of the capital market. To reduce the economy’s dependency on banks, while also increasing companies’ financing options, authorities aim to develop the national capital market. To this end, several projects have been implemented with the support of the European Commission. Furthermore, the authorities together with the four largest private banks established a National Development Fund (see Box 3.4.1) to run as Qualified Investor Fund. The creation of the CEEplus Index () is another initiative that could create further opportunities for the capital market.

Housing market House prices continue to grow, albeit more moderately than in 2017 and 2018. House prices increased in real terms by 9.2% in 2017 and 6.2% in 2018, exceeding the price level seen in the 2008 house price peak by over 20%. In 2019, price growth appears to have levelled off at slightly more moderate levels (+5.6% in the third quarter), partly influenced by the central bank’s new macroprudential rules. Valuation indicators of the housing market suggest a positive and increasing valuation gap. According to the European Commission’s internal calculations, the housing market was overvalued by around 6% in 2018. The widest gap relates to the price-to-income ratio, which was 11.4% higher than the long-term average (+1.7 percentage points compared to 2017). Calculations from the Czech National Bank also suggested an increasing mismatch between transaction and fundamental prices in the housing sector of around 15-20% in mid-2019, mainly due to an undersupply of homes in cities. However, the increasing difference in recent months between growth in asking and purchasing prices for flats suggests that realized property prices could moderate in coming quarters. Due to the sustained price increase, affordability has worsened further. Deflated house prices have steadily outpaced real wage growth at an average rate of 2.1 pps per quarter since 2014, which has lowered affordability even in a context of declining borrowing costs. Alternative metrics also suggest a worsening of affordability – according to Deloitte’s House Price Index (Deloitte, 2019), Czechia has the lowest level of affordability in a sample of 12 EU countries, with 11.2 gross annual salaries needed to own a house, up from 7 salaries in 2015. Affordability problems are most acute in Prague and other large cities. Czechia has a high variation in price growth between regions. In cities, an increase in demand due to internal migration and a strong demand for prime properties by foreigners are putting an upward pressure on prices, especially since cities are suffering from supply constraints. Prague’s average offer price for new dwellings increased by 22.2% in 2018, significantly higher than the increase in the rest of the country (16.8% annual growth) (Deloitte 2019). Several sources also indicate that overvaluation is getting stronger in Prague (Andrle, M. and Plašil, M., 2019), which is particularly relevant as two thirds of the transactions in the country take place there. In parallel, the continued rise of Airbnb and other rental accommodation companies has been limiting supply, especially in the centre of Prague. Outside Prague, the city with the highest price growth was Ostrava, with a 30.3% rise in the price of flats in 2018. Housing construction is expanding, which could ease supply constraints in the medium term. The total number of newly started homes country-wide has been increasing since 2014 at an average rate of 9.6%% annually, albeit it is still below pre-crisis peaks. In Prague, although the number of newly started homes stalled throughout 2018, construction levels have increased significantly since the beginning of 2019 (+65% year-on-year in the second half of 2019). This will likely somewhat ease supply constraints in the coming years, although, according to Prague’s city council, construction levels should still increase threefold in order to satisfy demand. Graph 3.2.1:Number of started and completed housing projects (12 month moving average) Source: Czech Statistical Office Burdensome planning procedures continue to limit housing supply. According to the World Bank, 21 procedures need to be undertaken to receive a building permit in Czechia (OECD average is 12.5) (World Bank, 2019a). Some progress has been made in streamlining procedures, but the number of building permits is still far below the historical average. Meanwhile, the number of second-hand apartments for sale is declining, further constraining supply (Deloitte 2019). With a change in the legislation process only expected to come into force in 2021, housing supply will likely remain below demand in the years ahead. The slow progress on the future Prague Metropolitan Plan has also contributed to housing shortages in the capital. The total stock of housing loans continued to increase in 2019, although growth has moderated. The stock of housing loans has steadily increased over the past years, reaching a cumulative growth of 38% in 2019 compared to 2015. However, the annual growth rate has slowed in 2019 at 7.4%, down from 8.6% in 2018 and 9.3% in 2017. According to data by Hypoindex, the volume of new mortgages decreased by 16.9% in 2019 (Graph 3.2.2), partly affected by the new macroprudential recommendations by the central bank and the limited supply in the real-estate sector. Indeed, the number of new mortgages in Czechia decreased by 22% in 2019, fuelling this decrease in housing loan growth. Beyond mortgage growth, the average fixation period of new mortgages continued to increase, with more than 50% of new mortgages issued having a rate fixation period of more than 5 years. This could ease temporarily debt service requirements for households in the event of interest rate increases. Graph 3.2.2:Evolution of housing loans and mortgages Source: Hypoindex and Czech National Bank The central bank issued macroprudential recommendations to protect against systemic risks building in the banking sector. It currently recommends that lenders should not provide retail loans secured by residential property with a Loan-to-Value (LTV) of over 90%, and should limit the provision of loans with LTVs of 80%-90% to 15% of new loans in each quarter. Lenders should also not exceed a debt-to-net income (DTI) ratio of nine annual incomes and a debt service-to-net income (DSTI) ratio of 45% (with the permitted exception of 5% of new loans for both indicators). These recommendations were introduced to avoid the development of a spiral between property prices and property purchase loans that could pose a risk to financial stability. Nevertheless, until a legislative amendment is adopted by the Parliament, the central bank still lacks the statutory powers to issue binding macroprudential recommendations, potentially limiting the effect of the current measures in the medium term (ESRB, 2019). Banks have been broadly compliant with the new macroprudential recommendations. The share of loans with a LTV ratio between 80-90% remained below the 15% limit, at an aggregate share of 13.5% of loans in June 2019. Meanwhile, 3% of loans issued over the same period had an LTV higher than 90%, thus not complying with the recommendation and confirming the need to have legally binding limits. On the other hand, the limits for the DTI and DSTI were met by most banks. In the first half of 2019, the share of loans with a DSTI of over 45% was around 5%, while loans exceeding the DTI limit of 9 accounted for around 3%. Finally, the provision of loans that exceed all three limits was reduced. Overall, rising property prices can be a source of risk for financial stability. The European Systemic Risk Board (ESRB, 2019) issued a warning pointing to the medium-term vulnerabilities for financial stability stemming from the residential real estate sector. This is due to an overvaluation of house prices and high growth in housing credit up until 2019, coupled with loose lending standards and the non-legally binding nature of the macroprudential recommendations put forward by the central bank. Although the Czech National Bank sees the current limits as sufficient, continued growth in housing prices could warrant a reassessment of the limits. 3.3.Labour Market, education and social policies Labour market Labour market performance is far above the EU average. The employment rate of those aged 20-64 reached 80.4% in Q3-2019, 6 percentage points (pps) above the EU average. The activity rate (20-64) stood at 82.1% in Q3-2019, above the EU average of 78.8%. The unemployment rate dropped to 2% and is the lowest in the EU (see Graph 3.3.1). Employment is projected to increase, albeit by only 0.9% in 2019 suggesting that further labour market gains are limited. Labour shortages and demographics remain key challenges. Graph 3.3.1:Labour market developments Source: Eurostat Labour shortages are becoming a distinct constraint to further economic growth. Due to the high job vacancy rate, 39% of businesses cited labour shortages as the main factor limiting production in Q3-2019. Shortages are especially high in construction (47%) and industry (38%) but less pronounced in services (19%) which account for 55% of Czechia’s employment (see Graph 3.3.2). Persistent labour shortages and demographic change have triggered a policy focus on automation and robotisation (see Box 3.4.2). High demand for labour has improved the participation of underrepresented groups, but disparities remain. The youth unemployment rate (age 15-24) has decreased significantly (from 18.9% in 2013 to 4.8% in Q3-2019), and so has the long-term unemployment rate (from 2.4% in 2015 to 0.6% in Q2-2019). The participation and employment rates of older workers (age 55-64), grew from 55.5% in 2015 to 65.1% in 2018 (EU average: 58.7%). There are, however, significant regional differences. At 29.7 pps, Czechia has a higher than average employment rate gap between people with and without disabilities (24.2 pps in the EU in 2017) (ANED, 2018), partly due to the low general unemployment rate. There is therefore scope for improving the monitoring and targeting of active labour market policies, in particular for the most vulnerable groups. Measures to increase labour market participation of underrepresented groups would contribute to progress under Sustainable Development Goals 5 and 10.

Graph 3.3.2:Evolution of labour shortages Source: EU Business and Consumer Survey Women aged between 25 and 49 with small children continue to be underrepresented in the labour market. The negative impact of parenthood on female labour market participation continues to be high (34.2 pps compared to 9 pps in the EU). Despite the considerable increase in the number of childcare places created with the support of the European Social Fund (ESF), supply still falls short of demand. Thus, the participation rate in formal childcare for children under age 3 (9.1%) is below the EU average (35.1% in 2018). Authorities plan to amend the Children´s Groups Act by 2022 in order to harmonise the different rules and make childcare more affordable through increased resources, in particular for children under 3 for whom there is currently no legal entitlement to provide a place. The gender gap in employment and pay remains high. The (unadjusted) gender pay gap stood at 21.1% in 2017, compared to the EU average of 16%. One of the main factors behind this wage gap is the long leave taken by women after childbirth, leading to a lower labour market participation of mothers (Cukrowska-Torzewska, E. and Lovasz, A., 2019). The government implemented a project called ‘22% to Equality’, funded by ESF, to ensure equal pay for equal work. In 2019, an action plan was launched to raise awareness on this issue among employers and the general public, entailing media campaigns, studies, conferences and gender audits. However, its impact has been rather limited so far. A more flexible parental leave allowance to encourage the use of childcare was introduced on 1 January 2020. The strategy also proposes flexible working arrangements for which the legal framework should be in place by 2021. Due to labour shortages, employers are attracting more foreign workers. According to the Ministry of Labour and Social Affairs, the number of EU and non-EU nationals working as employees in Czechia reached 606,483 by mid-2019 (37,807 more than in 2018). In the context of a thriving labour market, in 2019 authorities passed legislation to facilitate employment of non-EU nationals, in particular for skilled and qualified workers (). The measure raised the quotas for a number of workers from selected countries and set minimum wages for foreign workers above the national minimum wage. The aim is to attract foreign talent, speed up the process and provide decent standards of living. Nonetheless, the increase in quotas may not be sufficient to reduce the illegal employment of foreign workers. Undeclared work provided through temporary work agencies represents a challenge. According to the Ministry of Labour and Social Affairs, the labour inspectorates identified 4,583 illegal situations in 2018 (among all employers) with over 75% concerning workers from non-EU countries. The so-called “grey” agencies benefit the most from the strong labour market performance, hiring foreign workers, while ignoring official rules and procedures. Further measures may encourage legal employment of temporary workers and less fraud. Current skills shortages are likely to increase in line with technological advances. There is currently a shortage of around 340,000 low and medium skilled workers across all sectors (European Commission, 2019a). This may be a particular challenge, considering the ongoing digital transformation that will require specialised technical and digital skills (see Box 3.4.2). The low-carbon transition could mitigate ongoing job polarisation resulting from automation by creating mid-level jobs in terms of wages and skills which could increase employment by 2030 (European Commission, 2019b). The level of advanced digital skills is below the EU average. While the country is above the EU average in the share of population with at least basic digital skills (62% compared to an EU average of 58%), only 26% of people have above basic digital skills (EU average: 33%). The Work 4.0 Action Plan designed by the government in cooperation with social partners is being rolled out. It includes specific measures to adapt to technological change and develop workers’ digital skills through two promising projects – ‘Development of systematic support of digital literacy’ and ‘Development of the system of further education in the area of digital skills’. A comprehensive national skills strategy encompassing initial education, lifelong and in-work training is not yet in place. The National Register of Qualifications, currently under development, should increase the supply of skilled labour through greater recognition of skills, including those obtained through non-formal learning. Whereas the vocational education and training (VET) qualifications are well covered, the validation system does not include higher education. In 2017, the ESF project ‘Kompas’ was launched to coordinate a reliable labour market barometer. Its results should be soon available and guide the future skills forecasting. The initiatives to define a single national skills, competences, qualifications and occupation framework remain scattered. This makes it difficult to create an effective system that can anticipate the skills needed by a labour market that is currently adapting to automation, digital transformation and a to a carbon-neutral economy. Significant increases of the minimum wage also reflect the tightness of the labour market. The minimum wage increased by 9.4% in 2020. However, the labour market effects of this change are likely to be small at this stage, since only 4% of workers were earning around the minimum wage in 2017. Younger and older workers, the low-skilled and employees of small firms or with a short tenure are more likely to earn a minimum wage (Grossmann, J., Jurajda, Š. and Smolka, V. 2019). According to Eurofound, a higher share of Czech women compared to the EU average, earn the minimum wage. Czechia also has a system of seven additional minimum guaranteed wages that increase automatically in line with the minimum wage, with a potential impact on a larger population. Reinforcing active labour market policies can improve demand-supply matching and address the specific needs of certain groups. The difficulties in setting up an efficient system to gather, analyse and process evidence on labour market developments by the public employment services limit the design of efficient active labour market policies (European Commission, 2019b). Efforts to address weaknesses in the implementation and monitoring of activation programmes have so far been limited. Support is insufficient for the most disadvantaged groups and current measures, such as the public work schemes, provide only short-term solutions. In 2019, Czechia announced an ‘Employment Package’ to improve the targeting and support of active labour market policies, particularly for the most vulnerable groups, but the scope of the announced measures remains limited. Social partners are relatively well involved in policy design, but there is scope for further progress. Social partners participate in collective bargaining at national level on key labour market policies. However, the membership of Czech social partners’ organisations is rather low. Further efforts to build up capacity of social partners, including their analytical capacity may help. There is scope for greater involvement and more stable funding for the civil society organisations. Established consultation bodies support discussions with these organisations on key employment and social issues. However, they need more time to review policy, legal or programme proposals. In addition, the lack of stable funding often limits their capacity and influence. Education and skills Despite a good overall performance in education and the provision of basic skills, socio-economic inequalities persist. The performance of 15 year olds in the OECD’s 2018 Programme for International Student Assessment (PISA) remained above the EU average for all three areas tested (reading, mathematics and science) and the proportions of low-achievers remained below the EU average. The proportion of low-achievers in reading decreased by 2.3 pps since 2009, while the share of top-performers increased by 3.1 pps. In reading, students from advantaged backgrounds outperformed by 105 score points the ones from disadvantaged backgrounds (up from 85 in 2009), equivalent to more than 2.5 grades, significantly above the EU average (95 points). The latest PISA results show that the percentage of 15 year-old students with a low socio-economic background who underperform in reading is 29.7 pps greater than for those with a high socio-economic background. Low-achieving students in reading are less much likely to attend the same schools as high-achievers than the EU average (). The performance gap in reading between socio-economically advantaged and disadvantaged schools is comparatively high (see Graph 3.3.3). The future Strategy for Education 2030 aims to develop key competences and reduce inequalities, supporting teachers and school heads and transforming the content and methods of education. Disparities in the rates of early leavers from education and training are increasing. Early school leaving declined in most regions in 2018. However, the highest regional rate in Severozápad further increased to 17.1% (see Section 3.4). The rate for Roma pupils was estimated at 57% in 2016 among Roma families that participated in the survey (FRA, 2016). The early school leaving gap between people with and without disabilities is also one of the highest in the EU (25.5 pps compared to an EU average of 10.1 pps in 2018). Policies to address disparities in the quality of teaching in schools and regions and to assign the most qualified and experienced teachers to the most challenging schools could help reduce existing gaps. Graph 3.3.3:Difference in reading scores between advantaged and disadvantages schools Source: OECD, 2020 In 2019, Czechia adopted the second Action Plan for Inclusive Education. The 2019-2020 action plan seeks to address potential segregation challenges in schools with more than 50% Roma pupils, by introducing anti-bullying measures among others. The inclusive education reform has not substantially diminished the share of Roma children in special schools. There is no evidence of putting concrete desegregation measures into practice, including those recommended by the Czech Ombudsman (). On the contrary, authorities adopted legislative measures that raise concerns about a potential negative impact on Roma inclusion. The implementation of the inclusive education reform has been adjusted and efforts are being made to apply it more consistently across the country. To increase the reform’s impact, further teacher training to teach pupils with special needs, including those from disadvantaged backgrounds, may be needed. Participation in early childhood education and care continued to rise. Overall, participation reached 92% in 2017. Regional participation rates vary between 85.5% in Severozápad and 96.1% in Střední Čechy. In 2016, only an estimated 34% of Roma children aged 4+ participated in this level of education (FRA, 2016).

School principals report teacher shortages. According to a 2019 national survey, 61.7% of schools face recurring difficulties in hiring qualified teachers (Ministry of Education, 2019). Shortages are most pronounced in primary education and for teachers of English, physics, information and communications technology (ICT) and mathematics (European Commission, 2019c). The teacher population is ageing, with 3 out of 8 teachers forecast to be replaced over the next decade (OECD, 2019a). PISA test results showed that the proportion of Czech students aged 15 that (strongly) agreed their teacher enjoy teaching is one of the lowest in the OECD (55% compared to the 74% average). Students also seemed to score higher when they perceived their teacher as more enthusiastic. There is scope for further development of teachers’ training in ICT skills. The TALIS survey reports a need for more training in advanced ICT skills for teachers. The ongoing revision of school curricula includes digital skills among the subjects to be strengthened. However, schools are not well equipped with digital technologies and teachers are not properly trained. Despite the targeted projects supported by funding by the ESF, the education system is not addressing fast enough the changes triggered by the digital transformation. Despite pay rises, salaries of teachers and school principals remain relatively low. This has been reflected in comparatively low expenditure per student at all education levels over time (OECD, 2019b). Salaries are relatively low compared with both other tertiary-educated workers and by international standards. In 2018, the government announced that by 2021 teachers’ average wages would increase by 150% compared to 2017. However, in 2017-2018 the increase was lower than for other public servants, further reducing attractiveness of the profession (OECD, 2018a). Many talented young teachers leave the profession early, often for financial reasons (Münich, D., 2017) but also because there is little room for career development. Authorities adopted measures to improve the attractiveness of the teaching profession. New framework requirements for initial teacher education programmes increase the compulsory practical training for future teachers. An amendment to the Act on pedagogical staff, which will make a two-year induction period supporting new teachers compulsory, is currently pending approval. These measures seek to better prepare and integrate new arrivals and prevent early dropouts. However, their impact will depend on the conditions ensured for those mentoring future teachers (their pay, reduction in workload for other tasks and training). Authorities want to improve the completion rate of tertiary education and reduce socio-economic disparities (European Commission, 2019c). Only 18% of children whose parents attained upper secondary or post secondary non-tertiary education as their highest qualification achieve tertiary education themselves. This is the lowest proportion among OECD countries (OECD, 2018a). According to PISA, socio-economic status strongly affects students’ expectations to complete tertiary education, with 50.8% more of advantaged students expecting to do so compared with disadvantaged ones. The employment rate of recent tertiary education graduates remains high at 91.5% in 2018. The projected increase in population in the higher education age bracket may soon require additional funding and capacity. The provision of vocational education and training is improving. In June 2019, Czechia approved a long-term plan for education (2019-2023) to improve the quality of vocational education and training (VET). The plan includes measures to better align the VET curricula with the needs of employers. Projects financed by ESF support this trend and take into account the specific needs of the regions, involving both schools and employers. The initiatives are positive step for higher quality VET (Cedefop, forthcoming), but their impact needs to be closely monitored. Few unemployed adults participate in lifelong learning. Less than 10% of the unemployed participated in training in 2018. On the other hand, supported by ESF (), the figures for continuous vocational training of the workforce are very high (83.7% compared to an EU average of 40% in 2015). Most of the continuous vocational training focused on developing technical job-specific skills. While adult learning is considered a key element for career development, most of the funding only comes from the EU. Social policies Poverty indicators show that Czechia performs better than the EU average, yet some challenges remain. The share of people at risk of poverty or social exclusion is 12.2% in 2018, below the EU average of 21.9%. In-work poverty is also low (3.4 in 2018)%. However, the share of older people (65 and over) at risk of poverty or social exclusion is rising steeply (from 10.1% in 2016 to 15.6% in 2017, see Graph (3.3.4)). People without employment and single parents are at a relatively higher risk of poverty (21.7% and 36.9% in 2018, respectively) (). The proposal to compensate single parents with children that do not receive maintenance payments could reduce their poverty risks. The new Social Inclusion Strategy for 2021−2030 is being prepared to underpin the investment projects in the next programming period of EU funds. It will focus on issues such as indebtedness, access to housing and social exclusion. There are strong disparities in poverty and social exclusion rates between people with and without disabilities. People with disabilities face a higher risk of poverty and social exclusion (a gap of 13.5 pps in 2018 compared to an EU average of 9.5 pps according to ANED calculations based on Eurostat data). This is linked to higher education dropout rates, lower education attainment and lower employment levels. The impact of sickness and disability benefits on reducing poverty decreased in the last decade, but such benefits still have the highest impact on reducing poverty, in particular for the most vulnerable groups (European Commission, 2019b). Graph 3.3.4:Groups at risk of poverty or social exclusion Source: European Commission The number of excluded localities continues to grow. According to the national Roma monitoring report, in 2018 there were 830 excluded localities with 127,000 inhabitants, significantly higher than in 2015 (606 localities with 115,000 inhabitants). Under the EU-funded ‘coordinated approach to the socially excluded localities’, 103 municipalities are developing inter-sectoral strategies to improve coordination of relevant social services. However, the measures had a limited effect in stopping the growing exclusion. The design and targeting of future measures will benefit from the methodology for mapping social exclusion currently developed by the Agency for Social Inclusion. There are many homeless people in Czechia and many more are at risk. There are around 68,500 homeless people (of which 21,230 adults and 2,600 minors are ‘roofless’ according to the 2019 census) and 119,000 are at the risk of becoming homeless, according to estimates of the Ministry of Labour and Social Affairs. In 90% of cases, the reason for homelessness is indebtedness. Around 37% of Czech children live in households suffering from housing problems (FEANTSA, 2018). With rising housing costs, an increasing number of elderly people are also experiencing similar problems. The current legislative framework puts the responsibility on municipalities to provide qualitative and affordable housing, as does the social inclusion strategy. Several national and EU () investment schemes are in place to enable municipalities to enlarge their social housing stock. However, the response from municipalities has so far been limited. After the social housing legislation was put on hold in 2018, the Ministry of Regional Development began in 2019 to work on an Affordable Housing Act. Czechia has taken steps to address the growing consequences of indebtedness. These include changes in legislation to improve the debt relief procedure, and making it possible for the debtor to keep a significantly higher minimum amount of money after all their debts are deducted to encourage taking up better paid jobs. This should motivate debtors to pay their instalments rather than work in the grey economy. In addition, children can no longer take over the debts of their parents and the advertising of usury loans is being limited. Despite these measures, households with overdue liabilities in 2018 constituted about 5.1% of the Czech population with an average overdue debt of €1,580. The share of people in enforcement proceedings reached 9.7% in 2018 (some 863,000) with an average debt of around €11,000 per person. While an inter-ministerial group to strengthen financial literacy was set-up, more targeted support from education institutions and social services is still necessary, mainly for groups facing the greatest risks (e.g., the unemployed, pensioners, single parents and minorities). Health status has improved but disparities remain. Life expectancy increased by 4 years between 2000 and 2017. However, Czechia still performs below the EU average in many areas related to health and healthcare. Notably, treatable mortality is higher than the EU average and there are substantial regional differences in health status, for example life expectancy at birth for both men and women can differ by more than 4 years (OECD, 2018a). Socio-economic issues are the main contributing factors, but also unhealthy eating and drinking habits. Furthermore, care needs associated with multiple chronic diseases are expected to increase with an ageing population. There are differences in access to healthcare. While overall self-reported unmet needs are one of the lowest in the EU, there are regional disparities as regards the distribution of health care resources and health care personnel. The difference between the highest and lowest density of doctors is more than double and there are sometimes substantial differences in the provision of primary care. There are plans to increase provision between regions with combined practices providing primary care as well as other services. There are also challenges in providing healthcare to vulnerable groups, notably homeless people. A move away from hospital-centred care (see Section 3.1), complemented by a further expansion of primary care, the integration of care and the necessary infrastructure can help address gaps and disparities in healthcare provision and contribute to progress under SDG 3. Population ageing is projected to increase pressure on long-term care services. The governance of long-term care, as well as palliative, health and social care remains an issue. One of the biggest challenges for the provision of long-term care is the integration of health and social services. Fragmentation and disparities in conditions for accessing care continue to undermine the effectiveness of the multiple support schemes. Around 20% of those needing long-term care reside in health or social care facilities, well above the EU average of 13% (EC-EPC 2018 Ageing Report) (European Commission, 2018b), which may indicate a lack of home-based services. Most people who need long-term care receive cash benefits, and their care is provided informally by people close to them (Ministry of Labour and Social Affairs, 2015), but there are rising concerns about the effectiveness and quality of such care. The care allowance is insufficient to cover professional social home care services. Costs and lack of information remain the two main barriers to the greater use of long-term care services. The current reliance on informal family care may not be sufficient and may have a negative impact on labour market participation. The reform of the institutional care system has stalled, in particular due to its complex governance framework. The reform of psychiatric care, supported by EU funds, is promising. As for community-based social services, there are growing regional differences (e.g. in approach to institutionalisation of children under 3 years). Some social services, such as community-based services for adults and children with multiple handicaps or autism are missing. In addition, social services are often severely understaffed, and their current staff is unpaid (European Commission, 2019g). There are plans for a systemic change of the social services. The ‘Fundamental Principles for Systemic Modification of Funding and Other Proposed Changes in Social Services’ announced by the Ministry of Labour and Social Affairs in 2019 aims to increase the mandatory national spending based on a multiannual framework and to set new governance mechanisms, new personnel, material and technical standards to reduce administrative burden for social services providers. These changes aim to address the non-systemic nature of the financial framework that impacts the availability of social services, including their staff. However, it is hard to predict its results at this stage. It is also crucial that the simplification of services does not go against clients’ needs. The changes to financing must also be considered from the clients’ perspective and include transparent quality criteria. Czechia is among the Member States with the highest number of institutionalised children. It remains one of the few Member States that places young children and infants in institutions, such as orphanages. In 2018, about 7,800 children lived in 300 institutions, despite evidence showing that 99% of them are not orphans. While there were some attempts to change the situation in the past, no concrete plans are currently on the table. There is scope for greater focus on preventive social services and support to vulnerable families.

3.4.Competitiveness, reforms and investment Productivity Labour productivity growth slowed down in 2018 but remained above the euro area average. The slowdown in productivity growth from 2.3% in 2017 to 1.6% in 2018 was mostly due to disappointing outcomes in the manufacturing sector, while productivity continued to grow in the services sector. Total factor productivity also saw a drop in growth from 2.7% in 2017 to 1.1% in 2018, but was still above the EU average growth (0.7%). According to Davies, E. et al. (forthcoming), productivity developments in 2010-2016 were driven by the growth of the average enterprises, as the more productive enterprises grew significantly less, potentially driven by a suboptimal allocation of resources. They link this misallocation to barriers to doing business and to competition. The share of zombie enterprises (firms that would typically exit in a competitive market) is below 5% in both manufacturing and services, in line with the EU average. While productivity implications are less pronounced, the effects of these enterprises on employment and investment are higher when compared to the EU average (Bauer, P. et al., 2020). There is a significant productivity gap between large and small enterprises, particularly in manufacturing. In 2017, the labour productivity of large enterprises was around 66% higher compared to microenterprises (down from 80% in 2014), and around 25% higher compared to small enterprises (35% in 2014). The gap between medium and large enterprises was smaller (15%, down from 20% in 2014). The gaps were significantly wider in the manufacturing sector, where larger enterprises are 50% more productive than medium ones and almost twice as productive as smaller ones. Additionally, the gap between the most productive and lagging enterprises has been increasing over the years (IMF, 2018). Since domestic SMEs provide the largest share of employment and value added, authorities aim to improve their productivity and competitiveness by developing a new SME Strategy and Implementation Plan for 2021–2027 with the technical support of the European Commission. The World Bank (2019b) also concluded an analysis on the SMEs policy mix and its alignment with the country needs, identifying actions to improve the effectiveness and coherence of the SME policy mix. It found gaps in improving management capabilities and adopting new digital technologies to catch up with more productive enterprises. There is also a resource misallocation across regions and sectors and a lack of synergy between instruments across agencies. Promotion and support of entrepreneurship remains low, hampering productivity growth. The net business population growth has remained rather flat since 2015 and turned slightly negative in 2017. The churn rate - a measure of business dynamism – reached 17.5%, well above its 2008, but the lowest score among the Visegrad countries (for both birth rates and death rates of enterprises). In 2017, the three-year survival rate of enterprises was 61%, whereas the 5 year survival rate was below 50%. Attitudes to entrepreneurship are becoming less positive and the country ranks among the weakest performers in entrepreneurial education. In this context, authorities launched support programmes targeting technological start-ups like ‘CzechStarter’ that provides early-stage start-ups with mentoring and training. However, the provision of dedicated entrepreneurship support to young people, women, migrants or the unemployed is lacking. While new measures to introduce a legal definition of family business were announced, there is a lack of support for business transfers and generational change. Firms also invest a smaller share of value added in managerial organisational capital than most other advanced economies (OECD, 2016). Czech graduates generally possess good technical skills but less developed soft skills and large gaps exist in the perceived quality of management schools. Innovation-driven high-growth enterprises are key to economic development and industrial renewal. These enterprises are responsible for a large share of job creation and productivity gains and can leverage efficiency and competitiveness gains in the sectors and regions where they are located (Hallak, I. and Harasztosi, P., 2019; Haltiwanger, J. et al, 2017; Monteiro, G., 2019). Many enterprises have successfully scaled up their operations in recent years and, by 2016, 4,241 enterprises were considered high growth enterprises (11.3% of all enterprises with at least 10 employees compared to an EU average of 10.7%). The geographic distribution is fairly homogeneous, with a higher percentage in Prague, Severovýchod, Jihovýchod and Střední Morava (Flachenecker et al., 2020). Czech enterprises are highly integrated in value chains but due to the productivity gap, focus mainly on low value added activities. According to the European Central Bank (2019), based on the World Input-Output Tables, Central and Eastern European countries have one of the highest participation in global and regional value chains. In fact, Czechia had the highest volumes of regional value chain trade in the EU in 2014 (Stöllinger et al., 2018), based on the strong bilateral links with Germany. Nonetheless, Czechia is positined more downstream in the global production chain (exports have a high import content – 38% in 2016 according to OECD data), as a large part of the economic activity is based on compiling and assembling processes. In 2016, the share of domestic value added in the total exports amounted to 62%, one of the lowest figures in the EU. In the car industry, the share was even lower at 46%, compared to 76% in Germany. A recent analysis showed that 9 out of 10 most important economic sectors by export volume are placed on the parts of the value curve with low value added (Deloitte, 2019b). Nonetheless, export composition has evolved in the last three decades, moving from metal products to machinery and electric products (see Graph 3.4.1). Graph 3.4.1:Composition of Czech exports, % of total Source: Eurostat Access to conventional finance is above the EU average but risk financing is less developed. Almost 90% of applying SMEs received the full amount of the bank credit they requested, one of the highest success rate at EU level. Borrowing costs are also relatively low. A majority of Czech SMEs (74%) also report they occasionally or regularly face problems with late payments (European Commission, 2019e). Risk financing remains underdeveloped. In a World Bank assessment, the domestic capital market cannot fully support the expected structural change of Czechia. Together with the private sector, the authorities decided to create a new National Development Fund (see Box 3.4.1). Venture capital remains very low. Czechia ranks among the countries with the lowest funds raised through venture capital (see Graph 3.4.2). Funding is mostly concentrated in start-ups and almost non-existent in the seed and later development stages, especially for high-risk projects. Equity issuance is also negligible. In this context, the government approved in 2019 the National Strategy for the Development of the Capital Market 2019-2023. The early stage equity Fund of Funds financed from EU funds has also started operating. Graph 3.4.2:Venture Capital in 2018 as a share of GDP Source: Invest Europe, Eurostat, European Commission Box 3.4.3: The National Development Fund The Czech government and the four largest banks agreed to create the National Development Fund. The four commercial banks (all foreign-owned) signed a Memorandum with the Czech government in September 2019 and committed to make an initial contribution to the fund amounting to around CZK 7 billion (€275 million) for a 10-year period. Investments into the Fund remain voluntary and the government is currently in discussions with other private investors that may join later. The sole owner of the Fund is the Czech-Moravian Guarantee and Development Bank (ČMZRB), the national promotional bank. The Bank plays an important role in the implementation of EU financial instruments as it has successfully contributed to the allocation of more than €350 million through its instrument for small and medium enterprises (‘Expansion’ soft loans and guarantees programme). The bank was also able to increase the volume of bank guarantees thanks to the counter-guarantee received from the European Investment Bank under the EU programme for the Competitiveness of Enterprises and Small and Medium-sized Enterprises (COSME). The management of the Fund will be a new activity of the Bank. The Fund will operate as a Qualified Investor Fund. It will be set as a subsidiary of ČMZRB in the