Prime Minister Mirek Topolánek's address: "The Prime Minister's Information on the Impacts of the Global Financial Crisis on the Czech Republic," 2 De

Esteemed Madam MP, esteemed MPs, allow me to acquaint you with my view on the global financial crisis and its possible impacts on the Czech Republic, respectively with the viewpoints and approaches to eliminating potential risks flowing from this crisis. I would like at the introduction to also say that my contribution is built upon base materials and analyses from the Czech National Bank; it devotes attention both to the causes that began the crisis as well as a detailed analysis of the actual status of key indicators of the Czech Republic's financial stability, as well as to the interpretations and evaluations, and then a plan for how to most effectively face the threats of the global crisis. My speech will be more analytical than political in the sense that it is more of a speech by the prime minister than by the chairman of a party, and it should start serious discussions not only in the Chamber of Deputies. Now to my speech itself. Almost everyone agrees today that the main impulse for the global financial crisis was the so-called mortgage crisis in the USA. I would just like to remind you that the mortgage crisis began to appear in the USA in mid-March 2007, but only sharply influenced American capital markets in mid-July 2007. The crisis spilled over to Europe in the first half of August 2007. It has its roots in the sector of the American mortgage market for less creditworthy clients and on the basis of a benevolent approach, banks began providing loans to these clients. After a period of relatively low interest rates, the American central bank, the Fed, began to raise interest rates due to rising inflationary pressures, which led to increases in mortgage interest rates and the amount of payments these clients had to make. Less creditworthy borrowers then stopped repaying mortgage loans and it was finally evident that some would not even begin to. The transmission mechanism for spreading losses and insecurity was the so-called securitisation of assets, which means a less cautious approach for derivative trading, for example. That enabled loan institutions, at a time when there was a surplus of liquidity on world markets, to create risks off their balance sheets through securities sales and with the use of financial innovations. These toxic assets were transferred to investors the world over and throughout subjects in the financial sector. But under the influence of a decline of quality in loan portfolios and an overvaluation of risk, the value of securities tied to the problematic assets began to fall dramatically as a result. Mutual mistrust began to spread among banks, as the stopped trusting each other and lending (the so-called liquidity crisis in the interbank sector). In an extreme case, this situation could lead to the collaps of not only the entire banking sector, but of financial markets as well. To divert this threat, central banks began to free up hundreds of billions of dollars so that commercial banks could begin to lend if they temporarily needed cash. Central banks tried in some way to substitute the functions of the interbank market with liquidity. So after the crisis in transparency and the crisis of guardedness, there was a crisis in trust we got to a crisis in confidence and a crisis in liquidity, which of course has negative consequences for the economy, because even healthy (and solvent) banks can get into difficulties due to a loss of liquidity. There is a danger of this spilling over into the corporate sphere, if long-term solvent companies cannot get loans for financing regular activities, respectively the standard refinancing of currently valid loans. To a certain extent, this is starting to happen here as well. What was originally only a crisis on the financial markets has, with the passage of time, becime a crisis across the entire economy of the United States. Connected with this, a decline in American household consumption has been reflected in the demand for imported goods. Countries which are the USA's main trading partners, have gotten into problems in their export sectors. Considering the importance of the American economy for the development of the global economy, the USA's problems have been transferred to other countries as well, and there a slowdown in economic growth has occured in the eurozone as well as in the rest of Europe, Russia and China. The nervousness which ruled the markets since the last wave of declines at the beginning of this year have recently changed - and of course we recorded this as well – has led to a panik which is starting to turn into a recession in the most important world economies, and what was originally a financial crisis is starting to become a worldwide economic crisis. The Czech financial system has thus far remained relatively isolated from the global financial crisis, although certain impacts have gradually started appearing. Aside from the macroeconomic impacts of the impending cooling of economic activity in the eurozone, which is already visible today in the Czech real estate sector, the financial crisis is starting to be expressed in tensions on Czech financial markets. The Czech banking sector is continuing in the hardening of interest and no—interest terms in a number of segments of the loan market, and the tempo of loan provision is slowing. This is practically leading to an outflow of loans for private companies. UPDATE ON KEY INDICATORS OF FINANCIAL STABILITY IN THE CZECH REPUBLIC If we want to have the most objective view possible on the potential risks and impacts of the financial crisis on the Czech Republic, then it is necessary to carry out an update of key indicators of financial stability in the Czech Republic. On the basis of an update of key financial stability indicators in the Czech Republic carried out by the central bank, the following can be said in detail about individual markets, segments and indicators: In the financial sector, nervousness on the interbank market in the USA and Europe has ruled in the last few months. The premium for credit risk has risen sharply in the last month. A mild calming of the situation on the interbank market occurred after more coordinated reactions of European states and the implementation of a set of measures by the Fed on supplying liquidity to non-banking institutions, especially to money market funds. On the Czech money market, there was a more important limit in trading in maturity longer than 1 week throughout October, and activity concentrated especially on the so-called "overnight segment." At the same time, there was an expansion of the buy-sell gap from 10 basis points ("bps") to 20-25 bps according to the maturity and growth in credit premiums, but in a lower scope than in the case of the USA or eurozone. The credit premium on Czech money markets is thus far not showing the signs of a decline, which is supported by continuing nervousness on the Czech interbank market. The yield gap in Czech bonds denominated in euros compared with yields of benchmark Western European government bonds are still maintaining a lower level across the board than is the case in other countries of the Central Europe region, and this is despite a sharp rise in risk aversion in recent weeks, Hungary's growing problems and a significant outflow of capital from countries of Central and Eastern Europe. In comparison with the level of risk in eurozone countries in the eurozone with the Czech Republic in October momentarily got to the high level of 200 bps, but after the stabilization at the end of October 2008, this returned to similar values as Greece or Italy. A specific manifestation of the global financial crisis on Czech financial markets was the drying up of liquidity on the market for state bonds; roughly in the middle of October in a situation of excess supply of these securities, which led to the expansion of the buyer-seller gap among market makers from the usual cca 20 bps to around cca 300 bps in bond prices. The central bank reacted to the implementation of liquidity-providing repo operations, which are constructed in such a way as to enable the acceptance of state bonds as collateral (aside from short-term treasury certificates) and in this way helped to mitigate the fears of market participants that these securities could not be quickly converted into the necessary liquidity. A partial renewal of the creation of prices on the interbank market for state bonds later occurred with an approximately one-week interval. The volume of state bond trading is moving only barely below the level usual before the expansion of the buyer-seller gap. The steep sell-off on stock markets has continued, especially in recent weeks. The main stock indexes have already lost nearly half their "pre-crisis" value in the crisis. Even if the Prague stock exchange fell more in the ongoing crisis as compared to Western European and American indexes, the value of the PX index is now above 2004 levels, while American and Western European indexes have fallen to levels from 2003. A steeper decline in shares in banking titles, especially European, is noticeable from the beginning of October, when prices reached a five-year minimum. Apparently, speculation on their worsening economic performance and about possible capital increases has led to the drop. Shares in domestic banks and their parent banks of Czech banking institutions have not avoided a drop; they have tended to be hit by the global financial crisis in a limited and indirect way. A pronounced drop in share prices in certain banks could bring additional risks in the sense of a decline in confidence in the banking sector and its stability. In some segments of the Czech financial market, liquidity has fallen in recent months. This development is apparent mainly on the money and bond markets, but the currency market appears relatively liquid. In the sector of the real economy, which is probably most important to us at this moment, non-financial companies have had to face a number of unfavourable circumstances in 2008. Foreign and then domestic demand have decreased as a result of the crisis on world financial markets. At the same time, companies have problems with financing because banks have greatly toughened their loan standards in connection with the global financial crisis, and in a number of cases the companies' sources have risen in price. Adding to these circumstances is an exchange rate which has been strengthening greatly since mid-2007. This rise has been negatively projected into companies' competitiveness, which has then contributed to the level of insolvencies increasing to the current 6 %; at the beginning of 2007 this indicator was at around 3 %. Economic growth is among the main determinants for insolvency in the corporate sector, as is the level of corporate debt and the currency exchange rate (its correlation with the level of insolvency is more than 50 %). Additional negative developments could lead to an up to 9 % increase in insolvencies; in an extreme case, this could even be 10 %. With a certain delay, similar values could affect the share of unpaid loans to overall loans, which currently is also slightly increasing, and in September 2008 came to 3.8 %. This indicator's rapid approach toward the levels for insolvency will be contributed to mainly by the fact that the loan dynamic has palpably slowed down loans to companies. As with non-financial services companies, the effect of an economic slowdown and a tightening of banks' loan standards are starting to impact on households. What's more, real household disposable income has been negatively influenced by high inflation. The population's increasing debt burden indicates a growth in the indicators of ratio of debt to gross disposable income, financial assets, GDP and an increase in interest paid in relation to gross disposable income. But developments in the first half of the year point to a certain correction in the high tempo of loan growth from the end of 2007. Aside from an appreciable slowdown in mortgage loans, there has even been an absolute decline this year in loans provided by non-bank financial institutions. This could be perceived as a desired correction to the excessive growth in this segment last year. During 2008, household credit risk as measured by the level of insolvency gradually rose from 3 % in 2007 to the current 3.6 % in September 2008. An increase in the values of these indicators occurred both in the mortgage and consumer loan segments. But the share of unpaid loans on loans overall for the population has not yet reacted to the level of insolvency and in recent months has fallen slightly. By the end of September 2008, this share was near the relatively low level of 2.6 %. Values of both indicators of the population's credit risk should continue to increase slightly, depending on developments in the world and domestic economies. What is the situation on the real estate market like? In the course of the first three quarters of 2008, the impacts of the world financial crisis have been somewhat limited on residential real estate prices in the Czech Republic; even in this period, price increases for apartments continued in most regions of the country. According to various sources, year-on-year increases in the offer prices of real estate in Prague in the 3rd quarter of 2008 held to high values in the range of 18 to 21 %. These increases are either at the level record year-on-year increases from the second half of last year, or there has been a certain slowdown in the dynamics. For regions outside Prague, general price increases are higher considering the lower growth base, because it is true that higher percentage increases in prices have taken place in regions with lower starting prices for apartments (in Ostrava and Ústí nad Labem the price increases have been roughly double those of other regions). However, in most other regions in the 3rd quarter of 2008 there has been a noticeable decline in growth dynamics from around 30 % year-on-year to around 20 %, price convergence across regions is slowing instead. Continuing increases in apartment prices led to a gradual worsening of simple indicators of growth sustainability for these prices in the 3rd quarter of 2008. Rent revenues fell from the end of 2007 in Prague and Brno by roughly 0.2 % despite interest rate increases from housing loans of roughly 0.4 percent. In other regions, rent revenues improved in the main, with Liberec having the most at 0.5 %; on average, however, this improvement was smaller than the aforementioned increase in interest rates. The estimate for the price to income indicator is increasign for all regions of the Czech Republic, and it has exceeded its value from mid-2003, when a "bubble" appeared on the real estate market related to the Czech Republic's entry into the EU. Relatively high apartment construction rates remain a risk factor that could mean a surplus of real estate offers, and therefore a decline in their prices: According to Czech Statistical Office figures, the year-on-year number of apartment completions rose by 9 % in the first half of 2008, the number of developed apartments rose by 14 % and the number of apartments under construction rose by 2 %. At the same time, apartment construction continues to be concentrated mainly in Prague and the Central Bohemia region (around 41 % of all completed apartments and 40 % of all apartment starts), which, from the standpoint of the indicators of revenue from rent and this ratio of price to revenue, have been identified as the riskiest. For the number of apartments in apartment buildings, which is where developer companies' activities can be assumed to be strongest, the dominance of these two regions is even greater (the share of completed apartments is 55 %, 59 % for starts; for Prague itself these numbers are 46 % and 44 % respectively). In this context, an interesting figure is the high year-on-year increase in apartment starts in apartment buildings in the 1st half of 2008, which was a sharp 30 % (while there was a 10 % year-on-year decline in completed apartments in apartment buildings). Let's take a look at the financial sector as a result of increased caution on the part of banks while financing the real estate sector in a situation of increased risk aversion, and an expected economic cooling off slowed down banks' tempo of loan provision. Loan dynamics decreased for households and companies from the beginning of 2008. A slowdown in growth in new crown-denominated loans to households from the beginning of 2008 continued in May, June and August with an absolute decline in the housing loan segment. While new loans in the corporate sphere rose in January 2008 with a year-on-year tempo of 32 % - which is the highest value from the end of 2006 – growth increased in May by nearly 16 % and in September by only 15 %, which means that the dynamics slowed down to less than half from the beginning of the year. A slowdown in loan growth has not appeared in a stronger way in the share of unpaid household loans, but for companies this indicator has been increasing since the beginning of 2008. Analysis of interest rates from new crown-denominated loans showed that during 2008 there was a tightening of loan terms, especially in the segment of loans to the population (consumer loans and housing loans) and sole proprietors. While the three-month PRIBOR interbank rate fell by 25 basis points between December 2007 and September 2008, the avarage rate for new housing loans rose across fixations by 15 to 50 basis points, rates for consumer loans by 60 basis points and rates for loans to sole proprietors by 45 basis points. In the household sector, both types of loans had the highest interest rates since the end of 2006, and probably reflected banks' reactions to developments brought about by the mortgage crisis abroad, as well as a re–evaluation of expected developments on the domestic real estate market. In the area of new crown-denominated loans to companies, the situation has been somewhat heterogenous: Rates of small company loans more than copied the decline in interbank rates, while rates of big loans fell only slightly and their gap as compared to the interbank rate – which reflects the credit risk of the client – increased. But the development of interest rates from new crown-denominated loans differend among individual individual bank groups. In the case of corporate loans, rates provided by small and medium banks decreased more sharply, and in the case of sole proprietors, rates were only minimally higher than major banks. This fact may have been caused by small and medium banks' efforts to gain greater market share. In the case of corporate loans, it does not confirm the hypothesis that small and medium banks – more dependent on the interbank market or financing from parent companies – have tightened interest rate terms more sharply than major banks with adequate deposit bases at their disposal. An analysis of the volume provided, however, shows a certain increase in the share of major banks on newly-provided loans to these segments overall. The reaction of small and medium banks to the difficulties in gaining resources could have occurred through volume limits rather than interest rates. The opposite development occurred with new housing loans, where on the contrary, small and medium banks increased interest rates more than major banks or building and loan associations. Building and loan associations increased rates in their dominant segment (fixation longer than 10 years) in a relatively minor way, and, similar to major banks, despite having a tightening reflect insecurity about future developments. Basic liquidity conditions in the banking sector continued in 2008 in a slight worsening, but when compared to what was going on internationally, this is a relatively safe level. At the end of 2008, the ratio of rapid liquid assets fell to 23 %, which under standard market conditions could be considered an acceptable level. It is similarly true for the 78 % share of loans to primary deposits. An expected constraint in loan emissions will improve bank liquidity to a certain extent, as long as the level of loan defaults does not increase at the same time. Short-term commitments and call commitments compared to banks have gradually fallen since 2007, and sharper declines occurred especially in the area of commitments toward non-resident loan institutions. It is mainly households which are continuing to provide liquidity. An increase in the risks of alternative investments (mainly in share funds), a preference toward being having money at one's disposal if liquid resources are needed and a higher interest rate for bank deposits have been reflected in the growth of non-time deposits by inhabitants by more than 18 % per year (September 2008) and time deposits by more than 6 % in 2008. Changes in deposit insurance parameters, which according to the government's proposal (compensation of 100 % of the volume of insured deposits, with a maximum of EUR 50,000) now covers the vast majority of individuals' deposits. Some banks are temporarily increasing their currency rate exposure in relation to abroad, mainly toward their parent banks. However, the engagement of banks in the Czech Republic toward their parent banks has in the long term been around roughly half of the maximum regulatory value, and no sharper increases have been recorded in the crisis period. The engagement of domestic banks toward their parent companies is moving below 1 % of deposits of the banking sector. The latest developments indicate that certain major banks will have lower profits, both as a result of re-evaluating securities and as a result of expected increases in the level of loan defaults, which will lead to a higher creation of corrective line items. A dampening of loan and investment activity may be expressed positively in the maintaining adequate capital soundness at the current time, but this will probably lead to a decrease in the high profitability of previous years. Data on the health and performance of the banking sector available as of September 2008 thus far does not indicate a more meaningful worsening of domestic banks' positions. The aggregate index of banking stability, which declined slightly in recent years, recorded a certain amount of stabilisation in previous years, and banks' robustness toward shocks is signalized as well in the results of standardised burden tests carried out in mid-2008. In a certain way, the global financial crisis has also been reflected in the economic results of non-bank financial institutions. In the sector of domestic insurers, developments on the financial markets - together with an expected cooling off of economic growth - has been expressed in a decline of gross prescribed premiums. While the growth tempo of prescribed premiums rose by 7.5 % in 2007, in the 1st half of 2008 it was only 4.8 %. At the same time, the financial crisis has influenced the overall economic performance of domestic insurers, and together with inflation growth, it has caused a tendency away from life insurance products, caused by clients being increasingly careful when investing their financial resources. A technical life insurance account recorded on 30.6.2008 a year-on-year drop of 57.1 %, and it strongly took part in a decline in domestic insurers' overall net profits, which fell by 52.2 % in year-on-year comparisons, to CZK 4.3 billion. The pension funds sector was especially hit by a decline in the prices of assets that pension funds invest in. A sharper markup occurred in the balance entry for differences in valuation, where pension funds invoice most of the losses stemming from a decline in the real value of assets held. While the valuation difference came to CZK -4.4 billion at the end of 2007, in mid-2008 this valuation difference came to CZK -8.4 billion. This sharply influenced their capital base, which with this went into negative numbers. In reaction to such unfavourable developments in asset prices, pension funds changed the structure of their portfolios and increased the share of bonds at the expense of stocks. Another segment of the non-banking financial system which has felt the effects of the financial crisis has been open-end funds. While the assets in domestic open-end funds came to CZK 162 billion at the end of 2007, by October of this year it had fallen by roughly CZK 42 billion to CZK 120.5 billion. The largest decline in assets occurred with share and bond funds (by roughly 52, or respectively 32 %), and the assets of money market funds, which still make up nearly 40 % of all funds' assets, fell by 22 %. A major turning point in the sale of shares in domestic open-end funds occurred this year, when, for the first time, the value of funds' redeemed share certificates exceeded the value of the share certificates they sold by CZK 24 billion. The lowest interest in investment into shares or a strong interest in getting rid of shares was later expressed this October, when the net sale reached a value of CZK 12 billion. At the same time, in the sector of non-banking brokers of financial assets, there has been a certain amount of cooling off. Overall loans provided through these brokers rose by 13.7 % year-on-year as of 30 June 2008, but in absolute terms a marked slowdown in the 1st half of this year occurred. While in the 1st half of 2007 the overall volume of loans provided by this sector increased by nearly CZK 19 billion, (by CZK 38 billion in the 2nd half of 2007), the absolute growth in loans for the 1st half of this year was only CZK 1.5 billion. Leasing loans increased by a total of 13 %, but nonetheless, in absolute terms what occurred was a decline of more than 1 %, influenced by a decline in the growth of leasing loans to households. Consumer loans, loans in the form of sales on payments and loans from credit cards from other companies increased by 17 %, but nevertheless this was roughly the same growth tempo as in the previous year. The CERTIS system of interbank payments did not record any non-standard developments in the period. As far as the number and volume of transactions, the status from previous months and years was maintained. The average daily transaction turnover in the first three quarters of 2008 are slightly lower compared to last year (by 6 %), but one must take into consideration the fact that the final months of the year is the traditional period when the largest payments occur. An increased interest in intraday loans was not observed either; that could signal a need for system participants to supplement liquidity – on the contrary, compared to previous years the overall volume fell by CZK 3.011 billion in the 3rd quarter of 2008, as opposed to CZK 7.152 billion for 2007 - a decrease of about 44 % compared to the equivalent term last year). In the system of short-term SKD bonds, lower monthly values for processed transactions can be traced back to February 2008 (an average decline of around 14 %). In a more-detailed view of daily transaction volumes in the last 30 days, this trend is also evident, which is related to lower volumes of Czech National Bank repo operations in 2008 and could partially indicate a dampening on the short-term bond market. THE GLOBAL FINANCIAL CRISIS' TRANSMISSION CHANNELS INTO THE CZECH ECONOMY Transmission channels can be divided according to numerous viewpoints. I have chosen a basic division into so-called direct channels, which are directly captured onto the balances of financial institutions and only then into the real economy, and not indirect channels, where the impacts on the financial sector occur through problems in the real economy, respectively through impacts on sectors where the financial sector has the greatest exposure (mainly in the corporate and household sectors). The direct channels are: 1. Direct market channel (impacts on balances through securities holdings) 2. Direct exposure channel toward afflicted foreign financial institutions 3. "Liquidity transfers" from the domestic financial sector channel 4. Decline in capital facilities channel 5. Declining competitiveness in the Czech banking sector channel 6. "Crisis of confidence" among banks and in the entire financial sector channel 7. Slowdown in the development of the capital market and non-bank financial brokers channel Indirect channels: 8. A "crisis of confidence in transforming economies" channel ("Pure contagion") 9. A channel of slowing foreign economic activities; 10. An exchange rate channel; 11. A channel of direct foreign investment; 12. A fiscal channel. Individual channels vary both in the probability they will occur as well as in the presumed size of their impacts. The timing of the impacts of these channels is also important; some of them impact financial institutions' balance sheets very quickly, while others will rather be expressed indirectly and in a longer timeline (a slowdown in the financial system, for example). It must also be said that the aforementioned channels will not occur in isolation; they influence each other mutually, which could strengthen impacts on the financial sector. Judging the probability and presumed impacts of individual channels, including their timing, is in large part subjective, and I will not explicitly pursue this further. In the Czech economy's existing starting positoin, we can define several probable combinations of the aforementioned mechanisms: 1. The exchange rate channel has been acting on our economy for some time, and external competitivness has been decreased as part of the crown's excessive valuation, as has demand for Czech exports. In the existing slowdown of foreign economic activity, demand for Czech exports continues to decrease and at the same time a decline in direct foreign investment can be expected. 2. If there was a sharper drop in domestic economic activity and a weakening of macroeconomic balance, the currency channel could have an effect again, this time in a depreciative direction. This would be contributed to mainly by financial flows (liquidity transfers, further declines in direct foreign investment, a decline in the capital facilities of parent banks). This scenario would be connected with an increase in domestic interest rates in a regime of targeting inflation. 3. What cannot be ruled out is that additional channels could afflict the aforementioned processes. What could especially occur is a pure infection of the domestic system as a result of a crisis of confidence in transforming economies and other elements of a general loss of confidence (an overall non-functioning of the money and bond markets, difficulties for certain banking institutions, financial and other), which could lead to the creation of exceedingly pessimistic expectations and to a panic by domestic and foreign investors. On the basis of these probable combinations, the Czech National Bank has put together two risk scenarios for stress testing, which were marked as "economic drop" and "dramatic development." The second of the two scenarios is different from the first in that it counts on an even sharper drop in domestic economic activity and especially with a weakening crown, which will call forth an increase in domestic interest rates. In its annual Report on Financial Stability, the central bank publishes results of stress tests for individual parts of the financial system. The goal of carrying out these tests is to identify the financial system's level of resistance to unfavourable shocks, both exogenous and those coming from an internal (macroeconomic) environment as well as market shocks from a domestic environment. Then throughout the year, the Czech National Bank repeatedly carries out stress tests for a key component of the Czech financial system – the banking system. In October, stress tests were carried out on the banking sector, which were based on the impacts of unfavourable developments abroad as a result of a deepening financial crisis, confirmed that the domestic financial sector should be able to resist these shocks to a greater extent. But if the economic drop is very deep and long-term, banks' capital facilities would decrease and some banks may come under pressure from a capital soundness perspective. In this situation, they would be forced to increase their capital so as to be within regulatory rules and at the same time ensure sufficient credibility from the perspective of other market participants and clients. The necessity of having relatively high amounts of their own capital at their disposal is set by the fact that in a situation when the a high level of mistrust exists in the entire system, even a report about a relatively minor loss at a specific bank could have major impacts. At the same time it is clear that for certain private co-owners of banks, it could be difficult in the current crisis to allocate resources for a capital increase, even if during more favourable times they would not have a problem with such a capital injection. It is these factors that are in the background of certain governments' capital injections into their national banking sectors, which are, as opposed to losses thus far, are apparently very high. As of October 2008, American and European banks have shown an aggregate loss of around USD 600 billion; compared to this, shareholders increased capital by around USD 430 billion. During September and October, governments then committed to provide up to USD 550 billion in new capital. But aside from this, governments and central banks have committed to widespread assistance using other tools, which means indispensable support for banks in the longer term. The previous description I gave you illustrates that in certain circumstances, Czech national economic policy (currency and fiscal) could face major challenges in the coming period and I do not want in any way to downplay them. The difficulty in deciding will come when, in the event of markedly unfavourable developments, the state national economic policy could find itself having to choose whether to place emphasis on long-term goals even at the price of sharper economic declines, or whether to mitigate the economic decline and temporarily modify strategy and use non-standard means. I have therefore considered it necessary to have an up-to-date description of key indicators, the direction of impacts of the global financial crisis on the Czech Republic and outlines of the challenges we may face in the near future. But now I would like to devote myself to a more specific perspective and to considerations about the future, namely possible reactions to the possible challenges which could threaten us in connection with the global financial crisis. At the start I must state beforehand that 2008 was a year for the Czech Republic in which the impacts of this government's first set of reforms started to appear. It was a year of reforms and steps that have started to bring the following tangible effects, and which have also led to a somewhat soft landing, which he have experienced in the past few months: - The compound tax quota will fall in 2008 to 35.7 %, which is 2.3 % less than in 2005; in other words, an additional CZK 87 billion will remain in the wallets of citizens and companies, and not with the state. - We are managing to change the structure of taxation toward a higher share of taxed consumption and a lower taxation of income. - In the area of income taxes, the reform steps that have been passed thus far will decrease the tax burden by around CZK 42 billion by 2010. - In the area of social spending, the public budget burden will decrease by around CZK 94 billion in total by 2010. - We have improved the conditions for doing business, decreased administrative burdens at the start of doing business and have secured more comfortable contacts with authorities. - There are those service charges that we constantly want to cancel. - We have prepared and gotten passed a systematic change in the area of unemployment, social benefits and disability payments, toward directness and motivation to work. - We got the first phase of pension reforms passed, and another two phases are prepared for discussion in the parliament. - Unemployment in 2008 will fall to 4.4 %, compared to 8 % in 2005. - The public finance deficit as shown under EU methodology fell to 1.2 % of GDP in 2008; compared to the previous government's 3.5 % of GDP. - We successfully modified the Czech Republic's convergence programme, which respects our long-term fiscal commitments to the EU and was accepted as credible. - The cumulative debt of the Czech Republic will fall in 2008 to 28.8 % of GDP, which is 1 % lower than in 2005. Nevertheless - and both the coalition and the opposition assumed this, I think – the economy has begun to hit the limits of its potential production, especially as a result of a lack of labour. The lower dynamic of household consumption, in the context of reform efforts to prefer investments before consumption, will also have an influence on a lower growth tempo. Nonetheless, we counted on the reforms having a slight cooling effect, and in our considerations, 2008 was supposed to have been a year heading toward consolidation of fundamentals and the economy's repeated aspirations to further accelerated growth. But these reform deliberations, strategies and phases were negatively affected in 2008 by the aforementioned potential influence of the global financial crisis, which is gradually growing into an economic crisis, one which in 2008 began to fully afflict the largest European economies. As I have already mentioned, the Czech economy has thus far withstood the global financial and economic crisis, because our banking sector was directly afflicted by the financial crisis; it has been shown that the reforms this government carried out have contributed to greater flexibility and adaptability of the economy and public finance. But it is especially because – and I consider this to be key – we have not given in to mindless panic. I realise that for our open economy, a recession of the global economy poses a potentially serious threat, and for this reason it is necessary to think seriously about steps toward the elimination of risks resulting from the global financial and economic crisis. In the context of the threats resulting from this crisis, it would be premature and irresponsible to give into mindless panic on one hand, or on the other hand to act as if nothing is happening, or to wait passively until when, where and how the crisis will strike us. As long as we do not give in to panic and we look at the situation with prudent vision, and if we will abide by the proven rule that says that it is best to turn a threat into an opportunity, then an effective strategy can be formulated against the challenges of the global financial and economic crisis, one I would call the "Preparedness Strategy." As long as we systematically and thoroughly contemplate the necessary steps which could eliminate the looming risks, then aside from short-term passive or active steps, we will always come to the systematic conclusion that a country and an economy that has healthy public finance and has flexible institutions, markets and segments will be the most resistant to potential external threats. And from that systematic view, I have to admit that we have reservations; not all reform considerations and concepts are implemented and carried out successfully. That is to say that everyone who wants to seriously and responsibly seek a prescription for how to face the threats of the global crisis must admit that the most effective prescription is for further continuation and acceleration of reform efforts. The advantage of carrying out and completing reforms is their long-term effect. While short-term steps respective to the threats and results of the crisis will fade away with time, the long-term effects of reform will remain and then contribute to a longer-term acceleration of economic growth – the acronym is "SPAR:" STRATEGY FOR PREPAREDNESS AND GROWTH ACCELERATION ["SPAR" in Czech] On the basis of these considerations, I would therefore be glad to formulate a long-term comprehensive plan in reaction to the global financial and economic crisis, a plan, which I have given the working title of the "Strategy for Preparedness and Growth Acceleration." [SPAR in the Czech acronym]. The strategy follows four basic goals: 1. A renewal of confidence in the financial sector 2. The prevention and elimination of risks from the global crisis 3. Stabilising the economic environment and making it more flexible 4. Growth impulses for the economy The goals will be followed through two approaches: A. An analytic approach examining the main causes of the threats, which can be divided into two main groups of causes: Long-term recession abroad - Spreading infection and spiraling domestic effects and impacts - Limiting steps of the main players - Pure contagion An active approach made up of an appropriate activation of a combination of tools and measures for securing SPAR's goals - The goals will be fulfilled through the following set of tools and measures (in order): a) Fiscal and currency policy b) Structural policy c) Supply stimuli in the economy d) Demand stimuli in the economy The set of tools and measures will be activated in the event that the following scenario occurs: 1. a crisis scenario, which is if the GDP growth dynamic for 2009 falls below 2 % 2. a pessimistic scenario, which is if the GDP growth dynamic for 2009 is between 2 and 3 % 3. the expected scenario, which is that the GDP growth dynamic for 2009 will be between 3 and 4 % 4. the optimistic scenario, which is that the GDP growth dynamic would be around 4 % Tools and measures for fulfilling goals 1. Renewal of confidence in the financial sector 1.1 More intensive communication between the government and the Czech National Bank about currency policy issues 1.2 Increasing deposit guarantees to EUR 50,000 1.3 A more active role for the Czech National Bank and possibly the government, on the financial markets, incumbent on preparations to accept necessary measures: 1.3.1. In banks' inadequate capital facilities 1.3.2. in inadequate liquidity for certain segments of the financial market 1.3.3. in resolving a large number of households' inability to repay loans 2. Prevention and elimination of risks from the global crisis 2.1. Regular information from ministers on the impacts of the crisis on their departments 2.2. Regular information from the Czech National Bank on developments in the area of loan provision and interest rate developments 2.3. Export support 2.3.1. Strengthening the capital of ČEB, the Czech Export Bank 2.3.2. Strengthening capital and insurance funds for EGAP, the Export Guarantee and Insurance Corporation 2.3.3. Creation of stimulus tools for financial institutions' commercial participation in the support and maintenance of competitiveness and export performance for domestic business entities 2.4. Strengthening of distribution channels for the distribution of resources to the economy 2.4.1. Strenghtening of capital for ČMZRB, the Czech-Moravian Guarantee and Development Bank 2.4.2. New and strengthened programmes for support to small and medium enterprises 2.5. Restructuring and strengthening of EU programmes for support to small and medium enterprises 3. Making the economic environment stable and more flexible 3.1. Maintaining fiscal discipline 3.2. Maintaining spending and investment priorities 3.3. Maintaining low interest rates 3.4. Acceleration of administrative reforms (justice, codes, registries) 3.5. Bolder cuts in administrative burden 3.6. Unifying collection points for the collection of taxes and levies 3.7. Accelerating additional reforms to the labour market, especially in the labour code for reasons of workforce mobility 3.8. Reviewing the green card system and making it more flexible 3.9. More assertive supervision of price creation in network sectors, which has essentially already started to be realised, as well as for information from the sectors, where we do not have direct tools for influence; we have reached for indirect tools of course in that electricity prices will be frozen in 2010, and gas prices – according to information I have received for next year – will not be increased 3.10. Carrying out an inventory of requirements for the business environment in cooperation with the Czech Chamber of Commerce and the Confederation of Industry of the Czech Republic 4. Stimuli for economic growth The last package I want to discuss relates to economic growth stimuli. And it must be said that these go from all the way from supply side to the demand side, and we have already carried out the first steps. A nearly doubling of investments into infrastructure in amounts greatly exceeding CZK 80 billion per year is exactly the stimulus the government could provide and provided as a result of an expected cooling of the economy. 4.1. Speeding up the drawdown of EU funds, which could at a given time replace dropouts in direct foreign investment 4.2. The possible review of spending ceilings and planned deficits. As far as the budget goes, which I really recommend approving in the form it has been proposed and in January –or possibly February – markedly discussing the way this budget should be changed as a result of numbers and impacts that will be better known. 4.3. The review and possible rearrangement of spending priorities 4.4. Cuts in income tax rates for corporate entities to as low as 15 % 4.5. Cuts in social insurance paid by employees by 1.5 %, which is in a proposed law we will discuss 4.6. Increased workforce mobility 4.7. Additional cuts in indirect labour costs. In the event of a worsening situation it is possible to accede to a one-time cut in the basic assessment for pensions by an amount resulting from an analysis of pensioners' spending on health 4.8. A possible increase in the volume of wages in the public sector so as to compensate for inflation with the overall impact on public finance of roughly CZK 2.5 billion, which could be a subject for the second reading of the budget and is based on growth analyses that are a week old, possibly a decline in real wages. These are the basic goals and structures of the Strategy of Preparedness and Growth Acceleration, which I have the honour of presenting to you today. I would like to use this opportunity to emphasise that I have tried to introduce a sort of basic fan of methods, measures and steps, whose application is not trivially and methodically described, because it will greatly depend on the quality, interpretation and evaluation of analytic base materials, which will gradually pile up. Methodically – and greatly simplified – I would like to point out that in every scenario, tools will be activated for fiscal, currency and structural policy which aim for a renewal of confidence in the financial sector and which aim for stabilization and flexibility in the economic environment, as well as to support exports. These tools are prepared and we will gradually implement them. Until – and again, this is very greatly simplified – in the pessimistic scenario, tools and measures may be also be brough in representing stimulus to the supply side of the economy, and if the crisis scenario should occur, only then will tools and measures representing stimulus to the demand side of the economy be brought in. Let's not live in the illusion that a simple direct solutions or tools exist, because the economy - and especially the globalised Czech economy – is a very complicated mechanism, where the law of action and reaction called the reaction of the market works very effectively. There is still a complication in that the economy is an interaction of several markets at the same time. If someone has direct ambitions to radically and simply resolve the situation (most with the help of dramatic regulation or subsidies) on one of the markets of the economy, it will sooner or later develop a deformation and turbulence on the market with multiple times the cost later to calm it down. With forethought, therefore, it will always be necessary to seek sensitive solutions, steps and tools that are a mix for the aforementioned fan of approaches and tools, and which will reflect the degree of threat to our economy, but always in the context of not deforming natural market ties and mechanisms. Such solutions are very short-term, but are very expensive and mainly, unmaintainable in the long term. But what is certain,–and what is always pays off - both as it appears from the standpoint of the threat we must face in the global financial and economic crisis – is to continue and intensify our reform efforts. In my opinion, this is and must be the constant in our approach to the global crisis; other guides to principle solutions are either short-term, lobbyist or panic-spreading. And in recognition of this, may we all be granted the guidance and inspiration to avoid both the current global crisis and those in the future. Thank you for your attention.