Czech Republic’s false start
Strange things are happening in the Czech Republic, once the darling of western investors. If it is not demands for blood-letting among the political elite, it is a sluggish economy slowing down one of eastern Europe’s most important economies.
In November 1999, Prague saw 50,000 protesters supporting demands by former leaders of the “velvet revolution” for the top politicians to resign, who feared that the republic was sliding back to the East.
When accepted as a fast-track EU applicant the Czech economy appeared sturdier than rivals Hungary and Poland. But that was before a deep recession, which has taken longer than anticipated to turn around. Despite signs of recovery, many analysts remain neutral on the country, although the government is trying to talk things up. “The macro figures are improving in line with the government’s expectations,” says Martin Horak, at CSOB in Prague. “GDP showed a slight improvement in the third quarter last year and we are now expecting this to continue into 2000.”
Jindrich Weiss, at ZB Asset Management, agrees, but says from an investors’ point of view there are two tendencies at the moment. Some companies are growing – those that have been receiving foreign investment for some time but these “are far outweighed by those which are in bad shape; heavy machinery, mining, steel and energy. Here ownership remains in government hands with a sprinkling of private investors. Closures and restructuring seem the only way forward”. Struggling sectors have had a major influence on the whole economy, making a negative impact in 1999, but he says these are shrinking so their influence is diminishing.
Peter Szopo, managing director at East Fund Management in Vienna, also highlights these restructuring problems, and is pessimistic. “I am one who believes that the recovery will be slow. Much will depend on whether the government can stick to its own timetable on reforms and privatisation.”
If the proposed pension reforms are any guide, the outlook is grim. “The privatisation of the banks has been delayed again, and telecom sell-off is still lagging behind the original dates announced last year. There have been further announcements in December, but we shall have to wait and see,” he says. He sees little signs for optimism or change from a supply side point of view, and asserts that there are only “five or six stocks worth looking at on the exchange”.
Weiss agrees, saying: “In equities, the possibilities are very narrow. Portfolio managers are looking to blue chips – such as telecoms, where they see positive trends but not huge potential.” Although he believes the privatisation programme could be good for the market, it will remain difficult to pick up opportunities. “If the government really is committed to solving the problems in the sector, financial stocks could be rewarding,” he says.
Meanwhile, the fixed-income market is mirroring the economy. The turnaround meant that decreasing rates stopped six months ago and the positive view has seen a rising yield curve. “The 10 to 15-year maturity bonds represent a very liquid market, and the real value is based on a convergence play which may yet develop,” says Weiss, adding that he sees “no great risk there”. With most funds carrying more than 60% of their asset value in domestic fixed-income stock, investors trust he is right.
The biggest problem investors face in the Czech Republic is the attitude towards the financial markets in general, in marked contrast to that in Hungary and Poland and which many feel is holding the country back.
“At the beginning of privatisation the government decided to copy a German-style, bank-dominated system, rather than make use of the capital markets. Experience in emerging markets tells us that countries which do not utilise the capital markets have problems later," says Szopo. “A good example of how to do it properly is Hungary. There, management were exposed to western-style techniques and capital market culture at an early stage. This has stood many companies in good stead since, as well as pointing the privatisation process in the right direction.”
He says the governments of Vaclav Klaus and current prime minister Milos Zeman have not always been quite as liberal as they have claimed. “For some reason the whole political elite is cautious so far as capital markets are concerned,” he says.
Similarly there remain problems with transparency. Looking at fund performance and fees, Horak highlights a problem.
“There is really no effort at performance analysis, because there are simply no indices or formulas in place to facilitate it.” Regarding fees, his own company’s charges were “not in the public domain”. In Prague, however there is nothing unusual about that.
“Institutional investors negotiate private contracts, the content of which is generally a well guarded secret,” says Weiss. “Competition will squeeze fees as elsewhere, but generally it all comes down to direct negotiation with the client.” Such negotiation often takes the form of sealed bids.
Consultants are rare on the streets of Prague – they are awaiting progress in pension reforms, which should increase the number of asset managers, and reforms from the Securities Commission. The latter issues licences for asset management companies, but is also dogged by controversy.
One manager, who declined to be named, says there are several illegal entities avoiding the high costs associated with the registered companies.
In the financial services industry it seems it will need something tougher than a “velvet revolution” for the Czech Republic to make up the ground lost over the past five years.