Morningstar DBRS Assigns AA Credit Rating to Czech Republic, Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) assigned the Czech Republic's Long-Term Foreign and Local Currency -- Issuer Ratings to AA. At the same time, Morningstar DBRS assigned the Czech Republic's Short-Term Foreign and Local Currency -- Issuer Ratings to R-1 (high). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS

The AA credit ratings on the Czech Republic (Czechia) are underpinned by its generally effective institutions, prudent policy framework, a moderate government debt level and membership of the European Union (EU). Czechia also holds strong external buffers--large official reserves and a flexible local currency--that support the country's capacity to mitigate adverse external shocks. In Morningstar DBRS' view, Czechia benefits from the EU's common policy response to address economic challenges, including those stemming from geopolitical risks. Still, Czechia's small, open economy and predominantly medium value-added content exports make it susceptible to adverse external developments and constrain the ratings.

The Stable trend reflects Morningstar DBRS' view that Czechia's growth outlook remains robust over the medium-term despite external headwinds to its export-oriented economy. Domestic consumption driven by recovering incomes is set to accelerate economic momentum over the next year, and the inflow of EU funds will likely support investments over the next few years. By contrast, trade will likely continue to be subdued in the short-term as Czechia's manufacturing exporters are facing U.S.-tariffs, other international competitiveness pressures and weak international demand. Morningstar DBRS takes the view that Czechia can broadly maintain its sound fiscal position, although fiscal pressures from defence spending are now higher. While domestic political fragmentation has increased in Czechia over the past decade, Morningstar DBRS foresees policymaking continuing to address social and economic challenges effectively, and the authorities will likely remain committed to common EU policies following the upcoming parliamentary election in autumn later this year.

CREDIT RATING DRIVERS

Morningstar DBRS could upgrade the credit ratings on Czechia if: 1) structural reforms are successfully implemented that bolster the economy's growth potential and institutional quality and/or 2) fiscal performance and the debt trajectory significantly outperform our current expectations.

Morningstar DBRS could downgrade the credit ratings on Czechia if one or a combination of the following occur: 1) the economic growth outlook weakens materially, for instance resulting from an external trade shock or structural challenges in key industries and 2) fiscal performance deteriorates materially, leading to a subsequent significant increase of the country's public debt burden and 3) political uncertainty evolves into a significant weakening of institutions and of trust in effective policymaking.

CREDIT RATING RATIONALE

Strong Institutional Framework Anchored by Deep EU integration; No Major Post-Election Shift in Economic Policies Expected

Morningstar DBRS expects overall policy continuity for Czechia following the upcoming parliamentary elections. This continuity relates to the country's business-friendly economic policies, comparatively prudent fiscal policies, and good relations with the EU institutions. While political fragmentation and polarization have increased in Czechia over the past decade, it remains contained compared with peers in Central and Eastern Europe. Despite occasional episodes of heightened political volatility resulting from government coalition disparities, policymaking in recent years has been generally effective in addressing arising economic and fiscal challenges. The current government led by the center-right alliance SPOLU passed key longer-term structural policies such as a major pension reform, increasing domestic energy production capacities, and higher defense spending. The next regularly scheduled general elections are due in October later this year. The current largest opposition party ANO is leading over incumbent SPOLU by a wide margin in recent polls (Politico Poll of Polls), after already making major gains in regional and upper house elections last year. Morningstar DBRS takes the view that Czechia will continue to broadly adhere to rule-of-law standards, and common EU trade policies and security agreements. The election debate is focused on households' economic situation and on social policies following inflation-induced real income loses in recent years. Therefore, a politically popular partial reversion of recent pension and tax reforms could incur moderately higher fiscal costs post-election compared to current projections.

Czechia's membership of the EU anchors its good institutional quality which is reflected by the countries' generally high and stable rankings in World Bank's Worldwide Governance Indicators. The country's trade openness is facilitated by the EU's single market, freedom of movement and common trade policies with the rest of the world. A business-friendly regulatory environment contributes to a high investment/GDP ratio by international comparison. Czechia also benefits from common security agreements with EU and NATO partners, which mitigates potentially elevated external security risks in Eastern Europe.

Rising Real Incomes and Lower Interest Rates Are Set to Accelerate Domestic Demand; US-tariffs Add to Czechia's External Headwinds

Morningstar DBRS foresees a further strengthening of economic growth in Czechia over the next two years, owing to a further acceleration of private consumption and high investment spending. Consumer confidence and household incomes are still recovering from the purchasing power loss in 2022/2023 when inflation amounted to a cumulative 25%. Morningstar DBRS expects that stronger private consumption over the next two years will be supported by elevated wage growth reflecting still more compensation for past inflation, persistently high labor demand, and a lower propensity to save as interest rates have declined. Moreover, sizable inflows of EU-investment subsidies, grants and loans amounting to ca. 8% of GDP in 2025, that are available to spend over the next three years under the 2021-27 Cohesion Policy and NGEU programs, will provide a significant stimulus to investment spending. Public investments, on expanding energy production and defense capacities will remain elevated in the medium-term. Still, more pronounced growth of businesses investment could be held back by still subdued international demand that Czechia's export-oriented industry sector is reporting for some two years now. Additionally, more restrictive international trade policies, particularly a permanent imposition of US import tariffs, would lead to a further weakening of the external environment (see also "Unpredictable Protectionism: The Global Fallout of U.S. Trade Policy"). Against this backdrop, Morningstar DBRS anticipates that the continued weak external trade environment will limit contributions from net exports to Czech growth, at least over the next year. The IMF projects Czechia's real GDP to expand by about 1.6% in 2025,1.8% in 2026 and around 2% p.a. over the remaining forecast horizon until 2030.

Czechia's export-oriented economy is closely integrated into European manufacturing supply chains, in particular its large auto sector which accounted for almost 30% of total Czech goods exports in 2024. Permanently imposed US-import tariffs would be felt mainly indirectly through the anticipated adverse impact on U.S.-trade volumes via larger EU economies, like Germany, while Czechia's direct trade exposure to the U.S. is relatively small (about 3% of total Czech goods exports and imports in 2024). Contrary, Morningstar DBRS anticipates that Czechia could benefit from other major international policies shifts, in particular from the anticipated large fiscal stimulus to the European defense sector. Czechia is home to several export-oriented, small-and-medium sized defense sector companies that have already reported strong exports growth as public defense spending accelerated over the past two years and could further benefit from the anticipated shift to EU domestic production of military equipment.

Like its European peers, Czechia's manufacturing export sector is facing structural challenges posed by global competitiveness pressures, technological transitions and headwinds from more restrictive trade policies. Non-EU competitors have increased their production capacities and advanced technologically, particularly in the auto sector. The tariff-related uncertainty in the international trade environment poses an additional challenge for exporters. Additionally, large wage increases have outweighed productivity gains amid a tight labor market in recent years. The restricted supply of labor is also illustrated by the swift absorption of about 300,000 Ukrainian workers over the past three years. However, there are signs of labor market easing in early 2025 with unemployment rates edging up and fewer reported vacancies. Still, Czechia's generally ageing workforce will likely start to weigh on economic growth potential in the next few years. While energy prices remain persistently higher after Czechia had to cut its previously high dependance on cheap Russian energy imports, the country invests heavily in increasing domestic energy production capacities over the medium- to longer-term. Czechia has one the highest shares of private and public investments relative to output in an EU comparison, averaging at about 25% of GDP over the past decade. Its strong industrial base was a major contributor to the strong economic wealth convergence to aggregate EU levels over the past two decades¿in 2025 Czechia's per-capita GDP amounts to about 73% of the aggregate EU level.

Balanced External Payments Accounts and a Robust International Balance Sheets Mitigate External Vulnerabilities

Morningstar DBRS anticipates that Czechia's external position will remain robust over the medium term, despite stronger headwinds in the international trade environment. The IMF projects a current account deficit of 0.4% of GDP on average over 2025-2030. However, Czechia is in addition set to benefit from the significant inflows of EU-funds in the country's capital account. Czechia's structurally large export surpluses in goods and services (around 7% of GDP in 2024) are partially offset by outflows resulting from the foreign profit income generated on the large stock of FDI in the country. Inward FDI stands at about 65% of GDP, mainly consisting of foreign auto manufacturing plants and European banks operating in Czechia. Greenfield FDI inflows, other than reinvestments of earnings, have slowed over the past few years. Other private sector and the government's external debt is moderately low which limits the Czech economy's susceptibility to external volatility. On the assets side of the IIP, the Czech National Banks (CNB) possess a large stock of EUR- and USD-denominated reserve assets (CAD to a lesser extent) amounting to around 40% of GDP as of year-end 2024. Overall, Czechia's net IIP stood at -7% of GDP at the end of 2024.

The large official reserves and Czechia's flexible local currency, the Czech Koruna (CZK), serve as a strong buffer to potential adverse external shocks and provide a sufficient degree of flexibility for the Czech economy to adjust structurally to international developments. The CNB fixes daily CZK-exchange rates against other currencies based on developments in the interbank foreign exchange market, making the CZK floating in principle. The CNB also stands ready to occasionally intervene in episodes of heightened volatility, as happened 2022/23, and is selling generated income on its official reserve assets on a regular basis (amounting to about CZK 300mn per month). While Czechia has not joined the Euro area to date, the CZK was pegged to the EUR between 2013 and 2017 to support Czechia's business cycle synchronization to the Euro Area.

Consumer Price Inflation Back at Target but Medium-Term Upside risks Remain Significant; Financial Stability Risks Contained

Czech inflation remains contained in early 2025 (2.7% YOY in March, CPI national definition) after the broad inflationary pressures induced by the energy-price shock in 2022/23 abated over the past year. CPI inflation stood at 2.6% in 2024 on average, thus returning to levels consistent with the CNB's stated inflation target--spanning a 1% tolerance band around the target rate of 2%. Subsequently, the CNB gradually cut the key policy rate to 3.75% as of April 2025, down from 7% back in December 2023, the peak of the previous hike cycle. Morningstar DBRS takes the view that the permanent imposition of more restrictive U.S. trade policies could lead in the short-term to additional downward pressure on inflation. This could materialize because of the additional supply from excess exports capacities in Asia and elsewhere in Europe, and lower energy prices, which have fallen significantly in anticipation of weakening global growth. Domestically, sticky services price inflation driven by the elevated growth of wages remain a key upside risk to Czech inflation. Over the medium-term, upside risks from significantly higher, debt-financed defense spending across Europe (in particular Germany) and the materialization of efficiency losses due to lost trade pose key external upside risks for Czech inflation. Also, a weaking of the Czech Koruna (CZE) driven by external factors, like interest rate differentials, vis-à-vis larger economies, could potentially exert upward pressure on Czechia's import prices. The IMF projects inflation to slow further to 2.3% in 2025 and to 2% in 2026.

Financial stability vulnerabilities for Czechia remain contained as banks are well capitalized asset quality is in check and private debt is comparative low. The Czech banking sector has maintained strong capitalization levels, healthy profitability and good asset quality amid the current cycle of interest rate cuts and subdued domestic economic developments in recent years. The total non-performing loan ratio remains close to all-time lows at 1.7% as of February 2025. Overall private sector indebtedness at around 85% of GDP in 2024 Q3 is comparatively low compared with other EU member states. Banks have built up significant buffers (total capital ratio at 19.2% at the end of 2024) to potentially provide resilience in the face of any externally induced adverse volatility of credit conditions or a decline in domestic credit quality. While the CNB has kept the countercyclical capital buffer rate at 1.25% and the upper limit on the LTV ratio at 80%, reflecting stable domestic credit conditions, it has introduced a 0.5% systemic risk buffer in January 2025 to account for increased exposure of the Czech economy and financial sector to elevated geopolitical and global competitiveness pressures. In the course of the tightening of the CNB's monetary policies, bank's minimum reserve requirement was raised to 4% in October 2024 up from previously 2%.

Recent Fiscal Reforms and Sound Economic Growth Prospects Underpin Czechia's Solid Fiscal Position

Morningstar DBRS expects Czechia's fiscal deficits to remain moderate over the next years because of the anticipated economic rebound and a further unfolding of recently passed major tax and pension reforms. Additional defense spending pressure is moderate by European comparison. The government decided in March 2025 to gradually increase military spending to 3% of GDP annually until 2030 from about 2.1% of GDP in 2024 (see also "European Sovereign Debt Struggles Amplified by Defense Spending Needs"). Increases in corporate taxes and social security contributions, the phasing out of temporary energy-crisis measures and broad operating cost savings have steered Czechia back on a path of fiscal consolidation. Public investment will remain high given the availability of EU-financed investment subsidies over the next few years and large spending needs stemming from defense and public infrastructure projects. The IMF projects Czechia's fiscal deficit at around 2.6% of GDP this year and 2.1% of GDP in 2026. Morningstar DBRS anticipates that the relaxation of EU-fiscal rules for higher defense spending will lead also for Czechia to some extent to less fiscal consolidation compared to its path outlined in the latest medium-term fiscal plan, which accounts for a negative qualitative adjustment to the Fiscal Management and Policy building block. In this context, Morningstar DBRS takes the view that further downside fiscal risks could materialize if Czech economic performance falls short of current projections, for instance due to a sustained weaker external environment resulting from more restrictive trade policies globally.

Morningstar DBRS takes the view that a new government following the elections in autumn 2025 will generally remain committed to prudent fiscal policies and to complying with national and EU fiscal rules. Czechia has a track-record of addressing episodes of fiscal pressures also with politically unpopular fiscal consolidation measures, like recently with the major pension reform. In this regard, Morningstar DBRS sees additional fiscal pressures from public pensions system for Czechia due to its ageing population at large mitigated by the reforms in recent years. Those have largely eliminated the need for future contributions from the state budget to balance public pension system accounts by increasing the retirement age and contain the future growth of average pension payments by adjusting indexation to a retiree consumer basket instead of national wages. Also, other public age-related expenditure, like for health and long-term care, are set to grow only contained over the medium-term, according to European Commission estimates.

Debt Burden Remains Moderate, Supported by Sound Economic Growth Prospects

Morningstar DBRS anticipates that Czechia's debt burden will remain moderate. Sound economic growth will broadly balance additional new borrowings stemming from moderate fiscal deficits and interest costs remain contained at around 1.3% of GDP over the next few years. The IMF projects Czechia's gross public sector debt to GDP-ratio at about 44% of GDP in 2025 and to increase gradually to about 50% of GDP over the forecast horizon until 2030. Czechia's state debt is predominantly denominated in domestic currency CZK and held by domestic investors which limits currency risk. The Czech ministry of finance occasionally intervenes in secondary markets to manage refinancing risks and market liquidity, and for this purpose holds a portfolio of own government bonds (amounting to about 3.5% of GDP as of April 2025). At the end of 2024, foreign currency-denominated state debt amounted to about 6% of total debt consisting predominantly of EUR-denominated loans from European institutions (such as the EIB and the European Commission) and smaller amounts of EUR T-Bills and Bonds. About a quarter of state debt is held by foreign investors resulting from the large presence of European banks in Czechia. A limited 12% share of variable-rate debt and a 6.3-year average-maturity of state debt of at the end of 2024, mitigate interest rate and refinancing risks over the medium-term. Morningstar DBRS foresees no change regarding primary financing via domestic markets over the next years. But Czechia could in principle also issue a small amount in foreign markets like it did in the recent past. Over the next few years, it could also receive a material share in subsidized EUR-loans under the EU's SAFE EUR 150bn financing envelope for additional defense spending. Cash reserves and liquid financial assets under management of the state treasury amounted to about 5% of GDP at the end of 2024. Notional amounts of contingent liabilities stemming from state-owned company's debt and public guarantee frameworks remain low and Morningstar DBRS views related materialization risks as very limited.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors

The following Social factor had a significant effect on the credit analysis: Human Capital and Human Rights. Czechia's GDP per capita is relatively low compared to its EU peers, estimated at around USD 33,000 in 2025. Morningstar DBRS considers this factor significant and has taken it into account within the Economic Structure and Performance Building Block.

There were no Environmental or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/452594.

Notes:
All figures are in Czech koruna (CZK) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Czech National Bank (CNB): Monetary Policy Report (Winter 2025), Financial Stability Report (Autumn 2024), Balance of payments report (2023); Ministry of Finance of the Czech Republic: Macroeconomic Forecast (April 2025), Funding and Debt Management Strategy (2025), Debt Management Annual Report (2024), Fiscal-Structural Plan (2025-2028 period); Czech Statistical Office (CZSO); Czech Fiscal Council (CFC); International Monetary Fund (IMF): Staff Report for the Art. IV Consultation (2024), World Economic Outlook (April 2025); World Bank (WB); European Commission (Eurostat and DG ECFIN): Economic Forecast (Autumn 2024); European Central Bank (ECB); Bank for International Settlements (BIS); Politico, AlTi Global Social Progress Index, Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

These credit ratings concern a newly issued newly rated issuer. These are the first Morningstar DBRS credit ratings on this issuer.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/452595.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Marius Schulte, Assistant Vice President - Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director - Global Sovereign Ratings
Initial Rating Date: 25 April 2025
Last Rating Date: Not applicable.

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