The bouncing Czech: investing in the Czech Republic for Soviet-like returns

July 2019 | EXPERT BRIEFING | FINANCE & INVESTMENT

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Like most Central European countries, the Czech Republic is in a state of political turmoil. Once hailed in the West as a prosperous post-communist success story, it had a bright future, a growing economy and a promising pro-Western intellectual society, courtesy of the late Czech statesman Václav Havel. But today, the ship is being steered by prime minister Andrej Babiš, and the differences could not be starker. It is all but certain that the Czech Republic will follow the alarming Central European trend of descending into one or another flavour of authoritarianism, threatening the recent economic prosperity that has been driven by local and foreign investment.

The Czech Republic has a long history of corruption in which the private sector is connected to the political, hence the country’s relatively poor ranking in Transparency International’s ‘Corruption Perceptions Index’. In 2017, the Czech Republic slumped into the bottom quarter of EU countries on the Index, perhaps a warning sign of dark days to come.

The political scene in the Czech Republic mimics growing populist sentiment in Europe. The ruling centre-right ANO party is essentially bound by little more than an expression of popular dissatisfaction with the old, liberal elite. ANO formed a ruling coalition with the Social Democrats, a union that relies heavily on the backing of the most unlikely bedfellows from the Communist Party, support which prime minister Babiš has exploited to promote flagship legislation and to build his browbeater coalition. Mr Babiš is widely acknowledged to have served as an agent of the Communist secret police in the former Soviet satellite of Czechoslovakia. Interestingly enough, the Communist Party’s foreign policy is almost synonymous with that of the Kremlin and the Czech Freedom and Direct Democracy Party (SPD), all advocating Czech withdrawal from both the European Union (EU) and NATO in the form of a ‘Czexit’.

This fusion of political and private has created a dangerous mix. The Economist, in its 2018 Corruption Report, suggested that, “The greatest risk to pluralism is in young democracies where checks and balances are not yet robust” – this could not be truer in the Czech Republic.

Russian influence on the High Castle

Russian influence on the Prague Castle has subsequently been growing, both politically and economically. For instance, the Czech government is currently seeking a business partner to complete the construction of nuclear-power plants in Dukovany and Temelin. Czech president Milos Zeman has made the case for why the Russian Rosatom should win the tender, suggesting the ‘Hungarian model’, a reference to Budapest’s willingness to give Rosatom a multi-billion euro contract to construct a nuclear power plant without any public bidding or tender. To counter, US energy secretary Rick Perry, in 2018, offered Prague a partnership with US company Westinghouse, warning against the dangers of allowing Russian Rusatom to build the reactor. The whole process, however, has been highly controversial, with Westinghouse claiming it was denied the right to bid for the contract by the Czech government.

President Zeman maintains close ties with Moscow and appears at times to be little more than a puppet of the Kremlin. He was the subject of a report by the Czech parliamentary foreign affairs committee, which concluded that he was acting unconstitutionally and serving Russian political and economic interests through his conduct over the extradition of a Russian hacker, Yevgeny Nikulin. The president’s suspicious friendships with Russia and China have also surfaced in the recent Huawei scandal, in which the Chinese telecoms giant was accused of spying on its users for the Chinese government. It later emerged that Mr Zeman’s office had a contract with Huawei for promotional purposes.

Even though exports to Russia and China represent only 2 percent and 1.4 percent of Czech trade, respectively, the political climate in the region is shifting eastwards. The Czech Republic is in the Russian sphere of influence and the Kremlin has taken an active part in trying to keep close ties through a record number of pro-Russian news sites, a suspiciously high number of Russian diplomats, high-ranking Russia-backed political advisers, and a close relationship with Vladamir Putin. The message is clear: Prague prefers to cut corners than deal with pluralistic, democratic governments.

Who wears the Czech crown?

The Czech Republic has a long history of eyebrow-raising privatisation and Soviet-esque exploitation. Key figures during the Czech Republic’s most corrupt era complained that the government was too corrupt to gain power. Apparently the apple does not fall far from the tree.

Mr Zeman, who served as prime minister from 1998 to 2002 before becoming president, oversaw one of the least transparent governments in Czech history. He was recently re-elected as president by leveraging populist and Islamophobic sentiment. Much like US president Donald Trump, he often attacks the media and calls for his critics, such as prominent business figures like Zdenek Bakala, to be imprisoned. Mr Zeman, in addition to widely controversial alliances, had a contentious hand in the privatisation of Škoda Auto. The company is now owned by Volkswagen, but a recent police investigation has revealed the payment of a $1.4m bribe and criminal activity conducted by four individuals. Most recently, the president alarmingly suggested the appointment of a chief justice to the Czech court “in exchange for making certain judicial decisions”.

Similarly, Mr Babiš built his own political career by portraying old-school politicians as corrupt and incompetent, while most of his $3.9bn in net wealth was made during this same period, a period which Mr Babiš refers to as the “most corrupt time in history”. Mr Babiš has been involved in several public controversies, including conflicts of interest in the transfer of the Czech mining company OKD to the state, which is currently being investigated by the Czech parliament, an ongoing investigation by the EU’s Anti-Fraud Office into the illegal use of funds, which has sparked a scandal of ‘Watergate’ proportions in the Czech Republic, and which has come to be known nationally as ‘Stork’s Nest’, and most recently, the shocking allegation that he ‘kidnapped’ his own son in order to obstruct justice. As finance minister, Mr Babiš was accused of malfeasance; today, as the most powerful politician in the land, he is the subject of a criminal investigation into subsidy fraud.

The dangers of Czech investing

At the end of 2018, the Czech Ministry of Finance announced that it had achieved a budget surplus of around $130m, and the government patted itself on the back. The figure, however, was an economic illusion used to mask reduced investment into the public sector. The surplus has alternatively been accredited to dividends from European projects of the previous decade, as well as reduced spending on education and public infrastructure. Most recently, it was forecast that unemployment will surge in 2019.

Cutting public investment has shown the darker side of state management. The now state-owned OKD coal-mining company, which generated significant gains under private ownership, has reduced capital expenditure in recent years, perhaps foreshadowing the December explosion that killed 13 miners. Even though the company is again profitable following losses during the coal crisis, current spending is only about one-tenth of what it was when the company was privately owned between 2008 and 2017. Worst of all, behind the facade of Soviet-like rhetoric that is claiming successful management is a negligent government that stole a national company from private investors.

The scene that is beginning to develop in the Czech Republic is reminiscent of a late 1990s Soviet thriller about powerful oligarchs, corrupt politicians and unfortunate businessmen. The practice of bribing officials to gain control of a company, bankrupting it and then selling it to the state for pennies on the dollar, as has happened with OKD, has become dangerously routine. All in all, the ‘Heart of Europe’ shows ominous signs of having become a woeful investment climate, where politicians control the Czechs and balances.

Peter Svoboda is a political risk analyst at Eurasia Group.

Peter Svoboda

Eurasia Group