UPDATE 2-S&P hikes Czech rating on public finance reforms

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By Jan Lopatka

Rating agency Standard and Poor's raised the Czech foreign currency rating by one notch to 'A' on Tuesday, saying the country's credit rose on the basis of fiscal reforms aimed at bringing down the budget deficit.

The hike puts the Czech Republic on a par with neighbouring Slovakia and above Poland with 'A-' and Hungary with 'BBB+'.

The crown currency inched up to 27.455 to the euro immediately after the announcement, but by 1300 GMT it was back at 27.490, down 0.07 percent on the session.

"The upgrade reflects the implementation of public finance reform, which will help bring down the Czech Republic's comparatively high government deficits," said Standard & Poor's credit analyst Kai Stukenbrock.

"The ratings are furthermore supported by good economic growth prospects, a well diversified and wealthy economy, and an above-par external position."

The Czech economy grew by 6 percent in the second quarter and analysts expect expansion of about 5 percent next year.

The cabinet pushed through parliament a package of tax changes and spending cuts last month, aimed at cutting the overall fiscal gap to 2.95 percent of gross domestic product next year, and to 2.3 percent in 2010.

This year, the government expects a deficit of 3.9 percent, far above the EU's 3 percent limit, due to a raft of spending hikes approved by parliament ahead of the 2006 election.

Budget deficits have forced the Czechs to abandon their 2010 euro entry target and the centre-right government, more cautious than its leftist predecessor, has declined to set a new one.

Prime Minister Mirek Topolanek sees 2012 as the earliest possible date, citing the need not only to meet the nominal criteria for membership but also to make wider reforms needed to make the euro beneficial for the central European country.

Analysts have said that while the newly approved adjustments would reduce the budget gap next year, they would not help in the long-run in the absence of additional measures.

"This (upgrade) is rather an acknowledgement of the fact that something has finally started to be done," said David Marek, chief economist at Patria Finance. "Also this is an expression of optimism that reforms will continue, mainly in the area of bringing down budget the deficit."

The Czech government tapped international markets with two Eurobond issues in 2004 and 2005. It has not excluded an issue this year and 2008 budget documents showed the country was considering returning to the foreign markets next year again.

Analysts said the upgrade may help shave a few basis points of the cost of Czech foreign debt, but noted that the market is still looking for progress in crucial sectors such as pension reforms.

"Today's upgrade is definitely good news for the Czech forex and fixed income markets," said Danske Bank analyst Stanislava Pravdova.

"Though we must say that although the fiscal reforms are positive, some important reforms such as in the pensions area are still needed, and the Czech government still has a long way to go."

One Prague trader said there was no immediate reaction in the local debt market. The outstanding Eurobonds also traded little changed, with yields hovering near two-week lows.

The Czech Republic has an 'A' rating from Fitch and 'A1' rating from Moody's. S&P said the outlook for the upgraded rating was stable.

(Additional reporting by Sujata Rao in London)

[PRAGUE/Reuters/Finance.cz]