UPDATE 1-Czech plan sees higher 2007 budget gap

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The Czech fiscal gap will rise to 4.0 percent of gross domestic product this year from 3.5 percent in 2007, an update to the country's draft euro Convergence Programme showed.

The document, obtained exclusively by Reuters on Wednesday, confirmed the country would not meet its earlier plan of reducing the deficit to 3.3 percent this year.

The deficit growth will keep the Czech Republic among countries subject to the EU's excessive deficit procedures which could eventually lead to a halt of funding from the EU's Cohesion Fund, which is up to 1.4 billion euro per year.

"A deviation from the approved trajectory within the excessive deficit procedure puts the Czech Republic into a very unfavourable light," the Finance Ministry said in a report accompanying the draft convergence programme.

"(It will) undoubtedly result in a negative assessment by the European Commission, including a proposal to the ECOFIN to decide on the next step in this procedure, for example, a new request to speed up the removal of the excessive deficit," it said.

The new centre-right government has dropped 2010 as the target date for adopting the euro due to the worsening fiscal outlook.

EU members outside the euro area submit annual updates to their convergence plans, normally in November.

The Czechs delayed their update due to a political crisis following an inconclusive June election.

The new Convergence Programme is due to be discussed by the cabinet and submitted to the EU by March 15.

The document sees the public sector gap falling to 3.5 percent of GDP in 2008 and 3.2 percent in 2009, still above the 3 percent ceiling imposed by euro adoption rules.

But it does not include any fiscal reform steps planned by the new cabinet.

The three-party government, which won a parliamentary vote of confidence last month, has agreed in its manifesto that it will slash the deficit to 3.0 percent in 2008, 2.6 percent in 2009 and 2.3 percent in 2010.

The ministry included the government manifesto as an appendix to the convergence programme in an attempt to demonstrate that corrective measures are in the pipeline.

The government aims to cut the deficit by stemming the growth of social expenditure, and reforms to the health and pension systems. It also aims to cut taxes hoping that such a move will help encourage people to pay their taxes.

Many of the plans will face stiff opposition in parliament, where the government controls just 100 out of 200 seats.

The government has not set a new euro entry target but ministers have mulled 2012-2013 as possible new entry dates.

[PRAGUE/Reuters/Finance.cz]