Determining Factors of the Czech Foreign Trade Balance: Structural Issues in Trade Creation

Using panel data for 29 industries, we test alternative specifications of Czech export and import functions. The balance of trade is primarily influenced by the real exchange rate, aggregate demand and tariff changes. Reduced growth of the Czech economy after 1996 was an important factor that has kept the balance of trade at a sustainable level in the medium-term, contributing even to the appreciation of the real exchange rate. The secondary fundamental factors, relevant for structural adjustments, a sustainable trade balance and an equilibrium exchange rate, rest, however, on supply-side characteristics such as changes in endowments of physical and human capital, inflows of FDI and growing competitiveness of domestic production. We can argue that appreciation of the real exchange rate is a handicap to Czech exports, especially to exports to non-EU countries. Nevertheless, in the EU case, the appreciation of koruna was countervailed by tariff concessions, improved quality, switchover to commodities with higher contents of value added, gains associated with FDI and growing foreign demand absorption. At the same time, appreciation of the real exchange rate has significantly opened the Czech market to imports but the unconstrained import penetration remained blocked by the growing competitiveness of Czech products in costs, prices and quality.