The feasibility of investing in the Czech Republic for a UK-based company

EXECUTIVE SUMMARY
Big Jay Jets is a fast-growing company located in a small hub at City Airport, London. Our business provides jets to transport corporate or business customers who are flying to different cities across Europe. We also provide extended services to make it more convenient for customers to settle in when they arrive at their various destinations.

Our goal is to provide excellent service to existing clients and to reach out to prospective clients. We aim to target high-demand markets, which in this case is the Czech Republic, due to a growing demand for our services in that region.

This report aims to give the Operations Director of Big Jay Jets a comprehensive and in-depth insight into the Czech Republic and what it offers, as the long-term success of the business will be dependent on decisions made now.

The report shows that the Czech Republic has an economy that has the potential to grow and currently is attracting a large volume of foreign direct investments. The country’s labour force has many technically skilled people and the country has clearly recovered from the communist era; the traces of corruption that are still present fall within the OECD average. However, now that the country is part of the European Union, many of its policies are in line with EU requirements, hence its openness to innovation and the embrace of direct foreign investments. Added to all this, the country also enjoys political stability which is of great importance and could present long-term benefits for our investment.

1.0 INTRODUCTION
The airline industry in the United Kingdom has experienced very difficult times in recent years leading up to 2010. This can largely be attributed to the global recession which had a huge effect on demand. The impact of increased oil prices in the early part of 2008 was also significant. It lead to an increase in airline operating costs causing some airline operators to cease trading and thus having a ‘domino effect’ on passenger numbers.

However, the airlines are expected to collectively return to profit in 2010, a year earlier than expected, as the global economy recovers from the depths of the financial crisis. The IATA (International Air Transport Association) has forecast that passenger traffic will grow by 7% as companies replenish their inventories. (www.marketwatch.com)

According to IATA, the UK still is arguably the most important air transport hub in Europe, having over 160 participating airlines coming in and out of the airports. It is home to one of the world’s busiest international airports, Heathrow, which is a significant driver of regional and national economic growth and productivity, thereby providing a good platform for international relations (www.iata.co.uk).

As a part of its plans for joining the EU, the Czech Republic instituted the legislation of the European Union. This is partly responsible for its positive investment climate as all international transfers such as profits and remuneration can be conducted without hindrance. Since accession to the EU, the air traffic infrastructure has seen a significant expansion, now boasting 91 civil airports of which about 24 can pride themselves on having international airport status. The biggest international airport is Prague-Ruzyne Airport which is designated mainly for international flights, but also used for domestic traffic. (www.czech.cz)

This report will look at the implication of the reforms in the Czech Republic for our business as a whole, with regard to the economic factors in the country, such as interest rates, national income growth, exchange rates, inflation and any major factors that can have an impact on our firm’s activities . In view of the fact that our business is highly influenced by the European business cycle, I will also be analysing the growth patterns and future prospects of these economies. Would it be expedient to start doing business with neighbouring countries? Is our business economically viable?

The report will also look at legal and ethical frameworks and the implications for our business with respect to the economy of the UK as a whole. I will explain in detail the processes involved in starting a business, the procedures required in handling disputes and how to deal with legal issues. We will also look at the Human Resource implications for our business and the policies and practices that would be important to consider. Other issues, such as the environment and the the growing desire to protect it from the impact of global warming, will be considered. Questions that need to be asked and answered include: Will it impose huge taxes on air travel? Does the country have the adequate technological support to meet prospective future expansions? We will also be looking into social factors, such as social trends and their impact on demand for our services and the country’s population distribution.

2.0 CZECH REPUBLIC
The purpose of this section is to give a general overview of the Czech Republic. As we intend to locate our business here, it is important to identify certain relevant aspects of the country in general, such as its investment climate, geographical location, infrastructures, political system, the people and their culture, the economy and every other aspect that is of importance in setting up a business.

The Czech Republic is one of the most stable of the post-communist states in central and eastern Europe. Its encouragement of an open investment climate has been an integral part of its transition from a communist centrally-planned economy to a functioning market economy. The country is located in the centre of Europe and has a relatively low cost structure which makes it a very attractive destination for foreign investments. (CIA Factbook 2010, Economy Overview of Czech Republic, www.cia.gov)

The country is now a leading recipient of foreign direct investment (FDI). As a percentage of its GDP, the Czech Republic has attracted, on average, more than 10% since 1999 and has continuously sustained high foreign investment. In order to attract more foreign investors, the Ministry of Industry and Trade in the Czech Republic is backing the foreign investment agency, ‘Czech Invest’ to promote the country as an investment destination and to demonstrate to prospective investors that the Czech Republic provides a more investment friendly climate than any other country in Europe. (Terterov & Reuvid, 2005)

2.1 INVESTMENT CLIMATE
The Czech Republic remains one of the most attractive economies in Europe with well over 130, 000 Czech firms across all the sectors having been supported by capital from FDI. The country practices a political system that is parliamentary in nature, hence political and economic stability has never been an issue. Its independent national bank has also maintained monetary stability since 1991. The country’s existing legislation guarantees equality for foreigners and citizens for all civil rights including the cover of property rights to the provision of incentives for investments. The government does not involve itself much in foreign investment projects except those to do with the banking and defence sectors. More interestingly, the Czech Republic has signed bilateral agreements with the UK and a host of other countries that are expected to attract and protect foreign investors. Other areas that have been addressed and which would have an impact on investment prospects include preventing double taxation with all EU member states (which applies to dividends & interest), the freedom to purchase real estate without restrictions, the freedom to effect international transfers such as profits, and facilitating the payment of remuneration connected with investments freely and without delay. (czechinvest.org)

This openness to foreign investment is in line to the policy of the UK which has a more advanced structure in place. It also has had long-term political, economic and regulatory stability coupled with relatively low rates of taxation and inflation. The major difference between the UK and the Czech Republic is the strength of its infrastructures; however that of the Czech Republic is rapidly strengthening.

2.2 CENTRAL LOCATION IN EUROPE
The Czech Republic has a unique location in Europe. It is located in the central part of Europe and it has borders with Poland (761.8 km), Germany (810.3 km), Austria (466.3 km) and Slovakia (251.8 km. This privileged geopolitical position in the heart of Europe is a major advantage for the business; Prague is only about a two-hour flight to most European capitals. This factor alone provides a boost to any investment decisions to locate our hub in Prague (www.czso.cz).

2.3 TRANSPORT INFRASTRUCTURE
The Czech Republic has an extensive system of transport routes which serve not only the Czech Republic but also make it easy to connect to other European destination. Its significance as a transport hub has grown since becoming a member of the EU and the density of its transport hubs ranks among the world’s most advanced countries.

Apart from the transport infrastructure, the Czech Republic also provides basic technological and scientific infrastructures which have had an impressive ranking, considering its population density. According to the IMD WORLD COMPETITIVENESS YEARBOOK 2010, the Czech Republic’s infrastructure rankings have been fairly consistent since 2006 and it is currently ranked 26th in the world (2010). It should be noted that in 2006, the United Kingdom was ranked 21st but is currently ranked 15th (www.worldcompetitiveness.com).

2.4 SYSTEM OF INVESTMENT INCENTIVES
The Czech Republic offers new and existing investors up to 60% of the cost associated with investment projects, mainly in manufacturing, technology centres and business support services. This aid includes:

Tax incentives: Availability of full corporate tax relief for up to five years for new companies; partial tax relief for up to five years for existing companies.

Training and re-training grants: Financial support for training and re-training of new employees (up to 45% of eligible training cost).

Job creation grants: The size of grants depends on the unemployment rate in the region where the investment is made and is usually up to €2000 per new job created.

These incentives are available in all regions except Prague as the country wants to encourage development in other regions (www.czechinvest.org).

2.5 EUROPEAN UNION MEMBERSHIP
The Treaty of Accession was signed on 16 April 2003. This meant that the country would have to integrate EU regulations into its existing framework in areas which would allow free movement of goods, persons and services. The requirements also included competition policy, transport policy, foreign and security policies and many more, all of which can be found in the Official Journal of the European Union, Legislation. Annex II: List referred to in Article 20 of the Act of Accession (eur-lex.europa.eu).

Accession to the European Union means that, as the United Kingdom is also a member of the EU and is bounded by the same trading regulations, there is ease of trading.

2.6 PEOPLE, CULTURE AND ATTITUDE
The Czech Republic has an estimated population of 10,201,707 (July 2010 est.), its population growth rate is -0.106 %( 2010 est.) while its of birth to death rate per 1000 people is 8.76 to 10.79. Its ethnic makeup consists of Czech (majority), Moravian, Slovakian and other nationalities (minority). Its major language is Czech and about 99% of the population have high literacy levels (www.cia.gov).

In surveys conducted on attitude, affluence and wealth are not described as the highest values the Czech population should strive for. The mentality, culture and attitudes are similar to those found in Western countries.

2.7 STABLE SOCIAL POLITICAL SYSTEM
Institutionally, the Czech Republic has strong similarities to western European democracies, with parliamentary systems based on the separation of power. The modern Czech Republic has moved from the communist model of extreme centralization and has established an enhanced role for local and regional government structures. Although the EU has had a major part to play in promoting decentralization, regional structures and functions were developed in anticipation of the extensive benefits that would be incurred from EU funding. (Batt et al., 2007)

The current president of Czech Republic is Vaclav Klaus who was sworn into office in March 2008. Presidents are elected by the parliament for five-year terms.

2.8 LABOUR COST AND PRICE STABILITY
In the Czech Republic, one potential reason for increased labour costs is in the increased length of service or the age of employees. This also occurs in the UK and it is to encourage experienced employees to commit to their firms. The Czech Republic’s age-earning profile for both men and women is relatively flat compared to United Kingdom. A similar pattern as the age-earning profile to emerge, although with some variation, is that for levels of education. Workers with a tertiary education tend to experience increases in their earnings early in their careers. (OECD, 2004)

In comparison with other CEE countries, the Czech Republic has a higher level of labour costs; very well educated, skilled and multilingual. Annual wages over the last five years have soared by around 6-7%, but are still lower in comparison with western Europe (www.czechinvest.org).

In terms of price stability, the Czech Republic has been compliant with the Maastricht criteria for Price Stability. Domestic inflation as well as interest rates have been low, according to Ministry of Finance of the Czech Republic (www.mfcr.cz).

2.9 SKILLED WORKFORCE
The Czech Republic has a labour force that is considered to be well-educated. About 90% of the workforce has qualifications beyond the basic education and 11% of those employed have university or higher education levels. (World Bank, 1999)

The Czech Republic also devotes special attention to enhancing language skills; about 95% of secondary-level students are currently studying English and German. These high standards have a great impact on the quality of workforce and make the Czech Republic the skills hub of Central Europe (www.czechinvest.org).

3.1 THE ECONOMY AND BUSINESS ENVIROMENT
The integration of the economy has had its advantages. The investment climate in the country has improved and the risk premium has been reduced; joining the European Union makes the economy potentially less risky for all investors. According to the World Bank Report on Past European Integration, EU membership assures a level of competition and coherent state aids, promotes efficient allocation of resources, secures market contestability, economic freedom and trade and capital account liberalisation (World Bank, 1999).

However, the advantages for our business, as earlier stated, are the trading benefits associated with being a member of the EU, of which the United Kingdom is a powerful member. The EU recognises that trade can boost economic growth and, as such, has negotiated the reduction or removal of tariffs and quotas on imports from developing countries. Competition between imports and local products lower prices and raises quality; it generally encourages open trade between the developed and developing countries in the region.

3.2 FORECAST OF GROWTH PATTERN FOR CEE10 COUNTRIES
The GDP gives a measure of the country’s economic outlook. According to reports from WoError! Hyperlink reference not valid.) (www.imf.org), the Czech Republic has a higher GDP, based on Purchasing Power Parity (PPP), per capita than Hungary, Latvia or Poland. Only Slovenia has a higher GDP. The Czech Republic’s GDP is expected to grow significantly over the next five years and could be a good potential destination for our investment. In terms of its inflation rate, the Czech Republic stands at merely 1.5%. This is low when compared to most developed countries; an exception is Latvia which has an inflation rate of -3.734%. Other countries in the region appear to be quite stable. Since the growth of an economy also has an impact on employment rate, it is fair to say that it is because of this that the Czech Republic has a higher employment rate, as the figures state in appendix 1.

However, according to a report by Cienski, (2010) in the Financial Times, countries such as Poland seem to be moving forward amidst regulatory obstacles; although not yet as politically stable as the Czech Republic, it has continued to grow.

3.3 BUSINESS RISK ASSESMENT
This is important in order to identify the advantages, disadvantages, risks and opportunities involved with doing business in the Czech Republic. The risk assessment was performed using ‘Coface Analysis’.

STRENGTHS

• Primary destination for foreign direct investment; highest level of FDI per capita in central Europe.
• The country’s progressive integration into Western organisations works in favour of stability in its political system and this is important for our business.
• Modernisation and restructuring efforts undertaken as well as an increase in investments, helping to improve competitive exports for all investors.
• Work productivity has been increasing sharply.

WEAKNESSES

• Relies hugely on Western Europe’s economic cycle.
• Ageing population and skills shortage (mainly with professional graduates).
• The country’s political environment is a bit sceptical of new reforms.

ASSESMENT OF RISKS (COUNTRY)

• The country is expected to find its path to growth this year, as it was affected by the economic recession in the European Union. Though the recession ended with a 4.2% contraction in GDP for 2009, a report by Global Edge (2010) notes that investments in the country should improve as foreign demand for Czech exports increases, though this might be dependent on how fast Germany recovers from the recession.
• Structurally Sound Economy
  Though the country was affected by the recession, due to the high foreign demand for its exports, the economy withstood the impacts of the recession better than most members of the EU. The country’s solidity was attributed to factors such as a strong banking sector, control of its credit growth, small current account deficit and private foreign debt, and low degree of euro-isation of the economy. These factors therefore make the country one of the best risks of the region. (Terterov & Reuvid, 2005) (www.coface.com)

3.4 IMPLICATION FOR OUR BUSINESS

• Integration of the Czech Republic economy with the EU gives our business the economic freedom that it already enjoys in the United Kingdom. It means that there can be tariff-free trade and an increase in the power of consumers creating export opportunities.
• Geographically close to the UK, offering easy access to other EU markets, particularly the accession countries.
• We also stand to benefit from political and macro-economic stability.

4.0 LEGAL ENVIROMENT
According to the laws of the Czech Republic, both foreign and domestic investors are allowed to engage in business activities under the same conditions; this is in compliance with the Commercial Code of 1991 which states that a foreign person may institute and participate in a Czech legal entity and has the same rights and duties as a Czech national. This code complies with most EU commercial norms.

4.1 CRIME AND CORRUPTION
The Czech Republic is a relatively safe country. On 17 December 1997 it became a signatory to the Organisation for Economic Co-operation and Development (OECD) Anti-Bribery Convention and on 29 April 1999, the parliament passed the necessary amendments to the Czech criminal code. In order to implement the Convention, Czech law makes the giving and receiving of bribes a criminal act with a jail sentence of up to eight years, regardless of title or nationality. (Francois-serge & Zoubir, 2003)

4.2 JUDICIAL SYSTEM, DISPUTE SETTLEMENT AND BANKRUPTCY PROCEDURES
The judicial system of the Czech Republic is made up of Constitutional, Supreme, Supreme Administrative, high regional and district courts. Its commercial and civil codes mostly draw on the German system and regulations pertaining to legal matters are analogous to US corporate law. However, its commercial laws have certain grey areas due to inexperience in dealing with commercial cases and disputes such as bankruptcy issues tend to drag on for years. The Czech Republic is an affiliate of the New York Convention on the recognition and enforcement of arbitration awards in any dispute between Czech and foreign parties; however the country does not permit settlements of disputes between two Czech companies outside the country, even if the owner is foreign. (Francois-serge & Zoubir, 2003)

4.3 TAXATION, ACCOUNTING AND AUDITING
The Czech Republic’s tax codes are in line with the EU tax policies. The government has continuously cut back corporate tax from being as high as 45% in 1992 to as low as 20% in 2009. Tax rates for investment, mutual and pension funds are 5% and personal income tax has been changed to 15%, joining countries like Estonia and Latvia with a flat rate. Employer and employee social insurance contributions are 25% and 6.5% respectively. (www.mfcr.cz)

4.4 LAWS ON ESTABLISHING AND CONTROLLING BUSINESSES
Foreign and domestic private companies are legally allowed to set up and own businesses but ownership of real estate by foreign individuals or companies is not permitted. However, foreign investors can establish sole proprietorship, joint ventures or branch offices. The country’s government also recognises joint-stock companies, limited liability companies as well as general or limited commercial partnerships. The country also has a language requirement as part of the process to obtain trade licences for business but permits the use of a Czech associate to assist with meeting this requirement (François-Serge & Zoubir, 2003).

According to World Bank Report (2010), the average 15 days that it takes to start up a business in the Czech Republic is slightly longer than the 13-day OECD average.

4.5 CLOSING A BUSINESS
The time (6.5 years) and cost (15%) involved in cases of bankruptcy in the Czech Republic appear to be a lot higher than the OECD average which is 1.7 years and 8.4%. According to the World Bank Report (2010), this presents a weakness in the country’s bankruptcy laws and processes (www.doingbusiness.org).

5.0 CORRUPTION
Corruption in any country will present an administrative and financial burden on firms, thus reducing efficiency in their operations. According to the World Bank Report, Czech Republic country profile (2009) certain corruption indicators were used to determine the level of corruption. The first measured the percentage of firms (Graft Index) that expected to pay bribes when soliciting services, permits or licences. The second indicator showed the degree to which bribe payments were required by regulatory officers during meetings with tax inspectors. The Czech Republic appears to be slightly above the OECD average, but in terms of bribe tax measures, it is very low compared to the OECD average. This outcome should be a welcome boost for any sort of potential investment in the Czech Republic. (www.worldbank.org)

The country is also currently ranked 52nd according to Transparency International’s corruption index, with the confidence range between 4.3 – 5.6 which seems to be in line with other potential investment countries like Poland & Hungary. (www.transparency.org)

6.0 CONCLUSION
The Czech Republic is capable of attracting FDIs; its economy appears to be viable considering its level of technical skills, technology, infrastructure, low rate of corruption, stable political system and incentives for potential investors. The same applies to other accession countries particularly Slovenia which has an impressive economy in relation to the other accession countries. With a labour force that has the potential to be better skilled in these regions it might present a haven for future investments.

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Appendix