Important economic reforms have been implemented since the currency crisis of 1997, gradually improving conditions for doing business. Attracted by privatisation, tax incentives and prospects of EU accession, large amounts of foreign direct investment (FDI) have flowed in, helping to modernise the productive capacity. Nevertheless, the Czech economy has remained burdened for longer than other transition countries with a large number of poorly performing enterprises, suffering from weak corporate governance, which had been kept alive by soft loans from state-dominated banks. The major challenge in this context is to overcome the dualism between the prospering FDI sector and the still considerable part of Czech industry in need of further restructuring. Broadening the FDI boom requires the reallocation of resources -- mainly labour -- to more productive uses. In order to prevent unavoidable layoffs from turning into permanent withdrawals from the labour market, and to preserve the inherited high participation and employment rates, new reforms should improve the demand for labour and strengthen the incentives to take up work. This requires a market framework that facilitates large-scale reallocation of labour among firms and sectors through low hiring and firing costs. On the macroeconomic front, the Czech Republic faces the difficult task of rebalancing the policy mix so as to create conditions for greater financial stability and avoid a loss of external competitiveness through excessive wage increases and overshooting exchange rates. A substantial fiscal adjustment is needed, first of all to claw back the excessive fiscal loosening over the period 2002-03, but beyond that to deal with social-security spending pressures and to create room for tax cuts and growth-enhancing expenditure increases in areas like infrastructure investment, education and business-relevant public services. The probable Czech entry into the European Union next year will strengthen the framework for conducting broad ranging economic reforms, but also further increases the need to stay on such a reform path.