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WorldJanuary 2 2013

The euro: a path worth taking?

The eurozone's troubles of the past few years have meant that the headlines have been dominated by those countries deemed likely to leave the currency union. However, there are EU members that still wish to sign up to euro membership. The question is, why?
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The euro: a path worth taking?

It is easy to forget that discussing the eurozone without adding the now inevitable 'crisis' suffix was ever a reasonable possibility. It is easy too, to overlook the fact that back in the buoyant founding years of the economic and monetary union, membership was a coveted prize for bright-eyed, new EU members, and one for which policy-makers would gladly forsake their native currency as quickly as possible. 

But back then, the euro was not invoked as a phantasm to spook those who might rush into an ill-conceived and poorly integrated monetary union. Nor was its financial situation and uncertain future a constant source of concern for politicians, bankers and economists across the globe. Instead, a spot in the largest currency union ever attempted lent participants a certain degree of credibility as part of a stable, continent-wide monetary regime.

That was then. Now, avoiding the euro completely might seem like a saner course of action. Unfortunately, it is technically also an illegal one. Upon joining the EU in 2004 and 2007, all 12 of the new, emerging EU members committed to join the single currency once they achieved the Maastricht convergence criteria. Thus far, Slovenia, Cyprus, Malta, Slovakia and Estonia have made good on this pledge, leaving the other seven – Bulgaria, the Czech Republic, Latvia, Lithuania, Hungary, Poland and Romania – legally obliged to join. Upon its 1995 EU accession, Sweden too signed up to membership, failing, unlike Denmark and the UK, to secure itself special dispensation to opt out.

Adoption postponed

Adoption plans in the non-euro area new member states, termed the NMS7 by the European Commission (EC), have been postponed repeatedly since economic calamity overwhelmed the eurozone. A predictable, and entirely reasonable, upsurge in Euroscepticism was experienced across the EU, particularly among those states yet to join the euro. Now, according to the EC’s most recent ‘Eurobarometer’, 54% of NMS7 residents surveyed thought euro introduction would have 'rather negative' or 'very negative' consequences as of April 2012, up significantly from the 32% recorded in May 2009. Czechs and Poles were most sceptical, while only Romania (54%), Latvia (45%) and Hungary (44%) saw a higher proportion of respondents believing that the introduction of the euro would have positive consequences for them personally rather than feeling they would suffer as a result.

The economic benefits once assumed to follow membership are looking rather more illusory than they once did. Improved financial stability and lower interest rates, for example, are by no means guaranteed. Moreover, for a new member, the prospect of being forced to contribute to bailouts and rescue funds is unlikely to appeal to even the most charitable of finance ministers.

Meanwhile, the effects of the crisis mean that progress towards compliance with the Maastricht convergence criteria has stalled, or in some cases, regressed.

According to the European Central Bank’s 2012 convergence report, none of the examined countries fulfilled all five adoption criteria in price stability, government budgetary position, participation in the exchange rate mechanism II (ERM II), long-term interest rates and legal convergence. According to recently published ABN Amro research (see table), Latvia currently complies with four of the five criteria, while Bulgaria and Romania comply with three, Czech Republic and Lithuania two, and Poland and Hungary are both stuck on just one.

Legal obligation or not, however, the thought of the EC entering into forcible enlargement of the currency union is politically unthinkable. And given that the eurozone – both constituent parts and monolithic whole – is now in a situation that even the most optimistically minded of Brussels-based Europhiles would struggle to describe as anything more positive than ‘highly dysfunctional’, increased anti-euro sentiment and slipping end dates should not come as a shock. What might surprise, however, is that adoption is still aspired to by anyone at all. And yet, for some at least, it remains a goal, and a not too distant one at that.

Latvia leaps

Indeed, an 18th member could be added to the currency union as early as 2014 in the shape of the most entry criteria-compliant EU member – Latvia. The Baltic state is the only country with an implementation date still standing (currently  January 1, 2014), and is set to decide whether or not to ratify that in early 2013.

“We are still firmly committed from the government side to have introduced the euro by 2014,” says Latvian finance minister Andris Vilks, adding that the country intends to apply for a new convergence report in February. “We meet all of the convergence criteria now… and while the situation is much different from how it was three or four years ago, this is a very strong commitment and we are not going change it.”

The European Commission also expects that Latvia will make its proposed end-date. Officials say the commission is currently monitoring the situation and providing assistance in doing so, which includes financial aid for communication requirements.

Lithuania has also shown interest in joining the eurozone, having previously been rebuffed in its attempts to do so in 2007 due to its high inflation. This could be stymied, however, by the recent round of elections which saw anti-austerity parties win power. Nevertheless, it does have a reasonable chance of membership by as early as 2015, according to Arjen van Dijkhuizen, a senior economist for emerging markets at ABN Amro.

Poor relations

Elsewhere, policy-makers in Romania and Bulgaria – the EU’s two poorest countries – remain positive about their prospects of euro membership. However, both have recently suffered from severe crises, followed by a slight recovery and then a subsequent cycle of low growth, rising unemployment and continued austerity measures, all of which makes the two countries unlikely to qualify for euro membership in the near future.

Nevertheless, it was only in late-2012 that Romania formerly renounced its stated euro membership date of January 1, 2015, although speaking to The Banker in October, National Bank of Romania governor Mugur Isarescu admitted that with elections approaching, its purpose was more holistic than realistic. “There was a danger that with the postponement of the 2015 target, there would be the perception of a relaxation among the political classes and a temptation to have a wider budget deficit and the like. It worked as a catalyst for consistent policies, and we preferred that than to be quoted by someone as saying it would not happen,” he said.

As of December, Romania has yet to identify a new eurozone membership target date, though in an e-mail exchange Mr Isarescu said it remained a topic of discussion. “The NBR will assess with the new government this issue, taking into account both the developments in Europe and the positions of other peer [non-eurozone] countries”.

However, while Romania is making progress towards the Maastricht criteria, the country's gross domestic product (GDP) per capita was 49% of the EU average in 2011, the second lowest figure of any European country. “Real convergence is far enough away to rule out euro adoption as a short- or even medium-term plan,” says Raiffeisen Romania’s chief economist, Ionut Dumitru.

Compliance with the Maastricht criteria

Little chance of change

Elsewhere, the rest of the NMS7 seem even less likely to be granted, or seek, eurozone membership.

Hungary’s high public debt, poor track record on inflation and difficult relations with the EU and IMF mean that only a few enthusiastic central bankers would seriously discuss adoption. Polish membership too remains a very distant prospect, albeit for very different reasons. The country is governed by a generally pro-European centre-right party, but its flexible exchange rates helped it circumvent a post-Lehman recession and it currently enjoys a rate of growth far healthier than its eurozone counterparts. As a result, the National Bank of Poland’s monetary policy committee has said it will only enter ERM II once the euro crisis is over, leaving potential membership a very distant prospect.

“My personal belief is that because, unlike the Baltics, we are relatively less open and have a larger economy and a floating currency, we are not exposed to the same kind of risk we would be if we had a fixed rate, and not as dependent on the eurozone and the rest of the world,” says Ryszard Kokoszczynski, director of the bureau of macroeconomic research with the National Bank of Poland. “I’m afraid that setting a euro joining date without knowing what the state of the eurozone will be then would be counterproductive in Poland.”

The Czech Republic has an extremely euro-sceptic president in the shape of Václav Klaus, but the country’s stance could change with a new administration, according to Ludek Niedermayer, director of Deloitte CZ and former vice-governor of the Czech National Bank. “For the time being, President Klaus has a very strong influence, and his appointments in the central bank are [similarly eurosceptic]. However, things might change after he steps down, so the political landscape could look different quite soon.”

As for Sweden, joining seems to not be an option, despite the EC’s official position that “in accordance with the Maastricht Treaty, [Sweden] will do so once it meets the necessary conditions”. Indeed, back in 2003 – happier times for the eurozone – 55.9% of Sweden's population voted against membership of the single currency area in a non-binding referendum. A spokesperson for Sweden's national bank says there has been no further discussions since then, and judging by survey results released by Statistics Sweden, such a decision would be political suicide. The poll carried out by the research company found that if there had been a referendum on adoption in November 2012, 82% of Swedes would have voted against, while just 10% would have voted in favour – the lowest level of support yet recorded.

So why bother?

Attitudes differ drastically, but there remains a handful of EU member states that still have a genuine desire to be a part of the single monetary area. Perhaps the most striking question is why?

Ask a confirmed europhile, such as Bernard Snoy, president of the European League for Economic Co-operation (ELEC), and the appeal is obvious “Joining the eurozone means joining the core of Europe," he says. "Many of these countries value the European integration project more than the UK or other eurosceptic countries. They’re realistic; they know that in the future that’s where the rules are going to be made… so for them, it remains an important political objective.”

Even if eventual expansion seems inevitable though, it still does not explain why a non-member country would choose to pursue joining the eurozone in the immediate future given the degree of uncertainty currently enshrouding it.

For the Baltic states of Latvia and Lithuania (Estonia joined the eurozone in 2011) – the EU’s most enthusiastic and likely current future eurozone members – part of the answer lies with the fact that it may not make an enormous difference to their monetary policies. Currency pegs have been an important part of macroeconomic policy in the Baltics since parting from the Soviet Union, and both Latvia and Lithuania are already strictly pegged to the euro. Fixed exchange rates impose some costs on the duo, as does their open nature and close ties with the rest of the eurozone, without necessarily conferring any particular benefits.

Why not then, so the argument goes, welcome them into the eurozone’s inner sanctum, enabling them to have a say in the decision-making process? Estonia’s thus far positive experience as a new member provides additional encouragement. “Euro membership was always a very substantial strategic goal of Latvia. Our neighbour is now in the eurozone and going quite well, and Latvia would like to follow,” says Mr Vilks.

Outside of economics

There is, moreover, an additional geopolitical element to the decision, given the two countries’ proximity to Russia. “It’s all about politics, the economics are not really as important as many of us would like them to be,” says Lars Christensen, chief analyst and head of emerging markets research with Denmark's Danske Bank. “I have a hard time understanding why Latvia is eager to join [the eurozone]. I can appreciate the geopolitical and exchange rate arguments, but at the moment, membership is an option. It will not have the option to leave once it is a member, or at least if it does join, the cost to leave will be much higher."

For Romania and Bulgaria, the other two most likely future eurozone members, the attraction may be motivated more by the potential for accession to drive structural reforms and sound fiscal policy – what Mr Snoy describes as “the reward to be received at the end of a long and painful journey”. Certainly the role of convergence criteria as a catalyst for reform, and of membership as a guarantee of certain standards, could have real value for Romania, according to Mr Isarescu.

Even the countries which have ruled themselves out of the single currency for the foreseeable future appreciate the benefits eurozone membership has for international business. “[The Czech Republic's] economy is highly linked to Germany, so for our industry it important to reduce currency risk,” says Mr Niedermayer of Deloitte CZ.

Just as opinion is split over whether adopting the euro will be beneficial for prospective members, the wisdom of further enlarging the eurozone is not always accepted.

There will, of course, always be Brussels-centric factions who advocate the expansion of the European cause above all else and see further integration as the solution to every ill. “Anglo-Saxon commentators continue to underestimate how strong the magnet and drag is in that direction,” says Mr Christensen at Danske Bank. Strength of feeling certainly can be surprising. At an ELEC event in Bucharest earlier this year, Professor Alfred Steinherr of the University of Bolzano was roundly heckled by attendees during a presentation for suggesting that some countries might be better off outside of the eurozone.

Nevertheless, the question of whether the eurozone would be a more optimal currency area than it already is with the addition of any of the NMS7 is far from clear cut. It could arguably find itself in an even less favourable position, given that each prospective member currently has lower than average per capita GDP, productivity and price levels, and many are in need of structural reforms. “It is very hard to argue that any of the outside countries would contribute to make the euro a better currency union,” says Mr Christensen.

There is no doubt that even some elements within the European Council feel the same way. An EC official who spoke on the condition of anonymity admitted that once negotiations on the addition of a new member begin in earnest, some level of opposition from certain countries and factions is inevitable. Especially, the official added, as the possibility of ejecting some member states from the eurozone is currently the topic of some informal discussion.

Nevertheless, even Mr Steinherr suggests that the more financially sound members of the eurozone could have good, albeit faintly cynical, reasons to favour expansion. “Obviously it would be helpful for Germany, and the countries around Germany, to receive strong members, such as Sweden and probably Poland, to share the economic burden,” says Mr Steinherr.

Little choice

Whatever the verdict, once an EU member achieves the convergence criteria and decides to join, there is very little current members can do to keep them out. “When you fulfil the criteria for joining, the system is rather rigid and there isn’t really anything stopping it,” says Mr Christensen. “If the Germans, for example, wanted to keep Latvia out, it would actually be very hard.”

That could be a major cause for concern, given that many view the current convergence criteria as inadequate. Certainly, they were not enough to prevent the eurozone crisis in the first place – although not all members have been compliant all the time. "It has been shown that these criteria are a necessary condition for convergence but not sufficient by themselves,” says Mr van Dijkhuizen at ABN Amro. He adds that he expects the assessment of prospective members to include broader external positions and competitiveness.

Ultimately though, many of the more standoffish countries still plan to work towards these criteria and if the eurozone’s woes are ever successfully resolved, they will see eventual non-membership as a non-option. “The UK, for example, can go indefinitely outside of the eurozone in terms of political credibility, and I can imagine Sweden could take a very long view on joining,” says Mr Kokoszczynski at the National Bank of Poland. “Poland lacks some of their advantages, however, and in some ways joining does seem inevitable, providing the eurozone survives in the medium term.”

Meanwhile, Deloitte CZ’s Mr Niedermayer sees membership as truly advantageous in the long term. “We are extremely integrated to the core of the eurozone and that won’t change year to year. The desirability is still there even if the political will is not.”

The eurozone's appeal may be severely tarnished, and its stability and long-term future in question, but against what sometimes appears to be startlingly unlikely odds, its appeal endures.

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