Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

When is the right time for EMU entry?

Despite some difficulties, several new EU member countries could also be part of the euro currency zone as early as 2008. Given the demands of the process and their consequences, Marianne Kager reports on whether sooner is better.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

The introduction of the euro in the new EU member states is the next big challenge in the process of these countries’ integration in the Union. Compared with accession to the EU, joining the euro should be an easy undertaking. But public discussions often seem to suggest that it is the other way round.

This disproportion may partly be due to a wrong interpretation of economic policy reality in the EU. The new member states will be strongly integrated in the EU’s economic policy guidelines, including the Stability and Growth Pact, from May 1, 2004 onwards, ie, even before the possible date of their adoption of the euro.

New conditions

Nevertheless, the conditions imposed by the EU on the new member states for implementing economic policy objectives will probably depend on whether a country aims to join the euro quickly or at a later date. This means that the new member states will be faced with different conditions determining the way in which they will, or should, join the euro.

Discussions surrounding the introduction of the euro in central and eastern Europe (CEE) focus on the question of how the Maastricht criteria can be met. The new members’ answer to the question of whether CEE displays a sufficient degree of real and nominal convergence to the euro area willprobably be “yes”.

This view is based mainly on two strong arguments: the new member states are strongly integrated in the euro area’s economy, with 60% of exports from the new EU member states going to the euro area; on the basis of an enlarged euro area, the figure would be more than 70%. And the scope for pursuing independent exchange-rate and monetary policies appears to be rather limited, especially for the small and open economies in CEE.

Despite the recent currency turbulence in Hungary and Poland, most countries in the region enjoy a considerably higher level of exchange rate stability than today’s euro members did four years before they joined the euro. The inflation rate in the new EU member states was at about the same level of 2% as in the euro area in 2003, however, as a consequence of the catching-up process, future inflation rates may be higher in the CEE than in the old euro area.

The main question that each of the new member states is now facing with regard to the date of adoption of the euro is this: at what time on the horizon will the “cost” of introduction be lowest? In this context, “cost” refers mainly to the loss of growth a country has to accept to meet the Maastricht criteria, especially the deficit criterion.

1462.photo.jpg

Criteria and a pact

As mentioned before, the EU’s economic policy guidelines require the budget to be balanced in the medium term so that the countries’ budget deficits will not rise to a level exceeding 3%, even in times of economic recession. The countries must present programmes (convergence programmes for the “pre-ins” and stability programmes for the “ins”) in which they outline the measures they will take to achieve a balanced budget.

This means that complying with the requirements of the Stability and Growth Pact in its current form, and independently of the introduction of the euro, will present a challenge to all new EU member states.

The following calculation illustrates the restrictive effect that the Stability and Growth Pact might have on CEE countries: if CEE countries fully met the Stability and Growth Pact from 2004 onwards (balanced budget over the business cycle), their debt ratio would fall from currently 44% of GDP to 34% in 2006 and to below 20% in 2013.

Room to manoeuvre?

The “Maastricht” deficit criterion of 3% was established for economies with potential growth of 2% to 2.5% and a debt ratio of more than 60%. Higher economic growth in central and eastern Europe – this year growth could reach 4% in real terms, compared with 1.6% in the euro area – in combination with a low debt ratio (CEE: 44%, euro-area average: 70%) would thus allow a somewhat different interpretation for CEE countries.

These economic considerations are to be weighed against political considerations (equal treatment). As a realistic interpretation of the Stability and Growth Pact, based on the same assumptions for the new EU member states as those for the current members, the new EU member states would have to cut their deficits by half a percentage point annually. This would enable five of the eight new EU member states from central and eastern Europe to meet the Maastricht criterion of a budget deficit of less than 3% in 2006. However, this does not include Poland, the Czech Republic and Hungary, the large CEE countries.

It is true that, on the above assumption, the large economies in CEE would also be able to join the euro in 2008. However, compliance with the 3% deficit criterion required to be met in 2006 (assumption: convergence report 2007 based on 2006 data, basis for EMU entry on January 1, 2008) would considerably dampen economic growth.

Apart from these economic aspects, the question arises of whether CEE countries should not be allowed to have higher budget deficits for a certain period, as an “investment for the future” – given the fact that the transformation process will not yet be complete at the time of their accession to the EU, and in view of their low debt ratio, while the higher potential economic growth remains unchanged.

Even if the European Commission has already indicated certain concessions, the extent of such concessions to the accession candidates seems to depend on whether they want to be members of the euro area and on how ambitiously the various countries pursue their plans with regard to euro membership.

Paradox or not, all signs suggest the reality of Brussels politics is such that the later countries plan to adopt the euro, the more the EU will show understanding in respect of the fulfilment of the economic requirements laid down in the Stability and Growth Pact. This means the “ambitious” countries are burdened with more rigorous consolidation requirements, and they therefore have to accept stronger negative growth effects in the short term than the countries with higher unsustainable budget deficits for whom the consolidation requirements will consequently be eased.

Finally, what are the risks arising for the “old” euro-12 area from an enlargement of the euro area? The risks arising for the current euro area from such an enlargement are probably low. If the new EU member states had been members of the euro area in 2003, economic growth in the euro area would have reached 0.6% instead of 0.4%. Inflation would have been unchanged, the public sector deficit would have been one-tenth of a percentage point higher and the debt ratio about one percentage point lower.

1464.photo.jpg

Few alternatives

Summing up: from an economic point of view, there are few alternatives to a quick introduction of the euro. If the new EU members did not join the euro, they would gain only a little additional room for manoeuvre in their monetary policies.

But despite the Stability and Growth Pact, they would enjoy more scope for fiscal policy measures. This means the timing of the introduction of the euro depends on the possibilities of budget consolidation and the requirements to be met in this respect. The question is not “to join or not to join”, but “under what conditions at what time?”

Marianne Kager is Chief Economist of Vienna-based Bank Austria Creditanstalt (BA-CA). BA-CA is a member of HVB Group/Germany and operates the leading international banking network in Central and Eastern Europe with 900 branches in 11 countries and total assets of E23bn.

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe