The other side of the coin
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The other side of the coin

Despite Slovakia’s green light for euro adoption, delays are growing across central Europe as governments weigh the economic and political costs of monetary union

Despite Slovakia’s green light for euro adoption, delays are growing across central Europe as governments weigh the economic and political costs of monetary union

From enthusiasm to indifference in four short years. When the 10 new member states joined the European Union in 2004, half of them – the Baltic states, Hungary and Slovenia – were keen to join the euro area as soon as possible.

But of that initial group just one, Slovenia, has made that dream a reality. It joined at the start of 2007. But the country is already giving European Central Bank (ECB) officials nightmares, with inflation in Slovenia having soared to 6.2%, the highest in the euro area.

Malta and Cyprus, which joined the euro area at the start of the year, have similar inflationary problems, and this led to uncertainty as to whether the latest euro applicant, Slovakia – which was finally accepted this May – should be considered a suitable candidate.

“The long-awaited green light was not seen as granted even a couple of weeks before the official announcement,” says Juraj Kotian, co-head of macroeconomic research at Erste Bank in Vienna. “Even though it has been obvious since the beginning of the year that Slovakia would fulfil all of the explicit Maastricht criteria, never-ending disputes about sustainability of fulfilment continued to the very end of the process.”

In the end, the European Commission’s convergence report gave its blessing to Slovakia’s euro area membership bid, while acknowledging ECB concerns about the country’s ability to cap inflationary pressures once it joins the single currency bloc.

Membership has to be formally approved by EU finance ministers, after discussions with the European Parliament and the European Council, with the conversion rate for the Slovak koruna to be announced at the beginning of July.

Slovakia’s experience demonstrates that qualification for the euro area is tougher than before. “During the euro-adoption process we could see that qualification was not an easy task,” says Kotian. “The inflation criterion has become more challenging after the number of EU countries has been increased. Stronger emphasis on price sustainability has been another challenge.”

Kotian says that, with prices in Slovakia still only around two-thirds of the EU average, further price convergence is inevitable. “As a consequence, we expect generally higher inflation in Slovakia compared to the euro area in the next 10-20 years.”

He says Slovakia will serve as a benchmark for the assessment of other candidates from central and eastern Europe with flexible exchange rate regimes and relatively low price levels.

Missing political enthusiasm

While Slovakia is set to join the euro bloc in January 2009, in the neighbouring Czech Republic there is far less political enthusiasm about the single currency. Czech prime minister Mirek Topolanek is lukewarm to both the EU and the single currency.

He says the Czech Republic should be in no rush to adopt the euro – the latest in a series of signals from several central European economies that their governments are again pushing back their timetables for joining the single currency.

Topolanek has made no secret of his euro scepticism, saying that for the Czech Republic to hitch itself to the single currency could bring with it further inflationary pressure, notably by cooling gains for the Czech crown that have offset rising global energy costs.

His Civic Democrat government has quietly abandoned the 2012 target set by the previous administration, which would have been unachievable mainly due to high budget deficits and a lack of reforms that would secure the long-term sustainability of public finances.

The opposition Social Democrats, however, continue to believe the country could join the euro area in 2012 and are pushing the government to set a target date for entry. The country’s largest exporters have also recently become more vocal in pushing for swifter euro adoption. They argue that their competitiveness is being harmed by the appreciation of the Czech crown, which is near record levels against the dollar and euro.

Topolanek says the appreciation of the Czech crown is healthy as it is backed by real economic growth and that putting the crown into the pre-euro Exchange Rate Mechanism (ERM) II currency grid could curb the ability of the strong currency to mitigate the high prices of fuels. “If we fixed the crown to the euro in the ERM II system, then this advantage would disappear,” says Topolanek.

The administration in Prague has worked hard to rein in government spending, passing a 2008 state budget that aims to cut the deficit to 2.95% of GDP this year, which is below the obligatory 3% ceiling set in the Maastricht treaty. In 2009 the aim is for it to drop to 2.6% and 2.3% in 2010.

However, Czech finance minister Miroslav Kalousek reckons that long term, the country will be unable to keep the public finance deficit below 3% of GDP, until it completes pension and public health system reforms, which are only now getting underway.

Martin Lobotka, an analyst at Ceska sporitelna in Prague, believes that the current lack of political will for the single currency means it could be many years before the Czech Republic joins the euro area.

“The public discourse in the Czech Republic seems more wary of the potential risks associated with premature adoption, and more opinions seem to be voiced that are against the adoption of the euro at all costs,” he says. “All in all, the largely unreformed [pension and healthcare] systems and tepidity of a substantial part of the elite towards speedy euro adoption lead us to forecast euro adoption no sooner than 2015.”

Zdenek Tuma, governor of the Czech National Bank, says it is still too early to say what influence Slovakia’s entry into the euro bloc will have on attitudes to euro adoption in the Czech Republic.

“Inflation, especially as perceived by the general public, may increase after joining, and then one can imagine arguments like ‘You see what euro adoption may cause’ appearing in the news,” he says. “However, businesses and the financial markets may consider entry as a step forward, and it can – psychologically – influence perceptions in the Czech Republic. The decision about the timing of euro adoption is primarily a political one.”

With the exception of the inflation criterion, the country meets all the Maastricht criteria for euro adoption. “Seen from a technical perspective, January 2012 is still an option,” says Lobotka. “If the government says yes this summer, we may join ERM II by the end of this year, and will be able to evaluate the exchange rate criterion as well as other criteria during the spring of 2011, and could join the euro area in January 2012.

“Such a strategy is, however, highly unlikely. The government has prioritized the completion of important reforms – including the healthcare and pension systems – first, and is then looking to begin discussions on the timing of our membership in the euro area.”

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