Fitch Ratings, the international rating agency, says it expects Estonia, Lithuania and Slovenia to meet the Maastricht criteria in mid-2006 and become the first of the 10 new European Union (EU) member states to join the euro area in January 2007. However, the risk of a delay to the euro adoption timetable of these front-runners, as well as Latvia, has risen somewhat over the past 12 months mainly owing to an increase in inflationary pressures.
"In some respects there has been a 'de-convergence' over the past 12 months in that a majority of countries met fewer of the Maastricht criteria in mid-2005 than in mid-2004," says Edward Parker, Senior Director in Fitch's Sovereign Group. "The main problem has been with meeting the inflation criterion, as low inflation rates in some EU countries have dragged down the reference rate. The challenge is particularly acute for the Baltic states where inflation has increased owing to rising cost pressures from oil prices, indirect tax and administered price hikes, and strong underlying pressures from rapid GDP, wage and credit growth as their economies continue to catch up with 'Old Europe', while their exchange rates are tightly pegged to the euro."
In a report published today, entitled "EMU Convergence Report: 2005", Fitch provides its latest assessment of when the 10 countries that joined the EU in 2004 are likely to join the European Exchange Rate Mechanism (ERM) II and adopt the euro, and sets out the rating implications of their convergence path towards the European Economic and Monetary Union (EMU). Fitch regards the eventual adoption of the euro as a positive factor for the external creditworthiness of the new EU member states that could lead to further one to two notch upgrades of their Long-term foreign currency (LTFC) ratings over the coming (how many) years. Fitch last year upgraded the LTFC ratings of Estonia, Latvia, Lithuania and Slovenia by one notch based on their euro adoption prospects. However, Fitch is making no further rating changes at this time.
Despite the risk from inflation, Fitch's central expectation is for Estonia, Lithuania and Slovenia to adopt the euro in January 2007. After a positive decision on their joining of the euro area, Fitch would then upgrade their LTFC ratings, which are consequently on Positive Outlook. Latvia, Cyprus and Malta joined the ERMII in April indicating their commitment to euro adoption in 2008. However, Fitch revised Latvia's LTFC rating Outlook to Stable from Positive in August, as inflationary pressures mean there is a risk of a delay in its euro timetable from 2008 to 2009. Fitch views Cyprus' and Malta's 2008 target date as attainable, reflected in the continued Positive rating Outlook, but both will require sustained painful fiscal consolidation.
Euro adoption remains a more distant prospect for the larger Central European countries and therefore has no direct impact on the rating Outlook at this time. In contrast to the Baltic states, public finances are likely to be the main constraint. Nevertheless, Fitch regards Slovakia's convergence programme and 2009 euro adoption date as credible. Poland has made progress on convergence over the past 12 months in terms of inflation, bond yields and public finances. It could still meet its target of joining the euro in 2009. But that would require a clear policy commitment and rapid fiscal adjustment by the next government after elections in September, so that Fitch views 2010 as a more likely and central forecast. Hungary has also seen a marked decline in inflation and bond yields over the past 12 months. However, fiscal targets continue to slip such that Fitch views 2011 as a more realistic euro adoption date than the government's 2010 target. Fitch assesses the Czech Republic's chances of joining the euro in 2010 as about even. It also requires difficult public finance reforms as well as a clear commitment to the goal of 2010 entry.