|
Contact Us • FAQ • Index • Search | ||
|
|
||
|
|||
|
|
|||
| ||||||||||||
|
The Great Euro Debate: A No-Fly Zone or a
Growth Accelerator? The accession countries’ long march toward the euro will accelerate as soon as they join the EU in mid-2004. Two more years of anchoring their currency firmly to the euro and complying with the Maastrict criteria, and in 2006 at the earliest, the door to the euro zone will open for them. In the meantime, discussions about the pace of convergence are escalating. Unlike existing EU members, the new EU member states will be obliged to join the euro zone: the accession treaty will not contain any opt-out clauses. To this end the accession countries will first have to satisfy the Maastricht criteria and, according to current rules, prior to euro zone entry they must spend at least two years in the exchange rate mechanism (ERM-2), in which their currencies fluctuate up to 15 percent on either side of a central rate with the euro. As well as showing a record of exchange rate stability within the ERM-2, the Maastricht convergence criteria include a government budget deficit of less than 3 percent of GDP, a public debt level of less than 60 percent of GDP, an inflation rate that is within 1.5 percent of the three best-performing members, and long-term interest rates that are within 2 percent of the three best anti-inflation performers. Spirited Euro Debate Debate on how quickly the euro should be adopted is growing. Many argue that it should be adopted as quickly as possible. Officially, the first possible date is 2006, given the two-year ERM-2 period after EU membership in 2004. Proponents of early adoption argue that as small, open economies already highly integrated with the EU through trade flows, the accession states will benefit from the stability associated with a single currency and that these benefits should be tapped as soon as possible. Overall, adopting the euro is meant to boost growth through lower interest rates and the elimination of exchange rate risk and by increasing asset values. Some in the region, usually central banks, also point out that an ambitious euro entry target can provide a useful instrument for fiscal discipline, which would otherwise be much harder to achieve. However, critics argue that the euro is an economic straightjacket designed for mature economies that may not fit these countries until 2010 or even later, and that the process of preparing for euro entry can be damaging. Indeed, the EU accession countries’ main priority is rapid growth and catch-up with the EU average. At present, the gap in development levels between the EU15 and the candidate countries remains enormous. Furthermore, despite the return to growth in the mid-1990s, between 1996 and 2001 there was no catch-up with the EU, that is, no change in the income disparity between the EU and the average for the 10 candidate countries. Thus euro entry may be undesirable for countries at a much lower level of development that still have to undergo far-reaching structural and institutional changes. For structural reasons, developing, rapidly growing economies will tend to have higher inflation than richer, slower-growing economies. Strong catch-up productivity growth in the tradables sector pushes up wages in both the tradables and, through domestic competition, the nontradables sectors (which includes, for example, road construction, education, and environmental control). This in turn pushes up the prices of nontradables, and thus the general price level, the so-called Balassa-Samuelson effect. In their 1964 seminal papers Balassa and Samuelson pointed out that in a given economy, productivity growth in the open or traded goods sector was usually higher relative to that of the closed or nontraded goods sector. Given that wages tend to be roughly the same across sectors, faster productivity growth in the tradable sector pushes up wages in all sectors. This in turn increases the relative prices of nontradable goods. Productivity growth is higher in transition economies than in industrial countries, which means that transition economies should expect higher inflation and also upward pressure on their currencies. Empirical evidence on the size of the effect varies, but it seems to account for at least 1 to 2 percent of inflation per year, and possibly more. Strict pursuit of the unadjusted Maastricht criteria could lead to overly tight policies, inhibiting growth. Another problem is that growth could be adversely affected by overly rapid fiscal adjustment. Fiscal deficits are a problem in all the largest accession economies: the Czech Republic, Hungary, Poland, and Slovakia. In the next few years great pressure on spending will come from requirements related to the acquis communautaire (the body of EU law), as well as from obligations stemming from NATO membership. Some estimates put the overall costs of EU entry to the new members, most of them budgetary, at 3.5 percent of GDP for the first three years, the period that would coincide with attempts to meet the Maastricht criteria. Once countries join the ERM-2 and have established the central rate against the euro, this rate could become the conversion rate when the currency is replaced by the euro. Indeed, the central ERM rate was used for all existing European Monetary Union (EMU) members as the final conversion rate; however, both Greece and Ireland had their central rates changed less than a year before joining the EMU. In both cases the change was a small revaluation. The Maastricht Treaty explicitly states that a country should not have its central rate devalued in the two years preceding EMU membership. This may prove to be another contentious issue, given the sensitivity to the danger of locking in at insufficiently competitive rates, especially because over the next few years the accession countries’ currencies are likely to be under upward pressure because of structural reasons associated with the Balassa-Samuelson effect and because of continued strong foreign capital inflows. Various Agendas Across Countries Views vary significantly across countries, depending also on their current foreign exchange regimes (table 1). In Poland, the Ministry of Finance is a strong supporter of early entry to the EMU and expects to meet the Maastricht criteria in 2005 and enter the EMU by January 1, 2007. In the Czech Republic, the Ministry of Finance has stated that entry is unlikely before 2010, given that fulfilling the budget deficit criterion without hurting growth will take many years. However, some experts argue that early entry by other candidates might put pressure on the Czech Republic. Slovakia, whose fiscal deficit will surpass 7 percent of GDP in 2002, aims to meet the Maastricht criteria by the end of the government’s term in late 2006. This would mean adopting the euro in 2008 or so, despite central bank pressure for an earlier date. Hungarian officials have maintained that the country would be able to qualify for the EMU by 2007. This appears to be a target that both the National Bank of Hungary and the Ministry of Finance accept. However, some recent talk has indicated that this may be delayed, leaving more time to meet the Maastricht criteria. Further delay is indeed highly likely. Hungary will have some difficulty in meeting the fiscal criterion (its 2002 budget deficit ballooned to an estimated 8.8 percent of GDP, with about 2 percent of that attributable to one-off expenditures), and it may also not achieve the inflation criterion easily. In the Baltic states and Slovenia, fiscal deficits are under better control than in the four Visegrad countries, and they are well placed in terms of currency management. They could meet the Maastricht criteria in time for entry in 2006 or 2007, although the Baltic states’ relatively low development levels may expose some of the potential contradictions between nominal and real convergence. The Bank of Slovenia wants to join the ERM-2 immediately after EU accession so as to be able to adopt the euro as soon as possible, but problems could arise because Slovenia still has relatively high inflation. Estonia wants to transfer from its currency board to the euro, dispensing with the ERM-2, as soon as possible. In 2000 Estonia raised the issue of adopting the euro prior to EU membership, but the EU frowned on this. Latvia’s currency is pegged to the SDR, the IMF’s currency basket. Its central bank is targeting 2005 to join the ERM-2 and 2007 for euro entry. Lithuania repegged the litas from the dollar to the euro in February 2002, and has committed itself to maintaining the regime until EU accession. It aims to join the EMU as soon as possible after accession, but admits that this seems unlikely until 2007 at the earliest. Upgrades and Downgrades: Currencies Scrutinized In November Moody’s, the international credit ratings agency, upgraded its long-term ratings for foreign currency-denominated government bonds by two to three notches for all eight Central and Eastern European countries set to join the EU in 2004. The new ratings, with previous ratings in parentheses, are the Czech Republic, A1 (Baa1); Estonia, A1 (Baa1); Hungary, A1 (A3); Latvia, A2 (Baa2); Lithuania, Baa1 (Ba1); Poland, A2 (Baa1); Slovakia, A3 (Baa3); and Slovenia, Aa3 (A2). The sharp upgrades reflect Moody’s belief that the economic and financial integration of these countries in the EU is irreversible and that EMU membership is also assured. The countries’ foreign currency debt ratings now equal those of government-issued bonds in the respective local currencies. Ratings agencies normally assign a lower rating to a country’s foreign currency debt on the grounds that it can ultimately, if need be, print its own currency to service local currency debt. Moody’s justified its decision on the grounds that foreign currency risk is falling and would be eliminated completely by the time these states joined the euro zone, which it believes will be as early as 2006 for some of the countries. This would mean that the level and trend of government debt, regardless of the currency in which it is issued, will become the main drivers of creditworthiness, just as in the developed OECD economies. To some extent, Moody’s action reflected market sentiment, as prices already reflect the belief that the EU candidate states are heading for early membership of the euro zone. However, both Standard & Poor’s and Fitch-IBCA reacted with caution to Moody’s move. Standard & Poor’s has even recently downgraded a few sovereign credit ratings, albeit for debt denominated in local currency, and Fitch-IBCA has raised the possibility of going counter to Moody’s and downgrading the headline foreign currency rating for certain countries, in particular, for Hungary, which is experiencing renewed "twin deficit" fiscal and current account problems. The ratings agencies are famous for following each others’ lead, so such a divergence of opinion is relatively rare. The Economist Intelligence Unit produces its own set of ratings, with its sovereign debt ratings category being closest to the agencies’ foreign currency-denominated government debt ratings. They differ from the credit ratings agencies’ measures mainly in the adopted time frame. In contrast to the agencies’ framework—which, formally at least, covers a medium-term horizon—the Economist Intelligence Unit ratings are limited to forecasts of political developments, the policy environment, and economic performance over the next two years, with the focus on the coming year. Otherwise they are roughly equivalent to those published by the credit ratings agencies, with particular attention paid to currency stability, sovereign creditworthiness, and the health of the banking sector. These ratings are more broadly comparable with ratings from Standard & Poor’s and Fitch-IBCA than with those from Moody’s (see table 2). Whereas the Moody’s upgrade means that Slovenia’s rating is equal to Singapore’s and that half of the eight East European countries are moving toward the upper reaches of investment grade, the Economist Intelligence Unit’s ratings are more cautious. All EU accession countries are rated the equivalent of investment grade, but only by one or two notches, as many continue to struggle with large fiscal deficits in particular. Future improvements in the countries’ creditworthiness will be underpinned by the speed with which they implement new bodies of law to facilitate their full EU and EMU integration and with which their income levels catch up. The author is regional director, Central and Eastern Europe, Economist Intelligence Unit. This article is based on his article in the December 2002 issue of Economies in Transition—Regional Overview. He can be reached at the Economist Intelligence Unit, 15 Regent Street, London SW1Y 4LR, United Kingdom; URL: http://www.eiu.com/. Table 1. Accession Countries’ Foreign Exchange Regimes
Table 2. Risk Ratings Compared, December 2002
Note: The first panel of figures refers to investment-level grades, and the second panel refers to subinvestment grades.
|
| ||||||||||
