1 / 24

Outline

Convergence The Road towards the Euro 26 November, 2004 Mats Olausson Chief Strategist Emerging Markets mats.olausson@seb.se +46-8 506 232 62. Outline. Real convergence - the goal Mechanism Today Future Nominal convergence - the next step and challenge Criteria and interpretation

nolen
Download Presentation

Outline

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Convergence The Road towards the Euro26 November, 2004Mats OlaussonChief StrategistEmerging Marketsmats.olausson@seb.se+46-8 506 232 62

  2. Outline • Real convergence - the goal • Mechanism • Today • Future • Nominal convergence - the next step and challenge • Criteria and interpretation • Stumbling blocks • Timetable • Implications • Market convergence - risks and opportunities • Foreign exchange • Stock market • Fixed income market

  3. Real convergence - the goal • 20% of population, 5% of GDP • Significant structural achievements made • GDP/capita in euro 24% of EU average • GDP/capita in PPS up 10% points to 54% of EU15 average in 10 years • Living standards gap narrowed only slowly • Potential growth. Labour + capital + structures • What will it look like in 2025?

  4. Real convergence - labour • Low employment ratio • High unemployment • Negative population growth • Adverse demographic structure • Risk of migration • Long working hours • Employment growth expected to be 0.3% 2004, same as EU 15 • Key to change incentives that increase labour supply and demand

  5. Real convergence - capital • High investment ratios • Insufficient savings (current account deficits) • EU structural funds • FDI • Financial intermediation • Tax competition • Capital accumulation set to continue

  6. Real convergence - structures • Huge progress made in 15 years • Crowned by EU accession • Two on the Top 20-list • 1/3 of Top 14 Emerging Markets • Potential for further improvement • Product markets • Labour market • Legal framework • Tax system • Red tape/corruption • Knowledge economy • Reforms pay off

  7. Real convergence - mixing the cocktail = productivity growth • Strong productivity growth • TFP more difficult • Labour productivity in total business 1998-03 • CEE 4 4.1% yearly av. • EU 15 0.7% • Ireland 3.1% • USA 2.5% • Potential growth ranges from 3-7% compared to 2% in EU 15 and 3% in the US

  8. Real convergence - catching-up • Catching up in PPS terms: • 3% growth 62 years • 5% growth 21 years • 7% growth 13 years • Political goal in PPS • You don’t buy trucks for PPS • Labour cost convergence in Euros • Catching up in Euro terms with 1.5% additional inflation: • 3% growth 58 years • 5% growth 33 years • 7% growth 23 years • OECD expects the gap in PPS to half in 30-40 years • Differential gradually decreases

  9. Nominal convergence - the criteria • Legislation must be compatible with Treaty and Statute of ESCB/ECB • The ratio of government deficit to gross domestic product must not exceed 3% • The ratio of government debt to gross domestic product must not exceed 60% • There must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination, which does not exceed by more than 1.5 percentage points that of the three best performing Member States in terms of price stability • There must be a long-term nominal interest rate which does not exceed by more than 2 percentage points that of the three best performing Member States in terms of price stability • The normal fluctuation margins provided for by the exchange-rate mechanism on the European Monetary system must have been respected without severe tensions for at least the last two years before the examination

  10. Nominal convergence - interpretation • Legislation. Hungary listened to ECB criticism • Inflation. 12 month average HICP during the year preceding examination. Average for 3 countries (not deflation) • Interest rates. Normally 10 years maturity. Estonia an exception • Deficit. Below 3% of GDP or declining substantially and continuously or exceptional and temporary factors. Eurostat decided on private pension funds. Stability and Growth Pact revisions under way. • Debt ratio. Below 60% of GDP or declining • Exchange rate. Normal fluctuation band +/- 15% band with automatic and unlimited intervention. But evaluation of exchange rate stability is likely to vs. a narrower band (asymmetrical with -2.25%). “Without severe tensions” is qualitative. Finland and Italy had stayed in ERM2 less than 2 years at the time of examination

  11. Nominal convergence - general • No opt-out • No set time-table • Must abide to the SGP, but no sanctions • Inflation must be the overriding monetary policy target • Principle of equal treatment… • …but probably less generous interpretation • Balassa-Samuelsson makes the inflation criterion inappropriate • Inflation in the enlarged club a tougher challenge • The Greek experience to make creative accounting harder • The decision will be made by European Council based on assessment reports by the European Commission and ECB • “Big bang” introduction of bills and coins is likely upon euro conversion

  12. Nominal convergence - Status today

  13. Nominal convergence - Inflation • Progress made. 5 meet criteria • Rising trend. Challenge for Baltics • Challenges ahead • Balassa-Samuelsson-effect • Food more important • Oil price sensitivity • Last steps most difficult • Tricks possible • Smaller credit market weakens transmission mechanism • Exchange rates important • Trade-off with growth • Higher inflation after entry is little problem for EMU

  14. Nominal convergence - Budget deficit • The biggest challenge for CEE 3 • High deficits despite high growth • Eurostat rules against Poland on private pension funds. EcoFin decides in February • What happens to the SGP? • Little budget help from EU-funds • Already high tax burden… • …and inflexible spending • Painful to reduce structural deficits. Electoral cycle important

  15. Nominal convergence - Public debt ratio • Lower debt ratio in CEE 10 at 45.7% in 2003 compared to 70.4% in the euro zone and 63.3 % in EU 25 • Only Hungary at risk and possibly Poland (3% points higher ratio when excluding transfers to private pension funds) • Trend to fall by time of examination • Small debt stocks reduce scope for positive budget effects from lower interest rates

  16. Nominal convergence - Interest rates • By-product of meeting other criteria • Only 2 countries miss the target • Inflation differential + political risk premium + FX risk • Automatic convergence once inflation falls and a credible convergence program is in place

  17. Nominal convergence - Exchange rate • Estonia, Lithuania and Slovenia joined ERM2 on 28 June • Potentially a bigger risk than recognised • 15% or 2.25% fluctuation band, “without severe tensions”? • Two target and one instrument - an invitation to speculators? • if the convergence program lacks credibility • and/or the central parity rate is perceived as overvalued • Revaluation will be tolerated • Fluctuation last two years • PLN 23% • HUF 18% • CZK 10% • SKK 9%

  18. Nominal convergence - The euro: not very popular around here • Short term political costs to meet the criteria • Policy actions may come into conflict… • …or growth must be sacrificed • EU accession deadline and race was a carrot and a whip • Reform fatigue • Hard to score political points on rapid move to the euro • 3 of EU 15 outside

  19. Nominal convergence - Timetable

  20. Convergence - Impact of euro adoption • Maastricht criteria as an anchor for sound economic policies • Reduced crowding out of investments • Lower real interest rates • Less distortions with lower inflation • Not designed for transition countries • Higher natural rate of inflation • Conflicting targets in the run-up to euro conversion • Temporarily negative for real convergence • Loss of monetary/exchange rate policy puts higher burden on fiscal policy • Social disruption if structural fiscal deficits are reduced rapidly • Once in the euro zone • Lower transaction cost in intra-EU trade • Now currency risk in 3/4 of trade. Mostly completed • Current account risk turn into credit risk. Baltic example? Risk of bubbles! • Harmonisation of credit ratings • More difficult to find optimal interest rate for ECB • Trade-off near term. Lower inflation and end of current account risk should spur credit expansion and lead to higher growth

  21. Market convergence - FX market • Deviation from 2.25% on the strong side is OK • High productivity growth should lead to real appreciation via the exchange rate rather than inflation in the run-up to ERM2 • Speculation about central parity levels will cause temporary overshot if remaining positive interest rate differential • Fixing at an overvalued rate is dangerous. Hungary, Baltics? • Consensus expects small changes from current levels

  22. Market convergence - Stock market • Greece’s outperformance faded • Still, South Europe is ahead • CEE outperformed last 3 years • Bratislava, Tallin and Vilnius on top since 2001 • CEE stock markets are small with low market capitalisation... • P/e ratios have caught up • Higher productivity is driving • Portfolio diversification • Lower liquidity and market capitalisation • Lower transparency • FX risk

  23. Market convergence - Interest rates • Deconvergence 2003-2004 on rising budget risk • Easing inflationary risks lately and supportive global backdrop • HGB higher spread than 2000 when inflation was over 10% • Not if, but when • Southern Europeans converged 4-1 years ahead of euro adoption • New opportunities ahead • Earlier and quicker • Credible convergence program is key

  24. Convergence - The Road towards the EuroThanks for participating!26 November, 2004Mats OlaussonChief StrategistEmerging Marketsmats.olausson@seb.se+46-8 506 232 62

More Related