Accession of the New EU Members into the Eurozone

1. Accession of the New EU Members into the Eurozone Tamás Réti Institute of Economics HungarianAcademy of Sciences

2. Outline • Milestones of integration into the European Union • Forerunners of accession into the eurozone • Latecomers: Bigger countries • Countries with currency board or fixed exchange rate • Conclusions

3. Milestones of integration • Europe Agreements – free trade area + politicaldialogue. Trade and financialintegration, banking integration • Copenhagencriteria – functioning market economy + capabilitytocopewithcompetitivepressure and market forces • From 1998-1999 entrynegotiations Pre-accession boom inthecandidatecountries Nominal and realconvergence • 2004-2007 Membershipinthe EU Frompost-accession boom toeconomicrecession • Entryintotheeurozone Slovenia (2007), Slovakia (2009), Estonia (2011)

4. Annual GDP Growth (%)(Eurostat, 2011)

5. Vulnerability Indicators (Transition Update May 2011)

6. Slovenia: thebest is thefirstStrategy of euro adoption • 2003 Government + Central Bank accepted program of joining the ERMII and adoption of euro • First priority of government economic policy • Joining ERMII on June 2004 (together with Estonia and Lithuania) less than 2 months after EU accession • Minimum two-year period. Smooth stay. Market exchange rate close to central parity. • European Commission + ECB: Slovenia fulfilled all Maastricht convergence criteria & ready for inclusion (May 2006) • Reasons for success: focus on fiscal and BOP equilibrium, wide support among political parties & in the public. Social pact with labor unions. Consensus across governments. Target date accepted as realistic, credible, lowered inflationary expectations. Tradition to save in DM/Euro

7. Slovenia

8. Slovenia, euro and the crisis • Global crisis shifted ratio between benefits and costs of membership • Slovenian model of consensus-seeking + high government redistribution is being questioned. • Inflation higher than expected. Strongly trade-dependent economy – no possibility of devaluation • Growth of nominal unit labor costs (2008: 6.2%, 2009: 7.9%) • Political changes: Social democrats defeated centre-right government (2008) - unfunded social promises • Deeper and longer lasting crisis – Slow recovery. Decreased foreign demand + lack of foreign financing • Largest strike of public employees (October 2010).Cuts in social benefits, increase of retirement age • Public referendum rejected government programme (June 2011)

9. Slovakia: from political federation to economic-monetary union • Political consensus across governments to early entry in the eurozone. • Future membership is an external anchor to implement market reforms. • SKK enttered ERMII on November 2005 with a central parity at 38.455SKK/EUR. • SKK was revalued from March 2007 by 7.8% to 35.4424 • On May 2008 by 15% to 30.1260. • The centre-right Mikulas Dzurinda government elaborated entry strategy in 2004 and set the target date by January 2009. • The social-democratic Fico government asked the European Commission and the ECB on April 2008 to evaluate its preparedness and to authorize the entry on January 2009. • Positive standpoint by the European Parliament, ECOFIN Council, and European Council: exchange rate 30.126SKK/EUR

10. Slovakia

11. Slovakia, euro and the crisis • Highly export dependent – over 80% of GDP • Production of transport equipment, consumer electronics. Steep decline during the crisis, but fast recovery. • SK faced global recession with a de facto fixed exchange rate since mid 2008. Became too strong in relation to neighbouring countries’ devaluated currencies • Big and persistent decline in manufacturing employment • Unusual price increase (service prices) as a result of changeover from December 2008 to February 2009. • Severe deterioration in public finances. • Euro-membership offered a shield – higher investor confidence, more favourable bank lending rates

12. Estonia: from currency board to single currency • Political and social consensus about the need of the entry into the eurozone. Pre-accession government won the 2011 election despite the serious effects of the crisis. Economic–monetary integration does not contradict to political sovereignity. • Small and very open economy – need to further advance integration. Significant economic convergence. Prudent fiscal policy before the crisis – liquidity reserves. Corruption perception lowest in CEE. • 2000-2007 Fast economic growth based on private credit expansion, strong investment flows . Household and corporate debt doubled. Real interest rates turned negative. Wage increases outpaced productivity, pushed up unit labor costs. Appreciation of real effective exchange rate. Two digits current account deficits. Overheated economy.

13. Estonia

14. Estonia: Changeover to Euro • Andrus Ansip PM : For many Estonians besides positive emotions changeover to Euro could easily remain almost unnoticed • Fixed exchange rate – no hope to lower production costs via depreciation • Economic adjustment started in early 2008. Cummulative GDP loss amounted to 19% in 2008-09. • Internal devaluation. Labour shedding, reduction of working time, decline in wage bill. Downward flexibility of wages. • Recovery from crisis faster than expected. Rapid convergence in per capita income

15. Latecomers: Bigger countriesCzechia: almost able but not keen • Floating exchange rate + inflation targeting • Prior to crisis: External balances are solid, central bank is able to manage monetary policy. Lack of pressing constraints to change. Hard measures could be postponed. • Government document on the fulfilment of the convergence criteria (Dec. 2010): • Compliant with price stability criterion • Sustainability of public finance is not being fulfilled – excessive deficit procedure was opened for the second time • Appropriate timing of ERMII entry is key importance. • Low degree of spontaneous euroisation is due to confidence to domestic currency + sustained low inflation • Low government debt started to rise fast – high share of mandatory expenditure

16. Czech Euro: Invisible • ‚Milestones on the Road to Adopting the Euro in the Czech Republic’ • October 2003 Government adopts Euro Changeover Strategy – possible term 2009-2010 • August 2007 Original unofficial term (2009-2010) is being abandoned. • May 2010 3 party coalition – agreement do not fix date of adoption • July 2010 New Czech government decides not to fix date for euro adoption • Government should not set a target date for the entry and should not attempt to enter ERMII during 2011 • Since the global crisis: exchange rate and interest rate volatility, government deficit and public debt increased. Austerity measures invited strong social resistance: strike of public transportation workers • Budget deficit 2010: GDP 4.7% - 2013: 2.9% • Nominal cuts in the wages of public employees, rise in retirement age, reductions in social benefits – Consitution Court rejected austerity package

17. Czech and Polish Convergence Data

18. Poland: not able, not keen • Strategic Guidelines for National Euro Changeover Plan (October 2010) • Full membership among top priorities: as soon as possible, however secure euro area membership • Expected economic benefits: elimination of PLN/EUR exchange rate risk, drop in market interest rates, increased stability and credibility of government’s macroeconomic policy • Political benefits: participation in decision process of ECB and activities of Eurogroup • Benefits will stimulate trade, investments, reduce debt servicing costs, strengthens competitive position • Immediate benefit (estimate): 0.9-1.9% of GDP • Long-term benefit: 2.5-7.5% of GDP • Costs: organisational and technical adjustment, adaptation of IT systems, acquisition and distribution of euro banknotes and coins etc. • Risk of temporary, atypical price developments, abandoning independent monetary policy

19. Polish Convergence Programme 2011 • Integration with euro area – one of the government’s priorities • Changes made introduction more distant • Safe membership in ERMII – impossible to set credible target date • Economic policy framework consistent with priorities of ‚Europe 2020’ • Objective to reduce general government excessive deficit, ensure long-term sustainability of public finances • Political and social consensus is required to adopt the euro • Need to change the constitution – lack of political support

20. Romania: keen but not able • Target date for euro adoption 2015 • Economy has been severely hit by the crisis • Real convergence is progressing slowly • Especially inflation rate, government budget deficit, long-term interest rate are far beyond convergence criteria • Political cohesion is weak between political parties

21. Bulgaria, Latvia, Lithuania (currency board) • Litas joined ERMII already in June 2004 . Lithuania planned to adopt euro from 1. January 2007, but average annual inflation was marginally higher than reference value therefore European Commission rejected its application on May 2006. Lithuania had 8.9 % budget deficit in 2010 and its long term interest rate was too high, 12.1%. • Bulgaria was not allowed to join ERMII in 2010 due its higher than expected budget deficit. Bulgaria main weaknesses were in 2010 long term interest rate (6.0%), unemployment rate (10.2%). Its budget deficit amounted to 3.2%, government debt to 16.2%, and inflation 3.0%. In the previous years it had two digits deficit in current account. • Latvian lats entered ERMII on May 2005. Its government sets January 2014 for Euro adoption. Latvia had 7.7% budget deficit in 2010. Government debt and inflation figures were low, but it had 17.8% rate of unemploment. • The sustainability of these figures could be questioned.

22. Conclusions • Besides nominal and real convergence, capability to cope with competitive pressure is important criteria (Maastricht + Copenhagen) • Timing and international environment of the entry to ERMII and eurozone are having significant importance. Eurozone itself is going through changes concerning its regulation therefore it is getting harder to enter. • Political cohesions, consensus, political culture, cross-party solidarity is required to enter the eurozone • Global economic-financial crisis has changed governments’ priorities. • Political constituency of adoption of euro has been weakening • Those who are already in may further benefit. • Alternative solutions to adoption of the euro are not providing better results.