BALKAN BLOG: Southeast Europe remains keen on eurozone despite its woes

BALKAN BLOG: Southeast Europe remains keen on eurozone despite its woes
By joining the eurogroup Southeast Europe would get a bigger say in how the union develops in the future.
By Clare Nuttall in Bucharest November 30, 2016

Amid the numerous crises to hit the European Union in recent years, the planned expansion of the eurozone has run out of momentum, because of a lack of political will both in Central Europe and in Brussels. However, the newer member states on the southeast fringe of the bloc are still keen to benefit from closer integration. While the timing of when Bulgaria, Croatia or Romania will join the eurozone is unclear, and all three countries are a long way off being ready to join, politicians of all stripes have expressed their political commitment to joining.

For the most part, as the EU struggles to handle the wave of refugees from the Middle East and Africa, Brexit, as well as the Greek debt crisis - Brussels has looked to retrench rather than expand, a stance that affects both enlargement of the EU and of the eurozone. More threats loom on the horizon, among them the rise of far right leaders such as Marie Le Pen in France, whose ambitions for a “frexit” referendum would pose a real threat to the future of the union should she be elected president next year.

However, the new entrants on the periphery of the EU have for the most part responded to the new reality with a desire to embed themselves in the heart of Europe and, by adopting the single currency, to join the inner circle of EU members, thereby also getting a bigger say in how the union develops in the future.

The countries of Southeast Europe, both within and outside the EU, are in general much more positive about the bloc than their peers from Central Europe that joined a few years earlier. Broadly speaking, in Southeast Europe the EU is still seen as a force for good - spanning areas from the fight against corruption, to economic reform, to structural funds for much needed infrastructure projects.

By contrast, the countries of Central Europe, in particular Viktor Orban’s Hungary, have taken a much more eurosceptic stance, with both Hungary and Poland seeking greater autonomy for member states within the bloc.

In Romania, the rival centre-right and centre-left political blocs are both in favour of eurozone entry. Former Prime Minister Viktor Ponta of the centre-left Social Democratic Party (PSD) set 2019 as the deadline for euro adoption two years ago. The target has since been dropped, as confirmed by President Klaus Iohannis, following repeated warnings from the central bank that Romania was not ready. Nonetheless, both the PSD and the rival National Liberal Party (PNL) want to see Romania within the eurozone as soon as practicable.

This reflects public opinion in Romania, where a 2015 Eurobarometer survey found that 54% of the population - the highest level in any country surveyed - backed euro adoption.

Inferiority complex

The proportions of the populations in favour of eurozone entry were lower in Bulgaria but other studies of public opinion there show that the EU is by far the most trusted institution by Bulgarians, well ahead of local politicians in particular. This is most likely one of the reasons why politicians from both right and left advocate Bulgaria’s further integration with the EU and have been keen to demonstrate their credentials as responsible EU member states.

“The financial crisis in Europe has exposed a certain inferiority complex regarding Bulgaria’s position within the EU,” wrote Daniel Smilov in a paper on Bulgaria for the European Council for Foreign Relations (ECFR). “As the EU’s poorest member Bulgaria sees the Union as the surest way to improve its economic position … But is also aware that its links to Greece, the fall-out from the euro crisis more generally, and a reputational problem over the efficiency of the country’s government and corruption might deny it the full benefits enjoyed by previous joiners of the EU.” As a result, “Bulgaria has striven to demonstrate that it justifies its membership, for instance through financial discipline,” Smilov concludes.

This concern was voiced by Bulgaria’s outgoing President Rosen Plevneliev, who told Bloomberg in late September that the country “needs to speed up its efforts to join the euro area in order to avoid being sidelined in European politics”. In an interview with the newswire, he called for Bulgaria to accelerate its preparations for euro adoption, “or it risks falling behind in the decision making process.” Plevneliev is due to be replaced by General Rumen Radev, the Bulgarian Socialist Party (BSP) in January. However, there is no substantial policy difference on EU integration between the main centre-right parties and the BSP.

In Croatia, the Social Democratic party, which had been less enthusiastic on euro entry, was replaced in office by a centre-right coalition comprising the Croatian Democratic Union (HDZ) and Bridge of Independent Lists (Most). The coalition is headed by a former European parliament member, Andrej Plenković.

Croatia’s President Kolina Grabar-Kitarovic said back in April 2015 - as Croatia started to emerge from a six-year recession - that she envisaged entry to the eurozone in 2020. Finance Minister Zdravko Maric, who has kept his post through the collapse of the first HDZ-Most government and the formation of a new coalition, took a slightly more conservative position in an interview with Bloomberg in April, saying Croatia could enter the exchange rate mechanism (ERM) by 2020. Zagreb “is sticking to preparations for joining the euro area even as the Greek debt crisis has curbed the common currency’s appeal among other post-communist members of the trading bloc,” Maric told the newswire.

Like all the other EU member states that have not adopted the euro yet, except for Denmark and the UK, which have opt-outs, the countries of Southeast Europe are required to join the eurozone when they meet the entry criteria. The convergence criteria measure price stability, soundness and sustainability of public finances, exchange-rate stability and long-term interest rates, to assess the durability of the convergence achieved by fulfilling the other criteria.

The latest convergence reports published by the European Commission and European Central Bank on June 7 found that while the seven countries assessed had made progress on convergence, none was yet ready to join the euro.

Specifically, the assessments found that all the member states fulfilled the long-term interest rate criterion, all except Sweden the price stability criterion, and all except Croatia the criterion on public finances. Croatia is currently in the EU’s Excessive Deficit Procedure due to its high general government deficit and public debt. In 2015, Croatia's general government deficit was 3.2% of GDP (slightly above the 3% limit set by the EU), while debt reached to 86.7% of GDP - well above the 60% target. On the other hand, Croatia was the only country whose legislation  was fully compatible with EMU rules.

Political will

None of the countries have yet joined the Exchange Rate Mechanism (ERM II); countries need to be part of the mechanism for least two years before joining the euro area. The last is a political issue, since it is up to members of the eurozone to approve applications to join the ERM, though there must also be political will on behalf of applicants to enter the mechanism.

This is largely academic in Bulgaria, where the lev has been pegged to the euro for more than a decade. However, concerns were expressed about macro-imbalances in the country, as well as the state of the business environment and the situation in the banking sector after the collapse of Corporate Commercial Bank (Corpbank) in 2014.

There are also concerns about excessive macroeconomic imbalances in Croatia, and about the government’s Swiss franc loan conversion programme, which is the subject of an investigation by the European Commission.

Unlike Croatia, Romania met conditions on public finances and public debt, but more needs to be done to harmonise its legislation with the eurozone.

In addition, GDP per capita is still well below the eurozone average across the region. Even Croatia, which has the highest GDP per capita, is considerably below where Slovakia’s was when it joined the eurozone in 2009.

This has led to a belief in some of the potential eurozone members that it would be better to wait until their incomes rise before joining the bloc.

The case for waiting until Romania is fully prepared was put forcefully in a new report, ‘Romania and the accession to the Eurozone: the question is IN WHICH CONDITIONS!’ published by the European Institute of Romania. The report’s authors warn against nominally fulfilling the membership criteria and rushing into membership, calling instead for deep reforms within Romania to put the country in a strong position before it enters the single currency.

The report’s coordinator, Professor Daniel Daianu, tells bne IntelliNews that even if Romania is invited to join the eurozone, “we believe we have to achieve a critical mass of real convergence … going beyond the nominal convergence criteria.” He lists areas where reform is needed within Romania, in particular addressing the wide income disparities between urban and rural areas and improving the “pathetic” level of tax collection.

The report warns that the lessons of the eurozone crisis need to be taken into account, including the failure to allow sufficient convergence between member states and the lack of tools for dealing with asymmetric shocks.

For Bucharest, accession to the eurozone “should be a decision made rationally, considering lessons of the last decades and major problems which are facing the European Union,” the report says. At the same time, Daianu argues there is a need to improve the functioning of the euro area in particular with regard to banking union.

Internal demand

Another argument for Romania and other large economies such as Poland or the Czech Republic to wait before joining the eurozone is that their need for the benefits of facilitated trade is less potent than in the smaller economies with less of a domestic market.

Notably, the five states from the former eastern bloc that have joined the euro - Estonia, Latvia, Lithuania, Slovakia and Slovenia - are all small economies. Slovakia has the largest population at just under 6mn, while most have populations of 2mn-3mn. Joining the eurozone “can potentially be more difficult for bigger countries, but I think its more that the attractiveness from their side is more limited because they have internal demand they can rely on,” says Robin Huguenot-Noël, policy analyst at the European Policy Centre (EPC).

At the same time, the existing eurozone members are becoming more cautious and less eager to expand the single currency zone to members who could potentially be problematic - a stark lesson from the Greek crisis.

Bulgaria in particular, which has strong business ties with neighbouring Greece, has been faced with “the difficult task of convincing the rest of the EU that … Bulgaria is not Greece despite all the geographical, cultural and historical similarities,” writes Smilov. Caution arising from the Greek crisis works the other way too: Bulgaria’s outgoing Prime Minister Boyko Borissov said in June that Bulgaria was in no hurry to enter the eurozone, citing the experience of neighbouring Greece, according to Reuters.

“[T]he financial crisis has discouraged Euro Area member states from expanding to new members unless the candidate country is perfectly prepared and economically well synchronised with the Euro Area core,” says Juraj Kotian, head of CEE Macro Research at Erste. “Not only headline numbers will need to comply with the Maastricht criteria, but also structural deficits, the level of economic and price convergence and economic imbalances of the candidate country will be more carefully analysed. From this perspective, the Czech Republic would be more ready than Romania.”

According to Huguenot-Noël, “the political balance between the eurozone and the member states potentially joining was quite impacted by the crisis. [Member states] now have a bit more power over deciding mostly the timing of joining the eurozone, and this has been recognised by the European Central Bank.”

There has also been a shift from the perspective of the European institutions, in that they are now “very inwards focussed, on many levels that tends to be much more the dynamic now,” says Huguenot-Noël. This is part of a wider trend across the EU, reflecting not just the eurozone crisis, but also the twin political shocks of Brexit and the refugee crisis.

At present, the three crises facing the EU seem as troubling as ever. A new package of debt relief for Greece is currently under discussion. The terms on which the UK will exit the EU are unclear, and confusing messages from London have plunged the rest of the EU28 into uncertainty. Turkey’s President Recep Tayyip Erdogan has threatened to unleash floods of refugees into Europe if Turkey’s accession talks do not progress. Under these circumstances, expansion of the eurozone remains far from being a priority for its existing members.