COMMENT: Euros in the wallets of the Slovaks, but who will be next?

By bne IntelliNews May 8, 2008

Erste Bank -

Shortly after the new member states joined the EU in 2004, the Baltic countries, Hungary and Slovenia expressed interest in joining the Eurozone as soon as possible. Some of them who had a fixed exchange rate regime even questioned whether it was necessary to spend an additional two years in ERM-II before the assessment.

For many countries, euro adoption became a political agenda without a deeper understanding of economic trade-off or political costs. The CEE preference for early euro adoption has changed since, because politicians are now confronting the reality in terms of the economic trade-off and political costs related to early adoption.


The highest political costs related to fiscal consolidation occurred in Hungary, where the government had to cut the fiscal deficit during an economic slump, which always hurts. Now, it seems that Hungary will not be able to meet its Medium Term Objective plan to cut the structural deficit to below 1% before 2012, because of the high political costs related to reforms in Hungary. Orsolya Nyeste, macro analyst at Erste Bank Hungary, says: "Hungary does not have any official euro adoption target date, but implemented a fiscal adjustment programme in 2006 that resulted in a budget deficit reduction to a more sustainable level. In addition, the abolition of the forint exchange rate band announced this February could create a basis for a market-determined ERM-II entry rate, as a preliminary stage for EMU entry. However, 2014 seems to be the earliest possible date for Hungary to join the monetary union."

Czech Republic

Much better positioned for euro adoption is the Czech Republic, but the single currency is currently not at the top of the political agenda. This is mainly because the country wants to make structural reforms first in order to increase the flexibility and competitiveness of the economy. Positive public perception of the crown's appreciation, which is a benefit of sovereign monetary policy and a more convenient way to achieve price convergence, is another reason why the Czech Republic is not in a hurry to adopt the single currency. Therefore, we do not expect the Czech Republic to join the Eurozone before 2015.

"The Czech Republic does not have any strictly set date for Euro adoption - a strategy approved in 2007 now only says that 'the euro adoption date will depend on strengthening of the Czech economy's flexibility and on solving problems associated with public finance reform'. All in all, largely unreformed systems and a lukewarm reaction from a substantial part of the elite towards speedy euro adoption lead us to forecast euro adoption no sooner than in 2015," says Martin Lobotka, macro analyst at Ceská sporitelna.


In contrast to the Czech Republic, Poland might benefit from strong governmental support of early euro adoption and could adopt the single currency by 2013. "Poland currently does not have an officially agreed national target date for euro adoption. We expect that the most likely entry year will be 2013, so the country would enter ERM-II not later than in 2010," says Lubos Mokras, macro analyst at Ceská sporitelna. "The current climate of higher inflation, which has both domestic and international sources, is in our view only temporary and the determined monetary policy of the central bank will ensure inflationary stability."


Romania needs much more time to advance its structural reforms ahead of euro adoption, but it is interesting that Romania's ratio of public debt to GDP is one of the lowest of new EU members. The price level is not so far from Hungary's (57% versus 60% of the EU27), so Romania is much better positioned to fulfill the Maastricht criteria in the medium term than Hungary. Romania can apply for euro adoption by 2013 and join the Eurozone in 2014. Before that, financial markets will have to regain confidence in the Romanian currency and enable smooth entry to ERM-II in 2011. It seems that this is still not properly priced in long-term yields to actually provide the most interesting "convergence play" opportunity.

"Although Romania made good progress in terms of convergence in the last few years, there is still a long way to go. At the end of 2007, two out of five nominal convergence indicators were not consistent with Maastricht Criteria, such as inflation and long term interest rates. We expect that rising inflation and significant external imbalance only have a temporary nature. Thus we still see the adoption of the European single currency in 2014 as a real possibility. This will of course strongly depend on the continuation of the economic reforms and restructuring of the economy - and the next three years will be crucial from this point of view," says Dumitru Dulgheru, macro analyst at Banca Comerciala Romana.


While for the above-mentioned countries the biggest obstacle in euro adoption is fiscal consolidation, the Baltics face a completely different challenge - how to meet the inflation criteria. Their pegged currencies do not support the disinflation effort, compared to CEE countries with floating regimes where currency appreciation takes away part of the inflationary price convergence. It will take at least two years for the recently elevated inflation to settle down. Baltic countries have been in the ERM-II for longer than the required two years, so they can apply for the single currency in any year they fulfill the inflation criteria. However, sustainability will be always questioned and that remains the main risk.


Alen Kovac, macro analyst at Erste & Steiermärkische bank in Croatia, says: "At this point, prior to EU entry, it might be too early to speculate around Croatia's entry to the Eurozone. According to the present timeline Croatia should become an EU member in 2011, meaning that Eurozone entry would be scheduled no earlier than 2014. Croatia would not be likely to wait long to apply for ERM-II, and become a Eurozone candidate, since the proportion of 'Euroization' in the economy is already high and the loss of monetary sovereignty would therefore not be substantial. So, from the current picture, fulfillment of the Maastricht criteria should be well within the reach - nevertheless with such a long timescale some risks may arise along the way."

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