Despite ECB scepticism, Commission to recommend Slovakia for euro

By bne IntelliNews April 30, 2008

Jan Cienski in Bratislava -

A year ago, questions about whether Slovakia would be able to adopt the euro produced on-the-record statements of confidence, but off-the-record comments from officials and analysts that were much more skeptical. That mood of guarded concern has evaporated in Bratislava amid a firm conviction that Slovakia has jumped all the hurdles it needed to clear before becoming the first former Soviet bloc country to be admitted to the common currency.

"Slovakia's euro ambitions are in the bag," declares Jan Toth, chief economist for ING Bank in Slovakia.

The latest positive signal for Slovakia came in the final week of April, when the European Commission released its economic forecasts. Those showed Slovakia's inflation rate will likely drop off next year, reducing worries that inflation will soar when it abandons its koruna for the euro in January. The final formalities will take place on May 7, when the Commission and the European Central Bank each release separate analyses of the euro candidate countries.

The online news service EUobserver claims to have seen a draft of the Commission's report recommending the introduction of the single European currency euro in Slovakia as of January 1, 2009. "In its convergence report, the commission concludes that amongst the assessed member states only Slovakia fulfills the conditions for the adoption of the euro," EUobserver quotes the draft document as saying.

However, sources say the ECB report is likely to be more scathing, pointing out the dangers of admitting unprepared and very fast-growing economies into the Eurozone. "The report will be very tough, we want to send a warning signal to the Commission," says an official at the bank.

Even so, the Commission is not obliged to heed the bank, and the decision to let Slovakia in will be as much political as economic. Not admitting Slovakia despite it meeting all of the Maastricht criteria for entry would send a dismaying signal to the other new member countries of Central Europe. The message would be that they are to be permanently consigned to second-class status and have no chance of being allowed into the Union's top club.

Meeting the dress code

Slovakia has met all of the convergence conditions. Its budget deficit, public debt and interest rates meet the targets, and it has been in the ERM-2 exchange rate mechanism since November 2005. Inflation averaged over the last 12 months was 2.2%, comfortably below the 3.2% threshold. The remaining worry had been the sustainability of inflation, with the fear being that once it gives up the koruna, Slovakia will lose the buffer of an appreciating currency and its inflation will rise much faster than other countries in the common currency area, mainly because of its scorching growth - expected to be 7% this year. The ECB has been burned by other new members whose inflation took off immediately after joining, the prime example being Slovenia, which now has the highest inflation among euro countries.

But those doubts will likely be too little to stop Slovakia from adopting the euro in January. Just a month earlier, Toth estimated the chances of Slovakia being allowed in at 82%, now he says it's close to 100%. That certainty would have seemed ludicrous just a few years ago, when Slovakia appeared about to drop off the edge of Europe as it stagnated under the authoritarian rule of former prime minister Vladimir Meciar and toyed with re-entering Russia's embrace while neighbours like Poland, Hungary and the Czech Republic raced toward membership in Nato and the EU.

Slovakia staged a comeback in 1998 under the leadership of Mikulas Dzurinda, who helped ram through one of the most dramatic economic reform programmes in the region. After shepherding Slovakia into both Nato and the EU and creating the conditions for an economic boom, Dzurinda was turfed out of office in 2006 by current PM Robert Fico and his populist coalition. "Before the elections, Fico promised to cancel the reforms," says Ivan Miklos, who as Dzurinda's finance minister had been one of the architects of the reform programme. "Initially, markets and analysts were very suspicious, but the previous commitment to enter the euro acted as a brake."

Some of Fico's early comments spooked financial markets, but a meeting early in his tenure with the Slovak central bank appears to have persuaded him to the political benefits of adopting the euro. Fico has tweaked some of the reforms, ending an unpopular user fee for health care services, but in the main he has not upended the reform programme. "In general they are not following irresponsible policies, although they are not doing enough to sustain economic growth," says Miklos.

The result is a government of inaction that has become fixated on entering the euro as its overarching economic policy goal. Fico's economic advisor, Peter Stanek, says: "We are preparing a strategy for the next two years and the prime minister says, 'Don't change anything'."

Viliam Patoprsty, chief economist for UniCredit Bank in Slovakia, says: "Two years ago, the expectations for Fico's economic management were a lot worse. They are playing at the image of being a leftist government without doing anything significant."

While Fico's image as a populist may have taken a bit of a beating, the fiscal probity that made Slovakia one of the EU's tiger economies hasn't been abandoned, and the country of 5m will see its reward next year when it becomes the newest member of the Eurozone.

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Despite ECB scepticism, Commission to recommend Slovakia for euro

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