New kids in the euro bloc

By bne IntelliNews June 29, 2010

Mike Collier in Tallinn -

You can learn a lot from a motorcade. Russians recently took to the streets with dummy blue lights atop their Ladas in protest at being constantly run off the road by oligarchs, and in much of Central and Eastern Europe the high-speed fleets of expensive metal for minor ministers reach proportions that any tin-pot South American dictator would be proud.

Following Estonian Prime Minister Andrus Ansip's motorcade out of Tallinn is rather different. For one thing, it takes 10 minutes to notice that the car in front is the PM's. His "fleet" consists of two nearly-new BMWs of a kind that are rather common in BMW-mad Estonia. Neither of the cars has flashing lights, sirens or flags. They obey the speed limit even on long, empty straights. They stop at traffic lights and pedestrian crossings, trundling behind tractors when necessary and covering the kilometres southwards at a steady pace.

Then, waiting at the Latvian border is a vast fleet of Latvian police and security cars that swallow up Ansip and whisk him away at top speed over Latvia's bumpy, dusty highway towards a meeting in Riga.

Such sensible and steady progress could usefully serve as a metaphor for his country's drive towards the Eurozone, which it is likely to join next year once EU finance ministers give their final approval on July 13. That should be a mere formality, a view shared by Ansip himself. "Our main goal for this year is to join the Eurozone from January 1st, 2011 and now it seems that developments are quite positive," Ansip told bne at the World Forum for Foreign Direct Investment in Tallinn, a day after the same group of ministers signalled their readiness to wave Estonia into the club on May 12. "According to our understanding, we fulfill all the Maastricht criteria limits in a sustainable way."

Maybe so, but many have begun questioning whether the current crisis afflicting the Eurozone will mean that other new EU countries find the bar to joining the euro has been raised, or that simply many of them won't want to join the euro at all.

Nordicness needed

Speaking to Ansip it's clear that calmness and conservatism aren't just an affectation. With his smart but modest dark grey suit, measured tones and impressive powers of data recall, he seems a living example of the "Nordicness" that Estonians believe makes them temperamentally and economically closer to Scandinavia than Central and Eastern Europe.

Though Estonia's progress towards the Eurozone is winning the small nation of 1.3m people lots of positive headlines, Ansip resists the temptation to say "I told you so" to those who doubted it would reach its goal. "I don't want to act as an example. Estonia isn't so perfect that it can teach others how to act because unemployment is awfully high, the growth rate was awfully negative last year [-15%] and in our case the quick reaction to the crisis was really the only option we had. As a result, our deficit last year was 1.7%, which was the third smallest in the EU, but still a deficit."

His speech is peppered with a recurring phrase: "conservative fiscal policy." It serves as a useful soundbite but, Ansip insists, also has its basis in Estonia's Nordic nature. "We don't like deficits here in Estonia. It is really so - public opinion does not support borrowing money from our children and grandchildren. This balanced budget is a must for Estonian public opinion," he explains.

Ansip freely admits that Estonia's eagerness for the euro has less to do with general euro-enthusiasm than some much more pragmatic reasoning. "It is mainly a publicity issue and less a financial issue," he says. "In fact, the euro is in use in Estonia already because of the fixed exchange rate and 90% of credit has been taken in euros. The only difference is the pictures on our banknotes - our banknotes are more beautiful than euro banknotes," he jokes.

Ansip notes that 70% of the foreign direct investment that Estonia gets is from Sweden and Finland. Given that companies there have had difficulties at home because production volumes have decreased and they need to cut their expenditures, one way to do that is to move production to Estonia. "But those entrepreneurs still have some doubts because they remember how the Swedish crown and Finnish mark were devalued during the last recession in the early 90s. The only way out of those rumours about a possible devaluation is to join the Eurozone as soon as possible."

Ansip says that in fact Estonia hasn't changed the exchange rate of the kroon for the last 18 years, but investors often don't trust small national currencies. As an example of how little the markets really knew about Estonia's relative strength, he cites the market for credit default swaps (CDS). "We were pretty surprised a year ago when CDS for Estonia were at a very high level. Sorry, but we don't have government bonds. We practically don't have government sector debt at all, but CDS were being sold at high prices. It's emotional behaviour from the financial markets."

Ansip waves away the theory that Estonia could be climbing aboard the Eurozone just as it starts to sink, thanks to Greece, Portugal Italy and Spain - countries that certainly don't share Estonia's culture of Nordic restraint - but not everyone is so sure the effort will prove worthwhile. "We were invited to the wedding, but it seems to be the funeral," says Andres Arrak of the Tallinn-based Mainor Business School. "The economic, social and political environment in the Eurozone is changing so quickly that nobody in Estonia knows what exactly we are stepping into on January 1. Already the Eurozone is not what it was with the ECB [European Central Bank] giving loans to governments."

Arrak doubts that Europeans are ready to transform the EU from a union of countries into a US-style federal state. "But simple macroeconomic theory says that unified monetary policy combined with independent social, labour and budget policies doesn't work. There is no simple solution. I think that it must be clear and easy to exclude from the union these countries who are not able to meet the criteria," Arrak says.

Alf Vanags, another respected regional economist at the Stockholm School of Economics in Riga, thinks along similar lines. "If I was running a country in CEE, I would not be any rush to go into the Eurozone. Certainly if I was Estonia, I would be thinking whether it's something I really want to do. Do I want to be in there spending money on Greece, Portugal, Italy, Spain and possibly others?

Vanags spells out a good reason not to join, one that's been made by British Prime Minister David Cameron, whose Conservative party has made it clear it will never take the UK into the Eurozone. "The way it works is if [Greece, Portugal, Italy, Spain] are in trouble, the other Eurozone countries have to put in resources to support them. If you're not in the Eurozone, you don't have to do it."

Big enough to stay out

If Ansip's pragmatism is based on the fact that Estonia's kroon is at best misunderstood and at worst invisible, the same argument cannot be made for the Polish zloty or Czech koruna, which have deep markets and lubricate fairly balanced economies.

Poland, the Czech Republic, and even more troubled Hungary and Bulgaria look like they will play hard to get, as recent statements by politicians and officials suggest.

Immediately before his confirmation as the new Polish central bank governor, Marek Belka said on June 11: "The fact that we weren't in the euro area at the worst of the crisis helped us tremendously, because the depreciating zloty helped shield the economy from its impact."

Czech President Vaclav Klaus, Bulgarian central bank deputy governor Kalin Hristov and even the US economist Steve Hanke, whose suggestions formed the basis of Estonia, Lithuania and Bulgaria's currency regimes, have all said there should be "no rush" to adopt the euro.

In contrast, Latvia and Lithuania are still pinning all their hopes on the euro as their "exit strategy" targeting 2014-15 as their accession dates and believing Estonia's success shows the door is still open to them. "Ultimately you have to have stronger political integration in order to have a better chance that these fiscal problems don't re-emerge," Alf Vanags argues. "That means constraining fiscal sovereignty of individual states."

Bulgaria's fiscal position is a case in point of why many Eurozone states, notably Germany, aren't particularly keen to see newer EU members join the single currency. In April, the new centre-right government in Bulgaria revealed dozens of unaccounted public procurement deals signed by the previous government, which forced it to revise its end-2009 budget deficit to 3.9% of GDP, well above the 3% limit for the euro, from 1.9% initially. In mid-June, the EU Economic and Monetary Affairs Commissioner Olli Rehn expressed his alarm at this situation. "We have had some concerns about the statistical performance of Bulgaria and are considering sending a mission shortly," he said.

In the long run, the future of the euro is bound up with the future of the EU as a political entity, Alf Vanags says. "Possibly the most likely outcome is a two-speed Europe with a federal Eurozone core and then some kind of fringe of the other states."

It remains to be seen how fast the wheels of such a "twin-speed" Europe would turn. EU policymakers might like to study Andrus Ansip's motorcade for some tips.

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