Single solution for Central Europe's currencies

By bne IntelliNews March 18, 2009

Ben Aris in Berlin -

With emerging European currencies in meltdown from the start of the year, some experts at the International Monetary Fund reputedly came up with a radical solution to stabilise the wobbly economies: get some countries in Central Europe to make a one-off devaluation and let them adopt the euro the following day.

The idea went down like a lead balloon, as existing euro members are afraid of debasing their currency, but the idea has some merit. By devaluing the currency, countries could deal with the changed realities in the global economy and, most importantly, reduce their ballooning current account deficits. Then by switching to the euro they would, at a stoke, impose currency stability. Adopting the euro comes with the added bonus that investors tend not to lump a Eurozone country in with the rest of the basket cases in emerging Europe - something the better-off countries in the region have complained bitterly about recently.

"The idea sounds nice but it's a non-starter," says Ralf Wiegert, an analyst with Global Insight. "It would have caused not only a big surprise, but also outrage among many older Eurozone members and especially Germany."

There are various legal problems to a rapid adoption of the euro, too. For example, Poland (one of the candidates for a rapid switch) ostensibly can't adopt the euro unless the constitution is changed. Then there is the logistical nightmare that rushing into the Eurozone would create. Even so, the issue of accelerated membership is now definitely on the table and set to become an increasingly hot topic over the next few months. Indeed, Polish Finance Minister Jacek Rostowski told newswires in mid-March that if the opposition Law and Justice party continued to oppose the planned changes in the constitution to adopt the euro, the government would find a way to enter the Eurozone without amending the constitution.

Best solution

Clearly, the $24.5bn the World Bank and others have promised to prop up CEE isn't going to be enough. The EU will be asked - and has half committed itself - to offering bailout loans to struggling countries in the region. The trouble is, how are the suddenly impoverished member states going to finance billions of dollars worth of loans for their neighbours? "The cheapest option from the EU's point of view by far would be to grant ERM-2 access to those countries that have credible euro adoption plans, eg. Poland. Of course, this wouldn't give a boost to the economy, but should go to great lengths to stabilize the currency," argues Oliver Weeks of Morgan Stanley.

The rating agency Standard & Poor's said in a recent report that Slovakia's economy has enjoyed some shelter from the storm thanks to its adoption of the euro at the start of this year: Slovak economic growth should slow to 2% year on year in 2009 from 7% in 2008, but that would still make it one of the best performers in the world.

However, EU leaders voted overwhelmingly to keep the euro accession question off the agenda at the last meeting on March 1. And the ECB hates the idea. The bank said at the start of March: "Allowing a member state to take a 'short-cut' to the euro could be detrimental to that country and possibly the euro area because: 1) a sustainable convergence that is conducive to the maintenance of price stability and coherence of the euro area may not have been achieved; 2) it would breach the principle of equal treatment, and 3) it would not ensure that the country in question pursues the right policies to thrive under the euro."

All the aspirant countries except Slovenia and Slovakia have so far been excluded, as none meet the so-called Maastrict criteria - the Baltic states nearly made it two years ago, but missed entry by a whisker because their inflation rates were too high. But now the world is in crisis, people have started getting less fussy about the rules and are concentrating more on what will work - and especially what will work cheaply

Proponents of opening the doors to the euro point out that most of the big members of the Eurozone routinely flout the Maastrict criteria with impunity, so the rules are already meaningless. Secondly, countries like the Baltics, which have a combined GDP of only €70bn, would make no noticeable difference to the value of the currency as they are simply too small, but adoption would have enormous benefits for them. The alternative of defending the Baltics' currency pegs (with EU bailout money) could become very expensive.

The idea would work best for countries that have currencies already pegged to the euro: Estonia, Latvia and Lithuania, plus Bulgaria. But experts say accelerated adoption of the euro would make far less sense for the bigger countries with floating exchange rates - the Czech Republic, Hungary, Poland and Romania - as none of these is ready for the tough discipline of a single currency that rules out any future devaluation. Their premature entry could fatally weaken the euro, they say.

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