Transcript The enlargement(s) of the euro area

Preparing for euro
adoption
Anatoli Annenkov
Principal Economist
Directorate Economic Developments
12 October 2006
The views expressed in this presentation are solely those of the presenter and do not
necessarily reflect those of the European Central Bank
Outline
• Benefits of adopting the euro
• Risks related to premature euro adoption
• ERM II
• The formal enlargement process
• The convergence criteria
• State of convergence
• Some policy challenges
• Price and exchange rate stability
2
Benefits of euro adoption
• a) For the individual country:
- stable exchange rates in relation to most
important trading partners;
- credible framework for monetary policy and
price stability = low risk premia and low long-term
interest rates;
- reduced transaction and information costs;
- higher protection against financial disturbances.
• b) For the euro area:
- completion of the internal market, providing
price and cost transparency;
- economies of scale and more efficient allocation
of production factors.
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Risks related to premature euro adoption
• a) For the individual country:
- differences in business cycles may lead to ‘suboptimal’
interest rates in the national context and the emergence of
local “bubbles”/“crises”;
- unless convergence is sustainable, a country can run into
competitiveness problems, with no resort to exchange rate
changes;
- without sufficient flexibility to adjust to changes in
competitiveness - risks of protracted economic losses.
• b) For the euro area:
- less cohesion in the euro area may complicate the single
monetary policy;
- lack of convergence and flexibility may affect the credibility
of EMU.
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The road to the euro
(as stipulated in the Treaty)
Optional:
Pre-ERM II phase
Accession to
the EU
ERM II membership
Entry into ERM II
ERM II membership
Technical preparations
Adoption
of the
euro
Assessment of convergence,
formal decision on entry and
conversion rate
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Exchange Rate Mechanism II
• ERM II membership voluntary but expected
• Main features of ERM II
–
Fixed but adjustable exchange rates vis-à-vis the euro
–
Standard fluctuation band ±15%
–
Central parity and fluctuation bands mutually agreed
–
Both the ECB and the Member State concerned can
trigger a review of the central parity
6
Exchange Rate Mechanism II (cont’d)
• Entry is not subject to legal criteria
–
Case-by-case assessment based on equal treatment
–
Major policy adjustments (e.g. price liberalisation and
fiscal reforms) to be undertaken prior to entry
–
Need to follow credible fiscal consolidation path
• Length of participation
–
Minimum two-years prior to examination of
convergence
–
No restrictions on length of participation beyond
minimum period
–
Should be assessed on the basis of what is most
helpful to accompany the convergence process
7
Formal enlargement process - role of the ECB
• Every second year, or at the request of a country, the
ECB and the European Commission report on the state
of convergence in their Convergence Reports.
• Case-by-case examination based on the convergence
criteria and the principle of equal treatment.
• Based on these examinations and on a proposal by the
Commission, the (ECOFIN) Council will decide which
countries fulfil the necessary conditions for adopting the
euro.
• The Council will also decide the conversion rate at
which the national currency will be replaced by the euro.
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Convergence criteria
The criterion on price stability
“the achievement of a high degree of price stability;
this will be apparent from a rate of inflation which is
close to that of, at most, the three best performing
Member States in terms of price stability”
– Reference value: average HICP inflation rate of,
at most, three best performing EU Member
States + 1.5 percentage points.
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Convergence criteria
The criterion on the government budgetary position
“the sustainability of the government financial
position…will be apparent from having achieved a
budgetary position without a deficit that is excessive…”
– Reference value: the ratio of the government
deficit to GDP should not exceed 3%.
(unless the ratio has declined substantially and come close to the
reference value)
– Reference value: the ratio of government debt to
GDP should not exceed 60%.
(unless the ratio is sufficiently diminishing and approaching the
reference value)
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Convergence criteria
The exchange rate criterion
“The observance of the normal fluctuation margins
provided for the exchange–rate mechanism of the EMS,
for at least two years, without devaluing…”
– The ECB examines whether a Member State has
participated in ERM II for at least two years prior
to the examination without severe tensions, in
particular, without devaluing its currency against
the euro.
– Focus is put on the exchange rate being close to
the central rate against the euro, while also
taking into account factors that may have lead to
an appreciation.
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Convergence criteria
The long-term interest rate criterion
“The durability of convergence achieved by the Member
State and of its participation in the exchange–rate
mechanism of the EMS being reflected in the long-term
interest rate levels”
– Reference value: average of long-term interest
rates in the three best performing EU Member
States in terms of price stability + 2 percentage
points.
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State of convergence – price stability
H ICP inflation
(annual average percentage change, September 2005 - August 2006)
9
8
7.0
9
7.4
7.8
8
7
7
6
6
5
4.1
4
Reference value 2.6%1
3
2.3
2
2.4
2.7
3.0
3.1
4.4
5
3.4
4
3
1.4
1.3
2
1
1
0
0
Poland Sweden Cyprus
Czech Slovenia Hungary Malta Lithuania Slovakia Estonia
Rep.
Latvia
Bulgaria Romania
1
Source: Eurostat. From the May 2006 Convergence Report, based on inflation in Sweden, Finland and Poland. Euro area average = 2.4%.
Denmark and the UK are not shown as they have a special status and are presently
not candidates for joining the euro area
13
State of convergence – government balances in 2005
4
2
General government surplus (+) or defict (-)
(%of GDP)
2.9
4
3.1
1.6
2
0.2
0
0
-2
-4
-0.4
-0.5
Reference value -3% of GDP -1.8
-2
-2.4
-2.5
-2.6
-2.9
-4
-3.3
-6
-6
-6.1
-8
-8
Sweden Estonia
Latvia Lithuania Slovenia Cyprus
Source: European Commission Spring 2006
Poland
Czech
Rep.
Slovakia
Malta
Hungary Bulgaria Romania
14
State of convergence – government debt in 2005
General government gross debt
(% of GDP)
80
70.3
74.7
80
70
70
Reference value 60% of GDP
60
58.4
50
50
42.5
40
29.1
30
30.5
34.5
18.7
20
10
60
50.3
11.9
40
29.9
30
15.2
4.8
10
0
Estonia Latvia Lithuania Slovenia Czech Slovakia Poland Sweden Hungary Cyprus
Source: European Commission Spring 2006
Rep.
20
0
Malta Bulgaria Romania
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State of convergence – exchange rate criterion
• Estonia, Lithuania and Slovenia joined end-June 2004.
• Cyprus, Latvia and Malta joined in early May 2005.
• Slovakia joined in end-November 2005.
Participation in ERM II with effect from
Czech Republic
-
Estonia
28 June 2004
Cyprus
2 May 2005
Latvia
2 May 2005
Lithuania
28 June 2004
Hungary
-
Malta
Poland
2 May 2005
-
Slovenia
28 June 2004
Slovakia
25 November 2005
Sweden
-
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State of convergence – long term interest rates
Long-term interest rates
(in percentages, annual average, September 2005 - August 2006)
9
8
7
6
5
4
3
2
1
0
6.9
Reference value 5.9%1
5.1
3.6
3.7
Sweden
Czech
Rep.
4.1
3.9
Slovakia Lithuania
3.8
3.8
Latvia
Slovenia
4.3
4.2
9
8
7
6
5
4
3
2
1
0
Malta
Cyprus
Poland
Hungary
1
Source: European Commission and ECB. Reference value based on interest rates in Sweden, Finland and Poland.
N.B. No comparable long-term interest rates are currently available for
Estonia, Bulgaria and Romania.
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Policy challenges in the run-up to euro adoption
• Achieve sustainable price stability and fiscal prudence
• Complete all transition related reforms (price
liberalisation, administered prices, indirect tax
harmonisation etc.)
• Interaction between structural and cyclical factors:
- Price level convergence and inflation;
- Strong domestic demand, fuelled by low interest rates,
credit and house price expansion;
- large current account deficits raises questions on
sustainability.
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The relation between price and exchange rate stability
• The process of real convergence can make it difficult
to combine price and exchange rate stability.
• Ultimately, price stability is the primary objective in
all EU Member States, irrespective of the chosen
monetary policy strategy.
• Before fixing the exchange rate, it is important that:
– major policy adjustments (e.g. price liberalisation
and fiscal consolidation) are undertaken;
– the economy is flexible and has well-functioning
markets, so that shocks are easily absorbed
without resorting to the exchange rate;
– the central rate against the euro is chosen close
to the equilibrium value.
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Economic characteristics euro area – Bulgaria and
Romania in 2005
Population (millions)
GDP per capita (EU 25 = 100)
Sectors of production 1)
Agriculture, fishing, forestry
Industry (incl. construction)
Services
Unemployment rate
Employment rate
Exports (goods and services, % of GDP)
Government expenditure (% of GDP)
R&D expenditure (% of GDP) 2)
Credit to the private sector (% of GDP)
Euro area Bulgaria Romania
312.9
7.8
21.7
106.3
32.1
34.7
2.3
26.5
71.3
8.6
63.5
19.2
47.5
1.9
109.0
11.6
29.8
58.3
10.1
55.8
75.1
43.0
0.5
28.0
13.0
36.8
48.1
7.7
57.6
91.3
20.0
0.4
14.0
Source: Eurostat, ECB, European Commission
1)
Based on value added data for 2003.
2)
Data refers to 2004
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Thank you for your attention!
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