Transcript Convergence - The road towards the EU

Convergence
The Road towards the Euro
26 November, 2004
Mats Olausson
Chief Strategist Emerging Markets
[email protected]
+46-8 506 232 62
Outline
 Real convergence - the goal
 Mechanism
 Today
 Future
 Nominal convergence - the next step and challenge




Criteria and interpretation
Stumbling blocks
Timetable
Implications
 Market convergence - risks and opportunities
 Foreign exchange
 Stock market
 Fixed income market
2
Real convergence - the goal
Population (mn)
Cyprus
Czech Republic
Estonia
Hungary
Latvia
Lithuania
Malta
Poland
Slovenia
Slovakia
CEE 10
EU 15
0.7
10.2
1.4
10.1
2.3
3.5
0.4
38.2
2.0
5.4
74.2
380.4
GDP (Euro bn)
GDP/capita
(Euro)
11.3
75.7
8.0
73.2
9.9
16.1
4.3
185.2
24.5
28.8
437
9279
16143
7422
5714
7248
4304
4600
10750
4848
12250
5333
5889
24392
GDP/captia in
Euro
(EU 15 = 100)
66.2
30.4
23.4
29.7
17.6
18.9
44.1
19.9
50.2
21.9
24.1
100
GDP/captia in
PPS
(EU 15 = 100)
78
62.7
42.2
55.3
36.6
41.4
69.2
42.9
69.7
49.1
54.7
100
Employment
rate
68.6
65.4
62
56.6
60.4
59.9
54.5
51.5
63.4
56.8
59.9
64.3
Productivity per
worker
(EU 15 = 100)
78.3
53.7
41.8
62.6
37.1
41.9
89.8
48.8
68.4
56.2
57.9
100
 20% of population, 5% of GDP
 Significant structural achievements made
 GDP/capita in euro 24% of EU average
 GDP/capita in PPS up 10% points to 54% of EU15 average in 10 years
 Living standards gap narrowed only slowly
 Potential growth. Labour + capital + structures
 What will it look like in 2025?
3
Real convergence - labour
 Low employment ratio
Employment rates
 High unemployment
70
68.6
65.4
62
60.4
56.6
60
64.3
63.4
59.9
54.5
56.8
59.9
 Negative population growth
50
 Adverse demographic structure
40
 Risk of migration
51.5
30
 Long working hours
20
 Employment growth expected to
10
EU 15
CEE 10
Slovakia
Slovenia
Poland
Malta
Lithuania
Latvia
Hungary
Estonia
Czech Republic
0
Cyprus
Percent of population age 15-64
80
be 0.3% 2004, same as EU 15
 Key to change incentives that
increase labour supply and
demand
4
Real convergence - capital
 High investment ratios
Investment/GDP
 Insufficient savings (current
35
25

20

15

10

5

Lat.Am 4 av.
Asia av excl China
Asia 6 av.
Eurozone
CEE 8 av.
Slovenia
Slovakia
Poland
Lithuania
Latvia
Hungary
Estonia
0
Czech Republic
Percent
30
account deficits)
EU structural funds
FDI
Financial intermediation
Tax competition
Capital accumulation set to
continue
5
Real convergence - structures
Top 20 economies on the ease of doing business (World Bank)
1 New Zealand
11 Switzerland
Emerging Latvia
2 United States
12 Denmark
Markets
Chile
3 Singapore
13 Netherlands
following Malaysia
Czech Rep.
4 Hong Kong
14 Finland
Estonia
5 Australia
15 Ireland
6 Norway
16 Belgium
South Africa
7 United Kingdom 17 Lithuania
Tunisia
18 Slovakia
8 Canada
Jamaica
9 Sweden
19 Botswana
10 Japan
20 Thailand
 Huge progress made in 15 years
 Crowned by EU accession
 Two on the Top 20-list
 1/3 of Top 14 Emerging Markets
 Potential for further improvement






Product markets
Labour market
Legal framework
Tax system
Red tape/corruption
Knowledge economy
 Reforms pay off
6
Real convergence - mixing the
cocktail = productivity growth
 Strong productivity growth
Labour productivity in manufacturing
av. 1998-2003
 TFP more difficult
12.0
 Labour productivity in total
10.0
business 1998-03
8.0




6.0
4.0
2.0
CEE 4
EU 15
Ireland
USA
4.1% yearly av.
0.7%
3.1%
2.5%
 Potential growth ranges from
Slovenia
Slovakia
Poland
Lithuania
Latvia
Hungary
Estonia
Czech
Republic
0.0
3-7% compared to 2% in EU 15
and 3% in the US
7
Real convergence - catching-up
 Catching up in PPS terms:
350
EU 15 = 2%
CEE 10 = 3%
300
250
CEE 10 = 5%
CEE 10 = 7%
200
150
100
50
0
20
03
20
06
20
09
20
12
20
15
20
18
20
21
20
24
20
27
20
30
GDP/capita PPS. 100=EU 15 2003
400
 3% growth
 5% growth
 7% growth
62 years
21 years
13 years
 Political goal in PPS
 You don’t buy trucks for PPS
 Labour cost convergence in Euros
 Catching up in Euro terms with
1.5% additional inflation:
 3% growth
 5% growth
 7% growth
58 years
33 years
23 years
 OECD expects the gap in PPS to
half in 30-40 years
 Differential gradually decreases
8
Nominal convergence - the criteria
 Legislation must be compatible with Treaty and Statute of ESCB/ECB
 The ratio of government deficit to gross domestic product must not exceed 3%
 The ratio of government debt to gross domestic product must not exceed 60%
 There must be a sustainable degree of price stability and an average inflation
rate, observed over a period of one year before the examination, which does not
exceed by more than 1.5 percentage points that of the three best performing
Member States in terms of price stability
 There must be a long-term nominal interest rate which does not exceed by
more than 2 percentage points that of the three best performing Member States
in terms of price stability
 The normal fluctuation margins provided for by the exchange-rate mechanism
on the European Monetary system must have been respected without severe
tensions for at least the last two years before the examination
9
Nominal convergence interpretation
 Legislation. Hungary listened to ECB criticism
 Inflation. 12 month average HICP during the year preceding




examination. Average for 3 countries (not deflation)
Interest rates. Normally 10 years maturity. Estonia an exception
Deficit. Below 3% of GDP or declining substantially and
continuously or exceptional and temporary factors. Eurostat
decided on private pension funds. Stability and Growth Pact
revisions under way.
Debt ratio. Below 60% of GDP or declining
Exchange rate. Normal fluctuation band +/- 15% band with
automatic and unlimited intervention. But evaluation of exchange
rate stability is likely to vs. a narrower band (asymmetrical with
-2.25%). “Without severe tensions” is qualitative. Finland and Italy
had stayed in ERM2 less than 2 years at the time of examination
10
Nominal convergence - general
 No opt-out
 No set time-table
 Must abide to the SGP, but no sanctions
 Inflation must be the overriding monetary policy target
 Principle of equal treatment…
 …but probably less generous interpretation
 Balassa-Samuelsson makes the inflation criterion inappropriate
 Inflation in the enlarged club a tougher challenge
 The Greek experience to make creative accounting harder
 The decision will be made by European Council based on
assessment reports by the European Commission and ECB
 “Big bang” introduction of bills and coins is likely upon euro
conversion
11
Nominal convergence - Status today
Czech Republic
Cyprus
Estonia
Latvia
Lithuania
Hungary
Malta
Poland
Slovenia
Slovakia
Legal
compatibility
No
No
No
No
No
No
No
No
No
No
Inflation
Public finances
Exchange rate
Interest rates
Yes
Yes
Yes
No
Yes
No
No
No
No
Yes
No
Yes
No
Yes
Yes
No
No
No
Yes
No
No
No
No
No
No
No
No
No
No
No
Yes
-Yes
Yes
Yes
No
Yes
No
Yes
Yes
12
Nominal convergence - Inflation
 Progress made. 5 meet criteria
The 3 best
Criterion
Lithuania
Czech Rep.
Slovenia
Estonia
Poland
Slovakia
Hungary
Latvia
Aug 04/
Aug 03
0.8
2.2
3.2
3.7
3.9
4.9
7.0
7.2
7.8
12-month av.
in Aug 04
0.9
2.4
-0.2
1.8
4.1
2.0
2.5
8.4
6.5
4.9
2005
average
1.0
2.5
2.5
3.0
2006
average
1.3
2.8
2.7
2.8
3.2
3.5
4.2
4.7
5.5
2.9
3.0
3.8
4.2
3.0
 Rising trend. Challenge for Baltics
 Challenges ahead
 Balassa-Samuelsson-effect
 Food more important
 Oil price sensitivity
 Last steps most difficult
 Tricks possible
 Smaller credit market weakens
transmission mechanism
 Exchange rates important
 Trade-off with growth
 Higher inflation after entry is little
problem for EMU
13
Nominal convergence - Budget
deficit
2004
2004
2005
2005
2006
2006
Target
SEB
Target
SEB
Target
SEB
Estonia
0.7
0,3
0,0
0,5
0,0
0,0
Latvia
-2,1
-1,7
-2,2
-1,8
-2,0
-2,0
Lithuania
-2,7
-2,6
-2,5
-2,9
-1,8
-2,5
Slovenia
-1,9
-2,0
-1,8
-1,5
-1,5
-1,5
Slovakia
-4,0
-3,8
-3,9
-3,8
-3,9
-4,0
Hungary
-4,6
-5,5
-4,1
-5,0
-3,6
-4,8
Czech Rep.
-5,6
-4,8
-4,9
-5,0
-4,0
-5,0
Poland*
-5,7
-6,9
-3,9
-6,2
-2,8
-4,8
* Polish budget targets are based on exception form Eurostat’s
decision that transfers to private pension funds shall be regarded as
outside public sector finances.
 The biggest challenge for CEE 3
 High deficits despite high growth
 Eurostat rules against Poland on





private pension funds. EcoFin
decides in February
What happens to the SGP?
Little budget help from EU-funds
Already high tax burden…
…and inflexible spending
Painful to reduce structural
deficits. Electoral cycle important
14
Nominal convergence - Public debt
ratio
 Lower debt ratio in CEE 10 at
80
71.1
70.9
70.7
70
60
63.3
59.1
60
45.4
50
42.6
37.8
40
29.4
30
21.4
20
14.4
5.3
10
EU 25
Eurozone
Slovenia
Slovakia
Poland
Malta
Lithuania
Latvia
Hungary
Estonia
Czech Rep.
Cyprus
Criteria
0
45.7% in 2003 compared to 70.4%
in the euro zone and
63.3 % in EU 25
 Only Hungary at risk and possibly
Poland (3% points higher ratio when
excluding transfers to private
pension funds)
 Trend to fall by time of examination
 Small debt stocks reduce scope for
positive budget effects from lower
interest rates
15
Nominal convergence - Interest
rates
9
 By-product of meeting other
8.1
8
7
6.9
6.4
6
5.2
5
4.7 4.6
5
5.1 5.2
4.7 4.7
4.3
4.6
4
3
2
1
EU 25
Eurozone
Slovenia
Slovakia
Poland
Malta
Lithuania
Latvia
Hungary
Estonia
Czech Rep.
Cyprus
Criteria
0
criteria
 Only 2 countries miss the target
 Inflation differential + political
risk premium + FX risk
 Automatic convergence once
inflation falls and a credible
convergence program is in
place
16
Nominal convergence - Exchange
rate
CEE 4 exchange rate fluctuation
Index 100 = 2002 average
130
125
120
115
110
105
100
95
90
85
jan
130
125
120
115
110
105
100
95
90
85
PLN
HUF
CZK
SKK
maj
sep
03
jan
maj sep
04
Source: EcoWin
 Estonia, Lithuania and Slovenia
joined ERM2 on 28 June
 Potentially a bigger risk than
recognised
 15% or 2.25% fluctuation band,
“without severe tensions”?
 Two target and one instrument an invitation to speculators?
 if the convergence program lacks
credibility
 and/or the central parity rate is
perceived as overvalued
 Revaluation will be tolerated
 Fluctuation last two years




PLN
HUF
CZK
SKK
23%
18%
10%
9%
17
Nominal convergence - The euro:
not very popular around here
 Short term political costs to
Survey on EU 10 support for the euro
50
45
45
44
41
40
40
40

35
30

25
20
19

15
10

5
0
Positive Negative Positive Negative As soon As late
for
for
on
on
as
as
country country personal personal possible possible
level
level


meet the criteria
Policy actions may come into
conflict…
…or growth must be sacrificed
EU accession deadline and race
was a carrot and a whip
Reform fatigue
Hard to score political points on
rapid move to the euro
3 of EU 15 outside
18
Nominal convergence - Timetable
Czech Republic
Cyprus
Estonia
Latvia
Lithuania
Hungary
Malta
Poland
Slovenia
Slovakia
ERM 2 entry
forecast
2007
2005
2004
2005
2004
2007
2005
2007
2004
2006
Euro adoption
forecast
2010
2008
2007
2008
2007
2010
2008
2010
2007
2009
Euro adoption
national target
2009/10
2007
2006
2008
2007
2010
2008
2009
2007
2008/09
19
Convergence - Impact of euro
adoption
 Maastricht criteria as an anchor for sound economic policies
 Reduced crowding out of investments
 Lower real interest rates
 Less distortions with lower inflation
 Not designed for transition countries





Higher natural rate of inflation
Conflicting targets in the run-up to euro conversion
Temporarily negative for real convergence
Loss of monetary/exchange rate policy puts higher burden on fiscal policy
Social disruption if structural fiscal deficits are reduced rapidly
 Once in the euro zone





Lower transaction cost in intra-EU trade
Now currency risk in 3/4 of trade. Mostly completed
Current account risk turn into credit risk. Baltic example? Risk of bubbles!
Harmonisation of credit ratings
More difficult to find optimal interest rate for ECB
 Trade-off near term. Lower inflation and end of current account
risk should spur credit expansion and lead to higher growth
20
Market convergence - FX market
SE 4 exchange rate fluctuation
 Deviation from 2.25% on the
Index 100 = 1996 av. Greece lagged 2 years
120
115
Italy
110
105
100
95 Portugal
Greece
90
85
95
96
120
115
110
105
100
95
90
85
Ireland
97
98


99
Source: EcoWin
Real Effective Exchange Rates
125
120
115
110
105
100
95
90
85
HUF
CZK
PLN
SKK
98
99
00
01
02
03
125
120
115
110
105
100
95
90
85


strong side is OK
High productivity growth should
lead to real appreciation via the
exchange rate rather than
inflation in the run-up to ERM2
Speculation about central parity
levels will cause temporary
overshot if remaining positive
interest rate differential
Fixing at an overvalued rate is
dangerous. Hungary, Baltics?
Consensus expects small
changes from current levels
04
Source: EcoWin
21
Market convergence - Stock market
Stock markets SE 4 + Europe
Index 1997-01-01 = 100
700
600
500
400
300
200
100
0
Greece
Ire, Ita, Por, Spa
Europe
95
96
97
98
99
00
01
02
03
700
600
500
400
300
200
100
0
Local currency. Index 2001-01-01 = 100
99
00
01
02
03
 Still, South Europe is ahead
 CEE outperformed last 3 years
 Bratislava, Tallin and Vilnius on

04
Source: EcoWin
Stock markets Visegrad, Baltics + Europe
350
300
250
200
150
100
50
0
 Greece’s outperformance faded
350
300
250
200
150
100
Europe 50
0
04






top since 2001
CEE stock markets are small
with low market capitalisation...
P/e ratios have caught up
Higher productivity is driving
Portfolio diversification
Lower liquidity and market
capitalisation
Lower transparency
FX risk
Source: EcoWin
22
Market convergence - Interest rates
Percent
5Y spread vs. Germany
11
11
9
9
Poland
7
Hungary
5
3
3
1
Czech
-1
-1
99
00
01
02
03
9


04
Sothern Europe - 5Y spread vs. Germany
Source: EcoWin
9
Euro zone entry
7
Percent
7
5
1
 Deconvergence 2003-2004 on
7


Italy
5
5
Greece
3
1
Spain
-1
95
96
97
98
99
00
01
02
03
3

1

-1

04
rising budget risk
Easing inflationary risks lately and
supportive global backdrop
HGB higher spread than 2000
when inflation was over 10%
Not if, but when
Southern Europeans converged
4-1 years ahead of euro adoption
New opportunities ahead
Earlier and quicker
Credible convergence program is
key
Source: EcoWin
23
Convergence - The Road towards the Euro
Thanks for participating!
26 November, 2004
Mats Olausson
Chief Strategist Emerging Markets
[email protected]
+46-8 506 232 62