Having joined the European club, many of the countries in Central and Eastern Europe are now knocking on the door of the rather more exclusive club of euro entry. It has never been easy to satisfy the criteria, but the next round of entrants worry the goalposts have been moved. Solomon Teague found out more.
Those Eastern European countries outside the euro but looking in are expected to join at different times. Slovakia is the first likely new entrant, and is expected to join in 2009. The Czech Republic, Poland and Hungary are on course to be the next entrants, with Czech possibly be ready to join around 2011–12 and the other two countries in 2014–15.
The Baltic states, which had hoped for a rapid passage into the club, were held back by runaway inflation, but could also see their journey to membership completed in 2015 (assuming they are successful in taming inflation – now running at more than 10%).
Inflation has been a bugbear beyond the Baltics. Countries like Romania, Bulgaria and Slovakia have seen impressive reforming zeal undermined. “Most countries have underestimated the potential for price rises,” said Nigel Rendell, senior emerging markets analyst at RBC Capital Markets in London. Liberalisation of energy prices has taken its toll, as has a poor harvest this year in Eastern Europe.
Some of the existing euro club have reservations about the feasibility of admitting poorer countries and the impact this will have on the European Central Bank’s ability to manage inflation throughout the continent, noted Nestor. The Czech Republic poses least problem in this respect, having around 80% of the euro area average GDP, compared with Portugal, which joined with 75%. Slovakia, which is expected to be given the green light to join at the end of the month, has a GDP of around 70% the European average, but Hungary, Poland and Romania, with around 60%, 50% and 40% respectively, would cause considerable inflationary pressure.
The only hold up is the ability of each country to fulfil the entry criteria, said Rendell, although in some cases countries may have taken the decision that it is not in their interests to join at the earliest possible opportunity, deciding instead to wait for the macro economic conditions to be favourable.
These countries look at the experiences of Italy, Portugal, Spain and Greece, which might be viewed as having rushed to join the euro, essentially locking in unfavourable exchange rates that have given them prohibitive labour costs and undermined their competitiveness. In Italy labour costs are rising faster than in Germany, making it very difficult for it to register any growth at all. “It’s all about timing,” said Rendell. “You need to get in at the right exchange rate and boost productivity first.”
Hungary is having perhaps the worst problems ahead of joining the single currency, said Barbara Nestor, an analyst at Commerzbank. While it is closer to Western Europe in terms of fulfilling euro-entry criteria, a succession of populist administrations mean it is actually regressing. Romania and Poland, which initially made less progress in preparing for convergence, are at least moving in the right direction, she noted.
Slovakia is an example of what can be achieved by acting decisively and radically. It enacted sweeping fiscal reforms, which it was able to do due to its relatively small population – it has 5m inhabitants, compared with 37m in Poland. It reformed its tax and welfare payments systems and introduced a flat income and corporate tax of 15%. Its reward is strong growth of 10% that has seen it move from the back of the line for euro entry to the front.
Unfortunately for countries looking to join the euro, the entry requirements, which could be characterised as bendy in the past – for example, when it came to allowing the likes of Italy and Greece to join – appear to have become decidedly more rigid.
“Inflation is the difficult one for most countries, and to a lesser extent the budget deficit provision,” said Rendell. “The debt is not a major obstacle. Most ex-communist countries have very low debt anyway.”
There is a tangible feeling of resentment around Europe regarding this inflexibility – especially considering the problems some countries within the euro are having living within the rules. The budget deficit limit is especially problematical. It is generally agreed that several countries went down the path of creative accounting, while the Greeks made sizeable revisions to the historic numbers once they were safely inside the Euro. “In the past ministers turned a blind eye in the interests of getting the project going,” Rendell said.