Global Economics

Why CEE Countries Must Adopt the Euro


Soonest possible entry to the eurozone is vital for Slovakia, Hungary, and others: Any delay only makes it harder to meet the criteria and to prosper once inside

As one country after another in Central Europe postpones its target date for adopting the euro, it has become fashionable to argue that this is not just a necessity but also a virtue.

Siren voices – mostly on the right but increasingly in all parties – proclaim that the new European Union members’ failure to meet the convergence criteria on inflation, interest rates, debt, and budget deficits shows not only that they are not ready but that entry to the eurozone would be harmful in the near future. From here it is but a short step to propose that the new member states delay entering the eurozone for as long as possible.

In Poland and Slovakia populist parties in government now rail against the rigid confines of the convergence program and the double standards of the eurozone, which allows existing member states to breach the Stability and Growth Pact's fiscal discipline rules with impunity, while forcing new members to fulfill inappropriate entry conditions to the letter. In Slovakia – which still plans to enter in 2009 – it is not hard to imagine that in the first tough choice between fulfilling the convergence criteria and easy populism, euro entry will come a poor second.

Such populism is now growing in all parties, even among Social Democrats who had been the strongest supporters of joining the eurozone up to now as part of their general enthusiasm for all things EU. The Czech Social Democrats now see early euro entry as a threat to the welfare state and contemplate a delay. The Hungarian Socialists remain loyal to the euro dream but the dire state of public finances forces the government to undertake reforms anyway, while also ruling out entry until the middle of the next decade. Meanwhile the government’s attachment to the euro is allowing the rightwing opposition to play the populist card in the streets in order to try to bring it down.

The right-wing parties now in government in Poland and the Czech Republic were never very interested in adopting the euro anyway and are not bothered by the delay. The Czech Republic could actually keep to the target date of 2010 but the Civic Democrats have no will to do so and are content to blame any delay on the profligacy of the previous Social Democrat administration. They are focused instead on introducing a low flat tax which would widen the budget deficit, at least in the short term, and breach the convergence criteria. Some influential voices in the party – led by President Vaclav Klaus – are also hostile to the euro idea itself out of a mixture of nationalism and economic dogmatism.

DELAY AT YOUR PERIL

It is true that some countries, notably the Czech Republic, have little more to gain from adopting the euro in the short term. Czech interest rates are already at eurozone levels, exports are thriving, so the only significant benefits of eurozone entry remaining are lower transaction costs and the removal of currency risks.

It is also true that premature entry could be damaging if a country is forced to make savage budget cuts to restrain inflation and stay within the stability pact’s provisions. All the new member states are likely to have higher inflation than the eurozone while their price levels converge. Once the exchange-rate tool is abandoned, inflation is the only outlet for price convergence; once the interest-rate tool is abandoned, only fiscal austerity can restrain inflation.

Yet Poland, the Czech Republic, and Hungary will still clearly benefit in the long run from the macroeconomic stability, the removal of currency pressures, and the greater trade and foreign investment that adopting the euro should bring. Unfortunately, they have been forced to put back their target dates for euro adoption because they have been slow to reform public finances. Budget deficits have overrun convergence programs agreed with the EU as politicians have found it easier to give handouts to voters than to cut spending.

Delaying entry until some unspecified future date – none of the three larger countries in the region now has a specific target – would allow politicians to postpone reform for as long as possible. This would make it more difficult to ever meet the criteria and could encourage the European Central Bank to take an even tougher line towards new entrants. Euro entry might not just be put off till the middle of the next decade but much longer.

Delaying reform would also make it more difficult to prosper once inside the eurozone. Governments must reform public spending and improve the competitiveness of labor and industry because fiscal policy will be the only tool available after entry and competitiveness will determine how well the economy performs inside the eurozone. If public spending remains bloated by social programs, it cannot be used for economic fine tuning, and if the labor market remains inflexible, rising wage costs will lead to unemployment.

It is therefore vital that Central Europe continues to prepare for euro entry as if it were about to enter the eurozone and that it aims for entry as soon as feasible to avoid any further slippage in the timetable.

Provided by Transitions Online—Intelligent Eastern Europe

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