Nordic markets: Sweden and Emu: Risks and opportunities

Research guide to European Monetary Union

However, prime minister Gran Persson has announced that he will insist on being allowed to keep all options open beyond 1999, and will not disregard the possibility of membership at a later stage. This requires constitutional changes, namely that the Central Bank Act must be put forward later this year and accepted by Parliament before the election in 1998. The motions to the SDP congress in September 1997 indicate that a large majority of the rank and files are negative on Emu. By May, at the latest, the party leadership must announce its proposal for the precise text of the congress decision. We expect the party leadership (ie the present government) to announce that Sweden will not participate in Emu from the outset. At the same time we expect the leadership to try to leave the door open for a later entry.

In contrast to the political uncertainties surrounding a Swedish Emu entry, Sweden is not expected to have difficulties in meeting the Maastricht criteria. For instance, the 1997 public sector budget deficit is forecast to be below 2% of GDP. Public debt is on a downward trend and inflation in March was 1.0%, according to the new harmonized consumer price index. The interest rate spread against Germany is fluctuating at present at between 120bp and 140bp.

On a European level we expect Emu to take off as scheduled in 1999, with some eight countries participating. We think that the most likely scenario is a core Emu in 1999 accompanied by informal commitments from other countries to make a larger Emu in 2001.

Italy is the key country in this context. In spite of the major efforts which are being made by Italy to fulfil the convergence criteria in 1997, we do not expect Italy to become a member from the start in 1999. Italy will probably be excluded on the grounds that Germany and others are unconvinced on the treaty's demand for "sustainable" convergence. It is not difficult to argue that debt is not in a "sustainable" way "sufficiently diminishing" and not "approaching the reference value at a satisfactory pace". However we expect Italy to make it in a second wave together with Spain and Portugal.

The Swedish decision is very much dependent on the number of countries becoming Emu members. The larger the club becomes, the more costly it is for Sweden to stay outside, economically and politically. For this reason, the policies of the UK government will also be important for Sweden.

The strength of the European business cycle during the first half of this year will be important for the formation of the monetary union. If business conditions become very weak there is a possibility that the whole project will be called into question and delayed for a long time. However, we don't see this as a very likely outcome. Instead we believe that Europe will continue to recover and business conditions will improve.

There are four possible domestic Swedish scenarios which are labelled "yes", "soft yes", "soft no" and "no". The "yes" scenario implies a decision by the government and Parliament that Sweden will take part from the start in 1999.

By a "soft yes" we mean that the government announces that it is likely that Sweden will participate in 1999. This includes a proposal to thoroughly change the Riksbank Act in order to comply with the Maastricht criteria and Emu's phase three. Other ingredients may be to underline the importance of the convergence programme, the "growth and stability pact" and to take a positive attitude on ERM.

The "soft no" is characterized by a "wait-and-see" attitude: continued ambiguity regarding constitutional reforms before the 1998 election and less priority given to the convergence programme.

The "no" scenario consists of straight forward negative congress decision on Emu, no changes in the Riksbank Act and probably also a hesitant attitude to the convergence programme.

The different Swedish positions depend very much on the character and size of Emu. We assume that it is more costly to say no to a large Emu than to a small Emu. If Sweden were to say no to or not qualify for even for the "weakest" form of Emu, both politics and economic policies would be likely to be affected. A core Emu in 1999, followed by a large Emu in 2001, generates the lowest spread and, consequently, the lowest interest rates. A core Emu turning into a large Emu maximizes the probability of Sweden becoming an Emu member.

All in all we think that the most likely scenario is one where Sweden becomes an Emu member in the "second wave".