Nordic markets: Denmark and Emu

Research guide to European Monetary Union

A special report prepared by Handelsbanken Markets

The budget deficit will fall to under 1% this year, the debt to GDP ratio is declining rapidly and inflation is hovering at around 2% to 2.5%. Denmark is also a long-standing member of the ERM and would therefore, on a criteria basis, be a clear candidate for first round membership.

However, there is a big obstacle for Denmark on the road to Emu membership - the Danish people. Danes are EU and Emu sceptics at heart. The support for Emu is not much higher than in the UK, even though the latest opinion polls point to a somewhat less hostile Emu attitude among the Danes. Still, opposition to Emu is widespread, which is witnessed, for example, by the appeal by some Danes to the Danish High Court to rule Danish Emu membership unconstitutional. The High Court decision will probably come later this year.

But the obstacles to Danish Emu-membership do not end there. In 1992 the Danish people voted against joining Emu from the start. The practical effect of this is that if the government wants Denmark to join Emu, it first has to hold a new referendum. Such a referendum seems unlikely before 1999, since the government will not go ahead with a referendum without being sure that it will result in a "yes" vote, mainly because another "no" vote would have serious long-term consequences for Denmark's status in the EU.

The Danish government will therefore certainly not hold a referendum before 1999 and consequently Denmark will not participate in Emu from the start. How long it it will take before a referendum can take place depends primarily on the success of the single currency and how the cost/benefits of Denmark staying outside Emu materialize.

A larger band

When weighing up the different Danish Emu alternatives, one has to bear in mind that the Danish exchange rate policy differs slightly from the UK's. Denmark's exchange rate policy is closely tied to the rest of Europe's, something which in the long-term might make not entering Emu costly.

Unlike the UK, Denmark will still participate in many of the institutional set-ups surrounding Emu in the Maastricht treaty. Denmark will be obliged to maintain its central bank independence, and to follow the same economic policy guidelines as Emu members do. Denmark will also participate in a future exchange rate mechanism, ERM2, which will link the Danish krone with the euro. A central question is whether this band will tolerate large fluctuations like today (±15%) or whether it will be much narrower.

Denmark is one of the few countries that has managed to keep its currency more or less within in the older, narrower ERM band of ±2.25% during the last couple of years. But if ERM2 has a narrower band, this could lead to heavy intervention costs to defend weaker European currencies.

Another disputed Emu issue in Denmark is Target, the real time payment system that will link European central banks. Although non-Emu countries will also be linked to Target, Emu's likely core countries are keen to restrict access to central bank credit within the system. Denmark and the UK, among others, argue that intra-day credit should be accessible to all EU-members under the same conditions. As long as this intra-day credit does not spill into overnight credit it will have no monetary implications, they argue. So far Germany and France have remained sceptical.