| Research guide to European Monetary Union They must guarantee democracy, the rule of law, human rights and the protection of minorities, establish a viable market economy, be able to withstand competitive pressure and market forces within the European Union and be able to meet the obligations of membership of a union that is not only political and economic but also monetary. In preparation for accession, the EU has signed Europe Agreements with each of these countries and has introduced the PHARE aid programme and a process of so-called structured dialogue. June 1997 will be an important month for these countries. It is then that the EU heads of state and government will meet in Amsterdam under the presidency of the Netherlands to decide on institutional reforms within the EU and to further smooth the path towards monetary union. The enlargement of the union to include the central and eastern European countries (CEECs) will also be on the agenda. Negotiations on accession will begin only if the intergovernmental conference is a success and a so-called Treaty of Amsterdam is adopted. After the conference, the European Commission will present the Council with a detailed report on the individual countries, dealing primarily with the following points: * The European Commission's opinion regarding each country's application for membership. The emphasis will be laid on the extent to which they fulfil the entry criteria, namely the application of the acquis communautaire, the implementation of economic reforms and the degree of maturity their democracy has attained. * Comprehensive documentation of the effects of enlargement on the objective of intensifying relations between member countries. * The effects of enlargement on EU policy, especially agricultural policy, and on the structures of the Union. * The Commission's views on the financial situation of the Union, with particular regard to the entry of new members. After the presentation of this document, the European Commission will open membership negotiations with each country individually. Whereas past enlargements of the union were carried out in a relatively calm atmosphere, the union now stands on the threshold of the transition to Emu, from which the issue of enlargement cannot be separated. In these circumstances, whether enlargement takes place will depend on several conditions: * whether Emu begins in 1999 as planned and the euro zone is an area of monetary stability; * whether the reforms within the EU will make enlargement possible in the years to come; * whether the applicant countries continue with stabilisation and reform; * whether enlargement will take place in stages according to the progress achieved by the applicant countries. The CEECs will be affected not only by the necessary preparations for accession to the European Union, which are essentially set out in the European Commission's White Paper, but also by the introduction of the euro, even if they are not yet members of the EU in 1999, which it is already safe to say they will not be. One obvious effect, albeit one that will materialise far in the future, is that sooner or later all these countries will also want to introduce the euro as their national currency. Before that, however, monetary union will affect their economies in other ways: the euro will be the anchor currency and an essential reserve asset for these countries and they will borrow increasingly in the euro capital market. The following analyses explain the impact of Emu on the individual CEECs and the action they need to take with a view to joining the European Union.
HUNGARYOn April 8 1994 Hungary and Poland applied to join the European Union and were the first eastern European countries to sign Europe Agreements as long ago as 1991. Hungary's political system is highly comparable with those of EU member states, and the advanced state of the economy was confirmed by the country's accession to the OECD. A further important step in the liberalization of trade will be taken when the import surcharge is possibly abolished on July 1 1997. Hungary nevertheless still faces a number of problems, namely low economic growth, which will have to be significantly higher than the EU average over a long period in order to raise living standards to the EU level, continued high inflation and high public debt. The need to reform the social security system, whose deficits are financed from the budget, is concomitant with the problem of public debt. Improvements must also be made in infrastructure, industry and technology to raise Hungary's competitiveness, and further reform of the banking system is required. As non-European component imports enjoy preferential customs treatment, the pan-European rules on country of origin cannot be applied to Hungarian exports to the EU. To resolve this problem, Hungary must bring its customs regulations into line with those of the EU. Priority should be given to the reform of agriculture, as Hungary has a surplus in agricultural trade with the EU. Hungary is the only country to have adopted the Ecu as a basket currency, but in view of the small volume of foreign exchange trading in the unit it was removed from the basket as of January 1 1997 and replaced by the Deutschmark. This change would have to be revoked once the euro was introduced, which could have repercussions on the exchange rate of the forint, depending on which countries participate in Emu, as the euro would account for 70% of the basket if the present proportions were maintained (30% dollar, 70% Deutschmark). Hungarian forint and zloty versus Deutschmark
Source: Investmentbank Austia/Datastream POLANDPoland is the European Union's most important trading partner in central Europe, ranking ahead of the Czech Republic and Hungary. Poland has also been a member of the OECD since last November, a fact that reflects well on the economic reforms the country has carried out. Together with Hungary, Poland was a pioneer in establishing contacts with the EU. Despite a multitude of agreements regarding Polish import taxes and the protection of Poland's oil and steel sectors, a number of obstacles must still be cleared away before final EU membership. These relate primarily to the requirement to market certain EU products in Poland and the preferential position of a non-EU car manufacturer in Poland. The introduction of the euro will have several direct effects on Poland's monetary and exchange rate policy. The number of currencies in the exchange rate basket will be reduced, if that has not already happened by that time as part of Poland's programme for entry to Emu. Sterling, which makes up 10% of the basket, will probably be replaced by the euro, even if the United Kingdom is not part of the first wave of countries joining Emu. The Swiss franc might also be dropped, as the euro will have a far greater influence than the Swiss franc on Poland's foreign exchange dealing and merchandise trade. Over the long term, Poland has set its sights on meeting the convergence criteria for accession to Emu within 10 years. To that end, the crawling peg will have to be abandoned, the zloty tied to the euro and the fluctuation margins reduced. As a first step in this direction, which will be taken in 1998 at the earliest, it is planned to modify the composition of the currency basket. Then the crawling peg will be abandoned and finally the fluctuation margins reduced. As regards the convergence criteria, at the end of 1996 Poland already met the public finance requirements, which a series of EU countries will struggle to meet in 1997. However, it is still a long way from reaching the target for inflation. Czech and Slovak koruna versus Deutschmark
Source: Investmentbank Austia/Datastream THE CZECH REPUBLICAs with the four other central European countries (Poland, Hungary, Slovakia and Slovenia), the European Union also held out the prospect of EU membership to the Czech Republic. The conditions the Czech Republic must fulfil were set out in the European Commission's White Paper and in bilateral negotiations with the EU. The financial assistance needed to enable the country to adapt to EU regulations is being provided by the EU under the PHARE programme. Since 1990 the country has received grants worth more than Ecu433 million and will probably collect a further Ecu330 million by the end of 1999. More than half of Czech exports go to the EU. Since the start of reform, the Czech Republic has made great strides with regard to democracy and the economy. The focus now moves to the adaptation of the country's legislation and economic system to accord with those of the EU and to the implementation of legislation. Although the Czech Republic is not a member of the EU, it already meets the most important Maastricht criteria: there is a slight budget deficit of 0.1% of GDP, a far cry from the 3% ceiling on net borrowing, and public debt amounts to only 12% of GDP. The currency has been stable since December 1990. Inflation, however, is still high in relation to the EU average (7.4% year on year in January 1997), but displays a clear downward trend. At present there are no 10-year government bonds in issue, but the yield on the new 5-year bond (10.55/2002) implies that the yield on a 10-year bond would be well above the required level. Just because the Czech Republic complies with several of the Maastricht criteria, it should not be supposed that the country is already ripe for EU membership. Many reforms still have to be undertaken, especially in the corporate sector, in the social security system and in infrastructure. However, the extent to which it does meet the criteria implies that the country is a natural candidate for membership and will be at the head of the queue of applicants in 2002. The most visible impact of the euro on the Czech Republic will be the replacement of the Deutschmark by the euro in the currency basket. It can also be assumed that trading in the Czech koruna will increase significantly after the start of Emu; the currency is already an attractive investment in view of the large interest rate differentials in relation to the core European currencies and the dollar. There is a danger, however, that the exchange rate will shift out of line with the economic fundamentals in view of large capital inflows. For that reason it can be assumed that the koruna will become more volatile after the introduction of the euro. SLOVAKIASlovakia's participation in the eastward enlargement of the EU is based on the association agreement signed with the former Czechoslovakia. Slovakia performed well economically until 1995, although not as impressively as the other successor state, the Czech Republic, owing to greater political uncertainty. Foreign direct investment, a useful indicator of the economic development of transition countries, lagged behind the levels recorded in other central and eastern European countries, as investors in the EU were watching political developments. In the second half of 1995 the trade and current accounts began to show deficits, which have widened considerably since then. The Maastricht criteria will be difficult to meet unless Slovakia adopts more restrictive monetary and fiscal policies. The Slovak koruna is pegged to a currency basket consisting of 60% Deutschmark and 40% dollars. The National Bank of Slovakia fixes the exchange rate daily within a fluctuation band of ±7.0% in close accordance with developments in the foreign exchange market. The composition of the basket may well be changed, by substituting the Ecu for the Deutschmark. The koruna has been stable since its introduction, but it is now under substantial pressure from the external accounts. However, it is not performing entirely in line with economic fundamentals; at present the exchange rate is being supported by strong inflows of speculative capital due to high Slovak interest rates. Such a exchange rate development could be not acceptable for a EU member and is thus bound to be the subject of controversy before Slovakia is able to participate the union. Slovenian tolar versus Deutschmark
Source: Investmentbank Austia/Datastream SLOVENIASlovenia was the last in the group of five CEECs to conclude an association agreement with the EU. Although the agreement was not signed until June 1996 owing to Italian objections stemming from an unresolved dispute about property ownership rights, Slovenia hopes to become a member of the EU by the year 2001. The country has achieved impressive economic growth and currently meets nearly all of the Maastricht criteria except that for inflation, which is likely to remain at a high year-on-year rate of around 9% into 1997. Slovenia has also achieved a high level of political stability, but it needs a workable government, as important decisions regarding its integration with the EU are looming. In view of the extremely small size of the Slovenian foreign exchange market, even a moderate inflow of foreign portfolio investment could cause a relatively large appreciation of the Slovenian tolar. The Slovenian central bank has adopted a very restrictive stance, limiting the scope for foreign speculative inflows as well as the possibility for domestic entities to hold foreign currency. The central bank's primary goal is to prevent the tolar from appreciating to an unsustainable level. Under the association agreement with the EU, Slovenia must reopen its financial sector to foreign capital. It should now be preparing for the new situation. A switch from the managed floating exchange rate regime to a fixed one with a close tie to the euro may be made in conjunction with the liberalisation of financial transactions. Currently about 67% of imports and 63% of exports are with EU countries, so that pegging the exchange rate to the euro would be a recommendable way of achieving a more workable adjustment. THE OUTLOOKThe five associated countries are performing well economically and have also achieved eligibility for membership in terms of political maturity and legislation. On the other hand, the EU itself must prepare for the eastward enlargement. Changes in comitology and questions of budget distribution must be settled before the eastern European candidates are admitted. Once that has been done, there should be nothing to stand in the way of eastward enlargement after the turn of the millennium. The Maastricht Criteria
Bank Austria AG Investmentbank Austria AG Mr René Riefler Tel: +43 1 588 84 ext 425 |
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