CEEC countries watch euro closely

Date: 28/11/1996

By Mark Turner

THE applicant countries of central and eastern Europe (CEECs) are watching the progress towards EMU with more than detached interest.

Whenever the Union chooses to enlarge, and how far, EMU will have a profound impact on the transition economies of the region - and some are asking whether they will be able to cope.

Brussels officials refuse to make any hard and fast predictions about when the CEECs will be ready to join the single currency.

“It is really far too early to tell when they will be ready for EMU, or even to compare which are the more advanced,” said one.

“Things are changing very rapidly and no one knows exactly what the impact of joining the Union will be on the central and eastern European economies.”

Others point out that the Union's internal market requirements are hard enough to achieve without adding the weight of meeting the convergence criteria.

Nevertheless, Polish Finance Minister Grzegorz Kolodko recently announced a new long-term plan specifically designed to prepare his country for EMU entry between 2006 and 2008.

But, for the time being at least, most attention is being paid to how the CEECs will cope with life outside the single currency zone both before and after they join the Union club.

The CEECs are already feeling the effects of de facto membership of the Union's trading empire without any substantial input into its policy-making.

According to Council of Europe sources, who are paying close attention to EMU's impact on the whole European picture, “changes in the monetary and exchange rate policies of EMU would have an immediate impact on central and eastern European economies”.

EU experts believe that this impact should, if all goes well, be beneficial. Many CEECs are likely to peg their currencies to the euro (especially if they are pegged to the deutschemark at present), or increase its weight where they use a basket of currencies.

That should result in increased monetary stability and a lower exchange rate risk. At the same time, as invoices for services and goods change over to the euro, trade should become substantially easier.

It is not certain, though, how far applicant countries will be expected to comply actively with EMU rules while in the waiting room.

Upon accession, if they do not immediately join EMU, new Union members will have to accept the community acquis for 'outs' - those in the EU but outside monetary union.

That will include price stability, independent central banks and low budget deficits. Experts predict that this will involve a lot of work on the part of the CEECs as they try to impress their potential partners.

On the top of many candidate countries' shopping lists will be a radical overhaul of their financial sectors. A mixture of banking crises compounded by bad loans and excessively high interest rates has plagued the transition economies.

At the same time, public administrations in the applicant countries are still comparatively immature and need to strengthen considerably before they can successfully implement and enforce necessary legislative changes. Many also believe that even with the best will in the world, it could be technically beyond central and eastern European policy-makers to impose the monetary stability they desire.

The rapid proliferation of new enterprises, or reconstituted firms following the break up of large state-owned companies, make it very difficult for CEEC bankers to predict demand for money. Large informal economies that are, by nature, hard to quantify also place extra pressure on the cash supply and make control of money aggregates an uphill task.

These problems should, however, diminish with time, and are certainly not unique to the CEECs - Germany being a case in point.

In fact, German reunification is a useful example for EU candidates. “If I had to draw one lesson from that,” said an expert, “it would be not to try to fix exchange rates prematurely, especially if the CEECs expect big capital inflows. On the other hand, they should try to stabilise their currencies, even though an equilibrium is difficult to determine.”

One useful tool for that could be de facto membership for the CEECs of the 'ERM II' - a planned Exchange Rate Mechanism for 'outs', allowing currency variations of 15&percent; either way from the euro.

On the other hand, many fear the effects of a mechanism designed for the west upon eastern economies. Experts suggest yet another mechanism - ERM III - might be needed for new members.