EU sends stability message to eastern applicants but sounds note of caution

Date: 24/09/1998

By Tim Jones

FOR once, the message to the enlargement candidates is clear: don't run before you can walk.

While most EU officials currently involved in monetary policy-making welcome any strides the central and eastern European countries (CEECs) can make towards the goal of a single currency, they emphasise that this comes a distant second to straightforward Union membership.

This means complying with the other 30 chapters of the EU's rule book and raising general levels of wealth in each country before trying to ape the budget-cutting and currency-stabilising rules of the Maastricht Treaty.

Given that CEEC income per head - even after a decade of economic reform - is just 40&percent; of the Union average, the applicants understandably have much more than the Maastricht Treaty criteria on their minds.

Nevertheless, when they do eventually decide to get rid of their recently restored national currencies, these countries will have to fulfil the same requirements which were met, one way or another, by the first 11 EMU nations.

Their national central banks must be entirely independent, their inflation rates within 1.5 percentage points and their long-term interest rates within 2 percentage points of those in the euro-zone, and their currencies stable and within the Exchange Rate Mechanism.

In addition, their budget deficits must have been slimmed to less than 3&percent; of gross domestic product and their public debt must be dropping as a percentage of GDP.

The front-running applicants for EU membership - Poland, the Czech Republic, Hungary, Slovenia, Estonia and Cyprus - are years away from being able to meet these criteria sustainably while also boosting their general wealth.

In a recently published study, analysts at the Dun & Bradstreet consultancy put the Slovenians top of the regional economic league; combining, as they do, sound balance of payments, budgets close to balance and rising living standards. But, in terms of strict macroeconomic orthodoxy, it has to be Estonia which wins the prize.

Every year, the Estonian budget must be balanced by law and no currency can be issued unless it is backed by an equivalent amount of earned foreign exchange. This is the kind of 'currency board' that former Russian Premier Viktor Chernomyrdin was seeking before his candidacy for the leadership was withdrawn earlier this month by President Boris Yeltsin.

Even with rules as strict as these, Estonian Prime Minister Mart Siiman still decided to toughen up his spending round negotiations for the 1999 budget by forcing each departmental minister to justify extra expenditure and identify finances to pay for it.

At the same time, while winning accolades for 'stability-oriented' policies, Estonia still suffers from 8&percent;-plus inflation rates (euro-zone inflation is 1.4&percent;) and will be hit harder than any of the other candidate nations by the Russian crisis.

The big boys - Hungary and Poland - are expected to weather the storm from the East relatively intact. Like Finland, both have worked hard at diversifying trade away from the former Comecon nations towards developed western countries and Asia. If they do collapse into recession, it will be because the rest of the world has.

Recognising that growth will slow down, both Warsaw and Budapest are redrafting their 1999 budget plans.

Poland, the region's giant, will have to trim another 740 million ecu from spending next year but, despite a Russia-related speculative attack on the zloty, the central bank has managed to keep an arsenal of 22 billion ecu in its foreign currency reserves.

National Bank of Hungary governor Gyorgy Suranyi recently dismissed suggestions that the forint would have to be devalued.

On the contrary, he said, slower growth should push inflation below the government's 13&percent; target this year and make it possible to reduce the speed at which the currency was devalued in its so-called 'crawling peg'.

It is the Czechs who are bucking the trend. Some might say that the minority Social Democratic government of Milos Zeman is challenging the economic orthodoxy operating throughout the EU. A more enlightened view would be that Prague is following the spirit of the euro-zone's stability and growth pact.

By proposing a 1999 state budget with a deliberate widening of the budget deficit to 800 million ecu, Zeman seems to be breaking all the fiscal rules.

“It is our obligation to put an end to restrictive policies which did not work and, on the contrary, caused a crisis,” he said.

With the Czech economy shrinking by 0.9&percent; in the first three months of the year, Zemin felt it was time for a public-spending expansion to boost demand.

Nevertheless, in line with the pact, the deficit will be kept comfortably within 3&percent; of GDP.