Outsiders in no hurry to enter ERM

Date: 21/12/1995

By Tim Jones

LIKE a well-known credit card, the Maastricht Treaty is turning into a flexible friend.

Anyone who has had to follow the debate on economic and monetary union at all closely since the treaty was signed has made it a matter of pride to learn the notorious 'convergence criteria' off by heart.

Countries wanting to adopt the newly-christened Euro in 1999 should achieve a “high degree of sustainable convergence”, meeting numerical targets on their budget deficits, public debt and long-term interest rates.

But one of the forgotten parts of Article 109J is the currency stability rule.

This will be judged by “the observance of the normal fluctuation margins provided by the exchange-rate mechanism of the European Monetary System for at least two years without devaluing against the currency of any other member state”.

Since the Madrid summit last weekend confirmed that the short list for the Euro will be drafted in early 1998, the race is now on for the non-members of the ERM to join.

The treaty makes it quite clear that the Swedish krona and the Finnish markka must join and the Italian lira and the British pound must rejoin the ERM if they want to be considered for membership of EMU in January 1998.

Or does it?

“My feeling about the convergence discussion is that it is possible for us to enter the monetary union without being a member of the ERM system,” says Swedish Finance Minister Göran Persson. “Talking about a stable currency, that's what is in the treaty and that does not necessarily mean that you have to be a member of the ERM.”

While the European Commission and the European Monetary Institute are keeping their heads down, they do not appear to share the same opinion as the Swedish minister.

“They have to be in,” says a senior EU official. “You have to take into account not only the effective stability of the exchange rate, but also the effective participation in the ERM.”

With ERM member currencies having been allowed to swing 30&percent; since August 1993, the reasons for staying out are puzzling. Yet none of the outsiders looks like joining the grid before next spring on the understanding that that rule will be applied flexibly.

The front-runner appears to be the markka. Inflation in Finland is the lowest in Europe at 0.3&percent;, the country boasts a trade surplus and the budget deficit has been cut to 4.7&percent; from 7.5&percent; in 1993.

The Finnish parliament last week approved the 1996 budget, which capped the deficit at 6.2 billion ecu, lower than previously forecast. This backs up a four-year deal to cut spending by 3.5 billion ecu every year.

The currency has stabilised around 3.00 to the deutschemark and the government is in the process of changing the law to allow the markka to be pegged to an outside currency system.

The decision at last week's Madrid summit to press ahead with EMU in 1999 also brought ERM entry closer, according to Finnish Finance Minister Iiro Viinanen.

“The decision strengthens the feeling that EMU will be a reality in 1999 and it means that we will consider also next year what our relations with the ERM will be,” he said as he left the summit.

“Our currency is very stable. It has been very stable for two years and it strengthened last year, but we haven't yet got the legislation prepared. It will be prepared and taken to the parliament in the beginning of next year sometime,” he added.

However, Finland may be reluctant to lock the markka into a system without a joint move by the Swedish krona since the two countries compete in the area of pulp, paper and forestry products. The strengthening of the krona over the past few months has taken some of the pressure off Helsinki.

“This is very good for us because we are competing on the same markets with the same products and it's very important that no country can win an advantage by the currency level,” says Viinanen.

“Now the big difference between Sweden and Finland is narrowing and that's very good.”

For Sweden, the problem could be psychological and related to the massive and unforgettable attack on the krona's voluntary peg against the Ecu in November 1992.

As Sweden entered its third year of recession, a banking crisis and a soaring public-sector deficit, the central bank was forced to raise interest rates to 500&percent; in defence of the currency peg. It failed.

The Riksbank, which determines exchange rate policy, is thought to be targeting the krona around 4.50 to the mark and may be aiming to make this its central rate in the ERM.

“It looks like they want a stable currency around 4.50 and they want to say they can do this on their own rather than because they joined a system,” says Keld Holm, who analyses the Scandinavian economies at London bank Lehman Brothers International.

The central bank will not be hurried into a decision even as the economy reaps the benefits of the past few years of structural reform.

Sweden seems to be entering its best year since the Nineties began, with the krona gaining 6&percent; against the Ecu since August.

Public debt is expected to stabilise as a proportion of gross domestic product this year at around 80&percent; and start falling in 1996, while the budget deficit may be eliminated in 1998. As recently as 1993, the deficit was over 10&percent; of GDP.

An unexpectedly strong spurt in growth in the first half of this year was responsible for the better-than-expected budgetary performance.

Growth has been healthy, based on investment and exports, while the share of public consumption has dropped with budget-cutting measures.

Growth in 1995 as a whole is expected to be 3.5&percent;, up from the 2.5&percent; growth rate predicted in April.

As a result, Persson was able to introduce a three-year growth programme in November after years of austerity. ERM entry was not on the agenda.

For Italy, the problem is more one for other members of the EU. Caretaker Prime Minister Lamberto Dini is very keen to bring the currency back into the system, possibly at around 1,000-1,050 lire per deutschemark, but other countries are worried that the continued political instability would make the system wobble.

Even Dini now recognises the scale of the challenge. “It would be difficult to rejoin without a minimum of political stability,” he said after the Madrid summit.

Dini heads a government of technocrats installed in December last year after the collapse of the right-wing government of Silvio Berlusconi.

Although he has pledged to resign at the end of the year once the 1996 budget is passed, it is uncertain whether he will be asked to stay on, another government will be formed or an election called.

In October, soon after Dini expressed an interest in bringing the lira back into the system, the Italian currency fell 3&percent; in one week. The drop came after the hard-line of the old Communist party turned against the government in a confidence vote, threatening to topple the eight-month-old government after Dini had been forced to remove his justice minister.

Only last week, on the eve of the summit, Dini again put confidence in his government to the test, calling a vote on two maxi-amendments to the 1996 budget.

The key to the performance of the lira will, to some extent, lie in the success of this budget, which foresees a 15.6-billion-ecu reduction in the deficit partly through public spending cuts of 7.4 billion ecu.

As for the UK, the government will not and cannot rejoin the ERM at least before the next general election due by May 1997.

The EU monetary authorities pride themselves on their ability to surprise. Perhaps the krona and the markka will join the ERM in the New Year, sneaking in while no one is looking, rather like the Austrian schilling's entry last January.

But all the signs are that the latest entrants to Europe's flexible exchange rate club will not be seen until early spring.