Central Europe and the euro: Patience, patience

Date: 26/07/03

Don't rush into the euro, central bankers say

A YEAR or so ago, when ten, mostly ex-communist countries were finishing negotiations to join the European Union, the path to adopting the euro shortly afterwards looked hilly, but not too difficult. To some, it now appears uncomfortably steep. Several candidates have bigger budget deficits than the entry conditions permit. One, Hungary, has been straining to cope with a gyrating currency. And Pedro Solbes, the EU's economics and finance commissioner, has said that candidate countries' currencies will have to spend two years in a narrow band, 2.25% either side of a central parity, not the 15% they had counted on.

Now central bankers are suggesting that some countries should be in no hurry to attempt the climb, even if the politicians are eager. At a joint press conference on July 16th, Hungary's government and central bank committed themselves to entering ERM2, the pre-entry exchange-rate mechanism, in May 2004, with a view to joining the euro in January 2008. Yet on July 21st the central bank sounded a note of caution. It was not clear, it declared, that Hungary would be able to join the euro at a time of its own choosing.

The central bank also cast doubt on the government's plan to cut the budget deficit, 9% last year, to 2.5% by 2006. Joining ERM2, it said, would stabilise the exchange rate only if the plan to join the euro looked credible. Given Hungary's recent difficulties, credibility requires more than setting a date. And planning to spend three-and-a- half years instead of only two in ERM2 is not exactly a sign of confidence.

The Czech central bank also says it would be foolish to rush. In a report published on July 15th, it advised its government to stay out of ERM2 until it is closer to meeting the Maastricht criteria for joining the euro for inflation, public debt, the budget deficit and long-term interest rates. It also gave warning that staying in the mechanism for longer than the minimum two years could call both the exchange rate and macroeconomic stability into question. “Even two years is a long time if you are not sure you can make it,” says Ludek Niedermayer, the deputy head of the Czech central bank. Unlike Hungary's, the Czech Republic's government is in no particular hurry.

The hesitating central banks were supported on July 21st by the monthly report of Germany's Bundesbank. By waiting outside ERM2, argues the Buba, the newcomers could preserve the monetary flexibility that they might need to cope with the pressures of the single market.

Not every candidate country has the same worries. The Baltic states already operate fixed exchange-rate regimes, which ought to make their transition to the euro fairly smooth. Some analysts, however, cannot see what all the fuss is about. Charles Robertson, of ING, a Dutch bank, thinks that the commission, although insisting in public on a narrow band, will turn a blind eye to temporary breaches. A few current members of the euro area were allowed plenty of leeway on some of the Maastricht criteria. The chances are that, if they want in, the newcomers will be, too.

Central bankers from Hungary and the Czech Republic caution against their countries rushing into the euro. With fixed exchange-rate regimes the Baltic states may find the process easier.