THOMAS MIROW IS unequivocal about it being in the best interests of the leading central and eastern European countries that are members of the EU to join the eurozone. “Definitely, yes,” says the president of the European Bank for Reconstruction and Development.
On January 1 Estonia became the newest member of the troubled currency bloc, following Slovakia and Slovenia as part of the first wave of former Communist countries to adopt the single currency. “For a small economy like Estonia with very strong trade relationships with Finland, this is the right thing to do,” says Mirow. “On top of this it’s also a very good sign that even though the euro area is struggling it is still attracting new members and is willing to take up new members, even though I presume there will be a pause before there is further enlargement.”
This is particularly pertinent to the big three central European economies of the Czech Republic, Hungary and Poland and their intentions. Each has delayed entry into the euro club and none has a definite target date. Not surprisingly, public opinion is not enthusiastic about joining.
The Czech prime minister, Petr Nicas, has dampened expectations about adopting the euro, arguing that the country benefits more from having a flexible exchange-rate regime. Hungary’s Fidesz-party government seems less eager than the previous administration led by Gordon Bajnai.
Viktor Orban’s government has enough on its hands in resuscitating Hungary’s ailing economy. Last month, Moody’s downgraded the sovereign’s credit rating by two notches to Baa3, just one level above junk status. The country is the most indebted eastern member of the EU, although with a targeted shortfall this year of 3.8% of GDP, its fiscal deficit is much lower than those of many western European economies.
Poland’s government is also dragging its feet. In October it published a long-awaited document, the Strategic framework for the national euro adoption plan. In a classic example of government fence-sitting, the document promised nothing, simply laying out the costs and benefits of joining the euro. The next step will be in the third quarter of 2011 when the government will publish another document – with the same title, except that “strategic framework” will be dropped.
Mirow, however, remains hopeful that these countries will be inclined to join by about 2015 and be in a position to do so. “I think we’ll see two things happening at the same time,” he says. “One, the euro area has to solve its problems. Two, the accession countries need some more time because of the financial crisis to prepare themselves well to be able to join. As of the middle of this decade, I’m certain this will happen.”
By well prepared, Mirow means that accession countries need to do more than just meet the Maastricht rules of a public debt level of no more than 60% of GDP and a maximum fiscal deficit of 3%, two criteria that have proved woefully insufficient in assessing an economy’s preparedness and have been ridden over roughshod by various members of the eurozone.
“They are still reasonable numbers, but the lesson is that just these numbers would not suffice to provide a fully fledged view on the robustness and resilience of an economy,” says Mirow. “At the same time you have to look at private-sector debts, growth potential, demographics, the exposure of a country’s financial sector. All these elements add to a picture of whether a country is stable or not.”
Mirow rejects the notion that before any more countries are admitted to the euro bloc there needs to be further clarity about possible exit mechanisms. “I’m very sure there will be no extension of the euro area if the question of long-term ability to fulfil that requirement is not very carefully scrutinized,” he says. “Whether an exit option would be and should be created has not been debated and I wonder what the effects would be if such a debate came up in the current situation.”
A former technocrat in the German finance ministry, Mirow stops short of saying that the solution to the eurozone’s troubles lies with fiscal union. However, he thinks further fiscal integration is necessary.
“One probably needs more fiscal union elements than have been introduced up to now,” he says. “You also need better and more efficient policy coordination and you would probably need to accept a certain, though not too high, amount of transfers and this is what EU governments are debating.”
Although Mirow believes that a common tax system is unlikely, he argues that certain fiscal reforms need to be considered. “The question is whether or not you can get more comparable tax bases than you have up to now,” he says. “Is it possible to narrow the differences in direct and indirect taxes? For example, can VAT rates be brought closer together? So these kinds of issues need to be discussed. But it is extremely difficult.”
What about the thorny issue of corporation tax? Ireland’s rate of 12.5% is half the eurozone average of 25.7%, which has led to criticism from several quarters, including the German government and the EU, which argue that it distorts competition. “That’s another one, a very difficult one,” says Mirow. “I would not expect Ireland to be willing to get closer to a German model on this one.”
For many of the countries that fall under the EBRD’s watch, the eurozone’s problems could not come at a worse time. Most countries in central and eastern Europe have started to recover, although at varying speeds, from the credit crisis. There are three reasons, according to the development bank’s latest Transition report – a recovery in world trade, fiscal policies and the unwinding of pre-crisis imbalances.
Given the trade links, however, the region cannot escape the problems afflicting its neighbours to the west. “As we have all learned there is no such thing as decoupling, at least not for important economies. There are many sources of contagion,” says Mirow. “Much of the reversal in growth in the region during the crisis was due to trade shocks rather than to financial shocks. So the demand side, which relates mostly to western Europe, is extremely important for many countries.”
He adds: “There are more specific sources of potential contagion, such as Greek banks playing a role in a number of countries in southeastern Europe; remittances playing a role in many countries; and the degree to which labour markets in big economies deteriorate. Central and eastern Europe depends very strongly on what is going on in other parts of the world.”
Mirow reckons that, despite certain similarities, the causes of the eurozone’s troubles are mostly different to those behind emerging Europe’s in 2008. Eastern Europe largely suffered a private debt crisis, such as high exposures to foreign-currency risk and non-performing loans. The issues facing many of the eurozone countries, notably Greece and Portugal, are mostly related to sovereign risk. “Fortunately most of the countries in central and eastern Europe do not have debts that are comparable with the more fragile western European countries,” says Mirow.
Even in those western European countries where the private sector was more at fault – such as Ireland and Spain – Mirow believes the comparisons with emerging Europe are misleading. “The overleveraged banks, which have put so much pressure on Ireland, were not something we’ve seen in the region. Spain again is different because, although the banks have mostly behaved very reasonably, some were engaged in an inflated construction sector.”
In that sense, the closest comparison in eastern Europe is with the Baltic republics, which also suffered from a property bust. And like Ireland, the Baltic republics, especially Latvia, undertook drastic austerity measures to get themselves out of their hole. But whereas the spending cuts, reductions in state pay and tax rises – equivalent to 9% of GDP – appear to have worked in Latvia, Ireland’s woes show no sign of diminishing.
“The basic difference is that there are no Baltic banks that in terms of size of exposure to GDP can be compared with the Irish banks,” says Mirow. “In most of the Baltic countries, the Scandinavian banks play a decisive role. They also took hits but they continued to engage and the hits they took from the Baltics were comparatively small compared with their overall balance sheets,” says Mirow.
He adds: “The Baltic countries deserve a lot of praise for their capacity and willingness to take hardships. As we’ve seen in Latvia the government was not blamed but re-elected. But of course addressing the crisis and defining the remedies always needs a close look at the sources of the problems and Ireland is different in so far as the banking problems overshadow anything else. First and foremost, the Irish authorities have to solve the banking issues.”
Although the outlook for emerging Europe is better than at any time since 2008, notwithstanding the eurozone’s problems, some countries remain stuck in a rut. Romania and Bulgaria continue to struggle – the former has suffered seven consecutive quarters of negative growth.
Arguably the biggest worry, however, is Hungary. Since the Fidesz government was installed in May, it has unsettled the markets with a series of moves including a challenge to the independence of the central bank, plans to redirect private pension savings to the state to tackle the budget deficit, and a proposed levy on the financial sector.
“All have a short-term benefit in terms of income but bear a risk on medium-term investment and growth,” says Mirow.
