Euro adoption: Crunch makes euro attractive

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By:
Guy Norton
Published on:

Eastern Europeans think it could be a haven in troubled times.

The euro is poised to emerge as one of the biggest gainers from the global credit crunch as regimes across central and eastern Europe are rethinking their attitude toward the single European currency project. After years of high growth and rising foreign direct and portfolio investment, many countries in emerging Europe are now being buffeted by the chill winds of an economic and investment downturn and consequently are looking towards European monetary union as a potential safe haven from currency crises.

Most recently, the Polish government announced that it was looking to accelerate its plans to join the eurozone, setting an ambitious entry date of January 1 2012. Prime minister Donald Tusk is planning to make constitutional changes next year that would allow the country to join the European exchange rate mechanism (ERM-2) in summer 2009, which would be the precursor to its setting a final exchange rate between the Polish zloty and the euro in the summer of 2011.

Poland

Commenting on the Polish plans for euro entry in 2012, Juraj Kotian, co-head of macroeconomic and fixed-income research at Erste Bank in Vienna, says that the biggest obstacle to the government meeting its entry date will be a political rather than an economic one. "The opposition wants a referendum on euro adoption before agreeing to any change in the constitution that would allow Poland to join the eurozone." Without the support of the Law and Justice party headed by former prime minister and arch-eurosceptic Jaroslaw Kaczynski, the Tusk administration lacks the necessary two-thirds majority to push any constitutional change through parliament. Kotian believes that there will need to be a great deal of political horse-trading before the Law and Justice party agrees to support euro adoption, and that process could derail Tusk’s envisaged 2012 entry date.

The financial crisis in neighbouring Hungary, however, has caused a weakening of the Polish zloty and has served to highlight the vulnerability of even strong economies such as Poland’s, which are outside the eurozone. "The financial and currency markets in those European Union member countries outside the eurozone have proved weaker than those inside," says Kotian, adding that the general public has come to realize the benefits of a stable currency. Recent opinion polls in Poland show that 70% of the population is now in favour of joining the single-currency bloc.

Juraj Kotian, Erste Bank

"The financial and currency markets in those European Union member countries outside the eurozone have proved weaker than those inside"
Juraj Kotian, Erste Bank

The next central and eastern European state to adopt the euro will be Slovakia, which will join on January 1 2009. Although there had been reservations from the European Central Bank about the danger of increased inflationary pressures in Slovakia following euro entry, the European Commission ultimately gave the country the go-ahead in May this year. Kotian at Erste claims that this was a landmark decision for the entire single-currency project. "If the European Commission hadn’t given the green light to Slovakia to adopt the euro because of inflation sustainability concerns, it would have made it practically impossible for other countries in the region to join the eurozone," he says. "It shows that the European Commission plays a bigger role in the euro adoption process than the European Central Bank." Kotian adds that potential inflationary pressures that concerned the ECB about Slovakia’s eurozone membership have in any case since been mitigated by the economic downturn in the single-currency bloc.

Slovakia test case

Slovakia’s early experience with the euro will certainly be closely monitored in the Czech Republic, where at present there is far less political enthusiasm about the single currency. Martin Lobotka, economic analyst at Ceska sporitelna in Prague, says that prime minister Mirek Topolanek is lukewarm on euro adoption and that means it could be many years before the Czech Republic joins the euro area.

"The public discourse in the Czech Republic seems more wary of the potential risks associated with premature adoption, and more opinions seem to be voiced that are against the adoption of the euro at all costs," he says. "All in all, the largely unreformed [pension and healthcare] systems and tepidity of a substantial part of the elite towards speedy euro adoption lead us to forecast euro adoption no sooner than 2015."

Zdenek Tuma, governor of the Czech National Bank, says it is still too early to say what influence Slovakia’s entry into the euro bloc will have on attitudes to euro adoption in the Czech Republic.

"Inflation, especially as perceived by the general public, may increase after joining, and then one can imagine arguments like ‘You see what euro adoption may cause’ appearing in the news," he says. "However, businesses and the financial markets may consider entry as a step forward, and it can psychologically influence perceptions in the Czech Republic. The decision about the timing of euro adoption is primarily a political one."

While the authorities in Prague may be eurosceptic, in Budapest they are much more euro-friendly. "Policymakers have been supporting the earliest possible date for joining the single currency," says Orsolya Nyeste at Erste Bank Hungary. But with Hungary recently having had to secure $25 billion of emergency funding to prop up its tottering economy there is little prospect of its joining the eurozone before 2014.

Even though the pros and cons of eurozone membership will continue to be hotly debated, some observers believe that there are demonstrable benefits to euro adoption. Michael Buhl, joint chief executive of Austria’s Wiener Börse, which bought a majority stake in the Ljubljana Stock Exchange in Slovenia in October, says: "Most of the increase in the Slovenian equity markets last year was due to euro adoption," adding that many foreign portfolio investors had previously not wanted to take on foreign exchange exposure to the thinly traded Slovenian tolar. Slovenia joined the eurozone at the start of 2007 and registered a 90% rise in its benchmark equity index as a result of the increased investor focus.