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1.3.3.1.1. Subject to what conditions can a country be a member of the EMU?

Every Member State of the EU is entitled to participate in the Economic and Monetary Union (EMU) providing it meets the convergence criteria (see chapter 1.2.4.). A country can ask to join the EMU at any time and the suitability of each country to be a member is analysed at least every two years (article 109 K.2)

Greece wanted to join the EMU as early as 1998, but at that time it did not meet the criteria. However, in June 2000 the European Council judged that Greece then met the convergence criteria, so it was admitted to the EMU in January 2001.

1.3.3.1.2. Which EU countries are not part of the EMU?

These countries fall into several categories. Firstly, there are the ones that chose not to join automatically when the EMU was launched, even if they met the convergence criteria. In this way. the United Kingdom and Denmark obtained the right not to participate in the EMU (through an “opt-out clause). We would also mention that the German Constitutional Court had put it’s country’s accession to the EMU to a parliamentary vote on the extent to which it met the convergence criteria.

According to the EU Treaty, the countries benefiting from an opt-out clause are considered as enjoying a “derogation”. They are also called the “pre-in” countries to distinguish them from the “in” countries. Their position is, in fact, transitory: so, in the spirit of the treaty, it involves a postponement and not a final refusal for them to enter the EMU although they are part of the EU.

Then there are the countries that joined the EU after the creation of EMU. Their capital market will have to become integrated with that of the euro, and preparation for entry to the EMU is part of the accession criteria. Only Sweden has been able to join the EU after the ratification of the Treaty on the Union without having to adopt the euro immediately for that reason.

Finally, there are the countries that joined the EU in May 2004 and January 2007. They must meet the convergence criteria before they can join the EMU, as well. Slovenia has done so and joined the EMU in January 2007.

1.3.3.1.3. What are the implications of the advent of the euro for firms outside the euro zone?

Just as it does for the companies of the euro zone, the new currency will greatly simplify all commercial, accounting and financial operations, particularly for firms exporting to several countries in the zone.

Non-euro countries trading with the euro zone find that the resultant improvement in inflation control and the stability of the euro are advantages of doing so. The greater stability of the euro and its increasing use in international trade alongside the US$ and the Japanese Yen will, firstly, have the effect of reducing inflation for trading partners because the prices of their exports will be more stable. It will also help to stabilise the international monetary system, which will be advantageous to countries outside the euro zone.

Companies in general, and especially those in the tourism industry, will benefit from dual-pricing – in the national currency and in euros – and making it easy to pay in euros, as Switzerland has been doing since 1999.

1.3.3.1.4. When is it in a country’s interest to join the EMU?

It is not necessarily in the interests of a country to accept the EMU’s rigour in monetary management if its economy isn’t prepared for it. That could result in a loss of competitiveness and jobs, which would very quickly become socially unacceptable. The exchange rate between the currencies of these countries and the euro must fluctuate within +/- 15% margins fixed in the context of the EMS, which operates under the control of the ECB.

A country wishing to join the EMU must satisfy the convergence criteria and the European Commission has reaffirmed that the criteria would be applied with the same rigour as they were for the first countries of the EU.

These criteria are regularly the subject of discussion (see question 1.2.4.9) but it is very unlikely that they will be changed because it would be very hard to get all the members of the EU to agree on the subject.

The inflation criterion will call for particular attention. Most of the new member countries have per capita income well below the EU average. Their efforts to develop could cause income growth leading to inflation higher than that in the euro zone (the Balassa-Samuelson effect). Similarly, difficulties in connection with the public deficit can be expected insofar as governments will have to invest more in order to equip their countries with infrastructures of an EU standard.

Robert Mundell, Nobel Prize for Economics 1999, came out at the time in favour of speedy integration of candidate countries into the EMU because he felt that this integration would stimulate foreign investment, and the independence of monetary policy would oblige political authorities to accelerate the required structural reforms to align their economies with that of the EU. The question remains open, however, because it depends on the capacity of a country’s people to bear the social burden of these adjustments and to increase their productivity quickly.

Robert Mundell

The ECB has expressed its opposition to any unilateral adoption of the euro by any country unless it is a member of the EU first and strictly respects the convergence criteria. Moreover, new candidates are normally obliged to incorporate into the reforms required for accession to the EU the juridical changes needed for their subsequent integration into the EMU, with particular emphasis on those guaranteeing the independence of the national central bank. .

For a definition of the Balassa-Samuelson effect: see

http://www.melchior.fr/mechior/melchior.nsf.allbylD/FCD204200602C1A2C1256CF5004B33

1.3.3.1.5. What is the United Kingdom’s position?

Since 1998, the UK has very largely met the convergence criteria, except the one about keeping exchange rate of the GBP within the limits of the EMS. The long term reference rate of interest is very near that of the euro although the short-term interest rates are still largely higher (3.5% compared with 2% in Germany, for instance). The economic growth rate of the UK is regularly higher than that of the euro zone and, since its labour market is a lot more flexible, the rate of structural unemployment there is quite a bit lower (5.5.%). Finally, the state’s share in economy is smaller there (40.6% compared with 45.5% in the euro zone ). So you can understand the reluctance of the British people to join up with a less vigorous economy, where unemployment is higher and taxation heavier. However, the interests of the London financial sector, Europe’s biggest, and the UK risk-capital market coincide with those of the euro zone.

The government of the United Kingdom has set itself as a condition for taking up the euro similar criteria to those imposed on other countries. The only one that could present a problem is aligning the exchange rate of the pound with that of the euro for two years. The UK still remembers “Black Wednesday” in 1992, when the GBP, which had come into the EMS at too high a rate, was attacked by speculators and had to leave the EMS never to return. That exchange rate will suffer the divergent effects of, on the one hand, a foreign current account regularly in deficit and, on the other, stronger economic growth.

The British government has decided to put the adoption of the euro to a referendum (within four months of the government deciding that the general economic conditions meet the criteria mentioned above). The majority of the British are against the euro, although polls indicate that people tend to be more in favour of it the better informed they are. Seventy percent of the population think it is inevitable that the country will enter the euro zone.

It is generally considered that, when it comes to the euro, the British services are the best prepared, the press services the best informed and the British internet sites among the most complete in Europe. One of the sources of reluctance that the UK shares with Denmark, in particular, is the link between the euro and political Europe. These countries have a particular attachment to their sovereignty and they fear that the adoption of the euro will ineluctably draw them towards a “supranational” political Europe.

For more information:

The British Treasury’s site http://www.hm-treasury.gov.uk

The Bank of England’s site http://www.bankofengland.co.uk

The site “Britain in Europe” http://www.euromove.org.uk

Graham Bishop’s site:http://www.grahambishop.com/public/catlisting.asp?CatID=1&Category=Britain_and_the_Euro

Also: Federal Trust http://www.fedtrust.co.uk

1.3.3.1.6. What is Denmark’s situation?

National sentiment is particularly alive to this subject in Denmark. Two referenda have revealed the Danish people’s opposition to their country’s joining the EMU. In September 2000, 53% of Danes voted “no” to Denmark’s entry into the EMU with a 90% turnout

The country has in common with the UK its low rate of unemployment (4.6% for Denmark) and its healthy public finances (regular budgetary surpluses and a public debt that has fallen below 50%) but the similarities end there. Growth has been as modest as in the euro zone but, on the other hand, the State’s share in the economy is one of the highest in the EU, at 54.6%.

The Danes’ opposition to the euro stems from the fear of losing a particularly generous and efficient social aid system, being dragged into the construction of a federal Europe where the little countries would be swamped by the big ones and losing the picture of the Queen on their banknotes.
At the time it was also inspired by the prevailing lack of confidence in the euro, which had just fallen sharply against the USD on the international markets.

The impact of the Danish “no” on the euro was minimal because the Danish economy weighs less than 10% of the economy of the euro zone and, in any case, the Danish Krona is still tied to the euro.

Europeans’ fondness for euro notes and coins would have since reversed the trend, but the success of the nationalist party and fears over European political integration have prevented the country’s leaders from fixing a date for a new referendum. In the meantime, the euro seems to have been well received in commerce and by Danish tourists

1.3.3.1.7. What is Sweden’s situation?

Sweden’s economic case is like Denmark’s (growth: 1.4%, unemployment: 5.2% and the State’s share in the economy: 58.2%). It shares the UK’s doubts about the soundness of restricting the movements of the exchange rate of its currency, which was under-valued. On the other hand, Sweden is in a different legal situation. It came into the Union with Finland and Austria after the EU Treaty was brought into force. Its Parliament decided in 1997 not to join the EMU, a precedent that is not without significance for candidate countries wishing to be part of the EU without adopting the euro.

After the success of the euro notes and coins, a 58% majority of Swedes were said to be in favour of the euro, as against scarcely 35% in 2000. The government had in mind a referendum in Spring of 2003, before the consultations in the UK and Denmark , that is, in order to avoid their potential negative influence. That didn’t stop the referendum result being negative, with 56% of the Swedes opposing the replacement of their currency by the euro. This failure caused the planned referenda in Denmark and the UK on a change to the euro to be put in cold storage.

1.3.3.1.8. What is the situation of the other countries of Western Europe?

The Principality of Monaco, the Vatican and San Marino have adopted the euro and struck their own coins. Andorra has no national currency but used the Spanish peseta and the French Franc, equally. With the euro, Andorra now has the one currency. The Norwegians (in 1972 and 1994) and the Swiss (in 1992) have rejected proposals by their governments to join the EU.

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1.3.3.2.1. What is the contribution of the new member countries?

The accession of twelve new countries to the EU has considerably increased the population benefiting from it (103 million more inhabitants, not to mention the 77.3 million Turks), but the scant economic weight of these countries did not affect the overall situation of the EU much when they joined. Their economic potential increased the GDP of the EU by 4.8% in 2006. They have annual growth rates nearly double those of the EMU countries (5.5% in 2006) so their comparative economic importance should increase in the future.

The economic situation of these countries are as different as their size and levels of economic development. Their per capita income is still a lot lower than in the (older) EU countries but it is increasing rapidly and by 2008 it should exceed 7,000 euros per capita, that’s 30% of the European average. As far as unemployment is concerned, it will have fallen from an average of 10% to 15% in the period 1995 – 2002 to less than 10% from 2008 onwards (a forecast made by the Commission in Spring 2007).

Some analysts think the candidate countries should have been admitted as soon as they asked. Others, Ireland for instance, oppose rapid accession too quickly (negative referendum on the treaty of Nice). It is clear that the matter has less to do with the good will of the candidate countries than lack of preparation and conflicts of interest within the EU.

Illustration 1.3,3.a : Demographic and general indicators concerning the new member and candidate countries.

Illustration 1.3,3.b : Economic growth rates of the countries which have recently joined the EU and candidate countries.

Illustration 1.3,3.c : Per capita income in the countries which have recently joined the EU and candidate countries.

Illustration 1.3,3.d & dd: Unemployment in the countries which have recently joined the EU and candidate countries.

1.3.3.2.2. What were the general conditions for accession by candidate countries and the stages involved?

These conditions were fixed by:

The Copenhagen summit of June 1993:

• criteria of a political, economic, financial and monetary nature;

• stable institutions guaranteeing democracy, primacy of the law, human rights and respect for and protection of minorities (political criterion)

• a viable market economy and the capacity to face up to the pressure of competition and market forces within the European Union (economic criterion);

• the candidate country should be in a position to undertake the obligations of the Union and, in particular, to subscribe to its economic, political and monetary objectives (criterion of the acceptance of the

In Essen in December 1994, the European Council fixed the strategy of alignment for the countries that have signed an association agreement with the EU.

On the 6th of October 1997: The Foreign Ministers of the fifteen gave a positive reception to the French plan for a “European Conference” intended to support the enlargement process in the years to come.

On the 12th of March 1998: the first European Conference met in London, with all the member countries of the Union and all the European countries aspiring to join the Union and tied to it by an association agreement (except Turkey, which declined the offer).

In May 1998 the Council of Luxembourg defined a first group of six countries (Estonia, Hungary, Poland, the Czech Republic, Slovakia and Slovenia) whose accession in 2002 was considered possible with a view to their participation in the 2004 elections to the European parliament.

In December 1999 the Helsinki Council decided to organise conferences as from 2000 in order to speed up the accession of the six other countries (except Turkey, which had a trade agreement and a partnership agreement), and these six were called the “Helsinki agreement countries”. The Council made it clear that this classification was not definitive and that the rate of accession would be finally decided on the basis of each candidate country’s readiness.

The EU earmarked 21 billion euros for financing the preparation of the candidate countries for their accession. An additional 100 million euros was assigned for investments in the six second-wave countries. To these donations must be added a total of 15.5 billion euros granted by the EIB to the candidate countries at the end of 2001 for financing long-term investment projects. These amounts were swollen by the sums contributed by the EU to finance provided by the World Bank and the BERD in these countries. The candidate countries complained about the insufficiency of the Member States’ donations, which represent 1/15 of the amount in real terms that the United States spent under the Marshall Plan on rebuilding Europe after the second world war and less than what was spent by Germany on developing its Eastern part after the fall of the iron curtain. This situation illustrates the drawback of not having a larger autonomous community budget.

For many people the accession of the countries of Central and Eastern Europe has come too quickly, sometimes without the really being accepted by them. The case that has given rise to the most publicity is the entry of Malta without that country observing the European directive on the protection of wild birds (79/409/EEC of 2 April 1979), the consequence of which being the regular massacre of numerous protected species during their migration. On the 15th of March 2007 the European Parliament condemned Malta, but the practice continued. In future the legal amendments required for the adoption of the whole of the and entry to the EMU must be passed the new State joins.

1.3.3.2.3. Does the euro put any particular conditions on candidate countries?

The euro imposes particular conditions and some candidate countries think they are an additional obstacle to them joining the UE. In order for them to be members of the EU, countries must have sufficiently developed financial markets capable of “channelling savings towards investment”. In putting forward their candidacy, the countries accept the objectives of the Treaty of the Union, not only the political and economic ones, but also those of a financial and monetary nature. Even if they are not in a position to adopt the euro as soon as they join, candidate countries must nevertheless fulfil the conditions of stage 2 of the EMU. That means that their central bank must be independent, their economic policy must be coordinated and they must meet the requirements of the Stability and Growth Pact, which limits public deficits*. The new members must renounce financing of the public sector by calling upon the Central Bank and they must complete the liberalisation of capital movements. Finally, they must take part in the exchange control mechanism at the heart of the European Monetary System and avoid variations in their exchange rate.

Currency situation of candidate countries’ currencies

Copyright Promeuro – Illustration 1.3.3.e.

1.3.3.2.4. What is the situation of new member countries, as far as inflation is concerned?

As for inflation, there seems to be a generalised reduction in it which brings to mind the situation of the 15 EU Member States before the launch of the euro (see illustration 1.2.4.b). In several countries, the rate is above the 3% limit which strict application of the convergence criterion would call for (1.5% above the three best performing countries in the euro zone). This is what was expected, bearing in mind the Balassa-Samuelson effect (see 1.3.3.1.4.).

The Commission’s forecasts suggest that Estonia, Lithuania, Hungary, Bulgaria, Rumania and Turkey will have the highest inflation rates of the group – the last-named with 6.1% forecast for 2008.

Illustration 1.3.3.f: Inflation rate of countries outside euro zone from 1997 to 2008*

1.3.3.2.5. What is the situation of new member countries, as far their public finances are concerned?

Public deficits: These countries generally exceed the 3% standard because they are investing massively to catch up in the economic field as soon as possible. They are looking to bridge the gap between their per capita income and that of other EU countries. So they are faced with a hard choice: either to reduce their public deficits in order to meet the convergence criteria and get into the EU or to meet the needs of their people as quickly as possible by increasing their rate of public spending. This is the situation, in particular, with Hungary (which admits having escaped a financial crisis by the skin of its teeth in 2006), the Czech Republic, Slovakia, Croatia and Turkey. However, you will see that there has been a remarkable reduction in the public deficits of all these countries, as a % of GDP, since 1997.

Illustration 1.3.3.g: Public deficits of new member and candidate countries as a % of GDP.

On average it is a lot lower than in the older countries of the EU. Only Cyprus (with 12,000 euros of public debt per inhabitant), Hungary, Malta and Turkey have levels exceeding the 60% limit, but they are still a long way behind the public debt champions of the old EU: Belgium, Italy and Greece, with nearly 100%. Besides, in 9 countries the level of public debt is down in 2006, compared with previous years.

 

Illustration 1.3.3.h: Public debt of new member and candidate countries as a % of GDP.

 

Illustration 1.3.3.hh: Public debt of new member and candidate countries in euros per person.

1.3.3.2.6. What is the situation of new member countries, as far the stability of their exchange rate is concerned?

The monetary situation of the candidate countries is very variable. Some of them, like Lithuania and Bulgaria, have tied their currency to the euro (with or without a currency board) or the euro and the US$, like Rumania. All have made their currency convertible. In 2007 Slovenia replaced its tolar with euros. Estonia tried to get into the EMU in 2006 but the ECB thought its application was premature. Its kroon has been stable with the euro since 1995. The exchange rate of the Estonian litas against the euro has been practically unchanged since 1995. As far as the others are concerned, the situation is variable but stable.

 

Illustration 1.3.3.i: The trend in exchange rates for all the countries.

Illustration 1.3.3.ii: The trend in exchange rates for some countries

 

 

1.3.3.2.7. What can candidate countries do to speed up the integration of their capital markets

In a 1999 study, the European Investment Bank (EIB) showed that, in certain conditions, the borrowing operations of the Multinational Development Banks (EIB, BERD, WB, IFC and the EIF…) help to integrate the capital markets of “emerging” countries into the international markets. The study analysed the Spanish, Greek and Portuguese markets, and cannot possibly be applied as such, to the new member countries. Nevertheless, the EIB considers it as giving useful indications.

All the candidate countries have established an infrastructure for domestic capital markets which generally has legislation on stocks and shares, a controlling authority and a clearance and payment authority for stocks and shares and a stock exchange. The capital markets of these countries are characterised by a prevalence of public and short-term issues, and activities restricting secondary markets; a lot of products such as swaps, derived products and options are rare or non-existent there. In some conditions, the loan activities of the MDB can diversify the markets and lengthen the interest curve by instituting longer term loans, reduce exchange risks for local investors, bring in innovations in finance, and so on.

These improvements seem all the more appropriate for the candidate countries since their need of capital investment is enormous: 80 billion euros a year for the first wave countries. As a comparison, the net requirements of the whole euro zone were 75 billion in 2001. These countries have abundant savings which the local banks are not managing to collect. Even when they do, these banks prefer to diversify their assets by investing abroad.

By 2002, the EIB had launched 21 loan operations in Estonia, Hungary, Poland the Czech Republic and Slovakia for a total amount of 300 million euros. It started similar operations in the other countries as soon as they asked it to.
 

All the countries, except Malta, had indicated their interest in joining the EMU sooner or later.

Long term interest rates are similar to those of the euro, with only the Cypriot pound, the Hungarian florint and the Polish zloty showing any marked deviation (more than 5% in 2005). There’s no data for the currencies of Bulgaria, Rumania, Croatia, Macedonia and Turkey because the loans are still essentially short-term there, bearing in mind the uncertainty as to price variations and the state of the national capital market.

Illustration 1.3.3.j : Countries’ long term interest rates

1.3.3.2.8. Does the entry of the candidate countries into the EMU weaken the euro?

The inclusion of Spain and Portugal in the composition of the ECU had been feared as a cause of weakening of the European currency. It did no such thing. The new countries have much weaker currencies than those of the EU, but that is not in itself a factor of monetary instability if the countries observe the convergence criteria. Quite the contrary, the accession of new countries will increase the total economic power of the euro zone. The need of capital in countries could even cause the euro to rise, as happened with the DM from 1990 to 1995 because of similar needs linked to the integration of East Germany.

Things will balance out in various ways and, overall, the accession of new countries will have a positive effect on the euro. Of course, the essential bases of political and monetary stability – rigour in government and the fight against corruption – will have to become effective. The Commission has proposed a pact against organised crime in order to eradicate this scourge undermining the credibility of a currency. This action is especially important because the candidate countries are contributing to the work of the Convention.

Promeuro illustration 1.3.3.k Ranking of European countries in terms of the perception of the level of corruption. Transparency international.

See also:

http://www.transparency.org/policy_research/surveys_indices/cpi/2006

1.3.3.2.9. On what dates should the new member countries enter the EMU?

Slovenia entered the EMU on the 1st of January 2007. The European summit of June 2007 decided that Cyprus and Malta could enter in January 2008. Slovakia could enter in 2009 and the others are likely to do so between now and 2015.

See also: the article: “Enlargement of the euro area: Opportunities and Challenges” by Servaas Deroose of the European Commission (only in English).