Klas Eklund Riga, January 24, 2003

1. Klas EklundRiga, January 24, 2003 THE ROAD TO THE EU AND THE EURO: CONSEQUENCES FOR POLAND AND THE BALTIC ECONOMIES

2. TOPICS • General macro overview • Macroeconomic effects of EU accession • Investment and migration • Policy challenges • The road to the euro • The company perspective • Institutional challenges

3. GLOBAL UNCERTAINTY • Lengthy hangover from the burst bubble - underestimated by most economists • What potential US growth rate after the burst bubble? • Deflation or reflation? • Will there be a war? • How long will Germany’s troubles persist?

4. THE GLOBAL ENVIRONMENT • A wobbly international environment • Slow European growth - bleak German performance • Volatile financial markets • Bond yields up in 2003 • Euro somewhat stronger • Baltics and Poland must rely on own strength - and impetus from EU convergence

5. BALTICS & POLAND • Impressive shift to independence and democracy • Credible fiscal policies, but external vulnerability • Positive medium term growth outlook • Potential growth rates 5-6% in Baltics, 4-5% in Poland • Main constraints: Ageing populations in Baltics, weak public institutions, oversized public sector and imbalanced economic policy in Poland • Fairly attractive to foreign investors • What impact of EU/EMU?

6. THE EU • Single market • Increasing trade within EU • Increasing investments • Utilising economies of scale • Higher productivity growth • Cross border transfers • But also increasing transformation pressure and vulnerability for individual companies and sectors

7. REAL CONVERGENCERatio of per capita GDP to EU average

8. CONVERGENCE TO CONTINUE GDP/cap level % of EU av. Price level % of EU av. Source: EU Commission, Nov 2002

9. “Reference” No EU membership No changes “Central scenario” Integration into Internal Market Increasing FDI Sectoral shifts “Optimistic” Comprehensive reforms Rapid sectoral shifts 2.9% 4.6% 6.1% GROWTH PROJECTIONS FOR NEW MEMBERS 2005-2009 Source: EU Commission 2001

10. FISCAL PRUDENCE - AND TRANSFERS • Macroeconomic stability in EU presupposes strong public finances • Avoid crowding out, support low inflation and c/a stability • Stability Pact: Balanced budgets or surpluses to have room for stabilisation policies • Challenge: Tax revenue • Political aim to cut taxes - while reaching surpluses • EU harmonisation ahead - meant increasing taxes in Club Med • EU transfers and common tariff • Necessary: Strict budget procedures, institutional reform

11. Estonia Latvia Lithuania Poland Strengthen SMEs Complete privatisation Liberalise utilities New bankruptcy law Stamp out corruption Strengthen SMEs Continue privatisation Liberalisation of Energy New bankruptcy law Strengthen SMEs Continue privatisation Restructure industries Promote entrepreneurship Revise bankruptcy law MAIN STRUCTURAL REFORMS NEEDED IN ENTERPRISE SECTORSAccording to EU Commission

12. EUROPEAN FDI TO SPAIN AND CANDIDATE COUNTRIESBn USD Source: laCaixa

13. MIGRATION FROM NEW MEMBERS TO OLDAnnual migration from year 1 of membership, Per cent of home countries’ population Source: EU Commission, 2001 Note: Peak equals some 220,000 persons

14. THE EMU Strengthens the single market: • Transparency, economies of scale, lower costs • Means higher productivity and growth But also: • Greater pressure on individual companies through pricing • Greater difficulties in finding an optimal stabilisation policy • Monetary policy decided in Frankfurt, fiscal policy left on the national level • And some risks along the road

15. TIME TABLE FOR BALTICS AND POLAND • Referendum 2003 • EU accession: May 2004 • ERM: Autumn 2004? Maybe even spring? • No great change for Estonia & Lithuania • But Latvia and Poland must peg to EUR • 2005-2006: Assessment of Maastricht criteria • EMU entry: January 2007? • Maybe 2006 if short ERM period is allowed?

16. MAASTRICHT CRITERIAMembers-to-be 2001, Club Med 1994 Budget Debt Inflation Bond deficit yields Estonia +0.5 5 5.8 6.8 Latvia -1.6 16 2.5 10.2 Lithuania -1.9 23 1.3 6.3 Poland -3.9 39 5.3 8.4 Average -1.7 21 3.7 7.9 Portugal -5.9 61 6.9 9.5 Spain -6.7 59 5.3 10.1 Italy -9.4 118 5.5 11.1 Greece -10.5 109 8.9 n.a Average -8.1 87 6.7 10.2 Source: CEPS 2002

17. VULNERABLE EXTERNAL POSITIONS • All four countries run c/a deficits • Dependence on FDI makes them vulnerable to shifts in investor confidence Source: SEB Baltic Outlook, Oct 2002

18. POSSIBLE STRAINS DUE TO MAASTRICHT CRITERIA & ERM • Criteria are nominal • Low inflation, low interest rates, low debt, low budget deficit, stable exchange rate • But a higher inflation is natural during the catch-up process • To fight it with appreciating currency is not compatible with ERM - and to respond to stronger currency with low interest rates (Hungary!) may cause even higher inflation • To fight it with tight budgets is politically difficult • So: Nominal criteria can cause real problems

19. EXCHANGE RATES • Baltic states should not face severe problems • Poland: A conflict between the need for a weak zloty and appreciation pressure • Conclusion: Preserve flexibility as long as possible! • Or persuade ECB to move straight from currency boards to the euro • Probable compromise: Keep currency boards within ERM • Or to adjust inflation target up

20. THE NEED TO FIND THE RIGHT CONVERSION RATE Strong currency • Slower exports - slower growth - lower inflation - higher real rates - negative effect on asset markets - even slower growth Weak currency • Stronger exports - stronger growth - higher inflation - lower real rates - booming asset markets - even stronger growth

21. STRATEGIC CHOICES FOR COMPANIES • Larger domestic market • Single market and common currency will give economies of scale • New procurement policy, aiming for the whole of EU • Price transparency for comparable products • Sharper competition: More competitors and pricing in common currency • Higher costs for consumer & environment protection • Less graft & corruption. Insider contacts less important

22. WINNERS OR LOSERS? • More joint ventures will come • Deeper integration of East European firms into supply chains of leading Western manufacturers • To make only operational preparations is a defensive policy for short-term survival • An aggressive, long-term strategy means focusing on markets, competitors, products and prices • The choice made can make the difference between survival or disaster

23. CONSEQUENCES FOR BANKS • Opportunities for cross-border business in EU • Means also tightening competition • EU structural funds will support projects - opportunities to participate as a co-financier • EMU means smaller FX volume • Less volatile interest rates; devaluation risks disappears • Potentially stronger demand for lending - but watch out for changing credit risks! • Prepare new euro products! • Prepare systems updates!

24. INSTITUTIONAL REFORMS • More members mean today’s institutions must modernise • The Nice treaty • The ECB • The Stability Pact • The need for institutional reform of national fiscal policy • The Convention • The Nordic/Baltic fear of a superstate: Let’s work together for openness!

25. CONCLUSIONS • EU membership is beneficial to growth • But a challenge to companies - and individuals • Transformation pressure will sharpen • Prudent fiscal policy necessary • ERM is a risk • Several imbalances may result • Institutional reforms on EU and national level will change economic policy-making • Companies face crucial strategic decisions • As do banks!