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Euro area enlargement – the ECB Convergence Report May 2010

Euro area enlargement – the ECB Convergence Report May 2010. Reiner Martin EU Countries Division SUERF/MNB Conference Budapest, 23 June 2010. The views expressed in this presentation are solely those of the presenter and do not necessarily reflect those of the European Central Bank. Outline.

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Euro area enlargement – the ECB Convergence Report May 2010

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  1. Euro area enlargement – the ECB Convergence Report May 2010 Reiner Martin EU Countries Division SUERF/MNB Conference Budapest, 23 June 2010 The views expressed in this presentation are solely those of the presenter and do not necessarily reflect those of the European Central Bank

  2. Outline • Macroeconomic background in CEE • The enlargement process • Economic convergence criteria and the state of convergence

  3. Macroeconomic background in CEE Real GDP growth (in percent) Source: Eurostat. Note: Romania included from 2000 onwards. Lines: unweighted average. Shaded areas: maximum-minimum.

  4. Macroeconomic background in CEE Annual HICP inflation (in percent) Source: Eurostat. Note: Bulgaria is excluded in 1997. Lines: unweighted average. Shaded areas: maximum-minimum.

  5. Macroeconomic background in CEE Current account balance (percentage of GDP) Source: Eurostat. Note: Lines: unweighted average. Shaded areas: maximum-minimum.

  6. Macroeconomic background in CEE General government balance (percentage of GDP) Source: Eurostat. Note: Lines: unweighted average. Shaded areas: maximum-minimum.

  7. The enlargement process (as stipulated in the Treaty) Adoption of the euro Optional: Pre-ERM II phase ERM II membership Technical preparations ERM II membership Assessment of convergence, formal decision on entry and conversion rate Accession to the EU Entry into ERM II

  8. The enlargement process • Every second year, or at the request of a country, the ECB and the European Commission report on the state of convergence in their Convergence Reports • Case-by-case examination based on the convergence criteria and the principle of equal treatment • Based on such examinations and on a proposal by the Commission, the (ECOFIN) Council decides which countries fulfil the conditions needed for adopting the euro • The Council will also decide the conversion rate at which the national currency will be replaced by the euro (based on a proposal by the Commission and after consulting the ECB)

  9. Convergence criteria • There are 4 convergence (Maastricht) criteria for examining economic convergence • Price stability • Fiscal position (general government deficit and debt) • Exchange rate • Long-term interest rate • In addition, “legal convergence” (i.e. compatibility of national legislation) is examined

  10. Convergence criteria – general rules • A number of general rules are used in the application of these criteria • Criteria are strictly interpreted and applied • Criteria constitute coherent and integrated approach (no hierarchy) • Criteria must be met on the basis of hard data • Application of criteria should be consistent, transparent and simple • Convergence must be achieved on a sustainable basis and not just at given point in time.

  11. Convergence criteria – price stability The criterion on price stability “the achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best performing Member States in terms of price stability” • Reference value: average HICP inflation rate of, at most, three best performing EU Member States + 1.5 percentage points

  12. The state of economic convergence – price stability

  13. Convergence criteria – government budgetary position The criterion on the government budgetary position “the sustainability of the government financial position…will be apparent from having achieved a budgetary position without a deficit that is excessive…” • Reference value: the ratio of the government deficit to GDP should not exceed 3%. (unless the ratio has declined substantially and come close to the reference value, or the excess over the reference value is only exceptional and temporary and the ratio remains close to the reference value) • Reference value: the ratio of government debt to GDP should not exceed 60%. (unless the ratio is sufficiently diminishing and approaching the reference value)

  14. The state of economic convergence – government balances

  15. The state of economic convergence – government debt

  16. Convergence criteria – exchange rate The exchange rate criterion “The observance of the normal fluctuation margins provided for the exchange rate mechanism of the EMS, for at least two years, without devaluing…” • The ECB examines whether a Member State has participated in ERM II for at least two years prior to the examination without severe tensions, in particular, without devaluing its currency against the euro • Focus is put on the exchange rate being close to the central rate against the euro, while also taking into account factors that may have led to an appreciation

  17. The state of economic convergence – ERM II

  18. Convergence criteria – long-term interest rate • The long-term interest rate criterion “The durability of convergence achieved by the Member State and of its participation in the exchange rate mechanism of the EMS being reflected in the long-term interest rate levels” • Reference value: average of long-term interest rates in the three best performing EU Member States in terms of price stability + 2 percentage points.

  19. The state of economic convergence – long-term interest rates

  20. Estonia – long-term interest rates • The Estonian financial system is characterised by the absence of a well-developed market for long-term debt securities denominated in Estonian kroons. • A broad-based analysis of financial markets has been conducted taking into account a variety of relevant indicators. • Developments in financial markets over the reference period suggest a mixed assessment. • A number of indicators show that market participants had significant concerns regarding the sustainability of convergence in Estonia. These concerns were especially pronounced during the peak of the global crisis.

  21. Estonia - key recommendations • The Estonian authorities should aim at achieving a fiscal surplus in line with their medium term strategy and be ready to take counter-cyclical measures if needed to counter the risk of overheating. • Wage developments need to respond more to changes in labour productivity growth, labour market conditions and developments in competitor countries. • Structural policies should support the reallocation of domestic resources from the non-tradable to the tradable sectors and from low wage-based to high value-added activities • Financial sector policies should be geared towards preventing excessive credit growth in the future. • In order to prevent the reoccurrence of macroeconomic imbalances, which are then followed by a period of difficult adjustment, it is crucial to strengthen policy tools to contain booms in domestic demand that may be related to further episodes of strong capital inflows or overly optimistic expectations about future growth prospects.

  22. Thank you for your attention!

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