Benefits and challenges of euro adoption

1. Benefits and challenges of euro adoption Massimo Suardi Head of Unit, DG ECFIN European Commission Conference TEN YEARS BULGARIAN CURRENCY BOARD AND CHALLENGES OF EURO ADOPTION 18 September 2007, Sofia

2. Presentation structure • Overview • Benefits • Challenges • The policy agenda ahead

3. Overview - NMS on the way to the euro … and beyond • Euro adoption: all EU MS (except UK, DK) expected to join the euro under the Treaty • Rules-based framework, based on fulfilment of criteria • Sequenced process – MS have room for manoeuvre in managing their path towards the euro • Sovereign in choice of exchange rate regime, but XR policy is a matter of common interest (Art. 124) • Important to take the long view: what matters is long-term performance before and after euro adoption • Key challenge: achieving real and nominal convergence in the context of catching-up

4. Overview • CY + MT in the euro area since January 2008 • SK targets 2009 • Most other countries have no target dates: • ERM II : EE , LV, LT, SK • outside ERM II : BG , CZ , HU, PO , RO , SE • opt-out: DK, UK • Postponement of early euro adoption plans due to rising inflationary pressures and/or unsound budget positions • No immediate deterioration in investors’ sentiment , but markets react to lack of policy discipline or rising macro instability

5. Benefits of euro adoption • Benefits • Greater policy discipline and macroeconomic stability • Completion of the internal market • Increased trade/FDIs • Elimination of currency-risk and vulnerabilities • Reduction of risk premia • NMS well placed to benefit from euro adoption • High level of integration (trade, FDI, financial) • Correlation of business cycle • But, how does euro adoption interact with real catching-up ?

6. Challenges of euro adoption • Two challenges: • 1 – To get there • 2 – To prosper in the euro area • Treaty : • When rather than whether • Rules-based framework • Costs of euro adoption • Loss of monetary policy • Function of domestic policies and structures • New dimension: loss of the nominal exchange rate to accomodate real appreciation

7. Challenges of euro adoption • No one-size-fits-all strategy • Two (three) groups of countries: • Fixed exchange rate regimes (EE, LV, LT, BU) • More flexible regimes (CZ, PO, HU, RO) • SK: SKK in ERM II, exploiting the band

8. Fixers Smaller Earlier stabilisation Higher GDP growth (from lower levels) Sounder fiscal position Very large CA deficit Strong interest rate convergence Very high credit growth FX mismatch ERM II participation Early euro adoption plans Flexible Larger Slower stabilisation Slower real convergence Often high budget deficits CA deficit Some interest rate spreads remaining Robust credit growth Lower FX mismatch Not in ERM II (exc. SK) No euro date or late date Challenges of euro adoption

9. The policy agenda ahead • To sum up: MS with hard pegs fixed have performed better in several respects, but are also currently experiencing larger domestic and external imbalances • Common challenges to support real and nominal convergence : • Stable macro-economic framework • Price stability • Fiscal discipline (appropriate fiscal stance ; quality of public finacne ; budgetary framework) • Capacity to adjust (labour and product markets) • Manage credit growth (prudential and other measures) • Appropriate allocation of domestic savings and capital inflows, including EU funds • Reforms should not be undertaken because of the euro, but because they are in the long-term interest of countries