The race for the euro: the central and eastern Europeans eagerly seek club membership. Here are the hurdles

International Economy, The, Spring, 2003 by Jurgen Stark

The European Council in Copenhagen in 2002 was a historic milestone on the way to the enlargement of the European Union: Accession negotiations were concluded with ten new member states, most of which are from central and eastern Europe--Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, the Slovak Republic, and Slovenia. The successful conclusion of negotiations with these ten candidate countries also lends new dynamism to the accession of Bulgaria and Romania, which were offered the prospect of becoming members of the EU in 2007. It is envisaged that--once the Accession Treaty has been signed and the national ratification procedures completed-the ten new members will join the EU on May 1, 2004. This would allow them to participate in the 2004 European parliamentary elections.

Upon accession, the ten countries will join the European Economic and Monetary Union (EMU) as "member states with a derogation"; their central banks will become part of the European System of Central Banks. The new "member states with a derogation" will have to conduct exchange rate policy as a matter of common interest, which will exclude, for example, competitive devaluation. However, the hurdles of strengthening real and nominal convergence still have to be overcome before a country can adopt the euro and participate in the Eurosystem.

The EU enlargement negotiations began back in December 1997. Since that time the candidate countries have made considerable progress in the race to adopt the euro. The process involves several integrative steps which build on one another. Most of the accession countries were formerly communist states and have had to go through a deep process of transition in order to fulfill the criteria laid down by the 1993 European Council in Copenhagen. While the Copenhagen criteria regulate accession to the EU, they are also important for participation in the EMU. Furthermore, a high degree of sustainable convergence--a condition for the adoption of the euro---complements the political criteria relating to the integration process.

AMENDING CENTRAL BANK LEGISLATION

The Copenhagen criteria imply the existence of a functioning democracy guaranteeing human and minority rights (political criteria), the existence of a functioning market economy able to cope with competitive pressure and market forces in the internal EU market (economic criteria) and the ability to take on the obligations of membership, including adherence to the aims of political, economic, and monetary union (criterion of adopting the acquis communautaire). As far as monetary integration is concerned, aligning central bank legislation with the provisions of the EC Treaty is a major challenge. The accession countries need to amend their central banking laws and statutes in order to incorporate price stability as the primary objective and to guarantee central bank independence.

INTRODUCTION OF THE EURO AS A RESULT OF A MULTILATERAL PROCESS

Most accession countries wish to adopt the euro as soon as possible. However, they will become members of the euro area and their central banks will become part of the Eurosystem only after a high degree of sustainable economic convergence has been achieved. They should not introduce the euro unilaterally; in the Eurosystem's view, that would not be in line with the spirit of the Treaty. The introduction of the euro will be the result of a multilateral process with the check of real and nominal economic convergence. The convergence criteria aim at fostering stability within the monetary union and the accession countries. The Maastricht Treaty lists four convergence criteria; these were applied to the present euro-area countries and will also be applied to the acceding countries. The "Maastricht criteria"--which must be applied strictly--are as follows.

* The inflation rate is to be not more than 1.5 percentage points above the average inflation rate of the three best-performing member states of the Eurosystem;

* Long-term interest rates are to be not more than 2 percentage points above the corresponding level in those three countries;

* The public sector deficit must not exceed 3 percent of GDP and the level of public debt must not be above 60 percent of GDP; and

* The country must have participated for at least two years in the European Exchange Rate Mechanism (ERM II) within the normal fluctuation margins, without any devaluation being required.

In order to assess the sustainability of the convergence achieved, the "results of the integration of markets, the situation and development of the balance of payments on current account, and [...] the unit labor costs and other price indices" must--according to the EC Treaty--be taken into account.

REMARKABLE PROGRESS OF DISINFLATION

The progress of disinflation in the accession countries was remarkable in the last decade. Inflation has come down from double-digit rates to relatively low levels. Nonetheless, further lowering of inflation rates remains a challenge. The ongoing price liberalization and deregulation and the Balassa-Samuelson effect will contribute to inflation differentials between the current euro-area member states and the acceding countries. (1)