Thursday, June 16, 2005

Eurozone expansion

The Financial Times today reports that the French premier calls for freeze on enlargement Regardless of whether you agree with de Villepin or not it is certainly a bit too late to be making such a call.

But what about enlargement of the Eurozone? Perhaps it is the case that enlargement of the Eurozone is one part of the so called “European project” that will continue unabated, or will it? Certainly the 10 new EU member states have no opt out on the single currency, as per the accession Treaty signed by these states governments and ratified in referendums, but the accession treaty laid down no timetable for Eurozone accession.

A report today at the Hungarian financial news portal, Portfolio Online, whilst outlining some of the benefits of eurozone enlargement, also suggests some reasons that may bring about a halt to expansion of the €uro area.

Central Europe's manufacturing industries would strongly benefit from a quick adoption of the euro but this might further increase the fears of workers in current euro zone, Michal Dybula, Warsaw-based analyst of BNP Paribas, said in a research note.

While ‘No' votes at the French and Dutch referenda on the European Union's Constitution might slow the convergence process of Central Europe, policymakers in Western Europe might also be concerned with regards to the poor fiscal track record in Central Europe, fearing renewed deficit overshoots once countries enter the euro zone.

"New risks would emerge if the political commitment of various European institutions to accept new members declines, reducing the incentive for accession countries to implement the measures required in order for the nominal convergence criteria to be met," Dybula said.

Central Europe's manufacturing industries can rely on a cheap but skilled labour force, lower taxes and, thanks, to strong FDI, good access to global markets via parent companies' sales channels. "Yet, for workers in many of the EU-15 countries, the success of newcomers poses a risk to their jobs." In several major EU-15 countries, including Germany and France, the relocation of production and/or inflow of cheaper labour from Central and Eastern Europe to the West start "to shape the language of the political debate", the analyst said.

While big companies, owned by western firms can manage the FX risks efficiently and rely on cheap loans from the parent firm, for smaller manufacturing businesses in Central Europe the adoption of the single currency would remove many obstacles to enter foreign markets in the Union.

“Also, smaller companies from EU-15 countries...could benefit from an expansion of the euro zone as the relocation of production to cheaper locations would become easier," Dybula said. “That, however, might mean a further reduction of manufacturing jobs in western Europe and the lack of sufficient labour market reform in the West would indicate that those lost jobs might not be swiftly replaced."

Dybula said that talking down a swift adoption of the euro by Central Europe should not be particularly difficult on the basis of, for example, the recent fiscal performance of most countries of the region.

"With deficits well above 3% of GDP in Poland, Hungary and the Czech Republic and little commitment to remove structural obstacles to sound public finances, policymakers in the current euro zone could insist that accession countries should deliver more than the current criteria, arguing for the need of assurance that their deficits will not slip out of control again after the adoption of the euro," the analyst said.

Dybula noted that Central Europe's policy makers “whose policy horizons often last for only four years", are unlikely to accept any demands to tighten entry criteria.

From - Central Europe and the Euro
As I noted the other day the austerity measures required to meet Eurozone membership criteria are not going to be politically popular – local politicians might, in private, be glad of a delay but of course they couldn’t admit to it in public.