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THE EURO – AN ASSESSMENT OF ITS GROWING GLOBAL AND REGIONAL ROLE

Cicero Foundation

(June 15, 2001. Paris)

 

What are the Prospects for Euro-Zone Membership for the Candidate Countries and What Will Be its Impact on their Respective Economies?

 (Hungary and the euro)

by

Professor Tibor Palánkai

Budapest University of Economic Sciences and Public Administration

Director of Centre for European Studies and Education

 

 

EU ASSOCIATION OF CEE CANDIDATES AND THEIR MONETARY POLICIES

 

After the democratic revolutions of 1989, in Central and Eastern Europe, the EU signed association agreements with 10 CEE countries between 1991 and 1996. Although the Europe Agreements referred to promoting the convertibility of currencies of CEE partners, they did not contain any monetary provisions. The CEE countries associated already with an EU of single market and constructing EMU, but the monetary relations or “co-operation” had to be built outside of these agreements. The rapidly growing and restructuring co-operation under Europe Agreements had broad monetary implications, but they were dealt basically with unilateral steps and measures of the CEE countries. It was clear from the beginning, that successful implementation and full exploitation of possibilities of associations, the convertibility and relative stability of currencies of CEE partners should be secured as soon as possible.

 

First steps to convertibility were made immediately after democratic changes, and in some countries (Hungary and Poland) already well prior to them. The notion of convertibility was on agenda both in expert discussions and political declarations, particularly in the reforming countries, after the 1970s. In Hungary, the proposal of "forint convertibility" has been raised from time to time, after 1968. It was an important development, when Hungary joined the IMF and the World Bank in 1982. Real steps toward convertibility of the national currency have been made only after 1988. For Visegrad countries, convertibility was achieved for current account transactions, and foreign direct investments by 1996. (The same stage was completed in Western Europe by 1958). 

 

In the reforming countries, particularly in Hungary and Poland, the exchange (trade) rate was used as an "active" economic policy tool after 1973. It meant, first, anti-inflationary re-valuations and later, de-valuations for import (energy) savings and improving export competitiveness. The overvalued tourist rates served as a certain taxation of foreign tourists, because of the subsidized food or services, in all countries. Unified exchange rates were introduced in Hungary, in October of 1981 and in Poland, in 1982.

 

After 1989-90, the exchange rate policies of CEEcs have been important part of monetary policies, and the countries have followed fairly different priorities. In some countries, and in some periods the monetary stability, and the anti-inflationary considerations got priority, in others, the competitiveness was the primary concern. Although, all countries turned to unified exchange rates after 1990-91, the CEEcs pursued fairly diverging exchange rate policies in the following years, either by fixing (Czech Republic), or by crawling peg (Poland after 1991 and Hungary after 1995)[1] or relatively free floating (Czech Republic since 1997, and Poland since 1998).

 

Uniting fixing its exchange rate, the Hungarian National Bank turned to a currency basket first in 1981, and till 1991, it mostly followed the currency structure of the Hungarian foreign trade. The structure of the basket changed during the 1990s, and from January 1 of 1999, the forint was linked to a basket of 70% Euro and 30% dollar.[2] From point of view of gradual approaching to the Euro-zone, it was an important step that the exchange rate of the Hungarian forint was linked (pegged) fully to the Euro from January 1 of 2000. The changes were supported by an analysis of the Hungarian National Bank, which indicated that the optimal currency basket is that of composed from 90-95% in Euro and 5-10% in dollar.[3]

 

The full linking to Euro means that the Hungarian monetary policy “will be more strongly related to the monetary processes of the Euro-zone and the monetary policy of the European Central Bank. As result of closer relations, the monetary and real-economy shocks of the Euro-zone would be more strongly transferred to the forint than in the previous years.”[4] By that step, the monetary policy of Central Bank became more transparent, as far as the effects of changes of the cross rates were eliminated. The exchange rate risks have been reduced substantially.

 

The fixing of HUF to the euro was no doubt a step for the right direction, but due to following strong devaluation of the euro, on the short run, it caused some difficulties, particularly in terms of anti-inflationary policy aims of the Hungarian government.

 

The Hungarian National Bank introduced several new measures in the monetary policy in the first half of 2001.  In the pegging, the monthly devaluation rate was further reduced to 0,2% from April 1. By that, HUF got close to fixing, in fact, many experts feel, that by such small devaluation, the crawling peg has lost its meaning. Others stress that 10% annual inflation is too high for any fixing. In optimal case, taking into account the relatively rapid productivity growth of the country, the inflation should be brought down to about 5% in order to make the exchange rate sustainable. According to the finance minister and the president of the National Bank, the crawling peg in Hungary will be abolished from the beginning of 2002.

 

From May 4, the band of free floating for the HUF was enlarged from the earlier +and –2,25%, to +and –15%, applied by the ERM countries.[5] According to the Board of the National Bank, the main aim of enlarging the band was “sustainable reduction of inflation”, which was halted by several factors. The inflation got stuck to around the 10% level and government could not achieve its targets for reducing inflation in the last two years. First as result of increase in energy prices, and recently due to rapid rise in prices of food and some services. It was realised that more monetary rigour is needed.

 

In the first month of the enlarged band, the HUF was re-valued by more than 8%. Experts, however, expect an about 4-5% revaluation on an annual basis. That could bring down inflation by 2-3%. The anti-inflationary effects may be moderate this year, but for 2002 1.8-2% reduction in inflation can be reached.[6] Some fear of increased volatility of the forint, which may have negative effects both in terms of fight against inflation, and competitiveness. Official estimates, however, do not expect revaluation approaching 15%. As a logical step, the “stability of currency” (exchange rate) as primary monetary policy objective is replaced by inflation targeting, like Poland and Czech Republic did after floating their currencies. 

 

The revaluation of the forint is good for companies with high import inputs (most of the transnationals investing in Hungary) and bad for agriculture with high domestic cost components. Companies with high foreign currency debts (MATAV – telecommunication company) or with large net import (MOL – national oil company) will be on the winning side, while large exporters loose in terms of their profitability. On the part of the companies increase of risk awareness is needed.

  

From June 15, the remaining restrictions on external transfers were abolished, the capital transactions were fully liberalised. After 70 years, the Hungarian forint became fully convertible again.

 

The liberalisation measures mean: abolishment of compulsory home transfer of revenues earned abroad, freedom of opening bank account abroad by Hungarian companies or individuals, free transfer and holding of foreign currencies by Hungarian and foreign subjects, unlimited possibilities to acquire share or full foreign property by Hungarians abroad, free and unlimited holding and export-import of the foreign currencies across the border, access of foreigners to the security and forward markets etc.

 

These are considered strategic steps toward adjustment and implementation of single market upon entry into the EU, and then rapid joining the euro-zone soon afterwards.

 

STABILISATION OF TRANSFORMING ECONOMIES

 

It was clear from the beginning, that the monetary stability assumed the broad stabilisation of the economies. After the years of “transformation slump” (Professor János Kornai) between 1989-1993, the recovery started in 1994 in most of the countries of Central Europe and the economic growth of these countries reached about 4-5% in the following years. In Hungary, in fact, after a period of 25 years stagnation, the economic growth accelerated only in 1997.  After 1973, the Hungarian growth rate never reached more than 3%, except 1987 and 1994. In 1997 the Hungarian growth of GDP in real terms was 4,6%, 5,1% in 1998, 4,5% in 1999 and 5,2% in 2000. The world financial crisis and the Kosovo war have lead only to some minor slowdown of the Hungarian economy. Contrary to the last quarter of century, high growth was achieved without serious deterioration of internal budget and balance of payments, and heavy increase in indebtedness. It seems that Hungary can take a „sustainable growth” path for the coming years, except, of course, if external conditions seriously deteriorate. The 4-5% growth corresponds to the rate prognosticated for the whole Central European region.

 

In light of large differences in levels of developments between EU and the CEE candidates (Hungary’s per capita GDP is around 50% of the EU average), the 4-5% growth of CEE countries is highly desirable, in order to close gradually that gap in the foreseeable future. If we assume about 2-2,5% growth in the EU, the about double rate is desirable and realistic, even if it needs great effort. An about 2% growth „surplus” of CEE countries could be achieved easier with more dynamic EU growth, while it could be hardly sustainable if the EU economies stagnate or go into recession. As the economies of these countries are highly dependent on external factors, the slow EU growth means an unfavourable macro-condition for present enlargement.

 

In Hungary, the unemployment was around 6% in 2000 (it was 12% in 1991), which was somewhat lower than the average of the EU countries. There are some differences in the employment levels of the CEE countries, but in spite of more dynamic growth, in these respects dramatic improvements and return to full employment can not be expected in the near future. The unemployment in Hungary has strong regional character, it exists mainly in the Northern and Eastern regions, while the other parts of the country rather faces labour shortages. As result of structural reforms (and in fact, single market and euro) in the EU countries, there are some improvements, but it is to be seen, how the program against unemployment (Lisbon decisions in April 2000) will change the past trends. The unemployment on both sides is important constraint concerning enlargements, particularly in shorter run, and from points of view of some member countries.

 

One of the conditions of any type of joining ERM is that the inflation should be brought down to an acceptable (at round 4-5%) level and the deficit of the balance of payments should be kept down so that the switch to a fixed exchange-rate could be made. The necessary monetary reserves are available in most countries, but their required level and proper structure for exchange rate stabilisation should be studied.

 

The rate of inflation in Hungary was 23,6% in 1996, which was reduced to 18,3% in 1997 and to 14,3 to 1998. It decreased to 10% in 1999 and it could be brought down only a little bellow that level (to 9.8%) in 2000. The 4-5% level of inflation in Hungary could be produced by around 2004, which is supposed for sustainable exchange rate fixing, needed for joining ERM2. As the inflation of most of the candidate countries is in the range of 10%, the same applies to the others.

 

The closing the gap with the EU countries, however, may complicate these aims. “Their GDP per head is far below the European average. Joining the EU, or the prospect of it, ought to help them catch up. However, as they catch up, their price levels as well as average incomes should in theory converge on the European average. That implies a higher inflation rate.”[7]

 

The Hungarian deficit of balance of trade was reduced from its peak of $3,9bn in to $1,7bn in 1996, and it seems possible to be kept down near the level of $2,5bn (4,5-5% of the GDP) in spite of acceleration of economic growth after 1997. The deficit gradually escalated to $2,1bn in 1997 and to $2,8bn in 1999, but it increased mostly due to extraordinary external factors (effects of world financial crisis and more than $1bn profit repatriation) and not for structural reasons. The financing of deficit has been well secured by net inflow of FDIs and it seems to continue so in the coming years (about $1,5bn). The Hungarian external debt was drastically decreased from its peak of $30,7bn in 1995 to $20,1bn in 1998. It somewhat increased to $24,4bn in 1999. The deficit of balance of payments of some other CEE candidates tended to increase more dynamically.

 

During 2000, the Euro rate moved further down, the Hungarian forint was also devalued in real terms to the dollar. These effects have remained relatively modest on the whole of Hungarian foreign trade, as 77% of our export is conducted in euro. The corrections in the exchange rate policies were not required. Due to devaluation, the competitiveness of our export improved toward Russia and the South East Asian region, while the Russian oil import had some sensible negative effects on Hungarian balance of payment. This was primarily, result of oil price explosion, which was further aggravated by the devaluation. Some of the Asian import was replaced by cheaper euro-zone import, but these developments have not had any palpable trade diverting effects, and the shares in the Hungarian foreign trade basically have not changed. The same happened in terms of direct and portfolio investments, while due to greater volatility of the forint the interests of the leading overseas portfolio investors moderated somewhat towards the Hungarian market. At the same time, the share of dollar and other currencies remained around 23% in foreign trade transactions. The volatility of the oil prices had some negative effects on balance of trade, terms of trade and at final end, on inflation. The aim of reducing Hungarian inflation to about 7-8 percent could not be fulfilled, by 2000, its rate remained at around 10%.

 

EASTERN ENLARGEMENT AND THE EMU

 

By end of 1990s, the development of the EU integration arrived to a new, critical stage. The EMU entered into the third phase of its implementation on January 1 of 1999 and the launching of the Euro as a single currency started. The gradual introduction of the Euro (in cash form) will be completed by February of 2002. We expect that the membership negotiations, which started with the first round CEE countries in 1998 (screening in March, and real negotiations in November), could be concluded sometime around following this time. In Hungary, we assume that we can be in the first round of joining, probably by 2004 or 2005.

 

The full EU membership of CEE candidate countries necessarily includes their EMU participation. It corresponds to membership requirements as the Copenhagen criteria set, they should have the „ability to take the obligations of membership, including adherence to the aims of political, economic and monetary union.” The CEE candidates, however, are not expected immediately joining EMU upon membership, but only after a certain transition period. After adhesion, they first join EMS and the exchange-rate mechanism (ERM-2) and entering EMU can be realistically put only some years later (probably not earlier than 2006). The CEE candidates would not be fully prepared before that, and the Agenda 2000, which assume first Eastern entries around 2003, does not foresee it either. It is another question, how long transition period the CEE countries need for adjusting to the EMU and joining the Euro-zone. For several reasons, some assume, that it may take many years, probably more than a decade. We do not exclude that transition would and should not be too long and for Hungary could be realised around or not much later than 2006.

 

The recent official Hungarian preparation plans calculate with the possibility of joining EMU around 2006, and there are similar endeavours in other CEEcs. According to György Szapary, the vice-president of Hungarian National Bank, Hungary can meet the Maastricht convergence criteria by 2004, and will be ready to join the euro-zone 2 years later. He does not see the anxieties of the ECB founded that early joining of Hungary and others to the euro-zone would endanger the price stability of zone. “The economies of new EU members are too small to exert sensible negative influences, and till the entry there is enough time to achieving real convergence.”[8]

 

Of course, one should be aware, that realistically, the enlargement process is very complex and could be delayed by many factors. One should take into account the worst case scenarios and the adhesion of all candidate countries could be realised probably by several rounds. That applies to the presently negotiating 12 countries, not to speak about a Union with 35-38 members, which may emerge in the next 20-25 years. But by the decisions of Helsinki and Nice summits, the enlargement has clearly become a priority, and according to the “Regatta Principle”, it depends on the progress of adjustment and preparation of the candidates, which countries will be the first to join. The first round may be realised around 2004-2005, and the conditions seem to be secured on both sides. In the paper, we analyse the problems in general, and in most cases, the dates of joining do not influence our conclusions.

 

The EMU has far-reaching impacts on the economies of CEE candidates and they have to implement a complex program of adjustment before they can join EMU in the future. These objectives and impacts should be analysed for different periods:

 

1. Before entering EMU by CEE new members during a transition period (in ERM-2),

2. Joining the EMU at the end of the transition period and after.

 

The EMU membership is foreseen only after a certain transition period, certainly not before they adjust and adhere to the single market, and the CEE candidates are also expected to meet Maastricht convergence criteria.

 

CEE candidates including Hungary, however, can join ERM2 upon their entry the EU, and the conditions seem to be secured by that time. The Hungarian National Bank is prepared for the tasks in connection with the exchange-rate interventions in terms of both staff and structure. It would be an important condition on the part of the EU to open and provide those monetary funds, which are necessary for the exchange-rate interventions.

 

The participation in the ERM-2 would require closer relation between inflation and the stability of the exchange-rate in terms of economic policies. This would assume the consolidation of the Hungarian economy to an extent at which its participation in the ERM does not threaten the „sustainable economic growth”, its export-competitiveness (the restriction of devaluation), and the difference to the EU inflation rate is no more than 2-4%. This aim can be achieved if a consistent stabilisation policy is maintained in the future.

 

The budgetary constraints of „deepening” and „enlargement” are somewhat more serious for the both sides. Although, the euro-zone member countries have managed to bring down their budget deficit to 1,2% in 1999, but the union budget has relatively marginal sources to cope with pressures on transfers if the stability of EMU would be in danger. The budgetary implications of adjustment and preparation for membership of CEE candidates are enormous, particularly in terms of infrastructure, environment or structural modernisation. According the calculations after closing the chapter on environment, Hungary need about euro100bn investments into improving environment in order to meet the EU standards.  The transfers, envisaged by Agenda 2000, are relatively modest in light of those needs and the national budgets of the candidates can cope only partly with these problems. These is particularly true to Hungary, which contrary to other candidates, who already „fulfil” the 3% Maastricht ceiling, had a budget deficit of 4,6% in 1997 and 4,5% in 1998 and 3,5% in 2000. The financing of adjustments could be mostly on commercial grounds, but it depends on several economic and political factors. The budgetary implications are probably the most complicated dilemmas of economic policies on the both sides. On shorter run, the slower growth, the higher unemployment and the budgetary constraints may negatively influence the relations between the EU and CEEcs and the enlargement process.

 

STAGES AND CONDITIONS OF EMU MEMBERSHIP

 

As it is indicated by Agenda 2000, the EU does not expect the entry of EMU by CEE candidates before 2006 and such target would not be realistic also on the side of the new members. While they have to go through difficult adjustment, there may be several arguments, which support that this can happen already around that time. Of course, it should be also stressed, that the CEE candidates more or less will and should follow the same timetable of evolution to the EMU as in the case of present members.

 

2.1.  Integration into the Single European Market (the first stage of the EMU). If we copy the timetable of the EU members, the precondition of the EMU is the complete realisation of the four liberties: the liberalisation of the movement of goods (this includes the integration into CAP), services, capital and labour. Our integration into the EMU postulates our full market integration in all of the fields.

 

In consideration of the White Book of June 1995, the implementation of the internal market program has already started in all candidate countries. The complex tasks of legal harmonisation, institution building, application of the EU standards, reform of public services and policies takes long time and they will hardly be completed before 2004 or 2006. With determined preparation and adjustment, single market integration of first round CEE candidates (Hungary) could be achieved by around 2006. As it is stressed by Riecke Werner, the vice-president of the Hungarian National Bank, that from points of view of EMU preparation the most important is that “the Hungarian economy should be able to stand on the European single market”.[9]

 

The real question marks arise about transition periods, which seem to be unavoidable in certain important fields. Originally both sides agreed that with a too long transition period, the single market could be undermined, and for that reason, why both sides strive to minimise derogations. The recently emerging compromise on 5-7 years transition period on free movement of peoples, (with the same delay in acquisition of arable land in the CEE candidates by the foreigners) creates new situation. Of course, one can argue that really only the free movement of capital is, which counts from points of view of smooth functioning of the EMU, and that will be fulfilled. Although, the labour mobility is considered important by the theories of the optimal currency area in terms of avoiding aggravation of regional differences, from points of view of joining euro-zone by CEE countries, these limitations are not relevant problems. The question of arable land is a marginal issue.

 

2.2. Contrary to the „preparation strategies” of some CEE candidate countries, which concentrate only the fulfilment of the convergence criteria (the second stage of the EMU), it is irrelevant without the single market integration. Put it otherwise, some countries may well fulfil Maastricht convergence criteria, but they still remain unprepared for EMU.

 

On the other hand, the meeting of convergence criteria is important as way of stabilisation of economies of candidate countries. Recently, Hungary started a “pre-convergence program”, which turns to be obligatory upon full membership. According to the Joint Assessment of the Economic Policy Priorities of the Republic of Hungary, the Hungarian budget deficit can be brought down near to 3% by 2002, the consumer price index to 6-8% and the gross public debt to 55-58% in the same year.[10] The convergence of Hungarian economy can be consolidated till 2006, including probably the requirement of exchange rate stability.

 

Some feel that the CEE candidate countries, being far behind the level of development of the present EU members, probably should face stricter conditions, because their meeting of “the Maasticht criteria in themselves would not secure the stability of the European currency.”[11] It is suggested that CEE candidates should spend more than 2 years in the ERM2 prior to EMU entry, and keep their exchange rate in a 2.25% band (unlike for example Greece, which enjoyed the 15% band).

 

Of course, we cannot exclude the probability of the prolongation of the stabilisation process if the liberalisation put too much burden on the economy, especially if this effect is strengthened by external factors, such as the unfavourable development of the European or the international economic situation. It is not clear, how the full membership will effect the national budgets. Even if the transfer of the 4% of the GDP from EU budget were realised, the net effect on the national budget could be negative (payment of about 1,27% of the GDP into the Community budget, burdens of co-financing, indirect budgetary requirements, while the budget transfers to CEE countries does not improve the budget balances). If that is the case, this stage might become longer, especially if on entering the EMU, the CEE countries are called more strictly to account for the fulfilment of the convergence criteria than the present members.

 

3. Joining the EMU by CEE first round candidates, namely changing the national currencies (Forint) to Euro (the third stage of the EMU): It turned out only after the Maastricht decisions that the introduction of the single currency in cash form cannot be done with the „big bang” method. The member countries gave 3 - 3.5 years for themselves for the accomplishing of this task. CEE candidates do not have to stick to the same schedule and pace but they might have to face some serious difficulties. The preparation of the micro- (especially the commercial banks) and the macro-spheres may be done continuously and it is possible that the transition can be done in less than three years.

 

We have to take into account, that going through the stages to EMU by CEE countries have to be implemented, when the Euro had already been introduced in the EU member countries. By around 2002-2006, some more countries may take part in the EMU, while the distinction between „core” and outsiders probably remains.  For these outsiders (CEEcs), the Euro may function with high probability as „parallel currency” and therefore, the possibilities and expenses of the „crowding out effects” and the Euro should be carefully examined. It is a general opinion that even in the most developed outsider countries (like Great Britain), the Euro may be used in internal transactions and circulate in the economy parallel to the national currency. In the less developed CEE countries the stronger currency may crowd out the weaker one. A lot of yet unexpected tensions can emerge between the stable Euro of the „core countries” and the national currencies of the outsiders. These effects are likely to influence the sectors, which are covered by transnational companies or based on intensive integration relations. The banks expect that the introduction of the Euro will result in a credit-card boom, which might help to ease the transition and will compensate the banks.

 

The implications of a possible “euroisation”, therefore, should be analysed. In case of parallel currency, the following problems should be considered:

-         the expenses of interventions to stabilise the exchange-rates,

-         necessary monetary policies offsetting the pressure of the increased inflation expectations,

-         the uncertainty of the control over the amount of money in circulation and its inflation effects.

 

Some countries (Estonia, Croatia or even Turkey) have already announced their intention to use euro as official currency prior to their entry into the euro-zone, or even into the EU. In fact, the currency board (Estonia) as fixing the national currency to the euro already implies some of the elements of euroisation, and probably it would be the case even more after 2002.

 

Officially, the EU is against any “euroisation”. According to the report of the Ecofin: “It should be made clear that any unilateral adoption of the single currency by means of ‘euroisation’ would run counter to the underlying economic reasoning of economic and monetary union (EMU in the treaty). Euroisation would not be a way to circumvent the stages foreseen by the treaty for the adoption of the euro”[12]

 

The question should be examined, whether these costs would not be bigger than the burdens resulting from a forced stabilisation expected on the basis of the convergence criteria. These considerations support the notion of rapid joining of EMU, even if it assumes relatively high adjustment costs.

 

If we take above circumstances, in case of CEE countries, the integration into the internal market, the meeting the convergence criteria, and that the change from national currencies to Euro could and should be achieved paralelly, so the separation of such stages in time will not be necessary as it was the case with the original members. Of course, this can vary form country to country in time.

 

HOW CEE CAN MEET REQUIRMENTS OF THE EMU?

 

If we examine the participation of CEE candidates in the monetary union, the first thing we have to analyse is to what extent they meet the structural and institutional requirements (how we fulfil the demands concerning the „optimal currency zone”) and the fulfilment of the convergence criteria set up in Maastricht is only the second thing to observe. We have to emphasise that the fulfilment of the structural and convergence criteria is not only the precondition of the integration but it also means the only way in which the advantages of integration outweigh its costs. This is the only way in which integration serves their interests.

 

Meeting the requirements of the „optimal currency area”:

 

The mobility of the „factors”: Theoretically, the liberalisation of the movement of capital and labour is one of the important preconditions. Due to its relatively low internal mobility it is hard to tell how mobile the Hungarian workforce could become under international conditions. (In this latter dimension, we do not have to take the underdeveloped real-estate market into consideration but we have to pay attention to certain other factors - i.e. the lack of the knowledge of languages, the hardships of fitting into a different society; the huge differences in terms of wages may also have a strong motivational effect etc.) The relations between the factors mentioned above require further research in terms of both the sectoral and the regional mobility of labour force. While the regional mobility of Hungarian labour force even inside the country have proved to be modest, the case was different on sectoral basis. There was a substantial shift from industry and agriculture to services in the last ten years. International mobility is another question. It is widely estimated that the Polish labour force would be probably the most mobile among the Visegrad countries. The fears, expressed by the presently proposed derogations in terms of labour mobility, seem exaggerated. Particularly on the long run, and for the whole Union. Not only the EU, but most of the candidate countries demographically are also deficit regions, and they need immigration in order to fill the gap on the labour market. That is the case with Hungary, and only the estimates differ how many foreign labour we need already in the near future. As result of enlargement, the threat of “flood” foreign labour is relevant only in certain regions (commuting in the border areas of Germany or Austria), and only in certain sectors.

 

The movements of capital have been liberalised by the May of 2001 measures of the Hungarian government, and probably the other candidates follow the suit soon.

 

The flexibility of the „factor prices”: The years of transition proved that the wages are much more flexible in the CEE countries that wish to join than it was assumed. What is more, they are more flexible than in the majority of the EU countries. The Central-European region’s greatest decrease in real wages took place in Hungary accompanied by intra-sectoral mobilities, without any serious social turbulence. The real wages in Hungary dropped by nearly 14% between 1993 and 1996 and they showed positive growth only in 1994 (election year). As it is proved by the demonstrations against the closing down of certain factories in Belgium, France or Germany, the social and political limits of wage-flexibility are stricter in the EU countries than in CEE. However, the tolerance of the CEE (Hungarian) society may change in the future. The newly introduced labour market regulations of CEE countries after 1990 were generally more liberal than that of existing in the EU members, and the recent Hungarian labour laws secure rather satisfactory market flexibility.

 

The possibility of „asymmetric shocks” (sectoral or regional): This possibility is relatively great in Hungary and in the other candidates due to structural reasons, since the ratio of sensitive products is high in their export. Owing to the export-dependency of these countries, this results in a high degree of sensitivity towards the business cycles. The probability of such „shocks” is increased by the significant dependence on the energy-import. At the same time, the share of “sensitive product”, which was about 58% in the Hungarian export in 1989, has drastically decreased bellow 20% by 1998, and the increasing ratio of intra-sectoral trade may decrease the country’s dependency on external shocks and the trends of recent years have been encouraging. These shocks are mainly related to structural reasons, so our closing up in terms of development is not an absolute priority on the short run.

 

Beyond the structurally based shocks it is hard to reckon with other unexpected events. Unavoidable external events („shocks” like the Gulf-war, the breaking up of the former Yugoslavia, Kosovo war, years of drought) caused Hungary a loss of billions of dollars (the civil war in the former Yugoslav republics about $2,5bn alone), for which the country did not get any kind of compensation. According to the WIIW estimates, the losses caused by the Kosovo war to Hungarian economy could be about 0,5% of GDP and 1% of export. Other estimates assume loss of 1% of GDP in the worst case. [13] The chances for compensations would be much better if Hungary were a full-member.

 

Budget transfers: It can be expected that the EU may be interested in delaying the joining the EMU by the CEE candidates in order to minimise the cohesion transfers. That could be the most important constraints of enlargement in this respect. It should be examined how these „costs” and those of competitive de-valuations relate to each other on the both sides.

 

The structural reforms that are inevitable for our successful integration into the unified market (legal harmonisation, creating the institutional conditions of the co-ordination of economic policies, the modification of the structures of economic planning and the institutional reforms) will take a long time and all the fields of the integration process will be affected by them. A lot of EU documents call the country to account for the sluggishness of „radical structural reforms” (the Country Report). When planning the integration process, it is absolutely important not only to work out the schedule of the EMU-connected harmonisation but to calculate its effect to the balance of the budget as well. We do not wish to define the pace of these tasks, it would be too early to prepare the analyses and calculations at this stage, including budgetary effects of EMU.

 

As the institutional conditions are concerned, the 1991 law created an independent national bank, and the recently proposed amendments mostly corresponds the EU requirements. The HNB has well trained staff.

 

The above conditions are mirrored in Copenhagen membership criteria. The mobility of factors and flexibility of factor prices are nothing else than requirements of “functioning market economy”, the coping with asymmetric shocks as structural criterion can be paralleled with “meeting competitive pressures”, and the building up the institutional framework of EMU is integral part of adoption of aquies communautaire. Meeting the Copenhagen membership criteria, on a large extent, means that Hungary is well advanced also toward EMU.

 

IMPACTS OF THE EURO ON CEE

 

In summary, the effects of EMU on the CEE candidates will be complex. Some of them are quantifiable and some not and they can be influenced by proper policies to good or bad.

 

- For Hungary the EMU would mean getting into a monetary zone the safety of which would be hardly achievable for the country left to its own devices. For a country the currency of which was completely valueless (the lack of convertibility) for decades and then, in the years of transformation going through rapid de-valuations (which became somewhat slower as a result of the stabilisation), joining the EMU is a benefit of unique significance.

 

A survey of Europay International conducted by SBS International about reception of Euro in 12 European countries indicated that Hungary showed the greatest interest about Euro among the countries outside the Euro-zone. [14] About one third of Hungarians (30%) favour Euro, because it brings economic stability, while the other one third (31%), because it means comfort and savings. The knowledge of possibility of paying already in Euro by bankcards was 94% in Germany and 91% in France of the questioned. While citizens of the Euro-zone countries were aware of that possibility in 82%, that was only 59% in the non Euro-zone countries. This share was 77% in Hungary.

 

The promise of a stable single currency has a great influence on the public opinion of the members (which happens to be negative in Germany since the citizens do not want to loose their strong national currency). The socio-psychological potentials of this fact have to be further exploited, and this „card” should be played for the support of the Hungarian public opinion.

 

- Belonging to a stable monetary zone improves the allocation of sources of capital, it widens the capital-market, its supply and betters conditions. Under the conditions of a relatively underdeveloped monetary system and capital market, black economy, plus high inflation, the capital is under-utilised and detoured from rational and optimal allocation (using the sources of capital for buying real estates, thesauration, prestige consumption, the flight of capital to abroad etc.). A higher capital-supply and more favourable interest rates can improve the chances of modernisation and economic growth. That would benefit both sides, the candidates and the EU as well.

 

- The introduction and overtaking of the single currency would mean savings, which in many respect if quantified, would be substantial. There will be no more conversion costs and the transactional expenses will decrease. The higher degree of monetary stability will make it possible for the banks and stock markets to reduce the general risk premiums, even if as function of national financial positions, they may remain diverging. This would mean that for example the Hungarian companies and institutions could reduce their present 3-4% risk premiums substantially. One of the most important gains will be the reduction in the expenses of anti-inflation policies. Due to the decrease of the rates of interest, it will be easier to manage the state budget (and the state debts). This may be crucial from the point of view of Hungary with high debt and high debt service (in 1999, the interest payment on debt took nearly 6% of the GDP). The amount of the official international reserves of the central bank may be significantly reduced.

 

- The single currency may contribute to the extension of trade (it may have a significant trade-creating effect according to some analysts) and it may improve the competitiveness of given sectors and the potential of national economies. It excludes the exchange-risk to some extent, which may create a better commercial environment from the point of view of both the development of trade and investment decision making. The benefits would be mutual.

 

- Joining the EMU is likely to make the country even more attractive from the point of view of foreign investment. The EMU may become an important factor of real integration. The analyses show that the exchange-rate expectations play an important role in where the leading companies choose to invest their capital. This might be the „most important impact” of the enlargement for all sides. [15] At the same time, recently by establishment of the Euro-zone, we experienced certain investment diversion effects from CEE to Euro-zone countries. (The investment of Toyota was diverted from Hungary or Poland to France among others on the ground of Euro-zone considerations.)

 

- The biggest price the national economies have to pay for joining the EMU is the loss of the national currency and the national exchange-rate mechanism (the possibility of devaluation) and the narrowing of the national monetary autonomy and sovereignty. This creates other, more direct compulsions for the economic participants, to which they are forced to adjust, since the mechanisms of the national economy (which could help them to adapt) are restricted. The loss of possibility of devaluation could have serious consequences to certain sectors, but the otherwise already narrow autonomy of candidates in the field of economic policies could be „widened” by their participation in the decision making of the Union.

 

- There are fears also, that by unified and centralised interest rate policy of ECB, it would be difficult to maintain the growth differences, particularly if they are substantial (“one size fits all”). As we pointed out the growth “surplus” of Hungary should be around at least 2-2,5% above the EU average for decades in order to catch up in the foreseeable future. At the same time, that growth differences do exist also among the present Euro-zone members, and they reached four times in magnitude in terms of annual growth rates among the countries at the two extremes of growth performance. It seems, that by proper national economic policy mix (more active structural, fiscal or income policies), such differences could be sustainable.

 

- The most unpredictable but one of the most crucial impact of the EMU will be the redistribution of incomes and wealth within the Union. This means that the introduction of the single currency will have a differentiating effect on the different countries, regions, sectors, companies, social layers and individuals. This effect cannot be foreseen with its volume, its directions and first of all, its economic and political consequences. It should be stressed that in this respects the cohesion transfers would be not simple „charities”, but well founded compensation of losses in favour of such countries, who gain on the one hand, but are hesitant to increase their budgetary contributions on the other.

 

- It may be an important consequence for the EU that with the introduction of the Euro the power relations will be changed on the international monetary markets, in the IMF or in the G8. In certain regions (Central and Eastern Europe, the Mediterranean countries, including Izrael, Africa - especially the Frank-zone - Communauté Financiare Africaine) will use the Euro probably very intensively. The Euro may take over the role of the Dollar on the energy (oil) markets, since Russia, the Mediterranean and the Arabic oil-countries are likely to prefer the Euro to the Dollar. In this respect, EMU could mean for CEE candidates that for example they buy oil for their own currency. Probably after a seemingly longer period of weakening following the introduction of the Euro, in longer perspectives, the dominance of dollar will be replaced by a bipolar or tri-polar international monetary system.

 

A concrete and comprehensive cost-benefit analysis would require more precise data and knowledge of conditions in order to make quantitative estimations regarding the factors mentioned above. This would be very important and should be made later if it is possible. But it is clear even without such estimations that if these countries met the basic criteria (structural and convergence as well), the net balance of the integration into the EMU of CEE candidates (and Hungary) is favourable for both sides.  Therefore, in the discussions, it would be a mistake to concentrate only on some aspects (fiscal transfers by the EU, loss of monetary sovereignty and exchange rate mechanisms by the CEE candidates) and not to take into account all costs and benefits.

 

In summary, it seems that on balance the impacts of the EMU on CEE countries, on the long run, will be positive. The introduction of the Euro will bring positive effects and the „stronger Europe” is a basic CEE interest.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

APPENDIX

 

Performance of the Hungarian economy

 

 

GDP

Annual growth in percentage

Inflation

(CPI)

Ind.

Agr.

Budget

Deficit

Unemployment

Production

1950-59

3.8

-

-

-

-

-

1960-69

3.1

-

-

-

-

-

1970-79

2.3

-

-

-

-

-

1980-88

1.1

-

-

-

-

-

1981-6*

1.5

6.7

-

-

-

-

1987

4.1

8.2

-

-

-

-

1988

-0.1

16.5

-

-

-

-

1989

-0.2

17.0

-

-

-

0.6

1990

-3.3

28.3

-10.2

-9.2

0.0

1.7 (23)**

1991

-11.9

35.0

-16.6

-6.2

-4.4

7.5

1992

-4.5

23.0

-9.8

-20.0

-6.5

12.3(675)**

1993

-2.3

22.5

4.0

-9.7

-5.8

12.1

1994

3.0

18.8

9.6

3.4

-8.1

10.4

1995

1.5

28.2

4.6

0

-6.5

10.4

1996

1.3

23.6

3.4

5.0

-3.0

10.7

1997

4.4

18.3

11.1

-1.3

-4.6

8.7

1998

5.1

14.3

12,6

-1,0  

-4.5

7,8

1999

4.5

10.0

10.2

-1.0

-3.9

7.0

2000

5.2

9.8                     

        -            

-

-3.5

6.4

2001+

4.6-5

8-9

-

-

-3.3   

6.2

*          Inflation 1980-85

**            Number of unemployed

+ Prognoses for 2001 by Hungarian Finance Ministry and Eurostat.

 

Central Statistical Office of Hungary. Annual Statistics.

Hungarian National Bank. Annual Reports.

Joint Assessment of the Economic Policy Priorities.

 

 

 

State of fulfilment of convergence criteria[16]

 

Country

Year

Inf.

In %

Budget

Deficit

(GDP %)

Public debt

In GDP %

Interests

(nominal)

Central European countries (CEFTA)

 

 

Hungary

1990

28.3

0.0

 

 

1991

35.0

5.0

 

 

1992

23.0

6.5

 

 

1993

22.5

5.8

64.2

25.4

1994

18.8

8.1

 

 

1995

28.2

6.5

72.6

32.6

1996

23.6

3.3

-

 

1997

18.3

4.9

62.9

 

1998

14.3

4.9

61.1

18.0

1999

10,0

3.9

60-61

15.0+

2000

9.8

3.5

58-60

13.0+

2001

8-9

3.3

55-58*

11.5

2002

5-6

3.2

55*

-

 

 

 

 

 

 

 

 

 

 

 

 

 

State of fulfilment of convergence criteria

 

Country

Year

Inf.

In %

Budget

Deficit

(GDP %)

Public debt

in GDP %

Interests

(nominal)

Central European countries (CEFTA)

Poland

1992

43.0

6.0

 

 

1993

36.8

5.5

55.7

 

1994

33.2

4.0

 

 

1995

28.0

3.3

 

 

1996

19.9

2.5

 

 

1997

15.5

2.8

 

 

1998

11.8

2.4*

28.3*

15.0

 

1999

9.8

2.7*

27.7*      

20.5+

 

2000

9.5         

2.2*

24.7*       

21.5+

 

Czech

Republik

1992

11.1

0.0

-

8.1

1993

20.8

0.1

27.2

 

1994

10.0

1.0

29.7

 

1995

9.1

0.6

35.0

 

1996

8.8

0.0

34.6

 

1997

9.0

0.0

38.1

 

1998

10.7

1.6*

42.7*

14.8+

 

1999                      

2.1*         

1.6*

41.9*

8.8+

 

2000

4.0

1.9*

44.9*

7.7+

 


 

 

 

State of fulfilment of convergence criteria

 

Country

Year

Inf.

In %

Budget

Deficit

(GDP %)

Public debt

in GDP %

Interests

(nominal)

Central European countries (CEFTA)

Slovenia

1992

208

0.2

 

 

1993

25.0

0.5

 

 

1994

19.8

0.2

16.0

 

1995

12.6

0.0

 

 

1996

9.7

0.1+

 

 

1997

8.8

0.5

 

 

1998

7.9

0.8*

25.6*

17.3+

 

1999

6.1

0.6*

28.0*

14.2+

 

2000

8.9

1.2*

32.1*

17.4+

 

Slovak

Republic

1992

10.0

3.1

 

 

1993

26.2

6.2

27.8

 

1994

13.4

3.4+

 

 

1995

9.9

3.1+

 

 

1996

5.8

1.3

 

 

1997

6.5

1.8

 

 

1998

6.7

4.7

57.5*

17.0+

 

1999

10.6

3.7

54.2*

15.3+

 

2000

12.4

3.2

56.4*

14.2+

 

Foreign debt. In Hungary, the internal public debt was 26,5% in GDP. This has to be added to the foreign debt for the total.


 

 

 

State of fulfilment of convergence criteria

 

Country

Year

Inf.

In %

Budget

Deficit

(GDP %)

Public debt

in GDP %

Interests

(nominal)

Baltic countries

 

Estonia

         

        

        

        

1992

  1076

        1.5

 

              

1993

  37.0

        2.0

 

 

1994

  42.0

        2.0

 

 6.2*

1995

  27.0

        1.0*

 

 

1996

  24.0

         -     

 

 

 

1997

11.2

         -

 

 

                      

1998

8.2

      +0.3

 

 

 

1999

3.3

        4.7

 

 

 

2000

4.9

        1.1*

 

 

 

Latvia

        

        

        

        

1992

        951

        1.6

 

 

1993

  35.0

        3.5

 

 

1994

  26.0

        4.0

 

9.0*

1995

  23.0

        2.2*

        9.0*

 

1996

  19.0

         -

        8.0*

 

 

1997

8.4

 

        7.0*

 

 

1998

4.7

 

        6.0*

 

 

1999

2.4

 

      10.0*

 

 

2000

3.0

 

        9.0*

 

 

Lithuania

        

        

        

        

1992

      1021.0

         0.0

 

 

1993

  188.0

         4.0

 

 

1994

  44.0

         4.0

 

7,2*

1995

  39.5

         4.5

       20.5*

 

1996

  24.6

         4.6

       29.5*

   

 

1997

8.9

        1.9

       27.8*

 

 

1998

5.1

        4.2

       30.5*

 

 

1999

2.3

        7.0

       35.2*

 

 

2000

5.5

        2.8*

       37.5*

 

 

 


 

 

State of fulfilment of convergence criteria

 

Country

Year

Inf.

in %

Budget

Deficit

(GDP %)

Public debt

in GDP %

Interests

(nominal)

Other candidates

 

Bulgaria

       

       

       

       

       

1992

 80,0

       10,6

       

 

1993

 63,9

       10,7

       

 

1994

 96,2

        6,3

106,3

 

1995

 62,2

        7,3

 81,2

 

1996

123,3

        9,0

97,9

 

1997

1074.0

        3.5

 104,8

     119.0+

 

1998

22.3

+1.5

82.7

       14.0+

 

1999

0.5*

1.1*

84.7

        11.5+

 

2000

11.0

1.0*

83.0

        11.5+

 

 

 

Romania

       

       

       

       

       

1992

210,0

        4,3

           

 

1993

256,1

        1,7

       

 

1994

136,7

        4,0

  15,1

 

1995

 32,3

        4,2

   

 

1996

 38,8

        5,8

 

52.0

1997

154.8

        3.6

24,7*

          63.7+

 

1998

59.1

3.7

21.9*

          56.9+

 

1999

54.8

2.6*

22.4*

          65.9+

                         

2000

40.0

4.0

23.4*

         55.0+

 

 

*  Maastricht criteria fulfilled.

+Lending rate

 

 

 

 

 

 

 

 

 

 

Hungarian Forint in the crawling peg

 

Monthly rates of devaluation of HUF

03. 12. 1995       1,9%

07. 01. 1995       1,3%

01. 01. 1996       1,2%

04. 01. 1997       1,1%

08. 15. 1997       1,0%

01. 01. 1998       0,9%

06. 15.  1998      0,8%

10.  01.  1998      0,7%

01. 01.  1999      0,6%

07. 01.  1999      0,5%

10. 01.  1999      0,4%

01.01.  2000      0,3%

04.01.  2001      0,2%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The currency basket to which HUF has been fixed

 

 

December 9, 1991.                    USD 50% - ECU 50%

August 2, 1993.                         USD 50% - DM  50%

May 16, 1994.                            USD 30% - ECU 70%

January 1, 1997.                         USD 30% - DM  70%

January 1, 1999.                         USD 30% - Euro 70%

                       January 1, 2000.                         Euro 100%

 

 

 

Intervention bands for HUF

 

July 1, 1992.                       + and  - 0.3%

                                  July 1, 1994.                       + and – 0.5%

                                  August 5, 1994.                  + and – 1.25%

                                  December 22, 1994            + and – 2.25%

                                  May 4. 2001.                      + and – 15%

 



[1] Monthly rates of devaluation of HUF:

                                                     03. 12. 1995       1,9%

                                                     07. 01. 1995       1,3%

                                                     01. 01. 1996       1,2%

                                                     04. 01. 1997       1,1%

                                                     08. 15. 1997       1,0%

                                                     01. 01. 1998       0,9%

                                                     06. 15.  1998      0,8%

                                                    10.  01.  1998      0,7%

                                                     01. 01.  1999      0,6%

                                                     07. 01.  1999      0,5%

                                                     10. 01.  1999      0,4%

                                                     01.01.  2000      0,3%

                                                     04.01.  2001      0,2%  

 

[2] December 9, 1991 – USD 50% - ECU 50%

  August 2, 1993  -      USD 50% - DM  50%

  May 16, 1994 -         USD 30% - ECU 70%

  January 1, 1997 -      USD 30% - DM  70%

  January 1, 1999 -      USD 30% - Euro 70%

  January 1, 2000 -      Euro 100%  

[3] Világgazdaság, October 19, 1999.

[4] Ibid.

[5] Intervention bands for HUF: from July 1,  1992               + and  - 0,3%

                                                          December 22, 1994    + and – 2,25%

                                                          May 4. 2001.              + and – 15%

                                   

[6] Üzleti7, May 14, 2001.

[7] The Economist, January 6,  2001. p. 64.

[8] Frankfurter Allgemeine Zeitung – Magyar Hírlap, May 28, 2001.

[9] Magyar Nemzet, January 15, 1999.

[10] Joint Assessment of the Economic Policy Priorities of the Republic of Hungary. Government of the Republic of Hungary and the European Commission Directorate General for Economic and Financial Affairs, April 6,2000 Br

[11] A study  of German HypoVereinsbank published by Eubusiness. Világgazdaság, May 3, 2001.

[12] Financial Times, November 8 2000.

[13] Világgazdaság, April 26, 1999

[14] Világgazdaság, April 30, 1999

[15] Views of Richard Baldwin, Joseph Francois and Richard Portes.

    [16] Commission of the European Communities

        Creditanstalt. Facts and Figures on Central and Eastern Europe.

       Central European Quarterly. IV/99- I/2000