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EURO FOCUS - ANALYSTS SINGLE OUT FISCAL AND INFLATION RISKS IN SATISFYING UNFORGIVING MAASTRICHT CRITERIA

Keeping genie in bottle key to meeting euro date

HOPE, the saying goes, is the last to die, and the January 1, 2009 date for euro adoption in Slovakia is certainly still alive after some determined resuscitation efforts by the new left-leaning cabinet of Prime Minister Robert Fico.

HOPE, the saying goes, is the last to die, and the January 1, 2009 date for euro adoption in Slovakia is certainly still alive after some determined resuscitation efforts by the new left-leaning cabinet of Prime Minister Robert Fico.

Nevertheless, analysts polled by The Slovak Spectator were still inclined to doubt that the current administration would be able to live up to the goals set by the previous right-wing Mikuláš Dzurinda government, and agreed that fiscal and inflation risks could postpone the date for the introduction of the common European currency in Slovakia.

The danger, they said, is that Slovakia will not be able to meet the Maastricht economic criteria for EU member states to enter the third and final stage of European Economic and Monetary Union (EMU) and adopt the euro (Slovakia has been in the second stage since November 2005, with its currency pegged to a plus/minus 15 percent fluctuation band around a central parity rate with the euro).

"The chance for euro adoption on January 1, 2009 is still alive, but I lean towards the opinion that there is a significant risk that the euro adoption will have to be postponed," Marek Gábriš, an analyst with ČSOB bank, told The Slovak Spectator.

Analysts who took part in a recent Reuters poll saw a loosening of fiscal policy after the change in government as the most likely reason for a possible euro delay, and picked 2010 as the most realistic date for the arrival of the euro in Slovakia.

Gábriš and Zdenko Štefanides, a senior analyst with VÚB bank, agreed with the fiscal risk view, and added growing inflation as another major barrier to January 1, 2009 as the date of adoption.

According to Štefanides, while inflation in Slovakia currently stands at 5 percent, the current Maastricht inflation limit is around 2.6 percent, meaning there may not be enough time to ratchet the figures down to scrape in under the wire.

"To enter the EMU on January 1, 2009, we will have to meet the inflation criterion in the evaluation that is written in June 2008, which will take into consideration the average inflation rate from April 2007 to March 2008," he said, pointing out that this gave the NBS less than nine months to cool price growth.

"The central bank estimates inflation at the end of 2007 at 2.8 percent, but only three months ago it thought inflation would be at 2 percent by that time."

While the current Maastricht inflation limit of 2.6 percent could move higher in future due to growth in energy prices, it is clear that the likelihood Slovakia will stumble over the inflation criterion has increased during the past several months.

Gábriš cited the example of Lithuania, which wanted to join the EMU in January 2007, but was prevented from doing so by the European Commission. According to the Convergence Report prepared by the European Central Bank in May 2006, the 12-month average inflation rate in Lithuania was 2.7 percent - just above the reference value of 2.6 percent. In its decision to bar the country, the EC emphasized the need for strict adherence to the Maastricht criteria, and expressed the fear that Lithuania would not be able to contain its inflation within the established limits in the short-to-midterm period.

"This example shows that even a tenth of a percent can play an important role in judging whether a criterion has been met. From this point of view, fighting inflation is crucial," Gábriš said.

The ČSOB analyst said that if the cabinet was serious about adopting the euro in 2009, it should use its government programme and the state budget to help the National Bank of Slovakia (NBS) fight inflation.

"I'm not talking about high energy prices, which is an external factor that neither the NBS nor the cabinet can really influence. But while the NBS has already increased its key interest rates three times this year, the new cabinet has announced increased expenditures in line with its pre-election promises. This means that Slovakia could find itself in a clash between restrictive monetary policy and expansive fiscal policy, which could complicate the situation. It would be better if the cabinet made an effort to fight inflation as well," Gábriš said.

The new cabinet expressed a willingness to keep the deficit at 3 percent of GDP in 2007 in its first public finance proposal, tabled on August 16. However, the Finance Ministry is relying mainly on the country's current over 6-percent economic growth and prospective savings on state administration to cover increased expenditures.

Gábriš said he was concerned that once parliamentary debates on the budget and pre-election promises begin, expenditures might spiral out of control.

"I'm afraid that the cabinet might let the genie out of the bottle, and that the political and economic debate during the approval of the state budget will be difficult to manage," Gábriš said.

The autumn report by the EC on the EMU candidates is expected to give a clearer picture of how far or close Slovakia is to its euro adoption goal.


Maastricht Criteria for Candidate Countries

- an inflation rate of no more than 1.5 percentage points higher than the 3 best-performing member states of the EU (based on inflation);
- a ratio of annual government deficit to GDP that is no higher than 3 percent at the end of the preceding fiscal year;
- a ratio of gross government debt to GDP that is no higher than 60 percent at the end of the preceding fiscal year;
- must have been part of the second stage of the exchange-rate mechanism (ERM II) under the European Monetary System for 2 consecutive years, and not have devalued their currency during the period;
- a nominal long-term interest rate of no more than 2 percentage points higher than the 3 best-performing member states.

How Slovakia Stacked Up Against Maastricht Criteria in June 2006

  Slovak Data
(June 2006 )
Euro Reference Data Meets the Criterion?
(June 2006)
Government Deficit 2.9% of GDP 3% of GDP Yes
Government Debt 34.5% of GDP 60% of GDP Yes
Inflation Rate 3.7% 2.8% No
Long-Term Interest Rate 3.8% 5.9% Yes
Exchange Rate In ERM II since
Nov. 28, 2005
currency in ERM II
without significant volatility
NA
Source: National Bank of Slovakia

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