ECB rejects euro short cuts in east Europe

From the FT this morning:

The European Central Bank on Monday dismissed proposals for European Union states in eastern Europe to scrap their currencies and introduce the euro, without formally joining the eurozone.

The ECB was responding to the publication in the FT of plans by the International Monetary Fund for the area as part of a regional anti-crisis strategy. The FT report helped spark a modest rally in east European currencies on Monday as traders saw the IMF report boosting prospects for early euro entry.

Officials and commentators in the EU’s new member states were divided. Some suggested that while the idea might not be suitable for states with floating exchange rates, such as Poland and the Czech Republic, it might be right for smaller countries with fixed exchange rates, notably the Baltic states.

Miroslav Singer, Czech National Bank deputy governor, said the proposals could be appropriate for fixed-rate economies as long as the currency reserves were sufficient. “I fully agree with the IMF proposal, but I am worried that the EU and ECB are simply not willing to change their stance.”

The ECB insisted countries must adopt the euro in full and meet all entry rules. Ewald Nowotny, ECB governing council member, told Reuters: “This [IMF proposal] is not realistic. The membership for European monetary union has very clear rules and these rules have to be followed. From an economic point of view, it would not be a good signal [for] the confidence . . . towards the euro.”

The ECB has long said countries that wish to adopt the currency must bring inflation, deficits, interest rates and exchange rates into line and spend two years in the pre-accession Exchange Rate Mechanism II. Jean-Claude Trichet, the ECB president, told the European parliament in June 2007: “Euroisation is not a way to bypass . . . the checking of stability inside ERM II”.

Jean-Claude Juncker, prime minister of Luxembourg and chairman of the Eurogroup of finance ministers, has stressed that countries wishing to adopt the euro could not take short cuts. A eurozone finance ministry official said on Monday all eurozone finance ministers had discussed the issue in past months and backed Mr Juncker.

In Poland, Piotr Kalisz, chief economist for Citibank Handlowy, a commercial bank, said the proposals were best suited to “small economies like in the Baltic countries. For countries such as Poland and the Czech Republic, this would only be useful in the event of a cataclysmic crisis”.

Officials in Hungary and Romania reacted with scepticism to the IMF proposal. Adrian Vasilescu, an adviser at the Romanian central bank, said a swift move to the euro was “impossible”.

But Torbjorn Becker, director of Stockholm Institute of Transition Economics, said euroisation made sense for the Baltic states. “They’ve been aiming at that for a long time. This is just an issue of timing.”

Market analysts were sceptical. “It’s not realistic,” said Gabor Ambrus, an economist at 4cast, the London consultancy. “The ECB has said they they won’t take responsibility for the non-eurozone countries. Politically, it would also be difficult to sell to European voters.”

Additional reporting by Nikki Tait in Brussels, Jan Cienski in Warsaw, Thomas Escritt in Budapest and Robert Anderson in Stockholm

IMF urges eastern EU to adopt euro
By Stefan Wagstyl, Eastern Europe Editor

Published: April 5 2009 22:04 | Last updated: April 5 2009 22:04

Crisis-hit European Union states in central and eastern Europe should consider scrapping their currencies in favour of the euro even without formally joining the eurozone, according to the International Monetary Fund.

The eurozone could relax its entry rules so countries could join as quasi-members, without European Central Bank board seats, says the fund.

“For countries in the EU, euro­isation offers the largest benefits in terms of resolving the foreign currency debt overhang [accumulation], removing uncertainty and restoring confidence.

“Without euroisation, addressing the foreign debt currency overhang would require massive domestic retrenchment in some countries, against growing political resistance.”

Disclosure of the confidential report, prepared about a month ago, could reignite a fierce debate over strategies to assist central and east Europe.

Even though global leaders hailed last week’s G20 summit as a success, eastern Europe’s challenges remain. Amid deepening recession, Ukraine and Latvia, two states already in IMF programmes, have in recent days balked at approving IMF-mandated reforms. A third, Hungary, is struggling to create a government capable of implementing reforms.

The IMF report was compiled to support a campaign by the fund, the World Bank and the European Bank for Reconstruction and Development to persuade the EU and eastern European states to back a region-wide anti-crisis strategy, including a regional rescue fund. The campaign failed amid widespread opposition from both west and east European states.

Eurozone members also oppose easing the eurozone’s entry rules, as does the ECB.

The IMF, which forecasts a 2.5 per cent decline in regional gross domestic product in 2009, estimates that “emerging Europe” – including Turkey – must roll over $413bn in maturing external debt in 2009 and cover $84bn in projected current account deficits.

The report estimates that “the financing gap” – money needed from international financial institutions, the EU and governments – will be $123bn this year and $63bn next, or $186bn in total.

Much could come from the IMF. But the report says “up to $105bn” could be needed from other sources, including the EU.

IMF warns of strains exerted on east Europe
By Stefan Wagstyl

Published: April 5 2009 22:04 | Last updated: April 5 2009 22:04

It is just as well that world leaders saw last week’s G20 summit a success in the fight to overcome the global economic crisis. A stark report from the International Monetary Fund, disclosed in Monday’s FT, shows what a tough job they face in one key region – central and eastern Europe.

The analysis, which covers Turkey, as well as the former Communist states, sees gross domestic product plunging 2.5 per cent this year, against a 4.25 per cent growth forecast last autumn.

“The financial crisis is putting severe strains on the pre-existing vulnerabilities of emerging European economies . . . Credit losses at foreign subsidiaries of west European banks are threatening to start a vicious downward cycle . . . Regional currencies have come under pressure and tension among currencies is increasing,” says the report, which was written about a month ago.

The IMF yesterday did not respond to the FT’s request for comment in time for publication.

The report’s forecasts are at the gloomy end of market projections, but not off the scale. The authors estimate the region (excluding Russia because of its huge foreign exchange reserves) must roll over $413bn in maturing external debt this year and finance $84bn in current account deficits, with smaller amounts due in 2010.

The Fund assumes the rate of debt rollover will decline to 50 per cent for private debt and 90 per cent for sovereign this year with modest improvements in 2010.

On this basis, after allowing for other variables, the IMF estimates the region’s “financing gap” – the money that cannot be found in the market – could be $123bn in 2009 and $63bn next year, or $186bn altogether. The largest gaps are in Romania ($34bn), Turkey ($40bn) and Poland ($59bn), a country which has so far escaped the worst of the crisis.

The IMF can help close the $186bn gap with more than $81bn of its resources, based on individual countries’ quotas for IMF financing. Up to $105bn may be needed from other institutions, including the European Union, and from creditor governments.

“There are stark differences in how individual countries are positioned to withstand the crisis”, say the authors. They contrast Poland, the Czech Republic and others that “face no immediate funding needs” but might need future liquidity; with other countries inside and outside the EU that are already in IMF programmes, such as Hungary, Latvia and Ukraine, as well as those finalising programmes, for example, Romania.

The report warns that old EU members may not be immune saying: “A pro-active strategy will be needed to address problems in advanced EU countries that could be affected by the financial turmoil from a crisis in emerging Europe.”

The IMF highlights the vulnerability of states with large shares of domestic loans in foreign currencies – headed by Estonia, Latvia and Serbia.

The region’s banks, largely the subsidiaries of west European groups, could face non-performing loans of about 20 per cent of total loans, estimate the authors, though this could be conservative. West European banks, with regional exposure of $1,600bn, could see losses of $160bn. They might need $100bn in new capital – or $300bn in “a more severe full-fledged regional crisis”.

“Where this burden would fall and how it would be shared between advanced and emerging markets is an open and critical question.”

The report calls for pan-European action, involving the EU and the European Central Bank, even though Brussels and the ECB have expressed doubts about this and are following a country-by-country approach.

It says “a wider crisis could start with the collapse of one of the currency boards or pegs which look increasingly unsustainable”, referring to fixed exchange rate regimes of countries such as the Baltic states.

A region-wide response should include short-term liquidity support, macro-economic stabilisation, bank recapitalisation with the support of western European authorities, bank restructuring in eastern Europe and debt restructuring.

For EU members, the IMF also recommends euroisation – adopting the common currency even without formally joining the eurozone or gaining ECB board representation. This raises political and economic difficulties.

A new currency is the silver bullet that supposedly kills all economic ills. Panama, El Salvador and Ecuador have the dollar; Montenegro and Kosovo the euro. Now it has been suggested that central European members of the European Union not in the eurozone should unilaterally adopt the euro too. This, the International Monetary Fund believes, could help forestall a regional crisis so severe that euroisation may happen anyway. Better to pre-empt the inevitable and euroise now.

It is hard to see, though, what lasting benefits this would have. Eastern Europe’s main problem is its foreign debt. About 60 per cent of all Hungarian loans are in foreign currency; almost 100 per cent in Latvia and Estonia. Euroisation might help the whole region roll over the $413bn that falls due this year by making devaluation impossible. That would reduce the region’s immediate need for IMF funds. But that is all. The debt problem would still remain. It would just be redenominated.

A new currency is no guarantee of stability. If anything, it makes it more important to get other policies right. A euroised country can only expand its money supply through exports or capital inflows. As neither is likely at the moment, that means undertaking other adjustments. These would be painful and require the kind of flexibility most of eastern Europe lacks – except, perhaps, the Baltic states. When Ecuador first adopted the dollar, for example, the country was compared to an optimistic but overweight woman who had bought a dress two sizes too small. Ecuador is still trying to struggle into that dress.


There would be technical issues to solve – such as the exchange rate euroisers used when switching over. There would be political problems too. Unilateral euroisation would threaten the Maastricht treaty's integrity and diminish the credibility of the eurozone as a whole. Its one-size-fits-all monetary policy would be even harder to believe if a multitude of new Greeces sprang up in the east. Anyway, all of the economic reforms that euroisation would subsequently require can be done through programmes supported by the now richly-endowed IMF, and less painfully too. Euroisation is no panacea.

BACKGROUND NEWS Crisis-hit European Union states in central and eastern Europe should consider scrapping their currencies in favour of the euro even without formally joining the eurozone, according to the International Monetary Fund. The eurozone could relax its entry rules so countries could join as quasi-members, without European Central Bank board seats, says the fund. "For countries in the EU, euro-isation offers the largest benefits in terms of resolving the foreign currency debt overhang [accumulation], removing uncertainty and restoring confidence," it says in a report. "Without euroisation, addressing the foreign debt currency overhang would require massive domestic retrenchment in some countries, against growing political resistance." Disclosure of the confidential report, prepared about a month ago, could reignite a fierce debate over strategies to assist central and east Europe.


Struggling European Union countries in
central and eastern Europe should switch to the euro even without full
eurozone membership, according to a confidential report quoted by the
Financial Times on Monday.
The 16-member eurozone could relax its entry rules so the states could
join as quasi-members, without European Central Bank seats, the paper
cited the report as saying.
"For countries in the EU, euroisation offers the largest benefits in
terms of resolving the foreign currency debt overhang (accumulation),
removing uncertainty and restoring confidence," said the report,
written around a month ago.
"Without euroisation, addressing the foreign debt currency overhang
would require massive domestic retrenchment in some countries, against
growing political resistance."
The paper said the report had been prepared to support an ultimately
unsuccessful campaign by the IMF, the World Bank and the European Bank
for Reconstruction and Development to support a region-wide
anti-crisis strategy for the European Union and eastern Europe.
The report, covering eastern Europe, former communist states and
Turkey, expects a 2.5 percent fall in gross domestic product for the
"emerging Europe" region this year, compared to a 4.25 percent growth
forecast last autumn.
It said the region would have to roll over $413 billion of maturing
external debt in 2009 and finance $84 billion in current account
deficits.
G20 countries agreed to boost IMF reserves to $750 million at their
summit in London last week to help emerging markets including those in
eastern Europe weather the global financial crisis.
In the last six months the IMF has pledged over $60 billion in loans
to the region, with Hungary, Latvia, Romania, Serbia and Ukraine among
those with programmes.