Is Estonia’s Euro Membership A Done Deal?

Well, if you read this report from Euractiv, citing unnamed EU Commission officials, it is:

“If nothing extraordinary happens, the Commission will give its positive opinion for the accession of Estonia to the euro zone on 12 May,” an EU official said, clearing the way for Baltic country to join the euro in 2011.

There just one little snag here: that extraordinary, “fat tail” event seems to have just happened. For the Commission to be able to move forward on Estonia’s Euro Membership, the ECB have to agree. And it is here that Estonian journalist Mikk Salu steps in (in Estonian in the newspaper Eesti Päevaleht, summarised in English here) and says “not so fast”. Salu reports on a closed-door meeting of the Economic and Monetary Affairs Committee of the European Parliament held last Tuesday (April 13). The meeting had a single-item agenda: Estonia’s membership of the Eurozone, and the meeting was attended by ECB Executive Board member Jüergen Stark. According to MEPs who attended the meeting (but did not wish to be identified), Stark was “stark”: Estonia is not going to be admitted. The reason given was that in the wake of the recent crisis affecting the Eurozone, new criteria will be introduced – including per capita GDP and competitiveness sustainability – and on these counts Estonia will not qualify.

Salu also spoke to Estonian MEP Ivari Padar, who attended the meeting and confirmed the substance of the discussion, although Padar did try to mediate the situation slightly, saying, “you know, he is a central banker, and central bankers are a conservative lot”, etc etc. On phoning the ECB itself and the Commission the only reply he got to a straight question seems to have been “no comment”.

Basically, as I said, maybe the ECB are a conservative crowd, but I think it is very hard to see Estonia being admitted to the Euro without ECB backing, and indeed looking at what is happening over in Greece at the moment, and in the German Constitutional Court, I think it is very hard to see any new members at all in the immediate future. Consensus thinking right now seems to be more towards small(er) is more beautiful.

None of this surprises me, indeed when I wrote my last post on Estonia, back in February, it seemed to be an increasingly likely outcome.

But as Fitch pointed out when they raised their Estonia outlook, while eurozone membership looks increasingly possible it is not yet certain. Fitch warned in their report that even if Estonia meat all the formal Maastricht reference criteria for euro entry there is still a risk that the European authorities’ interpretation of these same criteria could lead them to reject Estonia’s application. According to Fitch, in Estonia’s case uncertainty surrounded whether the idea of “sustainable price performance” was going to be consistent with the deflation which is to be expected from such a severe recession, after inflation had so recently been in the double digit range. The agency also added that one-off measures taken by the government to reduce the budget deficit in 2009 could also count against it in the EU authorities’ judgment of whether the medium-term budget plans are credible.

The first point is an important one I think, and is reiterated by the ECB’s own Jürgen Stark in an interview given to the German magazine Der Spiegel for this weekend: “But when taking on board new members, we will need to take an even closer look, concerning the data and the sustainability of convergence,” he is quoted as saying.

Indeed if we go back to the 172 page EU Commission document leaked to the German magazine Der Spiegel last month, the EU Stability and Growth Pact is increasingly going to focus on issues surrounding competitiveness as well as on fiscal deficit ones. That is what the whole deabate over the Greek and Spanish economies which EU leaders are engaging in this week is all about. And any country which is not considered to be in completely good health under the SGP criteria is hardly likely to get the green light from the ECB and Ecofin.

It is obvious that the Estonian economy is still suffering from earlier structural distortions which have not yet been corrected. If we come to the consumer price index, this was only down about 2% in 2009, far short of the deflationary adjustment which will be needed to restore growth and competitiveness.

And to cap it all, for the first time since the start of the financial crisis, Moody’s has chosen this, of all, moments to up its ratings outlooks for Lithuania, Latvia and Estonia. The decision was apparently based on the idea that the contraction has been stabilized (which it has), but as we are unfortunately about to see, stabilization and getting back to growth are not one and the same thing. In Estonia’s case the more favourable rating was a reflection of the expectation that the country “will soon be able to join the eurozone”:

Estonia’s “economy and banking sector are exhibiting signs of a gradual recovery,” Kenneth Orchard, a Moody’s analyst in London, said. “Equally important, the government’s impressive fiscal performance in 2009 means that Estonia is likely to be permitted to adopt the euro next year.”

And if I’m reading this report aright, Latvia just declared a 9% general government fiscal deficit for 2009, well above the 6.7% which was originally estimated. Cry victory if you will, but perhaps it would be prudent to wait till the war is actually over before you cry it too loudly.

This entry was posted in A Fistful Of Euros, Economics and demography, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

14 thoughts on “Is Estonia’s Euro Membership A Done Deal?

  1. The main originator of central debt in Baltic are exploding social costs, this is not a surprise. Other deficits were smaller than expected.

    Regarding Estonia, the competitiveness of Estonia may be pretty high. People are working really hard, for long hours a day. And doing that really good. Public debt is nonexistent, government costs are really competitive. This is a big difference from Latvia and Lithuania which are something like feudal societies dominated by landlords.

    But the really big problem of Estonia is its enormous dependence on exports combined with tiny internal markets. The demand for Estonian goods has fallen apart. And there is no reason why this must change. If Estonia could make stimulus, they can not profit from it, because nobody will purchase 5 mobile phones produced in Estonia. And making stimulus for people to puchase more Estonian food will increase health costs. The model of „small new economy” they were so proud of, has failed completely.

    Markets for Estonian goods have fallen apart. Large consumers of Estonia goods as Latvia have failed themselves.

  2. Edward, Isn’t the lesson of the PIGS that the loss of monetary sovereignty means that the only means of adjustment is deflation and/or default? Surely the Baltics must understand the risks of EZ accession by now.

  3. Dear Cristopher,

    the underlying problem in Baltics, why the countries are somewhere damned to join EUR – because investors avoid small countries due to their small currencies and unpredictability of exchange rate. Information costs are too high for such investments.

    Poland and CZ are in a very different situation, because they have substantial internal economies.

    Until the advent of crisis investors were not so nervous, but now they are extremely ones. 2009 and 2010 are years of massive investment exodus from Baltics.

    For small open economies, the model followed by Baltics, strong own monetary policy is contraindicated. If the economies want to start a profound monetary policy, they must change the whole existence model. They have then to go away from common market, reintroduce customs tax, massively tax good transportation in their territory. They can not stay in the EU.

    In fact, a significant part of the transition process was carried out with finances obtained from customs tax. This was the main source for the modernisation. Is it possible to go back to the old model, is not clear.

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  5. I certainly agree that the Baltics are in a tough spot. It is theoretically possible to succeed in a currency union if wage inflation is avoided and fiscal deficits avoided, but this is not politically possible for some countries. On the other hand, I can think of a number of small countries which float and have done well.

  6. again and again, what are the facts? Highest q3/q4 GDP growth (+2,5%) recorded in Estonia from all EC countries.And on this Edward still wrotes “but as we are unfortunately about to see, stabilization and getting back to growth are not one and the same thing”. Time for reality check?

  7. I have been of the opinion that Estonia will not be allowed to join for some time now, and for the very same main reason Edward is mentioning, namely ECB. But I have a question to Edward, Govs and any others who have some knowledge about the Baltics. If Estonia, the good boy in the Baltic class, is not allowed to join, what does that mean for Latvia and Lithuania? As far as I can tell it’s been the holy grail for them to qualify for membership of the single currency, and a “no” to Estonia will effectively make that target unrealistic. I’m especially interested in what this could mean for the upcoming election in Latvia.
    I look forward to your comments.

  8. Henrik,

    this will mean for Latvia – the IMF programm will be losing any target criteria and any exit-strategies. This will be an enormous pressure to change the program toward rapid devaluation, and the IMF maybe absolutely not against it. The next parliament will have for sure a 50-60% majority for devaluation. Despite the fact that exchange rate is determined by the Bank of Latvia, it needs only simple majority to move the currency board out of BoL towards a separate institution, as in Poland. Lithuania has already prepared law amendments for that, of course, the ECB is „dagegen Sturm laufen”.

    Regarding the elections in Latvia in Fall 2010, the question will be – what is the real impact on the population. However, I will expect rather limited direct consequences on the elections. There is a variety of unique elements in the collective memory in Baltic, which must be respected. First, there is memory of extreme difficulties during the 90-ies during the transitional phase.

    One very important point is also that political parties in the ascent of elections have very mystical, nebulous economic programmes, some do not have any. Even on the background of week programmes in transitional countries, the actual vacuum of ideas in Latvia is shocking. The tenor is: everything is determined by the IMF, programs do not make any sense. So I have extreme doubts that voters will be able to make a conscious public choice. They will vote by “feeling”. But the common feeling in Latvia can be expressed with two propositions: 1) everything what happened in the last 20 years, has failed completely, 2) better to be the western most progressive and rich part of an empire (as in 1910), than the poor and underdeveloped eastern border of the present EU empire.

    However, it is important to mention that in 90-ies there were many amortising factors which are absent now. Short list: (1) the land reform in 1990 created place for large number of low efficiency farmers, which were able, however, secure a self-subsistence near to natural economy. But they were not a burden to social systems. Actually nothing of that is true because the land property is concentrated in the hands of few landlords/property firms. At the moment the worst effects of austerity are seen exactly in the rural areas. (2) In 90-ies the sector of small trade and low added-value SMEs soughed in large part of unemployment resulting from the closing of socialist factories. Actually nothing of that is true because retail trade sector is extremely monopolised by two large players, and all the small businesses of 90-ies have died. (3) In the 90-ies factor prices in Latvia were competitive, even for imported goods. Actually nothing of that is true, 3 oil companies have created an absolute oligolpoly in Latvia, all prices are uncompetitive. But there will be well defined interest groups trying to keep the status quo.

    So the decision following the “No” to Estonia has to respect these issues. The problem is that the devaluation will bring not as much w.r.t. to the problems in Latvian economy. Origins of the uncompetitiveness of Latvian economy are in the market structure, not in the real exchange rate.

    However, devaluation could be of benefit to Estonia at the present stage of crisis. First, 15% devaluation will even not throw it out of ERM. The export dependence of Estonian economy and generally the much better monopoly control in Estonia make a different situation where devaluation can bring large benefits. If Estonia will devalue even slightly, Latvia will be forced to do that immediately, Lithuania as well because of common markets for them.

  9. Even if euro became reality for Estonia, Latvia and Lithuania would outside, probably for years. This is a huge risk to Estonia, as Latvia may be forced to float or devalue its currency.

    Estonia’s exports to Latvia would decrease (and to Lithuania as well, if they followed suit). Together that is about 13% of Estonia’s exports. In Estonia, an increase in foreign direct investment is understood to be perhaps the main benefit of euro. In case of a devaluation, much of that benefit (real or perceived) would go to Latvia. Estonia would be left with increased deflationary pressures.

    EU may prevent Latvia’s devaluation only for as long as they are willing to shovel in money. But for how long do the “rich” North European countries have money or political will? Greece alone will absorb 70-90 billion euros, and other PIIGS are feeling hungry too.

  10. Palantir,

    compared to that Latvian 3,5 bn EUR from EU are really very tiny.

    I agree anyway that with a very distant EUR perspective the keeping of the Latvian peg loses any sense.

    However, the uncertainty of the exchange rate is the real problem for investors in Latvia. They could activate if Latvia devalues and there will be trust in the new rate. Otherways investors will avoid Latvia.

    The really strange thing is that inside the EU Baltic states can not use EUR as much as they did before the EU, when a real parallel use was possible.

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