Publication of the ECB Convergence Report 2008
The European Central Bank (ECB) publishes today its Convergence Report 2008, an assessment of the economic and legal convergence of ten EU Member States: Bulgaria, the Czech Republic, Estonia, Latvia, Lithuania, Hungary, Poland, Romania, Slovakia and Sweden. The report examines whether a high degree of sustainable economic convergence has been achieved in these countries. In addition, it gauges compliance with the statutory requirements to be fulfilled for national central banks to become an integral part of the Eurosystem (legal convergence).
Overall, the report concludes that in recent years some countries have made progress with economic convergence, but in many countries important challenges have come to the fore, particularly in the form of rising inflation. Looking at the individual convergence criteria, the 2008 Convergence Report shows the following results.
Over the 12-month reference period from April 2007 to March 2008, the reference value for the criterion on price stability was 3.2%. It was calculated by adding 1.5 percentage points to the unweighted arithmetic average of the rate of HICP inflation over these 12 months in Malta (1.5%), the Netherlands (1.7%) and Denmark (2.0%). Over the reference period, Slovakia and Sweden had average HICP inflation rates below the reference value, whereas Poland was at the reference value. HICP inflation in the other seven countries was above the reference value, with particularly large deviations being observed in Bulgaria, Estonia, Latvia, Lithuania and Hungary. These developments in inflation have mostly taken place against the background of dynamic economic conditions, but they also reflect external factors. On the domestic side, buoyant domestic demand has contributed to inflationary pressures in many countries under review. Rapid employment growth, in combination with labour outflows to other EU countries, has led to a significant tightening of labour markets and upward pressure on wages in many of the countries examined. The most important external driver of inflation has been the increase in energy and food prices, which has had a strong impact in most countries in central and eastern Europe.
Government budgetary position
Of the ten Member States examined, the Czech Republic, Hungary, Poland and Slovakia are currently subject to an EU Council decision on the existence of an excessive deficit. In 2007, however, Hungary was the only one of these countries to record a deficit above 3% of GDP; the deficit was below 3% of GDP in the Czech Republic, Poland and Slovakia. Fiscal deficits were also recorded in Lithuania and Romania in 2007. In contrast, Bulgaria, Estonia and Sweden recorded fiscal surpluses in 2007, while Latvia posted a balanced budget. As regards general government debt, only Hungary exhibited a debt ratio above the 60% of GDP reference value in 2007; in the other countries debt ratios were lower.
Among the countries examined in this Convergence Report, Estonia, Latvia, Lithuania and Slovakia are currently in ERM II. All of these currencies have participated in ERM II for more than two years before the convergence examination, and none of their central rates was devalued in the period under review. The central rate of the Slovak koruna was, however, revalued in March 2007 (see below).
Long-term interest rate
Over the 12-month reference period from April 2007 to March 2008, the reference value for long-term interest rates was 6.5%. It was calculated by adding 2 percentage points to the unweighted arithmetic average of the long-term interest rates of the three countries entering the calculation of the reference value for the criterion on price stability, namely Malta (4.8%), the Netherlands (4.3%) and Denmark (4.3%). Over the reference period, Bulgaria, the Czech Republic, Latvia, Lithuania, Poland, Slovakia and Sweden had average long-term interest rates below the reference value. In Romania and Hungary, however, long-term interest rates were above the reference value during the reference period. In Estonia, due to the absence of a developed bond market in Estonian kroons and reflecting the low level of government debt, no harmonised long-term interest rate is available.
Of the ten Member States examined, only Lithuanian legislation is fully compatible with the Treaty and the Statute requirements for Stage Three of Economic and Monetary Union. Slovak legislation complies with the requirements for central bank independence, while Slovakia’s legal integration into the Eurosystem is in the process of being finalised. Estonian legislation complies with the requirements for central bank independence while there are incompatibility issues regarding Estonia’s legal integration into the Eurosystem.
Legislation in Bulgaria, the Czech Republic, Latvia, Hungary, Poland, Romania and Sweden does not comply with all the requirements for central bank independence or legal integration into the Eurosystem. In addition, legislation in Bulgaria, the Czech Republic, Latvia, Hungary, Poland and Romania does not fully comply with the monetary financing prohibition.
In this report, Slovakia is assessed in somewhat more depth than the other countries under review. This is due to the fact that the Slovak authorities submitted a request for a country examination on 4 April 2008 in view of Slovakia’s intention to adopt the euro as of 1 January 2009.
The ECB Convergence Report 2008 gives the following assessment of Slovakia.
Over the reference period from April 2007 to March 2008, Slovakia recorded a 12-month average rate of HICP inflation of 2.2%, which is well below the reference value of 3.2%. Benefiting from strong productivity growth, increases in unit labour costs have been low in recent years. However, annual inflation has been rising in recent months, reaching 3.6% in March 2008.
There are upside risks to inflation in Slovakia. These relate first to the fact that the dampening effects on inflation of the trend nominal appreciation of the Slovak koruna against the euro would fade away in an environment where the exchange rate would be fixed against the euro. Second, tight labour market conditions and emerging bottlenecks in specific regions and some labour market segments pose a risk of accelerating wage growth. Third, energy prices pose an upside risk to inflation, as the recent increase in global energy prices has not yet been fully reflected in consumer prices. The catching-up process is also likely to have a bearing on inflation over the coming years. In sum, there are considerable concerns regarding the sustainability of inflation convergence in Slovakia.
Slovakia is currently subject to an EU Council decision on the existence of an excessive deficit. In the reference year 2007 Slovakia recorded, however, a fiscal deficit of 2.2% of GDP, i.e. below the 3% reference value. A decrease to 2.0% is forecast by the European Commission for 2008. The general government debt ratio decreased to 29.4% of GDP in 2007, well below the 60% reference value. However, further fiscal consolidation is required for Slovakia to comply with the medium-term objective specified in the Stability and Growth Pact, which in the convergence programme is quantified as a cyclically adjusted deficit net of temporary measures of 0.8% of GDP by 2010.
The Slovak koruna has been participating in ERM II for over two years prior to the convergence examination. The ERM II central rate for the Slovak currency was initially set at 38.4550 korunas per euro, with a standard fluctuation band of ±15%. The Slovak koruna followed a process of trend appreciation vis-à-vis the euro over the reference period and its central rate was revalued by 8.5% to 35.4424 korunas per euro with effect from 19 March 2007, reflecting strong underlying economic fundamentals. Thereafter, the koruna consistently traded stronger than the new central parity, standing around 9% above it in early May. The trend appreciation of the currency in recent years makes it more difficult to analyse how the Slovak economy might operate under conditions of irrevocably fixed exchange rates.
The average level of long-term interest rates in Slovakia was 4.5% in the reference period from April 2007 to March 2008, i.e. well below the 6.5% reference value for the interest rate criterion. During the reference period, long-term interest rates broadly followed the dynamics of the corresponding euro area long-term interest rates.
Achieving an environment conducive to sustainable convergence in Slovakia requires, inter alia, the implementation of a sustainable and credible fiscal consolidation path. This would help to reduce the risk of a build-up of demand-induced inflationary and current account pressures, as well as safeguard the fiscal reform process and the current positive momentum of the economy. As regards structural policies, it will be crucial to improve the functioning of the labour market, which is characterised by persistently high structural unemployment, mismatches and insufficient labour mobility. Furthermore, wage increases need to remain responsive to changes in labour productivity growth, labour market conditions and developments in competitor countries. Slovakia will also need to resume its liberalisation of the economy and further enhance competition in product markets, particularly in the energy sector. Such measures, together with stability-oriented macroeconomic policies, will help to achieve an environment conducive to sustainable price stability, as well as promote competitiveness and employment growth.
The Slovak Ministry of Finance consulted the ECB on 20 July and 24 September 2007 with regard to a draft law on the introduction of the euro in Slovakia and on amendments to certain laws. In the light of this, the ECB’s Convergence Report 2004 and ECB Opinion CON/2007/43 of 19 December 2007 at the request of the Slovak Ministry of Finance on a draft law on the introduction of the euro in Slovakia and on amendments to certain laws, on 28 November 2007 the Slovak Parliament adopted a law (the “Amending Law”) which adjusted the Law on Národná banka Slovenska accordingly. Some provisions of the Amending Law entered into force on 1 January 2008 and the remaining provisions will enter into force on the date the euro is introduced in Slovakia. It is also noted that Slovakia has amended its legislation in order to ensure full compliance with the monetary financing prohibition since the December 2006 Convergence Report.
In producing the Convergence Report, the ECB fulfils the requirement of Article 122(2) in conjunction with Article 121(1) of the Treaty establishing the European Community to report to the Council of the European Union at least once every two years or at the request of a Member State with a derogation “on the progress made in the fulfilment by the Member States of their obligations regarding the achievement of economic and monetary union”.
At present, 12 EU Member States are not full participants in Economic and Monetary Union. Two of these countries, namely Denmark and the United Kingdom, have a special status in accordance with the terms of the relevant protocols annexed to the Treaty. As a consequence, Convergence Reports only have to be provided for these two Member States if they so request.
The ECB’s Convergence Report can be obtained in 22 Community languages on the ECB’s website ( http://www.ecb.europa.eu).