Central Europe cannot afford to delay the euro
With a deadline for monetary union, financial markets would have been less inclined to question commitment to a stable exchange rate
WOLFGANG MUNCHAU Financial Times
We all had a good laugh at the admission by Ferenc Gyurcsány, the Hungarian prime minister, that he lied morning, noon and night. But it is worth stepping back to look at the story behind the lies, and beyond Hungary. The 10 accession countries enjoyed seemingly miraculous economic runs through the 1990s, which ended at around the time of European Union accession, in 2004. Growth rates are still good and in some cases impressive. However, several of the states are growing at the expense of stability.
According to Lars Christensen of Danske Bank, Hungary’s budget deficit will reach 11.3 per cent of gross domestic product this year. Poland is forecast to do better, with 5.4 per cent GDP growth and a budget deficit of 3 per cent. But he says it faces political risks that could eventually translate into economic instability.
Hungary’s economy has already shown signs of instability. A big chunk of its deficit in 2000-2004 came in the form of mortgage subsidies. Hungarians have since discovered the allure of the foreign currency mortgage – mostly denominated in Swiss francs and euros. With a housing bubble about to burst, and unsustainable budget and current account deficits, the Hungarian economy is a time-bomb.
Poland looks in better shape and certainly has no problems with foreign currency mortgages. But appearances may be deceptive. The country should be running a much smaller budget deficit given its position in the economic cycle.
Meanwhile, the new Polish government is openly challenging the independence of the central bank by setting up a new financial supervisory body. It also plans to include the pursuit of economic growth in the bank’s formal mandate. The economic consequences of this political battle are still uncertain but it could clearly have a negative effect.
The primary reason, in my view, for the stalling central European economic engine has been the reluctance by several governments – including Hungary and Poland and recently the Czech Republic – to embrace monetary union as quickly as possible. This does not quite apply to all countries. Slovenia will join the euro next year. Lithuania also wanted to join, but was rejected this year, for reasons that were not entirely justified. This may serve as a further disincentive for others to make the effort. But this is not the main reason why some countries are
dragging their feet.
Those that prevaricated may have thought they needed more time for transition. There are indeed some sound economic reasons why countries in transition should not prematurely fix their exchange rates.
However, this should have been an argument against joining the EU, not against delaying membership of the eurozone. Under EU law, the new entrants were legally bound to run their economic policy compatibly with membership of the eurozone.
Central European countries should have followed the example of Italy and Spain in the 1990s. Both countries made adoption of the euro their top priority. While the euro did not solve Italy’s structural problems, it certainly led to substantial budgetary reforms that otherwise would not have taken place. Italy may find life inside the eurozone unbearable, but life outside would be far worse.
Hungary could have set itself a firm target for euro membership, say January 1 2009. The Hungarian government would have found it easier to implement responsible fiscal policies under those circumstances and financial markets would have been less inclined to question Hungary’s commitment to a stable exchange rate. Poland has benefited from an implicit assumption by investors that it will eventually enter the euro. But this goodwill may be withdrawn in due course, when investors realise that the zloty is there to stay for much longer.
Central bankers have long understood the importance of the euro to the economic transformation process. Hanna Gronkiewicz- Waltz, former Polish central bank chief, told me in the late 1990s that she hoped Poland would adopt the euro within a few years. Her successor, Leszek Balcerowicz, former finance minister, also made it his priority to prepare Poland for the single currency. But the central bankers lost the battle, not least Mr Balcerowicz, who will be replaced at the end of the year.
You may ask at this point: does it matter? The UK, Sweden and Denmark all did well outside the eurozone. Why should Poland and Hungary be different? The difference is that British mortgages are predominantly denominated in sterling, not euros. Nor do the UK, Sweden and Denmark face an acute current account crisis, run budget deficits of 10 per cent of GDP or have governments that openly flout EU law. When the global financial markets start to panic – and we got a hint of this in May – my prediction is that the UK will be fine, but Hungary will suffer. Big uncertainties lie ahead for Poland. The fundamental lie of central European politics is that there is a good life outside the eurozone, but inside the EU.