European European Economic and Economic and

Monetary UnionMonetary UnionSander WinckelSander Winckel

Adviser EIFAdviser EIFMinistry of Finance SRMinistry of Finance SR

Sofia, October 20-21, 2006Sofia, October 20-21, 2006

ContentContent

Economic theoryEconomic theory History of Economic and Monetary History of Economic and Monetary

UnionUnion EU new Member StatesEU new Member States

Models of Economic Models of Economic IntegrationIntegration

Preferential trade agreements ( Lome)Preferential trade agreements ( Lome) Free Trade Area (EFTA)Free Trade Area (EFTA) Harmonisation of external tariffs plus Harmonisation of external tariffs plus

free trade area (EEC)free trade area (EEC) Common Market: market integration Common Market: market integration

plus factor mobility (capital and labor). plus factor mobility (capital and labor). This stage may include This stage may include monetary monetary unionunion to ensure complete factor to ensure complete factor mobility (EU)mobility (EU)

Monetary union - Monetary union - definitiondefinition

In economics, a In economics, a monetary unionmonetary union is a is a situation where several countries have situation where several countries have agreed to share a single currency among agreed to share a single currency among them. them.

The European The European Economic and Monetary Economic and Monetary UnionUnion (EMU) exists between 12 of the (EMU) exists between 12 of the 25 member states of the 25 member states of the European UnionEuropean Union which have adopted the which have adopted the euroeuro as their as their single currency and who co-ordinate single currency and who co-ordinate their economic policies.their economic policies.

Theory of Optimal Currency Theory of Optimal Currency Areas Areas (OCA)(OCA)

Robert Mundell – 1961 (Nobel Prize 1999):Robert Mundell – 1961 (Nobel Prize 1999):

Size of OCA dependent on degree of integration of Size of OCA dependent on degree of integration of economy (highly integrated economy less susceptible economy (highly integrated economy less susceptible to asymmetric shocks), preferences regarding to asymmetric shocks), preferences regarding inflation and unemployment, different labor market inflation and unemployment, different labor market institutions, growth rates, balances of trade, fiscal institutions, growth rates, balances of trade, fiscal systems etc. (economic policy coordination)systems etc. (economic policy coordination)

Asymmetric shock: recession which only affects some Asymmetric shock: recession which only affects some members of a group of trading countriesmembers of a group of trading countries

Country needs separate currency if the economic Country needs separate currency if the economic costs of an asymmetric shock, through changes in costs of an asymmetric shock, through changes in wages and prices, factor mobility or government wages and prices, factor mobility or government budget, would be higher than those of altering the budget, would be higher than those of altering the exchange rateexchange rate

Optimal Currency Areas Optimal Currency Areas (cont.)(cont.)

Therefore, an independent monetary policy with Therefore, an independent monetary policy with exchange rate flexibility is the most efficient way exchange rate flexibility is the most efficient way to deal with asymmetric shocksto deal with asymmetric shocks

But …. asymmetric shocks sometimes occur only But …. asymmetric shocks sometimes occur only in one region or in a specific sector in one or in one region or in a specific sector in one or more countriesmore countries

Flexible exchange rate regime less efficient in Flexible exchange rate regime less efficient in open and/or small economiesopen and/or small economies

And …. theory is static (e.g. exchange rate And …. theory is static (e.g. exchange rate changes can be effected in short term, other changes can be effected in short term, other changes take much longer)changes take much longer)

Thus … more dynamic (and contrarian) theory in Thus … more dynamic (and contrarian) theory in follow-up paper:follow-up paper:

‘‘Uncommon Arguments for Uncommon Arguments for Common Currencies’ and ‘A Common Currencies’ and ‘A

plan for a European Currency’plan for a European Currency’ (Mundell, 1970)(Mundell, 1970)

Common currency can reduce impact of asymmetric Common currency can reduce impact of asymmetric shocks by better reserve pooling and portfolio shocks by better reserve pooling and portfolio diversification: diversification:

Negative effects on currency are shared with currency Negative effects on currency are shared with currency partnerspartners

Impact on economy of whole currency area will be Impact on economy of whole currency area will be less, therefore less risk premium needed on capital less, therefore less risk premium needed on capital market instruments denominated in that currencymarket instruments denominated in that currency

Macro-economic shocks weakened by capital Macro-economic shocks weakened by capital movementsmovements

Single currency reduces speculation (as in 1960s)Single currency reduces speculation (as in 1960s) EU economies are highly integrated (e.g. intra-EU EU economies are highly integrated (e.g. intra-EU

trade >90% of all members’ trade)trade >90% of all members’ trade)

Costs and benefits of Costs and benefits of Monetary UnionMonetary Union

CostsCosts:: Increasing loss of national sovereigntyIncreasing loss of national sovereignty Loss of control over monetary policy (instruments: Loss of control over monetary policy (instruments:

interest rate, exchange rate, open market ops, interest rate, exchange rate, open market ops, discount window, reserve requirements)discount window, reserve requirements)

BenefitsBenefits:: Lower transaction costs between member statesLower transaction costs between member states More efficient market – less price inequalityMore efficient market – less price inequality Greater economic certaintyGreater economic certainty Lower interest ratesLower interest rates SeignorageSeignorage Less speculation and currency riskLess speculation and currency risk Sharing of macro-economic shocksSharing of macro-economic shocks

Exchange rate system after Exchange rate system after WW IIWW II

Bretton Woods fixed exchange rates – Bretton Woods fixed exchange rates – since 1945since 1945

Currencies pegged to fixed USD/gold Currencies pegged to fixed USD/gold raterate

Currency had to remain within upper Currency had to remain within upper and lower bandsand lower bands

At shock reserves had to be soldAt shock reserves had to be sold US expansionary fiscal policy from US expansionary fiscal policy from

1965 (Vietnam) caused inflation and 1965 (Vietnam) caused inflation and stress to the systemstress to the system

Exchange rate system after Exchange rate system after WW II – cont.WW II – cont.

1967: devaluation UK pound1967: devaluation UK pound Increased speculative activities in Increased speculative activities in

money marketsmoney markets 1971: first US dollar devaluation1971: first US dollar devaluation 1973: second US dollar devaluation1973: second US dollar devaluation 1973: Bretton Woods system 1973: Bretton Woods system

abolishedabolished

Economic and monetary Economic and monetary integration in Europeintegration in Europe

1950: European Payments Union1950: European Payments Union 1951: European Coal and Steel 1951: European Coal and Steel

Community (ECSC)Community (ECSC) 1957: Treaty of Rome – European 1957: Treaty of Rome – European

Economic Community: 6 membersEconomic Community: 6 members 1958: European Monetary 1958: European Monetary

AgreementAgreement 1970: Werner Report1970: Werner Report

Werner ReportWerner Report

1969: Following Bretton Woods 1969: Following Bretton Woods System instability and impact of System instability and impact of Optimal Currency Areas theory of Prof. Optimal Currency Areas theory of Prof. Mundell, a High Level group, chaired Mundell, a High Level group, chaired by Prime Minister Werner of by Prime Minister Werner of Luxembourg, was set up during the Luxembourg, was set up during the The Hague summitThe Hague summit

Werner Report proposed a three-stage Werner Report proposed a three-stage plan to create an economic and plan to create an economic and monetary union (EMU) within 10 yearsmonetary union (EMU) within 10 years

Werner Report – cont.Werner Report – cont.

1) Reduction of fluctuation margins between 1) Reduction of fluctuation margins between Member states currencies, broad guidelines for Member states currencies, broad guidelines for economic policy, coordination of budgetary economic policy, coordination of budgetary policy, preparation of Treaty changes to facilitate policy, preparation of Treaty changes to facilitate later stages of EMUlater stages of EMU

2) Integration of financial markets and banking 2) Integration of financial markets and banking systems to create free movement of capital, systems to create free movement of capital, gradual elimination of exchange rate gradual elimination of exchange rate fluctuations, closer coordination of short term fluctuations, closer coordination of short term economic policies and budgetary and fiscal economic policies and budgetary and fiscal measuresmeasures

Werner Report – cont.Werner Report – cont.

3) Irrevocable fixing of exchange rates 3) Irrevocable fixing of exchange rates between participating national between participating national currencies, convergence of economic currencies, convergence of economic policies, establishment of a policies, establishment of a Community system of central banksCommunity system of central banks

1971: collapse Bretton Woods system 1971: collapse Bretton Woods system – temporary abandonment of EMU – temporary abandonment of EMU projectproject

European economic and European economic and monetary integration after monetary integration after

Bretton Woods - 1Bretton Woods - 1 1972: Snake in the tunnel: fluctuations 1972: Snake in the tunnel: fluctuations

between member currencies were between member currencies were narrowed (“snake”) in relation to narrowed (“snake”) in relation to fluctuations towards the US dollar fluctuations towards the US dollar (“tunnel”)(“tunnel”)

1970s oil crisis put system under heavy 1970s oil crisis put system under heavy pressure; sharp fluctuations, some pressure; sharp fluctuations, some leaving system; 1977: only 5 Members leaving system; 1977: only 5 Members remained in a zone based around the remained in a zone based around the German mark.German mark.

European economic and European economic and monetary integration after monetary integration after

Bretton Woods - 2Bretton Woods - 2 1973: new Member States: UK, 1973: new Member States: UK,

Ireland, DenmarkIreland, Denmark 1979: European Monetary System, 1979: European Monetary System,

consisting of:consisting of:1) currency basket (ECU)1) currency basket (ECU)2) monetary stabilisation mechanism 2) monetary stabilisation mechanism

(Exchange Rate Mechanism ERM) (Exchange Rate Mechanism ERM) 3) mechanism for financing monetary 3) mechanism for financing monetary

interventions (European Monetary interventions (European Monetary Cooperation Fund)Cooperation Fund)

European economic and European economic and monetary integration in the monetary integration in the

1980s1980s 1981: Greece joins EEC1981: Greece joins EEC 1986: Spain and Portugal join EEC1986: Spain and Portugal join EEC 1986: Single European Act (Delors 1986: Single European Act (Delors

Commission): creation of single market; free Commission): creation of single market; free movement of goods, services, persons, capital movement of goods, services, persons, capital (‘four freedoms’)(‘four freedoms’)

1989: Study on EMU (Delors Report) – 1989: Study on EMU (Delors Report) – completing the single market: introduction of completing the single market: introduction of EMU in three stages; using existing EMU in three stages; using existing institutional framework (unlike Werner Plan) institutional framework (unlike Werner Plan) and creating European system of Central Banksand creating European system of Central Banks

European economic and European economic and monetary integration – monetary integration –

Delors reportDelors report Stage 1: increased cooperation between central Stage 1: increased cooperation between central

banks in the field of monetary policy, removal of banks in the field of monetary policy, removal of obstacles to financial integration, monitoring of obstacles to financial integration, monitoring of national economic policies, coordination of national economic policies, coordination of budgetary policybudgetary policy

Stage 2: Preparations for final EMU phase, Stage 2: Preparations for final EMU phase, establishment of ESCB, gradual transfer of establishment of ESCB, gradual transfer of monetary policy to European institutions, monetary policy to European institutions, narrowing of margins of fluctuation within narrowing of margins of fluctuation within exchange rate mechanismexchange rate mechanism

Stage 3: fixing exchange rates between currencies Stage 3: fixing exchange rates between currencies and replacement by single European currency, and replacement by single European currency, transfer of responsibility for monetary policy to transfer of responsibility for monetary policy to ESCBESCB

European economic and European economic and monetary integration – monetary integration –

1990s1990s 1992: ERM under pressure: speculative 1992: ERM under pressure: speculative

attacks on GBP and ITL; ESP and PTE attacks on GBP and ITL; ESP and PTE devaluationdevaluation

1992: Maastricht Intergovernmental 1992: Maastricht Intergovernmental Conference establishing new Treaty on Conference establishing new Treaty on European Union, including the acceptance of European Union, including the acceptance of the Economic and Monetary Union (EMU)the Economic and Monetary Union (EMU)

Economic convergence criteria concerning Economic convergence criteria concerning inflation rate, public finances (relating to inflation rate, public finances (relating to deficits and debt), exchange rate stability and deficits and debt), exchange rate stability and long-term interest rates (“Maastricht long-term interest rates (“Maastricht criteria”)criteria”)

Economic and Monetary Economic and Monetary UnionUnion

1990 - Stage 1: elimination of exchanges 1990 - Stage 1: elimination of exchanges controls and most restrictions on capital controls and most restrictions on capital movements, better coordination of economic movements, better coordination of economic policies and intensification of central bank policies and intensification of central bank coordination among Member States; setting coordination among Member States; setting of criteria for entry into stage 3of criteria for entry into stage 3

1994 - Stage 2: closer policy coordination, 1994 - Stage 2: closer policy coordination, devising multi-annual programs to reduce devising multi-annual programs to reduce inflation and budget deficits, creation of inflation and budget deficits, creation of European Monetary InstituteEuropean Monetary Institute

1998 – Stage 3: fixing of exchange rates, 1998 – Stage 3: fixing of exchange rates, establishment of European Central Bankestablishment of European Central Bank

Maastricht CriteriaMaastricht Criteria Inflation rate: average inflation rate not more Inflation rate: average inflation rate not more

than 1.5 % from average of best three EU than 1.5 % from average of best three EU member statesmember states

Budget deficit: at or below 3 % of GDP, with Budget deficit: at or below 3 % of GDP, with tendency to 0 % or surplus in the medium termtendency to 0 % or surplus in the medium term

Public debt: not exceeding 60 % of GDPPublic debt: not exceeding 60 % of GDP Currency stability: respect for normal Currency stability: respect for normal

fluctuation margins of ERM without severe fluctuation margins of ERM without severe tensions for at least two years without tensions for at least two years without devaluationdevaluation

Interest rate convergence: average nominal Interest rate convergence: average nominal long-term interest rate not more than 2 % long-term interest rate not more than 2 % above that of best three EU member statesabove that of best three EU member states

European economic and European economic and monetary integration – monetary integration –

1990s – cont.1990s – cont. 1993: ERM fluctuation bands widened to +/- 15% after 1993: ERM fluctuation bands widened to +/- 15% after

UK pound and Italian lira had left the mechanism and UK pound and Italian lira had left the mechanism and Spanish peseta, Portuguese escudo, Irish punt and Spanish peseta, Portuguese escudo, Irish punt and French franc came under speculative attackFrench franc came under speculative attack

1994: launch of European Monetary Institute, 1994: launch of European Monetary Institute, forerunner of ECBforerunner of ECB

1995: Austria, Finland and Sweden become members 1995: Austria, Finland and Sweden become members of EUof EU

1997: Stability and Growth Pact (SGP) adopted and 1997: Stability and Growth Pact (SGP) adopted and ERM II set up to provide stability between euro and ERM II set up to provide stability between euro and non-euro EU currenciesnon-euro EU currencies

1998: decision on Euro members – 11 fulfilling 1998: decision on Euro members – 11 fulfilling convergence criteria. Greece and Sweden not fulfilling convergence criteria. Greece and Sweden not fulfilling criteria; opt-outs: UK and Denmarkcriteria; opt-outs: UK and Denmark

Stability and Growth Stability and Growth Pact (1997)Pact (1997)

To keep budgetary discipline in EMUTo keep budgetary discipline in EMU:: Political commitment to implement budget Political commitment to implement budget

surveillance process (peer pressure)surveillance process (peer pressure) Elements to prevent budget deficits> 3%: Elements to prevent budget deficits> 3%:

preparation according to specific format and preparation according to specific format and submission of stability and convergence submission of stability and convergence programs to Council; early warning programs to Council; early warning mechanismmechanism

Dissuasive elements requiring Member States Dissuasive elements requiring Member States to take corrective actions if 3% value is to take corrective actions if 3% value is breached, including sanctions (excessive breached, including sanctions (excessive deficit procedure)deficit procedure)

Exchange Rate Exchange Rate Mechanism IIMechanism II

Participating currencies have 15% fluctuation Participating currencies have 15% fluctuation bands around the central Euro ratebands around the central Euro rate

Denmark (participant since beginning of the Denmark (participant since beginning of the system in 1999) has narrower fluctuation system in 1999) has narrower fluctuation band of 2.25%band of 2.25%

Formal requirement of two year participation Formal requirement of two year participation before country can request to join Eurobefore country can request to join Euro

Intended to orient policies towards stability, Intended to orient policies towards stability, foster convergence and thereby helps them foster convergence and thereby helps them to prepare for Euro adoptionto prepare for Euro adoption

The institutions of the The institutions of the Economic and Monetary Economic and Monetary

UnionUnion European Central Bank and European System European Central Bank and European System

of Central Banks: The primary independent of Central Banks: The primary independent economic institutions of the EMU. Their goal economic institutions of the EMU. Their goal is maintenance of price stabilityis maintenance of price stability

The Council of Economic and Finance The Council of Economic and Finance ministers (Ecofin, Council): consists of all the ministers (Ecofin, Council): consists of all the Economic and Finance ministers of the EU Economic and Finance ministers of the EU Member StatesMember States

Euro-12 committee: meeting of the Ministers Euro-12 committee: meeting of the Ministers of Economy and Finance of the Euro-zone of Economy and Finance of the Euro-zone countries onlycountries only

European economic and European economic and monetary integration – from monetary integration – from

1998 until now1998 until now 1998: creation of European Central Bank 1998: creation of European Central Bank

(ECB)(ECB) 1998: conversion rates fixed1998: conversion rates fixed 1999: birth of Euro – with 3 year transition 1999: birth of Euro – with 3 year transition

period between creation of the Euro and period between creation of the Euro and introduction of notes and coins introduction of notes and coins

2000: Greece allowed to join Euro2000: Greece allowed to join Euro 2002: Euro becomes official currency in 12 2002: Euro becomes official currency in 12

member statesmember states 2004: 10 new states enter EU, including 2004: 10 new states enter EU, including

obligation to join EMU (no opt-out possibility)obligation to join EMU (no opt-out possibility) 2005: Stability and Growth Pact adjusted2005: Stability and Growth Pact adjusted

Stability and Growth Pact – Stability and Growth Pact – adjustments 2005adjustments 2005

Medium-term budgetary objective of close to Medium-term budgetary objective of close to balance or in surplus: more room for new CE balance or in surplus: more room for new CE Member States with low debt and high growth Member States with low debt and high growth potentialpotential

Member states to cut deficit and debt in good Member states to cut deficit and debt in good timestimes

EC: warnings to countries failing to consolidate in EC: warnings to countries failing to consolidate in upswingsupswings

Debt must fall at sustainable pace towards 60% of Debt must fall at sustainable pace towards 60% of GDPGDP

Assisting rather than punishing countries that Assisting rather than punishing countries that break 3% limit, but sanctions remain as last break 3% limit, but sanctions remain as last resortresort

Stability and Growth Pact – Stability and Growth Pact – adjustments 2005 – cont.adjustments 2005 – cont.

But …. new ‘get-out’ clauses if budget deficit But …. new ‘get-out’ clauses if budget deficit > 3%:> 3%:

Severe economic downturn – negative Severe economic downturn – negative economic growth (old: -2%)economic growth (old: -2%)

Small and temporary breaches because of Small and temporary breaches because of relevant factors, such as: development aid, relevant factors, such as: development aid, EU policy goals (e.g. R&D), cost of EU policy goals (e.g. R&D), cost of European (i.e. German) unificationEuropean (i.e. German) unification

Countries carrying out pension reforms: Countries carrying out pension reforms: small breaches allowedsmall breaches allowed

Time between deficit surpassing 3% and Time between deficit surpassing 3% and start of sanctions now minimum 5 years or start of sanctions now minimum 5 years or even longer in times of low growtheven longer in times of low growth

Fiscal surveillance:Fiscal surveillance:Broad Economic Policy Broad Economic Policy

GuidelinesGuidelines Guidance on macro- and microeconomic policies in Guidance on macro- and microeconomic policies in

Member StatesMember States 2005-2008: Integrated Guidelines – combination with 2005-2008: Integrated Guidelines – combination with

Employment Guidelines; links with Lisbon StrategyEmployment Guidelines; links with Lisbon Strategy Macro guidelines include: economic stability, efficient Macro guidelines include: economic stability, efficient

allocation of resources, coherence between macro- allocation of resources, coherence between macro- and structural policies and contribution to dynamic and structural policies and contribution to dynamic and well-functioning EMUand well-functioning EMU

Micro guidelines include: deepening internal market, Micro guidelines include: deepening internal market, create more attractive business environment, in create more attractive business environment, in particular for SMEs, stimulate R&D, ICT, industrial particular for SMEs, stimulate R&D, ICT, industrial base (Lisbon Strategy – base (Lisbon Strategy – criticism: Europe should not criticism: Europe should not concentrate on peer mechanism to reduce concentrate on peer mechanism to reduce productivity gap but increase working hoursproductivity gap but increase working hours))

Criteria for Euro Criteria for Euro membershipmembership

High degree price stabilityHigh degree price stability Sustainability of public financesSustainability of public finances Normal fluctuation margins in ERM Normal fluctuation margins in ERM

for minimum 2 yearsfor minimum 2 years Durability of convergence as reflected Durability of convergence as reflected

in long term interest rate levelsin long term interest rate levels …………translated in ‘Maastricht’- criteria:translated in ‘Maastricht’- criteria:

Maastricht CriteriaMaastricht Criteria Inflation rate: average inflation rate not more than 1.5 % Inflation rate: average inflation rate not more than 1.5 %

from average of best three EU member states (over a from average of best three EU member states (over a period of one year before the examination) period of one year before the examination) (Lithuania–(Lithuania–2006)2006)

Budget deficit: at or below 3 % of GDP, with tendency to Budget deficit: at or below 3 % of GDP, with tendency to 0 % or surplus in the medium term (there should be no 0 % or surplus in the medium term (there should be no excessive deficit)excessive deficit)

Public debt: not exceeding 60 % of GDPPublic debt: not exceeding 60 % of GDP Currency stability: respect for normal fluctuation Currency stability: respect for normal fluctuation

margins of ERM without severe tensions for at least two margins of ERM without severe tensions for at least two years without devaluation (in particular the Member years without devaluation (in particular the Member State shall not have devalued on its own initiative)State shall not have devalued on its own initiative)

Interest rate convergence: average nominal long-term Interest rate convergence: average nominal long-term interest rate not more than 2 % above that of best three interest rate not more than 2 % above that of best three EU member states in terms of price stability (on the EU member states in terms of price stability (on the basis of long term government bonds or comparable basis of long term government bonds or comparable securities)securities)

Progress towards Progress towards Maastricht criteria in 2006Maastricht criteria in 2006

CountryCountry Interest Interest rate rate

(average)(average)

Inflation Inflation rate rate

(average)(average)

Government Government budget budget balancebalance

GovernmenGovernment debtt debt

Reference Reference valuevalue

5.53 5.53

(July ’06)(July ’06)2.82.8

(July ’06)(July ’06)<-3<-3 <60<60

CyprusCyprus 4.204.20 2.22.2 -2.1-2.1 69.169.1

Czech Czech RepublicRepublic

3.643.64 2.32.3 -3.2-3.2 31.531.5

EstoniaEstonia 4.024.02 4.44.4 1.41.4 3.63.6

HungaryHungary 6.736.73 2.92.9 -6.7-6.7 59.959.9

LatviaLatvia 3.773.77 7.07.0 -1.0-1.0 11.311.3

LithuaniaLithuania 3.793.79 3.23.2 -0.6-0.6 18.918.9

MaltaMalta 4.354.35 3.13.1 -2.9-2.9 74.074.0

PolandPoland 5.075.07 1.31.3 -3.0-3.0 45.545.5

SlovakiaSlovakia 3.933.93 3.93.9 -2.9-2.9 33.133.1

SloveniaSlovenia 3.743.74 2.62.6 -1.9-1.9 29.929.9

Pros and cons of early Pros and cons of early joining Eurojoining Euro- examples- examples

Pro:Pro: Stimulus for trade and foreign investment (greater Stimulus for trade and foreign investment (greater

certainty)certainty) Stimulus for reigning in public spendingStimulus for reigning in public spending Volatile capital flows can heavily influence exchange Volatile capital flows can heavily influence exchange

rate (e.g. Hungary, Czech Republic, Poland, Slovakia)rate (e.g. Hungary, Czech Republic, Poland, Slovakia)

Con:Con: Transitional restructuring unfinished (e.g. high Transitional restructuring unfinished (e.g. high

government deficit in Hungary)government deficit in Hungary) Rapid productivity growth (e.g. Baltics) and high inward Rapid productivity growth (e.g. Baltics) and high inward

investment are offset via appreciation or inflation; fixing investment are offset via appreciation or inflation; fixing of exchange rates will close off former routeof exchange rates will close off former route

Exogenously induced inflation limits room for Exogenously induced inflation limits room for endogenous inflation (Slovakia)endogenous inflation (Slovakia)

Euro entry preparations–Euro entry preparations–current situationcurrent situation

Denmark participates since start of ERM-II (1.1.99)Denmark participates since start of ERM-II (1.1.99) Estonia, Lithuania joined ERM-II on June 27, 2004, but high Estonia, Lithuania joined ERM-II on June 27, 2004, but high

inflation makes some obstacles to adopt Euro before 2010. Slovenia inflation makes some obstacles to adopt Euro before 2010. Slovenia has already fulfilled all Maastricht criteria and EMU entry is has already fulfilled all Maastricht criteria and EMU entry is approved from January 2007 by relevant European institutionsapproved from January 2007 by relevant European institutions

Cyprus, Latvia and Malta joined ERM-II on May 2, 2005, Cyprus and Cyprus, Latvia and Malta joined ERM-II on May 2, 2005, Cyprus and Malta plan to join the Eurozone in 2008 (and to start using Euro Malta plan to join the Eurozone in 2008 (and to start using Euro notes and coins as from January 1, 2009), while Latvia will have to notes and coins as from January 1, 2009), while Latvia will have to wait until 2010 because of high inflation.wait until 2010 because of high inflation.

Slovakia joined ERM-II on November 28, 2005, plans to join the Slovakia joined ERM-II on November 28, 2005, plans to join the Eurozone in 2008 and to start using Euro notes and coins as from Eurozone in 2008 and to start using Euro notes and coins as from January 1, 2009.January 1, 2009.

The Czech Republic envisaged to adopt the Euro in 2010, but delay The Czech Republic envisaged to adopt the Euro in 2010, but delay has already been admitted by the prime minister and CNB governor, has already been admitted by the prime minister and CNB governor, so ERM-II participation is only foreseen as from 2008so ERM-II participation is only foreseen as from 2008

Hungary could realistically join ERM II between 2007 and 2009 Hungary could realistically join ERM II between 2007 and 2009 aiming to adopt Euro between 2011 and 2013.aiming to adopt Euro between 2011 and 2013.

Poland could be prepared for EMU entry in 3 years, but in line with Poland could be prepared for EMU entry in 3 years, but in line with market expectation based also on reactions of rating agencies it is market expectation based also on reactions of rating agencies it is not very probable before 2012.not very probable before 2012.

Adopting Euro – Adopting Euro – economic requirementseconomic requirements

Ability to deal with asymmetric shocks:Ability to deal with asymmetric shocks: Synchronisation of business cycles with Synchronisation of business cycles with

Euro areaEuro area Stabilising role of fiscal policy (budgetary Stabilising role of fiscal policy (budgetary

room in case of unforeseen shocks)room in case of unforeseen shocks) Wage and price flexibility (in the absence Wage and price flexibility (in the absence

of the former, competition in product of the former, competition in product markets)markets)

Appropriate level of competitiveness Appropriate level of competitiveness (wage growth consistent with (wage growth consistent with productivity)productivity)

Convergence Program Convergence Program 20020055-2010 Slovakia -2010 Slovakia (Nov 2005)(Nov 2005)

InflationInflation Government budgetGovernment budget(excl.(excl. - - costs of 2nd pillar costs of 2nd pillar - -

incl.)incl.)

Government Government debtdebt

20032003 8.48.4 - 3.- 3.88 - 3.- 3.88 4343..11

20042004 7.7.55 - 3.- 3.22 - 3.- 3.22 4242..66

20052005 2.92.9 - - 44..11 -4.9-4.9 3333..77

20062006 3.63.6 - 2.9- 2.9 -4.3-4.3 3535..55

20072007 2.02.0 - 1.- 1.66 -3.0-3.0 3535..22

20082008 2.02.0 - 1.3- 1.3 -2.7-2.7 3636..22

20092009 2.42.4 - 0.3- 0.3 -1.8-1.8 3535..55

20102010 2.62.6 +0.6+0.6 -0.9-0.9 3434.0.0

Latest estimatesLatest estimates SlovakiaSlovakia

InflationInflation

(June (June 2006)2006)

Government budgetGovernment budget(excl.(excl. - - costs of 2nd pillar costs of 2nd pillar - -

incl.)incl.)

Government Government debtdebt

20052005 2,72,7 - - 2.92.9 --3.63.6 34.534.5

20062006 4,54,5 - 2.- 2.22 --33..55 33.133.1

20072007 2,52,5 - 1.- 1.88 -3.0-3.0 31.931.9

20082008 2,02,0 - 1.- 1.22 -2.-2.55 31.231.2

20092009 2,42,4 - 0.- 0.77 --2.02.0 30.130.1

Comparison Convergence Program Comparison Convergence Program 20020055-2010 -2010 (Nov 2005)(Nov 2005) with Draft with Draft 2007-2009 2007-2009 BudgetBudget ((AugustAugust 2006) 2006)

Draft 2007-2009 Draft 2007-2009 BudgetBudget Convergence Program Convergence Program 20020055-2010-2010

Government Government budgetbudget

(excl(excl--costs 2nd pillarcosts 2nd pillar--incl.)incl.)

GovernmGovernment debtent debt

Government Government budgetbudget

(excl.(excl.--costs 2nd pillarcosts 2nd pillar- - incl.)incl.)

GovernmGovernment debtent debt

20052005 -2.9-2.9 -3.6-3.6 34.534.5 - - 44..11 -4.9-4.9 3333..77

20062006 -2.-2.99 -4.-4.22 3333..11 - 2.9- 2.9 -4.3-4.3 3535..55

20072007 -1.-1.88 -3.0-3.0 3311..99 - 1.- 1.66 -3.0-3.0 3535..22

20082008 -1.2-1.2 -2.5-2.5 3311..22 - 1.3- 1.3 -2.7-2.7 3636..22

20092009 -0.-0.77 -2.0-2.0 3300..11 - 0.3- 0.3 -1.8-1.8 3535..55

20102010 -- -- -- +0.6+0.6 -0.9-0.9 3434.0.0

Slovakia: convergence – Slovakia: convergence – cont.cont.

Interest rates safely settled below threshold value Interest rates safely settled below threshold value (3(3..99% in SR vs reference 5.% in SR vs reference 5.33% on average in % on average in July July 2002006)6)

Pension reform, health reform, public administration/ Pension reform, health reform, public administration/ finance reform - necessary to achieve long-term finance reform - necessary to achieve long-term stabilitystability

Thanks to higher economic growth (6.0Thanks to higher economic growth (6.0% SR vs 1.4% % SR vs 1.4% EU15 in 2005EU15 in 2005)), , real convergence also under way: GDP real convergence also under way: GDP per capita (PPP; 2005) per capita (PPP; 2005) 5050.0%; labour productivity per .0%; labour productivity per capita (2005) 57.7%, relative price level (2004) 52.8% - capita (2005) 57.7%, relative price level (2004) 52.8% - necessary to achieve long-term stabilitynecessary to achieve long-term stability

But unemployment still problem: 15.5% in 2007; 14.7% But unemployment still problem: 15.5% in 2007; 14.7% in 2008-10 (ESA95)in 2008-10 (ESA95)

And inflation rising in 2006 due to higher energy pricesAnd inflation rising in 2006 due to higher energy prices

Thank youThank you