Vol 1, No 4, 19 July 1999

N E W   S E R I E S:
EMU and Central Europe


Rob Smith

A new series in Central Europe Review

The European Union represents the dominating economic force in European commerce. Its latest experiment, Economic and Monetary Union (EMU), for eleven of the fifteen member states, seems destined to become a permanent measure, and its implications go far beyond the introduction of the single currency. EMU will affect the economic policies and commercial practices of countries and companies throughout Europe, not just those nations that participate.

Across Central and Eastern Europe, most nations, with the exception of Russia have either the majority of their trade with the EMU region, are considering membership of the EU and EMU or have pegged their currency to the euro. The implications of the EMU initiative by most of the counties in Western Europe will clearly influence economies, businesses and politics. For those countries interested in joining, there is a chance to learn from the experiences of the first wave participants.

In the first of a series of articles, Rob Smith, of Evergreen euro covers the fundamental issues of what EMU is all about, and as the series develops, it will provide an expanding guide to the commercial and cultural implications for Central and Eastern Europe.

EMU is born

1 January 1999 introduced the single currency, the euro, as an electronic replacement for the national currencies of the eleven participating nations, (Austria, Belgium, Finland, France, Germany, Holland, Ireland, Italy, Luxembourg, Portugal and Spain). Until 31 December 2001, the conversion rates between the ten national currencies (Luxembourg and Belgium share a common currency already), and between those currencies and the euro, are fixed. For transactions completed electronically within any of the eleven member states, either the euro or the national currency can be used for settlement, without prejudice or compulsion.

The conversion rules between national currencies and with the euro are explicit, although, at times, they may appear unduly complex. Across Western Europe, companies are struggling to comply with these rules, as well as adjust their business operations to euro compliance before the end of the three-year, dual currency period. Many are waiting until they have completed their Millennium preparations.

On 1 January 2002, euro notes and coins come into circulation. Each participating member state then has a maximum of six months to phase out their domestic currencies. Some are planning to complete this process in a matter of weeks. Widespread confusion is predicted as members of the public have to come to terms with a new currency as well as the changeover of ATM's and coin operated machinery such as telephones, parking metres and vending machines.

So why bother?

Clearly, three members of the EU are asking precisely this question, as they have elected not to join the first wave of EMU. Denmark, Sweden and the UK have all elected to reserve their right to join as have a number of the Central European states who are currently applying for membership. Greece remains the only member of the EU that wishes to join but hasn't yet had its application approved. (It failed the criteria for 1997, but has reapplied since)

The above question does have some answers, however. The initial advantages of EMU are seen in the commercial sector. By agreeing to a single currency, the member states of EMU eliminate currency conversion costs on internal transactions. In many international businesses this can account for up to 5% of profits.

But there are many implications that affect commercial operations beyond currency, computers and electronic transactions.

One consequence is the consolidation of the capital markets. A single currency requires a single monetary policy (operated by the new European Central Bank, or ECB) and a single base interest rate. That means the same base interest rate in Ireland as in Italy, with all of the implications this has for economic prosperity and inflation. The ECB sets the interest rate based on the requirements of the EMU zone as a whole. This could mean that the resulting interest rate fits no single nation's requirements, being too high for some and too low for others.

The consolidation of capital creates a much deeper and more liquid source of capital for EMU domestic companies. This is already loosening up a market traditionally held firmly in the grasp of the banking sector.

Harmonisation

The whole focus of EMU is on harmonisation of national economies. The first step of combining all of the currencies into a single unit, the euro, is only the initial stage in a whole set of initiatives. For EMU to operate effectively, national governments must learn to manage their economies without the tools of monetary policy. In addition, membership requires compliance with the stability pact, an agreement to meet a series of economic targets, aimed at harmonising national economies.

There is also an initiative to harmonise fiscal policies and taxation. This is the political minefield that recently cost Oskar Lafontaine his job as German finance minister. Whether this is merely the elimination of national tax competition, (where one country offers fiscal incentives to tempt commercial investment), or the introduction of a single European fiscal code, depends on which politician you listen to. What is clear, is that tax law will evolve quickly whilst remaining a political hot potato.

Is EMU a practical route toward a federated Europe?

Economic theory says that for currency unions to be successful, an optimal currency region must exist. The EMU region fails on three key counts. These are:
(1) the mobility of labour
(2) the availability of federal funds for regional assistance and economic stability
(3) the central control of economic policy

The recent fall of the euro's value may represent the market's misgivings about an economic experiment of this scale in light of these deficiencies. At the present time, however, there is insufficient evidence to judge one way or another.

What we do know is that EMU exists and cannot be ignored.

Rob Smith, 13 July 1999

For more information on preparing for and coping with EMU, have a look at the website of Evergreen euro.

Rob Smith's series on EMU continues in a few weeks.

 

THIS WEEK:

THEME:

Information
Technology

Hungarian IT
Past and Present

Surfing the Baltic


REGULAR COLUMNISTS:

Catherine Lovatt: Romanian
Economy in Crisis

Vaclav Pinkava:
Transitional Thoughts

Sam Vaknin:
Ephemeral Balkan Promises

Jan Culik:
Czech Press Distort the Outside World

Andrew Stroehlein:
Premier Zeman and
the Czech Media

Tomas Pecina:
When Czech
Fights Czech

Mel Huang:
Lithuanian
Parliament's Shame


NEWS:

Baltic States
Czech Republic
Poland
Romania


SLICE OF LIFE:

God's Land:
Tbilisi, Georgia


BOOKS:

Book Review:
Traveller's Literary
Companion: Eastern
and Central Europe

The CER
Book Shop


MUSIC:

Lithuanian Jazz

Jazz on CD

The CER
Music Shop


ON DISPLAY:

Central European
Culture in the UK


KINOEYE:

Austrian and German Escapist Films of the 1930s


PARTNER SITE:

Transitions Online
Watch for their
relaunch on
21 July.


NEXT WEEK:

The EU:
promised land or
bad neighbour?


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