Thursday, May 13, 2010

Estonia defies critics to join the euro zone

While it might seem bizarre given Greece’s current troubles, other European countries are still keen to join the euro zone. Yet just this week the European Commission has given its blessing to Estonia to take up the common currency. The commission announced yesterday that it would recommend that EU governments let the Baltic country switch to the currency in January 2011. Estonia, which currently uses the kroon, would become the 17th nation to adopt the euro. The announcement was accompanied by a report showing eight other EU countries do not yet satisfy the conditions for euro area membership - Bulgaria, the Czech Republic, Latvia, Lithuania, Hungary, Poland, Romania and Sweden. (photo by tm-tm)

Estonia meanwhile was also invited this week to join the Organisation for Economic Cooperation and Development alongside Israel and Slovenia bringing its membership to 34 countries. All three countries were reviewed by 18 OECD Committees with respect to their compliance with OECD standards and benchmarks. OECD Secretary-General Angel Gurría said Estonia has been receptive to OECD recommendations on important issues. “The OECD accession process has delivered real policy changes and reform in all candidate countries,” Gurría said. “Once countries become members, this transformational process continues.”

There is little doubt that Estonia has undergone an astonishing transformation in the last 20 years. After a 51 year absence, it returned to the world map in 1991 as an independent country during the collapse of the USSR. According to The Economist Estonia confounded its critics in the years that follow. It had a fast-growing economy, based on flat taxes, free trade and a currency board. In 2004 it joined the EU and NATO. Despite property values collapsing last year, the economy stabilised with the help of flexible wages and prices. It said Estonia was one of two EU countries (with Sweden) that met the common currency’s rules.

The European Central Bank has issued a cautionary note offering amore negative assessment of Estonia’s qualifications. It says that while Estonia is well within the limits on government spending and debt, the country’s current low inflation rates reflect mainly temporary factors. The ECB says Estonia has a history of high inflation that raises concerns. “Maintaining low inflation rates will be very challenging given the limited room for manoeuvre for monetary policy,” said the ECB. “Once output growth resumes, with a fixed exchange rate regime, the underlying real adjustment is likely to manifest itself in higher inflation.”

However the ECB did not explicitly say that Estonia should be denied and its opinion is not binding on the final decision makers, the EU governments. The New York Times said political leaders have form in brushing brushed off central bank concerns in their eagerness to expand the zone. “Greece won admission even after the central bank reported in 2000 that the country’s debt equalled 104 percent of gross domestic product, far above the limit of 60 percent in the Maastricht Treaty,” the NYT said. That decision has of course rebounded on the EU as it embarks on a $106 billion rescue of Greece’s wrecked economy in conjunction with the IMF.

Estonia has no such worries at the moment. Its inflation rate is 2.9 percent and its economy has rebounded out of the GFC with expected growth of 1 percent in 2010. BusinessNewEurope said judicious use of reserves accumulated during the boom years means government debt levels are currently the lowest in the EU. It also said the country’s pioneering adoption of a flat-rate tax system in 1992, combined with the "safe haven" label that membership of the Eurozone confers (Greece notwithstanding) “should make Estonia an interesting investment destination in the future.”

The Estonian finance minister has been playing down negative impacts of the euro to his country. Jürgen Ligi said that there is no real danger of the euro bringing major price increase to Estonia despite the temptation of traders to round prices up after the conversion. There will be parallel posting of prices in both euros and kroons for the obligatory six months before adoption of the euro. Ligi said that the country’s planned sales tax might mess up things but general studies show that “we don’t have the room for price increases for anything substantial to take place”.

Estonia has two more hurdles to jump before it is confirmed as a member. An EU committee meets at the end of May to discuss the move, followed by a finance ministers’ summit in early June for final confirmation. By January next year they will join the 329 million people that use the euro every day, nearly two-thirds of the EU population.

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