Wednesday, May 7, 2008

Slovakia's Euro Entry Bid Accepted

Slovakia today won EU approval to adopt the euro on Jan. 1 2009, thus becoming the 16th member of the European single currency zone. The EU Commission announced today on its Web site that Slovakia had reduced both the fiscal deficit and inflation sufficiently to qualify. At the same time the Commission announced that they were terminating the excess deficit procedure, a move which is a mandatory to joining the euro region.

EU finance ministers must now endorse the commission's recommendation in July. Not everybody is entirely convinced it seems, and the European Central Bank still has "considerable concerns'' about the sustainability of the inflation path, according to a report published by the bank today in Frankfurt. I share many of these concerns - as I have already explained at great length in this post here.

Even in Slovakia itself people retain their own reservations as according to a survey conducted by the Slovak Statistical Office between March 1-7 some 72 percent of respondents had a negative attitude towards the proposed change due to the perception that - in a way which is similar to what happened in countries like Spain and Greece after adoption - prices may well rise faster than anticipated and household budgets become strained.


However I do think that today is really not the time to pursue these concerns, since at this point they would smack more of sour grapes than of anything else. I would really simply like to take this opportunity to congratulate Slovakia on all the hard work they have put in to preparing their membership bid, and wish them every success in the introduction of what now looks like it is soon set to become their new currency.

``To ensure that the adoption of the euro is a success, Slovakia must pursue its efforts to maintain a low-inflation environment, be more ambitious with regard to budgetary consolidation and strengthen its competitiveness position,'' EU Monetary Affairs Commissioner Joaquin Almunia


Of course eyes well beyond Slovakia will now be watching the month by month movements in the Slovak CPI, since should the more optimistic expectations on the future inflation path not be fulfilled, then this will only make further applications from other EU10 countries - Bulgaria, Latvia, Lithuania, the Czech Republic, Estonia, Romania, Poland and Hungary - much more difficult in the future.

Update 13 May 2008


Slovakia's inflation rate rose in April to a 17-month high, increasing pressure on the government to convert the koruna to the euro at the strongest possible rate before Jan. 1 adoption to tame price growth. The rate advanced to 4.3 percent from 4.2 percent in March, the Bratislava-based Slovak Statistical Office said in a statement today. Prices rose a monthly 0.2 percent, compared with a 0.3 percent gain in March.




To adopt the euro, Slovakia has to keep its 12-month average inflation rate, using the EU HICP methodology no the one reported on here, to within 1.5 percentage points of the average 12-month rate of the three EU nations with the slowest price growth.

If final approval for Slovakia's application is secured, the Central Bank and the government may well try to lock the koruna rate to the euro one - at a higher rate -final time before the national currency is discontinued. Securing the strongest exchange rate possible at the time of adoption is seen by many as a way of continuing the damping effect the Slovak koruna now has on capping imported prices, thus helping tame inflation once the koruna no longer exists. This approach, however, does have its dangers, as It may make exports more expensive in the future, especially if Slovak prices and wages get a strong kick upwards from euro adoption. Thus Slovakia - if she is not careful could face the difficulty of having a longer term trade deficit.
Posted by Edward Hugh at 2:55 PM

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Spotlight On Hungary

Welcome to the Eastern Europe Economy Watch Blog. By clicking the older posts link (at the foot of the page) you will be able to leaf through the normal chronological blog posts. But first we have our country of the month feature where we would like to present some charts which provide background data we hope will help the first time reader better assess and get to grips with the general argument being presented on the blog. Below you will find charts for Hungarian male life expectancy, fertility, quarterly GDP growth, inflation, household demand, retail sales, and import and exports growth. Please click on thumbnails for better viewing.

On the left you can see a chart for Hungarian male life expectancy, and on the right there is one showing Hungary's population development. Just why such factors are important, and need to be taken into account along with more standard macro economic data in order to understand what is currently happening in Hungary and what might subsequently spread across Central and

Eastern Europe can be discovered by reading my Hungary analysis:Just Why Is Hungary So Different From the Rest of the EU 10?The basic arguments being advanced here are that long term fertility and life expectancy do matter, since in the long run they condition the labour force and consumption patterns, and with these inflation and internal demand.



Above left you can see Hungarian ferility, and above right the evolution of the population median age, which are also key parameters, since they influence saving and consumption, and with these internal demand growth. On either side here you can see charts for inflationand quarterly GDP.


Next on the left we have a chart for recent movements in private internal consumption (which shows us the state of internal immediate consumption demand) while on the right we can see changes in constuction activity, (which serve as a nice proxy for fixed capital formation). Finally the chart on the bottom left shows a comparison of Hungary's trade balance 2006 and 2007,


while on the right you can see the evolution in non-forint mortgages for immediate consumption purposes. Arguably these are all the data points you need to understand my lengthy post on why we face a possible recession in Hungary, and why post-recession Hungary may be converted into yet another export dependent economy.


2008 Forecasts: The OECD in December revised their 2007 Hungary forecast down to 1.8%, and 2008 to 2.6%. These numbers are very hard to accept. I will be very surprised if we see calendar year 2000 as high as 1.8%, but more to the point 2.6% seems to be assuming a strong rebound, an assumption for which there is no real substantive evidence. In particular even to get what growth we have been getting in 2007 the Hungarian govenment has been running a deficit of around 6% of GDP. This is going to tighten yet further in 2008, so there is no supportive fiscal environment. And as I keep arguing, it is very hard to see a supportive monetary one. The IMF in their October World Economic Outlook also put a similar figure of 2.7%, while the EU commission in November 2007 came in with the same 2.6% as the OECD.

Perhaps the prize for the most exaggerated prediction here must go to GKI Gazdaságkutató Zrt, who argue that Hungary should expect the incredible annual growth rate of 3.5%. My own view is much more nuanced. I think I am reasonably confident in holding to my recession forecast for 2008, although of course, "recession" does not mean negative growth for the whole year (technically it is simply 2 consecutive quarters of negative growth), so we might then go on to see what, between 0.5 and 1% growth over whole year 2008 (and the only really doubt is whether the contraction starts in Q4 2007, or in Q1 2008). But it is what happens in 2009 and 2010 that matters really, and at this point so many variables are in play (and interrelated ones to boot) that I can only say I envy those who have the courage - or the temerity - to stick their necks out). And of course, if we get a large correction in the value of the forint, then all those carefully weighed and weighted forecasts will, without a shadow of a doubt, go straight and directly off into the bin.