Ungarn und der Euro: Getrennte Wege

In diesem Artikel befasst sich Miklós Blahó  mit Ungarns holprigem Weg in den Euro-Raum. Der Artikel wurde herausgegeben von The Analyst, einer neuen Zeitschrift zu politischen, wirtschaftlichen und sozialen Entwicklungen in Mittel- und Osteuropa.

At a conference of the British Euromoney magazine, held in Vienna in January 2005, Konrad Reuss, managing director of Standard and Poor’s, expressed the essence of the euro debate engaging the old and new Union members very concisely. 

„The EU made a political decision on the first round of the implementation of the common currency, but this will not happen any more,“ he said. „If a country wants the euro, it will have to go this tough road all the way and demonstrate, even though the conditions are full of contradictions, that it is capable of putting its own finances in order.“ 

He said this in response to a question whether it would have been more reasonable in May 2004, upon the large scale enlargement, to let the ten countries join not only the European Union, but the monetary union as well. 

Leaders of national banks of Central European countries participating in the conference responded to this statement by pointing out that the longer they have to wait in the lobby, the more tension that may develop in the individual economies. The share of the ten new countries from the Gross Domestic Product (GDP) of the EU-25 is less than ten per cent. So the expansion of the boundaries of the monetary union would not have caused serious difficulties. That is all the more true since the euro has broken through anyway. It is widely used in countries of the region. In Hungary, in the space of a few years, household debts registered in Swiss francs and euro went from nil to HUF 800 billion, and in 2005, banks extended loans almost exclusively in these two currencies, rather than the national currency. Owing to the higher HUF interests, a good quarter of the HUF 3500 billion total bank indebtedness of households is registered in foreign currency, increasingly in euro. At this point it is difficult to determine whether this phenomenon, also called spontaneous euroization, will have a meaningful effect on the timetable of the implementation of the common currency. 

The one year since the conference seems to support the argumentation of Reuss. The accession to the Union signified that the old and new members are moving in the same direction, and the latter have lined up close behind the former in many respects. However, when it comes to implementation of the euro, the roads seem to diverge. At least, that is true if one compares the current members of the euro zone with the three countries declared at the top of the league 10-15 years ago, the Czech Republic, Poland and Hungary. 

Recently, the Czech Republic modified the date of adoption of the euro from 2009 to 2010, Hungary earlier postponed the deadline from 2008 to 2010, while Poland did not even declare a specific time. Its new conservative cabinet and head of state plan a referendum, and do not conceal their doubts. It may be a coincidence that these three countries, considered the pioneers of reform one and a half decades ago, have become so uncertain simultaneously. It is also possible that there are other, common concerns that make compliance with the conditions of euro membership more difficult – conditions that were otherwise not formulated for these countries. 

The European Union is not pushing the enlargement of the euro zone. Official statements clearly declare that the new members should only enter the zone when they are fully prepared. We can discover voices of concern in these positions. When the strong economies of the euro zone do not observe the requirements that were designed with them in mind, what will happen to the less developed new members? 

It further increased the uncertainty that the process of adopting a European constitution got stuck, and there is still no agreement on common finances for 2007-2013. The new members can count on lower financial support from the common funds than the Irish, the Spaniards, the Portuguese or the Greeks received earlier, while the adoption of the euro requires budget austerity, sometimes painful reforms. All this did much to damp interest in the common money. 

In addition to Hungary, Poland and the Czech Republic, the case of Estonia, a country providing 0.1% of the GDP of the EU, also seems to prove the theory of diverging roads. This Baltic state has no public debt, the surplus of the state budget is two per cent of GDP, and it could just walk into the euro zone. It plans to do so in 2007. But there are more and more concerns raised in Tallinn that this will not happen, because inflation stands at 4.9%, while compliance would require 2.4%. However, while the economies of the euro zone are expanding at a modest rate of 2%, the Estonian economy is growing at almost 10%. It pegged its exchange rate to the euro long ago, and cannot appreciate or depreciate its currency. So the only way to express the much higher rate of growth and productivity increase is to let inflation jump higher. 

Officials in Brussels are aware of this basic relationship of economics, but do not intend to authorize any exceptions, lest they create a precedent. Willem Buiter, a tutor at the London School of Economics, considers the artificial suppression of inflation economic foolery. Foolish or not, a rule is a rule. But if we consider the relationship between Hungary and the euro, nothing follows from this statement. Hungary uniquely used up all the benefits of the stabilization of 1995 and found itself once again with a bad financial balance. The country has to fight its way out of this, regardless of whether the euro will come in 2010, or whether the requirements of the euro zone are reasonable. In this regard we already have a common consensus in Hungary. But, owing to parliamentary elections due in spring 2006, opinions widely differ as to what should be done, how and when to restore the balance. 

Where is the euro zone going? 

If a political decision was made in or before 1999 about the introduction of the new currency, a political decision was made in 2004 as well, on slowing down the continued penetration of the already existing euro. The reason lies precisely with the first political decision. 

At that time, the requirements of the Growth and Stability Pact, the agreement summarizing the practical action points deriving from the spirit of the Treaty of Maastricht, were applied in such a manner that the euro could be implemented in the founding countries of the Common Market in any case. Observance of the upper limit of each condition, for example, the condition that public debt must not exceed 60% of GDP, was waived. Moreover, primarily on the proposal of the Germans, a relatively stringent set of rules was created to contain Italy, a state prone to excessive spending and currency depreciation. 

In addition to the public debt, it was prescribed that the balance of the state budget should reflect an equilibrium with cyclical adjustments, inflation must not exceed the mean value of the best three countries by more than 1.5 percentage points, and interest rates should be low. These criteria were triggered partly by political worries and partly by problems suspected right from the beginning. If interest policy is directed by one single central bank while central budgets are shaped by the national governments, cornerstones should be designated for everyone to adhere to. 

However, the public debt ratio of 60% to which the requirements were matched – in such a manner that economic growth of 2-2.5% per annum was anticipated – was nothing else than the average level of public debt at the time of the formulation of the Treaty of Maastricht. The rules were defined not with regard to the future enlargement of the Union, but with a view to the developed West European region. In the long period leading to the implementation of the euro, the converging Irish, Spaniards, Portuguese and Greeks had generous help from the funds of the Union, and did not have to take on the straitjacket of the Union right away. 

By the beginning of the new millennium, growth had slowed to half the planned rate in the EU-15. It is primarily the leading countries, Germany, France and Italy, that are doing modestly, with economic performance sometimes showing signs of recession. That made them exceed the deficit threshold of 3% in an effort to offset weak performance. Although the Commission and financial ministry procedures (Ecofin) initiated against them made them promise to curb the deficit, they asked for deadline modifications again and again, which were always granted. 

The difficulties disrupted the pact. Reform was authorized in the first half of 2005. The requirement of a balanced budget was replaced by acceptance of a deficit of 1%. Furthermore, it is allowed to decrease the calculated public deficit under an entire set of various development excuses: research and development, the pension reform, or in the case of Germany, the costs of integrating the eastern provinces. 

Despite that, the euro has taken root in the 12 member states successfully and become one of the reserve currencies of the world economy. At the same time, the two basic pillars, the Treaty of Maastricht and the Growth and Stability Pact, need further and far-reaching reforms. The „one size fits all“ approach has created a system burdened by over-simplification and containing serious internal tension. In this system there is too much attention on government finances, but not enough on the different circumstances of individual countries, the sustainability of financial situations, the current account, household savings and the quality of economic policies. 

Although the reform of 2005 refined interpretation, it did not go far enough. Another factor making analysis with numerical elements in focus more difficult is that there are statistical-methodological debates and theoretical debates in economics. These throw a different light on the processes of Hungarian government finances, receiving increasingly sharper criticism both domestically and abroad. And they may provide important lessons as to what we should do, if successive governments are willing to consider them. 

Maastricht and the stability pact were not created in a vacuum. The grand vision of monetary union was partly designed with the intention of creating an expanding region that would catch up with the United States. This matched Lisbon Strategy, accepted in 2000, on making the EU the most competitive and innovative region of the world. Now it is clear that this objective will not be accomplished by 2010. In terms of per capita GDP, the region failed to catch up with the U.S.A. 

However, the basic principles of monetary union also responded to doctrines of previous decades. The doctrines developed in response to the Great Depression of the previous century – most often associated with John Maynard Keynes of Britain – started from the notion that governments are allowed to spend in order to level off business cycles. In bad times, they may interfere by tax reductions or increase of public expenditure, while in good times they may restore the balance. 

However, after the war reconstruction period of the fifties and sixties and the development of the models of the welfare state – which now cause problems with competitiveness and government finances owing to inflated costs during the recent decades, yet remain politically difficult to change – it has become clear that this kind of budget policy is bleeding from several wounds. It is impossible to find out accurately when is the right time for intervention, and it takes a long time for a decision to be reached in parliament. So when the additional money going into the economy has a chance to start working, the economy may already be in a surge. What starts out as a counter-cycle measure may well end up as pro-cycle action, increasing the budget deficit and the public debt. 

This is clearly reflected by experiences of West European states as well. What is more, one of the studies of the International Monetary Fund (IMF) concluded in 2004 that member states of the euro zone have pursued a pro-cyclical policy over the last three decades. 

Back in the eighties it seemed that the ideas of Keynes had gone out of fashion for good. But practice does not support this notion. Maastricht was preceded by an extremely peaceful financial period. There were no wars ravaging, no worries that the population qualifying for pension was ageing, no tax competition among states, globalization was not as full fledged as now, and China, India and Mexico only challenged the economies of Europe in a restricted way. The twelve countries now forming the euro zone augmented public debt from 31 to 75% between 1977 and 1997. 

Maastricht was meant to halt the process. It had temporary success. In the years preceding the implementation of the euro, public debts decreased by five to six percentage points, but they have resumed increasing since 2000. The clear response to the slowdown of growth was the increase of the deficit, especially in Germany, France and Italy. 

The smaller Union countries that have undergone reforms and do not match this trend view the alleviation and re-interpretation of the stability pact with anger, and regard it as a counter-attack in the spirit of Keynes. They also emphasize that within the EU as well, states that perform well are those that have completed their fiscal consolidation projects. 

The lessons to be learned by Hungary are clear. In the league of euro zone members with fast growth, states that do well (Ireland, Finland) are ones that have shaped their fiscal course such that public indebtedness decreases. 

The worst problem of the system operating the euro is not the return of Keynesian policy, but the fact that the quality of government finances is disregarded. 

„A higher deficit than allowed may serve as a foundation of faster economic growth in future, while a deficit pushed under the allowed upper limit by force may reflect irresponsible governmental behaviour.“ 

It is incomprehensible why the founders of the euro placed so much emphasis on fiscal policy, while in the meantime the really big challenge of economic policy is the maintenance of external balance. It is only possible to sustain and finance the deficit of the current account if it equals the value of incoming capital that does not generate debt – i.e., investment of operating capital, re-invested income, money from EU funds, etc. This determines how far the budget can go. 

In Germany, where the current account shows a surplus and households traditionally accumulate savings, the higher deficit only offsets the lack of internal demands. If it were pushed down quickly, this would trigger further tension. In Hungary, where the propensity of households to savings was eliminated by the governmental financing program for housing announced in 2001, and later reduced in an effort at austerity, a current account deficit of 8 – 9% of GDP has become unsustainable. Even in the best case scenario, direct foreign investments only cover half of it. 

So in our case, the EU is supposed to ask for fulfilment of more stringent conditions than would follow from the stability pact. But the new Central European members are growing much faster. Although during growth they produce one or two percentage point higher inflation than the economies of the euro zone, they deliver on the public debt figure of 60% even with a state budget deficit of four or five per cent. There is no scientific basis to the 60%. 

Where is the Hungarian economy going? 

In line with arguments for and against the stability pact, Hungary should consider when to enter the euro zone. It is not a matter of whether financial balance should or should not be restored. Indeed, the most disturbing element of the Hungarian debates on economic policy is that these two processes – accession to the euro zone and development of a reasonable monetary policy – seem to get blurred. 

The economy should be organically connected to the euro zone, with the fastest reasonable growth rate. It was a mistake in 2002 to mention 2006 as the target date. And then it was not a good idea to set 2008 as the date for the implementation of the common currency. Without this, we could have avoided the awkward change of the deadline to 2010. 

It is not certain that in 2010 Hungary will join the monetary union. The last time the Hungarian economy was in a state that it could have easily walked into the currency zone within the foreseeable future was around the turn of the millennium. But then the economy left the course of healthy and balanced growth, and has not returned. 

After the political changes of 1990, Hungary became a pioneer state in the region in the build-up of the institutions of democracy and market economy. But as early as 1995, a financial stabilization program had to be introduced since the balance was tipped. Called the Bokros Package, after the finance minister of the time, this austerity program reversed the trend. 

Over the last 10 years, the country has been on a new course. Investments and exports have tripled, and industry has expanded by an annual average 11%. Compared to the situation 10 years before, a stronger, competitive and developed economy was integrated into the European Union. Compared to the euro zone, the growth of the economy is at least twice as high. Compared to the other seven new EU members that are in Central and Eastern Europe in 2004-2005 Hungary was at the bottom of the league even with this pace. Once again, it is there together with the Czech Republic and Poland. Within the region, the economies where the per capita national income is relatively high are the ones that are growing more slowly. Countries with low per capita national income are growing faster, like the Baltic countries. 

But the average value of this period of 10 years is made up of two different stages. This is the essence of today’s problems and the key to the solution. 

After the stabilization of 1995, the economy had accelerating growth, decreasing inflation rate and unemployment rates, spectacularly expanding exports and rising investments. That lasted till 2000. Up until 1999, the deficit of the current account was fully covered by influx of capital, so indebtedness improved. Budget deficits reached four-five per cent of the GDP and the leading markets considered the deficits sustainable in terms of financing. 

The other stage, the time between 2001 and 2004-05, is different. In the first five years the economy produced a growth of four-five per cent, while in the second five years, it was three-four per cent. In the first and second half of the period of ten years mentioned above, exports increased by 28% and 6%, industry by 14% and 5%, and investments by 22% and 9%, respectively. From 2000, financing of the current account deficit was more and more taken over by debt-generating items, and the measure of the deficit first reached, then exceeded 9% of GDP, extremely high by international standards. 

The actual deficit of government finances that reached four-five per cent of the GDP first went up to seven per cent from 2002, while inflation was pushed down to eight-ten per cent. It then became about six per cent annually, while inflation dropped to three-four per cent. This means the operational deficit is even higher. 

The outstandingly high interest and the strong exchange rates applied as anti-inflationary tools resulted in deteriorating exports and decreasing competitiveness. Public debt, which was as high as 90% of GDP in the beginning of the nineties, decreased to 54% by mid 2001. Since then it has come close to the magical 60%. The increase is in line with the trend of the euro zone, but as we have seen it differs from the practice of successful countries. 

It was unique in the region how Hungary gave up its competitive advantage, wasting assets obtained in the stabilization of 1995, assets that were accumulated from social sacrifice and genuine, healthy economic growth. The start of financial deterioration can be defined accurately. It was the third year of the Orbán government, 2000, when good performance made politicians complacent. They started distributing the benefits, partly for election purposes. From this point on, „fiscal policy was shaped by false notions and turf battles, which undermined the budget discipline essential for an enduring growth course.“ 

The most spectacular element of the loosening, in addition to the halt, slowdown and change of direction of the pension and health insurance reform, was the announcement of the state sponsored housing support program. This imposes a heavy burden on the budget even now, although the Socialist and Free Democrat Medgyessy Government, elected in 2002, tried to narrow the scope of eligible citizens. The benefits that triggered the housing boom reduced the saving propensity of the residential sector to nil. From a growth driven by export and investment, the economy shifted to consumption-driven growth. 

This dramatically worsened the financing of the budget and current account deficits, which were increasing of necessity, and launched an increase of external debt. To cap it all, the new coalition announced a 50% pay raise in the public sector without reforming government finances. Though the raise was necessary, it should have been implemented with a reduced community of public servants. Similar raises have taken place in the health and education sectors that have expected new solutions since then. 

After the elections of 2002, in September 2004 Péter Medgyessy was replaced by Ferenc Gyurcsány as the head of the Socialist-Liberal ruling coalition, inheriting the deteriorating processes. Over recent years, more major items have been added to the budget besides financial support for housing and pay rises. The tax exempt status of the minimum wage, the decrease of personal income tax, the reduction of the 25% upper range of VAT to 20%, the redemption of external quotas in cooperatives, the decrease of corporation tax from 18 to 16%, the halving and then abolition of the fixed healthcare contribution, and the purchase of Gripen fighter planes. Disregarding wage rises, these factors burdened the budget by 2-2% of GDP. Without these items, or if these items had been applied differently, government finances would show a different picture, even though the necessity of further reforms would still be indisputable. 

The National Bank of Hungary, and its president, Zsigmond Járai, appointed during the Orbán government, approved the relaxation of discipline in government finances that had been apparent from 2001. However, from the middle of 2002, after the elections, the same Járai expressed grave concern at rising deficits. It is peculiar that between 1995 and 2000 the forint appreciated by 2.1% a year. This reflected the outstanding balances in the rates of inflation and productivity, comparing the Hungarian economy and the economies of the Union member states at the time. On the other hand, between 2001 and 2004 the forint appreciated by 7.5% annually. Underlying the strong exchange rate we find high interest rates. Underlying high interest rates we find higher debt servicing, i.e. higher interest liabilities and state budget deficit, and a current account that cannot be improved. 

The uneasy relationship between the government and the central bank, the disruption of harmony between fiscal and monetary policy, the constant open verbal debates and erroneous communications have become common features in the region. Markets responded to the disturbances strangely. First, in January 2003, efforts were made to strengthen the forint excessively. The intention was to push the currency out from the exchange rate range that was opened wide after the termination of crawling peg depreciation in 2001. The National Bank had to cut rates by three percentage points. In summer of the same year, the government decided to depreciate the middle of this range, to give a push to fledgling exports. The markets qualified this measure a rash move and started working on weakening the exchange rate, amid continuing fighting between the government and the national bank. 

By the end of the year, the national bank had increased the interest rate by six percentage points, and it was only in September 2005 that it brought down rates from 12.5% to 6%. This was despite the fact that in 2004 and 2005, growth picked up speed. Owing to the efforts of the government, it was once again driven by export and investment, the influx of foreign direct investment improved, and after May 2004 more support came from the Union. The position of the current account stopped deteriorating and its financing improved. 

While all this was happening, a high level of liquidity developed in the world economy. In this atmosphere, investors seemed willing to overlook deficits and imbalances. Both the government and the national bank could have exploited this better – with appropriate care and cooperation. 

At the same time, despite balance problems, inflation fell far below 4%, compared to which even the current interest rate can be considered high and exercises pressure on the budget. The forint also proved relatively stable over the last nearly two years. Capital flowing into state securities and direct investments, suuport from the Union, and the indebtedness of the population, i.e. spontaneous euroization, prevent any meaningful weakening of the exchange rate. 

However, the president of the national bank opened an individual campaign in the autumn of 2005, declaring several times a week that Hungary is threatened by a serious financial crisis. His words go unnoticed, which signifies that the national bank is not considered credible. At the same time, fiscal policy has lost much credibility. Over three years, it has not delivered on targeted deficit figures, and now has a conflict with the European Commission because of that. 

The government has appointed its third finance minister since 2002. This is always the minister responsible for exceeding the deficit target. 

The history of deficits in Hungary is peculiar. Today it is next to impossible to enumerate every change retroactively. It is disturbing that a new version was added to turnover and result-based accounting, when in the spring of 2005 the EU permitted impacted countries – such as Hungary, Poland, Sweden and Slovakia – to take into account the impact of pension reform. That means they can deduct it from the ratio compared to GDP, but to an extent that decreases annually, and only until 2010. Even so, the processes are now next to impossible to monitor. 

In 2002, the new government expected to reduce the difference to 2.5% of GDP by 2006. Instead, starting from 4.5%, the deficit ended up at 5.6% in 2003, in 2004 it started from 3.8% and became 5.1%, 5.3%, 6.1% and finally 6.5%, and in 2005 it became 6.1%. In 2006, the target figure is 4.7%, if we consider the adjustment of pensions. 

The forecasts given to the date of implementation of the euro reflect this situation. In 2002 alone, the old and new governments mentioned 2006, 2007, 2008 and 2009 as possible dates. One year later, the national bank talked about 2009 or 2010, but Medgyessy announced amidst the panic following the depreciation that we would have euro on January 1, 2008. In May 2004, Tibor Draskovics, then finance minister, talked about 2010 as the target date, and the Gyurcsány government adopted this date. In autumn 2005, after the debate with the Commission, the Prime Minister questioned and then confirmed 2010, but the market considered 2012 or 2013 likely dates, just like in the Czech Republic, currently preparing for elections, and Poland, where elections resulted in a fragile government. 

Almost immediately after enlargement in May 2004, the EU started excessive deficit procedures against six of the ten new members – Cyprus, the Czech Republic, Greece, Poland, Hungary, Malta and Slovakia. The Commission assessed convergence programs submitted by the impacted states, to see whether they fulfilled deficit reduction promises. By the end of the first year of membership, only Greece and Hungary could not go through this filter. By January 2005, the Hungarian government modified the program. In July, the Commission found that the promised steps would enable the reduction of the deficit to the planned level. 

Things changed by the autumn. Financial Commissioner Joaquin Almunia expressed his doubts about the transparency of the Hungarian state budget in mid September. A few days earlier, one of the vice presidents of the national bank, György Szapáry, told a the economic and financial committee in Brussels, in a way unique in the history of relationships between European governments and central banks, that the Hungarian government would sell the motorways built for it to a state enterprise, and use the revenue to reduce the deficit. Although the government did not keep the settlement attempt a secret, the earlier favourable assessment of Hungary suddenly turned adverse. 

On October 20, the Commission concluded that the budget outlook of Hungary had worsened. Planned at 3.6% of GDP, the deficit will be 6.1% in 2005, and instead of 2.9% targeted for 2006, the adjusted value is 5.2%. These figures are exclusive of the pension reform. The final figure may be even higher than the increased deficit figure. 

The Commission, and then a few days later the council of financial ministers, sharply criticized the tax cuts that were announced for 2006. And the Hungarian Central Bank felt it necessary to publish its own position on November 14, in which for 2006 it assumes a deficit at least one percentage points higher than assumed by the Commission. By 2008, the bank says, the deficit may be as high as 10%, making implementation of the euro impossible in 2010. 

The Commission also expressed doubts about the designated date of implementation, with the usual added remark that every country should walk its own road, but it has to start walking that road. In the middle of November, during the visit of Commission president José Manuel Barroso in Budapest, Prime Minister Ferenc Gyurcsány asked for a grace period of three years to restore financial balance, referring to the need to reduce social disparities and the expenditure necessary for economic development. 

The Hungarian economy has done well in the last 10 years, but in the last five years the hard-earned accomplishments of the preceding five years were wasted. The high deficit in government finances, the deficit of the current account and the increasing rate of public debt are consequences of this. Since the bold pension reform of 1997, no government dared implement meaningful changes in the large distribution mechanisms. Uniquely, the international investor environment also favoured procrastination. 

Under pressure of the community of economists, there is conspicuously more political willingness for action, putting the Hungarian economy on a course that maximizes growth, but also incorporates financial balance. This requires reform of government finances, creating a state administration sector that promotes efficiency, and a reconsideration of headcounts, services and financing in healthcare and education. This should follow the example of Ireland, Finland or Spain, and avoid the Italian or the Portugal model, countries that have experienced membership in the currency zone as a failure rather than a success. 

If the new Hungarian reform program is successful, a series of professional debates will have to be held in Hungary to determine the benefits of entering the euro zone, in light of the experiences of countries that entered earlier. Hungary should consider the possibility of postponing euro adoption, as was decided in Britain, Denmark and Sweden, countries that over-fulfilled the conditions of the stability pact but are able to produce higher growth outside the zone owing to social and state administration reforms. 

What does this mean in numbers? Assuming economic growth of at least 4%, the current account deficit will have to be reduced to 5-6% of GDP, while deriving from convergence, inflation would remain one or two percentage points above the average of the euro zone. The latter is a good 2% at this point. 

This would not increase public debt. In light of that, a deficit as high as 4% in government finance could prove sustainable if reforms rekindle the savings propensity of households. On the other hand, depending on household savings, a deficit figure close to zero could offer a state of comforting balance. 

Before the Hungarian elections, this notion is missing from the political programs. The opposition tries to beat the tax reduction plan of the government with the slogan of radical tax reduction. 

This may have two types of consequences. The new government established in late spring or early summer 2006 will either embark on powerful austerity and reforms, or postpone the implementation of the euro from 2010 to 2012 or later, assuming responsibility for the consequences. 

Although there are some good examples of political wisdom, consensus and good judgment, economic history shows that most countries have only learned the hard way, and changed their ways only when they had to surrender to the disciplinary force of international financial life. 

One of the often cited benefits of the euro zone is that: in addition to saving on the costs of exchange, it protects against outbursts of financial crises and eliminates exchange rate risks. However, these benefits will be reduced to zero if a country only seemingly fulfills the conditions of accession, and only for a transitional period, and then formulates its economic policy in conflict with the requirements of balance. That is, if it pursues loose fiscal policy, increasing public debt and, within that, external indebtedness. 

The benefit is also reduced to zero if the economy is not flexible and competitive enough. In that case, what may come is worse than a financial crisis from which the country can recover and draw some lessons. It would be a drawn-out economic crisis, stagnation, and deteriorating competitiveness. 

It is more difficult to find a way out of this situation if the impacted country has given up its own independent monetary policy and is not able to change interest or exchange rates. Today, Italy is often cited as a case in point, which cannot apply the tool of currency depreciation, while reforms elicit sharp social resistance. But actually, the problems of integrating the eastern half of Germany can also be considered a warning. Portugal also experienced slower economy growth after the implementation of the euro. The premise that the mere existence of a monetary union will increase growth is not true. 

If a country accepted the burdens of the pact, just to invoke an external or disciplinary force to control governments engaged in lavish spending, the history of monetary union so far warns us that this support is only available with restrictions. The institution of penalties were designed precisely to avoid the application of measures – for example, withdrawal of Union support or payment of a certain percentage of GDP into the common budget. 

Even with a responsible economic policy aimed at striking a balance, for most new members, observing the requirements of the stability pact raises serious issues. The problems of the three big countries and the three small Baltic states imply that even though two or three of the four basic criteria can be met, there will be a deviation from the fourth article. This would suggest that – with unchanged conditions, if the set of criteria of the pact are not reworked – the ideal date of accession would be the time when convergence of these countries in real terms (for example, productivity, income) are close to the Union average. Calculations vary as to how much time this might take, and the speed of the process also depends on whether an economic policy can be developed to accomplish the fastest possible economic growth, in order to implement convergence quickly. Enforced observance of today’s requirements would require a sacrifice in growth, since the pact is even more stringent for new Union members than for countries of the developed euro zone. 

The euro is a symbol of a single internal market, and will promote trade relations. The common currency determines the direction of development. Thus, there is no way to avoid this process, and not only because the accession agreement does not permit it. On the other hand, members of the currency zone founded the euro after organic development of several decades. Approaching the Union average as a basic condition also provides a guideline for Hungary. It offers the chance of growing into the euro zone organically. This would be good for the economy, which would also fulfill the obligation of monetary integration that way. 

Of course, the political slogans suggesting that Hungary should get into the currency union as soon as possible have underlying economic arguments. But the history of the euro zone so far, a history of five years, questions the validity of the often cited benefits, such as faster growth and fiscal discipline. It also points out disadvantages in competitiveness and sacrifices in growth. These can derive from badly prepared accession owing to exchange rates fixed erroneously, loose budgetary policy, or failure to introduce reforms. 

It deserves further investigation whether it would really bring tangible disadvantages if Hungary or Poland were among the last countries to adopt the euro. If the euro is already widely used in corporate life and household loans, how will the common and the national currency coexist in the longer term? 

Now that almost six years have elapsed since the introduction of the euro, there is no way to consider the advantages and drawbacks in an itemized manner, since every item depends on a thousand other items and conditions. 

Concluding remarks 

On May 1 2004, the European Union did not let the ten new accession countries join the monetary union and did not elaborate for them a modified stability pact that would better match their specific conditions. Owing to a currency regime that struggles with serious internal contradictions and the slowdown of the process of adopting the European constitution, even in the euro zone there is now less enthusiasm about the enlargement. The larger new members are beginning to suffer from doubts, as the drawn-out implementation of the euro raises more and more difficulties. That is partly owing to the nature of convergence. 

Instead of the often cited convergence, we see divergence. Hungary has done well in the last ten years but produced a two-faced development. It may draw important lessons from its own accomplishments in the second half of the nineties, the smaller and more successful countries of the euro zone, and countries that chose to stay out. Fast growth, sustainable balance and future-oriented reforms are things which, as a result of organic development, will lead the country into the euro zone, and may make operation of the economy comfortable and secure from the aspect of international finances – even outside the monetary zone for a time. 

 

The article was published in The Analyst
, a new quarterly focussed on the key political, economic and social developments in Central Eastern Europe.