18 September 2003

EZA Report 556 - Euro-Enlargement

Volatile capital flows to threaten accession nations' approach to euro
Despite Sweden's rejection of the euro last weekend, countries due to accede to the European Union next year are far more enthusiastic about the merits of joining the single currency. EU enlargement in May04 means a potential 10 new entrants to the euro-bloc. Unlike for the original western European monetary union members, there is no opt-out clause. The transition to euro-membership for the next EU 'wave' is thus automatic if the Maastricht criteria are met. The requirement for full capital mobility and the vague exchange rate stability criteria - membership of ERM2 - suggests continuing potential for high volatility in accession country exchange rates and interest rates for some time to come yet. It is highly likely that accession countries polarise into two groups – those with currency boards and well-developed financial systems, which push to join the euro as soon as possible, and those with weaker financial systems and greater fiscal challenges, which accept that they will be in a position to join only later. Some are likely to join the euro in 2006/7, but Poland may well fall casualty to very volatile capital flows likely to occur in the next few years.

SummaryAsset Conclusions: Accession country currencies, interest rates to show diverse developments after entry in May04 due Balassa Samuelson effect

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© Graham Bishop