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1998 In Review: EMU's Impact On The East

Prague, 14 December 1998 (RFE/RL) -- European monetary union is about to become a reality, with 11 member states of the European Union adopting a single currency, for accounting purposes, from Jan. 1.

This momentous move brings to life the new "euro", which is expected to take a place as a major world currency beside the U.S. dollar and Japanese yen.

The new currency will be intangible at first, because no notes and coins will be issued until January 2002. During the transition period the old national currencies will continue to circulate, but will be considered sub-units of the euro.

The new currency, however, will be free to find its own value against other currencies on the world's money markets. As such, the new currency will have considerable importance for the development of the transition countries of Central and Eastern Europe.

Most East European currencies are linked in some way to the Deutschmark, the most powerful and stable of the outgoing national currencies. For instance the Bulgarian lev is pegged to the D-mark at the rate of 1,000:1; the Estonian kroon at the rate of 8:1. The Czech and Slovak crowns and the Croatian kuna operate in a managed float which roughly shadows the D-mark, and Poland's zloty is managed against a basket of currencies in which the D-mark makes up 20 percent.

The introduction of the euro means those Eastern countries will have to re-think their exchange rate policies. Most of them are expected to simply replace the D-mark with the Euro. The new currency, through its own strength or weakness, will therefore have an influence on the inflation, trade and growth prospects of those transition economies.

The immediate impact of the new euro on the East will probably not be great, provided the launch of the currency goes well and there is not excessive volatility on currency markets. On that point, the stability of the currencies submerging into the euro suggests that the markets will accept the euro as strong and stable, at least during the initial phase.

German-based economist Adolf Rosenstock, chief analyst for Europe at the Nomura Bank, says there are several likely lateral impacts in the longer term. One is that, if the euro succeeds as expected and manages to generate new economic momentum in the "eurozone", as it is called, membership of the EU will become even more attractive to the Eastern countries. Most of these countries are in any case active aspirants to join the EU.

Rosenstock says that paradoxically, the process of eastwards enlargement will become more complicated, because the eurozone will be rapidly integrating, developing its own economic unity and balances. Therefore, as he sees it, it will become a more difficult area for outsiders to break into.

More generally, he sees geographical factors also playing a role: "I think those entities neighboring the EU, especially those which have a common border, stretching from Italy though Germany to Finland, these areas, and regions and countries will be drawn towards the euro area very soon because of their close trade relationships. So I would guess before long that the euro will become a type of second currency, even a circulating second currency, in those countries." Bordering or close to the EU are the Czech Republic, Poland, Hungary, Slovenia and Slovakia -- all of which already have more than 50 per cent of their trade with the EU. And all except Slovakia are already engaged in formal negotiations to join the EU.

A report issued earlier this month by Nomura Bank notes that by contrast, those transition states on the edge of the region, like Bulgaria and the Baltics, are less dependent on the eurozone 11.

The Baltics, for instance, have heavy trade concentrations with Sweden, Denmark and Norway -- the first two of which are EU members, but they are not joining the eurozone. And Bulgaria, for example, has strong trade ties with Greece, Turkey and Russia.

Despite these differing regional aspects, another German-based economist, Jens Dallmayer of Deutsche Bank Research, sees overall benefits for the East in the new efficiency of the capital markets:

"With the euro a very, very broad and deep financial market will develop, even deeper than the current more segmented market in Europe. This will offer better financing and investment possibilities not only for the financial institutions, companies and private households within the euro area, but also outside. The East European countries have a very strong focus and link with West Europe, and can also benefit from this development".

Dallmayer also says he expects most East European countries to develop monetary policies which promote domestic price stability while seeking to preserve stable exchange rates with the euro.

After the Eastern candidates join the EU, sometime early next century, they will probably consider joining the European Exchange Rate Mechanism (ERM), as a step towards full monetary union. The ERM is a harmonizing mechanism in which, from January 1, participating currencies will be assigned a central rate against the euro, with a fluctuation band around the central rate.

Only two countries will be participating in ERM, namely Denmark, which does not want to join the eurozone now and Greece, which cannot meet the terms for joining. Britain and Sweden, the other non-eurozone EU members, are letting their currencies float without a formal link to the euro.

Certainly, monetary union for the new members will not be accomplished overnight, but could be a fairly long drawn out process. Dallmayer notes that it has taken 20 years of effort by the EU states to bring the euro to reality.

(First of a series of three articles on the European Monetary Union.)