Saturday, January 13, 2007

The Maastricht Update (13/01/2007)

The Maastricht Update:

Sources: Eurostat, ECB, EBRD Transition Report 2006 , Inflation 2006m11, Interest 2006m12, Exchange rate up to 12/01/2007. Check post for details.
Note: * - currently not fulfilling MC; (a) Exchange rate criterion value calculated as maximum deviation (+ or -) of the daily exchange rate from reference value in the last two years. The reference value is in case of ERM II countries the central rate, while in the remaining countries it is a two year average of the daily exchange rate from today-2 year to today. (d) value for 2005 – this value is not available monthly; (d) Brackets contain forecasts for 2006 from the EBRD Transition Report 2006. Methodological discrepancies between national authorities and Eurostat in case of Hungary and Poland. In case of Poland this is due to different treatment of pension fund transfers associated with pension reform cost, the Polish deficit calculated according to ESA 95 methodology would be breaching the Maastricht criterion cut-off value; (e) ECB on Estonia: The current indicator represents the interest rates on new EEK-denominated loans to non-financial corporations and households with maturities over five years. However, a large part of the underlying claims is linked to variable interest rates and the claims are subject to a different credit risk than government bonds. Finally, the cut-off value is reported as average( min-max) as three countries have identical (low) inflation rates, but different interest rates which serve to calculate the criterion – the Maastricht Treaty is not clear on how to handle this situation, though it does not affect the conclusion, (x) the secondary market 10-year government bond yield for Romania is unavailable, but upon lending rates, shorter term bond yields and inter-bank interest rates, it is clear the interest rate in Romania is higher then the required by the Maastricht Treaty.

The new edition of the Maastricht Update incorporates two major events within the EU – first of all the enlargement on the 1st of January which saw Bulgaria and Romania join the EU, and the requirement to join the EMU “as soon as ready” is extended to the two states. The second important issue is the fact that Slovenia adopted the euro on the same date, by joining the EMU. Both of these deserve a blog entry, and I will try to insert something asap, as soon as I find some free time.

As for the Maastricht Update itself, it is important to notice a number of issues:
- first the only two countries that at the moment fulfill the inflation criterion are the Czech Republic and Poland – both of which do not express the will to join the euro in the near future. It is left to be observed whether Poland’s track record on low inflation will be upheld under the new governor of the central bank (this also deserves an entry, I suppose). All other countries are well in excess of the cut-off value (calculated upon November 2006 annual inflation values for (1)Malta, (2)Czech Republic and (3) equally Poland, Cyprus and Finland) regardless of the monetary regime adopted. As for the interest rate criterion, only Hungary and Romania exceed the cut-off value, regardless of which way it is calculated (see notes (e) and (x) below Table 1). All countries saw their exchange rates fluctuate within the +/-15% bounds, but noticeably Hungary and Slovakia faced rather high changes (the former a large depreciation mid 2006 and the latter a large appreciation relative to its ERM II central rate). As for government finances, we report official figures for 2005 and EBRD forecasts for 2006, but have enough information to speculate about developments in 2006 and possible developments in 2007. Clearly the largest problems with the deficit cap are faced by Hungary, where 2006 deficit as percent of GDP is perhaps in the two digit area, and will remain high, despite some efforts to bring it down, in the coming years. Poland faces the change of methodology in 2007 which will see its deficit rise possibly above 4% of GDP– despite being merely a change in accounting methodology, the change puts the deficit in excess of the Maastricht criterion. The Czech Republic heads for another year of failing to fulfill the criterion, while Romania and Slovakia draw close to the boundary. Government debt seems well within the 60% GDP bounds for all the countries aside Hungary, which in effect of large deficits may face exceeding it in the nearest future.
Overall the country being the worst performer in terms of the Maastricht criteria is, by far, Hungary. Noticeably most of the problems arise from the blown-up public finances – immediate effects are seen in huge deficits and rising debt, while the public spending creates inflationary pressures, and pressures on the exchange rate (admittedly partly to the increased perceived risk of the country) and consequently the interest rate.