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dr Erik Terk

For Whom do the Euro Bells Toll?

Estonians have well memorized the exchange rate of their kroons with the German mark (1:8), to which the kroons have now been pegged for 7 years. However as of January the exchange rate lists were complemented by one more figure, the new euro. This rate of exchange is a bit more difficult to remember for Estonians: 1 euro = 15.6466 Estonian kroons.

Impacts: direct and indirect

However, is this figure meaningful to Estonian companies and to the man in the street from a practical point of view? As it is, Estonia is not member of the European Economic and Monetary Union (EMU), neither is accession of Estonia to EMU a matter of the nearest future. However, the developments in the neighbouring region, in this closely knit world of ours, of necessity affect other countries. Estonia will naturally be affected by the currencies of the EMU countries. For Estonian companies the largest change is that the exchange rate of the Estonian kroon against its basic trade partner Finland's currency is now fixed rigidly: 2.63 Estonian Kroons against 1 Finnish Mark, and that's it. Undoubtedly that will simplify the business transactions between the two countries, and decrease the entrepreneurial risks. Holland, too is a relatively important partner for Estonia, and here too the added exchange rate security is a significant achievement. True, Sweden and Denmark, among larger economic partners of Estonia, have not yet joined the EMU. Dealers will reap profits in Estonia, like in other countries, from the narrowing of the gap between the selling and buying prices of currencies of EMU members. Enterprises involved in currency trading will be on the losing end, and they prognosticate a decrease of profits.
Euro will heighten the attractiveness of the area having been embraced by it, the "Eurozone", which will enjoy the loan interests that have been directed downward, an attractive market that is lucrative for investments, economic growth and other wonderful things. However, is it good or bad for countries remaining outside the Eurozone, including the countries acceding to the EU? The answers of different analysts to this question are conflicting. On the one hand, one can expect that the economic success in the Eurozone will translate, to some extent, also to the Central and East European (CEE) countries, being in economic relations with the EU. Under the IMF calculations, expected is the 1% growth of economy in the Eurozone, in the CEE area, amounting to 0.7-1.7% export growth and 0.2-0.5% GDP growth. On the other hand, however one fears lest the decrease of the transaction costs due to EMU cause relocation of FDI from the non-euro countries to euro countries. The competitiveness of Eurozone banks in the countries of the CEE markets will increase; this may have both positive and negative impacts on the economies of the CEE countries.
There are forecasts that the eradication of many currencies in the European Union might trigger interest in the socially peripheral currencies of Europe, i.e. potentially also towards the Estonian kroon. But it is by no means clear, when and if that interest might arise, and if the speculative interests should not take the upper hand. It is not conclusively clear what the impact on Estonia of the change of "power balance" of euro and dollar will be like. There are several problems involved here. First, the question how well, or badly the potential strengthening of euro will influence the Estonian economy against the dollar (up to now, euro has been rather weakening against dollar). Secondly, it is forecast that the exchange rate of euro against the dollar can become more volatile than heretofore, making the life in Estonia more complicated. Thirdly, the economies of such neighbouring countries of Estonia as Russia, Latvia and Lithuania have been more dollarised than Estonia, which is pursuing economic relations with predominantly Nordic countries, likely to create certain problems to Estonia, in relations with those countries.
The introduction of euro will influence the EU economic policy in the widest sense. E.g. in connection with the common currency there is an increasing international interest towards the ways the countries manage to balance their budgets. This interest will evidently expand from the Eurozone, and also embrace Estonia, as the country wishing to accede to the EU.
Managing with the euro has created strong pressures for the unification of the economic policy lines of the members states of the EMU, also outside the direct monetary policy. Take for instance the strong demand of Germans to start the unification of the tax policies of the EU countries. That might not be to the liking of Estonia, where there has been much talk about non-traditional tax policy solutions.
A separate topic is forecasting what the creation of the group of countries having joined with the EMU can bring about in the general network of international organizations and the distribution of functions between them. Estonia is interested, primarily, in what this will bring about for EU. Vice-chancellor of the Estonian Ministry of Foreign Affairs, Mart Laanemäe, is of the opinion that the formation of the so-called Euroclub, within the EU, may be a sign of a multi speed Europe. Inherent to these groupings are a deepening of internal links, strengthening of self-identification, and differentiation. If this is the case, would it be detrimental or useful to Estonia? Laanemäe does not think there is a danger lurking there. Euro-11 would allegedly be (unlike some other groupings) such where the door is ajar to everybody who wishes to accede, and who can meet the criteria. This means that Estonia, too can comply with the requirements.
Estonia's transfer to euro
The European Union does not require that the applicant countries should fix the exchange rate of their currency against euro as quickly as possible. In case of Estonia, the rigid pegging of its exchange rate to euro was no specific monetary policy decision, it came about automatically. Due to Estonian Kroon rigidly pegged to DEM, and Germany joining the EMU, the Bank of Estonia was left the job of organizing just some tertiary technicalities, so the exchange rate of Kroon and euro did not become a special object for discussion. However, the creation of euro triggered discussions regarding when Estonia would "actually" join the EMU and transfer to euro.
The President of the Bank of Estonia, Vahur Kraft, emphasizes that there is no getting away for Estonia from the euro. The option to say "no" to the EMU and "yes" to the EU was negotiated by Great Britain and Denmark. However it is hardly possible for new member states to be provided with such an option-you can't eat the cake and have it too! opines the President of the Bank of Estonia. But it is to be noted that the accession of Estonia into the EU does not give it automatically the right to promptly appeal for a place in the EMU.
Generally one has to admit that because Estonia tied up its hands with the 1992 monetary reform (i.e. waiving the option to use the change of exchange rate as an instrument of monetary policy, there is no great nostalgia regarding Estonia's own Kroon and the desire to retain Estonia's denomination at any cost).
Several Estonian banking figures and politicians have been ventilating the idea that Estonia should try to join the euro, prior to accession to the EU. Indrek Neivelt, Chairman of the Council of Hansapank, is the advocate of a rapid joining, offering three arguments, to corroborate his opinion: the elimination of the need to convert the currency; the decline of interest rates; and the suppression of the exchange rate risk. There are some Estonian analysts, however calling on Neivelt to "take it easy". The securities analyst Urmas Simson has doubted the validity of an argument by Neivelt concerning the interest rates. Namely, Simson suggested that the higher loan interest of Estonian banks, as compared to West-European banks, had not been caused by the fact that in circulation in Estonia was Kroon-it was conditional on how the risks were estimated by foreign investors placing money in Estonia, as well as by Estonian banks themselves. E.g., the interest rates of bonds of different governments of the EMU area, quoted in euros, were allegedly quite different; the estimates of investors of the risk level were allegedly just as different, in case of different countries. And the last: does Estonia really have to give up a significant part of its economic independence, perhaps in the future one would be faced with the need to change the exchange rate of Estonia's currency against the currency of West-Europe. What would one have to do in the latter case? Hypothetically it is conceivable that even EMU could face a crisis. Therefore Estonia linked to euro would be a better solution than a rapid transfer to euro.
An analyst of the business daily "Äripäev" Mati Feldmann recalls that even today the Estonian Kroon is not fully "the eighth part of the German Mark". Namely, when Estonia pegged its Kroon unilaterally to German Mark, certain obligations to maintain the stability of the currency were created only to the Bank of Estonia, not to the German Federal Bank. Similarly, it is not possible to shift to the shoulders of the leader of the European Central Bank Will Duisenberg, by a voluntary action, the concerns and worries of the President of the Bank of Estonia Vahur Kraft. In order to actually, not just unilaterally, join the euro, Estonia must toil hard, to reduce its inflation rate (this task should not be overly difficult, given the drop in the inflation rate, witnessed recently) and to observe that consolidated budget deficit should not step over the specified threshold.
Feldmann is of the opinion that one has to get into the EU, in the first place, whereafter one would be contained, for at least two years, in the test laboratory of ERM, whereupon euro can also cast its slanting rays at Estonia. Feldmann's prognosis is quite conservative, it being impossible to exclude that this will be the course the developments will take. Still: the idea of a more rapid joining of Estonia to euro, although utopian, is worthy of consideration. This is how Mr. Christian Nouyer, Vice-President of European Central Bank, speaking at the recent scientific conference on the 80th anniversary of the Bank of Estonia, perceives it.



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