Is the Eurozone a Reach Too Far?

Despite these stabilization efforts, the destabilizing effects of deregulation of international financial capital movements within SEA and national policies divergent monetary and fiscal policies of EMS members (e.g. the United Kingdom and reunified Germany) combined with uncertainties surrounding the ratification of the Maastricht Treaty (following its rejection by referendum in Denmark and difficulties in ratifying it in France), which led to increased market speculation, culminating in a currency crisis in 1992-93, forcing some member states (UK and Italy) to leave the ERM and others (Spain). and Portugal) to his devalue the currency. On January 1, 2002, the euro became legal tender in participating countries, and by the end of February 2002 national banknotes and coins ceased to be legal tender. Since then, the eurozone has gone through six rounds of enlargement – ​​Slovenia in 2007, Cyprus and Malta in 2008, Slovakia in 2009, Estonia in 2011, Latvia in 2014, Lithuania in 2015 and Croatia in 2023 – bringing the number of member countries to 20.

There are currently seven EU27 member states whose currency is not the euro. Of these seven member states, Denmark and the United Kingdom have (in the case of the United Kingdom, as a result of Brexit, from January 2020) a special status (based on “opt-out clauses”), while the other five are potential candidates for the adoption of the euro (i.e., “Member States with a derogation”) and have committed to join the euro area as soon as they meet the entry conditions (Bulgaria, Czech Republic, Poland, Romania, Hungary). Today, the Eurozone covers a population of 349 million (as opposed to 335 million in the US or 1410 million in China in 2023); their cumulative GDP is $15.6 trillion (compared to $26.9 trillion in the US and $17.7 trillion in China in 2023). The criteria for joining the Eurozone are specified by the European treaties (mainly the Maastricht treaty, called, with its successive and updated versions, the TFEU hereafter) and include:

Price stability is defined by the TFEU4 as a deviation of less than 1.5 percentage points from the three best-performing countries from this point of view. The interpretation of the top 3 countries is controversial because countries with deflation (negative inflation) are excluded, and in some cases, it is supported to “clean” the indicator of countries that have fiscal policy measures with significant effects on prices and inflation. At the same time, other elements may lead, following negotiations with the European Central Bank, to the modification of the criterion (the asymmetric impact of international economic shocks (COVID, energy crises, wars, etc.). divergent, idiosyncratic developments of some countries may lead to them not being taken into account within the “top 3 countries” (for example, in the ECB’s 2022 Convergence Report, Malta and Portugal were excluded, their related inflation rates being considered statistically invalid and determined by “exceptional” factors).

It should also be mentioned that inflation is measured by an average rate over the last year (before accession), related to the variation in prices calculated by Eurostat (this being the harmonised index of consumer prices), and its peculiarity is that, being an annual average, it changes slowly as economic developments persist in a certain direction. So the deviations from these criteria cannot be reversed quickly through economic policies with a quick effect. Fiscal developments that indicate sustainable convergence meet two criteria (deficit and debt). In practice, the deficit must be less than 3% of GDP and the debt less than 60% of GDP, both calculated in the European statistical methodology (called ESA20106). Although the system is relatively different from the values calculated on the basis of national methodologies (usually cash) due to the different statistical principles used, the differences are not very large and, over time, they compensate.

There are also clauses exempting from deviations from the deficit criterion: (i) the ratio of the budget deficit in GDP is on a continuous downward trajectory and approaching the reference value; (ii) the deviation from the reference value (3%) is only temporary and exceptional in nature, the rate being almost the same (the “corrected” n.n.) of the reference value. At the same time, there are other factors that must be taken into account according to the legislation, which require more sophisticated criteria (the size of the deficit in relation to the public investments made, compliance with the MTO, i.e., the medium-term structural deficit target established for the respective country by calculation, the introduction of debt criteria in national legislation, etc.). It should be noted that Croatia’s accession was achieved when the fiscal criteria were suspended as a result of successive crises (COVID, Russia’s war of aggression in Ukraine) and, under these conditions, they were not taken into account.

The exchange rate respects the maximum fluctuation band established in the framework of Exchange Rate Mechanism II (ERM II) in the last two years (plus/minus variations of 15% against the euro). The criterion also mentions the absence of “severe tensions” defined by (i) examining the degree of exchange rate deviation from ERM II central rates against the euro; (ii) the use of indicators such as exchange rate volatility against the euro and its trend, as well as short-term interest rate differentials against the euro area and their evolution; (iii) taking into account the role played by foreign exchange interventions; and (iv) consideration of the role of international financial assistance programmes in currency stabilization.

The long-term interest rate is not higher by more than 2 percentage points compared to the 3 best-performing countries regarding the criterion of inflation. The relevant interest rate is the average over a 1-year period before the moment of accession, calculated by the European Central Bank. Other relevant factors (defined within the TFEU at Article 140(1)) are: “The reports of the Commission and the European Central Bank also take into account (i) the results of market integration, the situation and evolution of (ii) current account balances, and an examination of the evolution of unit labour costs and other price indices.” In practice, this means compliance with the criteria included in the Macroeconomic Imbalance Procedure (MIP), which includes 14 macroeconomic indicators.

To these is added compliance with European legislation regarding the legal framework of the central bank (the Statute of the BNR in the Case of Romania and its adaptation to European legislation). So in fact, there are 5 economic criteria (of nominal economic convergence), doubled by the other 14 relevant indicators (which in principle aim at economic convergence), as well as legal conditions: the legislation and status of the central bank must be perfectly aligned with those of the Central Bank of the of the European Union and the European System of Central Banks. The level of development achieved by the respective country in terms of real convergence (arrived at purchasing power parity per capita) is also relevant.

Bulgaria’s situation and comparisons with Romania

The situation of the five nominal convergence criteria was presented for Romania and Bulgaria in March 2024, as follows: Bulgaria fulfils all the nominal criteria except the inflation rate, but the sustainable achievement of low inflation is difficult because the indicator is an average over a year that changes slowly, needing very low current inflations to compensate for higher ones. It would be possible, however, to make the criteria more flexible, and this “flexibility” could make Bulgaria qualify for joining the euro in the short term.

Romania does not comply with three criteria, with the inflation rate being in first place in the EU27, and, again, adjusting the indicator requires great efforts in the medium term. The deficit budget and long-term interest also assume, given the current gap, an adjustment effort of at least several years. Regarding the 14 criteria related to the MIP (Procedure of Economic Imbalances), it can be observed that Bulgaria, with the exception of the indicator regarding the unit labour cost, meets all the criteria (from the MIP—the 14). Romania, in contrast, does not meet three criteria, two of which are: the current account balance (average of 3 years) being difficult to adjust without adjusting the fiscal deficit, and the net investment position (% of GDP) being also an indicator that is very difficult to change, of the same nature as the public debt, only through persistent efforts over many years. In terms of GDP per capita estimated at comparable prices (or adjusting for different prices in each country)—a way of measuring real convergence—Bulgaria is at 62% of the European average in 2022 (the latest year with available data), and Romania is at 76%. Both values show a significant level of real convergence, compatible with joining the euro zone.

In terms of inequities between regions and between citizens in terms of GDP distribution, Romania is, together with Bulgaria (both with regressive tax regimes, which tax the poor percentageally more = single quotas), among the countries with Gini coefficients (of inequality) larger and with development gaps between the largest development regions. Thus, a recent article stated that 80% of Romania’s GDP is generated in 8 cities, and the standard of living in Bucharest is two times higher, adjusted for prices, compared to the EU average.

By Dr. Adrian Nastase