Euro in Poland no sooner than in 2019

„The process would have to be launched after the 2015 elections, so that the new government could take an appropriate decision”,  President Bronisław Komorowski declared in a number of his public addresses.

The President stressed that the process of meeting the convergence criteria should be separated from the very decision on the accession to the euro area. Therefore, let us first meet the EU membership criteria, and then let the new government decide whether or not we should apply for the adoption of the single currency.

This is not going to happen immediately. At least three years will pass from the decision to the appearance of new banknotes in our wallets. Therefore, we speak about autumn 2018 at the earliest which will also be conditioned upon the new government’s decision about accession to the euro area, and secondly the government will begin relevant consultations during the first days of office. Each delay would push us toward 1 January 2019, 1 May 2019, which is the 15th anniversary of Poland’s accession to the UE, or even to 1 January 2020.

The accession timetable is a consequence of numerous formal requirements that must be met by a country that wishes to adopt the single currency. Informal consultations concerning entering the “waiting room” before euro area membership, i.e. ERM II, will only be stage 1 of the process. ERM II is the European Exchange Rate Mechanism, which is commonly called the “currency snake”. It involves pegging of exchange rates of the still independent currencies within the standard fluctuation band for two years. The preceding negotiations last ca. 6 months and are initially mostly political. It is about choosing the right moment for the formal commencement of procedures and launching the process of pondering on the proposed exchange rate – in this case PLN to EUR.

Then comes a day when the Minister of Finance and the President of the National Bank of Poland sign the joint, confidential motion to the Chairman of the Ecofin Council for the ERM II entry. Ecofin is the Economic and Financial Affairs Council composed of ministers of finance and ministers of economy of EU Member States. ERM II is a multilateral system combining exchange rates of EU Member States with the euro.

Over the future presence of the zloty in ERM II, the currency could not weaken or strengthen by more than 15 per cent to the central parity agreed by the Minister of Finance and the NBP on the one hand and the ERM II Committee composed of the representatives of ministers of finance and central banks of Member States, the European Commission and the ECB on the other. In practice, this means that if the parity were set e.g. at PLN 4 against the euro, for two years our currency could not drop below the rate of PLN 3.40  against the euro on the one hand and exceed PLN 4.60 against the euro on the other.

The problem is that each setting of defence levels is also an encouragement for profiteers who – having adequate capital – could test the determination of the Polish central bank to defend the rate close to its minimum or maximum. It concerns the Polish bank because over the stay of the national currency in the “currency snake” the burden of its defence falls on the country seeking entry to the euro area.

„Considering the present volatility of the zloty, keeping its exchange rate within 15 per cent fluctuation band for two years would be extremely difficult. The zloty is now one of the key currencies of the emerging markets, and its market is quite liquid. All this makes our currency react very fast”, says Bartosz Sawicki, TMS Brokers analyst.

„Clear preparations for euro adoption, comprising fast compliance with the convergence criteria, would certainly not go unnoticed by the financial markets at an early point in time. The rate would then shift toward 3.80 against the euro, and its volatility could fall even before the ERM II entry”, says Marek Rogalski, chief FX analyst at DM BOŚ S.A. brokerage house.

What is important is that the set parity will not be the conversion rate at which zloty will ultimately be converted into euro. However practice has shown that the conversion rate is set at the last central rate in ERM II. Therefore it is so important that it corresponds to the equilibrium exchange rate. Too high a rate (weak zloty) may spark higher inflationary pressure, while too low a rate (strong zloty) may cause a loss of competitiveness of the economy and economic slowdown.

The exchange rate is nonetheless only one convergence criterion out of four. Using a dictionary definition, convergence is a process of moving towards uniformity. Therefore, the Polish economy must meet the criteria that will bring it closer to other economies of the euro area. Those criteria verify whether a country is able to function without disruptions despite limited freedom of monetary and budget policy. Besides the exchange rate, inflation, long-term interest rates and fiscal situation are other elements to be examined.

Every month, the indices are observed by the Ministry of Finance in the „Monitor konwergencji nominalnej” publication. The latest report from December 2012 concerns October data. At that time Poland did not meet any of the convergence criteria.

Firstly, we did not meet the price stability criterion. Average 12-month HICP increase was 4.0 per cent, which was 1.1pp above the reference value calculated on a basis of data from three states featuring most stable prices: Sweden, Ireland and Greece (2.9 per cent).

Secondly, we did not meet the interest rate criterion. The average long-term interest rate for the past 12 months was 5.3 per cent and was 1.7pp higher than the reference value (3.6 per cent). It was calculated on a basis of data from one state only, i.e. Sweden, since Greece and Ireland were excluded from this comparison category for being covered with EU and IMF aid programme.

Thirdly, the fiscal criterion was not met. The deficit of the general government sector in 2011 was -5.0 per cent of GDP GDP, and debt was 56.4 per cent of GDP, according to the EU methodology.

Fourthly, we did not meet the exchange rate criteria. We do not participate in ERM II, and the exchange rate of our currency was showing excessive volatility.

This is however only a freeze-frame of October 2012. Inflation and interest rates have been in the downward trend, the exchange rate of zloty stabilised, and in the still valid Convergence Programme 2012 the excessive deficit procedure was said to be lifted from Poland (although there is no certainty whether the obligation will re-appear the next Convergence Programme).

Therefore we should consider whether we are able to meet these criteria by 2015 but also over the key two years from 2016 (the year in the scenario we can expect Poland to be included in ERM II, at the earliest) to 2018. One would have to be a prophet to predict whether by that time the euro area will still exist in its present shape, what its economic growth rate will be and, what follows, what the inflation rate, the budget deficit and euro rate to zloty will be in Poland.

Let us assume, however, that all the criteria are met also in 2016 through 2018, since we have prepared reasonably early for it. This is how we should interpret the address of President Komorowski stating that we should meet the convergence criteria first and only then apply for the euro area membership. What next?

Legal harmonization must be addressed. The current Constitution of Poland of 1997 has Article 227, which says that “The central bank of the State shall be the National Bank of Poland. It shall have the exclusive right to issue currency as well as to formulate and implement monetary policy”, and the Monetary Policy Council is also described. If the euro is adopted, the NBP would lose its exclusive right, and the Monetary Policy Council would become redundant.

Assuming that in the new Sejm in 2015 there will be a qualified majority of two-thirds of votes cast to amend the Constitution, an absolute majority in the new Senate, and the new President (or again Bronisław Komorowski) will sign the amendment fast, the procedure of amending the Constitution will take but two months.

In the meantime, at the European level, a decision should be taken on ending a derogation. The word “derogation” comes from the Latin word derogatio, meaning “repeal partly”. Currently, Poland has a status of a Member State of the Economic and Monetary Union with a derogation, that is with the “partial repeal”. Hence we are obliged to meet the convergence criteria and adopt the euro, although the date of the euro adoption has not been specified.

From the practical point of view, this represents not much difference to the status enjoyed by the UK or Denmark, which negotiated the opt-out clause empowering them to make an independent decision on which currency they will have in the future. Poland may also specify that we would adopt the euro in e.g. 2140 and until then we would be subject to the derogation, which means a waiver of the obligations stemming from the membership in the monetary union. This would be lawful, although it could carry hard-to-predict consequences.

In the context of the euro, everyone thinks about a much shorter perspective. Six months usually pass between the decision to end a derogation and the euro area entry. The derogation procedure as such involves several stages. The EC prepares a motion to the Ecofin Council, and next consultations follow with the European Parliament and a discussion within the European Council. Then comes the time for a recommendation by the Eurogroup (Ecofin Council members representing Member States with euro currency), and finally a decision of the Ecofin Council is made with a qualified majority of votes.

In a country adopting the euro this is the time needed for technical preparations – replacement of computer systems, printing new banknotes, and carrying out an information campaign. We have already mentioned that taking into account the official announcements by politicians and the formal calendar for Poland’s EU accession, a “day zero” would most probably be 1 January 2019.

A lot can change over six years. The year 2015, as the starting point of Poland’s road to the euro, is not the first date announced by Polish politicians. What is new, however,  is an assumption that the reforms which will enable meeting the convergence criteria will certainly not harm Poland, and only time will tell whether these will serve the adoption of the single currency as well. Still – as Professor Leszek Balcerowicz emphasises– the deeper the reforms, the better. For it is not just about entering the euro area, but  also about which group of countries we would be closest to – the well-doing core or the peripherals plunged in crisis.