Author: Paweł Kowalewski

Economist, works at NBP, specialises in monetary policy issues and FX markets

Brexit might have been an impulse to expand the Eurozone

A year after Brexit decisions made by central banks in countries which were considering entering the Eurozone show that there is no intention to do so.
Brexit might have been an impulse to expand the Eurozone

Czech National Bank headquarters, Prague, Czech Republic (Paolo Rosa, CC BY-NC-ND)

Extending the Eurozone ended with Lithuania. All three countries that entered the Eurozone after the crisis (Slovakia entered in early 2009, but the decision to admit this country had already been made before the outbreak of the crisis) are small and open economies. Fulfilling the Eurozone criteria, due to exchange rate mechanisms that had been used in those countries long before the EU accession, was easy from a technical point of view.

Since the last enlargement of the Eurozone, only two countries are expressing (or at least once expressed) their interest in joining the Eurozone: Romania was interested until the end of 2015, although later the eagerness of authorities in Bucharest clearly evaporated, and so too did Bulgaria.

According to FT journalist Martin Sandbu, Bulgaria would fit the Eurozone better than Greece does. But will such an argument convince the Eurozone decision makers? Especially since Bulgaria is facing other problems, and although these are not the sectors indicated in the Maastricht criteria, they are certainly a serious barrier to Bulgarian entry into the Eurozone. One of the most important is corruption – it is hard to invite to a club a country that ranks 75th in the Transparency International ranking.

The ECB also has reservations about Bulgaria’s ability to meet the convergence criteria permanently (alongside legislative issues that have to be solved, including the introduction of regulations that guarantee the independence of the central bank and the ban on financing the budget deficit).

Other EU countries currently do not even want to start discussing whether to join the Eurozone. It can even be said that in terms of future membership in the Eurozone they represent a very British position, which involves keeping away from it as far as possible. Deputy Prime Minister of Poland, Mateusz Morawiecki, has recently declared that Poland could consider adopting the euro in 10-20 years.

Deflation has been avoided in the Czech Republic, but probably only because the central bank has made far-reaching interventions in the process of shaping the value of the CZK. Because of the massive interventions, it weakened the value of its currency first and then made every effort to keep its value not higher than EUR/CZK27 threshold.

On April 6th, the Czech National Bank (CNB) waived its commitment to hold the EUR/CZK exchange rate near 27. The decision to abandon the exchange rate policy that had been pursued since November 2013 is yet another proof of how central banks, outside the Eurozone, value the possibility of conducting autonomous exchange rate policy. It is not surprising that there are fewer and fewer volunteers to enter the Eurozone on their own free will.

Even the rapidly growing sense of political uncertainty, which has translated into volatility in the currency markets, is not able to change the attitude of the above-mentioned central banks.

The CNB’s departure from the previously conducted policy should be viewed through the prism of the bank’s desire to regain full independence in the conduct of monetary policy. In today’s world of capital flows, such independence is a fantasy. The recent moves of the Czech Republic show how difficult it is to refer to a fixed exchange rate policy.

Where is the integration going?

Facing the new political situation in Europe and in the world one question has to be asked. Should the Eurozone decision-making centres decide to loosen the entry criteria to the Eurozone, not only for the sake of its enlargement, but also for the sake of speeding up the integration of the EU members.

Since the ECB is actively buying government bonds – which seemed unthinkable 10 years ago, before the crisis – it may also become impossible to circumvent the demanding  participation in ERM II.

Unfortunately, such a probability practically does not exist.

The example of Denmark is proof that the exchange rate of a given currency (in this case the DKK) can be subordinated to the requirements of participation in ERM II (and earlier in ERM). The Danish experience shows that successful ERM II participation depends not only on the central bank’s monetary policy, but also on the overall economic policy. Subordinating the latter to one goal has required and still requires a lot of sacrifices from the Danes. It is all about being ready to introduce not always popular reforms that guarantee the competitiveness of the economy.

Over the past 30 years the Danes have been fortunate. If not for the 1993 decision to widen fluctuations within the old ERM from +/- 2.25 per cent to +/- 15 per cent, the DKK rate would probably have devalued in the mid 1990’s. And with respect to the countries remaining outside ERM II today, Eurozone policymakers will require that the depreciation deviations do not exceed 2.25 per cent (the so-called Solbes criterion and related concepts of serious tensions). Many countries simply cannot meet the criteria necessary to enter the Eurozone.

Brexit will not be a catalyst here

These countries have pledged to fully participate in the third stage of economic and monetary union. Only Denmark, which is in ERM II (therefore, de facto closest to euro area membership) has negotiated an Opt out clause that allows it to stay indefinitely outside the euro area.

When the United Kingdom decided to leave the European Union, some experts – though admittedly few of them – saw Brexit’s positive effect as a way to deepen EU integration, including currency integration. A year later, after a few central banks’ decisions in the countries which were considering this possibility, we can observe, however, that there is neither will nor intention to do so.

So far, neither Brexit nor any other geopolitical or geo-economic phenomena have been able to generate even the slightest impulse towards greater monetary integration, without which it is hard to imagine the expected deepening of integration across the EU.

One year after the referendum on Brexit, the room for ​​manoeuvre to exert pressure seems even smaller. For how, in a democratic world, is it possible to force a country to meet its obligations which are in conflict with the will of the majority of its citizens? It is also impossible to exclude the gloomy scenario that Brexit will find followers, and the likely insistence of European institutions to exemplarily punish Britons (and the English in particular) can only encourage countries – especially the Nordic ones – to further secessions.

If Eurozone policymakers really cared about meeting this commitment by the EU countries remaining outside the Eurozone, surely there would be effective ways of enforcing the commitments. Since no such measures were employed, we can assume that they simply did not care about accepting new countries.

Paweł Kowalewski is an economist at the Department of Economic Analysis of Poland’s central bank, NBP.

Czech National Bank headquarters, Prague, Czech Republic (Paolo Rosa, CC BY-NC-ND)

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