EU’s Least-Indebted State Is Model After Greek Crisis

President of the European Commission Jose Manuel Barroso
President of the European Commission Jose Manuel Barroso said yesterday Estonia “most likely” will join the euro area soon. Photographer: Jock Fistick/Bloomberg

Estonia, the least-indebted European Union member, may be the standard against which other euro candidates are measured as the monetary union moves ahead with enlargement after committing almost $1 trillion to defend its currency from Greek-induced hemorrhaging.

The Baltic state will outperform the 16 euro nations on the EU’s fiscal criteria this year, according to the European Commission, the bloc’s executive arm. That means Estonia will probably receive the backing of EU officials when they assess the country’s euro bid tomorrow, said Christian Keller, chief economist for emerging market currencies at Barclays Capital.

“Estonia seems pretty much a model of the fiscal discipline that the EU now wants to bring to the entire euro area,” Keller, who is based in London, said in an e-mailed response to questions.

Greece’s fiscal collapse and the ensuing contagion marked the biggest threat to the ideal of a united Europe with a single currency since the euro’s birth 11 years ago. In response, EU policy makers on May 10 agreed to an unprecedented loan package worth 750 billion euros ($960 billion) and a program of central bank bond purchases to buttress the currency.

The announcement, which sent the euro higher against both the dollar and the yen, relieved pressure from some groups “to simply declare a stop to all euro adoption for a period of several years,” Keller said.

‘Likely’ to Join

European Commission President Jose Barroso said yesterday Estonia “most likely” will join the euro area soon. It would be the second-smallest euro economy after Cyprus, with gross domestic product of about $23 billion.

While Estonia’s government doesn’t have any outstanding bonds, investors trade credit default swaps on the country’s debt. Five-year Estonian CDS averaged 98 basis points since the end of March, compared with 141 basis points on Italian five-year debt. That shows investors would be more at ease holding Estonian debt than bonds issued by a founding euro member.

Estonia, with debt estimated at 9.6 percent of GDP this year and a deficit equal to 2.4 percent of GDP, is an “exception,” and other candidate countries may face delayed membership as higher debt financing costs stretch deficits, Fitch Ratings said May 6.

Estonia’s austerity measures came at the cost of demand, and the economy contracted 14.1 percent last year. GDP shrank a seasonally adjusted 2.3 percent in the first three months of this year, the national statistics office said today.

Rising Poverty

The country now faces rising poverty particularly among retirees and must stave off hardship through government measures the Organization for Economic Cooperation and Development said in a statement today.

None of the existing euro members will meet the EU’s deficit ceiling of 3 percent of GDP this year, according to European Commission estimates. Among euro candidates, Poland’s deficit will widen to 7.3 percent of GDP and Hungary’s to 4.1 percent, the commission estimates. The Czech Republic’s will narrow to 5.7 percent from 5.9 percent.

Debt-to-GDP ratios, which will average 84.7 percent in the euro area this year, will swell to 78.9 percent in Hungary, 53.9 percent in Poland and 39.8 percent in the Czech Republic in 2010, the commission estimates. The 12 countries that entered the EU since 2004 are required to join the euro eventually. Slovenia and Slovakia have managed the currency switch.

Longer Delays

Fitch expects Estonia to join the euro in January, with Lithuania following in 2014. Bulgaria, Hungary, Latvia, Poland and Romania will switch in 2015, and the Czechs will convert in 2016, it said in the May 6 report.

“However, the risks are skewed towards longer delays,” Ed Parker, head of Emerging Europe at Fitch, said in the report.

Discussions raising the possibility of delayed euro area enlargement are “worrying,” Latvian Prime Minister Valdis Dombrovskis said in an interview with Bloomberg Television today, adding his government still targets 2014 accession.

It’s becoming “more difficult to achieve all the Maastricht criteria,” Lithuanian President Dalia Grybauskaite told Bloomberg Television.

That means investors who own bonds denominated in Polish zloty, Hungarian forint and Czech koruna may face longer waits before their holdings benefit from conversion to the euro.

“Latvian and Lithuanian Eurobond spreads would likely widen” if accession is delayed, said Andris Kotans, who helps oversee 370 million euros in east European assets at Parex Asset Management in Riga, Latvia. “Next in line should be Central Europe’s local currency markets, where euro adoption is one of the underlying assumptions.”

‘No Panacea’

Regardless of the deal to support the euro, the currency may be losing its appeal in some countries in line to join.

“Greece has demonstrated that euro zone membership is no panacea,” said Tim Haughton, a professor of east European politics at the University of Birmingham in the U.K.

About 4,000 Estonians have signed an online petition started last month to oppose swapping the kroon for the euro.

“Joining the euro zone would be a grave threat to the economic independence of Estonia and will pull us back to the times of the Soviet Union, while we have all preconditions to be an independent European country like Switzerland,” said Peeter Proos, a logistics worker from Tallinn who started the petition.

The currency’s popularity is sliding in other eastern states. In the Czech Republic, 55 percent of voters oppose euro adoption, the first time a majority has rejected the switch since the pollster started the surveys in 2001, according to an April 30 poll published by Prague newspaper Lidove Noviny.

“There are some massive advantages to these countries in joining the euro,” Haughton said. “But there are also some significant drawbacks. There’s been a little bit of a dose of realism to temper enthusiasm, but that is no bad thing.”

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