Estonia Wins Euro Backing; ECB Voices Inflation Doubt

European policymakers put Estonia on track to adopt the euro in 2011, even as the European Central Bank warned that the Baltic state may struggle to keep inflation under control.

The European Commission said Estonia, a one-time Soviet satellite that joined the European Union in 2004, passes the economic tests to become the euro’s 17th member. It called Estonia’s progress in reducing inflation “sustainable” in a report in Brussels today.

In a separate judgment released simultaneously in Frankfurt, the ECB said Estonia’s conquest of price pressures reflects “temporary factors” and “it may be difficult to prevent macroeconomic imbalances, including high rates of inflation, from building up again.”

The conflicting assessments set up a possible test of strength between European governments and the central bank over whether to let Estonia in, just as the ECB faces accusations that it buckled to political pressure to buy bonds in support of an almost $1 trillion aid package for debt-strapped euro countries.

The euro region’s 16 governments have the formal power over euro entry, and have never rejected a country backed by the commission, the EU’s executive body. EU treaties relegate the ECB to an advisory role. Government leaders will decide at their June 17-18 summit in Brussels.

Sovereign Debt Crisis

Estonia’s admission would probably mark the currency union’s last expansion for years as it copes with the swelling sovereign debt crisis. Lithuania and Latvia, the next in line, are aiming to join in 2014. Poland, the largest eastern European economy, and the Czech Republic haven’t set target dates.

“The euro area, like a house, needs repair and refurbishment,” Polish Finance Minister Jacek Rostowski said today, according to PAP newswire. “It’s better to stay out of the house while the builders are there. In a few years the euro area will be stronger and we can join without worry.”

With economic output of 14 billion euros ($18 billion), Estonia would rank as the euro’s second-smallest economy, ahead of Malta. Its central bank governor, Andres Lipstok, would take a seat on the ECB’s interest-rate setting council in January.

Estonia’s inflation rate jumped as high as 10.6 percent in 2008, the fourth-highest in the 27-nation EU that year. In the 12 months to March, the test period for euro entry, the rate was minus 0.7 percent, compared with a euro-admission target of 1 percent.

‘Remain Vigilant’

The commission forecast a full-year inflation rate of 0.2 percent, rising to 1.3 percent in 2010 and 2 percent in 2011. It called on the Estonian government to “remain vigilant to keep inflation at a low level.”

The central bank was more critical, saying the slowdown in inflation was mainly a byproduct of the Estonian economy’s 14.1 percent contraction last year. The cost-of-living rate is already set to increase “in coming months,” the ECB said.

Taking direct issue with the commission’s ruling, it voiced “concerns regarding the sustainability of inflation convergence in Estonia.” Prices in April, the month after the euro test, rose 2.9 percent from a year earlier, the fastest pace in 14 months.

Asked in a telephone interview how Estonia will counter the criticisms, Finance Minister Jurgen Ligi said he will work with European governments “to explain our case so that no doubts remain about our eligibility.” He said euro leaders don’t have a “political option” to say no to Estonia.

Estonia passes the other four economic tests for euro users covering budget deficits, debt, long-term interest rates and currency stability.

“It is exceptionally impressive that the government was able to meet all the Maastricht criteria under such difficult circumstances,” Kenneth Orchard, senior analyst at Moody’s Investors Service, said in an e-mailed response to questions. “Joining the eurozone will be positive for the government’s creditworthiness.”

The deficit fell to 1.7 percent of gross domestic product in 2009, below the euro’s 3 percent limit. While it is likely to rise to 2.4 percent in 2010, it will remain the lowest in the 27-nation EU, the commission forecasts.

Lowest Debt

Estonia also boasts Europe’s lowest debt, at 9.6 percent of GDP in 2010, compared with a euro target of 60 percent. It has kept its currency, the kroon, pegged at 15.6466 to the euro since the European monetary union’s debut in 1999.

Euro-region governments’ handling of Estonia’s bid will show whether the bloc is erecting new hurdles for the rest of eastern Europe, said Prime Minister Valdis Dombrovskis of Latvia, Estonia’s Baltic neighbor.

“If Estonia is accepted, it will show that euro-zone expansion is continuing,” Dombrovskis said on Latvian Television today. “Then, while overcoming this crisis, there will be no reason to say that other countries don’t need to be taken into the euro zone.”

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