Eastern Europe Uses Euro Crisis to Postpone Currency Switch

Eastern Europe Uses Debt Crisis to Delay Currency Adoption
Seven of the 10 former communist countries that have joined the EU since 2004 have yet to adopt the currency. Photographer: Chris Ratcliffe/Bloomberg

The euro-region debt crisis is giving Poland, the Czech Republic and Hungary an excuse to delay getting their economies in shape to join the single currency.

The European Union’s largest eastern members are slowing euro preparations as western governments struggle to end a debt crisis that nearly ripped the currency apart in May. Without a fixed timetable, buying the bonds of these countries is no longer a one-way bet on falling yields, said investors including Jean-Dominique Butikofer, who helps oversee about $1 billion of emerging-market debt at Union Bancaire Privee in Zurich.

Governments from Warsaw to Budapest are becoming more reluctant to adopt the tighter fiscal rules designed to prevent a new crisis that will be debated by euro-region leaders in Brussels today. Seven of the 10 former communist countries that have joined the EU since 2004 have yet to adopt the currency.

“It’s a convenient excuse and it may distract away from some of the measures they need to do at home to sort out budget deficits and structural changes,” Nigel Rendell, an economist at RBC Capital Markets in London, said in a phone interview. “It’s welcome news in some of the euro-skeptic countries.”

German Chancellor Angela Merkel is pushing EU leaders to commit to cutting debt and deficit levels and bolstering economic competitiveness in return for her pledge to back increasing efforts to fight the crisis. The plan includes targets in areas such as sustainability of public finances and the stability of financial systems. The discussion will also include proposals to beef up sanctions for offenders.

‘Just an Excuse’

That’s sparking concern among Polish, Czech and Hungarian officials because it may force them to cut spending and revamp social security and labor rules faster than they had planned.

Slower preparations weaken the “credibility regarding structural reforms, said Michael Ganske, head of emerging-markets research at Commerzbank AG in London. ‘‘It’s a good rationale for politicians and governments to say that the euro zone has this problem so let’s wait and see. But it’s really just an excuse because meeting the criteria is tough.”

Adopting the euro’s inflation and budget requirements may help reduce bond yields in east European countries. At the same time, the aftermath of the euro crisis means that some already enjoy yields lower than those of the bloc’s most-indebted countries.

Czech 10-year bonds yield 3.97 percent at 10:09 a.m. in Prague, compared with 3.21 percent for German bunds, Europe’s benchmark. Polish yields for the same maturity are at 6.3 percent and Hungarian yields at 7.46 percent. That’s still lower than Greek 10-year yield, at 12.5 percent. Spanish and Portuguese debt of similar maturity yields 5.47 percent and 7.34 percent, respectively.

‘Unimaginable Before 2020’

During the global credit crisis of 2008 and 2009, some eastern leaders lobbied western governments for faster euro admission as investors fled riskier markets. Now, politicians are rethinking euro timetables after flexible exchange rates helped them cope with the global recession and the euro’s own crisis. Poland was the only EU country to avoid an economic contraction in 2009.

Hungarian adoption is “unimaginable before 2020,” Prime Minister Viktor Orban said on Feb. 5. Czech Prime Minister Petr Necas said in December his country “de facto” has an “an opt-out” and can refuse to adopt the single currency as long it deems it beneficial to keep the koruna.

Poland’s switchover, slated for 2012 only two years ago, “isn’t on the agenda” because of Europe’s debt crisis, an adviser to Prime Minister Donald Tusk said on Dec. 8.

Risking Benefits

Some economists argue that they should keep their euro plans on track as it will help lure investment and eliminate currency risk for companies in the region.

While caution is “perhaps understandable” after the crisis, “the underlying justification for wanting to go into the euro project is still a very strong one,” said Peter Westaway, European chief economist at Nomura International Plc in London. “Every year that they are out, they are risking not being able to exploit the benefits that occur once you’re inside a strong monetary union and once you’re locked into that market.”

By postponing the changeover, some countries risk losing the determination to continue budget cuts after years of austerity, said Lars Christensen, chief emerging-markets analyst at Danske Bank A/S in Copenhagen.

“There is a risk that with the anchor disappearing, discipline is also going out the window,” Christensen said. “There are massive structural issues.”

Budget Deficits

The average euro-area budget deficit was 4.6 percent of gross domestic product last year, according to the European Commission’s November estimates, compared with 3.8 percent in Hungary, 7.9 percent in Poland and 5.2 percent in the Czech Republic. Debt in Hungary totaled 78.5 percent of GDP, compared with 55.5 percent in Poland and 40 percent for the Czechs. Euro-region debt averaged 84.1 percent, the commission said.

Investors who own bonds denominated in Polish zloty, Hungarian forint and Czech koruna and once put money on the so-called convergence play have to wait longer before seeing the benefits, said Ronald Schneider, who helps manage the equivalent of $1.1 billion in east European bonds at Raiffeisen Kapitalanlage in Vienna.

“This used to be one of the investment stories but at the moment it is not a near-term topic,” Schneider said.

With the absence of euro-adoption target dates, investors must weigh other factors, such as potential currency gains and the shape of public and external finances when buying euro candidates’ debt, said Butikofer at UBP. They also must assess countries on their individual merits.

‘Good and Bad’

“Investors will have to differentiate between the good and the bad” instead of “the blind convergence play,” Butikofer said.

Whether eastern EU members have a deadline for euro entry or not is less relevant as long as they don’t stray from meeting the conditions, said Michael Gomez, co-head of emerging markets at Pimco, manager of the world’s biggest bond fund.

“The important thing is to follow a set of policies that are consistent with the type of prudence that” euro entry would require, Munich-based Gomez said in an interview. “As long as countries are implementing proper and sound policy to put them back on a sustainable track, then that really is critical.”

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