Online Extra: A Painful Initiation to the Euro Club

East European candidates are eager for monetary union, but meeting its requirements could exact a high economic price

Poland has yet to formally join the European Union, but its central bank governor, Leszek Balcerowicz, is itching to ditch the national currency -- the zloty -- for new euro notes and coins. Balcerowicz is no wide-eyed Euro-idealist. The former Finance Minister was the tough-minded architect of the shock therapy that transformed the Polish economy in the early 1990s. But he reasons that adopting the single currency as soon as possible will give Poland much-needed monetary credibility, drive down interest rates (on Nov. 5, Poland's discount rate was 9% compared vs. 3.25% in the West), and help bolster the flaggingeconomy.

Adopting the euro would also weld Poland to the European Union's prosperous single market and remove the exchange rate that makes some foreign investors nervous about investing. As a bonus, it would also impose fiscal discipline on Polish politicians, who would be forced to keep deficit spending below 3% of gross domestic product -- in line with the EU's Growth & StabilityPact.

TOO KEEN?

  Balcerowicz isn't alone in his fervor to join the euro zone. Central bankers and government officials from most other EU candidate countries are just as eager to sign on. "You won't find much British-style skepticism about the single currency around here," says Slovenian Finance Minister Anton Rop, "Most new members see it as a driverof growth."

But for many in Central and Eastern Europe, qualifying for the new money club will demand some financial fortitude. New members must first join the EU's Exchange Rate Mechanism and hold their currencies stable against the euro for at least two years. They must then meet the "convergence criteria" set out in the Maastricht Treaty by keeping their budget deficits below 3% of GDP, taking steps to push the ratio of national debt to GDP below 60%,and bringing inflation down to near euro-zone levels.

Only Latvia, with inflation of 2.4%, a budget deficit of 1.8%, and national debt of just 13.9% of GDP, already meets those criteria. A number of other candidate countries, among them Slovenia and the Czech Republic, should beable meet them by 2006. The rest won't be ready until decade's end.

LESS WIGGLE ROOM.

  Despite the single currency's advantages, officials at the European Commission and European Central Bank are cautioning their Eastern neighbors against any hasty moves. Pedro Solbes, the EU's monetary affairs commissioner, says the candidate countries should first concentrate on achieving the kinds of basic reforms that will make them well-functioning market economies. "The ultimate objective is full and successful economic integration [with the existing EU]," he says. "It's essential that joining the euro is not seen as an end in itself."

Locking into monetary union prematurely could also leave these developing economies short on policy levers. Christian Noyer, former ECB vice-president, warns that rushing into the single currency would deprive the new entrants of the freedom to adjust their exchange rates -- a potentially useful tool for stimulating exports and boosting economic growth. And sticking with Stability Pact budget rules could mean that governments won't be able to pump moremoney into their economies to ease recessions.

"The economic gulf between most of these countries and the euro zone is huge," says one German central banker. "They should think long and hard about using the euro before they have narrowed the gap. France and Germany find it tough enough to abide by the single currency's rules. Just think how much harder it will be for Poland or Latvia."

COUNTERPRODUCTIVE?

  Michael Klawitter, an economist at WestLB Research in Dusseldorf, Germany, thinks the euro itself could be damaged if the new members adopt it too soon. Putting nations with such widely different economies into the same currency system runs counter to the core reasons for monetary union, he says, and it could erode the effectiveness of the institutions setting monetary policy.

He also cautions that taking the euro East will require big changes in the way the ECB works, a risky proposition as the institution has only just managed to establish its credibility in the financial markets. Bringing new nations into the bank's governing council will require new rule-making, which could mean lengthy negotiations and even some compromises that could affect monetarydiscipline.

All that, he says, makes a bigger monetary zone, "a burden for the euro. Investors are unlikely to give the EU enlargement process the benefit of the doubt." Is anyone in the East listening?

By David Fairlamb Frankfurt

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