Central Europe: What's Delaying The Euro

Momentum in Central Europe to adopt the euro as soon as possible has diminished. Low interest rates and upcoming elections are proving to be disincentives. As a result, it's unlikely that Hungary, Poland, and the Czech Republic will be switching to the euro by decade's end.

On Sept. 10, Hungary's central bank president, Zsigmond Jarai, said he was doubtful that the country would adopt the euro by 2010. And just days earlier, the Czech government pushed back its official currency adoption target from 2009 to 2010. The big obstacle is budget deficits. Currently, the three largest Central European economies, as well as Slovakia, are running shortfalls above the 3% of gross domestic product limit mandated by the European Union's Maastricht Treaty. Deficits in all four countries are also expected to top the 3% level in 2006.

Deficits Remain Too Large
Efforts by the region's central banks to align their respective short-term interest rates with the European Central Bank may be slowing down the process. All four countries have trimmed rates to approach the ECB's current 2% level. The moves reduce the cost of budget deficits. In addition, currency appreciation against the euro makes fiscal borrowing in euros even more attractive. That's especially true for Hungary, where the two-week deposit rate is 6.25%.

Elections will also hamper progress. Poland holds parliamentary elections on Sept. 25. The other three nations are scheduled to hold national elections in 2006. Economic reforms will be put aside for the time being and spending could actually loosen beforehand: Poland's government scrapped plans to end early retirement benefits for miners in August. Immediately following elections, the new governments are expected to rein in deficits, but there are also hopes that taxes will be trimmed.

A delayed euro adoption means continued currency volatility. Big fluctuations, especially on the upside, can hurt economic performance by making exports less attractive and imports cheaper. Nonetheless, analysts believe only Slovakia has a shot at adopting the euro by 2010. For the rest of the pack, 2012 looks more probable.

By James Mehring in New York

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