EU to lighten up on monetary policy requirements

By Timothy Sifert

The European Union's monetary affairs chief will soften his recently proposed stance on the Exchange Rate Mechanism 2 (ERM2) for Poland as the country begins to show signs that it will meet Maastrict criteria, Warsaw-based economists and market watchers say.

Adding confusion to the already scattered debate on the potential for the country to adopt the euro quickly, Pedro Solbes, the EU's monetary affairs commissioner, declared that accession countries would be forced to abide by a narrow exchange rate band of plus or minus 2.25% to the euro. This threatened, for Poland in particular, the more manageable plus or minus 15% that current euro-zone countries enjoyed after the European Union's first ERM fell apart in the early 1990s.

Critics of this "impossible" clause say Solbes' statement illustrates the EU's own fear of being able to swallow 10 new economies - of which Poland's is the largest - at the same time as some member states record ballooning budget deficits and rising unemployment. Those fears will calm, say economists.

"To me the speech wasn't that definite," said Sławomir Pawłowski, financial analyst at BRE Bank. "(Solbes) didn't say that it has already been decided. It would be difficult for all candidate countries to conduct (fiscal policy) under those conditions."

Should the "narrow band" of 2.25% go into effect after the country meets other convergence criteria (see chart), it would mean that any time the złoty would rise or fall more than 2.25% against the euro, the country's central bank would have to intervene. Such action is costly, economists say. Furthermore, in focusing very closely on keeping the exchange rate in line with the band, the government might not be able to rein in public debt or budget deficits - key elements of becoming a welcome contributor to the euro economy.

Poland also does not have the choice of opting out of adopting the euro, as do the U.K. and Sweden. In both of those countries debate over euro convergence is also heating up.

"The biggest problem is whether the euro-zone is ready to accept accession countries, in particular Poland," said Marcin Mróz, senior economist at SG Bank. "Poland has bigger problems. Mainly the problem the EU (has with Poland) is highlighted by the recent statement by monetary affairs commissioner Pedro Solbes, (which aims) to discourage new countries from joining the euro."

Mróz said it is logical to consider that the European Central Bank wants new, more wayward economies under tighter control, but he doubts whether the 2.25% band could ever see the light of day.

"The proposal is unacceptable from the point of view of FX market volatility," Mróz pointed out. "It's already been moving a couple of percentage points a day."

Should such a tight fluctuation gap be enforced, it would not be "mission impossible," Mróz added. But it would be eminently difficult to manage foreign exchange along with a sound fiscal policy.

Mróz said that this year he expects a conference between the finance ministry, the central bank and European Commission officials to discuss widening the band, though he declined to comment on what the outcome of the negotiations might be. "From the Polish point of view the wider, the better," he said.

Whatever the outcome, proponents of fast-track euro-zone entry say they don't want victory at any cost. Most analysts close to the debate and the country's economy place their bets on entry around 2010, which would give the government enough time to improve finances without having to take any politically disastrous measures.

"We are interested in joining the euro-zone as quickly as possible," said Janusz Krzyżewski, member of the Monetary Policy Council (RPP). "Are there ways of shortening the transition period? In my experience there is no way. (Nonetheless), entering the monetary union is an absolute necessity."

Still, some economists say it could make sense for Poland to enter the euro-zone from day one of EU membership.

Isaac Tabor, London-based director of fixed income research for emerging markets at Merrill Lynch, is an advocate of accession countries adopting the euro without any of the additional restrictions that have been proposed. He said that even if Poland joined the monetary union on the day of accession, the effects on the euro market would be "virtually nil."

But Tabor added that politically such a scenario is impossible.

"Most Polish problems are fiscal and structural," Tabor said. "The problems have nothing to do with currency. My view is that the European Council wants to use the euro to put pressure on (Poland), to improve the country's structural problems. Suppose (Poland) was welcomed into the euro on day one," he said. "What power will the council have to force (structural) change? Not much."

Echoing economists, Tabor said early entry would offer the country better access to capital markets, improve its attractiveness to foreign investors and its ability to trade with the entire euro-zone.

Nevertheless, the country and its governors still have work on the home front, especially controlling its budget deficit to get it into the range set by the Maastrict Treaty - no more than 3% of GDP. A recent report by BRE Bank states that the country's 2004 budget deficit would be €12.5-12.9 billion (zł. 55 billion-zł 57 billion), or more than 7% of GDP.